Audit of Investments for CA Intermediate

An investment is an asset held to earn income, capital gain or other benefit, such as shares, debentures, mutual fund units, government securities, or property held for investment. Investments are often high in value but few in number. So the auditor can test most of them, not just a sample.

The auditor works through assertions. Existence: does the investment really exist on the date of the balance sheet? Rights and ownership: is it in the entity's name, and is it free of pledge or lien? Valuation: is it carried at the correct amount, with a provision for any diminution that is other than temporary? Completeness and presentation: are all investments recorded and shown under the right heads with proper disclosure?

Classification matters. Under AS 13, investments are split into current investments (readily realisable and intended to be held for not more than one year) and long-term investments (all others). In the Schedule III balance sheet, current investments appear under current assets and non-current investments under non-current assets. Wrong classification is a presentation error even when the amount is right.

Valuation follows AS 13. Current investments are carried at the lower of cost and fair value. Long-term investments are usually carried at cost, with a reduction only for a decline other than temporary. AS 13 permits an increase of a long-term investment to fair value only in special circumstances, for example a restructuring of an enterprise that involves revaluation. Otherwise a long-term investment is carried at cost less any decline other than temporary. Where such a special write-up has been made, the auditor checks that the basis is disclosed. The auditor checks that the cost includes acquisition charges such as brokerage and fees, and that the decline test is supported by evidence such as market price, the investee's results and the entity's intention.

Investment income (interest, dividend, gains) is also audited. Interest accrues on a time basis. Dividend is recognised when the right to receive it is established. The auditor ties income to the investment records and checks for any tax deducted at source. Finally, the auditor checks the disclosures required by Schedule III and AS 13, and for companies, compliance with the Companies Act on loans and investments.

Under Section 186(1), a company cannot make investments through more than two layers of investment companies. There are two exceptions: a company may acquire a company incorporated outside India that has investment subsidiaries beyond two layers under the law of that country, and a subsidiary company may have an investment subsidiary to meet a requirement of any law, rule or regulation. Under Section 186(5), an investment (and likewise a loan, guarantee or security) needs to be sanctioned by a resolution passed at a meeting of the board (not by circulation) with the consent of all the directors present at the meeting. Where a term loan from a public financial institution is subsisting, that institution's prior approval is also needed. If investments, loans and guarantees would go beyond the limit in Section 186(3) (60% of the aggregate of paid-up share capital, free reserves and securities premium account, or 100% of free reserves and securities premium account, whichever is more), a prior special resolution of the members passed in general meeting is required under Section 186(3), in addition to the board approval. The company must record the investments in the register kept under Section 186(9).

Use the same frame for every question, whether it asks about verification, valuation or income. Tie each procedure to an assertion.