Chapter 10Finance and Investment CycleMultiple Choice Questions1. The typical business activity of the finance and investment cycle would not includeA.Proposals for cash forecasts, capital budgets, and business expansionB.Analyses of excess cash fundsC.Reconciliation of cashD.Sale of stocks, bonds, or notes Show
Difficulty: EasySource: Original2. Selecting a sample of paid notes and tracing interest to the general ledger account is a testof the PCAOB assertion for Get answer to your question and much more Difficulty: MediumSource: Original3. The typical assertions related to investments and related accounts would not include thePCAOB assertion that Get answer to your question and much more Difficulty: MediumSource: Original We have textbook solutions for you!The document you are viewing contains questions related to this textbook. Financial and Managerial Accounting Using Excel for Success Reeve/Warren Expert Verified 4. The decision of a company to have a transfer agent handle exchanges of shares is relatedprimarily to which of the functional responsibilities? Get answer to your question and much more Difficulty: EasySource: Original5. ABC Company has issued a bond that pays 5% interest semi-annually to bond holders onrecord June 30 and December 30. Payments are made on July 15 and January 15. ABCCompany has a December 31 fiscal year end. The auditor vouches the January 15, 2009payment to the liabilities recorded on the December 31, 2008 balance sheet. Which of thefollowing ASB balance assertions if the auditor testing?A.ExistenceB.Rights and obligationsC.CompletenessD.Valuation Difficulty: MediumSource: Original6. Auditors count investment securities held by the client primarily to test the ASB balanceassertion of Get answer to your question and much more Difficulty: EasySource: Original 7. Which of the following is not a substantive audit procedure for estimates of management? Get answer to your question and much more Difficulty: HardSource: Original8. Which of the following would not be a place in which owners' equity transactions would bedocumented? Get answer to your question and much more Difficulty: HardSource: Original Upload your study docs or become a Course Hero member to access this document Upload your study docs or become a Course Hero member to access this document End of preview. Want to read all 21 pages?
Upload your study docs or become a Course Hero member to access this document The following auditing standard is not the current version and does not reflect any amendments effective on or after December 31, 2016. The current version of the auditing standards can be found here. Auditing Derivative Instruments, Hedging Activities, and Investments in Securities fn 1
(Supersedes SAS No. 81)Source: SAS No. 92.Effective for audits of financial statements for fiscal years ending on or after June 30, 2001. Early application is permitted.Applicability.01[The following paragraph is effective for audits of fiscal years beginning on or after December 15, 2010. See PCAOB Release No. 2010-004. For audits of fiscal years beginning before December 15, 2010, click here] This section provides guidance to auditors in planning and performing auditing procedures for assertions about derivative instruments, hedging activities, and investments in securities fn 2 that are made in an entity’s financial statements. fn 3 Those assertions fn 4 are classified according to five broad categories that are discussed in paragraphs 11 and 12 of Auditing Standard No. 15, Audit Evidence, and address the following:
Derivative Instruments and Hedging Activities Included in the Scope of this Section.02The guidance in this section applies to derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as derivatives), of all entities. This section uses the definition of derivative that is in Financial Accounting Standards Board (FASB) Statement of Financial Accounting Standards (Statement) No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended [AC section D50] (hereinafter referred to as FASB Statement No. 133). FASB Statement No. 133 addresses the accounting for derivatives that are either freestanding or embedded in contracts or agreements. For purposes of applying the guidance in this section, a derivative is a financial instrument or other contract with all three of the characteristics listed in FASB Statement No. 133, which are the following.
