Auditing Investments
Firley, Moran, Freer & Eassa, P.C.
Firley, Moran, Freer & Eassa, P.C. is a CPA firm located in Syracuse, New
York and provides audit and assurance services, tax services, regulatory
compliance, business consulting and other financial-focused business
services. We provide a wide rage of services to over 20 credit unions
ranging from $28mm to over $1 billion in assets. We rank as the second
largest CPA firm in Central New York according to the CNY Business
Journal’s Book of Lists and currently employ over 75 people including 55
CPAs licensed in New York and various other states nationally.
We are also a member of the McGladrey Alliance which provides us with
unique access to “national firm” technical support, continuing education
and practice management assistance, while allowing us to retain our local
office ownership and autonomy. McGladrey is the fifth largest accounting
and consulting firm in the United States and is one of the leading credit
union service providers in the country.
Auditing Investments
Mark Colombo, CPA
mcolombo@fmfecpa.com
Mark is a Principal with Firley Moran, Freer & Eassa, P.C.
and is a Certified Public Accountant with 19 years of
public accounting experience providing auditing,
accounting and tax services to clients. Mark’s client
service experience primarily includes credit unions and
credit union service organizations.
Mark has an
extensive background in providing auditing, accounting,
tax and regulatory compliance services, and internal
control evaluations to credit unions. Mark manages
various projects for thirteen credit union clients ranging
in asset size from $26 million to over a billion dollars.
Mark also heads the firm’s internal audit co-sourcing and
regulatory compliance engagements. He has designed
internal audit programs, assisted in creating internal
audit departments and oversees the internal audit and
compliance work.
James Flynn, CPA
Mark holds a position as Treasurer on the Board of
Directors of the Central New York March of Dimes and is
a Director on the Board of the Fairmount Community
Library. Mark received his Bachelor of Science degree
from LeMoyne College and is currently a member of the
ACUIA, AICPA and the NYSSCPAs.
Jim is a member of the ACUIA, AICPA and the NYSSCPAs,
holds a Bachelor of Science degree, with distinction,
from Clarkson University and serves his community as
the fire chief of a local volunteer fire company.
jflynn@fmfecpa.com
Jim is a Senior Manager with Firley, Moran, Freer &
Eassa, P.C. and is a Certified Public Accountant with 18
years of public accounting experience providing auditing,
accounting, consulting, tax and forensic services to
clients. Four of his 14 years of public accounting
experience were with PricewaterhouseCoopers (formerly
Coopers & Lybrand), where he had a concentration in
financial institutions and insurance. He currently serves
clients in the credit union, group self-insurance and
construction industries, including a specialization in
auditing employee benefit plans. Jim has been involved
with the credit union movement since college when he
worked as a teller at a local credit union. He currently
performs services for eight of our credit union clients
ranging in size from $90 million to over $1 billion in
assets.
Overview of Content
1. Common Credit Union Investments
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Certificates of Deposit
US Treasury Bonds and Notes
US Government Agency Bonds
Mortgage Backed Securities
Collateralized Mortgage Obligations
FHLB Stock
Credit Union Service Organization (CUSO)
2. Financial Statement Disclosures Related to Investments
– FASB ASC 820, “Fair Value Measurements” (formerly SFAS 157)
– FASB ASC 320, “Investments – Debt and Equity Securities” (formerly SFAS 115)
3. Walkthrough of Significant Processes
– Walkthrough Assertions
Overview of Content (cont’d)
4. External Audit Procedures
– Testing of the Internal Control Environment
– Substantive Audit Procedures
• Debt and Equity Securities
• Investments in Closely Held Corporations, Partnerships or Joint Ventures
• Derivatives
• Interest Income
• Accrued Interest Receivable
• Disclosures
• Concluding Steps
Common Credit Union Investments
1. Certificates of Deposit
– Brokered
– Direct
2. US Treasury Bonds and Notes
3. US Government Agency Bonds
– FHLB
– FHLMC
– FNMA
– GNMA
– Etc.
