AUDITING INVESTMENTS IN A FULL SCOPE AUDIT

By Michael Lawrance, CPA

August 13, 2014

KPMG LLP

The views in this presentation do not necessarily reflect that of KPMG LLP or any of its subsidiaries or affiliates.

Objectives

understanding how to differentiate between the different types of investments in an employee benefit plan

understanding the basic investment procedures in a full scope audit

understanding the basics of how to audit hard-to-value investments

Full or Limited Scope?

Limited scope – ERISA Section 103(a)(3)(c ); investment information certified by a bank or similar institution or by an insurance carrier that is regulated supervised, and subject to periodic examination by a state or federal agency. (generally, the trustee or custodian of the plan)

Full scope – Auditor issues an opinion which includes the assertions for investments.

Common Investments That Look Alike

Registered Investment Companies (a.k.a. Mutual Funds)

Common/collective trusts Pooled separate accounts

It can be difficult to distinguish between these investment types.

The form of investment matters.

Common Investments

Registered Investment Companies (a.k.a. Mutual Funds) Registered with the SEC Sold to the general public Pools money from various investors to purchase

securities Classified by primary investments (fixed

income, equity, money market). Redeemable by investors daily Generally, not traded on an exchange (those

that trade on an exchange are called ETF’s) Reported on Part I, c(13) on the Form 5500

Bank or Trust Company

Common or commingled trust SEC does not regulate. Regulated by states

and/or other federal agencies Not sold to the public (retail investors) directly Pools money from numerous plans to purchase

securities May have a name that appears identical to a

mutual fund, which is the primary underlying investment

Maintained by bank or trust company Reported on Part 1, c(9) of Form 5500 Generally, lower fees than a mutual fund

Insurance Entity

Pooled Separate Accounts SEC does not regulate Not sold to the public (retail investors) directly Pools money from numerous plans to purchase

securities (pooled separate account) May have a name that appears identical to a

mutual fund, which is the primary underlying investment

Maintained by an insurance company Not commingled with other assets or the insurance

entity for investment purposes. Reported on Part 1, c(10) of Form 5500 Generally, lower fees than a mutual fund

Substantive Procedures

The procedures mentioned are an illustrative but not exhaustive list of procedures performed during a standard 401(k) plan full scope audit

Substantive - Investments

Confirmation of investments Confirm the existence of the units/shares

(mutual fund vs. common commingled trust vs. pooled separate account)

Substantive - Investments

Roll-forward Investment Balances Perform or obtain a roll-forward of the

beginning investment balance to the ending balance considering (purchases, sales, gains/losses)

Purchases – will include contributions; exchange in; re-invested income, etc.

Sales – will include distributions; exchange out; expenses, etc.

Don’t forget exchange in/out (often the same number with an opposite sign)

Addresses the completeness of investments

Substantive - Investments

Purchases Obtain a detail of purchases that shows trade

amount, trade date, and security name (preferably with a cusip)

Verify the reasonableness of the stated information for a sample by comparing such to the opening & closing balance of the security traded for the specified trade dates.

This establishes the reasonableness of the cost information.

Substantive - Investments

Sales Obtain a detail of sales that shows trade amount,

cost, trade date, and security name (preferably with a cusip)

Verify the reasonableness of the stated information for a sample by comparing such to the opening & closing balance of the security traded for the specified trade dates.

Re-compute the gain/loss on sale

This supports the accuracy of realized gains.

Substantive - Investments

Price Testing: Obtain a detail of investment holdings at year end

which indicates the number of units/shares and price

Compare the price listed to the closing price per a pricing source for the security for the specified date

Pricing sources include: Yahoo!Finance, IDC, Bloomberg, Reuters, etc.

This supports the valuation of investments and in conjunction with the purchase testing supports the accuracy of the unrealized gains/losses of investments.

What if the price isn’t listed?

Common or commingled trust; Pooled separate accounts – Audited financial statements are generally available Obtain the audited financial statements and

compare the audited unit value to the price listed by the trustee

Analytics may be performed if the audit date and the plan reporting date differ

What if audited financials are not available?

Test the existence and valuation of the underlying securities of the investment vehicle.

Obtaining the information to do so may be easier said than done. Scope limitations can result.

Remember materiality when applying procedures.

Substantive - Investments

Presentation: Agree investment balances from certified

custodial/trustee statements to the financial statements

Determine whether the Fair Value Level disclosures for investments in the financial statements are appropriate Make sure that the categories used are

indicative of nature and risk (e.g., growth funds, income funds)

Be careful with classification of “Asset Allocation” for target date funds

Hard-To-Value

Generally include but are not limited to, hedge funds, private equity funds, real estate funds, venture capital funds, offshore fund vehicles, etc.

Existence – Confirm with hedge fund &/or examine legal documents

Valuation – Understand management’s process to develop fair

value estimates Obtain audited financial statements Review transactions at or near the balance sheet

date

Unobservable Inputs

May require the use of a valuation specialist to determine a reasonable range of fair value.

Audit evidence may be obtained by valuation specialists employed by the audit firm

Audit evidence may be obtained by valuation specialists employed by an individual or organization outside the audit firm

Additional Guidance

AICPA Employee Benefits Plan Guide AICPA Investment Companies Guide AICPA Audit Guide Special Considerations

in Auditing Financial Instruments AICPA Practice Aid Alternative

Investments – Audit Considerations, a Practice Aid for Auditors

Questions?