Best Practices for Conducting Audit Procedures for Short-term Investments

Short-term investments are financial assets that companies hold for a short period and are readily marketable, and they play an essential role in a company’s financial statements. 

As such, auditors must perform effective audit procedures to ensure the accuracy and reliability of the financial information disclosed in the company’s financial statements.

This article will discuss the best practices for conducting audit procedures for short-term investments, including accounting under IFRS, audit risks, assertions, walkthrough testing, a test of control, and substantive audit procedures.

Accounting Under IFRS:

Recognition:

Under IFRS, short-term investments are recognized on the balance sheet at fair value on the date of acquisition. These investments are typically classified as either “held for trading,” “available for sale,” or “held to maturity.”

  • Held for Trading: Short-term investments that are bought and held primarily to sell in the near term are classified as held for trading. These investments are recognized at fair value, and any changes in fair value are recognized in profit or loss.
  • Available for Sale: Short-term investments that are not held for trading but are not intended to be held to maturity are classified as available for sale. These investments are recognized at fair value, and any changes in fair value are recognized in other comprehensive income until the investment is sold. At this point, the accumulated gains or losses are recognized in profit or loss.
  • Held to Maturity: Short-term investments held with the intention of being held until maturity are classified as held to maturity. These investments are recognized at amortized cost, and any changes in fair value are not recognized in profit or loss.

Measurement:

The fair value of short-term investments is determined based on observable market data or other reliable sources. The valuation method used will depend on the classification of the investment.

  • Held for Trading: Short-term investments classified as held for trading are measured at fair value, which is determined based on current market prices.
  • Available for Sale: Short-term investments classified as available for sale are also measured at fair value, which is determined based on current market prices.
  • Held to Maturity: Short-term investments classified as held to maturity are measured at amortized cost, which considers any discounts or premiums.
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Disclosure:

Under IFRS, companies are required to disclose certain information about their short-term investments in the notes to their financial statements. This information includes the following:

  • The classification of each investment (held for trading, available for sale, or held to maturity)
  • The fair value of each investment
  • The carrying amount of each investment
  • The nature and extent of any restrictions on the ability to sell or use the investments for liquidity purposes
  • The accounting policies used for the measurement and classification of short-term investments

Audit Risks:

Audit risks are the risks that the auditor will issue an incorrect opinion on the financial statements. In the audit of short-term investments, there are several audit risks that the auditor should be aware of. 

These include:

  1. Misstatement due to fraudulent financial reporting: There is a risk that the company may manipulate financial information to make short-term investments appear more profitable or valuable.
  2. Misstatement due to errors in recording short-term investments: There is a risk that the company may make errors while recording or reporting the value of the short-term investments.
  3. Misstatement due to misapplication of accounting policies: There is a risk that the company may not apply the appropriate accounting policies when reporting the value of short-term investments.
  4. Misstatement due to a lack of internal controls over short-term investments: There is a risk that the company’s internal controls over short-term investments may be weak or ineffective.
  5. Misstatement due to overstatement of the fair value of investments: There is a risk that the company may overvalue short-term investments.
  6. Misstatement due to understatement of the fair value of investments: There is a risk that the company may undervalue the short-term investments.
  7. Misstatement due to the overstatement of gains on investments: There is a risk that the company may overstate the gains made on short-term investments.
  8. Misstatement due to the understatement of losses on investments: There is a risk that the company may understate the losses incurred on short-term investments.
  9. Misstatement due to the overstatement of impairments on investments: There is a risk that the company may overstate the impairments on short-term investments.
  10. Misstatement due to the understatement of impairments on investments: There is a risk that the company may understate the impairments on short-term investments.
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Audit Assertions:

Audit assertions are the representations made by management regarding financial statements. In the audit of short-term investments, there are several audit assertions that the auditor should consider. 

These include:

  1. Existence: The auditor should verify the existence of the short-term investments by confirming their existence with the custodian of the investments.
  2. Valuation: The auditor should verify the accuracy of the short-term investments’ valuation by comparing the investments’ fair value to external market data.
  3. Rights and Obligations: The auditor should verify that the company has legal rights to the investments.
  4. Completeness: The auditor should verify that all short-term investments are recorded and included in the financial statements.
  5. Presentation and Disclosure: The auditor should verify that the short-term investments are presented fairly and appropriately disclosed.

Walkthrough Testing: 

Walkthrough testing is the process of tracing a transaction from its origin through to its financial statement presentation. It involves testing the entire process of how a transaction is recorded, processed, and reported. 

This testing aims to verify the accounting system’s accuracy and completeness, identify any potential weaknesses, and assess the design and effectiveness of internal controls.

During the walkthrough testing of short-term investments, the auditor will typically perform the following steps:

  • Understand the procedures and controls around short-term investments, including who has the authority to invest in these instruments and how they are recorded in the books.
  • Review the controls around the investments, such as who has the authority to approve investment decisions and how the investments are monitored and reported.
  • Trace a sample of transactions through the accounting system to ensure they are properly recorded and reported in the financial statements.
  • Identify any potential control weaknesses or areas for improvement in the system.
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Test of Control: 

Test of control is a type of audit procedure that assesses the operating effectiveness of internal controls. This testing aims to ensure that the internal controls are designed effectively and operating as intended.

During the test of control for short-term investments, the auditor will typically perform the following steps:

  • Identify the key controls around short-term investments, such as who has the authority to invest in these instruments and how they are recorded in the books.
  • Select a sample of transactions and test the relevant controls to ensure they operate as intended. For example, the auditor may test the investment approval process to ensure that it is followed consistently.
  • Document any control weaknesses or areas for improvement in the system.

Substantive Audit Procedures:

Substantive audit procedures are used to obtain direct evidence to support the amounts and disclosures in the financial statements.  These procedures are typically more detailed and extensive than tests of control.

During the substantive audit procedures for short-term investments, the auditor will typically perform the following steps:

  • Obtain a listing of all short-term investments and ensure it agrees with the general ledger.
  • Evaluate the accounting policies and disclosures related to short-term investments to ensure they are consistent with the applicable accounting standards.
  • Obtain confirmation of the short-term investments from the custodian or broker to verify their existence and valuation.
  • Evaluate the reasonableness of the fair value measurements for short-term investments.
  • Assess the adequacy of the allowance for credit losses on short-term investments.
  • Test for any impairment indicators that may require an impairment charge to be recorded.
  • Perform analytical procedures to identify any unusual trends or relationships related to short-term investments.
  • Evaluate any subsequent events or transactions related to the short-term investments that may impact their valuation or disclosure.
  • Document any significant findings or issues related to the short-term investments.
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