Other Financial Instruments

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Other Financial Instruments Audit Case Example: ABC Manufacturing Company

Context

ABC Manufacturing Company’s involvement with complex financial instruments necessitates thorough auditing to ensure accurate reflection in the financial statements, compliance with financial reporting standards, and adequate risk disclosure. The inherent risks, valuation models, and accounting treatments associated with these instruments present unique audit challenges.

Audit Objective

To obtain reasonable assurance that other financial instruments are appropriately recognized, measured, and disclosed in ABC Manufacturing Company’s financial statements in accordance with the applicable financial reporting frameworks, such as IFRS 9, Financial Instruments, or ASC 815, Derivatives and Hedging, under US GAAP.

Types of Audit Evidence and Documentation for Other Financial Instruments Assertions

1. Existence

• Case: Verify the physical or documentary existence of complex financial instruments through inspection of contracts, confirmation with counterparties, or examination of other relevant documentation.

• Documentation: Document the methods and results of verifying the existence of these instruments, including details of confirmations received, contracts reviewed, and any issues identified.

2. Rights and Obligations

• Case: Confirm the company’s rights and obligations related to these financial instruments, ensuring the company has control over the benefits and is obligated under the liabilities recognized.

• Documentation: Summarize the examination of legal documents, agreements, and contracts that establish the company’s rights and obligations for each type of financial instrument, noting the key terms and conditions.

3. Completeness

• Case: Ensure all financial instruments engaged by the company are recorded in the financial statements, including off-balance-sheet items.

• Documentation: Outline the procedures for assessing the completeness of records, such as reconciling the list of financial instruments with accounting records, trade confirmations, and bank statements.

4. Valuation and Allocation

• Case: Assess the fair valuation of these financial instruments, considering market data, valuation models, and inputs. For instruments used in hedging, evaluate the effectiveness of the hedge relationship.

• Documentation: Document the valuation techniques, models, and assumptions used, including sensitivity analyses for significant inputs and the rationale for chosen methods. Note the results of hedge effectiveness testing and any hedge adjustments made.

5. Presentation and Disclosure

• Case: Review the financial statements to ensure that financial instruments are correctly classified, described, and disclosed according to the applicable standards, including risks and fair value measurements.

• Documentation: Evaluate the accuracy and completeness of financial instrument disclosures, verifying that they meet the requirements of the financial reporting framework and provide clear information on risk management, valuation methods, and the effects on the financial position and performance.

Additional Considerations

• Internal Controls Assessment: Evaluate the design and effectiveness of internal controls over the recognition, measurement, and disclosure of complex financial instruments, including controls over valuation models and inputs.

• Inquiries and Expert Consultations: Make inquiries with management and, if necessary, consult with valuation or risk management experts used by the company to understand complex instruments and their accounting treatments.

• Impact on Financial Statements: Assess the overall impact of these financial instruments on the financial statements, especially regarding liquidity, solvency, and risk exposure, and document any significant findings or concerns.

• Communication with Governance Bodies: Discuss significant findings related to the audit of other financial instruments with management and those charged with governance, focusing on valuation uncertainties, complexity of risk management strategies, and adequacy of disclosures.

Conclusion

Auditing other financial instruments is crucial for ensuring their proper recognition, measurement, and disclosure in the financial statements, reflecting the company’s financial position and risk exposure accurately. Documenting the audit procedures and findings for each relevant assertion provides a foundation for the auditor’s opinion, enhancing the reliability and transparency of the financial reporting related to these complex instruments.