AP-8:

Company

Audit Program for Investments

Balance Sheet Date

The company has the following general ledger accounts that are classified in the investments captions of the balance sheet: General Ledger Number

Description or Brief Purpose of the ccount

Current or Noncurrent sset!

udit Program for "nvestments Company Balance #heet Date

udit $b%ectives udit Procedures for Consideration *"N NC" L #T T+,+NT ##+-T"$N# +&$ +)istence or occurrence. allocation. C Completeness. /& P&D /aluation or Presentation

N& 'or(paper Performed "nde) by

and disclosure. -&$ -ights and obligations. 0D"T $B1+CT"/+# . The balances reflect a complete listing of investments2 and the company3s ownership of such assets is evidenced by securities or other appropriate legal documents either physically on hand or held in safe(eeping by others 4assertions +&$2 C2 and -&$5. B. sset values2 investment income or loss2 valuation allowances2 gains or losses on sales of investments2 and changes in fair value are recorded and presented in accordance with G P 4assertion /& 5. C. "nvestments are properly described and classified in the balance sheet2 and disclosures have been made for any restrictions2 pledges2 or liens against the assets. The disclosures re6uired by G P have been made 4assertion P&D5. D. Derivatives are properly identified and measured as assets or liabilities2 and changes in fair value are recorded and presented in accordance with G P. The disclosures re6uired by G P have been made 4assertions +&$2 C2 -&$2 /& 2 and P&D5. IDENTIFI ATI!N !DES The letters preceding each of the above audit ob%ectives2 i.e.2 2 B2 etc.2 serve as identification codes. These codes are presented in the left column labeled 7 udit $b%ectives8 when a procedure accomplishes an ob%ective. "f the alpha code appears in a brac(et2 e.g.2 9 :2 9B:2 etc.2 the audit procedure only secondarily accomplishes the ob%ective. "f an asteris( precedes a procedure2 it is a preliminary step or a follow up step that does not accomplish an ob%ective. B #"C P-$C+D0-+# ;. 2 B2 C a. $btain or prepare an analysis of activity during the year in the securities portfolio separated by classification type 4trading2 held<to<maturity2 or available<for<sale5. Test the clerical accuracy of the analysis. Trace the opening balances to the ad%usted prior year wor(ing trial balance and the ending balances to the current *or debt and e6uity securities:

year3s wor(ing trial balance. b. "nspect the securities on hand and confirm securities held by others. -etain copies of all confirmations in the wor(papers. 4;5 The inspection should be performed in the presence of client personnel. $btain a receipt evidencing the return of the securities to the custody of the client. 4#ee CL<;=2 7-eceipt for #ecurities Counted by uditor.8) 4>5 Determine that the securities are made out to the client and that coupons2 if appropriate2 are attached. 4?5 Compare the securities inspected or confirmed to the portfolio activity obtained in #tep ;a. c. /ouch the cost of significant purchases and the proceeds from significant sales. Document the items tested. -ecompute the gain or loss from the sale of securities2 noting that the method used in determining the cost of securities sold 4specific identification@ first<in2 first<out@ or average cost5 was consistently applied. d. Test the reasonableness of current year dividend and interest income from investments if such income is material. "nspect published sources for dividends declared. Determine if dividends receivable should be accrued. -ecompute amortiAation of discount or premium on bonds. e. Test the carrying value of the security portfolio.

4;5 Test the propriety of the classification of securities as trading2 held<to<maturity2 or available<for<sale. 4>5 Trace mar(et values to published sources.

4?5 -ecompute the unrealiAed gain or loss for each classification. 4B5 Determine that the unrealiAed gain or loss on the trading portfolio has been properly classified in the income statement and that the unrealiAed gain or loss on the available<for<sale portfolio

has been properly classified in the e6uity section of the balance sheet. 40nrealiAed holding gains and losses on the available<for< sale portfolio should be reported as other comprehensive income.5 4=5 Determine that all transfers between the portfolios have been properly recorded in accordance with management3s authoriAation and note pertinent information for the management representation letter. 4C5 Determine that any other<than<temporary decline in value of securities available<for<sale or held<to<maturity has been properly recogniAed and accounted for. 4D5 Determine that unrealiAed gains and losses have been appropriately identified as temporary differences for purposes of computing deferred income ta)es. f. *rom a review of ban( confirmations2 debt confirmations2 debt agreements2 directors3 minutes2 in6uiry of management2 and physical inspection or confirmation of securities2 determine whether any security has been pledged or assigned to others to secure debt. #ummariAe any such situations for disclosure. g. -eview classification of securities as current or noncurrent.

h. #ummariAe in the wor(papers the financial statement disclosures re6uired by #* # No. ;;=2 #* # No. ;ED2 and #* # No. ;??. i. $btain a representation in the representation letter relating to the entity3s ability and intent to hold investments classified as held<to<maturity. n e)ample representation letter is provided at CL<>F. Practical Considerations: ,ost commercial businesses not in the financial services industry have limited investments in securities. ccordingly2 this financial statement caption is usually immaterial. These procedures should only be performed if the company has material investments in securities.

