AUDIT OF INVESTMENT

Investments in financial instruments consist principally of government bonds,

commercial papers, stock certificates and treasury bills . Because these financial
instruments are readily negotiable , the need for their physical protection and for strong
internal controls is almost as great as in the case of cash.

Based on level of ownership and management’s intent for holding the investment,
investment in equity securities (IFRS 9) are classified under the following classifications:
 Equity investments at fair value through profit or loss (FVPL);
 Equity investments at fair value through other comprehensive income
(OCI);
 Investment in associate

Equity investment held primarily for trading and non-trading equity investments in which
the company does not elect to designate such as fair value through other
comprehensive income belong to the category of investments at fair value through profit
and loss. These investments are presented as current assets. FVPL are initially
measure at purchase price and at reporting date reported at fair value. The change in
fair value during the reporting period is recognized in profit or loss.

Equity investments not held for trading but ownership is not enough to the investor
ability to exercise significant influence over the investee are also measured at fair value.
On the date of initial recognition, the entity may exercise its option to recognize the
change in the fair value through other comprehensive income. In such case, they are
initially recognized at purchase price plus directly attributable transaction costs. At
reporting date , they are measured at fair value with change in fair value during the
reporting period reported as component of other comprehensive income. The
accumulated balance of the holding gains and losses is a component of equity in the
equity section of statement of financial position.

Investment in associate, which gives the holders significant influence over the reporting
and financial policies of the investee are accounted for in the investor’s consolidated
financial statements using the equity method.

EQUITY INVESTMENTS
OCI PL
Inclusion Securities not held for *Securities held for
trading for which the trading
enterprises elects to *Securities not held for
recognize change in fair trading for which the
value through OCI company did not elect
measurement at fair
value through OCI
Initial recognition Purchase price plus Purchase price,
transaction costs transaction costs are
 taken to profit or loss
Measurement after initial Fair value Fair value
recognition
Amount taken to OCI *Unrealized gains and None
losses
*Realized gains and
losses, with no recycling to
profit or loss, instead
transferred to RE
Amount taken to profit or Dividends that are *Dividends that are
loss considered return on considered return on
investments investments
*Unrealized and realized
gains and losses

DEBT INSTRUMENTS
At amortized Cost At FV through OCI At FV through PL
Inclusion Debt instruments Debt investments *Debt investments
that are held within that are held within held for trading
the business model the business model *Debt investments
of collecting of collecting held within the
contractual cash contractual cash business model of
flows for which the flows and to sell, collecting
company did not for which the contractual cash
elect to measure at enterprise elected flows and for which
FV to recognize the the company
change in fair value elected to measure
through OCI at FV
*Debt investments
held within the
business
Initial recognition At purchase price At purchase price At purchase price
plus transaction plus transaction
costs costs
Measurement after At amortized cost, At fair value At fair value
initial recognition using the effective
interest method
Amount taken to None Unrealized gains None
other and losses due to
comprehensive change in FV, with
income recycling to profit or
loss when realized
Amount taken to *Interest revenue *Interest revenue *Interest revenue,
profit or loss *Realized gains *Realized gains for practicality
and losses, and losses based on nominal
including (recycled from interest
 impairment loss cumulative OCI), *Unrealized and
including realized gains and
impairment loss losses

INTERNAL CONTROL PROCEDURES

The major elements of adequate internal control over the investment securities focus on
the following:
 Separation of duties between the custody of the instruments, the maintenance of
accounting records and the authorization of purchase and disposals;
 Joint control (of at least two officials) over the investment securities, or the use of
an independent outside entity custodian;
 Complete detailed records of all securities owned and the related revenue from
interest and dividends;
 Registration of securities in the name of the company;
 Periodic physical inspection of securities by an internal auditor or other
independent official; and
 Formulation and implementation of investment policies

AUDIT OBJECTIVES

The auditor’s objectives in the audit of investments in financial instruments are to:
 Consider internal control over financial instruments held by the client;
 Determine the existence of investments and that the client has rights to the
instruments;
 Determine that all financial instruments held by the entity are reported and that
transactions affecting the investments are properly accounted for
(completeness);
 Establish the proper measurement of investments in financial instruments;
 Establish accuracy of the amounts recognized in profit or loss and OCI relating to
investments; and
 Determine that the presentation and disclosure to the investments is adequate.

