Audit of the capital acquisition and

repayment cycle
Lecture 11
Outline

• Characteristics of the capital acquisition and repayment cycle

• Accounts in the cycle
• Notes payble
• Owners’ Equity
 Relatively few transactions affect the account
balances, but each one is often highly material in
Characteristics amount

of the Capital The exclusion of a single transaction could be

Acquisition material in itself

and A legal relationship exists between the client entity

and the holder of the stock, bond, or similar
Repayment ownership document

Cycle A direct relationship exists between the interest and

dividends accounts and debt and equity tock, bond,
or similar ownership document
 • Notes payable
• Contracts payable
• Mortgages payable
• Bonds payable
Accounts in • Interest expense
the Cycle • Accrued interest
• Appropriations of retained earnings
• Treasury stock
• Dividends declared
 • Cash in the bank
• Capital stock – common
• Capital stock – preferred
• Paid-in capital in excess of par
Accounts in • Donated capital
the Cycle • Retained earnings
• Dividends payable
• Proprietorship – capital account
• Partnership – capital account
Notes payable
Notes payable - Methodology
Identify client business risks affecting notes payable Phase I

Set tolerable misstatement and assess inherent

risk for notes payable Phase I

Assess control risk for notes payable Phase I

Design and perform tests of controls and substantive tests

of transactions for capital acquisition and repayment cycle Phase II

Design and perform analytical procedures for N/P Phase III

Design tests of details of notes payable to satisfy

Phase III
balance-related audit objectives
Notes payable

Secured or
Legal
unsecured
Obligation
by assets
 Internal controls are adequate

Objectives of Transactions are properly authorized and

recorded
the audit of
notes payable The related liabilities and expenses are
properly stated

Disclosures related to notes payable and the

related interest expense satisfy the four
presentation and disclosure audit objectives
 Proper authorization for the issue of
new notes.

Adequate controls over the

Internal repayment of principal and interest.
Controls
Proper documents and records.

Periodic independent verification

Tests of
Controls and 01 02 03
Substantive Part of tests of controls Emphasize testing the Verify the accurate

Tests of
and substantive tests four internal controls recording of receipts
of transactions for cash from note proceeds
receipts and cash and payments of
disbursements principal and interest

Transactions
Analytical Procedures for Notes
Payable
Tests of Details of balances

The two most important balance-related audit objectives in notes

payable are:

1. Completeness: Existing notes payable are included.

Notes payable in the schedule are

2. Accuracy: accurately recorded
Owners’ Equity

Publicly Closely
held Versu held
corporation s corporation

Many shareholders Simple, few transactions

Frequent transactions Few shareholders
Occasional transactions
Owners’ Equity and Dividend Accounts
 • Proper authorization of transactions
Internal • Proper record keeping and
Controls segregation of duties
• Independent registrar and stock
transfer agent
Audit of Capital Stock and Paid-in Capital
Auditor concerns in auditing Capital
Stock and Paid-in-Capital accounts

Occurrence
Completeness and
Accuracy

Presentation
Accuracy and
disclosure
Audit of Capital Stock and Paid-in
Capital
Completeness
Confirm with the registrar or transfer agent
Review the minutes of the board of directors’
meetings
Examine client-held stock record books
Occurrence and Accuracy
Examine the minutes of the board of directors’
meetings for proper authorization
Confirm the amount with the transfer agent and
trace the amount of the recorded capital stock
transactions to cash receipts
Refer to the corporate charter to determine the
par or stated value of the capital stock
 Audit of Capital Stock and Paid-in Capital

• Confirm with the registrar or transfer agent or examine stock records for
number of shares outstanding
Accuracy • Verify calculation of ending balance of capital stock and capital in excess of
par
• Verify the number of shares for determining basic and diluted EPS.

Presentation • Verify information from corporate charter, the minutes of board of

directors’ meetings, and the auditor’s analysis of capital stock transactions

and disclosure • Examining legal documents or other evidence of the provisions of

agreements for stock options, stock warrants, and convertible securities
Audit of Dividends
Examine the minutes of board of directors’ meetings for authorization of the amount of the dividend per
share and the dividend date

Recalculate the amount on the basis of the dividend per share times the number of shares outstanding.

Verify the total amount of the dividend by recalculation and reference to cash disbursed

Unpaid dividends should be recorded as liability

Select a sample of recorded dividend payments and tracing payee information to the records produced by
the stock transfer agent or by tracing payee information on the cancelled check to the dividend records
Audit of Retained Earnings
Analyze retained earnings
for the entire year
Determine debits and
credits to retained earnings,
other than net earnings and
dividends
Trace the entry in retained
earnings to the net earnings
figure on the income
statement
Evaluate whether any
transactions should have
been included but were not
Tutorial exercises
22-20

22-22

22-27

22-28