4. Mortgage Backed Securities
– Participations in (i.e. actual ownership of) organized pools of residential mortgages, the
principal and interest payments on which are passed from the mortgage originators
through intermediaries (usually quasi-governmental agencies) that pool and repackage
them in the form of securities, to investors. Such quasi-governmental agencies, which
guarantee the payment of principal and interest to investors, include GNMA, FNMA,
RTCMA, and others.
Common Credit Union Investments (cont’d)
5. Collateralized Mortgage Obligations
– An instrument generally issued by a special-purpose vehicle (SPV) collateralized by a pool of
mortgages. The SPV may be legally organized as a trust, corporation, or partnership and may
issue CMO instruments in equity or non-equity form. The SPV purchases a group of mortgages
using the proceeds of an offering collateralized by the mortgages. The SPV uses the
underlying cash flows of the collateral to fund the return on the instruments required by
investors. The instruments are priced based on their own maturity and rate of return rather
than that of the underlying mortgages.
6. FHLB Stock
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Cost method investment in stock
7. CUSOs
– Wholly owned by the Credit Union or owned by multiple credit unions.
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C-Corporation
Limited Liability Company (LLC) or Partnership
– CUSOs engage in one or more of many types of services, such as; income tax return
preparation, personal investment services, insurance, shared branching, etc.
Financial Statement Disclosures Related to
Investments
• FASB ASC 820, “Fair Value
Measurements”
(formerly SFAS 157)
– Level 1 - quoted prices in
active markets for identical
inputs
– Level 2 - other significant
observable inputs
– Level 3 - significant
unobservable inputs
(including the Credit
Union’s own assumptions
in determining fair value)
Financial Statement Disclosures Related to
Investments (cont’d)
• FASB ASC 320, “Investments – Debt and Equity
Securities” (formerly SFAS 115)
– Credit Union’s typically classify investment securities as
either held to maturity or available for sale.
• Held to maturity securities are those that the Credit Union has the
positive intent and ability to hold to maturity, and are reported at
cost, adjusted for amortization of premiums and accretion of
discounts.
• Investment securities not classified as held to maturity are
classified as available for sale and are reported at fair value, with
net unrealized holding gains and losses reflected as a separate
component of members’ equity.
• Trading securities are reported at fair value but are typically not
applicable for Credit Unions. Unrealized gains or losses on the
trading portfolio are recorded in the income statement.
Walkthrough of Significant Processes
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Authorization and Initiation
Recording
Processing
Reporting
Safeguarding of Assets
External Audit Procedures
Test of Controls
– For each relevant assertion where the planned control risk
assessment is below the maximum, identify specific controls
that are designed to prevent or detect and correct on a timely
basis errors and fraud, which may be individually or
cumulatively material, in those assertions and determine that
such controls have been placed in operation.
– Perform one or more of the following procedures to test the
operating effectiveness of identified controls during the period
under audit:
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Perform corroborative inquiry
Perform observation procedures
Perform inspection procedures
Perform “re-performance” procedures
External Audit Procedures (cont’d)
Debt and Equity Securities
– Obtain an analysis of activity during the period in the securities
portfolio separated by classification type; trading(if applicable), heldto-maturity, or available for sale; and do the following:
• Trace the opening balances to the adjusted prior-year working trial balance
and the ending balances to the current-year working trial balance.
• Review any reconciliation to the general ledger and investigate any unusual
reconciling items.
– The following worksheets are recommended:
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Investment Rollforward and Analysis
Marketable Equity Securities Information
Investment Interest Accrual Information
Debt Security Amortization Information
Investments in Debt and Equity Securities
External Audit Procedures (cont’d)
Debt and Equity Securities (cont’d)
– Obtain supporting schedules of unamortized premium or unaccreated discount and reconcile to schedule(s) of securities and
derivatives in total.
– Where applicable, test the propriety of the classification of
securities as trading, held-to-maturity, or available for sale.
• Classification of debt and equity securities is based on (1) the type of
security and (2) management’s ability and intent to hold the
investment. The classification of debt and equity securities should be
documented by the Credit Union.
