Finance and Investment Cycle

ACC 300/BCTA
 Objectives
• Understand the nature, purpose and accounting
implications in the cycle
• Understand the documents utilised in the cycle and
describe the purpose of each, both manual and
computerised.
• Understand the risks in the cycle and be able to
recommend controls to mitigate risks evident in a case
study.
• Understand controls in the cycle (both manual and
computerised)
• Understand how to gather audit evidence in relation to
the affected account balances and or transactions.
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Purpose of the cycle
• Ensure that an entity invests funds in non-current
assets to commence and operate a business and
generate working capital = profits (one of the
company’s objectives) = Acquisition of capital assets
• Ensure that an entity invests excess funds in assets
that generate interest/dividends.
• Ensure that the entity obtains sufficient financing to be
able to start, operate and sustain a business = raising
of funds through owner’s equity and long-term debt
and repayment of funds borrowed.

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The link between the cycle and other cycles

Inventory & Production Receipt of

money from
SHs = cash

Receipt of
loan = cash Payments
of interest
and capital

Interest
income/dividends
PPE – dealt with under this = revenue/cash
cycle

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Cycle characteristics
Characteristic Understanding
Frequency of transactions Fewer number of transactions
Value of transactions Usually material ROMM
Legal and regulatory requirements Usually governed by a statute (Companies Act,
MOI)

Non-routine internal controls Generally, no routine controls, however controls

should exist

Many transactions are based on More complex transactions, can affect valuation
management estimates and ROMM
assumptions
Major risks within the cycle Completeness of liabilities
Existence & valuation of assets
ROMM
Validity of transactions

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Compensating controls
A compensating control is a
security measure implemented to
counterbalance or compensate for
a weakness or deficiency in another
control or process

Control
Planning • Decisions to invest or finance are often due to decisions
adopted by directors, therefore, are carefully planned.
• Planning involves
• formation of specific committees,
• preparation of capital budgets,
• decision on methods of financing etc
Authorisation • Authorisation by way of resolution. Resolution should be
minuted.
• Usually at the highest level (BOD) and may require specific
Companies Act or MOI approvals.
Implementation • Where the new investment (assets) is not straightforward
competent staff should be used to project manage
Review and approval • All transactions should be subject to review and approval
and regular monitoring against requirements to ensure
validity
Controls after asset is on • Material tangible assets should be secured.
hand • There should be a detailed fixed asset register an
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 The cycle pertains
acquisition of capital
Accounts affected assets, raising funds
through OE and LT-
Debt, repayments and
investments.

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 Investing vs. Financing Activities

Investing: Financing:
Acquisition & disposal:
Obtain funding through:
- PPE - Issue of shares
- Intangible assets - Loans
- Financial instruments - Debentures
Receipt & accrual of: Payments:
- Dividends - Loan repayments
- Dividends
- Interest income
- Finance charges
Accounting for change of use

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Accounts affected

Investing activities Financing activities

Statement of • PPE • Share Capital (& other owner’s equity

Financial Position • Intangible assets accounts)
• Goodwill • Retained income
• Financial instruments (A) • Long-term loans
• Revaluation reserves • Debenture financing
• Financial instruments (L)
Statement of Profit • Depreciation expense • Dividends declared/paid
or Loss and other • Amortisation expense • Finance expense
Comprehensive • Impairment expense • Gains and losses on financial
income • Profits and losses on instruments
disposals
• Revaluations
• Finance revenue
• Gains and losses on
financial instruments

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How does this fit into our audit of the
financial statements?

