Chapter 10

Finance and Investment Cycle

Credit has done a thousand times more to enrich mankind than all
the goldmines in the world. It has exalted labor, stimulated manufacture
and pushed commerce over every sea.
--Daniel Webster

McGraw- Copyright 2008 by The McGraw-Hill Companies, Inc. All

 10-2
INVESTING AND
FINANCING CYCLE
Concerned with transactions related to the
use of the organization's funds (investing)
and sources of those funds (financing) other
than operations.
Accounts affected by investing and financial
cycle transactions include investments in
securities; notes and bonds payable; and,
stockholders' equity accounts.
 10-3

Inherent Risks
Lease Accounting
Loan covenants
Related party transactions
Complex transactions
Impairments
10-4
 10-5
Investment and Finance
Activities
Financial Planning
Raise capital
Operate business (all other cycles)
Mergers and acquisitions
Invest excess funds
 10-6
Exhibit 10.2
Finance and Investment Cycle
 10-7

Control Considerations
Transactions authorized by BOARD OF DIRECTORS
Documentation:
Investments in securities: BROKER'S ADVICE
Property, plant and equipment: VENDOR'S INVOICE
(for purchased PPE) or INTERNAL COST RECORDS
(for manufactured PPE)
Bonds and notes payable: Documentation from
DEBTHOLDERS
Stockholders' Equity: Documentation from REGISTRAR
CASH RECEIPTS/DISBURSEMENTS JOURNALS
 10-8
Finance and Investment Cycle:
Control Procedures
Physical Controls
Securities numbered and in the client's name
Securities held by an independent custodian or in a secure location
Access to safe-deposit box requires the presence of more than one
employee
Physical items periodically compared to detail records
Cash receipts from Investing and Financing cycle transactions
deposited intact and daily
Separation of Duties
Transactions AUTHORIZED by the Board of Directors
General Accounting RECORDS transactions
A separate function or external custodian has CUSTODY
Performance Reviews
Compare current investing and cycle transaction data against prior-year
data or expected data
Compare revenue and expenses against organization standards or
expectations.
 10-9
CONTROL OVER
ACCOUNTING ESTIMATES
Communication of need for estimate
Accumulate data
Qualified personnel
Review and approval
Comparison to results
Compare with plans
 10-10
SUBSTANTIVE TESTSINTEREST-
BEARING LIABILITIES
Agree to BEGINNING BALANCE and CONFIRM with
holders or makers.
LOAN PROCEEDS
VOUCH to cash receipts
Recalculate Discount/Premium
Confirm IBL, examine note
LOAN PAYOFF
Recalculate Interest Expense
Recalculate Gain/Loss on Retirement
Verify cash disbursements
 10-11
INTEREST-BEARING
LIABILITIES
INTEREST PAYMENTS
Recalculate Interest Expense
Search for UNRECORDED liabilities
Inquiry of management
Bank confirmations
Unusual amounts of interest expense
Large receipts of cash during the year
Ensure DEBT COVENANTS are met.
Inspect loan agreements.
Consider GOING CONCERN implications if not met.
Ensure proper presentation and disclosure.
 10-12
Exhibit 10.4
Audit Documentation
 10-13
AUDITING STOCKHOLDER'S
EQUITY
Overview of audit approach
EXTERNAL PARTIES involved in record keeping
Transactions must be authorized by the BOARD OF
DIRECTORS
Transactions must be consistent with the client's
ARTICLES OF INCORPORATION
 10-14
AUDITING STOCKHOLDER'S
EQUITY
PAID-IN CAPITAL
Agree balances to prior year documentation
Examine issuances and repurchases of capital stock
Verify distribution of proceeds between CAPITAL STOCK
and ADDITIONAL PAID-IN CAPITAL
Examine CASH RECEIPTS and CASH DISBURSEMENTS
records
Determine that all transactions are RECORDED (TRACE
from BOD minutes)
Verify that all transactions are PROPERLY AUTHORIZED
 10-15
AUDITING STOCKHOLDER'S
EQUITY
RETAINED EARNINGS
Agree beginning balance with prior year documentation
Verify the appropriateness of prior-period adjustment
treatment
Trace net income/loss to INCOME STATEMENT
Ensure that DIVIDENDS are properly authorized by
BOARD OF DIRECTORS
 10-16
Auditing Investments:
Substantive Procedures
Agree balances to Prior Year Documentation
Purchases of investments
VOUCH to BROKER'S ADVICE (Statement)
Examine BOARD MINUTES for authorization
Sales of investments
VOUCH to BROKER'S ADVICE, CASH RECEIPTS
RECORDS, and BOARD MINUTES
Recalculate gain or loss on sale
Read minutes for sales of Investments and trace to
recording
 10-17
Auditing Investments:
Substantive Procedures (cont.)
Determine MARKET VALUE (SFAS 115)
Obtain 12/31 market price from Wall Street Journal or other sources
Evaluate for possible PERMANENT DECLINES
PHYSICALLY INSPECT or CONFIRM securities Verify Certificate
Numbers to ensure that there were no unrecorded sales and subsequent
repurchases
Made in company name
Can inspect at interim, if safe-deposit box
Verify DIVIDEND REVENUE
Examine CASH RECEIPTS records
Compare to external sources (Moody's, Standard & Poor's)
Evaluate presentation in BALANCE SHEET (short-term vs. long-term
asset)
 Trouble Spots in Audits of 10-18

Investments

Valuation of investments at cost, market, or value

impairment that is other than temporary.
Propriety, effectiveness, and risk disclosure of
derivative securities used as a hedges
Determination of the fair value of derivatives and
securities, including valuation models and the
reasonableness of key assumptions.
Determination of significant influence relationship
for equity method investments.
 10-19
Derivative Investments, Hedging Activities,
and Investments in Securities (SAS 92)
Inquiries about the nature of investments and the reasons
for holding them, especially hedging activities.
The classification affects the accounting treatment of
market values and the unrealized gains and losses on
investments.
Due to the complexity of SFAS 133 (Accounting for
Derivative Securities and Hedging Activities), auditors
may need special skills or knowledge to understand client
hedging transactions, to ensure that effective controls are
in place to monitor them, and to audit the transactions.
 10-20
Auditing Fair Value
Measurements (SAS 101)
Managements responsibility.
Market-based values preferred
If not availableuse assumptions market
would have used.
If not knownmanagement can use their
own assumptions
if no contrary data