1. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 21 - 1 Audit of the Capital Acquisition and Repayment Cycle Chapter 21

2. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 21 - 2 Learning Objective 1 Identify the accounts and the unique characteristics of the capital acquisition and repayment cycle.

3. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 21 - 3 Characteristics of the Capital Acquisition and Repayment Cycle Few transactions affect the account balances, but each one is often highly material in amount. The exclusion of a single transaction could be material in itself. 1 2

4. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 21 - 4 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. There is a direct relationship between the interest and dividends accounts and debt and equity. 3 4

5. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 21 - 5 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

6. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 21 - 6 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

7. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 21 - 7 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.

8. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 21 - 8 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.

9. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 21 - 9 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

10. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 21 - 10 Learning Objective 2 Design and perform audit tests of notes payable and related accounts and transactions.

11. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 21 - 11 Notes Payable A note payable is a legal obligation to a creditor. It may be unsecured or secured by assets.

12. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 21 - 12 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

13. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 21 - 13 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 Internal Controls

14. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 21 - 14 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

15. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 21 - 15 Analytical Procedures for Notes Payable Analytical ProcedurePossible Misstatement Recalculate approximateMisstatement of interest expense on theinterest expense and basis of average interest accrued interest, or rates and overall monthly omission of an notes payable.outstanding note payable

16. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 21 - 16 Analytical Procedures for Notes Payable Analytical ProcedurePossible Misstatement Compare individual notesOmission or outstanding with those ofmisstatement of a the prior year.note payable Compare total balance inMisstatement of notes payable,interestinterest expense and expense, and accrued interestaccrued interest or with prior year balances.notes payable

17. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 21 - 17 Major Balance-Related Audit Objectives in Notes Payable Existing notes payable are included (completeness). Notes payable in the schedule are accurately recorded (accuracy). Notes payable are properly presented and disclosed (presentation and disclosure). 1 2 3

18. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 21 - 18 Types of Audit Tests for Notes Payable Cash in BankNotes Payable Payments of principal Issue of new notes Payments of interest Interest Payable Ending balance TOC + STOT + AP + TDP = Sufficient competent evidence per GAAS Audited by TOC, STOT, and AP Audited by AP and TDP Audited by TOC and STOT Audited by TOC and STOT

19. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 21 - 19 Types of Audit Tests for Notes Payable Interest Payable Ending balance Audited by AP and TDP Audited by TOC, STOT, and AP Interest Expense Interest expense Ending balance Audited by AP TOC + STOT + AP + TDP = Sufficient competent evidence per GAAS

20. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 21 - 20 Learning Objective 3 Identify the primary concerns in the audit of owners’ equity transactions.

21. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 21 - 21 Publicly held corporation Closely held corporation Owners’ Equity

22. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 21 - 22 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

23. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 21 - 23 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

24. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 21 - 24 Proper authorization of transactions Proper record keeping and segregation of duties Independent registrar and stock transfer agent Internal Controls

25. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 21 - 25 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.

26. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 21 - 26 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

27. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 21 - 27 3 Capital stock is accurately recorded (accuracy). 4 Capital stock is properly presented and disclosed (presentation and disclosure). Audit of Capital Stock and Paid-in Capital

28. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 21 - 28 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).

29. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 21 - 29 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

30. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 21 - 30 Learning Objective 5 Identify capital acquisition issues for Internet-based companies.

31. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 21 - 31 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

32. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 21 - 32 End of Chapter 21