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.
Investing Activities
Types of transactions

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Documentation
 Capital budget

 Fixed asset requisition

 Minutes of BOD

 Invoices

 Fixed assets register

 General ledger accounts

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Flow of information

Fixed asset
Capital requisition/ Authorisations
budget quotations (minutes of
meetings)

Invoices
General Fixed
Financial (purchases
statements
ledger asset /
accounts register
sales)

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Fixed Asset Register (FAR)
FAR example
Risks
Inherent risks specific to investing activities:
 Management bias and incentive to misstate capex – achieve
budget, performance bonuses
 Complexity of the assets – errors in accounting such as property
development
 Valuation of intangible assets – goodwill & brands
 Determining useful lives of assets/fair market values
 Override of controls – unauthorised acquisitions
 Risk of fraud and theft – overstating investments, PPE
 Errors in recording

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 Risks at assertion level
Assertion Risk

• Existence • Non-existent assets are recorded in

the financial statements

• Valuation and allocation • Obsolete assets are recorded in the

and accuracy financial statements
• Depreciation, impairment or
revaluation is inappropriate

• Classification • Inappropriate capitalisation of

costs such as repairs and
maintenance, R&D
• Rights • The company may not have rights
to the assets

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 Investing main activities

Additions

Repair/
Maintenance & Disposals
Improvements

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Fixed asset additions

 Authorisation of additions:
Formal written proposal by the CAPEX committee
Supported by quotes and source of finance
Presented to BOD
Decision minuted
Large organisation –different levels of authorisation
Directors’ interest in contracts disclosed
Usual issue of purchase order/ DN from supplier/ invoice (Purchases and
Payables cycle)
Formal signed contract

 Assets acquired under lease:

BOD approval
Decision minuted
Formal lease agreement
Compliance with IFRS 16 requirements
Recognise the right of use asset and the corresponding lease liability for all long-
term leases
Disclose future lease commitments

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Disposal of fixed assets:
• Less formal controls around disposal
• Proceed = cash/trade-in value
• Major risk - assets disposed of can
still be reflected as assets

Repairs & maintenance:

• Major isk – items capitalised instead
of expensed (to overstate profits) Or
items expensed instead of capitalised

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Financing Activities
 Finance Activities

Finance activities:
Means by which entity obtain FUNDING for
business operations and capital investment
Two main sources:

Equity
(Issue of shares)
Borrowings
(Loans)

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Transaction in the cycle

 Share capital
 Issue of shares
 Share buybacks

 Retained income:
 Distributions

 Long-term loans, debentures, financial instruments

 Advances
 Repayments
 Interest
 Gains and losses

 Contingencies, commitments and provisions

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Significant Balances
Transaction Account debited Account credited

Issue of shares Bank Share capital

Retained earnings Various income/expense accounts Retained earnings
=net income

Dividends declared Dividends declared Shareholders for dividend

Bank
Shareholders for dividend

Share buy-backs Share capital Bank

Loans/Borrowings Bank Lender

Loans repaid Lender Bank
Interest paid Interest expense Bank

Lease assets acquired Right-of-use-asset Lease Liability

Interest expense Interest expense Lease Liability
Payments Lease Liability Bank
Depreciation Depreciation expense Accumulated depreciation
(RoUA)

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Key documents & records
Common Documents Details
• Minutes of shareholders/directors • Provide approval for share issue,
debenture share buy-
back, dividends declared
• Debenture trust deed • Terms of debenture issue and rights & obligation of
debenture holders.
• Prospectus • Document prepared for public share offering
containing all details regarding issue.
• Share certificate • Evidence of ownership given to shareholder, detail
number & type of share
• Loan/lease contract • Terms of loan/lease, amount, repayment terms
interest rate and security
• Mortgage bond • Agreement signed over property to secure
repayment of loan
• Journal voucher • Several entries made by journal –interest calc,
finance lease payments.

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 Risks
 Highly regulated environment, strict controls by directors
over financing activities
 Comprehensive disclosure requirements i.t.o. IFRS for
equity and borrowings
 Additional required information –assets pledged or
guarantees.
 Global markets – laws/regulations in foreign markets
affecting disclosure
 Foreign exchange gains/losses in income statement

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TEST OF CONTROLS
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Test of Controls

Reperform
Inspection
Observation
Inquiry
Recalculation

Remember the auditor’s toolbox

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Assertions for Investment and financing transactions

Control objective Classes of transactions and events

Investing and financing
Validity Occurrence and cut-off

Accuracy Accuracy and classification

Completeness Completeness

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Assertions for Investment and Financing balances
Control objective Account balances
Investing and financing
Validity Existence and Rights and
obligations

