Audit of the Financing and

Investing Cycle: Test of

Controls and Substantive
Tests of Transactions
Nature
▪ Include the responsibilities of planning the
cash needs, raising capital, and investing
funds
▪ These cycles embrace the major non-
operating activities of many companies
▪ Every business must raise money to
finance the acquisition of productive
assets used to produce revenue
Financing Cycle Transactions

▪ Borrowing from others excluding open

trade accounts with creditors.
▪ Share capital and dividend
transactions share issuance and
reacquisition, shares returned and
dividend declarations are the principal
transactions involving shareholder’s
equity
Investing Cycle Transactions

▪ Acquisitions and disposals

of financial assets.
▪ Lending to others, excluding
open trade accounts with
customers.
Accounts typically affected by the
financing and investing cycles:
▪ Notes payable – non trade (short term
and long term) ▪ Cash in bank

▪ Bonds payable ▪ Interest expense

▪ Mortgage payable
▪ Accrued interest payable
▪ Paid-in capital in excess of par
▪ Long-term liability under capital lease
▪ Donated capital
▪ Share capital
▪ Retained earnings
▪ Investment in securities (temporary
and long term) ▪ Appropriation of retained earnings

▪ Non-trade accounts receivable ▪ Treasury shares

▪ Property, plant and equipment ▪ Dividends declared

▪ Proprietorship – capital account
▪ Accumulated depreciation
▪ Partnership – capital account
▪ Intangibles and other assets
Documents and Records

▪ Share certificate – an engraved form showing the

number of shares owned by a shareholder in a
corporation
▪ Bond certificate – an engraved form showing the
number of bonds owned by a bondholder
▪ Bond indenture – a contract stating the terms of the
bond issue between the bondholder and the issuing
entity
▪ Broker’s advice – a statement from a broker specifying
the details of an investing transaction
Auditing the Financing Cycle

Possible errors related to financing activities include:

▪ Failing to make interest accruals, or making them twice
▪ Accruing interest in the wrong period
▪ Making incorrect estimates of allowances for obligations
▪ Failing to recognize that the entity violated a debt
agreement
▪ Failing to record dividends that were declared
Internal Control Over Financing Cycle
Transactions

▪ existence or occurrence/ rights and obligations

1. Issuance of long-term notes, bonds , and share capitals are made in
accordance with board of directors’ authorizations and legal requirements
and proceeds are promptly deposited intact
2. Payments of bond interest and cash dividends are made to proper payees
in accordance with the board of directors or management authorizations
3. Redemption and reacquisition of bonds and share capital transactions are
executed in accordance with board of directors’ authorizations
4. Cancellation of notes when they are paid to avoid double payment
5. Recorded balances are periodically verified with bondholders and
shareholders
Valuation / Completeness /
Classification

▪ Transactions and events are

correctly recorded as to amount,
classification, and accounting
period
▪ Transactions are promptly and
correctly posted to individual
accounts
Evaluation of Internal Control over
Financial Cycle Transactions

1. Current liabilities
▪. A system authorization on both as to original
transaction resulting in a liability and as to payment of
the liability should be well-defined and established
▪. Satisfactory system of record keeping with adequate
forms and documentation should be instituted
▪. There should be a plan of organization
Long-term liabilities

▪ Should be properly authorized

▪ There should be proper control over issued and
unissued obligations
▪ Redeemed bonds should be cancelled, properly
mutilated and retained
▪ Bond ledger should be used in which details of bonds
issued, cancelled and outstanding are shown
▪ Proper control should be exercised over the payment of
interest on long-term liabilities
Share Capital

▪ Internal control measures and proper accounting

▪ Share certificates should be serially numbered and the
authority for signing and issuing the certificates be
designated by the board of directors
▪ Corresponding records of certificates should be
prepared
▪ Cancelled certificates should be mutilated and any
necessary documentary stamps should be attached
▪ Entries for share issuances and transfers should be
made by a person who does not have authority to sign
and issue certificated
Auditing the Investing Cycle

▪ Basic considerations:
Audit risk for investing cycle transactions
and balances can generally be kept at a
very low level in most enterprises since:
1. These transactions occur infrequently
2. Effectivity controls can be maintained at
relatively little cost
Internal Control Over Investing
Cycle Transactions

▪ Three operating objectives of internal

control applicable to the investing
cycle are:
1.Executing of transactions
2.Recording of transactions
3.Custody of assets
Existence or Occurrence / Rights and
Obligations

▪ Purchases of property and equipment, securities and

intangibles are made in accordance with management’s
authorization
▪ Sales of property and equipment, securities and intangibles
should be authorized
▪ Dividend and interest checks from investments are promptly
deposited intact
▪ Access to property and equipment, securities and intangibles
are restricted to authorized personnel
▪ Recorded balances are composed with existing assets at
reasonable intervals
Valuation / Completeness /
Classification

▪ Transactions and events are

correctly recorded as to amount,
classification and accounting
period
▪ Transactions are promptly and
correctly posted to individual
investment accounts
Evaluation of Internal Control Over
Investing Cycle Transactions

1. Internal control over investments

▪. Purchases and sales should be made only on proper
authorization
▪. Access to securities should not be vested on one person
only
▪. Custodianship and accounting for securities should be
separated
▪. Securities must be physically controlled
▪. Revenues received from the investments periodically
should be reconciled with the amounts that should be
received
2. Internal control over fixed assets

▪ Proper authorization
▪ Clearly defined and sound policy for differentiation of
capital and revenue expenditures should be established
▪ Fixed assets controlling account should be conducted
and supported by detailed plant records
▪ Physical inspections of fixed assets
▪ Periodic review of adequacy of insurance
▪ Reasonable depreciation policy and must be
consistently applied
3. Internal control over intangible
assets

▪ Proper authorization
▪ Adequacy and consistency of accounting policies
governing intangible assets should be reviewed
periodically
▪ General ledger account should be supported by
adequate detailed records and should be periodically
reconciled
▪ Schedules of intangibles should be prepared periodically
and be reviewed by a responsible official
Test of Controls and Substantive Tests
of Transactions: Investing Cycle

1. Trace transactions for purchases and sales of property

and equipment, securities and intangibles through the
system
2. Review reports by internal auditors on their periodic
inspections to property and equipment, securities and
intangibles
3. Review monthly reports by officer of client company on
securities owned, purchased and sold, and revenue
earned
4. Review significant changes in the composition of
property and equipment and related liens and