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Chapter 10

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. Learning Objectives.

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Chapter 10

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  1. 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

  2. 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.

  3. Inherent Risks • Loan covenants • Related party transactions • Complex transactions • Impairments

  4. 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.

  5. Finance and Investment Cycle:Control 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

  6. Interest-bearingLiabilities • 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

  7. 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.

  8. 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

  9. 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.

  10. 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.

  11. Auditing Investments:Substantive 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

  12. Auditing Investments:Substantive 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)

  13. Auditing Fair Value Measurements (SAS 101) • Management’s responsibility • Market-based values preferred • If not available—use assumptions market would have used • If not known—management would use their own assumptions

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