Finance and Investment Cycle

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Chapter 10

• Finance and Investment Cycle

Credit has done a thousand times more to enrich
mankind than all the goldmines in the world. It
has exalted labor, stimulated manufacture and
pushed commerce over every sea. --Daniel Webster
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Learning Objectives

• 1. Describe the finance and investment cycle,
  including typical source documents and controls.
• Give examples of tests of controls over debt,
  owner equity transactions, and investment
  transactions.
• Describe substantive procedures for finance and
  investment accounts.
• 4. Consider common errors and frauds in the
  accounting for capital transactions and
  investments.

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Inherent Risks

• Loan covenants
• Related party transactions
• Complex transactions
• Impairments

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Investing and Financing Cycle

• Concerned with transactions related to the use of
  the organization's funds (investing) and sources
  of those funds (financing) other than operations.
  
• Accounts affected by investing and financial
  cycle transactions include investments in
  securities property, plant and equipment notes
  and bonds payable and, stockholders' equity
  accounts.

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Finance and Investment CycleControl Procedures

• Physical Controls
• Securities numbered and in the client's name
• Securities held by an independent custodian or in
  a secure location
• Access to safe-deposit box requires the presence
  of more than one employee
• Physical items periodically compared to detail
  records
• Cash receipts from Investing and Financing cycle
  transactions deposited intact and daily
• Segregation of Duties
• Transactions AUTHORIZED by the Board of Directors
• General Accounting RECORDS transactions
• A separate function or external custodian has
  CUSTODY
• Performance Reviews
• Compare current investing and cycle transaction
  data against prior-year data or expected data
• Compare revenue and expenses against expectations

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Interest-bearing Liabilities

• Agree to BEGINNING BALANCE and CONFIRM with
  holders or makers.
• LOAN PROCEEDS
• VOUCH to cash receipts
• Recalculate Discount/Premium
• Confirm IBL, examine note
• LOAN PAYOFF
• Recalculate Interest Expense
• Recalculate Gain/Loss on Retirement
• Verify cash disbursements

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Interest-bearing Liabilities

• INTEREST PAYMENTS
• Recalculate Interest Expense
• Search for UNRECORDED liabilities
• Inquiry of management
• Bank confirmations
• Unusual amounts of interest expense
• Large receipts of cash during the year
• Ensure DEBT COVENANTS are met.
• Inspect loan agreements.
• Consider GOING CONCERN implications if not met.
• Ensure proper presentation and disclosure.

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Auditing Stockholder's Equity

• Overview of audit approach
• EXTERNAL PARTIES involved in record keeping
• Transactions must be authorized by the BOARD OF
  DIRECTORS
• Transactions must be consistent with the client's
  ARTICLES OF INCORPORATION

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Issues in Audits of Investments

• Valuation of investments at cost, market, or
  value impairment that is other than temporary.
• Propriety, effectiveness, and risk disclosure of
  derivative securities used as a hedges
• Determination of the fair value of derivatives
  and securities, including valuation models and
  the reasonableness of key assumptions.
• Determination of significant influence
  relationship for equity method investments.

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Derivative Investments, Hedging Activities, and
Investments in Securities (SAS 92)

• Inquiries about the nature of investments and the
  reasons for holding them, especially hedging
  activities.
• The classification affects the accounting
  treatment of market values and the unrealized
  gains and losses on investments.
• Due to the complexity of SFAS 133 (Accounting for
  Derivative Securities and Hedging Activities),
  auditors may need special skills or knowledge to
  understand client hedging transactions, to ensure
  that effective controls are in place to monitor
  them, and to audit the transactions.

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Auditing InvestmentsSubstantive Procedures

• Agree balances to Prior Year Documentation
• Purchases of investments
• VOUCH to BROKER'S ADVICE (Statement)
• Examine BOARD MINUTES for authorization
• Sales of investments
• VOUCH to BROKER'S ADVICE, CASH RECEIPTS RECORDS,
  and BOARD MINUTES
• Recalculate gain or loss on sale
• Read minutes for sales of Investments and trace
  to recording

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Auditing InvestmentsSubstantive Procedures
(cont.)

• Determine MARKET VALUE (SFAS 115)
• Obtain 12/31 market price - Wall Street Journal
  or other sources
• Evaluate for possible PERMANENT DECLINES
• PHYSICALLY INSPECT or CONFIRM securities Verify
  Certificate Numbers to ensure that there were no
  unrecorded sales and subsequent repurchases
• Made in company name
• Can inspect at interim, if safe-deposit box
• Verify DIVIDEND REVENUE
• Examine CASH RECEIPTS records
• Compare to external sources (Moody's, Standard
  Poor's)
• Evaluate presentation in BALANCE SHEET
  (short-term vs. long-term asset)

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Auditing Fair Value Measurements (SAS 101)

• Managements responsibility
• Market-based values preferred
• If not availableuse assumptions market would
  have used
• If not knownmanagement would use their own
  assumptions