• Debt securities should not be classified as held-to-maturity if they will
be available to be sold in response to changes in the following:
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Market interest rates and prepayment risk.
Liquidity demands.
Availability or yield of alternative investments.
Funding sources and terms.
External Audit Procedures (cont’d)
Debt and Equity Securities (cont’d)
– Evaluate management’s intent and
ability to hold securities classified
as held to maturity.
– Determine that debt securities classified as held-tomaturity are valued at amortized cost and that debt and
equity securities classified as trading(if applicable) or
available-for-sale are valued at fair value.
– Determine that the unrealized gain or loss on the trading
portfolio has been properly classified in the income
statement and that the unrealized gain or loss on the
available-for-sale portfolio has been properly classified in
equity.
External Audit Procedures (cont’d)
Debt and Equity Securities (cont’d)
– Determine that any other-than-temporary decline in value of
securities classified as available-for-sale or held-to-maturity has
been properly recognized and accounted for.
• Relevant information to consider:
– Fair value is significantly below cost.
– The decline in fair value can be attributed to adverse conditions specifically
related to the security or to specify industry or geographic conditions.
– The Credit Union does not have the ability or intent to hold the investment for
a sufficient time period to allow for any anticipated recovery in fair value.
– The decline in fair value has existed for an extended period of time.
– A rating agency has downgraded a debt security’s rating.
– The financial condition of the security’s issuer has deteriorated.
– Scheduled interest payments on debt securities have not been made or
dividends have been reduced or eliminated on equity securities.
– Losses from the security have been recorded by the Credit Union subsequent
to period-end.
External Audit Procedures (cont’d)
Debt and Equity Securities (cont’d)
– A security is impaired if the fair
value of that security is less than its
amortized cost basis. The following
relevant information should be
documented:
• The magnitude of the impairment
(i.e. the unrealized loss as a
percentage of the adjusted cost
basis).
• The duration of the impairment (i.e.
the number of consecutive months
that the fair value of the security has
been less than its adjusted cost
basis).
• The original (i.e. purchase date)
ratings of the investment security
(i.e. Moody’s, S&P, Fitch).
• The current ratings of the investment
security.
• Qualitative information regarding the
financial condition of the issuer.
External Audit Procedures (cont’d)
Debt and Equity Securities (cont’d)
– Review general ledger activity
for purchases and sales of
investment securities recorded
within 5 business days before and after year end for
proper cut off.
– Review investment activity and inquire of
management about the existence of any repurchase
agreements, short sales, or wash sales.
External Audit Procedures (cont’d)
Debt and Equity Securities (cont’d)
– Test of Mechanical Accuracy
– Inspection and Confirmation of
Securities
• Inspect the original certificates of securities on hand
and confirm securities held by others.
• Document the items selected for confirmation.
• When inspecting securities, it is important not to be
left alone with the securities.
External Audit Procedures (cont’d)
Debt and Equity Securities (cont’d)
– Purchase Testing:
• Vouch the cost of significant purchases of securities
during the period of examining brokers’ advices and
other relevant documentation.
– Transactions should be recorded on the trade date rather than
the settlement date.
– Test of Sales Transactions:
• Vouch the proceeds from significant security sales
during the period by examining brokers’ advances and
other relevant documentation.
External Audit Procedures (cont’d)
Debt and Equity Securities (cont’d)
– Test of Income:
• Analyze the rates of return on major classes of securities (on
a month-to-month or quarterly basis, if more meaningful to
do so) and compare with those of prior periods, budgets, or
other expectations. Obtain explanations for any unusual
variations.
• Test investment income by means such as the following:
– Vouch dividends and interest received.
– Inspect published sources of dividends and interest income.
– Recalculate investment income based on balances, rates, and
time elapsed, and investigate significant differences between the
calculated and recorded amounts.
External Audit Procedures (cont’d)
Debt and Equity Securities (cont’d)
– Test of Classifications:
• Test the propriety of the classification of securities as
trading(if applicable), held-to-maturity, or available for
sale.
