Key Points of the AICPA Technical Practice Aid (“TPA”) on Auditing
Alternative Investments

The existence assertion is satisfied by the confirmation of the underlying
investment (the “Investee Fund”) in the aggregate. In addition, the auditor must
also confirm the Investee Fund’s holdings on a security-by-security basis.

If either the confirmation or the details of the Investee Fund’s holdings are not
returned to the auditor, alternative procedures are to be performed including:
o Reviewing executed agreements evidencing the client’s investment in the
Investee Fund
o Reviewing periodic statements from the Investee Fund
o Vouching cash receipts and disbursements for capital activity

The alternative procedures described above may also, in the auditor’s judgement,
be considered necessary even if the confirmation is returned by the Investee Fund.

The auditor must gain an understanding of the process used by the client to
determine the fair value of the Investee Funds and the related controls. The TPA
provides examples of the types of controls used to assess the strength or weakness
of management’s process. For example, what type of ongoing monitoring
procedures does the client follow?

An effective process for supporting fair value estimates of Investee Funds
includes the client having an understanding of the holdings and valuation
methodologies of the Investee Fund especially for Investee Funds with more
nonmarketable securities. However, simply obtaining a detailed schedule of the
Investee Fund’s holdings is by itself not sufficient.

This understanding may be obtained from interviews by the client of the Investee
Fund’s management or the annual audited financial statements of the Investee
Fund.

The client is not responsible for recalculating the fair values of the underlying
portfolios unless information has come to their attention that suggests that
valuation methodology or assumptions used by the fund manager are incorrect.

As the complexity of the Investee Fund’s underlying securities increases, the risk
of material misstatement of the client’s financial statements increases. Therefore,
the quantity and quality of the necessary audit evidence increases.

Audited financial statements of the Investee Fund by a qualified and reputable
audit firm as of the client’s balance sheet date “are among the highest quality
audit evidence”. A detailed listing or condensed schedule of investments enhances
the quality of the audit evidence.

The TPA identifies several client procedures that the auditor considers in
evaluating the client’s controls over valuation including the personnel assigned to
monitor and estimate the fair value of Investee Funds.

Initial due diligence controls do not replace the need for ongoing monitoring
controls.

A confirmation on a security-by-security basis may provide support of the data
used by the client in its valuation process. If this is not provided, the auditor
reviews other data that management used in its valuation process and performs
tests on such data.

Investments in or redemptions from an Investee Fund at or near the balance sheet
date may also provide support for the valuation.

For clients with year ends that differ from the Investee Funds, obtaining interim
financial information of the Investee Funds should be considered. Furthermore,
testing how management tracks the investment from the last audit date may be
possible.

Based on the lack of audit evidence obtained and/or the inadequacy of
management’s process for determining fair value, the auditor may conclude that a
qualified opinion or disclaimer on the financial statements is required
Conclusion
Based on the TPA, it appears that obtaining confirmations, with or without a detailed
schedule of investments, and annual audited financial statements of Investee Funds,
provided that they are as of the client’s balance sheet date and from reputable audit firms,
would constitute adequate audit evidence.
Where financial statements are not available, either because the Investee Fund’s audit is
not completed or because the client and the Investee Fund have different year ends,
additional audit procedures must be performed as described in the TPA.