A custodian can confirm every security listed while management uses an inappropriate measurement basis for the entire portfolio. The auditor must identify considerations relating to accounting classification before deciding whether a quoted price, adjusted cost, or investee financial results provide relevant evidence.
Under U.S. generally accepted accounting principles (GAAP), the measurement objective depends on the investment's characteristics and applicable accounting model.
- Debt securities classified as trading or available for sale are measured at fair value. Classification also determines the treatment of valuation changes.
- Debt securities classified as held to maturity use amortized cost, subject to applicable credit-loss requirements.
- Equity securities generally use fair value through earnings, subject to applicable exceptions, including qualifying equity-method investments and an eligible measurement alternative.
- For an equity security without a readily determinable fair value, an elected measurement alternative requires testing cost, impairment, and qualifying observable transaction adjustments.
- An equity-method investment requires evidence supporting the investor's share of investee results and relevant carrying-value adjustments.
Fair value measures an asset's market-participant exit price in an orderly transaction at the measurement date.
Common mistakes
- Confirmation treated as pricing. Agreement on Bracken's $1,000,000 par value does not substantiate its $880,000 recorded fair value.
- Duplicate-source confidence. Meridian and Cedar provide two documents but one underlying benchmark feed, leaving the adjustment unsupported in Example 2.
- Wrong hierarchy shortcut. An observable starting benchmark does not preserve Level 2 when a significant unobservable adjustment determines the final value.
Bottom line
- Accounting classification establishes the measurement objective before the auditor selects valuation evidence.
- Confirmed holdings support specified assertions but do not automatically establish fair value.
- Hierarchy classification follows the lowest-level significant input to the entire measurement.
- External prices require evaluation of their sources, methods, comparability, dates, and management adjustments.
Exam shortcut
Identify what the question supplies: quantities, a price, an assumption, or a disclosure. Select the procedure that addresses the missing evidence. Mark the measurement date and accounting classification before using a quotation. A correct price can answer the wrong measurement question. When several prices match, inspect their origin. When a price changes, isolate the adjustment and locate its support. For hierarchy questions, trace every significant input through the final value.
The full lesson (about 4,102 words, 27 min read) adds 2 worked examples, all 5 common mistakes, a self-check, free in the app.
Learning objectives
- III.E2
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