D. Marketable Securities PSP
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E&Y Global Audit Methodology and Supplemental Audit Guidance Global Supplemental Audit Manual Chapter 5 – Illustrative Substantive Procedures for Specific Account Balances 5.3 (D) Marketable Securities
5.3 (D) Marketable Securities Securities 1 Introduction This section deals with the audit of marketable securities. Guidance on the audit of investments and on derivatives and hedging transactions are set out in sections 5.7 (H) Investments, including Investments in Affiliates and 5.18 (S) Derivatives and Hedging Transactions in Transactions in this manual. manual . The measurement, recognition and disclosure of marketable securities are driven by the requirements of the financial reporting framework under which the financial statements are prepared. As a result, we refer to the applicable financial reporting framework when designing appropriate audit procedures to determine whether the measurement, recognition and disclosures comply with the financial reporting framework. When auditing marketable securities and the related investment income, we determine whether: l
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All marketable securities on the balance sheet are held by the entity or by custodians for the entity. All recorded income from marketable securities has accrued to the entity at the balance sheet date (Existence assertion); All marketable securities owned by the entity at the balance sheet date are included on the balance sheet. All income accruing from marketable securities at the balance sheet date has been recorded (Completeness assertion); Marketable securities are included on the balance sheet at the appropriate amount, in accordance with the financial reporting framework under which the financial statements are being prepared. (Some financial reporting frameworks require that such securities be accounted for at their market value and other financial reporting frameworks require that such securities be accounted for at the lower of cost and market value.) Investment income is stated on the income statement at the appropriate amount (Valuation assertion); The entity owns, or has a legal right to, the marketable securities included on the balance sheet. All marketable securities are free of liens, pledges, or other security interests or, if not, such liens, pledges, or other security interests are identified (Rights and Obligations assertion); Marketable securities and the related investment income accounts are properly classified, described, and disclosed in the financial statements, including notes, in accordance with the applicable financial reporting framework (Presentation and Disclosure assertion).
2 Inherent Risk Factors S08 Make Combined Risk Assessments of Assessments of the EY Global Audit Methodology (“EY
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GAM”) provides information on our inherent risk assessments. The following items are examples of inherent risk factors that may increase the inherent risk for this account or disclosure. When the opposite situations exist, that would decrease inherent risk for the account or disclosure. Nature of the item l
The size of the account or disclosure is significant;
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Our prior audit experience indicates that there have been frequent errors in the account balance;
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The results of our planning analytics do not coincide with our expectations; Complex or unusual transactions occurred at or near the end of the period; There are debt covenant or regulatory restrictions on the types and/or amounts of marketable securities; Marketable securities are susceptible to misappropriation by the entity staff; Documentation is susceptible to manipulation by the entity staff.
Nature of the business/industry l
The economy has weakened during the year;
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The volume of transactions is high;
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Disbursements are made on an irregular basis;
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There is little consistency in the volume of purchase and sale activity;
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There are unusual or non-standard transactions (e.g., manual disbursements made in a computerized system);
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There are a significant number of derivative arrangements in place;
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Derivatives are complex;
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The occurrence of transactions evidencing disbursements does not coincide with the recording of the disbursement (e.g., checks prepared and recorded but not mailed); The exchange rates of foreign currencies are volatile.
Organization of the Entity l
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The investment functions, including cash receipts and disbursements functions, are decentralized; The marketable securities, cash receipts, and/or cash disbursements functions involve a third party (e.g., a discretionary trust arrangement exists with a bank); Personnel responsible for this account have a lower level of competence or experience; The entity has inadequate IT systems for the volume of activity, size, and/or complexity of the account.
