AUDIT OF THE CAPITAL ACQUISITION AND REPAYMENT

CYCLE
Submitted to Fulfill the Task of Auditing 2
Lecturing Associated by:
Mr. Atta Putra Harjanto, S.E., M.Ak.

Arranged by:
Group 9
Farah Zata Yumnillah (7211420052)

Niken Anida Putri (7211420088)

Wira Yudha (7211420172)
Ilhan Satria Wirayudha (7211420221)

SEMARANG STATE UNIVERSITY

2022
 PREFACE

Assalamualaikum Wr. Wb.

Bismillahirrahmanirrahim, praise be to Allah SWT, who with His mercy has made it
easy for us to compile our paper entitled "Audit of the Capital Acquisition and Repayment
Cycle: Tests of Transactions, Substantive Tests of Transactions, and Accounts Payable". We
crafted this paper to fulfill the task of the Auditing 2 course with the lecturer Mr. Atta Putra
Harjanto, S.E., M.Ak.
We wanted to thank him for giving us the task of making this Auditing 2 paper. With
this assignment, we hope that we can be more familiar with our material as well. We also
wanted to thank those who have been the source in the preparation of our paper.
We are very aware that this paper is far from perfect. Therefore, if there is any invalid
information or misspelled words, we are open to receive suggestions and criticisms from the
readers.
Wassalamualaikum Wr. Wb.
Semarang, February 19, 2022

Authors
 TABLE OF CONTENTS

PREFACE…………………………………………………………………….….…...ii

TABLE OF CONTENTS…………………………………………………….…..….iii

CHAPTER I: INTRODUCTION……………………………………………………4

1.1 Background………………………………………………………………….…4

1.2 Formulation of the Problem……………………………………………………4

1.3 Objectives………………………………………………………………………4

CHAPTER II: REVIEW OF THE LITERATURE………………………………..6

2.1 Accounts in Cycle……………………………………………………………..6

2.2 Notes Payable….….…………………………………….……………………...7

2.3 Owner’s Equity……………………………………………………………..….8

CHAPTER III: STUDY CASE…………………………………………….………15

BIBLIOGRAPHY……………………………………………………………...……18
 CHAPTER I

INTRODUCTION

1.1 BACKGROUND
Capital acquisition and repayment cycle concerns about the acquisition of capital
resources through interest-bearing debt and owners’ equity and the repayment of capital. This
cycle also includes the payment of interest and dividends.
Four characteristics of the capital acquisition and repayment cycle influence the audit
of these accounts:
1. Relatively few transactions affect the account balances, but each transaction is often
highly material.
2. The exclusion or misstatement of a single transaction can be material.
3. A legal relationship exists between the client entity and the holder of the stock, bond,
or similar ownership document.
4. A direct relationship exists between the interest and dividends accounts and debt and
equity.
Auditors often learn about capital acquisition transactions while gaining an
understanding of the client’s business and industry, performed as part of the auditor’s risk
assessment procedures.
Also, when public companies issue additional debt and equity securities during the
year, SEC rules require auditor consideration of financial information included in the client’s
new securities offering prospectus. Auditors oftently identify business risk issues for capital
acquisition activities that should be considered in the design of audit procedures for
transactions, account balances, and disclosures in the capital acquisition and repayment cycle.

1.2 FORMULATION OF THE PROBLEM

1. Why we have to audit Capital Acquisition and repayment cycle?
2. What related account that we have to audit in Capital Acquisition and repayment cycle?
3. How to do an audit to Capital Acquisition?
4. What are steps to design Audit for Capital Acqusition and repayment cycle in a company?

1.3 OBJECTIVES
After studying this chapter, we are expecting you to be:
1. Able to explain the cycle of capital acquisition and repayment.
2. Able to identify the accounts and the unique characteristics of the capital acquisition and
repayment cycle.
3. Able to design and perform audit tests of notes payable and related accounts and
transactions.
4. Able to identify the primary concerns in the audit of owner’s equity transactions.
 CHAPTER 2

REVIEW OF THE LITERATURE

2.1 ACCOUNTS IN CYCLE

The accounts in a company’s capital acquisition and repayment cycle depend on the
type of business the company operates and how its operations are financed. All corporations
have capital stock and retained earnings, but some may also have preferred stock, additional
paid-in capital, and treasury stock. The unique characteristics of the capital acquisition and
repayment cycle affect how auditors verify the accounts in the cycle. These cycle usually
includes these accounts:

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

The methodology for designing tests of details of balances for accounts in the capital
acquisition and repayment cycle is the same as that followed for other accounts. The only
difference is just for the account’s type. As we know that, there are three phases in
methodology for designing test of details of balances:

a. Identify significant risks and assess risk of material misstatement (Phase 1)

b. Set Performance materiality to assess the risks of material misstatement (Phase 1)
c. Assess control risks by carrying out risk assessment procedures (Phase 1)
d. Design and perform test of control and Substantive test of transactions (Phase 2)
e. Design and perform substantive analytical procedures (Phase 3)
 f. Design and perform test of details of balance (Phase 3)

In designing test of details of balances for accounts receivable, auditors must satisfy
each of the eight balance-related audit objectives. This section relates to auditing standard
200, which relates to the overall objective of the auditor, which to obtain assurance that the
financial statements and the framework in them are properly presented and that there is no
material misstatement.

a. Detail tie-in
b. Occurrence and Existence
c. Completeness
d. Accuracy
e. Classification
f. Cut-off Timing
g. Realizable Value
h. Right

To best understand the audit procedures for many of the accounts in the capital
acquisition and repayment cycle, representative accounts that are significant parts of the cycle
for a typical business are included in this chapter. The following sections discuss:

(1) the audit of notes payable and related interest expense to illustrate interest bearing capital

(2) the audit of common stock, paid-in capital in excess of par, dividends, and retained
earnings to illustrate equity accounts.

2.2 NOTES PAYABLE

A note payable is a legal obligation to a creditor, which may be unsecured or secured by

assets, and bears interest. It is issued for a period somewhere between one month and one year. For
short-term loans, a principal and interest payment is usually required only when the loan becomes
due. For loans over 90 days, the note usually calls for monthly or quarterly interest payments.

The objectives of the audit of notes payable are to determine whether:

1. Internal control is carried out fairly according to procedures.

2. Payment transactions related to notes payable are recorded according to the six
objectives of the audit of transactions.
3. Notes payable, interest expense, and accrued liabilities are stated fairly.
4. Disclosure of notes payable and interest expense fulfills the four objectives of the
presentation and disclosure audit.

The internal controls of notes payable:

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:

● Involves the issuance of notes, payment of principal and interest on the loan.
● Auditors must verify accurate records of receipt of notes and payments of principal
and interest.

Analytical Procedures on Notes Payable

● SA 520: regulates the use of analytical procedures as substantive tests

● SA 500 (objective of analytical procedures): assist the auditor in drawing conclusions
on audit results
● SA 315: must perform appropriate procedures to obtain appropriate evidence
● SA 330: the auditor assesses the risks of misstatement
● Required procedures: analytical procedures and procedures for misstatement of notes
payable
 Audit objectives regarding notes payable balances:

1. Existing notes payable have been included (completeness).

2. The schedule of notes payable has been recorded accurately (accuracy).

It is important because misstatements can be material even if one of the notes is

omitted or incorrect. If control of notes payable is weak, the auditor should perform
further procedures to test for missing notes payable.

2.3 OWNER’S EQUITY

There is a difference in the audit of owners’ equity between a publicly held

corporation and a closely held corporation. In most closely held corporations, which typically
have few shareholders, occasional, if any, transactions occur during the year for capital stock
accounts. The only transactions entered in the owners’ equity section are likely to be the
change in owners’ equity for the annual earnings or loss and the declaration of dividends, if
any. For publicly held corporations, however, the verification of owners’ equity is more
complex because of the larger numbers of shareholders and frequent changes in the
individuals holding the stock.

2.3.1 Internal Controls

The following is several internal controls that are important for owners’ equity activities:
1. Proper authorization of transactions. Because each owners’ equity transaction is
typically material, many of these transactions must be approved by the board of
directors. The following types of owners’ equity transactions usually require specific
authorization:
 ● Issuance of Capital Stock. The authorization includes the type of equity to
issue (such as preferred or common stock), number of shares to issue, par
value of the stock, privileged condition for any stock other than common, and
date of the issue.
● Repurchase of Capital Stock. The repurchase of common or preferred
shares, the timing of the repurchase, and the amount to pay for the shares
should all be approved by the board of directors.
● Declaration of Dividends. The board of directors must authorize the form of
the dividends (such as cash or stock), the amount of the dividend per share,
and the record and payment dates of the dividends.