Accuracy Accuracy, Valuation and Allocation

Completeness Completeness

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Example of test of controls – Investment activities

Key risk & Assertion Internal control Test of control

Acquisition of tangible assets Adequate segregation of duties Confirm, through inspection of
- Occurrence is ensured – one individual is not capital asset purchase
Asset purchased may be invalid responsible for initiating and transactions that two people
(e.g., for staff personal use) and approving a capital asset signed the documents:
thus result in unnecessary asset purchase transaction. The one - Initiator
purchases or even fraud as a who initiates the transactions - Supervisor
result of non-legitimate signs the request, and a
payments being made. supervisor approves the
transaction by way of his
signature.
Accounting for the use and Material decisions with regard to Confirm, by inspection of CFO
change in asset values – these impairments or and financial director’s
Occurrence, Completeness revaluations are made by the signatures on the asset
and Accuracy CFO and financial director Masterfile that they authorised
Assets may be incorrectly based on relevant information decisions for impairments and
valued through the invalid, and authorise these decisions revaluations.
incomplete or inaccurate by way of signatures on the
recording of depreciation, asset Masterfile.
amortisation, impairments and
revaluations.

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Example of test of controls – Financing activities

Key risk & Assertion Internal control Test of control

Issue (or repurchase) of The board of directors by way Inspect minutes of board of
shares - Occurrence of resolutions authorise and director’s meeting for
Invalid issues (or repurchases) approve all share issue or resolutions taken to authorise
of shares may occur (i.e., that repurchase decisions. and approve share
are not in line with the issue/repurchase decisions.
requirements of the companies
act, companies regulations or
the MOI)
Accounting for finance All calculations of finance Confirm that the calculations of
charges, loan repayments charges and capital finance charges and capital
and other adjustments – repayments are made based repayments were made based
Occurrence, Completeness on properly signed loan on properly signed loan
and Accuracy agreements (signed by the agreements by inspecting the
Invalid, incomplete and/or director authorised by the loan agreements for the
inaccurate finance charges board) that include all relevant signature of the authorised
and/or repayment transactions- terms and conditions. director.
may be recorded and paid. Also confirm, by inspection of
the directors meeting minutes
that the director who signed
was indeed authorised by the
board.

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Substantive procedures
 TEST OF DETAIL:
INVESTING ACTIVITIES

a) Property, plant and equipment

b) Investments in shares – IFRS 9

c) Long-term loans made by the

company

d) Intangible assets – IAS 38

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Substantive test of detail - PPE

Assertion Procedure
Existence • Physically inspect assets, match
descriptions, asset numbers, serial
numbers (sheet to floor)
Completeness • Inspect repairs & maintenance for
material items, trace to supporting
documentation – determine if they are
R&M or additions
• Trace assets from floor to fixed asset
register (floor to sheet)
• Review financing agreements (leases)
Rights • Minutes of meetings
• Financing agreements
Cut-off • Asset additions and disposals close to
year end

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Substantive test of detail - PPE

Assertion Procedure
Valuation – depreciation • Review accounting policy
• Consider changes in estimates or
policies
• Recompute depreciation
Valuation – impairment • Evaluate processes for identifying
impairments (assumptions, methods)
• Discuss affect of business changes
relating to recovery of assets
• Consider market/environmental
changes
Valuation – revaluation • Review support for revaluations –
internal (audit calculations vs valuators
(ISA 620 – use of experts)
• Compare with independent sources

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Substantive test of detail - PPE

Additions
• Agree to budgets
• Invoices (cross reference descriptions, serial #)
• Physically inspect
• Depreciation policy and recompute
Disposals
• Inspect supporting documentation (sales documents)
• Consider authorisation of disposals
• Trace proceeds to receipts
• Recompute profit/loss on disposal
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Fixed asset register procedures

• Agree opening balances

• Recompute casting and extensions
• Recompute depreciations
• Asset additions procedures
• Asset disposal procedures 40
• Other considerations

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Substantive test of detail - PPE

