4.30 The tests of the capital accounts (shareholder accounting) of a mutual fund cover a broad area encompassing various aspects of transactions with shareholders. The principal audit objectives are to make sure that—
•
The number of outstanding shares of capital stock at the audit date is stated properly.•
Procedures are satisfactory for determining the number of out-standing shares used to compute daily net asset value per share.•
Procedures are satisfactory for determining the number of shares required to be registered under the 1933 Act.•
The receivable for capital stock sold and the payable for capital stock redeemed are stated properly.•
Distributions from investment income, net realized gains from se-curities transactions and capital, and their reinvestments, if any, are computed and accounted for properly.•
Procedures are satisfactory for maintaining control over the recordkeeping for individual shareholder accounts.Consideration of Internal Control
4.31 The auditor should become familiar with the following:
•
The rules and regulations under the 1940 Act and under section 17 of the 1934 Act that encompass shareholder accounting, in-cluding pricing of fund shares, recordkeeping requirements, and applicable exemptive orders•
The fund's current prospectus, which states the fund's policies for accepting sales orders and redemption of fund shares•
The agreement among the fund, its distributor, and those respon-sible for the stock transfer function as well as agreements with intermediaries for the acceptance and processing of transactions in fund shares•
State Blue Sky laws, NASD rules, and the fund's procedures for monitoring compliance4.32 The auditor should understand the shareholder accounting and trans-fer function, whether performed by the fund or outside agents. (See the
discussion in paragraphs 4.54 through 4.60 on reports on controls at outside service organizations.) The auditor should consider the controls over processing of the following:
•
Sales•
Redemptions•
Reinvestments•
Cash distributions•
Correspondence•
Stock issuance and stock dividends•
Letters of intent•
Transactions subject to rights of accumulation•
Collections on sales and repayments for redemptions•
Cancellation of sales and redemptions•
Check writing and telephone redemptions•
Account maintenance (address, name, dividend option, and so on) changes•
Inactive accounts (for example, dormant or undeliverable ac-counts)•
Fees imposed on, or other restrictions placed on, frequent trading of fund shares4.33 If the procedures for the above are implemented properly, the fund or its agent would be furnished promptly with the information required to process properly its shareholder records as required by the 1940 Act.
4.34 Administrative arrangements providing for such services as subtrans-fer agency and recordkeeping may exist among the fund, its custodian, transsubtrans-fer agent, or underwriter. The auditor should review the contractual responsibili-ties of the various parresponsibili-ties to those arrangements to determine whether to—
•
Obtain information about the controls of those parties that may affect the investment company's information technology.7•
Obtain a service auditor's report on controls at service organiza-tions that may affect the investment company's information tech-nology.•
Perform other procedures.4.35 Based on an understanding of internal control, and controls at service organizations, if applicable, the auditor may decide to obtain evidential matter about the effectiveness of both the design and operation of controls to reduce the assessed level of control risk below the maximum level. Such evidential matter may be obtained from tests of controls or from procedures that were not specifically planned as tests of controls but that nevertheless provide evidential matter about the effectiveness of the design and operation of the controls.
7AU section 319,Consideration of Internal Control in a Financial Statement Audit (AICPA, Professional Standards, vol. 1; AICPA, PCAOB Standards and Related Rules), describes the aspects of an entity's information technology that are relevant to an audit of financial statements. AU section 320,An Audit of Internal Control Over Financial Reporting Performed in Conjunction With an Audit of Financial Statements (AICPA, PCAOB Standards and Related Rules), describes the aspects of an entity's information technology that apply for an integrated audit.
4.36 The auditor may select transactions throughout the audit period to test controls in some of the following areas:
•
Pricing shares at net asset values next computed•
Review and approval of daily transaction totals•
As-of transactions•
Reprocessed transactionsAfter identifying specific controls relevant to specific assertions and performing tests of these controls, the auditor should evaluate evidential matter obtained through the testing and conclude on the assessed level of control risk. The auditor uses the assessed level of control risk (together with the assessed level of inherent risk) to determine the acceptable level of detection risk for financial statement assertions. The auditor uses the acceptable level of detection risk to determine the nature, timing, and extent of substantive tests to be performed.
4.37 The auditor may wish to review schedules maintained by the fund of sales of shares in each state concerning Blue Sky laws and federal regu-lations to test compliance with regulatory requirements or to determine that management is monitoring such compliance.
