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E&Y Global Audit Methodology and Supplemental Audit


Guidance
Global Supplemental Audit Manual
Chapter 5 Illustrative Substantive
Procedures for Specific Account Balances
5.3 (D) Marketable Securities

5.3 (D) Marketable Securities


1 Introduction
This section deals with the audit of marketable securities. Guidance on the
audit of investments and on derivatives and hedging transactions are set out in
sections 5.7 (H) Investments, including Investments in Affiliates and 5.18
(S) Derivatives and Hedging Transactions in this manual.
The measurement, recognition and disclosure of marketable securities are
driven by the requirements of the financial reporting framework under which the
financial statements are prepared. As a result, we refer to the applicable
financial reporting framework when designing appropriate audit procedures to
determine whether the measurement, recognition and disclosures comply with
the financial reporting framework.
When auditing marketable securities and the related investment income, we
determine whether:
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All marketable securities on the balance sheet are held by the entity or
by custodians for the entity. All recorded income from marketable
securities has accrued to the entity at the balance sheet date (Existence
assertion);
All marketable securities owned by the entity at the balance sheet date
are included on the balance sheet. All income accruing from marketable
securities at the balance sheet date has been recorded (Completeness
assertion);
Marketable securities are included on the balance sheet at the
appropriate amount, in accordance with the financial reporting
framework under which the financial statements are being prepared.
(Some financial reporting frameworks require that such securities be
accounted for at their market value and other financial reporting
frameworks require that such securities be accounted for at the lower of
cost and market value.) Investment income is stated on the income
statement at the appropriate amount (Valuation assertion);
The entity owns, or has a legal right to, the marketable securities
included on the balance sheet. All marketable securities are free of liens,
pledges, or other security interests or, if not, such liens, pledges, or
other security interests are identified (Rights and Obligations assertion);
Marketable securities and the related investment income accounts are
properly classified, described, and disclosed in the financial statements,
including notes, in accordance with the applicable financial reporting
framework (Presentation and Disclosure assertion).

2 Inherent Risk Factors


S08 Make Combined Risk Assessments of the EY Global Audit Methodology (EY

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GAM) provides information on our inherent risk assessments. The following


items are examples of inherent risk factors that may increase the inherent risk
for this account or disclosure. When the opposite situations exist, that would
decrease inherent risk for the account or disclosure.
Nature of the item
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The size of the account or disclosure is significant;


Our prior audit experience indicates that there have been frequent errors
in the account balance;
The results of our planning analytics do not coincide with our
expectations;
Complex or unusual transactions occurred at or near the end of the
period;
There are debt covenant or regulatory restrictions on the types and/or
amounts of marketable securities;
Marketable securities are susceptible to misappropriation by the entity
staff;
Documentation is susceptible to manipulation by the entity staff.

Nature of the business/industry


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The economy has weakened during the year;

The volume of transactions is high;

Disbursements are made on an irregular basis;

There is little consistency in the volume of purchase and sale activity;

There are unusual or non-standard transactions (e.g., manual


disbursements made in a computerized system);

There are a significant number of derivative arrangements in place;

Derivatives are complex;

The occurrence of transactions evidencing disbursements does not


coincide with the recording of the disbursement (e.g., checks prepared
and recorded but not mailed);
The exchange rates of foreign currencies are volatile.

Organization of the Entity


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The investment functions, including cash receipts and disbursements


functions, are decentralized;
The marketable securities, cash receipts, and/or cash disbursements
functions involve a third party (e.g., a discretionary trust arrangement
exists with a bank);
Personnel responsible for this account have a lower level of competence
or experience;
The entity has inadequate IT systems for the volume of activity, size,
and/or complexity of the account.

