Investment Securities

Substantive procedures for investments are extensive due to the cycle’s complexity, focusing on verifying existence and valuation, with adjustments based on control deficiencies or unusual transactions (e.g., moving tests to year-end if segregation of duties is weak).

Examples of Substantive Procedures and Assertions

Procedure: Positive external confirmation with a broker or direct physical examination of security certificates.  

• Assertion: Existence/Occurrence  

• Relation: Confirms investments recorded at period-end exist and are owned by the entity, addressing risks like fictitious securities.  

• Procedure Detail: Verifies client is listed as the owner, ensuring no theft or misrepresentation.

Procedure: Vouch reported market value to public sources (e.g., The Wall Street Journal).  

• Assertion: Valuation  

• Relation: Ensures investments (e.g., trading or available-for-sale securities) are recorded at fair market value, addressing risks of overstatement or impairment neglect.

Procedure: Recalculate realized and unrealized gains/losses on marketable securities.  

• Assertion: Valuation  

• Relation: Validates the accuracy of investment balances by confirming correct gain/loss recognition, critical for financial statement accuracy.

Procedure: Evaluate disclosures and assess reasonableness of management’s classification (e.g., trading vs. available-for-sale).  

• Assertion: Presentation/Disclosure  

• Relation: Ensures proper classification and disclosure per GAAP (e.g., ASC 815 for derivatives), addressing risks of misclassification impacting net income.

Procedure: Review subsequent transactions post-balance-sheet date for evidence of value impairment.  

• Assertion: Valuation  

• Relation: Identifies losses (e.g., sales below recorded value) indicating impairments, ensuring investments are not overstated.

Procedure: Vouch investment costs to brokers’ confirmations/statements and trace sales proceeds to cash receipts journal.  

• Assertion: Completeness, Valuation  

• Relation: Verifies all transactions are recorded and valued correctly, checking cost-out methods (e.g., FIFO) for consistency.

Procedure: Obtain audited financial statements of investee companies for equity method investments and recalculate client’s share of income.  

• Assertion: Valuation, Presentation/Disclosure  

• Relation: Ensures accurate carrying value and footnote disclosures, addressing risks of misstatement in complex investments.

Long-Term Liabilities and Related Accounts

Substantive procedures for long-term debt focus on ensuring all liabilities are recorded, interest is properly accrued, and disclosures are accurate, emphasizing completeness and presentation/disclosure.

Examples of Substantive Procedures and Assertions

Procedure: Obtain independent written confirmations for notes and bonds payable (e.g., standard bank confirmations).  

• Assertion: Existence/Occurrence, Completeness  

• Relation: Verifies recorded debt exists and captures all obligations, including unlisted banking relationships, reducing omission risks.

Procedure: Read bond indentures and confirm terms with bondholders/trustees (amount, interest rate, due date, covenants).  

• Assertion: Valuation, Presentation/Disclosure  

• Relation: Ensures debt is accurately valued and disclosed with all relevant terms, addressing misclassification or covenant violation risks.

Procedure: Inquire about financing sources for new PP&E acquisitions and examine large cash disbursements.  

• Assertion: Completeness  

• Relation: Identifies unrecorded liabilities (e.g., loans for equipment), ensuring all debt is included in period-end balances.

Procedure: Recalculate interest expense and verify accruals for unpaid interest, including premium/discount amortization.  

• Assertion: Valuation  

• Relation: Confirms interest and debt balances are accurately stated, addressing calculation errors.

Procedure: Review loan agreements for off-balance-sheet items (e.g., leases, guarantees) and assess disclosure adequacy.  

• Assertion: Presentation/Disclosure  

• Relation: Ensures commitments/contingencies are disclosed, addressing risks of hidden obligations.

Stockholders’ Equity

Audits of stockholders’ equity (except stock-based compensation) are low-risk, focusing on completeness and disclosure, with procedures leveraging external confirmations and internal records.

Examples of Substantive Procedures and Assertions

Procedure: Confirm capital stock details with third-party registrars (e.g., shares issued, terms, dividends).  

• Assertion: Completeness  

• Relation: Verifies all issued stock is recorded at period-end, addressing omission risks.

Procedure: Inspect stock certificates, charter authorizations, and directors’ minutes to corroborate issuances and terms.  

• Assertion: Completeness, Presentation/Disclosure  

• Relation: Ensures accurate recording and disclosure of equity transactions, confirming proper authorization.

Procedure: Obtain employee stock-based compensation plans and vouch to board approvals.  

• Assertion: Presentation/Disclosure  

• Relation: Verifies proper plan documentation and disclosure, addressing risks of misstatement in complex valuations.

Procedure: Recalculate compensation expense for stock options using option-pricing models.  

• Assertion: Valuation  

• Relation: Ensures accurate expense recognition, addressing risks from assumption-based valuations (e.g., volatility rates).

Procedure: Test allocation of stock option exercises between common stock and paid-in-capital accounts.  

• Assertion: Presentation/Disclosure  

• Relation: Confirms correct equity account presentation, addressing misallocation risks.

Key Takeaways

Substantive procedures in the finance and investment cycle verify significant account balances (Investments, Long-Term Debt, Capital Stock) at period-end, addressing assertions:  

Investments:  

• Existence/Occurrence: Confirmations/physical exams ensure assets exist.  

• Valuation: Vouching market values and recalculating gains/losses confirm accuracy.  

• Completeness: Vouching costs/sales ensures all transactions are recorded.  

• Presentation/Disclosure: Evaluating classifications ensures GAAP compliance.

Long-Term Debt:  

• Existence/Occurrence, Completeness: Confirmations and inquiries verify all debt.  

• Valuation: Recalculating interest ensures accurate balances.  

• Presentation/Disclosure: Reviewing terms ensures proper disclosure.

Capital Stock:  

• Completeness: Confirmations and inspections verify issuances.  

• Valuation, Presentation/Disclosure: Testing compensation and allocations ensures accuracy.

These procedures address risks like fictitious assets, valuation errors, and inadequate disclosures, critical due to the cycle’s complexity and high materiality.