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.
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.
James Flynn, CPA 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.
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.
 Overview of Content
1. Common Credit Union Investments 
– 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
– Cost method investment in stock

7. CUSOs
– Wholly owned by the Credit Union or owned by multiple credit unions.
• 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
• 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:
• 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), held-to-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:

• 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 un- accreated
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:
– 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-to-maturity 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-the-counter
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-than-temporary 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)

• 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

• 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.