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CHAPTER 19

Audit of the Capital Acquisition and Repayment Cycle


Copyright 2003 Pearson Education Canada Inc.

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What are the major accounts of the capital acquisition and repayment cycle?

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What are the major accounts of the capital acquisition and repayment cycle?
- long-term liabilities and related accounts

examples?
Copyright 2003 Pearson Education Canada Inc.

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What are the major accounts of the capital acquisition and repayment cycle?
- long-term liabilities and related accounts
~ notes payable ~ contracts payable ~ mortgages payable ~ bonds payable ~ interest expense ~ accrued interest ~ cash
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What are the major accounts of the capital acquisition and repayment cycle?
- long-term liabilities and related accounts - owners equity accounts

examples?
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What are the major accounts of the capital acquisition and repayment cycle?
- long-term liabilities and related accounts - owners equity accounts
~ common stock ~ preferred stock ~ treasury stock ~ contributed surplus in ~ proprietorship capital ~ partnership capital
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What are the major accounts of the capital acquisition and repayment cycle?
- long-term liabilities and related accounts - capital stock accounts - retained earnings and appropriations
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What are the major accounts of the capital acquisition and repayment cycle?
- long-term liabilities and related accounts - capital stock accounts - retained earnings and appropriations - dividends declared and payable
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In auditing the capital acquisition and repayment cycle, the auditor should consider:

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In auditing the capital acquisition and repayment cycle, the auditor should consider:

Relatively few transactions affect the account balances, but each transaction is often highly material in amount.
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In auditing the capital acquisition and repayment cycle, the auditor should consider:

The exclusion of a single transaction could be material in itself.


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In auditing the capital acquisition and repayment cycle, the auditor should consider:

There is a legal relationship between the client and the holder of the stock, bond, or similar ownership document.
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In auditing the capital acquisition and repayment cycle, the auditor should consider:

There is a direct relationship between the interest and dividends account and debt and equity.
Copyright 2003 Pearson Education Canada Inc.

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In auditing the internal controls related to long-term liabilities, the auditor will consider:

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In auditing the internal controls related to long-term liabilities, the auditor will consider:
- proper authorization for issues of notes or bonds
Ace Company Bond

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In auditing the internal controls related to long-term liabilities, the auditor will consider:
- proper authorization for issues of notes or bonds - adequate controls over payment of interest and principal

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In auditing the internal controls related to long-term liabilities, the auditor will consider:
- proper authorization for issues of notes or bonds - adequate controls over payment of interest and principal - proper documents and records
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In auditing the internal controls related to long-term liabilities, the auditor will consider:
- proper authorization for issues of notes or bonds - adequate controls over payment of interest and principal - adequate documents and records - periodic independent verification
Copyright 2003 Pearson Education Canada Inc.

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What are the primary audit objectives with regard to longterm liability account balances?

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What are the primary audit objectives with regard to longterm liability account balances?

- completeness
notes payable
contracts payable

mortgage payable bonds payable


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What are the primary audit objectives with regard to longterm liability account balances?

- completeness - accuracy
Copyright 2003 Pearson Education Canada Inc.

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What are the primary audit objectives with regard to longterm liability account balances?

- completeness - accuracy - presentation and disclosure


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Long-term Liabilities Audit Procedures

perform analytical procedures to test the reasonableness of long-term liabilities and interest expense

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Long-term Liabilities Audit Procedures

enquire of management regarding:


- completeness of liabilities

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Long-term Liabilities Audit Procedures

inquire of management regarding:


- completeness of liabilities - debt-related restrictions on assets
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Long-term Liabilities Audit Procedures

inquire of management regarding:


- completeness of liabilities - debt-related restrictions on assets - ability to pay interest
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Long-term Liabilities Audit Procedures

review contractual provisions of long-term liabilities


Debt Covenant

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Long-term Liabilities Audit Procedures

review contractual provisions of long-term liabilities


- consider pledging of assets related to debt (disclosure) - determine client adherence to contractual requirements (payment dates, working capital, ratios)
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Long-term Liabilities Audit Procedures

confirm debt balances, interest payments, and client compliance with contractual agreements with the creditors
auditor creditor
Canada 48

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Long-term Liabilities Audit Procedures

for all long-term liabilities, recalculate interest expense, interest payable, and amortizations of discounts or premiums
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Long-term Liabilities Audit Procedures


Trace receipt of borrowed amounts from cash receipts journal to bank statement
Bank Statement 5/31/04

cash receipts journal description _ $$ _ May 23, 2004 Bank loan 14,000

Deposits: 5/23 $14,000

Copyright 2003 Pearson Education Canada Inc.

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Long-term Liabilities Audit Procedures


Trace receipt of borrowed amounts from cash receipts journal to bank statement to deposit slips
cash receipts journal description _ $$ _ May 23, 2004 Bank loan 14,000 Bank Statement 5/31/04 Deposits: 5/23 $14,000

Deposit Slip 5/23/04


14,000
Copyright 2003 Pearson Education Canada Inc.

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Long-term Liabilities Audit Procedures


Trace receipt of borrowed amounts from cash receipts journal to bank statement to deposit slips to debt agreement.
cash receipts journal description _ $$ _ May 23, 2004 Bank loan 14,000 Bank Statement 5/31/04 Deposits: 5/23 $14,000

Deposit Slip 5/23/04


14,000

Debt Covenant Bank of Montreal hereby loans Ace Co. $14,000 on 5/23/04
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Long-term Liabilities Audit Procedures


Trace payments of principal and interest from cash payments journal to bank statement
Bank Statement 11/30/04
cash payments journal description _ $$ _ November 23, 2004 interest paymentBank loan 700 Deposits: Payments: 11/26 $700

Copyright 2003 Pearson Education Canada Inc.

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Long-term Liabilities Audit Procedures


Trace payments of principal and interest from cash payments journal to bank statement to cancelled cheques
Bank Statement 11/30/04 cash payments journal description _ $$ _ November 23, 2004 interest paymentBank loan 700 Deposits: Payments: 11/26 $700

Ace Corporation
pay to the order of

date 11/23/04

324

Bank of Montreal

$ 700.00

Copyright 2003 Pearson Education Canada Inc.

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Long-term Liabilities Audit Procedures


Trace payments of principal and interest from cash payments journal to bank statement to cancelled cheques to debt agreement.
Bank Statement 11/30/04 cash payments journal description _ $$ _ November 23, 2004 interest paymentBank loan 700 Deposits: Payments: 11/26 $700

Ace Corporation
pay to the order of

date 11/2304

324

Canadian Bank

$ 700.00

Debt Covenant Ace agrees to pay semi-annual interest of 10% on principal.


Copyright 2003 Pearson Education Canada Inc.

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What are the auditors primary concerns with regard to owners equity?

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What are the auditors primary concerns with regard to owners equity?

- authorization
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What are the auditors primary concerns with regard to owners equity?

- authorization - presentation and disclosure


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What are the auditors primary concerns with regard to owners equity?

- authorization - presentation and disclosure - accuracy


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Owners Equity Audit Procedures perform analytical procedures to test the reasonableness of owners equity accounts (including dividends)
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Owners Equity Audit Procedures

READ:
- articles of incorporation, bylaws
Ace Company Articles of Incorporation
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Owners Equity Audit Procedures

READ:
- articles of incorporation, bylaws - minutes of meetings
Note discussion of dividends, stock options, stock issues, etc.
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Owners Equity Audit Procedures

Confirm shares outstanding with the independent registrar and the stock transfer agent.

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Owners Equity Audit Procedures


Confirm shares outstanding with the independent registrar and the stock transfer agent.

Who are they?