.03An entity may enter into a derivative fn 5 for investment purposes or to designate it as a hedge of exposure to changes in fair value (referred to as a fair valuehedge), exposure to variability in cash flows (referred to as a cash flow hedge), or foreign currency exposure. The guidance in this section applies to hedging activities in which the entity designates a derivative or a nonderivative financial instrument as a hedge of exposure for which FASB Statement No. 133 permits hedge accounting. Securities Included in the Scope of this Section.04The guidance in this section applies to all securities. There are two types of securities—debt securities and equity securities. This section uses the definitions of debt security and equity security that are in FASB Statement No. 115, Accounting for Certain Investments in Debt and Equity Securities [AC section I80]. This section applies to debt and equity securities without regard to whether they are subject to the accounting requirements of FASB Statement No. 115. For example, it applies to assertions about securities accounted for under the equity method following the requirements of Accounting Principles Board Opinion No. 18, The Equity Method of Accounting for Investments in Common Stock [AC section I82]. The Need for Special Skill or Knowledge to Plan and Perform Auditing Procedures.05The auditor may need special skill or knowledge to plan and perform auditing procedures for certain assertions about derivatives and securities. Examples of such auditing procedures and the special skill or knowledge required include—
.06[The following paragraph is effective for audits of fiscal years beginning on or after December 15, 2010. See PCAOB Release No. 2010-004. For audits of fiscal years beginning before December 15, 2010, click here] Auditing Standard No. 9, Audit Planning, discusses the auditor's responsibilities for consideration of the use of persons with specialized skill or knowledge. Auditing Standard No. 10, Supervision of the Audit Engagement, discusses the auditor's responsibilities for supervision of specialists who are employed by the auditor. AU sec. 336, Using the Work of a Specialist, discusses the auditor's responsibilities for using the work of a specialist engaged by the auditor. Audit Risk and Materiality.07[The following paragraph is effective for audits of fiscal years beginning on or after December 15, 2010. See PCAOB Release No. 2010-004. For audits of fiscal years beginning before December 15, 2010, click here] The auditor should design and perform audit procedures regarding relevant assertions of derivatives and investments in securities that are based on and that address the risks of material misstatement in those assertions. The auditor may also consider the work performed by the entity’s internal auditors in designing procedures. Guidance on considering the work performed by internal auditors is found in section 322, The Auditor’s Consideration of the Internal Audit Function in an Audit of Financial Statements. Inherent Risk Assessment.08The inherent risk for an assertion about a derivative or security is its susceptibility to a material misstatement, assuming there are no related controls. Examples of considerations that might affect the auditor’s assessment of inherent risk for assertions about a derivative or security include the following.
Following are examples of how changes in external factors can affect assertions about derivatives and securities.
Control Risk AssessmentObtaining an Understanding of Internal Control to Plan the Audit.09[The following paragraph is effective for audits of fiscal years beginning on or after December 15, 2010. See PCAOB Release No. 2010-004. For audits of fiscal years beginning before December 15, 2010, click here] Auditing Standard No. 12, Identifying and Assessing Risks of Material Misstatement, requires the auditor to obtain an understanding of internal control that will enable the auditor to—
.10Controls should be related to management’s objectives for financial reporting, operations, and compliance. fn 6 For example, to achieve its objectives, management of an entity with extensive derivatives transactions may implement controls that call for—
.11[The following paragraph is effective for audits of fiscal years beginning on or after December 15, 2010. See PCAOB Release No. 2010-004. For audits of fiscal years beginning before December 15, 2010, click here] The extent of the understanding of internal control over derivatives and securities obtained by the auditor depends on how much information the auditor needs to identify the types of potential misstatements, consider factors that affect the risk of material misstatement, design tests of controls when applicable, and design substantive tests. The understanding obtained may include controls over derivatives and securities transactions from their initiation to their inclusion in the financial statements. It may encompass controls placed in operation by the entity and by service organizations whose services are part of the entity’s information system. Paragraphs 28 through 32 and B1 through B6 of Auditing Standard No. 12, Identifying and Assessing Risks of Material Misstatement, discuss the information system, including related business processes, relevant to financial reporting. Following the guidance in section 324, Service Organizations, a service organization’s services are part of an entity’s information system for derivatives and securities if they affect any of the following:
