AUDIT OF THE CAPITAL ACQUISITION AND REPAYMENT CYCLE

A. Accounts In The Cycle

- Notes payable - Cash in the bank
- Contracts payable - Capital stock-common
- Mortgages payable - Capital stock-preferred
- Bonds payable - Paid-in capital in excess of par
- Interest expense - Donated capital
- Accrued interest - Retained earnings
- Appropriations of retained earnings - Dividends payable
- Treasury stock - Proprietorship-capital account
- Dividends declared - Partnership-capital account
B. Notes Payable
Objectives of the audit of notes payable are to determine whether:
 Internal controls over notes payable are adequate
 Transactions for principal and interest involving notes payable are properly
authorized and recorded in accordance with the six transaction-related audit
objectives
 The liability for notes payable and the related interest expense and accrued liability
are properly stated as defined by seven of the eight balance related audit objectives
 Disclosures related to notes payable and the related interest expense satisfy the four
presentation and disclosure audit objectives.

Internal Controls

Four important 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

Tests of controls and substantive tests of transactions

 Substantive Analytical Procedure Possible Misstatement
Recalculate approximate interest expense Misstatement of interest expense and accrued
on the basis of average interest rates and interest or omission of an outstanding note
overall monthly notes payable. payable
Compare individual notes outstanding with Omission or misstatement of a note payable
those of the prior year.
Compare total balance in notes payable, Misstatement of interest expense and accrued
interest expense, and accrued interest with interest or notes payable
prior-year balances

Tests of detail of balances

Two most important balance-related audit objectives:

1. Existing notes payable are included (completeness)

2. Notes payable in the schedule are accurately recorded (accuracy)

When internal controls over notes payable are deficient, auditors may need to perform
extended procedures to test for omitted notes payable.

C. Owners’ Equity
Internal controls
- Proper authorization of transactions
 Issuance of capital stock
 Repurchase of capital stock
 Declaration of dividends
- Proper record keeping and segregation of duties
 Actual owners of the stock are recognized in the corporate records
 The correct amount of dividends is paid to stockholders owning the stock as of the
dividend record late
 The potential for misappropriation of assets is minimized
- Independent registrar and stock transfer agent
Required to engage an independent registrar as a control to prevent the improper issue of
stock certificates
Audit of capital stock and paid-in capital

- Existing capital stock transactions are recorded

- Recorded capital stock transactions occurred and are accurately recorded
- Capital stock is accurately recorded
- Capital stock is properly presented and disclosed

Audit of dividends

1. Recorded dividends occurred (occurrence)

2. Existing dividends are recorded (completeness)
3. Dividends are accurately recorded (accuracy)
4. Dividends are paid to stockholders that exist (occurrence)
5. Dividends payable are recorded (completeness)
6. Dividends payable are accurately recorded (accuracy)

Audit of retained earnings

Audit first analyze retained earnings for entire year. The audit schedule showing the analysis,
which is usually a part of the permanent file, includes a description of every transaction
affecting account.