3 Primary Substantive Procedures applicable to


Auditing Marketable Securities
EY GAM S11 Design Substantive Audit Procedures requires that we perform
Primary Substantive Procedures (PSPs) on all audit engagements for all
significant accounts, regardless of the combined risk assessments. The PSPs

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for Marketable Securities are set out in EY GAM S11_Exhibit 1 Appendix


A : Primary Substantive Procedures (PSP) by Account. Each of the PSPs is
discussed further below.
PSPs describe the nature of the procedures to be performed. As part of the
development of our audit plan, we also include the timing and extent of the
PSPs.
PSPs on their own will not necessarily provide all of the audit evidence we need
on a particular assertion for a significant account. Therefore, our audit plan also
includes analytical procedures, general procedures and other procedures to
respond to our combined risk assessment. Refer to Appendix 1 Illustrative
Procedures for Marketable Securities Regardless of Risk Assessment and
Appendix 2 Illustrative Procedures for Marketable Securities Responsive to Risk
Assessment.
An important consideration in auditing marketable securities is understanding
the nature of the securities or financial instruments that the entity holds or
trades. In periods of high or volatile interest rates, entities that attempt to
maximize their returns on their use of cash may enter into agreements for
overnight or short-term investments of funds (repurchase agreements). Other
entities may enter into agreements to buy or sell financial instruments at a
future date (such as interest rate futures contracts, forward placement
commitments, or standby commitments). Entities may enter into these types of
agreements for speculation or as hedges refer to section 5.18 (S) Derivatives
and Hedging Transactions in this manual.
We consider the possibility that an entity may have entered into such
agreements and recognize that their potential effects on the financial
statements can be significantly greater than might be expected from the
amounts (such as the size of margin deposits) that appear in the accounting
records.
In planning the audit of marketable securities, we also consider that certain
industries have accounting and auditing practices for securities (e.g., brokerdealers, investment companies, and insurance companies). This section does
not provide guidance with respect to specialized industry practices. Therefore,
we refer to authoritative pronouncements and any firm-developed guidance
materials that may apply to the entitys industry.
Generally, the classification and valuation of marketable securities is driven by
the requirements of the applicable financial reporting framework. For example,
in some financial reporting frameworks, the appropriate classification depends
on managements intent in purchasing and holding the financial instruments, on
the entitys investment activities, and on its ability to hold the instruments to
maturity.
The guidance which is set out in this section does not follow the requirements of
any particular financial reporting framework. Additional audit procedures may
have to be performed to audit the measurement, recognition and disclosures of
marketable securities in the financial statements to determine that these comply
with the applicable financial reporting framework.

3.1 PSP D1: Verification of Existence and Ownership


PSP D1: Verify the existence and ownership of recorded securities through
confirmation or examination of evidence of ownership (e.g., stock certificates, bank
statements, broker statements).

We may verify the existence of marketable securities by inspecting them. When

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we inspect securities, the inspection is usually conducted simultaneously with


counts of cash and other negotiable assets. If those assets cannot be inspected
at the same time, we apply other control procedures that will prevent the
substitution of one type of negotiable asset for another.
When inspecting securities, we observe:
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The exact names of the issuers;

The descriptions of the securities;

The name(s) of the indicated owner(s) of the securities;

Any evidence of pledging or restrictions on disposal shown on the


securities;

The certificate numbers on the documents; and

The number of shares of stock or face value of debt securities.

In addition to inspecting securities as above, we:


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Obtain a list of all securities counted by the entity;


Note details of other documents encountered during the count which we
believe may have a bearing on the audit; and
At completion of the count, obtain a written declaration from the
custodian confirming that the securities were examined in their
presence.

After the count, we perform appropriate follow up procedures, including:


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Tracing information obtained during the security count to the final listing
of marketable securities and investigating any significant differences;

Verifying the arithmetical accuracy of the listing;

Following up any other matters noted during the count.

When confirming securities held by custodians or depositories, we request the


same information as that obtained when inspecting securities. We follow up and
resolve any differences noted on the returned confirmations. For all non-replies,
we perform alternative procedures, which include checking confirmation details
to supporting documents and disbursement records.
The physical count or confirmation of securities may be performed at an interim
date if controls are evaluated as effective. Among the indications of effective
controls are:
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Maintenance of detailed security records, including certificate numbers,


by personnel not having access to, or control over, the securities
themselves;
Issuance of securities in the entitys name; and
Use of an independent custodian or depository to safeguard the
securities.

