Substantive Test of Investments
Substantive Test of Investments
Module 1
2. Describe the primary substantive audit procedures for investments and related
accounts
3. Identify assertions addressed by audit procedures for investments and related accounts
Introduction
Accounting for investments can vary depending on whether cost, fair value, equity, or
consolidation methods are used. Much depends on the entity's business model and
management's intentions, which are assessed through inquiry and knowledge of the
client's business and industry. Only auditors knowledgeable about the business can
determine the economic substance of an acquisition and whether it makes sense from an
industry perspective and the business's strategic plan.
In the audit of investments, the auditor should consider the related income statement
accounts such as investment income, holding gains (loss), impairment loss, derecognition
loss and other items.
Audit Objectives
When auditing investments, the principal objective for the substantive tests is to
determine the following:
Assertion Category Account Balances Audit Objectives
Occurrence All recorded income from investments has accrued to the entity at the reporting date.
Completeness All investments owned by the entity at the reporting date are included on the statement of financial
position. All income accruing from investments at the reporting date has been recorded.
Valuation and Allocation Investments are included on the statement of financial position at the appropriate amounts.
Accuracy Investment income is included on the statement of comprehensive income at the appropriate amount
Classification Income statement related items are appropriately recorded in the proper accounts in the statement of
comprehensive income.
Rights and Obligations The entity owns, or has a legal right to the investments included on the statement of financial position.
Presentation and Disclosure Investments and related investment income accounts are properly classified, described, and disclosed
in the financial statements, including notes, in accordance with the applicable PFRS.
All investment pledged or other security interests are adequately and properly disclosed.
Audit Procedures for Investments
The auditor's primary substantive procedures for investments typically include the
following:
If the securities (such as stock certificates) or evidence of ownership is held by the client during the
year, the auditor counts the securities or instruments on hand and examines evidence of ownership. The
count of securities is ideally performed at the reporting date and simultaneously with the count of cash
and other negotiable instrument to prevent substitution. When inspecting the securities, the auditor
should note the following:
5. Any certificates; evidence and of pledging or restrictions on disposal shown on the certificates; and
Some of the company's securities and other financial instruments held by a custodian
such as brokerage firm or banks for safekeeping. If this is the case, the auditor will
confirm to the custodian. Note that the dispatch and receipt of the confirmation request
should be always under the control of the auditor after it was signed by the client. The
auditor would normally include the information mentioned above ( e.g., name of
registered owner, number of shares, etc.) in the confirmation request.
Quick Check
To establish the existence and ownership of a long-term investment in the common stock
of a publicly traded company, an auditor ordinarily performs a security count or
a. Relies on the client's internal controls if the auditor has reasonable assurance that the
control procedures are being applied as prescribed.
b. Confirms the number of shares owned that are held by an independent custodian.
c. Determine the market price per share at the reporting date from published quotations.
a. Relies on the client's internal controls if the auditor has reasonable assurance that the
control procedures are being applied as prescribed.
b. Confirms the number of shares owned that are held by an independent custodian.
c. Determine the market price per share at the reporting date from published quotations.
a. Relies on the client's internal controls if the auditor has reasonable assurance that the
control procedures are being applied as prescribed.
b. Confirms the number of shares owned that are held by an independent custodian.
c. Determine the market price per share at the reporting date from published quotations.
Investment in associate and joint venture should be accounted under equity method, that
is the investor should account the investment initially at cost, plus (less) any share of
investees net income (net loss), plus (less) any change in investees other comprehensive
income less any dividends received. The auditor can verify the share in net income or loss
by examining the audited financial statement of the investee and making independent
calculation. For divided received, the auditor can examine published dividend record of
the investee. For impairment loss, please refer to a separate discussion in this module.