[The following note is effective for audits of fiscal years ending on or after November 15, 2007. See PCAOB Release 2007-005A. For audits of fiscal years ending before November 15, 2007, click here.] Note: When performing an integrated audit of financial statements and internal control over financial reporting, paragraph 39 of PCAOB Auditing Standard No. 5, An Audit of Internal Control Over Financial Reporting That Is Integrated with An Audit of Financial Statements, states "[t]he auditor should test those controls that are important to the auditor's conclusion about whether the company's controls sufficiently address the assessed risk of misstatement to each relevant assertion." Therefore, in an integrated audit of financial statements and internal control over financial reporting, if there are relevant assertions related to the company's investment in derivatives and securities, the auditor's understanding of controls should include controls over derivatives and securities transactions from their initiation to their inclusion in the financial statements and should encompass controls placed in operation by the entity and service organizations whose services are part of the entity's information system. .12Examples of a service organization’s services that would be part of an entity’s information system include—
.13Examples of a service organization’s services that would not be part of an entity’s information system are the following:
.14An auditor who needs information about the nature of a service organization’s services that are part of an entity’s information system for derivatives and securities transactions, or its controls over those services, to plan the audit may be able to gather the information from a variety of sources, such as the following:
In addition, if the services and the service organization’s controls over those services are highly standardized, information about the service organization’s services, or its controls over those services, obtained through the auditor’s prior experience with the service organization may be helpful in planning the audit. Assessing Control Risk.15[The following paragraph is effective for audits of fiscal years beginning on or after December 15, 2010. See PCAOB Release No. 2010-004. For audits of fiscal years beginning before December 15, 2010, click here] After obtaining the understanding of internal control over derivatives and securities transactions, the auditor should assess control risk for the related assertions. Guidance on that assessment is found in Auditing Standard No. 12, Identifying and Assessing Risks of Material Misstatement. .16If the auditor plans to assess control risk below the maximum for one or more assertions about derivatives and securities, the auditor should identify specific controls relevant to the assertions that are likely to prevent or detect material misstatements and that have been placed in operation by either the entity or the service organization, and gather evidential matter about their operating effectiveness. Evidential matter about the operating effectiveness of a service organization’s controls may be gathered through tests performed by the auditor or by an auditor engaged by either the auditor or the service organization—
Confirmations of balances or transactions from a service organization do not provide evidential matter about its controls. .17The auditor should consider the size of the entity, the entity’s organizational structure, the nature of its operations, the types, frequency, and complexity of its derivatives and securities transactions, and its controls over those transactions in designing auditing procedures for assertions about derivatives and securities. For example, if the entity has a variety of derivatives and securities that are reported at fair value estimated using valuation models, the auditor may be able to reduce the substantive procedures for valuation assertions by gathering evidential matter about the controls over the design and use of the models (including the significant assumptions) and evaluating their operating effectiveness. .18In some circumstances, it may not be practicable or possible for the auditor to reduce audit risk to an acceptable level without identifying controls placed in operation by the entity or a service organization and gathering evidential matter about the operating effectiveness of those controls. For example, if the entity has a large number of derivatives or securities transactions, the auditor likely would be unable to reduce audit risk to an acceptable level for assertions about the occurrence of earnings on those securities, including gains and losses from sales, without identifying controls over the authorization, recording, custody, and segregation of duties for those transactions and gathering evidential matter about their operating effectiveness. fn 10 Designing Substantive Procedures Based on Risk Assessments.19The auditor should use the assessed levels of inherent risk and control risk for assertions about derivatives and securities to determine the nature, timing, and extent of the substantive procedures to be performed to detect material misstatements of the financial statement assertions. Some substantive procedures address more than one assertion about a derivative or security. Whether one or a combination of substantive procedures should be used to address an assertion depends on the auditor’s assessment of the inherent and control risk associated with it as well as the auditor’s judgment about a procedure’s effectiveness. Paragraphs .21 through .58 provide examples of substantive procedures that address assertions about derivatives and securities. In addition, the auditor should consider whether the results of other audit procedures conflict with management’s assertions about derivatives and securities. The auditor should consider the impact of any such identified matters on management’s assertions about derivatives and securities. Additionally, the auditor should consider the impact of such matters on the sufficiency of the evidential matter evaluated by the auditor in support of the assertions. .20The provision by a service organization of services that are part of an entity’s information system may affect the nature, timing, and extent of the auditor’s substantive procedures for assertions about derivatives and securities in a variety of ways. Following are examples of such services and how they may affect the nature, timing, and extent of the auditor’s substantive procedures.
