New practice aid on AU 332 available from AICPA: Alternative investments - Audit considerations
The American Institute of Certified Public Accountants ("AICPA") issued a practice aid entitled Alternative Investments - Audit Considerations (the "Practice Aid") to provide guidance on applying existing professional literature on auditing investments (in particular, Interpretation No.1 to AU 332), based on input from the AICPA's Alternative Investments Task Force and certain AICPA member firms. The Practice Aid provides guidance to assist auditors in addressing the existence and valuation assertions associated with alternative investments due to the lack of a readily determinable fair value and the limited investment information generally provided by investee fund managers. This Practice Aid should be of interest to management of investor entities including, but not limited to, other investment companies (i.e., funds-of-funds), colleges and universities, hospitals and pension plans, as well as to management of the underlying investee funds.
Interpretation No. 1 to AU 332 (the "Interpretation") was issued in July 2005 to assist auditors in applying the provisions of AU 332 to alternative investments. The Interpretation provided guidance on the confirmation of an investor entity's interest in a fund by the investor entity's auditor. The Interpretation was controversial because it stated that simply confirming investments in the aggregate does not constitute adequate audit evidence with respect to the existence assertion. It stated that, in certain circumstances, confirmation of the holdings of the investee fund on a security-by-security basis would be necessary. Uncertainty existed over concerns whether auditors would be required to disclaim opinions on investor entities due to scope limitations resulting from the likely unwillingness of investee fund managers to confirm all requested information, and even if fund managers provided portfolio listings, what investor entities and their auditors would be expected to do, or even could do, with the information. The Practice Aid clarifies that while confirmation of the holdings of the investee fund on a security-by-security basis (or contemporaneous audited financial statements) typically would constitute adequate audit evidence with respect to the existence assertion, the auditor for the investor entity should consider alternative or additional procedures directed at the existence of the alternative investments.
The Practice Aid also reinforces that uncertainty as to whether the fund manager will provide the requested information does not obviate the auditor’s requirement to obtain sufficient appropriate audit evidence - either through confirmation or otherwise. If the confirmation request is not returned to the auditor or the details of the underlying investments are not otherwise provided by the investee fund manager, the auditor should perform alternative procedures. Even if all the requested information is provided, additional procedures may also be necessary in certain circumstances.
The Practice Aid particularly reinforces that management of the investor entity is responsible for the valuation of alternative investment amounts as presented in the investor entity’s financial statements and that this responsibility cannot be outsourced or assigned to a party outside of the investor entity’s management. Although the investor entity’s management may look to the underlying fund manager for the mechanics of the valuation, management of the investor entity must have sufficient information to evaluate and independently challenge the investee fund’s valuation. Management of the investor entity must therefore have in place an effective process and related internal controls to ensure that its investments in investee funds are recorded at amounts in accordance with its stated accounting policies. The nature, timing and extent of management's process will depend on management’s risk assessment with respect to the investee funds. The auditor's risk assessment, after considering management's process, will determine the quantity and quality of audit evidence necessary to support the existence and valuation assertions. A subtext to the Practice Aid is that, because the investments presented in an investor entity's financial statements represent investor management's assertion, the auditor should not rely exclusively on information obtained from the investee fund manager while ignoring investor management's controls, including its monitoring process.
With respect to this new guidance, we suggest that fund sponsors take the following actions:
1. Carefully consider these requirements — The demands of a growing and more institutional investor base along with other pressures have combined to force fund sponsors and portfolio managers to grapple with the issue of transparency. This means that hedge fund managers, in particular, are increasingly being asked to divulge more information on their strategies, portfolios and performance, whereas traditionally they have not been required to provide such information. In addition, private equity fund managers are being asked to provide more transparency around their portfolio company investments at a time where concerns around this information already exist as a result of the recent Freedom of Information Act requests.
2. Evaluate all aspects of your investor reporting — The issue of transparency incorporates all forms of information requested by, or provided to, current and potential investors, consultants, and others. The focus on investor management's monitoring controls is likely to increase investor contact with funds, as well as requests for various types of information throughout the year, not just on investor entities' annual reporting dates. As a result, portfolio managers, investor relations, legal/compliance and finance/accounting personnel need to collectively prepare for and assess these requirements.
Stay tuned for further guidance — PricewaterhouseCoopers is committed to helping our clients, including both investors in alternative products and fund managers, understand how this new guidance will be interpreted and applied in practice.
Specific advice and assistance may be sought from your PricewaterhouseCoopers engagement team or from any of the partners in our Alternative investment management practice.
To view the AICPA Practice Aid on AU 332, click here.
Publications Search Page