Investment in subsidiary
Financial at fair value through profit or loss or other comprehensive income is measured
at fair value every reporting date. To evaluate the appropriate valuation of the asset, the
auditor will examine quoted market price if there is an active market. For example, if the
shares are quoted in Philippine Stock Exchange, the auditor will check the valuation by
using the quoted price and multiplying it in the number of shares.
Quick Check
Of the following, which is the most efficient audit procedure for verification of interest
earned on bond investments?
In assessing the proprietary of impairment, the auditor should inquire with management their approach
in identifying indicators of impairment, and the actions taken as a result of any potential impairment
noted. If an impairment provision was made or the auditor considers it necessary, the auditor ordinarily
should perform the following procedures:
3. Evaluate the accuracy, completeness, and the relevance of the important data on which the estimates
or measurements are based.
The auditor should obtain and review minutes (shareholders, board, executive committee, etc.),
agreements and confirmation replies for evidence of existence, liens, pledges or other security interests
in investments; and of commitments to acquire or dispose of investments. This step may also disclose
unrecorded purchases and sales of securities or other financial instruments.
Review Financial Statement Presentation and Disclosure
of Investments Including Related Account
The auditor must determine that
investments are properly classified and
presented in the statement of financial
position. Short-term investments are
included in the current asset section
while long-term investments are
presented in the non-current asset
section. The auditor should also
determine that the related income
statement accounts should be reported
appropriately in profit or loss or as a
component of other comprehensive
income. The following table
summarizes investment related items
and where to report them:
Investment in Equity and Debt
Securities; and
Investment in Associate
Module 3
Asset that is not directly related to the central revenue producing activities of the enterprise but
are acquired for any of the following purposes:
Investments are expected to contribute to the success of the business either by exercising certain
favorable effects upon sales and operations or by making an independent contribution to earnings
over the long term.
FVTPL
Classification Debt, Equity or FVTOCI - Debt FVTOCI - Equity FAAC - Debt
Derivatives
Financial assets are recognized on the Statement of Financial Position
Initial
when the entity becomes a party to the contractual provisions of the
Fair Value
instrument
Fair value plus Fair value plus Fair value plus
Classification,
measurement transaction cost transaction cost transaction cost
Subsequent
Fair Value Fair Value Fair Value Amortized Cost
measurement
Measurement
G/L on
P&L OCI, net of tax OCI, net of tax N/A
remeasurement
Interest income on Effective rate Effective rate
Nominal rate
(initial and
debt (EIR x Beginning N/A (EIR x Beginning
(NR x Face value)
securities(P&L) amortized cost) amortized cost)
Dividends on
subsequent) and
P&L N/A P&L N/A
equity instruments
Subject to
No Yes No Yes
impairment test?
Classification
CATEGORIES OF FINANCIAL ASSETS
BASIS OF CLASSIFICATION
An entity shall classify financial assets as subsequently measured at amortized cost, fair
value through other comprehensive income or fair value through profit or loss on the
basis of both:
a. Principal – the fair value of the financial asset at initial recognition [PFRS 9.4.1.3a]
b. Interest – consists of consideration for the time value of money, for the credit risk
associated with the principal amount outstanding during a particular period of time
and for other basic lending risks and costs, as well as a profit margin [PFRS 9.4.1.3b]
Summary of Classification of Financial Assets (PFRS 9 version 2014)
FVTPL
Classification Debt, Equity or FVTOCI - Debt FVTOCI - Equity FAAC - Debt
Derivatives
Financial assets are recognized on the Statement of Financial Position
Initial recognition when the entity becomes a party to the contractual provisions of the
instrument
Initial recognition
Financial assets are recognized on the Statement of Financial Position when the entity
becomes a party to the contractual provisions of the instrument
FVTPL
Classification Debt, Equity or FVTOCI - Debt FVTOCI - Equity FAAC - Debt
Derivatives
Initial Fair value plus Fair value plus Fair value plus
Fair Value
measurement transaction cost transaction cost transaction cost
Initial measurement
All financial assets are measured initially at fair value, plus, for those financial assets not
classified at fair value through profit or loss, directly attributable transaction costs.