– Examine documentation of management’s intent such as the
following in considering the propriety of classification:
» Written and approved records of investment strategies.
» Records of investment activities.
» Instructions to investment managers.
» Board of directors’/Asset Liability Committee minutes.
External Audit Procedures (cont’d)
Debt and Equity Securities (cont’d)
– Test of Unrealized Gains and Losses and Carrying
Values:
• Re-compute the unrealized gain or loss for each security
classification.
• For fair value measurements identified by management as
Level 1 measurements:
– Compare the market values for a sample of securities with readily
determinable fair values (sales prices or bid and ask quotations
are currently available on a securities exchange or in over-thecounter markets that are publicly reported by NASDAQ or the
National Quotation Bureau to financial publications (such as the
Wall Street Journal) or to internet based pricing sources (such as
Yahoo) known to be reliable), or confirmed with a registered
broker-dealer or investment adviser.
External Audit Procedures (cont’d)
Debt and Equity Securities (cont’d)
– Test of Unrealized Gains and Losses and Carrying
Values (cont’d):
• Based on the understanding of the Credit Union’s
investment portfolio and valuation methodology, determine
if fair value of securities with Level 2 and Level 3
measurements will be tested directly or through the use of
an independent estimate.
• For fair value measurements identified by management as
Level 2 measurements:
– Identify the source(s) of the inputs and verify that those inputs
are observable
– Consider whether adjustments to Level 2 inputs might render the
fair value to be a Level 3 measurement.
External Audit Procedures (cont’d)
Debt and Equity Securities (cont’d)
– Test of Unrealized Gains and Losses and Carrying
Values (cont’d):
• If fair value of securities with Level 2 and Level 3
measurements will be tested directly, test management’s
significant assumptions, the valuation model, and the
underlying data.
• If developing an independent estimate to test fair value for
level 2 or level 3 measurements:
– Review the understanding of management’s valuation model and
significant assumptions.
– Develop independent estimate of fair value.
External Audit Procedures (cont’d)
Debt and Equity Securities (cont’d)
– Test of Unrealized Gains and Losses
and Carrying Values (cont’d):
• Consider whether events and
transactions occurring subsequent to
the balance sheet date should be
considered as audit evidence
corroborating or drawing into
question the relevant fair value
measurement.
• Compare the sales price to fair values
recorded at year end and determine
whether there is evidence that fair
values at year end were overstated.
• Verify that subsequently sold
securities were not classified as HTM.
External Audit Procedures (cont’d)
Investments in Closely Held Corporations, Partnerships,
or Joint Ventures (CUSOs, FHLB)
– Confirm the Credit Union’s ownership percentage in its
investees at the reporting date.
• Test of Cost Basis
– Vouch (if not previously vouched) the cost of the Credit Union’s
ownership interest by inspecting appropriate securities or legal
documents supporting ownership.
– Determine the proper method of accounting for the
investment (cost, equity, or consolidation).
• Consolidation is required for entities that are controlled other than
through a majority voting interest (that is, through variable
interests).
External Audit Procedures (cont’d)
Investments in Closely Held Corporations, etc. (cont’d)
• For investments accounted for using the cost or equity methods, do the
following:
– For investments accounted for using the cost method, compare the
investment and, if applicable, related earnings balances with prior period
amounts or other expectations.
– For investments accounted for using the equity method, review the latest
financial statements of the investee, make inquiries of management, etc., to
evaluate the reasonableness of the investment carrying value
– Determine if there has been any other-than-temporary decline in value of the
investment.
• Test of Carrying Value
– Review the latest financial statements of the investee, make inquiries of
management, etc., to determine whether there has been any other-thantemporary decline in value of the investment.
External Audit Procedures (cont’d)
Investments in Closely Held Corporations, etc. (cont’d)
• Tests of the Equity or Consolidation Method
– Examine documentation supporting material transactions between the Credit
Union and an investee accounted for on the equity or consolidation basis to
determine whether intercompany profits and losses are properly eliminated.