Examination of Transactions and Detail Records
4.38 The auditor performs substantive tests of activity and balances in the capital accounts based on many factors, including the assessed level of control risk.
4.39 Sales and Redemptions of Fund Shares. The auditor may wish to test whether details on the order form or other customer evidence used in processing a sale or redemption agree with the copy of the form ultimately sent to the shareholder to confirm the sale or redemption. Such tests should also determine whether the transactions conform with the fund's prospectus (including sales charges) and with the reinvestment and redemption options selected by the shareholder in his or her account application.
4.40 Depending on the method used to redeem shares, the auditor may examine shareholder requests, wire order forms, telephone tape recordings, telephone order forms, and copies of checks remitted to shareholders.
4.41 The auditor should test totals of daily sales, and redemptions of capital shares by comparing them with postings in the related journals. Capital stock outstanding for the days tested should be compared against the applicable daily net asset valuation worksheets used as the basis for computing the net asset value per share.
4.42 Settlement of Sales and Redemption Transactions. The auditor should gain assurance that procedures are in place to determine that receivables for shares sold and payables for shares redeemed are priced and settled promptly.
Subsidiary trial balances of receivables and payables should be reconciled with general ledger control accounts as of the balance sheet date. The timely can-cellation of sales and redemptions not settled within a specified time and the disposition of losses that may result should also be determined.
4.43 Reconciliation of Shares Outstanding. The auditor should become sat-isfied that the fund has reconciled its general ledger account for outstanding
shares with reports of the transfer agent throughout the audit period and satisfactorily resolved all reconciling items. The auditor should examine the underlying support for the reconciling items to the extent considered necessary.
4.44 At the balance sheet date, the auditor should confirm shares outstand-ing directly with the transfer agent and should determine whether the shares have been reconciled with the shares shown as outstanding in the fund's records.
Should the auditor conclude that audit risk has not been reduced to an accept-ably low level by the combination of obtaining an understanding of the control environment (including consideration of any related service auditor's report) and confirming shares outstanding in total with the transfer agent, the auditor may consider it desirable or necessary to confirm outstanding shares directly with shareholders. The auditor may perform the confirmation procedure at a date other than the balance sheet date. For example, the auditor may confirm the shares outstanding at the interim date of the audit.
4.45 Dividends and Distributions to Shareholders and Reinvestments. Pay-ments of dividends on capital stock may be tested to determine that payPay-ments in cash or in additional capital stock have been computed properly. Distribu-tions based on long-term realized gains from securities transacDistribu-tions, except for a supplemental distribution of up to 10 percent of the original distribution, may not be paid more than once a year by a registered investment company except that an additional distribution of long-term gains may be made solely to comply with Internal Revenue Code distribution requirements underexcise tax reg-ulations. However, pursuant to rule 19b-1(e) of the 1940 Act, a fund may apply to the SEC for permission to make an additional distribution(s) of long-term capital gains.
4.46 The auditor should review the board of directors' minutes for relevant dates and amounts of dividend declarations and should test whether shares out-standing on that date (ex-dividend date for open-end companies), according to the fund's records, have been reconciled to information reported by the transfer agent. The total dividend should be recomputed (outstanding shares times rate) and compared against a notification from the dividend-paying agent, who is usu-ally also the transfer agent. To test that the liability for a dividend was recorded on the proper date, the dividend should be compared with the general ledger and with the applicable daily net asset valuation worksheet. The computation of the number of shares to be reinvested, as reported by the dividend-paying agent, should be tested, and the portion of the dividend taken in shares should be compared against the capital stock accounts for agreement of both number of shares and dollar amounts.
4.47 The computations of daily dividend rates for funds that declare divi-dends daily should be tested for selected dates throughout the period.
4.48 Recordkeeping for Individual Shareholder Accounts. Based on the as-sessed level of control risk for assertions that relate to the activities of the transfer agent or shareholder servicing agent, the auditor may wish to select some accounts to test the validity and proper documentation of transactions for name and address changes, share transfers to or from individual accounts, and transactions that are not routine. The auditor may find it desirable to confirm some shareholder accounts, such as for a transfer agent that is not indepen-dent of the investment company or where the auditor cannot rely on the transfer agent's controls.