Audit of the Capital Acquisition and Repayment Cycle Chapter 22

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

Characteristics of the Capital Acquisition and Repayment Cycle 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 Capital Acquisition and Repayment Cycle 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

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

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

Methodology for Designing Tests of Balances – Notes Payable 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.

Methodology for Designing Tests of Balances – Notes Payable Phase II Design and perform tests of controls and substantive tests of transactions.

Methodology for Designing Tests of Balances – Notes Payable 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. Audit procedures Items to select Sample size Timing

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

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

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

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

Internal Controls Proper documents and records 3 Periodic independent verification 4

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

Analytical Procedures for Notes Payable 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. Possible misstatement

Analytical Procedures for Notes Payable 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.

Major Balance-Related Audit Objectives in Notes Payable 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

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

Types of Audit Tests for Notes 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 competent evidence per GAAS

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

Owners’ Equity Publicly held corporation Closely held corporation

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

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

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

Design and perform tests of controls, substantive tests of 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.

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

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).

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

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

= Sufficient competent evidence per GAAS 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 competent evidence per GAAS

= Sufficient competent evidence per GAAS Types of Audit Tests Dividends Payable Retained Earnings Dividends declared Net earnings 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 competent evidence per GAAS

Identify capital acquisition issues for Internet-based companies. Learning Objective 5 Identify capital acquisition issues for Internet-based companies.

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.

End of Chapter 22