Investment Cycle - M5

Question 1

How would an auditor assess the reasonableness of fair values of investments?

Answer 1

• The auditor should evaluate the appropriateness of the
  valuation model used by management.
• The auditor may develop an independent fair value estimate.
• The auditor should obtain management representations
  relating to intent and ability to carry out planned courses of action.

Question 2

How to verify the reasonableness of clients estimate in fair values for derivatives?

Answer 2

• Obtain an understanding of the method used by the broker-dealer to develop fair value estimates.
• Determine if the financial framework indicates the method used to determine fair value.
• Determine if the determination of the fair value is consistent with the specified valuation method

Question 3

What is analytical review used for in investments?

Answer 3

Used to ascertain the reasonableness of investment income in relationship to the amount invested.

Question 4

What criteria is the auditor evaluating when assessing the appropriateness of management’s rationale for selecting a model to measure the fair value of debt securities?

Answer 4

• The valuation model is appropriately applied based on generally accepted accounting principles.
• The valuation model is appropriate for the debt security being valued.
• The valuation model is appropriate for the environment in which the entity operates.

Question 5

What audit procedures should be done when auditing clients derivative transactions?

Answer 5

• Ascertain if the applicable financial framework indicates the method used to determine fair value.
• Evaluate whether the determination of fair value is consistent with the specified valuation method.
• Obtain an understanding of the method used by the broker-dealer to develop fair value estimates when the client obtains fair value estimates directly from a broker-dealer.

Question 6

What is the auditor’s responsibility for managements estimates of fair value estimates?

Answer 6

• If the quotation to support a fair value estimate is from the broker
  who initially sold the instrument, the evidence might be less objective and might need supplementation. (The broker may be biased because the broker sold it to the entity and may overstate the value of the instrument.)
• The auditor is required to obtain an understanding of the
  broker’s methodology for obtaining the fair value estimate.
• A broker’s quotation that is based on a combination of
  methodologies when used to assess asset or liability.
  -Cash Flow Methodology
  -Market Approach
  -Income Approach (which includes using a cash flow methodology),
  -Cost Approach