General procedures
a) Opening balances
b) Re-perform casts and extensions
c) Re-perform reconciliation of FAR to GL
d) Agree FAR, GL, TB and AFS
e) Presentation and disclosure

REMEMBER THE GENERAL PROCEDURES

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Other investing activities
b) Investments in shares
• Existence (share certificates)
• Rights (securities)
• Valuation methods
c) Long-term loans receivable
• Similar to debtors, therefore audit procedures are similar
d) Intangible assets
• IAS 38 considerations for recognition
• Similar audit procedures to that of PPE

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 TEST OF DETAIL:
FINANCING ACTIVITIES

a) Share capital
Companies Act
b) Reserves knowledge is NB!
c) Debentures
d) Long-term loans
e) Lease liabilities
f) Provisions, contingent liabilities
& assets

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a/b) Share capital and reserves
Assertion Procedure
Occurrence 1. Inspect MOI and resolutions, where shares
are issued or bought back, ensure
necessary Companies Act authorisations
have taken place.
2. Trace receipts and disbursements relating to
shares to bank accounts
Completeness Confirm with directors that no other shares have
been issued during the year
Accuracy, cut off and classification 1. Reperform calculations with regard to
considerations received
2. Review supporting documentation to ensure
cut off
3. Cast and perform extensions
Presentation Inspect AFS for appropriate disclosure of share
capital

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c) Debentures
Assertion Procedure
Occurrence 1. Inspect MOI and minutes of meetings to
establish if debentures have been issued
Completeness Inquiry from directors and inspect minutes
Accuracy, cut off and classification NOTE: initial recognition and subsequent
measurement
1. Reperform calculations with regard to
considerations received
2. Review supporting documentation to
ensure cut off
3. Cast and perform extensions
4. Recalculate effective interest rates based
on terms (subsequent measurement)
Presentation Inspect AFS for appropriate disclosure of
share capital

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d) Long term loans

 Auditing of the balance needs to be achieved by auditing the transactions making

up the balance
• Advances
• Repayments
• Interest
 An important accounting aspect is that loans should be measured at amortised
cost using the effective interest rate method
 Audit procedures are similar to debentures
 Obtain 3rd party confirmations (same considerations as for bank confirmations)
 The primary risk is completeness of loans
• Consider major acquisitions (investment) (how were they funded)
 Rights and obligations is an important audit aspect
 Ensure classifications are correct in AFS (long vs short term)

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e) Lease liability

 Audit procedures are similar to long-term loans

 Must consider both right of use asset and lease liability
together
 Rights and obligations
 Obtain 3rd party confirmations
 Inspect AFS to ensure IFRS 16 disclosures are met

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f) Provisions, contingencies and commitments
Definitions
Liability Present obligation arising from a past
event, settlement results in an outflow of
resources
Provision Liability of uncertain timing or amount
(adjustment in the financial records)

Contingent liability Possible obligation arising from a past

event which can only be confirmed by an
uncertain future event

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f) Provisions, contingencies and commitments

Audit implications
 Provisions balances/transactions are not straightforward and will vary from company to company
 Contingent liabilities are not recognised but disclosure is required
 Procedures for provisions and contingent liabilities are very similar
 Major risk is completeness (understatement) as companies would not like to include or disclose obligations
(why?)
Completeness
 Evaluate company policy for identifying provisions and contingencies
 Compare with prior periods and consider significant reductions
 Consider subsequent cash payments made/subsequent events
 Inspect minutes of meetings for evidence of provisions
• Warranties
• Guarantees
• Environmental issues
• Closure of divisions

Presentation
 Inspect AFS and consider disclosures in line with IAS 37
 Provisions are presented in a separate line on the statement of financial position
 Contingent assets and liabilities are only disclosed in the notes

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General procedures

 Opening balances
 Reperform casts and extensions
 Cut off procedures
 Obtain 3rd party confirmations at every possibility
 Obtain management representation letters for ….

NB! Knowledge of underlying accounting standards is very important in

investment and financing cycles, particularly concerning valuation
assertion

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RESOURCES:

 Module
 Lecture slides
 Question Bank
 Consultation (Lectures & Peers)

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