An auditor's inquiries of management disclosed that the entity recently invested in a series of energy derivatives to hedge against the risks associated with fluctuating oil prices. Under these circumstances, the auditor should:

Question

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Choice "B" is correct. Generally accepted accounting principles specify that, in order to qualify for hedge treatment, the entity must demonstrate and disclose a number of transaction features including risk exposure. The auditor would therefore need to examine the contracts to evaluate the character of the hedge and the degree to which losses should be recognized in the determination of income, as well as the character of any disclosures. Choice "A" is incorrect. Generally accepted accounting principles require this derivative to be valued at fair value. While the auditor does need to test management's assertions about fair value, analytical procedures are not the most likely way to do this. More likely, the auditor would obtain quoted market prices from financial publications, the exchanges, the National Association of Securities Dealers Automated Quotations System (NASDAQ), or pricing services. If quoted market prices were not available, estimates based on valuation models would be used. Choice "C" is incorrect. The auditor would not generally confirm marketability with a commodity specialist, but rather would test the valuation of such securities by reference to quoted market prices, by using pricing services, or based on a valuation model. Choice "D" is incorrect. There is no requirement that investments in derivatives be communicated to those charged with governance.

An Auditor's Inquiries of Management Disclosed That the Entity Recently