Subsequent measurement
Investment in equity securities with fair value may subsequently be classified as to either
financial assets at (1) FVTPL or (2) FVTOCI.
SUBSEQUENT MEASUREMENT: FVTPL FVTOCI
Note:
✓ The unrealized gain or loss that was recognized during the year for the Fair Value through
Other Comprehensive Income is presented in the Statement of Comprehensive Income (SCI).
✓ The accumulated balance of unrealized gain or loss for the Fair Value through Other
Comprehensive Income (FVTOCI) is presented in the Statement ·Financial Position and
Statement of Changes in Equity.
FVTPL
Classification Debt, Equity or FVTOCI - Debt FVTOCI - Equity FAAC - Debt
Derivatives
Subsequent
Fair Value Fair Value Fair Value Amortized Cost
measurement
Subsequent measurement
Investment in bonds(debt investment) classified as financial asset at fair value through profit
or loss (FVTPL) is subsequently measured at fair value, with changes in fair value included in
profit or loss. The formula is as follows:
The premium or discount on the financial asset at fair value through profit or loss is not
amortized at the end of reporting period.
FVTPL
Classification Debt, Equity or FVTOCI - Debt FVTOCI - Equity FAAC - Debt
Derivatives
Subsequent
Fair Value Fair Value Fair Value Amortized Cost
measurement
Subsequent measurement
Subsequent to initial recognition, investment in bonds (debt investment) classified as financial
asset at fair value through other comprehensive income (FVTOCI) is measured at fair value.
However, the amortized cost of the investment will still be computed using effective interest
method. The difference between the fair value and the amortized cost is the cumulative amount
presented in equity.
Gain/Loss on remeasurement
• Equity Instrument
• Debt Instrument
FVTPL FVTOCI
FVTPL
Classification Debt, Equity or FVTOCI - Debt FVTOCI - Equity FAAC - Debt
Derivatives
Interest income on Effective rate Effective rate
Nominal rate
debt (EIR x Beginning N/A (EIR x Beginning
(NR x Face value)
securities(P&L) amortized cost) amortized cost)
Dividends on
P&L N/A P&L N/A
equity instruments
1. Cash and property dividends received from equity investments at fair value are recognized as
dividend revenue unless they are considered as return . of investments (liquidating dividend)
or if they represent distribution of earnings earned prior to acquisition of shares. Such
dividends are credited to investment account.
2. Property dividends are distributions in the form of the investee's non-cash assets. They are
usually in the. form bf shares held by the investee in other companies. The investor records the
property dividends received as dividend revenue at the assets fair market value.
3. Share dividends (also called bonus issue) and share splits are accounted by the investor by
adjusting the amount of the previous shares held. No formal journal entry is required in the
accounts. A memorandum entry is made indicating the effect of the bonus issue.
4. However, when the bonus issue is in the form of another class of share capital (different from
shares held), the transaction is treated similar to a property dividend. The shares received are
recorded at its fair value with a credit to dividend revenue.
FVTPL
Classification Debt, Equity or FVTOCI - Debt FVTOCI - Equity FAAC - Debt
Derivatives
Dividends on
P&L N/A P&L N/A
equity instruments
Share rights are granted shares to are existing shareholders to subscribe for new shares
before such shares are offered for sale to the public. There is usually no fair value for the
rights upon their receipt; thus, only a memorandum entry is made. An investor that
receives the stock rights has three possible options:
FVTOCI
In accordance with paragraph 5.5.8 of PFRS 9, an entity shall recognize in profit or loss,
as an impairment gain or loss, the amount of expected credit losses (or reversal) that is
required to adjust the loss allowance at the reporting date. Note the following difference,
*The reversal shall not result in a carrying amount of the financial asset that exceeds what
the amortized cost would have been had the impairment not been recognized at the date
the impairment is reversed.
