Chapter Ten

Auditing Liabilities

Liabilities are obligation of a firm arise from past transactions and need future scarification of
resources for their settlement.

Audit for Accounts Payable

Account payables are obligations for the acquisition of raw materials, equipment, utilities,
repairs and many other type of goods and services that were received before the end of the year
and are to be settled with in a fiscal year. If an obligation includes the payment of interest, it
should be recorded properly as a note payable, contract payable or bond.

Audit Objective

The over all objective in the audit of accounts payable is to determine whether accounts payable
balance is fairly stated and properly disclosed on the financial statements.

Test of Transactions

 Trace individual vendor’s invoices to master file for names and amounts
 Trace the total to the general ledger
 Confirm that all accounts payable related transactions are properly recorded
 Confirm that all recorded account payable transactions are valid and occurred
 Review statements to make sure that long term and interest bearing notes are segregated

Audit for Notes Payable

A note payable is a legal obligation of entities that includes interest and requires the written
promise of the maker. A note is issued for a period between one month and one year, and even
for more than a year- are called long term notes.

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Audit Objective

The auditor’s objectives in examination of notes payable are to determine whether

 The internal control over notes payable is adequate

 Transaction for principal and interest involving notes are properly authorized and
recorded
 The liability for notes payable and the elated interest expenses and accrued liabilities are
properly stated in the financial statements.

Internal controls

 Proper authorization for the issue of new notes

Responsibility for the issuance of new notes should be vested in the board of director or
higher level management. The agreement should contain the amount of the loan, the interest
rate and the repayment terms

 Adequate control over the repayment of the principal and interest

The periodic payments of interest and principal should be controlled. When the note is issued
a copy should be sent to the accounting department for proper recording

 Proper documents and recorded

This includes maintenance of subsidiary records and use of appropriate documents

 Periodic independent verification

The details of the note records should be reconciled with the general ledger and compared with
the note holders’ records by an employee who is nor responsible for maintaining the detailed
records.

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Test of Transactions

Test of notes payable transactions involve the issue of notes and the repayment of principal and
interest.

 Obtain a schedule of notes payable and accrued interest – a schedule usually includes
detailed information of all transactions that have been taken place during the entire year
for the principal and interest, the beginning and ending balances of notes and interest
payable, and descriptive information about the notes, such as the due date and the interest
rate
 Confirm that all existing notes payable are included
 Confirm that notes payables are properly valued
 Confirm that notes payable are properly disclosed.

Chapter Eleven
Auditing owner’s Equity

Audit objectives
The auditor’s objectives in examination of owner’s equity are to determine whether

 The internal control over owner’s equity is adequate

 Owner’s equity related transactions are recorded
 Owner’s equity balances are properly stated and disclosed

Internal Controls

 Proper authorization of transactions – for issuance of stock, repurchasing of capital

stock, and declaration of dividend
 Proper record keeping -
 Adequate segregation of duties between maintaining owner’s equity records and
handling cash
 Independent internal verification of information in the records

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Audit of Capital Stock and Paid in Capital

There are four main concerns:

 Existing capital stock transactions are recorded

 Recorded capital stock transactions are authorized and properly valued
 Capital stocks are properly disclosed

Audit of Dividends

The most important objectives include determining whether

 Recorded dividends are authorized

 Existing dividends are recorded
 Dividends are properly valued
 Dividends paid to stockholders are properly valued
 Dividend payables are recorded
 Dividend payables are properly valued

Audit of Retained Earnings

The most important objectives include determining whether

 Existing transactions are recorded

 Recorded transactions are authorized
 Recorded transaction are properly valued
 Transactions are properly classified
 Retained earning balance is properly disclosed