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2003 Prentice Hall Business Publishing,Auditing and Assurance Services 9/e, Arens/Elder/Beasley 21 - 1

Audit of the CapitalAcquisition and

Repayment Cycle

Chapter 21

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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

Few transactions affect the account

balances, but each one is oftenhighly material in amount.

The exclusion of a single transaction

could be material in itself.

1

2

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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 accountsand debt and equity.

3

4

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Accounts in the Cycle

Paid-in Capital in Excess of Par

Donated Capital

Retained EarningsAppropriations of Retained Earnings

Treasury Stock

Dividends Declared

Dividends Payable

ProprietorshipCapital Account

PartnershipCapital Account

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7/322003 Prentice Hall Business Publishing,Auditing and Assurance Services 9/e, Arens/Elder/Beasley 21 - 7

Methodology for Designing Tests of

BalancesNotes Payable

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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Design and perform tests of

controls and substantive testsof transactions.

Design and perform analyticalprocedures for notes payable

balance.

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Design tests of detailsof notes payable to

satisfy balance-related

audit objectives.

Audit proceduresSample size

Items to select

Timing

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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 unsecuredor secured by assets.

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Notes Payable and the Related

Interest Accounts

Notes Payable Interest Expense

Cash in Bank

Interest Payable

Paymentsof

principal

Beginning balance

Issue ofnew notes

Payments ofprincipal

Interestexpense

Paymentsofinterest

Beginningbalance

Issue of new notes

Ending balance

Payments ofinterest

Interestexpense

Endingbalance

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1. Proper authorization for the issue of new notes2. Adequate controls over the repayment of

principal and interest

3. Proper documents and records

4. Periodic independent verification

Internal Controls

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Tests of notes payable transactions

involve the issue of notes and therepayment of principal and interest.

Tests of Controls and Substantive

Tests of Transactions

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Analytical Procedures

for Notes Payable

Analytical Procedure Possible Misstatement

Recalculate approximate Misstatement ofinterest expense on the interest expense and

basis of average interest accrued interest, or

rates and overall monthly omission of an

notes payable. outstanding note

payable

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Analytical Procedures

for Notes Payable

Analytical Procedure Possible Misstatement

Compare individual notes Omission oroutstanding with those of misstatement of a

the prior year. note payable

Compare total balance in Misstatement ofnotes payable,interest interest expense and

expense, and accrued interest accrued interest or

with prior year balances. notes payable

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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 anddisclosed (presentation and disclosure).

1

2

3

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Types of Audit Tests

for Notes Payable

Cash in Bank Notes Payable

Payments of principal

Issue of new notes

Paymentsof interest Interest Payable

Endingbalance

TOC+STOT+AP+TDP

= Sufficient competent evidence per GAAS

Audited byTOC,STOT,

and AP

Audited byAP and TDP

Audited byTOC andSTOT

Audited byTOC andSTOT

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Types of Audit Tests

for Notes Payable

Interest Payable

Endingbalance

Audited byAP and TDP

Audited byTOC,STOT,

and AP

Interest Expense

Interest expenseEnding

balance

Audited byAP

TOC+STOT+AP+TDP

= Sufficient competent evidence per GAAS

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Identify the primary concerns

in the audit of owners

equity transactions.

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Publicly heldcorporation

Closely held

corporation

Owners Equity

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Owners Equity and

Dividend Accounts

Cash in Bank

Capital StockCommon Paid-in Capital in Excessof ParCommonRedemptionof stock

Redemptionof stock

Beginningbalance

Issue ofstock

Endingbalance

Beginningbalance

Issue ofstock

Endingbalance

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Owners Equity and

Dividend Accounts

Cash in Bank

Dividends Payable Retained Earnings

Payment ofdividends

Dividendsdeclared

Beginningbalance

Dividendsdeclared

Endingbalance

Beginningbalance

Netearnings

Endingbalance

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Proper authorization of transactions

Proper record keeping and segregation of duties

Independent registrar and stock transfer agent

Internal Controls

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Design and perform tests of

controls, substantive tests oftransactions, and tests of details

of balances for capital stockand retained earnings.

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1 Existing capital stock transactions arerecorded (completeness).

2

Recorded capital stock transactions

exist and are accurately recorded

(existence and accuracy).

Audit of Capital Stock

and Paid-in Capital

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3 Capital stock is accurately recorded(accuracy).

4Capital stock is properly presented and

disclosed (presentation and disclosure).

Audit of Capital Stock

and Paid-in Capital

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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 yeardividends declared

There may be corrections to:

prior-period earnings

prior-period adjustments

appropriations of retained earnings

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Identify capital acquisition issues

for Internet-based companies.

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Auditors may identify specific business risks

associated with the method used by start-upcompanies to acquire capital.

The complexity of the capital transactions

may create unique financial reporting

and disclosure issues.

E-Commerce and

Capital Acquisition

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End of Chapter 21

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