 $ften a company3s security activity can be obtained from monthly activity reports prepared by the bro(er who handled the trades. Photocopies of these documents can sometimes be used in lieu of preparing a separate wor(paper schedule. "f the company3s investments are held by a bro(er&dealer or ban( trust department2 consider whether a # # No. DE report on the service organiAation is needed to gain a sufficient understanding of internal control in order to plan the audit. #ee section >E>. # # No. GC2 udit Documentation2 re6uires documentation of substantive tests of details involving inspection of documents to include identification of the items tested. The authors believe items tested can be identified by listing the items@ by including a detail schedule in the wor(papers2 such as a detailed analysis of securities activity2 on which the items are identified@ or by documenting in the wor(papers the source and selection criteria. *or e)ample: *or tests of significant items2 documentation may describe the auditor3s scope and the source of the items 4for e)ample2 all securities purchases greater than H=2EEE from the >EI> portfolio activity analysis5. *or haphaAard or random samples2 documentation should include the identifying characteristics of the items 4for e)ample2 the specific remittance numbers2 chec( numbers2 etc.5. *or systematic samples2 documentation may indicate the source2 starting point2 and sampling interval 4for e)ample2 a selection of chec(s from the cash disbursements %ournal for the period ;&;&I> to ;>&?;&I>2 starting with chec( number >;=E and selecting every ;EEth chec( thereafter5. # # No. GC is effective for audits of financial statements for periods beginning on or after ,ay ;=2 >EE>2 with early application permitted. #* # No. ;;= 4as interpreted by * #B Technical Bulletin No. GB<;5 re6uires that all debt securities and e6uity securities with readily determinable fair values be classified into one of three categories based on 4;5 the type of security and 4>5 management3s ability and intent to hold the investment. ccording to Paragraph F? of #* # No. ;;=2 the classification of debt and e6uity securities

should be documented by the entity. "n evaluating management3s intent and ability regarding investment classification2 the auditor should: $btain an understanding of management3s process for classifying securities as trading2 available<for<sale2 or held<to< maturity. Consider whether the company3s past activities corroborate or conflict with its stated intent. *or e)ample2 the auditor should 6uestion management3s intent if the company has sold investment securities classified as held<to<maturity for reasons other than those identified in #* # No. ;;=2 Paragraphs F and ;;. "nspect documentation of management3s intent. 4Documentation of the classification of debt and e6uity securities may be informal.5 Determine whether management3s activities2 contractual agreements2 or the company3s financial condition provide evidence of management3s ability to hold the investment. #* # No. ;?E2 -eporting Comprehensive "ncome2 re6uires unrealiAed gains and losses on securities classified as available<for< sale to be recogniAed as a separate component of other comprehensive income. PPC3s Guide to Preparing *inancial #tatements includes guidance on reporting comprehensive income. uditors should determine whether G P specifies the method to be used to determine fair value and whether the company3s determination of fair value is consistent with the specified method. *or e)ample2 if a 6uoted mar(et price is available2 #* # No. ;;= re6uires fair value to be determined using the number of trading units of a security times the 6uoted mar(et price. "f the auditor is unable to corroborate fair value from 6uoted mar(et prices 4for e)ample2 for securities that do not trade fre6uently52 the auditor should consider obtaining estimates of fair value from bro(er<dealers or other third<party sources. "f fair value

estimates are obtained from bro(er<dealers or other third<parties2 the auditor should consider the guidance in # # No. DE2 #ervice $rganiAations2 or # # No. D?2 0sing the 'or( of a #pecialist. 4The general procedures program at P<; includes additional procedures addressing the use of a specialist.5 "f a security is valued using a valuation model2 such as the present value of future cash flows2 auditors should perform procedures such as assessing the reasonableness and appropriateness of the model2 developing an independent e)pectation of the fair value estimate2 or comparing the fair value with subse6uent or recent transactions. uditors should consider the guidance in # # No. =D2 uditing ccounting +stimates2 on obtaining and evaluating evidence supporting significant accounting estimates and # # No. D? on using the wor( of a specialist. Jowever2 a valuation model should not be used to determine the fair value of securities that are re6uired to be valued using 6uoted mar(et prices. 'hen inspecting securities2 it is important not to be left alone with the securities. lso2 it may not be necessary to inspect all securities2 for e)ample2 while individually significant items should be e)amined2 it may not be necessary to e)amine all other securities. "llustrations of confirmation letters for securities in safe(eeping at outside locations are presented at CL<;C and CL<;D. "nvestments should be confirmed and inspected as of the same date. lso2 assets held at multiple facilities should be inspected simultaneously. This ensures that assets are not moved from one location to another to ma(e it appear that all assets are properly accounted for. "f the auditor2 based on his or her consideration of fraud ris( factors2 decides to modify procedures related to investments2 the auditor should consider evaluating the legitimacy and financial viability of the custodian when confirming material investments. This includes verifying the proper address of the custodian. 'hen inspecting security certificates2 the auditor should insist on seeing originals rather than copies. The auditor should also consider whether securities in the hands of an outside custodian2 such as securities held by a bro(er2 are susceptible to theft by means of