When auditing investments, the principal objective for the substantive tests is to
determine the following:
Assertion Category Account Balances Audit Objectives
Existence All recorded investments on the statement of
financial position exist.
Occurrence All recorded income from investments has
accrued to the entity at the reporting date.
Completeness All investments owned by the entity at the
reporting date are included on the statement of
financial position. All income accruing from
investments at the reporting date has been
recorded.
Valuation and Investments are included on the statement of
 Allocation financial position at the appropriate amounts.
Accuracy Investment income is included on the statement
of comprehensive income at the appropriate
amount
Classification Income statement related items are appropriately
recorded in the proper accounts in the statement
of comprehensive income
Rights and The entity owns, or has a legal right to the
obligations investments included on the statement of
financial position
Presentation and Investments and related investment income
Disclosure accounts are properly classified, described, and
disclosed in the financial statements, including
note, in accordance with the applicable PFRS.

All investment pledged or other security interests

are adequately and properly disclosed.

Verification of Existence and Ownership

To verify the existence and ownership of investments by the entity, the auditor’s
procedure depends whether the securities or evidence of ownership are held by the
client or held by a third party.

If the stock certificates (evidence of ownership) is held by the client , the auditor
counts the stock certificates at the reporting date and simultaneously with the
count of cash and other negotiable instruments to prevent substitution. When
inspecting the securities, the auditor should note the following:
a. The name(s) of the indicated owner(s) of the securities;
b. The names of the issuers of securities;
c. Whether the security is debt or equity;
d. The certificate numbers on the documents;
e. Any evidence of pledging or restrictions on disposal shown on the certificates;
and
f. The number of shares of stock or the face value of the debts.

Some of the company’s securities and other financial instruments may be held by a
custodian such as brokerage firm or banks for safekeeping. If this is the case, the
auditor will confirm to the custodian. The auditor would normally include the
information mentioned above in the confirmation request.

SUMMARY OF AUDIT PROCEDURES CLASSIFIED PER ASSERTION

Assertion Category Primary Audit Procedures
 Existence *Inspection of securities held by the client.
*Confirmation of securities held by third parties.
Occurrence *Evaluating the accounting methods used and test
the valuation.
Completeness Detailed minutes of meeting review
Valuation and *Evaluating the accounting methods used and test
Allocation of valuation
*Impairment test
Accuracy Evaluating the accounting methods used and test
the evaluation
Classification Review financial statement presentation and
disclosure of investments including related
account.
Rights and Obligation *Inspection of securities held by the client
*Confirmation of securities held by third parties
Presentation and *Detailed minutes of meeting review
Disclosure *Review financial statement presentation and
disclosure of investments including related
account.

AUDIT PROCEDURES

1. To establish existence or occurrence of transactions, the auditor confirms

balances with the trustee or broker if the financial instruments are in the custody
of an independent outside entity. Confirmations should be as of the same date,
so as to obtain a reasonable assurance that there is no switching of securities
to conceal a shortage
2. If the company officials keep the custody of the instruments, the auditor should
physically inspect and count all securities on and simultaneously.
3. Comparison of the serial numbers on securities with those in the prior year’s
audit working papers may reveal any substitution or “borrowing” of securities.
4. To establish completeness of account balances and recorded related transaction,
a cut-off test is conducted to obtain assurance that all investment transactions
are recorded in the proper reporting period.
5. Dividends and interest revenue is usually verified by independent computations
by auditors, or tests of reasonableness of the amount of revenue earned.