Financial Statement AssertionsExistence or Occurrence.21Existence assertions address whether the derivatives and securities reported in the financial statements through recognition or disclosure exist at the date of the statement of financial position. Occurrence assertions address whether derivatives and securities transactions reported in the financial statements, as a part of earnings, other comprehensive income, or cash flows or through disclosure, occurred. Paragraph .19 provides guidance on the auditor’s determination of the nature, timing, and extent of substantive procedures to be performed. Examples of substantive procedures for existence or occurrence assertions about derivatives and securities include—
Completeness.22Completeness assertions address whether all of the entity’s derivatives and securities are reported in the financial statements through recognition or disclosure. They also address whether all derivatives and securities transactions are reported in the financial statements as a part of earnings, other comprehensive income, or cash flows or through disclosure. The extent of substantive procedures for completeness may properly vary in relation to the assessed level of control risk. In addition, the auditor should consider that since derivatives may not involve an initial exchange of tangible consideration, it may be difficult to limit audit risk for assertions about the completeness of derivatives to an acceptable level with an assessed level of control risk at the maximum. Paragraph .19 provides guidance on the auditor’s determination of the nature, timing, and extent of substantive procedures to be performed. Examples of substantive procedures for completeness assertions about derivatives and securities are—
.23One of the characteristics of derivatives is that they may involve only a commitment to perform under a contract and not an initial exchange of tangible consideration. Therefore, auditors designing tests related to the completeness assertion should not focus exclusively on evidence relating to cash receipts and disbursements. When testing for completeness, auditors should consider making inquiries, inspecting agreements, and reading other information, such as minutes of meetings of the board of directors or finance, asset/liability, investment, or other committees. Auditors should also consider making inquiries about aspects of operating activities that might present risks hedged using derivatives. For example, if the entity conducts business with foreign entities, the auditor should inquire about any arrangements the entity has made for purchasing foreign currency. Similarly, if an entity is in an industry in which commodity contracts are common, the auditor should inquire about any commodity contracts with fixed prices that run for unusual durations or involve unusually large quantities. The auditor also should consider inquiring as to whether the entity has converted interest-bearing debt from fixed to variable, or vice versa, using derivatives. .24Derivatives may not involve an initial exchange of tangible consideration, as discussed in paragraphs .22 and .23. If one or more service organizations provide services that are part of the entity’s information system for derivatives, the auditor may be unable to sufficiently limit audit risk for assertions about the completeness of derivatives without obtaining evidential matter about the operating effectiveness of controls at one or more of the service organizations. Since the auditor’s concern is that derivatives that do not require an initial exchange of tangible consideration may not have been recorded, testing reconciliations of information provided by two or more of the service organizations as discussed in paragraph .20 of this section may not sufficiently limit audit risk for assertions about the completeness of derivatives. Rights and Obligations.25Assertions about rights and obligations address whether the entity has the rights and obligations associated with derivatives and securities, including pledging arrangements, reported in the financial statements. Paragraph .19 provides guidance on the auditor’s determination of the nature, timing, and extent of substantive procedures to be performed. Examples of substantive procedures for assertions about rights and obligations associated with derivatives and securities are—
Valuation.26Assertions about the valuation of derivatives and securities address whether the amounts reported in the financial statements through measurement or disclosure were determined in conformity with generally accepted accounting principles. Tests of valuation assertions should be designed according to the valuation method used for the measurement or disclosure. Generally accepted accounting principles may require that a derivative or security be valued based on cost, the investee’s financial results, or fair value. They also may require disclosures about the value of a derivative or security and specify that impairment losses should be recognized in earnings prior to their realization. Also, generally accepted accounting principles for securities may vary depending on the type of security, the nature of the transaction, management’s objectives related to the security, and the type of entity. Procedures for evaluating management’s consideration of the need to recognize impairment losses are discussed in paragraphs .47 and .48 of this section. .27Valuation Based on Cost. Procedures to obtain evidence about the cost of securities