instructions to the bro(er to ma(e trades that can be allocated to another entity or individual. The auditor should usually confirm the description of each asset held by a third party as well as the par or principal amount2 number of shares2 and total amount of the investment. "f the auditor2 based on his or her consideration of fraud ris( factors2 decides to modify procedures related to investments2 consider confirming all transactions during the period with the bro(er2 including purchases2 sales2 dividend and interest collections2 and interest and other e)penses paid. The confirmation may also see( verification of additional information such as who is authoriAed to ma(e investment transactions2 where interest and dividend dollars are sent2 etc. ,any small businesses do not have the internal ability to properly record transactions for significant portfolios of securities. Thus2 the auditor normally is re6uired to propose entries necessary to ad%ust the general ledger for accounting treatment necessary under G P. Consider using your paraprofessional staff prior to the start of the audit to perform this wor( and to prepare necessary schedules. #* # No. ;;= states that debt securities should not be classified as held<to<maturity if the entity has the intent to hold the security for only an indefinite period. *or e)ample2 securities should not be classified as held<to<maturity if the security will be available to be sold in response to changes in the following: ,ar(et interest rates and prepayment ris(. Li6uidity demands. vailability or yield of alternative investments. *unding sources and terms. *oreign currency ris(.

"n addition2 #* # No. ;BE2 ccounting for Transfers and #ervicing of *inancial ssets and +)tinguishments of Liabilities2

precludes a security from being classified as held<to<maturity if contract terms allow for the debt security to be repaid or otherwise settled in such a way that results in the holder not recovering substantially all of its recorded investment. 'hen determining whether an other<than<temporary impairment condition e)ists2 the auditor should evaluate whether management has considered relevant information to determine the e)istence of the following factors: *air value is significantly below cost and:

K The decline in fair value can be attributed to adverse conditions specifically related to the security or to specific industry or geographic conditions. K The company does not have the ability or intent to hold the investment for a sufficient time period to allow for any anticipated recovery in fair value. K The decline in fair value has e)isted for an e)tended period of time. rating agency has downgraded a debt security3s rating.

The financial condition of the security3s issuer has deteriorated. #cheduled interest payments on debt securities have not been made or dividends have been reduced or eliminated on e6uity securities. Losses from the security have been recorded by the company subse6uent to year end. +vidence should be obtained about these factors and auditors should consider whether the evidence corroborates or conflicts with management3s conclusion about whether an other<than<temporary impairment e)ists.

 'hen testing the propriety of classifying debt securities as held<to<maturity2 the auditor should evaluate whether the company has the ability to hold debt securities until maturity. Consideration should be given to the following factors: The company3s financial position2 wor(ing capital needs2 and operating results. Debt agreements2 guarantees2 alternate sources of li6uidity2 or other contractual obligations. 2 B2 C Laws or regulations. +)isting operating and cash flow pro%ections or forecasts.

>. *or investments in closely held corporations2 partnerships2 or %oint ventures: a. Determine the proper method of accounting for the investment 4cost2 e6uity2 or consolidation5 by in6uiry about management3s ability to e)ercise significant influence and by inspecting appropriate securities or legal documents supporting ownership. "nclude in the current or permanent wor(paper files abstracts or copies of significant agreements e)amined to evaluate appropriate accounting. b. +)amine the latest copies of the financial statements or ta) return of the investee to determine the materiality of the investee operations to that of the client. "f the investment is material2 or if the financial statements of the investee have a significant effect on the client3s carrying value of the investment2 perform additional procedures. Practical Considerations: *or most small businesses2 investments in closely held businesses are immaterial and the above procedures are normally ade6uate. Jowever2 additional procedures should be performed when such investments are material. ,anagement3s inability to obtain information from an investee may suggest that the client does not have the ability to e)ercise

significant influence. "f an investment is accounted for contrary to the presumption established by G P for use of the e6uity method 4for e)ample2 if an investment of >EL to =EL is accounted for using the cost method52 auditors should obtain evidence supporting that the presumption has been overcome and should determine that the reasons for not following the presumption are appropriately disclosed. D ?. "n6uire of the most (nowledgeable client representative 4in a larger company2 this may be the treasurer5 about the e)tent of the company3s derivative use2 the types of derivatives used2 and the company3s purpose in using these instruments. Practical Considerations: The auditor3s in6uiries should address aspects of the company3s operations that might present ris(s hedged using derivatives. -is(s hedged using derivatives may be present2 for e)ample2 if the company is in the financial services industry2 conducts business with foreign entities2 or is in an industry where commodity contracts are common. uditors should also in6uire about whether the company has converted interest<bearing debt from fi)ed to variable or variable to fi)ed using derivatives. +)amples of derivatives include commodity or financial put or call options@ commodity2 financial instrument2 or foreign<currency forwards or futures@ and interest<rate or other swaps2 caps2 or collars. Derivatives may be used for ris( management 4for e)ample2 fair value2 cash flow2 or foreign currency hedges5 or for investment. Derivatives may be freestanding contracts or may be embedded in other contracts. #ection ;EE> discusses common uses of derivatives in more detail. "f the entity has significant derivative transactions2 see the additional procedures to this program for further evaluation. "f the company is in a specialiAed industry2 such as an investment company2 hedge fund2 or bro(er<dealer2 or if the company engages in derivatives trading activities2 additional procedures generally will be necessary. uditors can also refer to the specialiAed industry audit guides published by the "CP for

