Audit of the Capital Acquisition and Repayment Cycle Chapter 21

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 1 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 3 There is a legal relationship between the client entity and the holder of the stock, bond, or similar ownership document. 4 There is a direct relationship between the interest and dividends accounts and debt and equity.

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 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 Design and perform tests of controls and substantive tests of transactions. Design and perform analytical procedures for notes payable balance.

Methodology for Designing Tests of Balances – Notes Payable Design tests of details of notes payable to satisfy balance-related audit objectives. Audit procedures Sample size Items to select 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 Payments of principal Beginning balance Interest expense Issue of new notes Interest Payable Ending balance Payments of interest Beginning balance Cash in Bank Interest expense Issue of new notes Payments of principal Ending balance Payments of interest

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

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 Analytical Procedure Possible Misstatement Recalculate approximate Misstatement of interest expense on the interest expense and basis of average interest accrued interest, or rates and overall monthly omission of an notes payable. outstanding note payable

Analytical Procedures for Notes Payable Analytical Procedure Possible Misstatement Compare individual notes Omission or outstanding with those of misstatement of a the prior year. note payable Compare total balance in Misstatement of notes payable,interest interest expense and expense, and accrued interest accrued interest or with prior year balances. notes payable

Major Balance-Related Audit Objectives in Notes Payable 1 Existing notes payable are included (completeness). 2 Notes payable in the schedule are accurately recorded (accuracy). 3 Notes payable are properly presented and disclosed (presentation and disclosure).

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

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 TDP Audited by AP TOC + STOT + AP + TDP = 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 Redemption of stock Beginning balance Issue of stock Issue of stock Ending balance Ending balance

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 1 Existing capital stock transactions are recorded (completeness). 2 Recorded capital stock transactions exist and are accurately recorded (existence and accuracy).

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

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

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 21