©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley Audit of the Capital Acquisition and Repayment Cycle Chapter 22

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley Learning Objective 1 Identify the accounts and the unique characteristics of the capital acquisition and repayment cycle.

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley Characteristics of the Capital Acquisition 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.

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley Characteristics of the Capital Acquisition and Repayment Cycle 4.A direct relationship exists between the interest and dividends accounts and debt and equity. 3.A legal relationship exists between the client entity and the holder of the stock, bond, or similar ownership document.

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley Accounts in the Cycle  Notes payable  Contracts payable  Mortgages payable  Bonds payable  Interest expense  Accrued interest  Appropriations of retained earnings  Treasury stock  Dividends declared

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley 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

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley Identify client business risks affecting notes payable Methodology for Designing Tests of Balances for Notes Payable Set tolerable misstatement and assess inherent risk for notes payable Assess control risk for notes payable Phase I

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley Methodology for Designing Tests of Balances for Notes Payable Design and perform tests of controls and substantive tests of transactions for capital acquisition and repayment cycle Phase II

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley Timing Items to select Sample size Audit procedures Methodology for Designing Tests of Balances for Notes Payable Design and perform analytical procedures for notes payable Design tests of details of notes payable to satisfy balance-related audit objectives Phase III

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley Learning Objective 2 Design and perform audit tests of notes payable and related accounts and transactions.

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley Notes Payable  A note payable is a legal obligation to a creditor  It may be unsecured or secured by assets

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley 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

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley Notes Payable and the Related Interest Accounts Notes PayableInterest Expense Cash in Bank Interest Payable Payments of principal Beginning balance Issue of new notes Payments of principal Interest expense Payments of interest Beginning balance Issue of new notes Ending balance Payments of interest Interest expense Ending balance

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley 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.

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley Tests of notes payable transactions involve the issue of notes and the repayment of principal and interest. Tests of Controls and Substantive Tests of Transactions

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley Analytical Procedures for Notes Payable Analytical procedure 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 Possible misstatement

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley Analytical Procedures for Notes Payable Analytical procedure Compare individual notes outstanding with those of the prior year Omission or misstatement of a note payable Possible misstatement 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

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley 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.

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley Types of Audit Tests for Capital Acquisition and Repayment Cycle Cash in BankNotes Payable Payments of principal Issue of new notes Payments of interest Interest Payable Ending balance TOC + STOT + AP + TDB = Sufficient appropriate evidence Audited by TOC, STOT, and AP Audited by AP and TDB Audited by TOC and STOT Audited by TOC and STOT

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley Types of Audit Tests for Notes Payable Interest Payable Ending balance Audited by AP and TDB Audited by TOC, STOT, and AP Interest Expense Interest expense Ending balance Audited by AP TOC + STOT + AP + TDB = Sufficient appropriate evidence

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley Learning Objective 3 Identify the primary concerns in the audit of owners’ equity transactions.

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley Owners’ Equity  Publicly held corporation  Closely held corporation

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley Owners’ Equity and Dividend Accounts Cash in Bank Capital Stock – Common Paid-in Capital in Excess of Par – Common Redemption of stock Redemption of stock Beginning balance Issue of stock Ending balance Beginning balance Issue of stock Ending balance

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley Owners’ Equity and Dividend Accounts Cash in Bank Dividends PayableRetained Earnings Payment of dividends Dividends declared Beginning balance Dividends declared Ending balance Beginning balance Net earnings Ending balance

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley  Proper authorization of transactions  Proper record keeping and segregation of duties  Independent registrar and stock transfer agent Internal Controls

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley 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.

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley Audit of Capital Stock and Paid-in Capital 1.Completeness: Existing capital stock transactions are recorded. 2.Occurrence and accuracy: Recorded capital stock transactions exist and are accurately recorded.

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley Audit of Capital Stock and Paid-in Capital 3.Accuracy: Capital stock is accurately recorded. 4.Presentation and disclosure: Capital stock is properly presented and disclosed.

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley Audit of Dividends 1.Occurrence: Recorded dividends occurred. 2.Completeness: Existing dividends are recorded. 3.Accuracy: Dividends are accurately recorded.

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley 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.

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley 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

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley End of Chapter 22