AUDIT OF SHAREHOLDERS’ EQUITY

Shareholders’ equity transactions typically involve stock issuances, acquisitions and sales of treasury stock, and
dividends. These transactions are usually few, but may involve significant amounts. Hence, the audit of
shareholders’ equity requires a small amount of audit time compared to those accounts that are affected by high
volumes of transactions. As a result, the auditor generally assesses control risk at the maximum level for
shareholders’ equity and test all transactions (detailed tests of transactions).

Share capital transactions in general. Because share capital transactions are usually significant in amount, the
auditor’s primary concern is that all share capital share transactions are properly authorized.
 Primarily, the auditor will vouch all entries in the share capital account to the minutes of the board of
directors’ meetings.
 Entries in the capital stock account can be traced to a resolution in the minutes of the board of directors'
meetings. Remember that changes in capital stock account are normally approved by the BOD.
 The auditor also reviews articles of incorporation, by-laws, and minutes of shareholders’ meetings.

Shareholder records. For internal control purposes, the maintenance of shareholder ledger and the preparation of
certificate of stock are incompatible.
 For large, publicly traded corporations, they employ the services of an independent registrar and stock
transfer agent to prevent improper issuances of shares, particularly over-issuance. When a client does not
maintain its own records, the auditor should obtain written confirmation (written under client’s
letterhead and mailed by auditor) from the transfer agent and registrar concerning:
o Number of shares issued and outstanding
o Balances at year-end (including any subscription receivables)
o Capital transactions during the year
o Shares reserved for future issuance (e.g. stock options)
o Unclaimed dividends
o List of principal shareholders of each class of shares

Note: Stock registrar – ensures that share issue is properly authorized by the company’s articles of
incorporation and is properly issued by the transfer agent; examines and registers new share
certificates prior to issuance. Transfer agent – facilitates transfer of shares; maintains detailed
shareholder records.

 When the entity acts as its own transfer agent and registrar, the auditor shall adopt alternative
procedures to obtain evidence that is not available by direct confirmation with outside parties.
o The auditor shall primarily rely upon inspection of the stock book at year-end and accounting for
all certificate numbers.
o The auditor shall reconcile the stock certificate book with the general ledger. Footing the shares
outstanding in the share register and comparing the total to the shares outstanding in the
general ledger addresses the audit objective of completeness.
o The auditor shall ensure that cancelled stock certificates are defaced to prevent reissuance and
attached to their corresponding stubs or certificate book (they are canceled, generally by
perforation).

Treasury Shares
 The audit approach for acquired treasury stock will normally include inspection of certificates, and tracing
transactions to the minutes of the board of directors’ meetings.
 Note that when auditing treasury shares, one objective of the auditor includes checking whether retained
earnings were restricted for the amount of issue price of the treasury shares.
  If the client corporation has a material amount of treasury shares on hand at year-end, the auditor should
count the certificates at the same time other securities are counted to prevent substitution and to
provide direct evidence that the treasury exist and in the possession of the client.

Stock options
 In performing tests concerning the grant of stock options, an auditor should trace the authorization for
the transaction to a vote of the BOD.
 When a corporation has stock options, the auditor must determine that enough shares are held in reserve
to fulfill the obligations.

Retained Earnings in general

Transactions in retained earnings normally consist of net income or loss, dividends, appropriations, quasi-
reorganizations, but they may also include adjustments to opening RE arising from changes in accounting policy
and prior period errors. Common audit procedures follow:
 Verify opening balance (for continuing auditor, this may be verified form the prior year working paper)
 Check for proper authorization for movements in RE, such as dividends
 Check propriety of entries related to transactions un RE
 Check for proper disclosure of restrictions of RE resulting from loans, agreements or law

Dividends
 An audit program should always include a step that requires the verification of the authorization for the
declaration of dividends (from minutes of BOD’s meetings)
 In verifying dividend amounts paid, an auditor will typically determine dates and amount of dividends
paid, examine arrearages of preferred stock dividends, and examine treatment of unclaimed dividends.
The auditor does not send confirmation to shareholders to verify payments.
 Other typical procedures involving audit of dividends include:
o Review of client’s compliance with contracts restricting the distribution of dividends
o Recomputing the amount of dividends
o Testing payee names and amounts on cancelled checks with the share capital register or share
certificate