3 Primary Substantive Procedures applicable to Auditing Marketable Securities EY GAM S11 Design Substantive Audit Procedures requires that we perform Primary Substantive Procedures (“PSPs”) on all audit engagements for all significant accounts, regardless of the combined risk assessments. The PSPs
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for Marketable Securities are set out in EY GAM S11_Exhibit 1 Appendix A : Primary Substantive Procedures (PSP) by Account . Each of the PSPs is discussed further below. PSPs describe the nature of the procedures to be performed. As part of the development of our audit plan, we also include the timing and extent of the PSPs. PSPs on their own will not necessarily provide all of the audit evidence we need on a particular assertion for a significant account. Therefore, our audit plan also includes analytical procedures, general procedures and other procedures to respond to our combined risk assessment. Refer to Appendix 1 Illustrative Procedures for Marketable Securities Regardless of Risk Assessment and Appendix 2 Illustrative Procedures for Marketable Securities Responsive to Risk Assessment . An important consideration in auditing marketable securities is understanding the nature of the securities or financial instruments that the entity holds or trades. In periods of high or volatile interest rates, entities that attempt to maximize their returns on their use of cash may enter into agreements for overnight or short-term investments of funds (repurchase agreements). Other entities may enter into agreements to buy or sell financial instruments at a future date (such as interest rate futures contracts, forward placement commitments, or standby commitments). Entities may enter into these types of agreements for speculation or as hedges – refer to section 5.18 (S) Derivatives and Hedging Transactions in this manual. We consider the possibility that an entity may have entered into such agreements and recognize that their potential effects on the financial statements can be significantly greater than might be expected from the amounts (such as the size of margin deposits) that appear in the accounting records. In planning the audit of marketable securities, we also consider that certain industries have accounting and auditing practices for securities (e.g., brokerdealers, investment companies, and insurance companies). This section does not provide guidance with respect to specialized industry practices. Therefore, we refer to authoritative pronouncements and any firm-developed guidance materials that may apply to the entity’s industry. Generally, the classification and valuation of marketable securities is driven by the requirements of the applicable financial reporting framework. For example, in some financial reporting frameworks, the appropriate classification depends on management’s intent in purchasing and holding the financial instruments, on the entity’s investment activities, and on its ability to hold the instruments to maturity. The guidance which is set out in this section does not follow the requirements of any particular financial reporting framework. Additional audit procedures may have to be performed to audit the measurement, recognition and disclosures of marketable securities in the financial statements to determine that these comply with the applicable financial reporting framework.
3.1 PSP D1: Verification of Existence and Ownership PSP D1: Verify the existence and ownership of recorded securities through confirmation or examination of evidence of ownership (e.g., stock certificates, bank statements, broker statements).
We may verify the existence of marketable securities by inspecting them. When
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we inspect securities, the inspection is usually conducted simultaneously with counts of cash and other negotiable assets. If those assets cannot be inspected at the same time, we apply other control procedures that will prevent the substitution of one type of negotiable asset for another. When inspecting securities, we observe: l
The exact names of the issuers;
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The descriptions of the securities;
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The name(s) of the indicated owner(s) of the securities;
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Any evidence of pledging or restrictions on disposal shown on the securities;
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The certificate numbers on the documents; and
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The number of shares of stock or face value of debt securities.
In addition to inspecting securities as above, we: l l
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Obtain a list of all securities counted by the entity; Note details of other documents encountered during the count which we believe may have a bearing on the audit; and At completion of the count, obtain a written declaration from the custodian confirming that the securities were examined in their presence.
After the count, we perform appropriate follow up procedures, including: l
Tracing information obtained during the security count to the final listing of marketable securities and investigating any significant differences;
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Verifying the arithmetical accuracy of the listing;
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Following up any other matters noted during the count.
When confirming securities held by custodians or depositories, we request the same information as that obtained when inspecting securities. We follow up and resolve any differences noted on the returned confirmations. For all non-replies, we perform alternative procedures, which include checking confirmation details to supporting documents and disbursement records. The physical count or confirmation of securities may be performed at an interim date if controls are evaluated as effective. Among the indications of effective controls are: l
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Maintenance of detailed security records, including certificate numbers, by personnel not having access to, or control over, the securities themselves; Issuance of securities in the entity’s name; and Use of an independent custodian or depository to safeguard the securities.
If the physical count or confirmation work is performed at an interim date, we review the rollforward of movements between the interim and balance sheet dates, such as: l
Significant new securities;
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Disposed of securities;
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Volume of activity (compared to prior periods and expectations); and
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Investigate significant changes, agreeing to supporting documentation or reconfirming with the third party if considered necessary.