2. Proper record Keeping and Segregation of Duties. When a company maintains its own
records of stock transactions and outstanding stock, the internal controls must be
adequate to ensure that:
● Actual owners of the stock are recognized in the corporate records.
● The correct amount of dividends is paid to the stockholders owning the stock
as of the dividend record date.
● The potential for misappropriation of assets is minimized.
The proper assignment of personnel, adequate record-keeping procedures, and
independent internal verification of information in the records are useful controls for
these purposes. The client should also have well-defined policies for preparing stock
certificates and for recording capital stock transactions. Internal controls affecting
dividend payments may include:
● Dividend checks are prepared from the capital stock certificate record by
someone who is not responsible for maintaining the capital stock records.
● After the checks are prepared, there is independent verification of the
stockholders’ names and the amounts of the checks and a reconciliation of the
total amount of the dividend checks with the total dividends authorized in the
minutes.
● A separate imprest dividend account is used to prevent the payment of a larger
amount of dividends than was authorized.
3. Independent registrar and Stock transfer agent. Any company with stock listed on a
securities exchange is required to engage an independent registrar as a control to
 prevent the improper issue of stock certificates. The responsibility of an independent
registrar is to make sure that stock is issued by a corporation in accordance with the
capital stock provisions in the corporate charter and the authorization of the board of
directors. Most large corporations also employ the services of a stock transfer agent to
maintain the stockholder records, including those documenting transfers of stock
ownership. The employment of a transfer agent helps strengthen control over the
stock records by putting the records in the hands of an independent organization and
helps reduce the cost of record keeping by using a specialist

2.3.2 Audit of Capital Stock and Paid-In Capital

Auditors have four main concerns in auditing capital stock and paid-in capital in excess of
par (The first two concerns involve tests of controls and substantive tests of transactions, and
the last two involve tests of details of balances and related disclosures):

1. Existing capital stock transactions are recorded (completeness transaction-related

objective). This objective is easily satisfied when a registrar or transfer agent is used.
The auditor can confirm with that person whether any capital stock transactions
occurred and the accuracy of existing transactions, and then determine if all of those
transactions have been recorded.
2. Recorded capital stock transactions occurred and are accurately recorded (occurrence
and accuracy transaction-related objectives). Extensive auditing is required for
transactions involving issuance of capital stock such as the issuance of new capital
stock for cash, the merger with another company through an exchange of stock,
donated shares, and the purchase of treasury shares. Regardless of the controls, it is
normal practice for auditors to verify all capital stock transactions because of their
materiality and permanence in the records. The occurrence transaction-related
objective can ordinarily be tested by examining the minutes of the board of directors
meetings for proper authorization.
3. Capital stock is accurately recorded (accuracy balance-related objective). Auditors
verify the ending balance in the capital stock account by first determining the number
of shares outstanding at the balance sheet date. A confirmation from the transfer agent
is the simplest way to obtain this information. When no transfer agent exists, the
 auditor must rely on examining the stock records and accounting for all shares
outstanding in the stock certificate records, examining all cancelled certificates, and
accounting for blank certificates.
4. Capital stock is properly presented and disclosed (all four presentation and disclosure
objectives). The auditor should determine that each class of stock has a proper
description, including the number of shares issued and outstanding and any special
rights of an individual class. Auditors should also verify the proper presentation and
disclosure of stock options, stock warrants, and convertible securities by examining
legal documents or other evidence of the provisions of these agreements.

2.3.3 Audit of Dividends

The emphasis in the audit of dividends is on dividend transactions rather than on the ending
balance. The exception is when there are dividends payable. The most important objectives,
including those concerning dividends payable, are:

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

Tests of dividends payable should be done in conjunction with declared dividends. Any
unpaid dividend should be included as a liability.

2.3.4 Audit of Retained Earnings

For most companies, the only transactions involving retained earnings are net earnings for the
year and dividends declared. Other changes in retained earnings may include corrections of
prior-period earnings, prior-period adjustments charged or credited directly to retained
earnings, and the setting up or elimination of appropriations of retained earnings. Accounting
standards require presentation and disclosure of information related to retained earnings. The
auditor’s primary concern in determining whether presentation and disclosure objectives for
retained earnings are satisfied primarily relates to disclosure of any restrictions on the
payment of dividends. Often, agreements with bankers, stockholders, and other creditors
prohibit or limit the amount of dividends the client can pay. These restrictions must be
disclosed in the footnotes to the financial statements.

