2. 22 - 1 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Audit of the Capital Acquisition and Repayment Cycle Chapter 22

3. 22 - 2 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Learning Objective 1 Identify the accounts and the unique characteristics of the capital acquisition and repayment cycle.

4. 22 - 3 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Characteristics of the Capital Acquisition and Repayment Cycle Relatively 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

5. 22 - 4 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 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

6. 22 - 5 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 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

7. 22 - 6 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 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

8. 22 - 7 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Methodology for Designing Tests of Balances for Payroll Liabilities 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.

9. 22 - 8 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Methodology for Designing Tests of Balances for Payroll Liabilities Design and perform tests of controls and substantive tests of transactions. Phase II

10. 22 - 9 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Methodology for Designing Tests of Balances for Payroll Liabilities Design and perform analytical procedures for notes payable balance. Phase III Timing Items to selectSamplesizeAuditprocedures Design tests of details of notes payable balance to satisfy balance-related audit objectives.

11. 22 - 10 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Learning Objective 2 Design and perform audit tests of notes payable and related accounts and transactions.

12. 22 - 11 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Notes Payable A note payable is a legal obligation to a creditor. It may be unsecured or secured by assets.

13. 22 - 12 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Notes Payable Objectives of the audit of notes payable: 1. The internal controls over notes payable are adequate. are adequate. 2. Transactions for principal and interest are properly authorized and recorded. properly authorized and recorded. 3. The liability for notes payable and the related interest expense and accrued related interest expense and accrued liability are properly stated. liability are properly stated.

14. 22 - 13 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Notes Payable and the Related Interest Accounts Notes Payable Interest Expense Cash in Bank Interest Payable Paymentsofprincipal Beginning balance Issue of new notes Payments of principal Interestexpense PaymentsofinterestBeginningbalance Issue of new notes Ending balance Payments of interest Interestexpense Endingbalance

15. 22 - 14 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Internal Controls Proper authorization for the issue of new notes 1 Adequate controls over the repayment of principal and interest 2

16. 22 - 15 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Internal Controls Proper documents and records 3 Periodic independent verification 4

17. 22 - 16 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 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

18. 22 - 17 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Analytical Procedures for Notes Payable Analytical procedure 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

19. 22 - 18 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 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.

20. 22 - 19 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 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

21. 22 - 20 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Types of Audit Tests for Notes Payable Cash in Bank Notes Payable Payments of principal Issue of new notes Payments of interest Interest Payable Endingbalance TOC + STOT + AP + TDB = Sufficient competent evidence per GAAS Audited by TOC, STOT, and AP Audited by AP and TDB Audited by TOC and STOT Audited by TOC and STOT

22. 22 - 21 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Types of Audit Tests for Notes Payable Interest Payable Endingbalance Audited by AP and TDB Audited by TOC, STOT, and AP Interest Expense Interest expense Endingbalance Audited by AP TOC + STOT + AP + TDB = Sufficient competent evidence per GAAS

23. 22 - 22 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Learning Objective 3 Identify the primary concerns in the audit of owners’ equity transactions.

24. 22 - 23 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Publicly held corporation Closely held corporation Owners’ Equity

25. 22 - 24 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Owners’ Equity and Dividend Accounts Cash in Bank Capital Stock – Common Paid-in Capital in Excess of Par – Common Redemption of stock Redemption Beginningbalance Issue of stock Endingbalance Beginningbalance stock Endingbalance

26. 22 - 25 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Owners’ Equity and Dividend Accounts Cash in Bank Dividends Payable Retained Earnings Payment of dividends Dividendsdeclared Beginningbalance Dividendsdeclared Endingbalance Beginningbalance Netearnings Endingbalance

27. 22 - 26 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Proper authorization of transactions Proper record keeping and segregation of duties Independent registrar and stock transfer agent Internal Controls

28. 22 - 27 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 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.

29. 22 - 28 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 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

30. 22 - 29 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 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

31. 22 - 30 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 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).

32. 22 - 31 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 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

33. 22 - 32 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 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 Endingbalance

34. 22 - 33 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Types of Audit Tests Payment of dividends Audited by TOC and STOT Cash in Bank TOC + STOT + AP + TDB = Sufficient competent evidence per GAAS Endingbalance Audited by TDBDividendsPayable

35. 22 - 34 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Types of Audit Tests Dividends declared Audited by TOC and STOT RetainedEarningsEndingbalanceDividendsPayable TOC + STOT + AP + TDB = Sufficient competent evidence per GAAS Audited by TDB Endingbalance TDB Net earnings Audited by TOC, STOT, AP, and TDB

36. 22 - 35 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Learning Objective 5 Identify capital acquisition issues for technology-based companies.

37. 22 - 36 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 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. E-Commerce and Capital Acquisition

38. 22 - 37 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder End of Chapter 22