ACCTG 025 Auditing and Assurance: Concepts and Applications 2

Module 1: Substantive Test of Investments

1.1 Classification, Initial Recognition and Measurement
Equity Instruments
At Fair Value through other At Fair Value through Profit or Loss
Comprehensive income
a. Securities held for trading
Securities not held for trading for which the
Inclusion elects to recognize change in fair value through b. Securities not held for trading for which the
other comprehensive income enterprise did not elect measurement at fair value
though other comprehensive income
Purchase price: transaction costs are taken to
Initial Recognition Purchase price plus transaction costs
profit or loss (Expensed outright)
Measurement after initial recognition Fair value Fair value
a. Unrealized gains and losses
Amount taken to other b. Realized gains and losses, with no recycling None
comprehensive income to profit or loss (but may be transferred to
Retained Earnings)
a. Dividends that are considered return on
Dividends that are considered return on investments
Amount taken to profit or loss
investments
b. Unrealized and realized gains and losses
Debt Instruments
At At Fair Value through Other
At Fair Value through Profit or Loss
Amortized Cost Comprehensive Income
Inclusion a. Debt investment held for trading
b. Debt investments held within the
Debt investments that are
Debt investment that are held within the business model of collecting contractual
held within the business
business model of collecting contractual cash flows consisting SPPI and which
model of collecting
cash flows and to sell, and which the enterprise elected to measure at fair value
contractual cash flows
enterprise elected to recognize the change in c. Debt investments held within the
consisting SPPI, and which
fair value through other comprehensive business model collecting contractual
the enterprise did not elect to
income cash flows and to sell, and which the
measure at fair value
enterprise did not elect to recognize the
change in FV through OCI
Initial Recognition At purchase price plus At purchase price; transaction costs are
At purchase price plus transaction costs
transaction costs taken to profit or loss
Measurement after At fair value, in a two-step process
initial recognition At amortized costs, using the
a. adjust to amortized costs At fair value
effective interest method
b. adjust to fair value through OCI
Amount taken to Unrealized gains and losses due to change
other comprehensive None in fair value with recycling to profit or loss None
income when realized
Amounts taken to a. Interest revenue for practicality based
a. Interest Revenue a. Interest revenue
profit or loss on nominal interest
b. Realized gains and losses b. Realized gains and losses (recycled from
b. Unrealized and realized gains and
including impairment loss cumulative OCI), including impairment loss
losses
1.2 INTERNAL CONTROL OVER INVESTMENT IN FINANCIAL INSTRUMENTS 1.3 Audit Objectives for Investments in Financial Instruments
The major elements of adequate internal control over the investment The auditor's objectives in the audit of investments in financial
securities focus on the following: instruments are to:
• Separation of duties between the custody of the instruments, the • Consider internal control over financial instruments held by the
maintenance of accounting records and the authorization of client (TOC)
purchases and disposals • Determine the existence of investments and that the client has
• Joint Control (of at least two officials) over the investment securities, rights to the instruments (Existence)
or the use of an independent outside entity custodian • Determine that all financial instruments held by the entity are
• Complete detailed records of all securities owned, and the related reported and that transactions affecting the investments are
revenue from interest and dividends properly accounted for. (Completeness)
• Registration of securities in the name of the company • Establish the proper measurement of investments in financial
• Periodic physical inspection of securities by an internal auditor or instruments (Valuation)
other independent official • Establish accuracy of the amounts recognized in profit or loss and
• Preparation of a budget of investment revenue other comprehensive income relating to investments (Accuracy)
• Formulation and implementation of investment policies • Determine that the presentation and disclosure of the investments
is adequate (Presentation and Disclosure)
ACCTG 025 Auditing and Assurance: Concepts and Applications 2
Module 1: Substantive Test of Investments
g. On December 1, Rosal declared P3 dividend per share on its
ordinary share, payable on January 15 to shareholders of record on
December 15, 2015
h. Fair values on December 31, 2015 were as follows:
Daisy ordinary share P22
Rosal Company share 35
Waling-waling ordinary share 28
ANALYSIS OF INVESTMENT IN EQUITY SECURITIES