• Inspect the most recent audited financial statements of the investee to verify the
carrying value of the investment and the current-year income or loss attributed to the
investment.
• Determine that the financial statements of the investee are on the same accounting basis
as the Credit Union’s and that the fiscal year end of the investee coincides with the Credit
Union’s.
• Test the accuracy and completeness of the Credit Union’s entry(ies) to consolidate or to
record the investment.
– For the Credit Union's investment(s) in its subsidiary(ies), roll forward account
activity since the prior year end and agree to Credit Union trial balance. Tie
out total investment in subsidiary to subsidiary's equity.
External Audit Procedures (cont’d)
Derivatives (Interest only strips, loan servicing assets, retained portion of loans sold)
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If considered necessary, update your understanding obtained during planning of
the Credit Union’s use of derivatives.
– Retained interest in loans sold
– Loan servicing assets
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For derivatives designated as hedging instruments:
– Determine that the hedged item meets the SFAS No. 133 criteria for designation as a hedge.
– Review the company’s documentation of the hedging relationship to ensure it meets the
documentation requirements of SFAS No. 133.
– Obtain an understanding of the methods used to determine whether the hedge is highly
effective and to determine the ineffective portion of the hedge. Determine that management
has assessed the effectiveness of the hedging relationship at inception and whenever financial
statements are prepared, or at least every three months, noting that the method of assessing
hedge effectiveness is the same as the criteria prescribed by the documentation prepared at
the inception of the hedge.
External Audit Procedures (cont’d)
Derivatives (cont’d)
• Test the valuation of the derivatives at year end.
– Trace fair values to quoted prices, if available (for example,
quoted market prices for derivatives listed on national
exchanges and quoted market prices from broker-dealers who
are market makers). If quoted market prices are not available,
perform appropriate tests based on the valuation method used.
– Test the measurement of the realized and unrealized gain or loss
for derivative contracts.
– Determine whether the unrealized gain or loss on the
instruments has been properly classified.
External Audit Procedures (cont’d)
Interest Income
• Analyze the rates of return on
major classes of securities (on a
month-to-month or quarterly
basis, if more meaningful to do
so) and compare with those of
prior years, current-year budgets,
or other expectations.
– Determine whether there are
dividends or interest that
should be accrued.
– Determine whether
amortization of discounts or
premiums on bonds should be
recorded.
External Audit Procedures (cont’d)
Accrued Interest Receivable
• Perform the following analytical procedures:
– Compare the balance in accrued interest receivable by type of
asset or in total with the balances for prior years or other
expectations.
– Divide the accrued interest balance for each type of asset or in
total by the related asset balance and compare that percentage
to the prior year percentage or other expectations.
– Investigate any unexpected results.
• Obtain and review a reconciliation of accrued interest
receivable to the general ledger account balance.
• Perform Tests of Mathematical Accuracy
External Audit Procedures (cont’d)
Accrued Interest Receivable (cont’d)
• Additional Procedures in Response to Fraud Risk
Assessment:
– Perform the following procedures (generally as a response
to identified fraud risks):
• Evaluate the legitimacy and financial viability of the custodian
(including verifying the proper address) with whom investments
are confirmed.
• Request confirmation of the following information:
– All transactions during the period, including purchases, sales, dividend
and interest collections, interest and other expenses paid.
– The identity of those authorized to make investment transactions.
– Where interest and dividends are sent.
External Audit Procedures (cont’d)
Accrued Interest Receivable (cont’d)
• Additional Procedures in Response to Fraud Risk
Assessment (cont’d):
– Obtain and review all contracts, agreements, and other
documents related to investments, including originals (rather
than copies) of actual securities certificates, broker’s
statements, and other applicable documents. Obtain an
analysis of investment activity directly from executing brokers.
– Review all investment-related journal entries and trace to
supporting documents if not already reviewed when performing
other procedures.
– Review the accounts at the institution of employees with access
to securities or authority to purchase or sell securities.