If the physical count or confirmation work is performed at an interim date, we


review the rollforward of movements between the interim and balance sheet
dates, such as:
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Significant new securities;

Disposed of securities;

Volume of activity (compared to prior periods and expectations); and

Investigate significant changes, agreeing to supporting documentation or


reconfirming with the third party if considered necessary.

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3.2 PSP D2: Detailed Confirmation Review


PSP D2: Review confirmation replies for evidence of the existence of marketable
securities, and of liens, pledges or other security interests in marketable securities.

We review bank confirmations and direct confirmations of marketable securities


for evidence of liens, pledges and other security arrangements over these
assets. If necessary, we determine whether adequate disclosure of such
arrangements is made in the financial statements.

3.3 PSP D3: Market Valuation


PSP D3: Inspect market quotations or other evidence of current value of marketable
securities, including those in foreign currencies.

For publicly traded marketable securities held by the entity at year end, we:
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Obtain market prices from published quotations at year end;


Calculate the market value by multiplying the market price by the
number of shares held (or par value in the case of quoted bonds and
debentures);
Discuss any differences with management, as necessary; and
Depending on the extent of new securities, consider the need to test a
sample of new items to supporting documentation.

If non-publicly traded securities are appropriately classified as marketable


securities, we determine the market value by reference to the investees
financial statements, with, if necessary, assistance from an EY valuations
professional.
If a marketable security is denominated in a foreign currency, we agree the
exchange rate used to the relevant published exchange rate.
If our work is performed at an interim date, we:
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Review the movements in valuation between the interim and balance


sheet dates;
Investigate significant changes, vouching to source documentation or
reconfirming with the third party if considered necessary.

3.4 PSP D4: Valuation in Accordance with Accounting


Policies
PSP D4: Test that marketable securities are carried in accordance with the client's
accounting policies or applicable financial reporting framework.
PSP D5: Inspect documentation and make inquiries to determine the validity and
extent of reclassification between categories of investments. By reference to the client's
accounting policies or applicable financial reporting framework, evaluate the
reclassification to determine its effect of the transfer on: 1) recognition of profit or loss,
2) effect on the stated intent and ability, and 3) effect on the classification of other
investments.

To test that marketable securities are carried in accordance with the entitys
accounting policies or the applicable financial reporting framework, we:
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Inquire as to whether there has been any change in accounting policy


compared to the prior year. We consider whether the accounting policies

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are reasonable and consistent with the prior year and applicable financial
reporting framework, and the impact of any new accounting standards
on the entity's accounting policy;
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Establish that marketable securities have been accounted for in


accordance with the stated policy and for any changes in policy, ensure
that adequate disclosure has been made. For example, using the same
sample as for existence and ownership testing, we obtain details of the
accounting treatment of each marketable security and check that this
treatment is in line with the stated accounting policy.

4 Procedures Responsive to Risk Assessment


Appendix 2 Illustrative Procedures for Marketable Securities Responsive to Risk
Assessment contains examples of procedures that may, together with the
procedures previously discussed, be useful in achieving the primary account
balance audit objectives when our evaluation of classes of routine transactions
indicates possible errors.
We need not perform these application-related procedures when we have
evaluated the controls as effective and tested them (using full tests of
controls) and found that we can place reliance on them, or when the PSPs can
provide sufficient assurance that the potential errors in question have not
occurred.
We consider performing these procedures when we have evaluated the controls
as effective, but have only performed limited tests of controls (especially when
our combined risk assessment for the account is moderate, since in such
circumstances we would have assessed inherent risk as higher), and we are
more likely to perform them when we have evaluated the controls as ineffective.
The timing and extent of the procedures performed are responsive to our
combined risk assessments.

5 Documentation
Documentation includes, but is not limited to, identification of the following:
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The nature, timing and extent of procedures performed (generally the


audit plan or reference to it) and conclusions reached with respect to the
procedures performed, together with a conclusion statement with
respect to marketable securities;
The evaluation of the flow of significant estimation, routine and nonroutine transactions and related controls within significant processes, as
well as the sources and preparation of information resulting in significant
disclosures;
The problems encountered and bases of resolution; and
To the extent appropriate, the following:
Summary of marketable securities and related accounts, and the
activity in those accounts during the period;

List of securities examined or confirmed;

Confirmation replies;

Documentation of tests of purchases and disposals of marketable


securities, if applicable;
Details of cost and market values or other appropriate carrying
amounts, and evidence supporting the carrying amounts;
Results of analytical review procedures performed; and

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Details of liens, pledges, security interests, or other restrictions


on the use or disposal of marketable securities.