1.4 Audit Procedures for Investments in Financial Instruments

These are the audit procedures that an auditor can perform to achieve
the audit objectives:
• Confirmation with trustee or broker the balances of the financial
instruments if its custody are in independent outside entity
(Existence or Occurrence)
• Physical inspection and count of all securities on hand
simultaneously (Completeness)
• Compare the serial number on securities with those recorded in the
prior year's audit working papers
• Confirmation with creditors for securities, held as collateral for loans,
to be directly mailed to auditor's office (Rights and Obligation)
• Cutoff Test of all investment transactions (Completeness)
• Analytical procedures such as recomputation of gains and losses
• Verify the computation of dividends and interests revenue through
independent computations (Accuracy and Valuation)
• Validate the measurement by referring the published price quotation
of securities
• Determine whether investments are properly classified and disclose
according to accounting standards
• Determine whether the management has considered relevant
information to determine the existence of impairment indicators
1.4.1 Illustrative Problems
EQUITY INVESTMENTS In the Statement of Financial Position
In your audit of the investments held by Rose Company, your client Current Assets:
you found the following transactions and other information for the year Equity investments at FVtPL P162,500
2015: Dividend Receivable 4,500
a. The financial statements of the company for the year 2014 revealed Noncurrent Assets:
the following investment balances: Equity Investments at FVtOCI 56,000
Financial Assets at Fair Value through Profit or Loss: Shareholder's Equity:
Instrument Number of Shares Balance Unrealized Cumulative Gain on Equity investment at FVOCI 4,000
Daisy ordinary share 5,000 P 84,000 In the Statement of Comprehensive Income
Rosal ordinary share 2,000 P 60,000 Profit or Loss:
You found that the December 31 balances approximated the fair Dividend Income 14,500
values of the securities Gain on Sale of Equity Investments 9,500
b. On April 3, Daisy Company distributed 20% bonus issue Other Comprehensive Income:
c. On April 29, Rosal paid P5 cash dividend declared on March 30, Cumulative unrealized gain on equity investments at FVtOCI 4,000
2015 DEBT INVESTMENTS
d. On May 15, Rose sold 1,000 of Daisy ordinary at P20 per share The Riverside Company engaged your services to examine its
e. On June 1, the Rose Company purchased at P25 per share 2,000 financial statements for the year ended December 31, 2015. It makes
of Waling-Waling ordinary. Rose paid transfer taxes and commissions an early adoption of IFRS 9 issued by the IASB in 2014. You identified
amounting to P2,500. The company exercised its option to designate from the trial balance that its debt investment, consisting solely of ANC
the Waling-waling shares as at fair value through other comprehensive 8% bonds has a balance of P925,250, representing ist acquisition cost
income of P1,084,250 of the P1,000,000 face value bonds, due on December
f. On October 1, Rose sold 500 of Rosal ordinary shares at P37 per 31, 2019 and net of P159,000 proceeds from sale of the investments.
share Interest is collectible every December 31. Riverside recorded the
interest collected amounting to P80,000 as credit to Interest Revenue.
ACCTG 025 Auditing and Assurance: Concepts and Applications 2
Module 1: Substantive Test of Investments
On December 31, after receiving the periodic interest, Riverside sold In Riverside's financial statements, the following items will be reported:
P150,000 of the bonds to generate enough funds for settlement of its On the statement of financial position
maturing obligation. The selling price of P159,000 represents the fair Noncurrent assets:
value of the P150,000 bonds investments sold. Debt investments at FVtOCI P 901,000
Because the entity holds these bonds in a portfolio of securities held Shareholder's Equity:
for collection and also for sale in response to financing requirements, Cumulative Net Realized Gain or Loss
the enterprise elected to designate the debt investments as at fair on debt investment at FVtOCI 7,909
value through other comprehensive income.
You audit staff has calculated an effective interest rate on these On the statement of comprehensive income
investments at 6%, and has provided you the following working paper In profit or loss section:
for the computation of the correct amortized cost and interest revenue. Interest Revenue 65,055
Amortization Table In other comprehensive income:
Nominal Effective Premium Amortization Unrealized loss on debt investments at FVtOCI,
Date net of P1,396 recycled to profit or loss 7,909
Interest Interest Amortization Cost
Jan 1, 2015 P 1,084,250
Dec 31, 2015 P 80,000 P 65,055 P 14,945 1,069,305
Dec 31, 2015 (160,396)
Dec 31, 2015
amortized P 908,909
cost per audit
Solution:
FV of the full debt investments before sale
P 159,000 \ 150,000 = 106% x 1,000,000 = P1,060,000
Amortized Cost of the debt investments 1,069,305
Unrealized loss on debt investments 9,305
Unrealized loss recycled to Profit or loss:
FV of investments sold 159,000
Amortized cost of investment sold
. 1,609,305 x 150,000\1,000,000 = (160,396) (1,396)
Balance of unrealized loss remaining in equity P 7,909
The entries that should have been made are as follows:
• Upon receipt of the periodic interest on December 31:
Cash 80,000
Debt investments at FVtOCI 14,945
Interest Revenue 65,055
• To adjust to fair value at December 31, before the sale:
Unrealized gain or loss on Debt investments at FVtOCI 9,305
Debt investments at FVtOCI 9,305
• To record the sale:
Cash 159,000
Loss on Sale of Debt investments 1,396
Debt investments at FVtOCI 159,000
Unrealized Gain or loss on Debt investments at FVtOCI 1,396
Audit Adjustments:
a. Interest Revenue 14,945
Debt investments at FVtOCI 14,945
b. Unrealized G or L on Debt investments at FVtOCI 9,305
Debt investments at FVtOCI 9,305
c. Loss on Sale of Debt Investments 1,396
Unrealized G or L on Debt investment at FVtOCI 1,396
Debt Unrealized Interest Gain or Loss
Investments Gain or Loss Revenue on Sale
Per client,
P 925,250 0 P 80,000 P0
Dec 31
Audit
Adjustment
a. effective
(14,945) (14,945)
interest adj
b. Adj to FV (9,305) (9,305)
c. Recycling
to Profit or 1,396 (1,396)
Loss
Balance per
(901,000) P 7,909 P 65,055 P (1,396)
audit