guidance on auditing companies in specific industries2 such as securities bro(er<dealers or investment companies. # # No. G>2 uditing Derivative "nstruments2 Jedging ctivities2 and "nvestments in #ecurities2 provides guidance for auditing derivatives. The "CP has issued a companion udit Guide that provides practical guidance and includes suggested procedures to clarify and illustrate the application of the re6uirements of # # No. G>. M B. Consider the need to apply one or more additional procedures. The decision to apply additional procedures should be based on a consideration of whether information obtained or misstatements detected by performing substantive tests or from other sources during the audit alter your %udgment about the need to obtain a further understanding of control activities2 the assessed level of ris( of material misstatements 4whether caused by error or fraud52 and on an evaluation of whether the basic procedures have been sufficient to achieve the audit ob%ectives. ttach audit program sheets to document additional procedures. Practical Considerations: Certain common additional procedures relating to the following topics are illustrated following this program: "nvestments in closely held corporations2 partnerships2 or %oint ventures. *air value disclosures. Derivatives. dditional procedures in response to fraud ris( assessment.

Practitioners may refer to PPC3s Guide to *raud "nvestigations for more e)tensive fraud detection procedures if it is suspected that the financial statements are materially misstated due to fraud. M =. Consider whether procedures performed are ade6uate to respond to identified fraud ris( factors. "f fraud ris( factors or other conditions are identified that re6uire an additional audit response2 consider those ris( factors or conditions and the auditor3s response

in connection with the performance of #tep ;; in P<;b. Practical Consideration: #pecific responses to identified fraud ris( factors are addressed in individual audit programs. "n connection with evaluation and other completion procedures in P<;b2 the auditor considers the need to perform additional procedures based on the results of procedures performed in the individual audit programs and the cumulative (nowledge gained from performing those procedures. M C. Consider whether the results of audit procedures indicate reportable conditions in internal control and2 if so2 add to the memo of points for the communication of reportable conditions. 4#ee section ;=EB for e)amples of reportable conditions2 and see CI<;F for a wor(sheet that can be used to document the points as they are encountered during the audit.5 C$NCL0#"$N 'e have performed procedures sufficient to achieve the audit ob%ectives for investments and related allowance accounts2 and the results of these procedures are ade6uately documented in the accompanying wor(papers. 4"f you are unable to conclude on any ob%ective2 prepare a memo documenting your reason.5

Additional Audit Procedures for Investments

"nstructions: dditional procedures will occasionally be necessary on some small business engagements. The following listing2 although not all<inclusive2 represents common additional procedures and their related ob%ectives.

"nvestments in Closely Jeld Corporations2 Partnerships2 or 1oint /entures 2 B2 C *or material investments in closely held corporations2 partnerships2 or %oint ventures2 perform the following procedures: a. /ouch the client3s ownership interest by inspecting appropriate securities or legal documents supporting ownership. b. "n6uire as to whether the client has the ability to e)ercise significant influence over financial and operating policies of the investee and the basis for the conclusion. +valuate the results of the in6uiry in relation to facts obtained during the audit. c. Based on the information obtained in #teps a and b2 determine the proper accounting method for recording the investment2 i.e.2 full consolidation2 e6uity method2 or cost. "f the method has changed because of a change during the year in ownership interest2 determine the effect on the auditor3s report and financial statements2 for e)ample2 e)planatory paragraph referring to the change and disclosure in the notes. d. *or investments accounted for using the cost method2 vouch the cost 4unless it was vouched previously5. -eview the latest financial statements of the investee2 ma(e in6uiries of management2 etc.2 to determine if there has been any other<than< temporary decline in value of the investment. *rom a review of ban( confirmations2 debt confirmations2 debt agreements2 minutes and in6uiries of management2 determine whether the investment has been pledged or assigned to others to secure debt. e. *or investments accounted for using the consolidation or e6uity method: 4;5 "nspect audited financial statements of the investee to verify the carrying value of the investment and the current year income or loss attributed to such investment. "f such statements are not available2 obtain unaudited financial statements or ta) returns of the investee and apply appropriate audit procedures to test the reasonableness of the carrying value of the investment and the current year income or loss attributed to such investment. 4>5 Determine that the financial statements of the investee are on the same accounting basis as your client and that the fiscal year

end of the investee coincides with your client3s 4or is within three months5. 4?5 Test the accuracy and completeness of the client3s entry4ies5 to consolidate or to record the investment on the e6uity basis. 4a5 "f the consolidation method is used2 test the propriety of eliminating entries for intercompany profit. lso determine that the auditor3s report2 financial statements2 and related notes are appropriate for consolidated financial statements. 4b5 "f the e6uity method is used2 tie current year3s income or loss recognition 4after eliminating significant intercompany profit5 to the appropriate revenue account. 4B5 +valuate the effect on the client3s financial statements of report 6ualifications2 contingencies2 etc.2 of the investee. 4This is appropriate for both the consolidation and e6uity methods.5 4=5 Determine that any other<than<temporary decline in value of investments accounted for using the e6uity method have been properly recogniAed and accounted for. 4C5 To identify subse6uent events or transactions occurring after the date of the investee3s financial statements but before the date of the report on the company3s financial statements2 read available interim financial statements of the investee and ma(e necessary in6uiries of the client3s management. 4D5 $btain evidence of material transactions between the client and the e6uity investee to determine if intercompany profits and losses are properly eliminated and appropriate related<party disclosures are made in the client3s financial statements. 4F5 Determine that differences in boo( and ta) recognition of income and losses are identified for purposes of computing deferred ta)es. 4G5 #ummariAe in the wor(papers the information needed to prepare the re6uired note disclosures. Practical Considerations:

# # No. G>2 uditing Derivative "nstruments2 Jedging ctivities2 and "nvestments in #ecurities2 establishes the audit re6uirements for significant long<term investments. +vidential matter e)amined for such investments normally should include audited financial statements of the investee. "f unaudited data is used2 the auditor should apply appropriate audit procedures to such data. "f another audit firm performs the audit or additional procedures on the investee2 the investor3s auditor should also consult # # No. ;2 0 =B?2 Part of udit Performed by $ther "ndependent uditors. *inancial statements of an investee that have been audited by an auditor whose report is satisfactory to the investor3s auditor may constitute sufficient evidential matter in support of the carrying value of an investment and the current year income or loss attributed to the investment. "f the auditor determines that additional evidence is needed2 however2 he or she should perform additional procedures such as reviewing information about the investee in the investor3s files and ma(ing in6uiries of investor management about the investee3s financial results. "f the audit report on the investee3s financial statements is not satisfactory to the investor3s auditor2 he or she should apply2 or arrange to have another auditor apply2 appropriate audit procedures to such data. "f the carrying amount of the investment in the investor3s financial statements reflects factors that are not recogniAed in the investee3s financial statements2 such as goodwill or fair values of assets that differ materially from the investee3s carrying amounts2 auditors should obtain sufficient evidence to support those amounts. n often overloo(ed problem of applying consolidation or e6uity accounting to an investment in another company is forgetting to determine if the investor and the investee are on the same basis of accounting. "f the financial statements of the investor are on the accrual basis2 the financial statements of the investee should also be on the accrual basis. "f the basis of accounting of the investee is not converted to agree with the investor before applying consolidation or e6uity accounting2 and the auditor believes the effect is material2 the auditor3s report should be 6ualified for a departure from G P. Jowever2 if the investee operates in a specialiAed industry that follows a specialiAed basis of accounting2 that basis of accounting should be retained in the financial statements of the investor.

 nother often as(ed 6uestion is whether the date of the results of operations of the investor must coincide with the results of operations of the investee. "n other words2 if the financial statements of the investor are dated December ?;2 >EI;2 must the e6uity in earnings of the investee also be recorded through December ?;2 >EI;! -B =; indicates that where the difference is not more than about three months2 it usually is acceptable to use the investee3s statements for its fiscal period@ when this is done2 recognition should be given by disclosure or otherwise to the effect of intervening events that materially affect the financial position or results of operations. The investor3s share of losses of an investee may e6ual or e)ceed the carrying amount of an investment accounted for by the e6uity method. The investor normally should discontinue applying the e6uity method when the investment is reduced to Aero. Jowever2 PB $pinion No. ;F also states that if the investor has guaranteed obligations of the investee or is otherwise committed to provide further financial support2 losses should continue to be recorded by the investor to the e)tent of additional funds committed. 4#ee also "CP Technical Practice id T"# >>>E.;>.5 n investment that has been reduced below Aero should be presented as a liability in the balance sheet of the investor. 'hen accounting for investments in other entities2 the auditor should also be aware that an 7e)cept for8 6ualification or disclaimer in the audit report on the investee3s financial statements2 if material2 could affect the report on the investor3s financial statements.

*air /alue Disclosures C $btain information about the fair values of financial instruments 4e.g.2 securities and investments in closely held companies other than those accounted for under the e6uity method5 for disclosure in the financial statements. Practical Considerations: #* # No. ;>C2 +)emption from Certain -e6uired Disclosures about *inancial "nstruments for Certain Nonpublic +ntities: n mendment of #* # No. ;ED2 ma(es #* # No. ;ED3s disclosures

about the fair value of financial instruments optional for companies that meet the following criteria: The company is a nonpublic company.

The company3s total assets are less than H;EE million on the date of the financial statements. The company has no instrument that2 in whole or in part2 is accounted for as a derivative instrument under #* # No. ;?? during the reporting period. "n many small businesses2 securities are not material. Jowever2 when they are material2 fair value will already have been determined to comply with the re6uirements of #* # No. ;;=. *or investments classified as trading securities or available<for<sale securities under #* # No. ;;=2 the only additional disclosures re6uired by #* # No. ;ED are of the methods and significant assumptions used in the fair value estimate. *or investments classified as held<to<maturity under #* # No. ;;=2 disclosure of fair value would also be needed. "n most small businesses2 determination of the fair value of investments in closely held companies is not practicable and2 thus2 is not re6uired under #* # No. ;ED. #* # No. ;ED does not apply to investments accounted for by the e6uity method. Jowever2 when a 6uoted mar(et price is available2 PB $pinion No. ;F re6uires disclosure of the mar(et value of such investments. Paragraph CE of #* # No. ;ED allows companies to use simplified assumptions to estimate fair value of financial instruments. Conse6uently2 it is important that the methods and significant assumptions used in the estimates are disclosed. #* # No. ;ED states that 76uoted prices2 if available2 are the best evidence of fair value of financial instruments.8 Jowever2 it does not specify whether the bid price2 the as(ed price2 or some combination of the two 6ualifies as the 6uoted price. #ome entities use the last bid price on the balance sheet date to estimate the fair value of assets. No matter which value is selected2 the authors recommend that the method used be disclosed.

