Want to know how to audit investments? You're in the right place.
Below I provide a comprehensive look at how you can audit investments effectively and efficiently.
The complexity of auditing investments varies. For entities with simple investment instruments, auditing is easy. Your main audit procedure might be to confirm balances. Complex investments, however, require additional work such as auditing values. As investment complexity increases, so will your need for stronger audit team members (those that understand unusual investments). Regardless, you need an audit methodology.
So, here we go.
In this post, we will take a look at:
First, let’s look at assertions.
Primary relevant investment assertions include:
The audit client is asserting that the investment balances exist, that they are accurate and properly valued, and that only investment activity within the period is recorded.
While investment balances in the financial statements are important, disclosures are also vital, especially when the entity owns complex instruments.
Second, perform your risk assessment work in light of the relevant assertions.
As you perform walkthroughs of investments, you normally look for ways that investments might be overstated (though investments can be understated as well). You are asking, “What can go wrong?” whether intentionally or by mistake. You want to know if:
In performing investment walkthroughs, ask questions such as:
As we ask questions, we also inspect documents (e.g., investment statements) and make observations (e.g., who reconciles the investment statements to the general ledger?).
If control weaknesses exist, we create audit procedures to address them. For example, if during the walkthrough we note that there are improperly classified investments, then will plan audit procedures to address that risk.
Third, consider the directional risk of investments.
The directional risk for investments is that they are overstated. So, in performing your audit procedures, perform procedures to ensure that balances are properly stated.
Fourth, think about the risks related to investments.
Primary risks include:
Fifth, think about control deficiencies noted during your walkthroughs and other risk assessment work.
It is common to have the following investment control deficiencies:
Sixth, now its time to assess your risks.
In my smaller audit engagements, I usually assess control risk at high for each assertion. (You may, however, assess control risk at less than high, provided your walkthrough reveals that controls are appropriately designed and that they were implemented. If control risk is assessed at below high, you must test controls for effectiveness to support the lower risk assessment.)
When control risk is assessed at high, inherent risk becomes the driver of the risk of material misstatement (control risk X inherent risk = risk of material misstatement). For example, if control risk is high and inherent risk is moderate, then my RMM is moderate.
The assertions that concern me the most are existence, accuracy, valuation, and cutoff.
The assertions that concern me the most are existence, accuracy, valuation, and cutoff. So my RMM for these assertions is usually moderate to high.
My response to higher risk assessments is to perform certain substantive procedures: namely, confirming investments, testing investment reconciliations, testing values, and vetting investment disclosures.
And finally, it’s time to determine your substantive procedures in light of your identified risks.
My customary audit tests include:
I don’t normally test controls related to investments. If controls are tested and you determine they are effective, then some of the substantive procedures may not be necessary.
My investments work papers normally include the following:
Now you know how to audit investments.
Next, we’ll see how to audit payables and expenses.
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Charles Hall is a practicing CPA and Certified Fraud Examiner. For the last thirty years, he has primarily audited governments, nonprofits, and small businesses. He is the author of The Little Book of Local Government Fraud Prevention and Preparation of Financial Statements & Compilation Engagements. He frequently speaks at continuing education events. Charles is the quality control partner for McNair, McLemore, Middlebrooks & Co. where he provides daily audit and accounting assistance to over 65 CPAs. In addition, he consults with other CPA firms, assisting them with auditing and accounting issues.
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