audit of the capital acquisition and repayment cycle

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 5 - 5

Audit of the Capital Acquisition and

Repayment Cycle

Chapter 22


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.


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.


Learning Objective 1

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


Accounts in the Cycle

Notes payable Contracts payable Mortgages payable Bonds payable Interest expense Accrued interest Appropriations of retained earnings Treasury stock Dividends declared


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


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

Phase I

Phase I



Design and perform tests of controls and substantive tests of

transactions for capital acquisition and

repayment cycle

Phase II


Timing

Items to select

Sample size

Audit procedures


Design and perform analytical procedures

for notes payable

Design tests of details of notes

payable to satisfy balance-related audit objectives

Phase III

Phase III



Design and perform audit test of notes payable and related accounts and transactions.


Notes Payable

Legal Obligation

Secured or unsecured by assets


Notes Payable

Objectives of the audit of notes payable:

Internal controls are adequate Transactions are properly authorized and recorded The related liabilities and expenses are properly stated


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.


Notes Payable and the Related Interest Accounts

Notes Payable Interest Expense

Cash in Bank

Interest Payable

Payments of principal

Beginning balance

Issue of new notes


Interest expense

Payments of interest

Beginning balance

Issue of new notes

Ending balance

Payments of interest

Interest expense

Ending balance


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


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 a note payable

Possible misstatement


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


Major Balance-related Audit Objectives in Notes Payable

The two most important balance- related audit objectives in notes payable are: 1. Completeness: Existing notes payable are included. 2. Accuracy: Notes payable in the schedule are accurately recorded.


Types of Audit Tests for Capital Acquisition and Repayment Cycle

Cash in Bank Notes Payable


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


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



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


Owners’ Equity

Publicly held

corporation

Closely held

corporation Versus

Simple, few transactions Few shareholders Occasional transactions

Many shareholders Frequent transactions


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


Proper authorization of transactions Proper record keeping and segregation of duties

Independent registrar and stock transfer agent

Internal Controls



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

Auditor concerns in auditing Capital Stock and Paid-in-Capital accounts

Occurrence and

Accuracy

Completeness

Accuracy

Presentation and

disclosure


Audit of Dividends

1. Occurrence: Recorded dividends occurred.

2. Completeness: Existing dividends are recorded.

3. Accuracy: Dividends are accurately recorded.


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.


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


End of Chapter 22

audit of the capital acquisition and repayment cycle

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