Investment Cycle Audits: Controls, Fair Value & Securities Testing Made Easy
Overview: The investment cycle often involves complex valuations, third-party custody, and fair value measurement. This guide walks through key audit steps, controls, valuation testing, and how to tackle impairment or pricing evidence challenges.
✅ Key Internal Controls
- Authorization: The board should authorize investment purchases or sales.
- Custody: Ideally use an independent third-party custodian; if not, maintain dual custody with periodic counts and reconciliation by someone independent.
- Recordkeeping: Handled by staff not involved in authorization or custody.
Controls must also cover classification (trading, AFS, HTM) and fair value measurement.
✅ Testing the Investment Balance
- Completeness: Search for unrecorded securities by examining transactions after year-end. Confirm all holdings with custodians or perform counts.
- Valuation: Foot listings by category, verify fair values using quoted market prices, recalculate amortized cost for HTM, test significant assumptions, and look for permanent impairment.
- Existence: Confirm securities with third parties and inspect on-hand certificates; reconcile interest earned to effective rates.
- Rights & Obligations: Use confirmations and review broker advices for ownership. Inquire about pledged securities.
✅ Testing Investment Transactions
- Use analytics to test dividend and interest income completeness.
- Review cutoff for purchases, sales, and income near year-end.
- Recalculate gains/losses and amortization.
- Ensure proper classification in OCI or net income per GAAP.
✅ Understanding Fair Value Levels
- Level 1: Quoted prices in active markets for identical items.
- Level 2: Observable inputs for similar items.
- Level 3: Unobservable inputs, using management’s models and assumptions.
Auditors must understand how fair value was determined and assess the appropriateness of assumptions. Consider using specialists if needed.
✅ Using Third-Party Pricing & Brokers
- Check the relevance and reliability of pricing services: method used, independence, and market activity.
- Broker quotes are stronger when they’re binding and from active market makers without disclaimers.
✅ Indicators of Impairment
- Fair value significantly below cost for extended periods.
- Adverse industry or issuer-specific conditions.
- Downgrades, reduced dividends, missed payments.
- Management’s intent and ability to hold must be evaluated.
✅ Final Presentation & Disclosure
- Verify that unrealized gains/losses are presented properly (e.g., OCI for AFS, earnings for trading).
- Review disclosures for clarity, accuracy, and completeness.
🔗 Helpful References
👉 Know your investments — test thoroughly, challenge assumptions, and ensure clear disclosures!
