copyright © 2007 pearson education canada 1 chapter 20: audit of the capital acquisition and...

Copyright © 2007 Pearson Education Canada

1

Chapter 20: Audit of the Capital Acquisition and

Repayment Cycle


20-2

Chapter 20 objectives

List the key characteristics of the capital acquisition and repayment cycle

Describe the methodology for designing tests of details of balances for notes payable

Discuss analytical review for notes payable Provide examples of common internal controls

for owners’ equity transactions Identify main concerns when auditing capital

stock


20-3

Characteristics of the capital acquisition and repayment cycle

Relatively few transactions affect the account balances, but each transaction is often highly material in amount

The exclusion of a single transaction could be material in itself

There is a legal relationship between the client entity and the holder of the stock, bond or similar debt or equity

There is a direct relationship between the interest and dividends accounts and debt and equity


20-4

Methodology for designing tests of balances for notes payable


20-5

Important internal controls over notes payable

Proper authorization for the issue of new notes Adequate controls over the repayment of

principal and interest Proper documents and records (controlling blank

notes and canceling paid ones) Periodic, independent verification (reconciliation

of notes outstanding to the general ledger)


20-6

Practice problem 20-17 (p. 584)

Identify the purpose of particular internal controls, potential misstatements, and audit procedures to audit the control


20-7

Analytical procedures for notes 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 or accrued interest, or omission of an outstanding note payable


20-8

Analytical procedures for notes payable (cont’d)

Analytical procedure Possible misstatement

Compare individual notes outstanding with the prior year

Omission or misstatement of a note payable

Compare total balance in notes payable, interest expense, and accrued interest with prior year

Misstatement of notes payable, interest expense or accrued interest


20-9

Practice problem 20-25 (p. 586)

How does becoming public affect a corporation’s accounts?

Explain how stock price changes affect the records and the audit


20-10

Tests of details for notes payable and interest: detail tie-in

Foot (add) the notes payable list for notes payable and accrued interest

Trace the totals to the general ledger Trace the individual notes payable to the

master file


20-11

Tests of details for notes payable and interest: existence

Confirm notes payable (normally with a positive confirmation)

Examine duplicate copy of notes for authorization

Examine corporate minutes for loan approval


20-12

Tests of details for notes payable and interest: completeness

Examine notes paid after year end to determine whether they were liabilities as at the balance sheet date

Review the bank confirmation for notes payable details

Review the bank reconciliation for new notes Obtain confirmations from prior creditors Analyze interest expense to identify notes Examine past notes for cancellation Review minutes of board meeetings


20-13

Tests of details for notes payable and interest: accuracy

Examine notes for principal and interest rates

Confirm notes payable, interest rates, and last date interest paid to

Recalculate accrued interest


20-14

Tests of details for notes payable and interest: classification

Examine due dates of notes to allocate liability among current or long-term

Review notes to determine whether any are related-party notes or accounts payable


20-15

Tests of details for notes payable and interest: cut-off

Examine notes to determine whether notes were dated on or before the balance sheet date


20-16

Tests of details for notes payable and interest: rights and obligations

Examine notes to determine whether the company has obligations for payment


20-17

Tests of details for notes payable and interest: presentation and

disclosure

Examine notes, minutes, and confirmation for restrictions

Examine balance sheet for proper disclosure of noncurrent portions, related parties, and restrictions resulting from notes payable


20-18

Practice problem 20-24 (pp. 585-86)

Audit procedures for the audit of bond indebtedness and interest expense


20-19

Internal controls in owners’ equity

Proper authorization of transactions:– Issuance of capital stock: type of equity,

number of shares, issue price, privileges or conditions

– Repurchase or redemption: timing, amount to pay

– Declaration of dividends: form (cash or stock), amount per share, record and payment dates


20-20

Internal controls in owners’ equity (cont’d)

Proper record keeping and segregation of duties objectives:– Owners of the stock recognized in corporate

records– Correct amount of dividends is paid to

shareholders as of record date– Potential for employee fraud is minimized


20-21


Proper record keeping and segregation of duties important procedures:

(1) well-defined policies for preparing stock certificates and recording capital stock transactions

(2) independent internal verification of information in the records


20-22


Independent registrar and stock transfer agent:– Employed to prevent the improper issue of share

certificates and to maintain shareholder records– Ensures that stock is issued by a corporation in

accordance with the capital stock provisions in the articles of incorporation

– Tends to be used by public corporations– Smaller organizations may use their lawyer or

maintain the stock register themselves


20-23

Main concerns in auditing capital stock

Completeness: existing capital stock transactions are recorded

Occurrence and accuracy: recorded capital stock transactions exist and are accurately recorded

Accuracy: capital stock is accurately recorded Presentation and disclosure: capital stock is

properly presented and disclosed


20-24

Auditing capital stock: completeness

If a registrar or transfer agent is used: auditor can confirm the nature of transactions and their valuation

For a smaller client: review records held by the lawyer or client

Review the minutes of the board of directors to uncover issuances and repurchases


20-25

Auditing capital stock: occurrence and accurate recording (transactions)

Normal to verify all capital stock transactions because of their materiality and permanence in the records

Examine minutes of the board of directors’ meetings for proper authorization

Cash received can be confirmed with the transfer agent and traced to cash receipts

Valuation of stock dividends or stock used to purchase assets is more difficult


20-26

Auditing capital stock: accuracy (of ending balance)

Based upon number of shares outstanding at the balance sheet date

Confirmation from transfer agent (or trace to shareholder records)

Value is par value or value received (complex when there are convertible securities, stock options, or warrants outstanding)


20-27

Auditing capital stock: presentation and disclosure

Most important sources are articles of incorporation, minutes of board of directors’ meetings and auditor’s analyses

Need to ensure that each class of stock is properly described

Disclosure of stock options, stock warrants and convertible securities can be verified by examining legal documents


20-28

Audit of dividends

Existence can be checked by examining the minutes of board of directors’ meetings

Accuracy is audited by computing the amount on the basis of the dividend per share by the number of shares outstanding

May be possible to trace to cash disbursement records, or confirm with stock registrar


20-29

Practice problem 20-23 (p.585)

Assess an audit of dividends

Identify additional audit procedures required


20-30

Audit of retained earnings

Normally, the only transactions are net earnings and dividends declared

May also be corrections or other adjustments (key then is to determine whether they should be recorded in the prior year or whether they are applicable to prior periods)

copyright © 2007 pearson education canada 1 chapter 20: audit of the capital acquisition and...

Documents

blank notes

completenessexamine

dates of notes

obligationsexamine notes

accuracyexamine notes

party notes

termreview notes

offexamine notes