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How to Audit Investments

As an auditor you have to test security investments such as your client’s stocks and bonds. Testing investments during an audit is no different from testing any other financial account, such as cash. You must make sure that the amounts shown as investment assets aren’t materially misstated and that all income and changes in an investment’s value are properly recorded.

 

Client    :

Financial Year:

Prepared By       :               Date:

Reviewed By      :               Date:

Approved by      :               Date:

Updated by        :               Date:

 

1. SYSTEM UPDATE


Update and document your understanding of the controls and accounting system through a review of the system notes in the carry forward section.

2. RISK ASSESSMENT


If specific risks have been identified in the risk assessment and planning process, modify the program procedures in accordance with the responses.

 3. INTERNAL CONTROLS EVALUATION


  1. Study and evaluate the system of internal control relating to investments to determine the nature, timing and extent of other audit procedures.
  2. Review the following aspects of internal control relating to investments:

i. Control over acquisition, accretion and disposal of investments:

Guidance:

There should be proper authority for sanction, acquisition and disposal of investments including renunciation of rights). It should also be ensured that investments are made in accordance with the legal requirements governing the entity as also with its internal regulations, e.g. the provisions of the articles of association, rules and regulations, trust deed, etc.

ii. Safeguarding of investments:

Guidance:

The investments should be in the name of the entity as far as possible. The legal requirements in this behalf, if any, should be complied with. There should exist a proper system for the safe custody of all scrips or other documents of title to the investments belonging to the entity.

iii. Controls relating to title to investments:

Guidance:

It should be ensured that in cases where the title does not pass on to the entity immediately on acquisition, the same is transferred to the entity in due course of time, along with the benefits that might have accrued since the acquisition of the investments. It should be ensured that there is no undue time-lag in the execution of various stages of the transactions.

iv. Information controls:

Guidance:

These controls should ensure that reliable information is available for recording acquisitions (including by way of conversion of securities, right issues or other entitlements, under schemes of amalgamation, acquisition, etc.), accretions and disposals, and for ascertaining the market values, etc. Detailed records regarding acquisition, disposal, etc., of the investments should be maintained along with proper documentation.

4.   EXAMINATION OF RECORDS:


  1. Ensure that the purchase / sale of investments are according to the Law, duly authorized and does not ultra vires the entity.
  2. Verify the acquisition / disposal of investments with evidence like contract note etc.
  3. Check whether purchases / sales are cum-dividend or ex-dividend, cum- right / ex-right, cum-bonus / ex-bonus and their proper adjustments there of in the books.
  4. Check whether proper adjustments in this regard have been made in the cost/sale value of securities purchased or sold

5.   PHYSICAL INSPECTION:


  1. Carry out physical inspection of investments in the form of shares, debentures and other securities
  2. In the case of transaction with depository services verify the periodic reconciliation between the records of the client and those entities rendering depository services
  3. Examine the certificates issued by such organizations confirming the holdings of the entity.
  4. Wherever investments are held by a third person other than the client obtain a certificate directly from the third person and examine the justification for the third party custody, e.g., securities in the custody of brokers or with the company concerned for transfer, consolidation, splitting up, conversion, etc. Evidence of securities held with others should be examined and, in appropriate cases, physical inspection of the relevant documents may be made, to the extent possible, in the course of audit. Where the investments are recorded at an office other than the one where the documents of title thereto are physically located, the local auditor may be requested to verify the same.
  5. If the investments are held otherwise than in the name of entity (e.g., in the name of nominees / trustees), ascertain the reasons for the same and examine the relevant documentary evidence (e.g., written confirmations from the nominees, trustees, etc.) supporting the real / beneficial interest of the entity in the investments.
  6. Examine any other aspects required to be examined or reported upon by the relevant statute.
  7. Where shares are held not in the name of the company but in the name of a director, officer, etc., examine whether the declaration referred to in Section 187C of the Companies Act, 1956 has been properly made.
  8. Examine whether the provisions of AS 13 has been applied on the Investments

6. IMMOVABLE PROPERTIES:


  1. Where immovable properties are held as investments, verify them in the same manner as in the case of immovable properties held as fixed assets.

7. ANALYTICAL REVIEW PROCEDURES:


  1. As a measure of judging the overall reasonableness of the amounts attributed to investments, relate the amount of income received from investments with the corresponding figures of investments and compare this ratio with the similar ratio for the previous years. For this purpose, investments may be classified into appropriate categories.

Thus, in the case of fixed interest- bearing securities, relate the amount of interest earned with the face value of the related securities.

  1. In the case of other securities, review the schedule of dividend and other returns and the schedule of investments prepared by the entity and judge their reasonableness.

8. MANAGEMENT REPRESENTATIONS:


  1. Obtain from the management of the entity a written statement regarding classification and valuation of investments for balance sheet purposes.

9. EXAMINATION OF VALUATION AND DISCLOSURE:


  1. Ensure that the investments have been valued and disclosed in the financial statements in accordance with recognized accounting policies and practices and relevant statutory requirements (Appendix II).
  2. Examine whether the method of valuation followed by the entity is consistently applied.
  3. Examine whether, in computing the cost of investments, acquisition charges such as, transfer fees, stamp duty, brokerage, etc., is included in the cost of investments. In case of any recovery of cost, ascertain that the same is calculated properly by appropriate allocation between pre- acquisition and post- acquisition periods.
  4. Ascertain the market value of the quoted securities from official quotations of the stock exchange. In case of unquoted securities, ascertain the method adopted by the entity for determining the market value of such securities.
  5. Examine whether the method adopted by the entity is one of the recognised methods of valuation of securities such as break-up value method, capitalisation of yield method, yield to maturity method, etc. In the case of investments other than in the form of securities (e.g. rare paintings), examine that the market value has been ascertained on the basis of authentic market reports.

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