6. The proper measurement of investments is validated by referring to published

quotations for securities that are measured at FV. If the securities do not have
published price quotations, the auditor shall consider obtaining estimates of fair
value from the security dealers/brokers or other third party sources.
7. The auditor should determine whether investments are properly classified and
the disclosures guidelines in the accounting standards are observed in the
financial statements.
8. In determining whether the investment has to be subjected to impairment testing,
the auditor should determine whether management has considered relevant
 information to determine the existence of impairment indicators such as adverse
conditions specifically related to security or to specific industry or geographic
conditions, deterioration of the investee’s financial conditions, and continuous
decline in the fair value of the securities.

EXAMPLE:

1. Identify by letter the assertions addressed in each of the following substantive

procedures relating to audit of investments:

Assertions:
a. Existence
b. Rights and Obligations
c. Completeness
d. Valuation and Allocation
e. Presentation and Disclosure

Substantive Procedures:
1. Confirm balances with the trustee or broker
2. Compare serial numbers of securities with those recorded in prior years’ working
paper.
3. Confirm with banks for investments used as loan collaterals
4. Recompute gains and losses on disposals of investments
5. Verify interest and dividends by recomputations
6. Inspect investment securities simultaneous with count of cash on hand balances
7. Obtain fair value from security dealers and from published priced quotations
8. Obtain an understanding of management’s process for classifying investment
securities
9. Evaluate information that indicates existence of impairment
10. Conduct cutoff test of purchases and sales of investments and accruals of
interest and dividends.

EQUITY INVESTMENTS

2. In your audit of the investments held by Pau Company you found the following
transactions and other information for the year 2020:
 The financial statements of the company for the year 2019 revealed the following
investments balances:
Instrument No. of shares Balance
Cam ordinary shares 5,000 Php 84,000
Mari ordinary shares 2,000 60,000
You found that the December 31 balances approximated the fair values of the
securities.
 On April 3, Cam Company distributed 20% bonus issue.
 On April 29, Mari Company paid P5.00 cash dividend declared on March 30,
2020.
 On May 15, Pau Company sold 1,000 of Cam Company ordinary at Php20 per
share.
 On May 15, Pau Company purchased a Php25 per share 2,000 of Grace
ordinary. Pau Company paid transfer taxes and commissions amounting to
Php2,500. The company exercised its option to designate the Grace Company
shares at FV through OCI.
 On October 1, Pau Company sold 500 of Mari Company ordinary shares at
Php37 per share.

 On December 1, Mari Company declared Php3 dividend per share on its

ordinary share, payable on January 15 to shareholders of record on December
15, 2020.

 Fair values on December 31, 2020 were as follows:

Cam ordinary shares Php 22
Mari ordinary shares 35
Grace ordinary shares 28

Gain
Or Unrealized
Grace Co. (FV- Dividen Loss Gains
Trans Cam Co. (FVPL) Mari Co. (FVPL) OCI) d on (Losses)
Income sale
Shares Amount Shares Amoun Shares Amoun
 t t
1/1/2020 5,000 84,000 2,000 60,000
4/3 1,000
4/29 10,000
5/15 (1,000) (14,000) 6,000
6/1 2,000 52,500
10/1 (500) (15,000) 3,500
12/1 4,500
12/31
before
adj 5,000 70,000 1,500 45,000 2,000 52,500 14,500 9,500
PL 40,000 7,500 47,500
OCI 3,500 3,500
12/31
balance 5,000 110,000 1,500 52,500 2,000 56,000 14,500 9,500

April 3 Memo entry

April 29 Cash 10,000

Dividend Income 10,000
(2,000 shares x Php5.00)

May 15 Cash (1,000 x 20) 20,000

Equity at FV through PL-Cam Co. 14,000
(84,000 x 1,000/6,000)
Gain on sale of investment 6,000

June 1 Equity investment at FV through OCI

-Grace Company 52,500
[ (2,000 x Php25=50,000) + Php2,500
Cash 52,500

Oct 1 Cash (500 x Php37) 18,500

Equity investment at FV through
PL- Mari Company
(60,000 x 500/2,000) 15,000
Gain on sale of investment 3,500