 "nterpretation No. ; of # # No. =D2 uditing ccounting +stimates 4 0 G?B>52 addresses auditing the client3s fair value estimates for disclosures re6uired by #* # No. ;ED. The "nterpretation re6uires that the auditor obtain sufficient competent evidence to provide reasonable assurance that: /aluation principles are in accordance with #* # No. ;ED2 consistently applied2 and supported by underlying documentation. The method of estimation and significant assumptions used are properly disclosed. 0 G?B> provides additional guidance for situations in which the client chooses to provide voluntary fair value information in addition to that re6uired by #* # No. ;ED. #* # No. ;ED does not re6uire that fair values of financial instruments be estimated if it is not practicable2 or cost effective2 to develop the estimates. The decision of whether it is practicable should consider such things as the importance of the financial instrument to the client3s business activities and the materiality of the carrying amount of the financial instrument to the financial statements. 'hen it is not practicable to estimate the fair value of a financial instrument2 disclosure must be made of: "nformation pertinent to estimating the fair value of the financial instrument. The reasons why it is not practicable to estimate fair value.

"f a fair value estimate is based on the wor( of an outside specialist 4e.g.2 an appraiser52 the re6uirements of # # No. D?2 0sing the 'or( of a #pecialist2 should be followed. The additional procedures to P<; contain audit procedures regarding using the wor( of a specialist.

Derivatives

*or entities with significant derivative transactions2 perform the following steps: a. -ead board of directors3 minutes for approval of derivatives transactions. b. -ead loan agreements2 bond indentures2 lease agreements2 insurance contracts and other relevant contracts to identify embedded derivatives. Determine whether embedded derivatives should be accounted for separately from the host contract in accordance with #* # No. ;??. "nclude in the current or permanent wor(paper files abstracts or copies of significant agreements e)amined to evaluate the appropriate accounting for embedded derivatives. c. Confirm with counterparties or e)ecuting bro(ers the outstanding transactions as of the balance sheet date. Consider also confirming with counterparties or e)ecuting bro(ers the derivatives activity during the year. #can derivatives activity and compare it with the description of the entity3s use of derivatives provided by the client. -etain copies of all confirmations in the wor(papers. d. Compare the terms of individual transactions with contracts or trade tic(ets. e. *or derivatives designated as hedging instruments:

4;5 Determine that the hedged item meets the #* # No. ;?? criteria for designation as a hedge. 4>5 -eview the company3s documentation of the hedging relationship to ensure it meets the documentation re6uirements of #* # No. ;??. 4?5 $btain an understanding of the methods used to determine whether the hedge is highly effective and to determine the ineffective portion of the hedge. Determine that management has assessed the effectiveness of the hedging relationship at inception and whenever financial statements are prepared2 or at least every three months2 noting that the method of assessing hedge effectiveness is the same as the criteria prescribed by the documentation prepared at the inception of the hedge.

f.

Test the valuation of the derivatives at year end.

4;5 Trace fair values to 6uoted prices2 if available 4for e)ample2 6uoted mar(et prices for derivatives listed on national e)changes and 6uoted mar(et prices from bro(er<dealers who are mar(et ma(ers5. "f 6uoted mar(et prices are not available2 perform appropriate tests based on the valuation method used. 4>5 Test the measurement of the realiAed and unrealiAed gain or loss for derivative contracts. 4?5 Determine whether the unrealiAed gain or loss on the instruments has been properly classified. 4B5 "f the derivative has been designated as a fair value hedge2 determine that the change in fair value of the hedged item has been accounted for in accordance with #* # No. ;??. 4=5 *or cash flow hedges of forecasted transactions2 evaluate management3s determination about whether the forecasted transaction is probable of occurring. g. Consider whether counterparties have the financial strength to participate in the agreement. h. #ummariAe in the wor(papers the financial statement disclosures re6uired by #* # No. ;??. i. $btain management representations regarding the e)istence and completeness of derivative transactions2 appropriate characteristics of hedges2 management3s intent and ability to enter into forecasted transactions for which hedge accounting is applied2 and proper valuation of derivatives. %. -eview ta) attributes of derivatives transactions in con%unction with overall ta) accrual audit procedures. Practical Considerations: #* # No. ;??2 ccounting for Derivative "nstruments and Jedging ctivities2 re6uires all entities to measure derivative instruments at fair value and recogniAe them as either assets or liabilities in the balance sheet. #* # No. ;?? also includes significant disclosure re6uirements.