Analytical Procedures on Owners’ Equity:

1. SA 540 A18 Specific components of equity, for example when accounting for the
recognition, measurement and presentation of certain financial instruments with
equity features, such as a bond convertible by the holder into common shares of the
issuer.
2. SA 240 A5 Misappropriation of assets is often accompanied by false or misleading
records or documents in order to conceal the fact that the assets are missing or have
been pledged without proper authorization.
3. SA 265 A4 Smaller entities often have fewer employees which may limit the extent to
which segregation of duties is practicable. However, in a small owner-managed entity,
the owner-manager may be able to exercise more effective oversight than in a larger
entity. This higher level of management oversight needs to be balanced against the
greater potential for management override of controls.
4. SA 540 A30 In smaller entities, the circumstances requiring an accounting estimate
often are such that the owner-manager is capable of making the required point
estimate. In some cases, however, an expert will be needed. Discussion with the
owner-manager early in the audit process about the nature of any accounting
estimates, the completeness of the required accounting estimates, and the adequacy of
the estimating process may assist the owner-manager in determining the need to use
an expert.
 CHAPTER III
STUDY CASE

The Redford Corporation took out a 20-year mortgage on June 15, 2011, for
$2,600,000 and pledged its only manufacturing building and the land on which the building
stands as collateral. Each month subsequent to the issue of the mortgage, a payment of
$20,000 was paid to the mortgagor. You are in charge of the current year audit for Redford,
which has a balance sheet date of December 31, 2011. The client has been audited previously
by your CPA firm, but this is the first time Redford Corporation has had a mortgage.

REQUIRED:
1. Explain why it is desirable to prepare an audit schedule for the permanent file for the
mortgage. What type of information should be included in the schedule?
SOLUTIONS:
It is desirable to prepare an audit schedule for the permanent file for the mortgage so
that the appropriate information concerning the mortgage will be conveniently
available for future years' audits. This information should include all the provisions of
the mortgage as well as the purchase price, date of purchase, and a list of items
pledged as collateral. It may also contain an amortization schedule of principal and
interest (especially if the auditor has access to a computer program for preparation of
such a schedule).

2. Explain why the audit of mortgage payable, interest expense, and interest payable
should all be done together?
SOLUTIONS:
The audit of mortgage payable, interest expense, and interest payable should all be
done together since these accounts are related and the results of testing each account
have a bearing on the other accounts. The likelihood of misstatement in the client's
records is determined faster and more effectively by doing them together.
3. List the audit procedures that should ordinarily be performed to verify the issue of the
mortgage, the balance in the mortgage and interest payable accounts at December 31,
2011, and the balance in interest expense for the year 2011.
SOLUTIONS
The audit procedures that should ordinarily be performed to verify the issue of the
mortgage, thebalance in the mortgage and interest payable, and the balance in the
interest expense accounts are:
1. Determine if the mortgage was properly authorized.
2. Obtain the mortgage agreement and schedule the pertinent provisions in the
permanent file, including the face amount, payments, interest rate, restrictions, and
collateral.
3. Confirm the mortgage amount, terms, and collateral with the lending institution.
4. Recompute interest payable at the balance sheet date and reconcile interest expense
to thedecrease in principal and the payments made.
5. Test interest expense for reasonableness.

4. Identify the types of information that should be disclosed in the footnotes for this
long-termnote payable to help the auditor determine whether the completeness
presentation and disclosureaudit objective is satisfied
SOLUTIONS
Accounting standards require disclosures related to long-term debt. The terms of the
debt agreement are to be disclosed, including interest rates, maturity dates, five-year
payment information, assets pledged as collateral, among other items. Significant
restrictions on the activities of thecompany, such as maintaining cash or other
compensating balances or restricting the amount of dividends that can be paid, should
be disclosed. Thus, auditors obtain copies of long-termdebt agreements to determine
that the client’s disclosures are complete and accurate.
 BIBLIOGRAPHY

Arens, A. A., Elder, R. J., Beasley, M. S., & Hogan, C. E. (2014). Auditing and
Assurance Services (6th ed.). Pearson Education, Inc.