Learning Objectives LO1 Describe the finance and investment process: risk assessment, typical transactions, source documents, controls, and account balances. LO2 Outline control tests for auditing control over debt, owner’s equity, and investment transactions. LO3 Describe the typical substantive procedures used to respond to the assessed risk of material misstatement in the main account balance, and in transactions in the finance and investment process. LO4 Describe the risks associated with derivative financial instruments. LO5 Describe differential reporting requirements for qualifying enterprises. 1

Control Risk Assessment Finance and investment transactions are usually individually material, each transaction usually is audited in detail.  Reliance on control does not normally reduce the extent of substantive audit work on finance and investment cycle accounts. However, lack of control can lead to significant extended procedures. LO2 2

General Control Considerations Responsibilities lay in the hands of senior management officials.  Difficult to have strict segregation of functional responsibilities when senior management officials are involved.  A compensating control feature involving two or more persons in each kind of important functional responsibility. LO2 3

Control over Accounting Estimates Management is responsible for making estimates, and should have a control structure in place.  Use of estimates in accounting is common.  Test of controls amounts to enquiry as to controls in place for estimation.  Substantive procedures will include recalculation, and comparison of auditor’s estimate to management’s estimate. LO2 4

Control over Accounting Estimates Control structure for estimates should include:  management communication of need for proper estimates,  accumulation of relevant, sufficient, and reliable data,  preparation of estimates by qualified personnel,  adequate review and approval by appropriate authority,  comparison with prior estimates to assess reliability, and  consideration by management of whether estimates are consistent with operational plans. LO2 5

Control Risk Assessment for Notes and Loans Payable Some companies may have numerous debt financing transactions, warranting a more detailed approach to testing of controls. An internal control questionnaire is presented in exhibit 14-2 to illustrate typical questions for the control objectives. LO2 6

Control Risk Assessment for Derivatives Key controls for derivatives:  monitoring by independent control staff,  derivatives personnel to obtain senior, management approval prior to exceeding limits,  senior management to address limit excesses,  accurate transmittal of derivatives positions,  performance of appropriate reconciliations,  traders and management to define constraints, monitor activities, and justify excesses,  regular review of controls and results, and  review of limits and risk tolerance. LO2 7

Control Objectives for Derivative Financial Instruments Control objectives for derivatives:  Transactions are executed in accordance with policies.  Information is complete and accurate.  Misstatements in processing information are prevented or detected in a timely manner.  Activities are monitored.  Changes in fair value are accounted for.  Control systems for hedges should assure that criteria are met. LO2 8

Control Risk Assessment Auditors will often audit 100% of investment and finance cycle transactions.  Few transactions make it efficient to give complete coverage.  Control deficiencies are still important to the audit.  Complicated financial instruments call for procedures to detect errors, irregularities, and frauds. LO2 9