may include inspection of documentation of the purchase price, confirmation with the issuer or holder, and testing discount or premium amortization, either by recomputation or analytical procedures. The auditor should evaluate management’s conclusion about the need to recognize an impairment loss for a decline in the security’s fair value below its cost that is other than temporary. .28Valuation Based on an Investee’s Financial Results. For valuations based on an investee’s financial results, including but not limited to the equity method of accounting, the auditor should obtain sufficient evidence in support of the investee’s financial results. The auditor should read available financial statements of the investee and the accompanying audit report, if any. Financial statements of the investee that have been audited by an auditor whose report is satisfactory, for this purpose, fn 14 to the investor’s auditor may constitute sufficient evidential matter. .29If in the auditor’s judgment additional evidential matter is needed, the auditor should perform procedures to gather such evidence. For example, the auditor may conclude that additional evidential matter is needed because of significant differences in fiscal year-ends, significant differences in accounting principles, changes in ownership, changes in conditions affecting the use of the equity method, or the materiality of the investment to the investor’s financial position or results of operations. Examples of procedures the auditor may perform are reviewing information in the investor’s files that relates to the investee such as investee minutes and budgets and cash flows information about the investee and making inquiries of investor management about the investee’s financial results. .30If the investee’s financial statements are not audited, or if the investee auditor’s report is not satisfactory to the investor’s auditor for this purpose, the investor’s auditor should apply, or should request that the investor arrange with the investee to have another auditor apply, appropriate auditing procedures to such financial statements, considering the materiality of the investment in relation to the financial statements of the investor. .31If the carrying amount of the security reflects factors that are not recognized in the investee’s financial statements or fair values of assets that are materially different from the investee’s carrying amounts, the auditor should obtain sufficient evidence in support of these amounts. Paragraphs .35 through .46 of this section provide guidance on audit evidence that may be used to corroborate assertions about the fair value of derivatives and securities, and paragraphs .47 and .48 provide guidance on procedures for evaluating management’s consideration of the need to recognize impairment losses. .32There may be a time lag in reporting between the date of the financial statements of the investor and that of the investee. A time lag in reporting should be consistent from period to period. If a time lag between the date of the entity’s financial statements and those of the investee has a material effect on the entity’s financial statements, the auditor should determine whether the entity’s management has properly considered the lack of comparability. The effect may be material, for example, because the time lag is not consistent with the prior period in comparative statements or because a significant transaction occurred during the time lag. If a change in time lag occurs that has a material effect on the investor’s financial statements, an explanatory paragraph should be added to the auditor’s report because of the change in reporting period. fn 15 .33The auditor should evaluate management’s conclusion about the need to recognize an impairment loss for a decline in the security’s fair value below its carrying amount that is other than temporary. In addition, with respect to subsequent events and transactions of the investee occurring after the date of the investee’s financial statements but before the date of the investor auditor’s report, the auditor should read available interim financial statements of the investee and make appropriate inquiries of the investor to identify subsequent events and transactions that are material to the investor’s financial statements. Such events or transactions of the type contemplated in section 560, Subsequent Events, paragraphs .05-.06), should be disclosed in the notes to the investor’s financial statements and (where applicable) labeled as unaudited information. For the purpose of recording the investor’s share of the investee’s results of operations, recognition should be given to events or transactions of the type contemplated in section 560.03. .34Evidence relating to material transactions between the entity and the investee should be obtained to evaluate (a) the propriety of the elimination of unrealized profits and losses on transactions between the entity and the investee that is required when the equity method of accounting is used to account for an investment under generally accepted accounting principles and (b) the adequacy of disclosures about material related party transactions. .35[The following paragraph is effective for audits of fiscal years beginning on or after December 15, 2010. See PCAOB Release No. 2010-004. For audits of fiscal years beginning before December 15, 2010, click here] Valuation Based on Fair Value. The auditor should obtain evidence supporting management’s assertions about the fair