FVTPL
Classification Debt, Equity or FVTOCI - Debt FVTOCI - Equity FAAC - Debt
Derivatives
Impairment Gain
N/A P&L (no limit) N/A P&L (no limit)
(i.e. Reversal)
FVTOCI
PV = Gross CA PXX
Loss Allowance XX
========================================
FAAC
PV = Gross CA PXX
Amortized Cost XX
Derecognition
Retained Earnings
Presentation
Equity Securities
When derecognized, gain or loss on investment in equity securities classified as FVTPL or FVTOCI is computed as
follows:
Formula:
Consideration received xx
Derecognition
Retained Earnings
Presentation
FVTPL
Classification Debt, Equity or FVTOCI - Debt FVTOCI - Equity FAAC - Debt
Derivatives
Derecognition
Directly closed to
Gain or Loss - P&L P&L P&L
Retained Earnings
Presentation
FVTPL
vs. EQUITY
Note the following difference in accounting for any gain or loss
due to changes in fair value accumulated in other
comprehensive income:
1. FVTOCI (debt) -UG (UL) recognized in equity is recycled
to profit or loss.
ln a reclassification to FVOCI,
• From .amortized cost, the new debt investment (FVOCI) is recorded at fair value and the difference
between fair value and amortized cost is taken to other comprehensive income. The effective interest
rate used as debt investment at amortized cost remains the same.
• From FVPL, the new debt investment (FVOCI) is recorded at fair value and an effective interest rate is
calculated based on the fair value on the date of reclassification.
Significant Influence is the power to participate in the financial and operating policy decisions of the
investee but is not control or joint control of those policies.
Identification of Associates
Less than 20% - presumed that the investor does not have significant influence, unless such influence can be
clearly demonstrated.
The existence of significant influence by an investor is usually evidenced in one or more the following ways:
The investor's share of the profit or loss of the investee is recognized in the investor's
profit or loss. Distributions received from an investee reduce the carrying amount of the
investment. Adjustments to the carrying amount may also be necessary for changes in the
investor's proportionate interest in the investee arising from changes in the investee's
equity that have not been recognized in the investee's profit or loss. Such changes include
those arising from the revaluation of property, plant and equipment and from foreign
exchange translation differences. The investor's share of those changes is recognized
directly in equity of the investor.
Adjustment of Investee’s (Associate)
Operations
Upstream Transactions
• profits and losses resulting from 'upstream' and 'downstream' transactions between an investor (including its consolidated
subsidiaries) and an associate are recognized in the investor's financial statements only to the extent of unrelated
investors' interests in the associate. 'Upstream’ transactions are, for example, sales of assets from an associate to the
investor.
Downstream Transactions
• 'Downstream' transactions are, for example, sales of assets from the investor to an associate. The investor's share in the
associate’s profits and losses resulting from these transactions is eliminated.
When "downstream transactions provide evidence of a reduction in the net realizable value of the assets to be sold or
contributed, or of an impairment loss of those assets, those losses shall be recognized in full by the investor.
When upstream transactions provide evidence of a reduction in the net realizable value of the assets to be purchased or of
an impairment loss of those assets, the investor shall recognize its share in those losses.
The share in the profit or loss of an associate is recognized only to the extent of unrelated investors' interest in the associate.
If the transaction is:
b. Upstream sale - eliminate the investor's share in unrealized profit. (percentage of ownership)
Comprehensive Problem – Equity
Investment
Microsoft Excel
Worksheet
Comprehensive Problem – Equity
Investment
Microsoft Excel
Worksheet
Comprehensive Problem – Debt
Investment
Microsoft Excel
Worksheet
Microsoft Excel
Worksheet
Comprehensive Problem – Investment in
Associate
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Comprehensive Problem – Investment in
Associate
Microsoft Excel
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Microsoft Excel
Worksheet
Comprehensive Problem – Investment in
Microsoft Excel
Associate
Worksheet