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Owners Equity Audit Procedures


Confirm shares outstanding with the independent registrar and the stock transfer agent.
- independent registrar - a third party paid by the client to ensure that stock is issued in accordance with articles of incorporation and boards directions
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Owners Equity Audit Procedures


Confirm shares outstanding with the independent registrar and the stock transfer agent.
- stock transfer agent - a third party paid by the client to maintain shareholder records and, possibly, to disburse dividends
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Owners Equity Audit Procedures

If the client does not use an independent registrar and stock transfer agent, the auditor must examine the stock certificate records and test any changes.
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Owners Equity Audit Procedures


Trace receipts from stock issues from cash receipts journal to bank statement
Bank Statement 5/31/04 cash receipts journal description _ $$ _ May 23, 2004 Joe Ace 23,000 Deposits: 5/23 $23,000

Copyright 2003 Pearson Education Canada Inc.

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Owners Equity Audit Procedures


Trace receipts from stock issues from cash receipts journal to bank statement to deposit slips
cash receipts journal description _ $$ _ May 23, 2004 Joe Ace 23,000 Bank Statement 5/31/04 Deposits: 5/23 $23,000

Deposit Slip 5/23/04


23,000
Copyright 2003 Pearson Education Canada Inc.

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Owners Equity Audit Procedures


Trace receipts from stock issues from cash receipts journal to bank statement to deposit slips to board minutes.
cash receipts journal description _ $$ _ May 23, 2004 Joe Ace 23,000 Bank Statement 5/31/04 Deposits: 5/23 $23,000

Deposit Slip 5/23/04


23,000

Board Minutes

... sell Joe Ace $23,000 of additional common...


Copyright 2003 Pearson Education Canada Inc.

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Owners Equity Audit Procedures


Trace payments related to dividends and treasury stock from cash payments journal to bank statement
Bank Statement 1/31/04 cash payments journal description _ $$ _ January 23, 2004 dividend distribution 4300

Deposits:
Payments: 1/26 $4,300

Copyright 2003 Pearson Education Canada Inc.

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Owners Equity Audit Procedures


Trace payments related to dividends and treasury stock from cash payments journal to bank statement to cancelled cheques
Bank Statement 1/31/04 cash payments journal description _ $$ _ January 23, 2004 dividend distribution 4,300 Deposits: Payments: 1/26 $4,300

Ace Corporation
pay to the order of

date 1/23/04

324

Shareholders

$4,300.00

Copyright 2003 Pearson Education Canada Inc.

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Owners Equity Audit Procedures


Trace payments related to dividends and treasury stock from cash payments journal to bank statement to cancelled cheques to board minutes.
Bank Statement 1/31/04 cash payments journal description _ $$ _ January 23, 2004 dividend distribution 4,300 Deposits: Payments: 1/26 $4,300
Board Minutes

Ace Corporation
pay to the order of

date 1/23/04

324

Shareholders

$4,300.00

... declare dividends of $4,300...


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Owners Equity Audit Procedures

Recalculate dividend distribution to common and preferred shareholders.


common

preferred
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Owners Equity Audit Procedures

Recalculate dividend distribution to common and preferred shareholders.


common

preferred

consider features of preferred (cumulative, participating)


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Owners Equity Audit Procedures


Inspect repurchased stock (treasury stock); recalculate treasury stock
transactions. Ace Ace Ace Ace Company Company Company Company
1 share of common 1 share of 1common share of common stock stock stock 1 share of common stock

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If all other accounts have been audited with satisfactory results,

Is the audit of retained earnings necessary?


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If all other accounts have been audited with satisfactory results,

Is the audit of retained earnings necessary?


Possibly not, but the audit of retained earnings is typically not time-consuming and may serve as a check on the audit of other accounts.
Copyright 2003 Pearson Education Canada Inc.

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Owners Equity Audit Procedures

Analyze all changes in retained earnings.


Copyright 2003 Pearson Education Canada Inc.

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