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3.2 PSP D2: Detailed Confirmation Review PSP D2: Review confirmation replies for evidence of the existence of marketable securities, and of liens, pledges or other security interests in marketable securities.
We review bank confirmations and direct confirmations of marketable securities for evidence of liens, pledges and other security arrangements over these assets. If necessary, we determine whether adequate disclosure of such arrangements is made in the financial statements.
3.3 PSP D3: Market Valuation PSP D3: Inspect market quotations or other evidence of current value of marketable securities, including those in foreign currencies.
For publicly traded marketable securities held by the entity at year end, we: l l
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Obtain market prices from published quotations at year end; Calculate the market value by multiplying the market price by the number of shares held (or par value in the case of quoted bonds and debentures); Discuss any differences with management, as necessary; and Depending on the extent of new securities, consider the need to test a sample of new items to supporting documentation.
If non-publicly traded securities are appropriately classified as marketable securities, we determine the market value by reference to the investee’s financial statements, with, if necessary, assistance from an EY valuations professional. If a marketable security is denominated in a foreign currency, we agree the exchange rate used to the relevant published exchange rate. If our work is performed at an interim date, we: l
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Review the movements in valuation between the interim and balance sheet dates; Investigate significant changes, vouching to source documentation or reconfirming with the third party if considered necessary.
3.4 PSP D4: Valuation in Accordance with Accounting Policies PSP D4: Test that marketable securities are carried in accordance with the client's accounting policies or applicable financial reporting framework. PSP D5: Inspect documentation and make inquiries to determine the validity and extent of reclassification between categories of investments. By reference to the client's accounting policies or applicable financial reporting framework, evaluate the reclassification to determine its effect of the transfer on: 1) recognition of profit or loss, 2) effect on the stated intent and ability, and 3) effect on the classification of other investments.
To test that marketable securities are carried in accordance with the entity’s accounting policies or the applicable financial reporting framework, we: l
Inquire as to whether there has been any change in accounting policy compared to the prior year. We consider whether the accounting policies
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are reasonable and consistent with the prior year and applicable financial reporting framework, and the impact of any new accounting standards on the entity's accounting policy; l
Establish that marketable securities have been accounted for in accordance with the stated policy and for any changes in policy, ensure that adequate disclosure has been made. For example, using the same sample as for existence and ownership testing, we obtain details of the accounting treatment of each marketable security and check that this treatment is in line with the stated accounting policy.
4 Procedures Responsive to Risk Assessment Appendix 2 Illustrative Procedures for Marketable Securities Responsive to Risk Assessment contains examples of procedures that may, together with the procedures previously discussed, be useful in achieving the primary account balance audit objectives when our evaluation of classes of routine transactions indicates possible errors. We need not perform these application-related procedures when we have evaluated the controls as “effective” and tested them (using full tests of controls) and found that we can place reliance on them, or when the PSPs can provide sufficient assurance that the potential errors in question have not occurred. We consider performing these procedures when we have evaluated the controls as effective, but have only performed limited tests of controls (especially when our combined risk assessment for the account is “moderate,” since in such circumstances we would have assessed inherent risk as higher), and we are more likely to perform them when we have evaluated the controls as ineffective. The timing and extent of the procedures performed are responsive to our combined risk assessments.
5 Documentation Documentation includes, but is not limited to, identification of the following: l
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The nature, timing and extent of procedures performed (generally the audit plan or reference to it) and conclusions reached with respect to the procedures performed, together with a conclusion statement with respect to marketable securities; The evaluation of the flow of significant estimation, routine and nonroutine transactions and related controls within significant processes, as well as the sources and preparation of information resulting in significant disclosures; The problems encountered and bases of resolution; and To the extent appropriate, the following: ¡ Summary of marketable securities and related accounts, and the activity in those accounts during the period; ¡
List of securities examined or confirmed;
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Confirmation replies;
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Documentation of tests of purchases and disposals of marketable securities, if applicable; Details of cost and market values or other appropriate carrying amounts, and evidence supporting the carrying amounts; Results of analytical review procedures performed; and
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Details of liens, pledges, security interests, or other restrictions on the use or disposal of marketable securities.
