Audit of the Capital

Acquisition and
Repayment Cycle

Chapter 22

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 Learning Objective 1

Identify the accounts and the

unique characteristics of the
capital acquisition and
repayment cycle.

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 Characteristics of the Capital
Acquisition and Repayment Cycle
Relatively few transactions affect the
1 account balances, but each one is
often highly material in amount.

The exclusion of a single transaction

2
could be material in itself.

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 Characteristics of the Capital
Acquisition and Repayment Cycle
There is a legal relationship between the
3 client entity and the holder of the stock,
bond, or similar ownership document.

There is a direct relationship between

4 the interest and dividends accounts
and debt and equity.

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 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

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 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

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 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.

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 Methodology for Designing Tests
of Balances for Payroll Liabilities
Phase II

Design and perform tests of controls and

substantive tests of transactions.

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 Methodology for Designing Tests
of Balances for Payroll Liabilities
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.

Audit Sample Items to

Timing
procedures size select
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 Learning Objective 2

Design and perform audit tests

of notes payable and related
accounts and transactions.

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 Notes Payable

A note payable is a legal obligation to a creditor.

It may be unsecured or secured by assets.

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 Notes Payable

Objectives of the audit of notes payable:

1. The internal controls over notes payable

are adequate.
2. Transactions for principal and interest are
properly authorized and recorded.
3. The liability for notes payable and the
related interest expense and accrued
liability are properly stated .

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 Notes Payable and the Related
Interest Accounts
Notes Payable Interest Expense
Payments Beginning balance Interest
of expense
principal Issue of new notes
Ending balance Interest Payable
Payments Beginning
of balance
Cash in Bank interest
Interest
Issue of Payments of expense
new notes principal
Ending
Payments of balance
interest

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 Internal Controls

Proper authorization for the issue of

1
new notes

Adequate controls over the repayment

2
of principal and interest

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 Internal Controls

3 Proper documents and records

4 Periodic independent verification

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 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.

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 Analytical Procedures for
Notes Payable
Analytical procedure Possible misstatement
Recalculate possible Misstatement of interest
interest expense on the expense and accrued
basis of average interest interest, or omission
rates and overall monthly of an outstanding
notes payable. note payable.

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

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 Major Balance-Related Audit
Objectives in Notes Payable
Existing notes payable are
1
included (completeness).

Notes payable in the schedule are

2
accurately recorded (accuracy).

Notes payable are properly presented and

3
disclosed (presentation and disclosure).

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

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 Types of Audit Tests for
Notes Payable
Interest Payable Interest Expense
Interest expense

Ending Audited by Ending

balance TOC, STOT, balance
and AP
Audited by Audited by
AP and TDB AP

TOC + STOT + AP + TDB

= Sufficient competent evidence per GAAS

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 Learning Objective 3

Identify the primary concerns

in the audit of owners equity
transactions.

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 Owners Equity

Publicly held
corporation

Closely held
corporation

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 Owners Equity and Dividend
Accounts
Cash in Bank

Capital Stock Paid-in Capital in Excess

Common of Par Common
Redemption Beginning Redemption Beginning
of stock balance of stock balance

Issue of Issue of
stock stock

Ending Ending
balance balance

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 Owners Equity and Dividend
Accounts
Cash in Bank

Dividends Payable Retained Earnings

Beginning Beginning
balance balance
Payment of
dividends Dividends Dividends Net
declared declared earnings

Ending Ending
balance balance

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 Internal Controls

Proper authorization of transactions

Proper record keeping and segregation of duties

Independent registrar and stock transfer agent

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 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.

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 Audit of Capital Stock and
Paid-in Capital

Existing capital stock transactions are

1
recorded (completeness).

Recorded capital stock transactions

2 exist and are accurately recorded
(existence and accuracy).

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 Audit of Capital Stock and
Paid-in Capital

Capital stock is accurately recorded

3
(accuracy).

Capital stock is properly presented and

4
disclosed (presentation and disclosure).

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 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).

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 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

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 Types of Audit Tests
Capital Stock and Paid-in Cash in
Capital in excess of Par Bank
Issue of stock
Redemption of stock
Both audited by TOC and STOT

Ending Audited by
balance TDB
TOC + STOT + AP + TDB
= Sufficient competent evidence per GAAS

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 Types of Audit Tests
Cash in Dividends
Bank Payable
Payment of dividends
Audited by
TOC and STOT
Ending
balance

Audited by
TDB
TOC + STOT + AP + TDB
= Sufficient competent evidence per GAAS

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

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 Learning Objective 5

Identify capital acquisition issues

for technology-based companies.

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 22 - 35

 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.

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 End of Chapter 22

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