 derivative instrument may be a stand<alone contract or it may be embedded in another contract2 such as a loan agreement2 bond2 or lease agreement. "n some cases2 #* # No. ;?? re6uires the embedded derivative to be accounted for separately from the host contract. #ection ;EE> provides an overview of the accounting and auditing considerations related to derivatives. Chapter >E of PPC3s Guide to Preparing *inancial #tatements provides an in<depth discussion on accounting for derivatives. uditors should use the assessed levels of inherent ris( and control ris( for assertions about derivatives to determine the nature2 timing2 and e)tent of substantive tests of derivatives. # # No. G>2 uditing Derivative "nstruments2 Jedging ctivities2 and "nvestments in #ecurities2 provides e)amples of considerations that might affect the auditor3s assessment of inherent and control ris( for assertions about derivatives. uditors should identify2 understand2 and differentiate the ways the company uses derivatives and tailor auditing procedures for each type of use. The "CP udit Guide2 uditing Derivative "nstruments2 Jedging ctivities2 and "nvestments in #ecurities2 provides practical guidance for auditing derivatives. The udit Guide includes case studies covering various types of derivatives2 such as swaps2 options2 forwards2 and futures2 as well as embedded derivatives. The company3s documentation of the hedging relationship should include identification of the hedging instrument2 the hedged item2 and the nature of the ris( being hedged@ the company3s ris( management ob%ective and strategy for entering into the hedge@ and the method of assessing hedge effectiveness. Confirmations can be used as a substantive test of various assertions about derivatives. *or e)ample2 confirmations can be designed to obtain information about 4;5 settled or unsettled transactions with a counterparty2 4>5 valuation assertions or underlying assumptions2 4?5 the e)istence of side agreements that affect the company3s rights and obligations2 4B5 the terms of an agreement that significantly impact whether an embedded derivative is accounted for separately2 or 4=5 whether the contract will settle net or result in physical delivery.

 Because derivatives may not involve an initial net investment2 when designing tests for completeness2 auditors should not focus e)clusively on evidence relating to cash receipts and disbursements. #ubstantive tests for completeness include: Confirming the e)istence of special terms or side agreements.

Confirming the e)istence of derivatives with counterparties who are fre6uently used2 but with whom the accounting records indicate there are currently no derivatives. Performing analytical procedures.

"nspecting documentation for activity after year end that may indicate the e)istence of derivatives at year end. -eading other information2 such as the minutes of board of directors3 meetings. "n more sophisticated organiAations2 it may be difficult to limit audit ris( for assertions about the completeness of derivatives to an acceptable level without performing tests of controls. "f a service organiAation provides services that are part of the company3s information system for derivatives2 it may be difficult to limit audit ris( for assertions about the completeness of derivatives to an acceptable level without obtaining evidential matter about the operating effectiveness of the service organiAation3s controls. "f 6uoted mar(et prices are obtained from bro(er<dealers who are mar(et ma(ers for certain derivatives or through the National Nuotation Bureau2 special (nowledge may be re6uired to understand the circumstances in which the 6uote was developed. "f 6uoted prices are not available2 fair value estimates might be obtained from bro(er<dealers or other third<party sources2 or determined by the entity using a valuation model. "f the client determines the fair value by using a modeling techni6ue2 auditors should perform procedures such as assessing the reasonableness and appropriateness of the model2 developing an independent e)pectation of the fair value estimate2 or comparing the fair value with subse6uent or recent transactions.

 "f the fair value is obtained from a third<party source2 such as a pricing service2 the guidance in # # No. DE2 #ervice $rganiAations2 may apply. "f the third<party source derives fair value by using modeling or similar techni6ues2 the guidance in # # No. D?2 0sing the 'or( of a #pecialist2 may apply. "n evaluating the reasonableness of the fair value of derivatives calculated using a model2 auditors should concentrate on (ey factors and assumptions that are significant to the estimate2 sensitive to variations2 inconsistent with historical patterns2 or sub%ective and susceptible to bias. #ensitivity analysis of (ey factors may help determine how they affect the estimate. #* # No. ;?? does not provide an e)emption from the re6uirement to determine the fair value of derivatives 4for e)ample2 because it is not practicable to do so5. Thus2 companies are re6uired to determine fair value in all circumstances. /aluation techni6ues for measuring derivatives should be consistent with the ob%ective of measuring fair value. Chapter >E of PPC3s Guide to Preparing *inancial #tatements discusses common methods of determining the fair value of derivatives. +valuating evidential matter for assertions about derivatives may re6uire the use of considerable %udgment. "n situations re6uiring considerable %udgment2 auditors should consider the guidance in # # No. =D2 uditing ccounting +stimates2 and # # No. D?. *or cash flow hedges of forecasted transactions2 the determination about whether the forecasted transaction is probable of occurring should not be based solely on management3s intent. The probability should be supported by observable facts and circumstances such as: The fre6uency with which similar past transactions have occurred. The ability of the company2 both financially and operationally2 to carry out the transaction. The e)tent of the loss that could result if the transaction does not occur. The li(elihood of using transactions with substantially

different characteristics to achieve the same business ob%ectives.

dditional Procedures in -esponse to *raud -is( ssessment 2B "f the auditor2 based on his or her consideration of fraud ris( factors2 decides to modify procedures related to investments2 the following procedures should also be considered: a. $btain and review all contracts2 agreements2 and other documents related to investments2 including actual stoc( or bond certificates2 bro(er3s statements2 and other applicable documents. $btain an analysis of investment activity for the period. Practical Consideration: "f possible2 these documents should be obtained from a source other than the employee responsible for the custody and recording of investments and related activity. The analysis of investment activity should be obtained directly from e)ecuting bro(ers. b. Perform analytical procedures that are predictive tests of investment<related income and e)penses. Practical Consideration: These analytical procedures generally involve recalculation of investment income and e)pense based on balances2 rates2 and time lapsed. "f significant differences are noted between the predicted amount and the recorded amount2 the reasons for the differences should be identified. c. 0se the information obtained in #tep a above and from confirmation procedures 4see basic procedures #tep ;5 to trace all transactions 4both realiAed and unrealiAed5 to the appropriate accounts. Practical Consideration: This procedure should be used to match anticipated receipts of income or sales proceeds to actual receipts 4ban( memos2 deposit slips2 etc.5.

d. -eview all investment<related %ournal entries and trace to supporting documents if not already reviewed when performing procedures aOc. Practical Consideration: Practitioners may refer to PPC3s Guide to *raud "nvestigations for more e)tensive fraud detection procedures if it is suspected that the financial statements are materially misstated due to fraud.