value of derivatives and securities measured or disclosed at fair value. The method for determining fair value may be specified by generally accepted accounting principles and may vary depending on the industry in which the entity operates or the nature of the entity. Such differences may relate to the consideration of price quotations from inactive markets and significant liquidity discounts, control premiums, and commissions and other costs that would be incurred to dispose of the derivative or security. The auditor should determine whether generally accepted accounting principles specify the method to be used to determine the fair value of the entity’s derivatives and securities and evaluate whether the determination of fair value is consistent with the specified valuation method. Paragraphs .35 through .46 of this section provide guidance on audit evidence that may be used to support assertions about fair value; that guidance should be considered in the context of specific accounting requirements. If the determination of fair value requires the use of estimates, the auditor should consider the guidance in section 342, Auditing Accounting Estimates. In addition, paragraphs 24 through 27 of Auditing Standard No. 14, Evaluating Audit Results, describe the auditor's responsibilities for assessing bias in accounting estimates. .36Quoted market prices for derivatives and securities listed on national exchanges or over-the-counter markets are available from sources such as financial publications, the exchanges, the National Association of Securities Dealers Automated Quotations System (NASDAQ), or pricing services based on sources such as those. Quoted market prices obtained from those sources are generally considered to provide sufficient evidence of the fair value of the derivatives and securities. .37For certain other derivatives and securities, quoted market prices may be obtained from broker-dealers who are market makers in them or through the National Quotation Bureau. However, using such a price quote to test valuation assertions may require special knowledge to understand the circumstances in which the quote was developed. For example, quotations published by the National Quotation Bureau may not be based on recent trades and may only be an indication of interest and not an actual price for which a counterparty will purchase or sell the underlying derivative or security. .38If quoted market prices are not available for the derivative or security, estimates of fair value frequently can be obtained from broker-dealers or other third-party sources based on proprietary valuation models or from the entity based on internally or externally developed valuation models (for example, the Black-Scholes option pricing model). The auditor should understand the method used by the broker-dealer or other third-party source in developing the estimate, for example, whether a pricing model or a cash flow projection was used. The auditor may also determine that it is necessary to obtain estimates from more than one pricing source. For example, this may be appropriate if either of the following occurs.
.39For fair-value estimates obtained from broker-dealers and other third-party sources, the auditor should consider the applicability of the guidance in section 336 or section 324. The auditor’s decision about whether such guidance is applicable and which guidance is applicable will depend on the circumstances. The guidance in section 336 may be applicable if the third-party source derives the fair value of the derivative or security by using modeling or similar techniques. If the entity uses a pricing service to obtain prices of securities and derivatives, the guidance in section 324 may be appropriate. .40If the derivative or security is valued by the entity using a valuation model, the auditor does not function as an appraiser and is not expected to substitute his or her judgment for that of the entity’s management. fn 16 Examples of valuation models include the present value of expected future cash flows, option-pricing models, matrix pricing, option-adjusted spread models, and fundamental analysis. The auditor should obtain evidence supporting management’s assertions about fair value determined using a model by performing procedures such as—
However, a valuation model should not be used to determine fair value when generally accepted accounting principles require that the fair value of a security be determined using quoted market prices. .41Evaluating evidential matter for assertions about derivatives and securities may require the auditor to use considerable judgment. That may be because the assertions, especially those about valuation, are based on highly subjective assumptions or are particularly sensitive to changes in the underlying circumstances. Valuation assertions may be based on assumptions about the occurrence of future events for which expectations are difficult to develop or on assumptions about conditions expected to exist over a long period; for example, default rates or prepayment rates. Accordingly, competent persons could reach different conclusions about estimates of fair values or estimates of ranges of fair values. .42Considerable judgment may also be required in evaluating evidential matter for assertions based on features of the derivative or security and applicable accounting principles, including underlying criteria such as for hedge accounting, that are extremely complex. For example, determining the fair value of a structured note may require consideration of a variety of features of the note that react differently to changes in economic conditions. In addition, one or more other derivatives may be designated to hedge changes in cash flows under the note. Evaluating evidential matter to support the fair value of the note, the determination of whether the hedge is highly effective, and the allocation of changes in fair value to earnings and other comprehensive income may require considerable judgment. .43In situations requiring considerable judgment, the auditor should consider the guidance in— [The following subparagraph is effective for audits of fiscal years beginning on or after December 15, 2010. See PCAOB Release No. 2010-004. For audits of fiscal years beginning before December 15, 2010, click here]
