Audit of the Capital Acquisition and Repayment Cycle

1. Audit of the CapitalAcquisition andRepayment Cycle Chapter 22

2. Learning Objective 1 • Identify the accounts and the • unique characteristics of the • capital acquisition and • repayment cycle.

3. Relatively few transactions affect the account balances, but each one is often highly material in amount. 1 The exclusion of a single transaction could be material in itself. 2 Characteristics of the CapitalAcquisition and Repayment Cycle

4. There is a legal relationship between the client entity and the holder of the stock, bond, or similar ownership document. 3 There is a direct relationship between the interest and dividends accounts and debt and equity. 4 Characteristics of the CapitalAcquisition and Repayment Cycle

5. Accounts in the Cycle • Notes payable • Contracts payable • Mortgages payable • Bonds payable • Interest expense • Accrued interest • Cash in the bank • Capital stock – common • Capital stock – preferred

6. Accounts in the Cycle • Paid-in capital in excess of par • Donated capital • Retained earnings • Appropriations of retained earnings • Treasury stock • Dividends declared • Dividends payable • Proprietorship – capital account • Partnership – capital account

7. Methodology for Designing Tests of Balances for Payroll Liabilities Phase I Identify client business risks affecting notes payable. Set tolerable misstatement and assess inherent risk for notes payable. Assess control risk for notes payable.

8. Methodology for Designing Tests of Balances for Payroll Liabilities Phase II Design and perform tests of controls and substantive tests of transactions.

9. Audit procedures Sample size Items to select Timing Methodology for Designing Tests of Balances for Payroll Liabilities Phase III Design and perform analytical procedures for notes payable balance. Design tests of details of notes payable balance to satisfy balance-related audit objectives.

10. Learning Objective 2 • Design and perform audit tests • of notes payable and related • accounts and transactions.

11. Notes Payable A note payable is a legal obligation to a creditor. It may be unsecured or secured by assets.

12. Notes Payable Objectives of the audit of notes payable: 1. The internal controls over notes payable are adequate. 2. Transactions for principal and interest are properly authorized and recorded. 3. The liability for notes payable and the related interest expense and accrued liability are properly stated .

13. Notes Payable Interest Expense Payments of principal Beginning balance Interest expense Issue of new notes Interest Payable Ending balance Payments of interest Beginning balance Cash in Bank Interest expense Issue of new notes Payments of principal Ending balance Payments of interest Notes Payable and the Related Interest Accounts

14. Proper authorization for the issue of new notes 1 Adequate controls over the repayment of principal and interest 2 Internal Controls

15. Proper documents and records 3 Periodic independent verification 4 Internal Controls

16. Tests of Controls and SubstantiveTests of Transactions Tests of notes payable transactions involve the issue of notes and the repayment of principal and interest.

17. Analytical procedure Possible misstatement Recalculate possible interest expense on the basis of average interest rates and overall monthly notes payable. Misstatement of interest expense and accrued interest, or omission of an outstanding note payable. Analytical Procedures forNotes Payable

18. Compare total balance in notes payable, interest expense, and accrued interest with prior-year balances. Misstatement of interest expense and accrued interest or notes payable. Analytical Procedures forNotes Payable Analytical procedure Possible misstatement Compare individual notes outstanding with those of the prior year. Omission or misstatement of a note payable.

19. Existing notes payable are included (completeness). 1 Notes payable in the schedule are accurately recorded (accuracy). 2 Notes payable are properly presented and disclosed (presentation and disclosure). 3 Major Balance-Related Audit Objectives in Notes Payable

20. Cash in Bank Notes Payable Payments of principal Audited by TOCandSTOT Ending balance Issue of new notes Audited by TOCandSTOT Audited by APand TDB Payments of interest Interest Payable Audited by TOC,STOT, and AP TOC + STOT + AP + TDB = Sufficient competent evidence per GAAS Types of Audit Tests forNotes Payable

21. Interest Payable Interest Expense Interest expense Audited by TOC,STOT, and AP Ending balance Ending balance Audited by APand TDB Audited by AP TOC + STOT + AP + TDB = Sufficient competent evidence per GAAS Types of Audit Tests forNotes Payable

22. Learning Objective 3 • Identify the primary concerns • in the audit of owners’ equity • transactions.

23. Owners’ Equity Publicly held corporation Closely held corporation

24. Cash in Bank Capital Stock – Common Paid-in Capital in Excess of Par – Common Redemption of stock Beginning balance Redemption of stock Beginning balance Issue of stock Issue of stock Ending balance Ending balance Owners’ Equity and Dividend Accounts

25. Cash in Bank Dividends Payable Retained Earnings Beginning balance Beginning balance Payment of dividends Dividends declared Dividends declared Net earnings Ending balance Ending balance Owners’ Equity and Dividend Accounts

26. Internal Controls Proper authorization of transactions Proper record keeping and segregation of duties Independent registrar and stock transfer agent

27. Learning Objective 4 • Design and perform tests of • controls, substantive tests of • transactions, and tests of details • of balances for capital stock and • retained earnings.

28. Existing capital stock transactions are recorded (completeness). 1 Recorded capital stock transactions exist and are accurately recorded (existence and accuracy). 2 Audit of Capital Stock andPaid-in Capital

29. Capital stock is accurately recorded (accuracy). 3 Capital stock is properly presented and disclosed (presentation and disclosure). 4 Audit of Capital Stock andPaid-in Capital

30. Audit of Dividends 1. Recorded dividends exist (existence). 2. Existing dividends are recorded (completeness). 3. Dividends are accurately recorded (accuracy). 4. Dividends as paid to stockholders exist (existence). 5. Dividends payable are recorded (completeness). 6. Dividends payable are accurately recorded (accuracy).

31. Audit of Retained Earnings Transactions involving retained earnings: – net earnings for the year – dividends declared There may be corrections to: – prior-period earnings – prior-period adjustments – appropriations of retained earnings

32. Capital Stock and Paid-in Capital in excess of Par Cash in Bank Issue of stock Redemption of stock Both audited by TOCand STOT Ending balance Audited by TDB TOC + STOT + AP + TDB = Sufficient competent evidence per GAAS Types of Audit Tests

33. Cash in Bank Dividends Payable Payment of dividends Audited by TOCand STOT Ending balance Audited by TDB TOC + STOT + AP + TDB = Sufficient competent evidence per GAAS Types of Audit Tests

34. Dividends Payable Retained Earnings Net earnings Dividends declared Audited by TOCand STOT Audited by TOC, STOT, AP, andTDB Ending balance Ending balance Audited by TDB Audited by TDB TOC + STOT + AP + TDB = Sufficient competent evidence per GAAS Types of Audit Tests

35. Learning Objective 5 • Identify capital acquisition issues • for technology-based companies.

36. E-Commerce and Capital Acquisition Auditors may identify specific business risks associated with the method used by start-up companies to acquire capital. The complexity of the capital transactions may create unique financial reporting and disclosure issues.

37. End of Chapter 22