Additional Audit Procedures for Investments Beginning Balance in Initial Audit

Company Balance Sheet Date

udit $b%ectives udit Procedures for Consideration Instructions: dditional procedures will be necessary in an initial audit. These procedures are applied to opening balances and differ depending whether you are relying on your review of a predecessor3s wor( or placing no reliance on a predecessor3s audit. 4#ection ;FE? discusses considerations when replacing a predecessor auditor2 including a discussion of what the term reliance means when used in this program.5 These procedures may be applied in con%unction with the basic procedures applied to the ending balance. The asteris(s preceding the procedures indicate that they are an intermediate step in achieving audit ob%ectives for the ending balance. M ;. "f a predecessor3s audit of the prior period3s financial statements is to be relied on: a. #can the predecessor3s wor(paper analysis of the activity in the securities portfolio during the prior period@ consider: 4;5 -easonableness of securities values.

N& 'or(paper Performed "nde) by

4>5 4?5

-easonableness of investment income. -easonableness of gains or losses on sales of securities.

4B5 ppropriateness of financial statement classification2 disclosure2 and valuation2 and the ade6uacy of the predecessor3s procedures to support these matters. b. #can the predecessor3s wor(papers for investments in closely held corporations2 partnerships2 or %oint ventures@ consider: 4;5 ppropriateness of the accounting method for the investment 4cost2 e6uity2 consolidation5 and the ade6uacy of the procedures supporting that determination. 4>5 -easonableness of the carrying value and any related income or loss and the ade6uacy of the procedures to support those amounts. 4?5 *or e6uity investments2 consider the ade6uacy of the procedures to support the investor3s ability to e)ercise significant influence2 allocation2 if any2 of original purchase cost between tangible assets and goodwill2 and appropriateness of increases 4income5 and decreases 4losses and dividends received5 since ac6uisition. c. #can the predecessor3s wor(papers for derivatives@ consider: 4;5 The ade6uacy of procedures performed to test for completeness. 4>5 The appropriateness of the accounting for derivatives designated as hedging instruments and the ade6uacy of procedures supporting that determination. 4?5 The reasonableness of the valuation of derivatives and the realiAed and unrealiAed gains and losses for derivative contracts and the ade6uacy of procedures to support those amounts. d. Consider whether any changes in classification or carrying

value made in the current period should have been made in prior periods. Practical Consideration: The ade6uacy of the predecessor3s procedures should be considered in light of the materiality of the investment. The materiality evaluation determines whether the basis of comparison should be the basic procedures or the additional procedures of the audit program for investments. M >. "f no reliance on a predecessor is planned or possible and the investment in mar(etable debt or e6uity securities is material: a. $btain or prepare a schedule of securities in the opening balance2 reconcile to the general ledger accounts2 and compare to the closing schedule of the current period. b. "n vouching significant sales during the current period2 trace to the opening schedule. c. #can any significant sales of securities in the prior period2 note the method of determining cost2 and compare to the method used in the current period. d. Consider whether any changes in classification or carrying value made in the current period should have been made in prior periods. Practical Consideration: These procedures supplement the additional procedures applied when the investment in securities is material in the current period. M ?. "f no reliance on a predecessor is planned or possible and an investment in a closely held corporation2 partnership2 or %oint venture is material: a. Consider whether any changes in the accounting method or recognition of impairment of value in the current period should have been made in prior periods.

b.

*or investments accounted for using the e6uity method:

4;5 "n6uire about whether the client3s ability to e)ercise significant influence has changed over the period the investment has been held. 4>5 Consider the appropriateness of the allocation2 if any2 of original purchase cost between tangible assets and goodwill. 4?5 #can a summary of the activity in the investment account from the original investment to the end of the current period. 4B5 Consider whether the inspection of the financial statements of the investee for the current period supports the reasonableness of the opening investment balance. Practical Consideration: These procedures supplement the additional procedures applied when an investment in a closely held corporation2 partnership2 or %oint venture is material. M B. "f no reliance on a predecessor is planned or possible and derivatives are material: a. $btain or prepare a schedule of derivatives in the opening balance2 reconcile to the general ledger accounts2 and compare to the closing schedule of the current period. b. Consider whether tests of activity in the current period provide evidence about the e)istence and valuation of derivatives in the opening balance. c. *or derivatives designated as hedging instruments2 evaluate whether the method of assessing hedge effectiveness is the same as the criteria prescribed by the documentation prepared at the inception of the hedge. d. *or cash flow hedges of forecasted transactions2 inspect evidence of the occurrence of those forecasted transactions. e. Consider whether any changes in classification or carrying

value made in the current period should have been made in prior periods. Practical Consideration: These procedures supplement the additional procedures applied when derivatives are material.