Appendix 1 – Illustrative Procedures for Marketable Securities Regardless of Risk Assessment This Appendix sets out examples of general and analytical procedures that may be appropriate when auditing Marketable Securities. General Procedures Obtain or prepare a lead schedule of sufficient detail to enable us to verify the correct classification, presentation and disclosure of items in the financial statements and corresponding notes. Build an expectation of the level of marketable securities per lead schedule by comparison with prior year, interim and knowledge of changes in the business. Note evidence of unusual investment transactions (e.g., churning or high risk securities). Consider specialized industry practices. Review any entity reconciliations of statements (e.g., from banks and brokers) with the entity’s records. Verify interest and dividend income by calculating interest earned and referring to published records of dividends paid. Review the marketable securities and related accounts (e.g., interest and dividend income) in the general ledger for unusual items. Analytical Procedures Compare the account balances with those of prior periods and investigate any unexpected changes (or the absence of expected changes). Compare current year’s to prior year’s market value of the security. Perform an overall test of the reasonableness of interest income by multiplying the average interest rates by the average amounts invested.
Appendix 2 – Illustrative Procedures for Marketable Securities Responsive to Risk Assessment The following are examples of procedures that may, together with procedures previously discussed, be useful in achieving the primary account balance audit objectives when our evaluation of classes of transactions indicates possible errors. Cash receipts and cash disbursements applications l
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Inspect brokers’ advices and other support to verify that additions and disposals have been recorded properly. Verify interest and dividend income by calculating interest earned and referring to published records of dividends paid. Review the marketable securities and related accounts (e.g., interest and dividend income) in the general ledger for unusual items. Determine if marketable securities are properly classified in the balance sheet.
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Procedures responsive to possible errors – cash receipts application Primary Substantive Assertion
1
Possible Error
Procedure
Other Substantive
2
Procedure
E
Marketable securities disposals are not recorded.
D1
1,2
E
All disposals of marketable securities are not classified as a reduction of marketable securities accounts.
D1
1,2,3,4
V
Marketable securities disposals are not recorded at correct amounts.
D1, D3, D4
1,2
C
Credits to marketable securities accounts are not for disposals of marketable securities.
D1
1,2
C
Marketable securities disposals are recorded in the wrong period.
D1
1
C
Credits to marketable securities accounts are not for marketable securities disposals.
D1
1,2,3,4
C
Cash receipts register is not correctly totaled.
D1
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C
Cash receipts and cash receipts register totals are not correctly posted to cash receipts register and general ledger, respectively.
D1
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3
Procedures responsive to possible errors — cash disbursements application Primary Other Substantive Substantive Assertion
1
Possible Error
Procedure
2
Procedure
E
Debits to marketable securities accounts are not for marketable securities additions.
D1
1
E
Debits classified as marketable securities are not for marketable securities.
D1
1,3,4
V
Marketable securities additions are not recorded at correct amounts.
D1, D3, D4 1
C
Marketable securities additions are not recorded.
D1
1
C
Marketable securities additions are recorded in the wrong period.
D1
1
3
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C
All marketable securities additions are not D1 classified as marketable securities.
1,3,4
C
Cash disbursements register and marketable securities records are not correctly totaled.
D1
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C
Totals in cash disbursements register not correctly posted to general ledger.
D1
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1 The Assertion column refers to the relevant financial statement assertion – E=Existence; C=Completeness; and V=Valuation. 2 The Primary Substantive Procedure column refers to the PSPs listed in EY GAM S11_Exhibit 1 Appendix A: Primary Substantive Procedures (PSP) by Account , which are also discussed in subsection 3 Primary Substantive Procedures Applicable to Marketable Securities above. 3 The Other Substantive Procedure column refers to the numbered procedures set out in this appendix. Go To Document ID: GSAM 5.3 Last Modified Date:14 Dec 2009
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