Appendix 1 Illustrative Procedures for


Marketable Securities Regardless of Risk
Assessment
This Appendix sets out examples of general and analytical procedures that may
be appropriate when auditing Marketable Securities.
General Procedures
Obtain or prepare a lead schedule of sufficient detail to enable us to verify the correct
classification, presentation and disclosure of items in the financial statements and
corresponding notes. Build an expectation of the level of marketable securities per lead
schedule by comparison with prior year, interim and knowledge of changes in the
business.
Note evidence of unusual investment transactions (e.g., churning or high risk
securities).
Consider specialized industry practices.
Review any entity reconciliations of statements (e.g., from banks and brokers) with the
entitys records.
Verify interest and dividend income by calculating interest earned and referring to
published records of dividends paid.
Review the marketable securities and related accounts (e.g., interest and dividend
income) in the general ledger for unusual items.
Analytical Procedures
Compare the account balances with those of prior periods and investigate any
unexpected changes (or the absence of expected changes).
Compare current years to prior years market value of the security.
Perform an overall test of the reasonableness of interest income by multiplying the
average interest rates by the average amounts invested.

Appendix 2 Illustrative Procedures for


Marketable Securities Responsive to Risk
Assessment
The following are examples of procedures that may, together with procedures
previously discussed, be useful in achieving the primary account balance audit
objectives when our evaluation of classes of transactions indicates possible
errors.
Cash receipts and cash disbursements applications
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Inspect brokers advices and other support to verify that additions and
disposals have been recorded properly.
Verify interest and dividend income by calculating interest earned and
referring to published records of dividends paid.
Review the marketable securities and related accounts (e.g., interest and
dividend income) in the general ledger for unusual items.
Determine if marketable securities are properly classified in the balance
sheet.

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Procedures responsive to possible errors cash receipts application


Primary
Substantive
Assertion

Possible Error

Procedure

Other
Substantive

Procedure

Marketable securities disposals are not


recorded.

D1

1,2

All disposals of marketable securities


are not classified as a
reduction of marketable securities
accounts.

D1

1,2,3,4

Marketable securities disposals are not


recorded at correct amounts.

D1, D3, D4

1,2

Credits to marketable securities


accounts are not for disposals of
marketable securities.

D1

1,2

Marketable securities disposals are


recorded in the wrong period.

D1

Credits to marketable securities


accounts are not for marketable
securities disposals.

D1

1,2,3,4

Cash receipts register is not correctly


totaled.

D1

Cash receipts and cash receipts


register totals are not correctly
posted to cash receipts register and
general ledger, respectively.

D1

Procedures responsive to possible errors cash disbursements application


Primary
Other
Substantive Substantive
Assertion

Possible Error

Procedure

Procedure

Debits to marketable securities accounts


are not for marketable securities
additions.

D1

Debits classified as marketable securities


are not for marketable securities.

D1

1,3,4

Marketable securities additions are not


recorded at correct amounts.

D1, D3, D4 1

Marketable securities additions are not


recorded.

D1

Marketable securities additions are


recorded in the wrong period.

D1

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All marketable securities additions are not D1


classified as marketable securities.

1,3,4

Cash disbursements register and


marketable securities records are not
correctly totaled.

D1

Totals in cash disbursements register not


correctly posted to general ledger.

D1

1 The Assertion column refers to the relevant financial statement assertion


E=Existence; C=Completeness; and V=Valuation.
2 The Primary Substantive Procedure column refers to the PSPs listed in
EY GAM S11_Exhibit 1 Appendix A: Primary Substantive Procedures (PSP)
by Account, which are also discussed in subsection 3 Primary Substantive
Procedures Applicable to Marketable Securities above.
3 The Other Substantive Procedure column refers to the numbered
procedures set out in this appendix.
Go To Document ID: GSAM 5.3
Last Modified Date:14 Dec 2009

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