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

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

5. Accounts in the Cycle • Notes payable • Contracts payable • Mortgages payable • Bonds payable • Interest expense • Accrued interest • Appropriations of retained earnings • Treasury stock • Dividends declared

6. Accounts in the Cycle • Cash in the bank • Capital stock – common • Capital stock – preferred • Paid-in capital in excess of par • Donated capital • Retained earnings • Dividends payable • Proprietorship – capital account • Partnership – capital account

7. Methodology for Designing Testsof Balances for Notes Payable Identify client business risks affecting notes payable Phase I Set tolerable misstatement and assess inherent risk for notes payable Phase I Assess control risk for notes payable Phase I

8. Methodology for Designing Testsof Balances for Notes Payable Design and perform tests of controls and substantive tests of transactions for capital acquisition and repayment cycle Phase II

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

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: • Internal controls over notes payable are adequate • Transactions for principal and interest are properly • authorized and recorded • The liability for notes payable and the related • interest expense and accrued liability • are properly stated

13. Notes Payable and the Related Interest Accounts 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

14. Internal Controls 1. Proper authorization for the issue of new notes. 2. Adequate controls over the repayment of principal and interest. 3. Proper documents and records. 4. Periodic independent verification.

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

16. Analytical Procedures forNotes Payable Analytical procedure Possible misstatement Recalculate approximate 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

17. 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 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

18. Major Balance-related Audit Objectives in Notes Payable 1. Completeness: Existing notes payable are included. 2. Accuracy: Notes payable in the schedule are accurately recorded.

19. Types of Audit Tests for Capital Acquisition and Repayment Cycle Cash in Bank Notes Payable Payments of principal Audited by TOC and STOT Ending balance Issue of new notes Audited by TOC and STOT Audited by AP and TDB Payments of interest Interest Payable Audited by TOC, STOT, and AP TOC + STOT + AP + TDB = Sufficient appropriate evidence

20. Types of Audit Tests forNotes Payable Interest Payable Interest Expense Interest expense Audited by TOC, STOT, and AP Ending balance Ending balance Audited by AP and TDB Audited by AP TOC + STOT + AP + TDB = Sufficient appropriate evidence

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

22. Owners’ Equity • Publicly held corporation • Closely held corporation

23. Owners’ Equity and Dividend Accounts 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

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

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

26. 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.

27. Audit of Capital Stock andPaid-in Capital 1. Completeness: Existing capital stock transactions are recorded. 2. Occurrence and accuracy: Recorded capital stock transactions exist and are accurately recorded.

28. Audit of Capital Stock andPaid-in Capital 3. Accuracy: Capital stock is accurately recorded. 4. Presentation and disclosure: Capital stock is properly presented and disclosed.

29. Audit of Dividends 1. Occurrence: Recorded dividends occurred. 2. Completeness: Existing dividends are recorded. 3. Accuracy: Dividends are accurately recorded.

30. Audit of Dividends 4. Occurrence: Dividends are paid to stockholders that exist. 5. Completeness: Dividends payable are recorded. 6. Accuracy: Dividends payable are accurately recorded.

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

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

34. Types of Audit Tests Dividends Payable Retained Earnings Net earnings Dividends declared Audited by TOC and STOT Audited by TOC, STOT, AP, and TDB Ending balance Ending balance Audited by TDB Audited by TDB TOC + STOT + AP + TDB = Sufficient appropriate evidence

35. End of Chapter 22