Audit of the Capital Acquisition and Repayment Cycle

1. Audit of the CapitalAcquisition andRepayment Cycle Chapter 22

2. Learning Objective 1 Identify the accounts and the unique characteristics of the capital acquisition and repayment cycle.

3. 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 Characteristics of the CapitalAcquisition and Repayment Cycle

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

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. 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. Methodology for Designing Tests of Balances – Notes Payable 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.

8. Methodology for Designing Tests of Balances – Notes Payable Phase II Design and perform tests of controls and substantive tests of transactions.

9. Audit procedures Sample size Items to select Timing Methodology for Designing Tests of Balances – Notes Payable Phase III Design and perform analytical procedures for notes payable balance. Design tests of details of notes payable balance to satisfy balance-related audit objectives.

10. Learning Objective 2 Design and perform audit tests of notes payable and related accounts and transactions.

11. Notes Payable A note payable is a legal obligation to a creditor. It may be unsecured or secured by assets.

12. Notes Payable 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 Notes Payable and the Related Interest Accounts

13. Proper authorization for the issue of new notes 1 Adequate controls over the repayment of principal and interest 2 Internal Controls

14. Periodic independent verification 4 Internal Controls Proper documents and records 3

15. Tests of Controls and SubstantiveTests of Transactions Tests of notes payable transactions involve the issue of notes and the repayment of principal and interest.

16. Analytical procedure Possible misstatement 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. Analytical Proceduresfor Notes Payable

17. 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. Analytical Proceduresfor Notes Payable Analytical procedure Possible misstatement Compare individual notes outstanding with those of the prior year. Omission or misstatement of a note payable.

18. 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 Major Balance-Related Audit Objectives in Notes Payable

19. Cash in Bank Notes Payable Payments of principal Audited by TOC andSTOT Ending balance Issue of new notes Audited by TOC andSTOT Audited by AP and TDB Payments of interest Interest Payable Audited by TOC,STOT, and AP TOC+STOT+AP+TDB = Sufficient competent evidence per GAAS Types of Audit Testsfor Notes Payable

20. Types of Audit Testsfor Notes Payable Interest Payable Interest Expense Interest expense Audited by TOC,STOT, and AP Ending balance Ending balance Audited by AP and TDB Audited by AP TOC+STOT+AP+TDB = Sufficient competent evidence per GAAS

21. Learning Objective 3 Identify the primary concerns in the audit of owners’ equity transactions.

22. Owners’ Equity Publicly held corporation Closely held corporation

23. 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 andDividend Accounts

24. Owners’ Equity andDividend 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

25. Internal Controls Proper authorization of transactions Proper record keeping and segregation of duties Independent registrar and stock transfer agent

26. 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.

27. Existing capital stock transactions are recorded (completeness). 1 Recorded capital stock transactions exist and are accurately recorded (existence and accuracy). 2 Audit of Capital Stockand Paid-in Capital

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

29. 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).

30. 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

31. Capital Stock and Paid-in Capital in excess of Par Cash in Bank Issue of stock Redemption of stock Both audited by TOCand STOT Ending balance Audited by TDB TOC+STOT+AP+TDB = Sufficient competent evidence per GAAS Types of Audit Tests

32. Types of Audit Tests Cash in Bank Dividends Payable Payment of dividends Audited by TOCand STOT Ending balance Audited by TDB TOC+STOT+AP+TDB = Sufficient competent evidence per GAAS

33. Types of Audit Tests Dividends Payable Retained Earnings Net earnings Dividends declared Audited by TOCand STOT Audited by TOC, STOT, AP, and TDB Ending balance Ending balance Audited by TDB Audited by TDB TOC+STOT+AP+TDB = Sufficient competent evidence per GAAS

34. Learning Objective 5 Identify capital acquisition issues for Internet-based companies.

35. E-Commerce andCapital 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.

36. End of Chapter 22