.44Negotiable securities, real estate, chattels, or other property is often assigned as collateral for debt securities. If the collateral is an important factor in evaluating the fair value and collectibility of the security, the auditor should obtain evidence regarding the existence, fair value, and transferability of such collateral as well as the investor’s rights to the collateral. .45Generally accepted accounting principles may specify how to account for unrealized appreciation and depreciation in the fair value of the entity’s derivatives and securities. For example, generally accepted accounting principles require the entity to report a change in the unrealized appreciation or depreciation in the fair value of—
Generally accepted accounting principles may also require the entity to reclassify amounts from accumulated other comprehensive income to earnings. For example, such reclassifications may be required because a hedged transaction is determined to no longer be probable of occurring, a hedged forecasted transaction affects earnings for the period, or a decline in fair value is determined to be other than temporary. .46The auditor should evaluate management’s conclusion about the need to recognize in earnings an impairment loss for a decline in fair value that is other than temporary as discussed in paragraphs .47 and .48 of this section. The auditor should also gather evidential matter to support the amount of unrealized appreciation or depreciation in the fair value of a derivative that is recognized in earnings or other comprehensive income or that is disclosed because of the ineffectiveness of a hedge. That requires an understanding of the methods used to determine whether the hedge is highly effective and to determine the ineffective portion of the hedge. .47Impairment Losses. Regardless of the valuation method used, generally accepted accounting principles might require recognizing in earnings an impairment loss for a decline in fair value that is other than temporary. Determinations of whether losses are other than temporary often involve estimating the outcome of future events. Accordingly, judgment is required in determining whether factors exist that indicate that an impairment loss has been incurred at the end of the reporting period. These judgments are based on subjective as well as objective factors, including knowledge and experience about past and current events and assumptions about future events. The following are examples of such factors.
.48The auditor should evaluate (a) whether management has considered relevant information in determining whether factors such as those listed in paragraph .47 exist and (b) management’s conclusions about the need to recognize an impairment loss. That evaluation requires the auditor to obtain evidence about such factors that tend to corroborate or conflict with management’s conclusions. When the entity has recognized an impairment loss, the auditor should gather evidence supporting the amount of the impairment adjustment recorded and determine whether the entity has appropriately followed generally accepted accounting principles. Presentation and Disclosure.49Assertions about presentation and disclosure address whether the classification, description, and disclosure of derivatives and securities in the entity’s financial statements are in conformity with generally accepted accounting principles. The auditor should evaluate whether the presentation and disclosure of derivatives and securities are in conformity with generally accepted accounting principles. As noted in section 411, The Meaning of Present Fairly in Conformity with Generally Accepted Accounting Principles, paragraph .04, the auditor’s opinion as to whether financial statements are presented in conformity with generally accepted accounting principles should be based on the auditor’s judgement as to whether—
[Title of section 411 amended, effective for reports issued or reissued on or after June 30, 2001, by Statement on Auditing Standards No. 93.] .50For some derivatives and securities, generally accepted accounting principles may prescribe presentation and disclosure requirements. For example—