Dec 1 Dividends receivable [(2,000-500) x

Php3.00) 4,500
Dividend income 4,500

Dec 31 Audit adjustments

Equity investments at FV through PL 47,500

Equity investments at FV through OCI 3,500
 Unrealized gains- OCI 3,500
Unrealized gains – PL 47,500

In the statement of Financial Position

Current Assets
Equity Investments at Fair Value through
Profit or Loss Php 162,500
Dividends receivable 4,500

Non-Current Assets
Equity Investments at Fair Value through
Other Comprehensive Income Php 56,000

In the Statement of Comprehensive Income

Profit or Loss
Dividend Income Php 14,500
Gains on Sale of Equity Investments 9,500

Other Comprehensive Income

Cumulative Unrealized Gain on Equity
Investments at Fair Value
Through Other Comprehensive Income Php 3,500

DEBT INVESTMENTS

3. Pau Company engaged your services to examine its financial statements for the
year ended December 31, 2020. You identified from the trial balance that its
debt investment, consisting solely of ABC 8% Bonds had a balance of
Php925,250, representing its acquisition cost of Php1,084,250 of the
Php1,000,000 face value bonds, due on December 31, 2024 and a net of
Php159,000 proceeds from sale of the investments. Interest is collectible every
December 31. Pau Company recorded the interest collected amounting to
Php80,000 as a credit to Interest Revenue. On December 31, after receiving the
periodic interest, Pau Company sold Php150,000 of the bonds to generate
enough funds for settlement of its maturing obligation. The selling price of
Php159,000 represents the fair value of the Php150,00o bond investment sold.

Because the entity hold these bonds in a portfolio of securities held for collection
and also for sale in response to financing requirements, the enterprise elected
to designate the debt investments as at fair value through other comprehensive
income.
Your audit staff has calculated an effective interest rate on these investments at
6%, and has provided you the following working paper for the computation of the
correct amortized cost and interest revenue.

Premium Amortized Cost,

Date Nominal Interest Effective Interest Amortization End
(8%) (159,00/150)-
100% = 6%
Jan 1, 2020 Php 1,084,250
Dec 31, 2020 Php 80,000 Php 65,055 Php 14,945 1,069,305
Dec 31, 2020 (160,396)
Dec 31, 2020,
amortized cost
per audit 908,099

Solutions:

FV of the full debt investments before sale

Php159,000/Php150,000 = 106%; Php1,000 x 106% Php 1,060,000
Amortized Cost of debt investments- refer to amort table 1,069,305
-----------------------
Unrealized loss on debt instruments Php 9,305
Unrealized loss recycled to profit or loss:
FV of investment sold Php 159,000
Amortized cost of investment sold
Php1,609,305 x Php150,000/Php1,000,000 ( 160,396) ( 1,396)
-------------------------
Balance of Unrealized of remaining in equity Php 7,909
==============

Entries:

Upon receipt of the periodic interest on December 31:

Cash 80,000
Debt investment at FV through OCI 14,945
Interest revenue 65,055

To adjust to fair value at December 31, before the sale:

Unrealized gain/Loss on Debt Investments
At FV through OCI 9,305
Debt Investments at FV through OCI 9,305

To record the sale:

Cash 159,000
Loss on sale of Debt Investments 1,396
 Debt investments at Fair Value
through OCI 159,000
Unrealized Gain/Loss on Debt Investments
at FV through OCI 1,396

Based on the above set of entries and the working paper and computations
provided by the member of the audit staff, the appropriate audit adjustments to
correct the investment balance and the amounts taken to profit or loss and other
comprehensive income are as follows:

Audit Adjustments:

(1) Interest Revenue 14,945

Debt investments at Fair Value
Through OCI 14,945

(2) Unrealized Gain/Loss on Debt Investments

At FV through OCI 9,305
Debt Investments at FV through OCI 9,305

(3) Loss on sale of Debt Investments 1,396

Unrealized Gain/Loss on Debt
Investments at FV through OCI 1,396

Debt Investments Unrealized Interest Gain (Loss) on

Gain or (Loss) Revenue Sale
Per Client Php 925,250 Php 0 Php 80,000 Php 0
Audit Adjustments
(1) Effective interest adjustment (14,945) (14,945)
(2) Adjustment to fair value (9,305) (9,305)
(3) Recycling to profit or loss 1,396 (1,396)
Balance per audit Php 901,000 Php 7,909 Php 65,055 Php (1,396)

In Pau Company’s financial statements, the following items will be reported:

On the Statement of Financial Position:

Non-current assets:
Debt Investments at Fair Value through
Other Comprehensive Income Php 901,000
Shareholder’s Equity
Cumulative Net Unrealized Gain (Loss)
on Debt Investments at Fair Value
through Other Comprehensive Income 7,909

On the Statement of Comprehensive Income:

In profit or loss section:
 Interest Revenue Php 65,055
In Other Comprehensive Income:
Unrealized Loss on debt Investments
at Fair Value through OCI,
net of Php1,396 recycled to profit or loss 7,909

4. On January 1, Pau Company established significant influence over Camil

Company by acquiring 60,000 ordinary shares, 1 30% interest, for Php570,000.
The book value of Camil Company was Php1,300,000 on January 1, 2020. Since
this purchase Camil Company earned and paid dividends as follows:
Year Net Income Dividends
2020 Php 180,000 Php 100,000
2021 310,000 140,000

The market value per share on Camil Company ordinary shares on December
31, 2020 and 2021 was Php8.00 and Php9.00, respectively. Pau Company
incorrectly accounted for this investment as if significant influence had not been
established.

Instructions:
As a result oof incorrectly applying accounting principles, the financial
statements of Pau Company are incorrect. At December 31, 2020 and 2021,
were the following accounts overstated, understated or correct? If incorrect, by
what amount? Show supporting computations.
1. Net Investment in Camil Company.
2. Net Income
3. Audit Adjustment 2020 and 2021.

Supporting Computation: Pau Company

 2020
1. Investment in Camil Company:
Cost Php 570,000
Less: Valuation allowance to reduce to
FV [60,000 shs x (9.50-8.00)] ( 90,000)
----------------------
Net Investment in Camil Company, as reported 480,000
----------------------
Under the Equity Method
Beginning balance Php 570,000
Add: Equity in Camil Company
(30% x Php180,000) 54,000
Less: Dividends received
( 30% x Php100,000) ( 30,000)
----------------------
Net Investment in Camil Company as should
have been reported 594,000
----------------------
Investment Understated Php 114,000
============

2. Dividend revenue recognized under

fair value method (Php100,000 x 30%) Php 30,000
Equity in investee income (Php180,000 x 30%) 54,000
---------------------
Net Income Understated Php 24,000
============
2020 Audit Adjustments
Transactions Entry Made Correct Entry (PFRS) Audit Adjustments
January 1
Purchase of Investment Equity Investment Investment in Investment in
At FV through OCI or Associates 570,000 Associates 570,000
PL 570,000 Cash 570,000 Equity Invest
Cash 570,000 At FV through
OCI or PL 570,000
December 31
Remeasurement Unrealized Gain Equity Inv at FV
Or Loss-OCI/PL 90,000 through OCI or
Equity Inv at No entry PL 90,000
FV through Unrealized gain
OCI or PL 90,000 or loss-OCI or
PL 90,000
Declaration of Profit by No entry Investment in Investment in
the Investee Associates 54,000 Associates 54,000
Inv income 54,000 Investment
Income 54,000
Dividends Received Cash 30,000 Cash 30,000 Dividend Inc 30,000
Dividend inc 30,000 Investment in Investment in
Associates 30,000 Associates 30,000