Auditing and assurance services 14e by arens chapter 22

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 22 - 2Characteristics of the Capital Acquisition and Repayment Cycle 1.. ©2012 Prentice Hall Business Publishi

Audit of the Capital

Acquisition and Repayment Cycle

Chapter 22

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©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 22 - 2

Characteristics of the Capital Acquisition and Repayment Cycle

1 Relatively few transactions affect theaccount balances, but each one is

often highly material in amount

2 The exclusion of a single transactioncould be material in itself

Characteristics of the Capital Acquisition and Repayment Cycle

4 A direct relationship exists between theinterest and dividends accounts and

debt and equity

3 A legal relationship exists between theclient entity and the holder of the stock,bond, or similar ownership document

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 22 - 4

Learning Objective 1

Identify the accounts and the unique

characteristics of the capital acquisition

and repayment cycle.

Accounts in the Cycle

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 22 - 6

Accounts in the Cycle

 Cash in the bank

 Capital stock – common

 Capital stock – preferred

 Paid-in capital in excess of par

 Donated capital

 Retained earnings

 Dividends payable

 Proprietorship – capital account

 Partnership – capital account

Identify clientbusiness risksaffecting notes payable

Methodology for Designing Tests

of Balances for Notes Payable

Set tolerable misstatement

and assess inherentrisk for notes payable

Assess control

risk fornotes payable

Phase I

Phase I

Phase I

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 22 - 8

Methodology for Designing Tests

of Balances for Notes Payable

Design and perform

tests of controls and

TimingItems to selectSample sizeAudit procedures

Methodology for Designing Tests

of Balances for Notes Payable

Design and perform

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 22 - 10

Learning Objective 2

Design and perform audit test of notes

payable and related accounts and

transactions.

Notes Payable

Legal

Obligation

Secured orunsecured

by assets

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 22 - 12

Notes Payable

Objectives of the audit of notes payable:

 Internal controls are adequate

 Transactions are properly authorized

and recorded

 The related liabilities and expenses are

properly stated

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

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 22 - 14

Notes Payable and the Related

Payments of

interest

Beginning balance

Issue of new notes Ending balance

Payments of interest

Interest expense Ending balance

Tests of notes payable transactionsinvolve the issue of notes and therepayment of principal and interest.

Tests of Controls and Substantive

Tests of Transactions

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 22 - 16

Analytical Procedures for

Notes Payable

Analytical procedure

Recalculate approximate

interest expense on the

basis of average interest

rates and overall monthly

notes payable

Misstatement of interest expense and accrued interest, or omission of a

note payablePossible misstatement

Analytical Procedures for

Notes Payable

Analytical procedure

Compare individual notes

outstanding with those

of the prior year

Omission ormisstatement of

a note payablePossible misstatement

Compare total balance in

notes payable, interest

expense, and accrued

interest with prior-year

balances

Misstatement of interestexpense and accrued

interest or notespayable

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 22 - 18

Major Balance-related Audit Objectives in Notes Payable

The two most important related audit objectives in notes payable are:

Types of Audit Tests for Capital Acquisition and Repayment Cycle

Payments of principal Issue of new notes

Payments

Ending balance

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 22 - 20

Types of Audit Tests for

Notes Payable

Interest Payable

Ending balance

Audited by

AP and TDB

Audited by TOC, STOT, and AP

Interest Expense Interest expense

Ending balance

Learning Objective 3

Identify the primary concerns in the audit of owners’ equity transactions.

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 22 - 22

Owners’ Equity

Publicly

held corporation

Closely held corporationVersus

Simple, few transactions Few shareholders

Occasional transactions Many shareholders

Frequent transactions

Owners’ Equity and Dividend

Ending balance

Beginning balance

Issue of stock Ending balance

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 22 - 24

 Proper authorization of transactions

Proper record keeping and segregation of duties

Independent registrar and stock transfer agent

Internal Controls

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.

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 22 - 26

Audit of Capital Stock and

Accuracy Presentation and

disclosure

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 22 - 28

Audit of Retained Earnings

Transactions involving retained earnings:

 Net earnings for the year

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 5 - 5

End of Chapter 22