.51[The following paragraph is effective for audits of fiscal years beginning on or after December 15, 2010. See PCAOB Release No. 2010-004. For audits of fiscal years beginning before December 15, 2010, click here] In evaluating the adequacy of presentation and disclosure, the auditor should consider the form, arrangement, and content of the financial statements and their notes, including, for example, the terminology used, the amount of detail given, the classification of items in the statements, and the bases of amounts reported. The auditor should compare the presentation and disclosure with the requirements of generally accepted accounting principles. (See paragraph 31 of Auditing Standard No. 14, Evaluating Audit Results.) Additional Considerations About Hedging Activities.52To account for a derivative as a hedge, generally accepted accounting principles require management at the inception of the hedge to designate the derivative as a hedge and contemporaneously formally document fn 17 the hedging relationship, the entity’s risk management objective and strategy for undertaking the hedge, and the method of assessing the effectiveness of the hedge. In addition, to qualify for hedge accounting, generally accepted accounting principles require that management have an expectation, both at the inception of the hedge and on an ongoing basis, that the hedging relationship will be highly effective in achieving the hedging strategy. fn 18 .53The auditor should gather evidential matter to determine whether management complied with the hedge accounting requirements of generally accepted accounting principles, including designation and documentation requirements. In addition, the auditor should gather evidential matter to support management’s expectation at the inception of the hedge that the hedging relationship will be highly effective and its periodic assessment of the ongoing effectiveness of the hedging relationship as required by generally accepted accounting principles. .54When the entity designates a derivative as a fair value hedge, generally accepted accounting principles require that the entity adjust the carrying amount of the hedged item for the change in the hedged item’s fair value that is attributable to the hedged risk. The auditor should gather evidential matter supporting the recorded change in the hedged item’s fair value that is attributable to the hedged risk. Additionally, the auditor should gather evidential matter to determine whether management has properly applied generally accepted accounting principles to the hedged item. .55For a cash flow hedge of a forecasted transaction, generally accepted accounting principles require management to determine that the forecasted transaction is probable of occurring. Those principles require that the likelihood that the transaction will take place not be based solely on management’s intent. Instead, the transaction’s probability should be supported by observable facts and the attendant circumstances, such as the following:
The auditor should evaluate management’s determination of whether a forecasted transaction is probable. Assertions About Securities Based on Management’s Intent and Ability.56Generally accepted accounting principles require that management’s intent and ability be considered in valuing certain securities; for example, whether—
.57In evaluating management’s intent and ability, the auditor should—
[The following subparagraph is effective for audits of fiscal years beginning on or after December 15, 2010. See PCAOB Release No. 2010-004. For audits of fiscal years beginning before December 15, 2010, click here]
Management Representations.58Section 333, Management Representations, provides guidance to auditors in obtaining written representations from management. The auditor ordinarily should obtain written representations from management confirming aspects of management’s intent and ability that affect assertions about derivatives and securities, such as its intent and ability to hold a debt security until its maturity or to enter into a forecasted transaction for which hedge accounting is applied. In addition, the auditor should consider obtaining written representations from management confirming other aspects of derivatives and securities transactions that affect assertions about them. fn 20 Effective Date.59This section is effective for audits of financial statements for fiscal years ending on or after June 30, 2001. Early application is permitted. What are the proper audit procedures to validate estimates?Auditing standards generally provide three approaches for substantively testing fair value measurements and other accounting estimates:. Testing management's process. ... . Developing an independent estimate. ... . Reviewing subsequent events or transactions.. Which of the following is not among the characteristics of the procedures performed?Which of the following is not among the characteristics of the procedures performed in completing the audit? The correct answer is A: They are optional since they have only an indirect impact on the opinion to be expressed. The procedures performed in completing the audit are very important in the audit process.
In which stage's of an audit are analytical procedures not performed?Purposes of analytical procedures
Analytical procedures are performed as an overall review of the financial statements at the end of the audit to assess whether they are consistent with the auditor's understanding of the entity. Final analytical procedures are not conducted to obtain additional substantive assurance.
What factors should an auditor consider in evaluating the reasonableness of accounting estimates?In evaluating whether management has identified all accounting estimates that could be material to the financial statements, the auditor considers the circumstances of the industry or industries in which the entity operates, its methods of conducting business, new accounting pronouncements, and other external factors.
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