Audit of the Capital

Acquisition and
Repayment Cycle

Chapter 21

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 Learning Objective 1

Identify the accounts and the

unique characteristics of the
capital acquisition and
repayment cycle.

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 Characteristics of the Capital
Acquisition and Repayment Cycle

Few transactions affect the account

1 balances, but each one is often
highly material in amount.
The exclusion of a single transaction
2
could be material in itself.

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 Characteristics of the Capital
Acquisition and Repayment Cycle

There is a legal relationship between the

3 client entity and the holder of the stock,
bond, or similar ownership document.
There is a direct relationship between
4 the interest and dividends accounts
and debt and equity.

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Accounts in the Cycle
 Notes Payable
 Contracts Payable
 Mortgages Payable
 Bonds Payable
 Interest Expense
 Accrued Interest
 Cash in the Bank
 Capital Stock – Common
 Capital Stock – Preferred
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 Accounts in the Cycle
 Paid-in Capital in Excess of Par
 Donated Capital
 Retained Earnings
 Appropriations of Retained Earnings
 Treasury Stock
 Dividends Declared
 Dividends Payable
 Proprietorship – Capital Account
 Partnership – Capital Account
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Methodology for Designing Tests of
Balances – Notes Payable
Identify client business risks
affecting notes payable.

Set tolerable misstatement and

assess inherent risk for notes payable.

Assess control risk for notes payable.

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Methodology for Designing Tests of
Balances – Notes Payable

Design and perform tests of

controls and substantive tests
of transactions.

Design and perform analytical

procedures for notes payable
balance.

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Methodology for Designing Tests of
Balances – Notes Payable

Design tests of details Audit procedures

of notes payable to Sample size
satisfy balance-related Items to select
audit objectives. Timing

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 Learning Objective 2

Design and perform audit tests

of notes payable and related
accounts and transactions.

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 Notes Payable

A note payable is a legal

obligation to a creditor.

It may be unsecured
or secured by assets.

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 Notes Payable and the Related
Interest Accounts
Notes Payable Interest Expense
Payments Beginning balance Interest
of expense
principal Issue of new notes
Ending balance Interest Payable
Payments Beginning
of balance
Cash in Bank interest Interest
Issue of Payments of expense
new notes principal
Ending
Payments of balance
interest
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 Internal 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

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Tests of Controls and Substantive
Tests of Transactions

Tests of notes payable transactions

involve the issue of notes and the
repayment of principal and interest.

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 Analytical Procedures
for Notes Payable

Analytical Procedure Possible Misstatement

Recalculate approximate Misstatement of
interest expense on the interest expense and
basis of average interest accrued interest, or
rates and overall monthly omission of an
notes payable. outstanding note
payable

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 Analytical Procedures
for Notes Payable

Analytical Procedure Possible Misstatement

Compare individual notes Omission or
outstanding with those of misstatement of a
the prior year. note payable
Compare total balance in Misstatement of
notes payable,interest interest expense and
expense, and accrued interest accrued interest or
with prior year balances. notes payable
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 Major Balance-Related Audit
Objectives in Notes Payable

Existing notes payable are included

1
(completeness).
Notes payable in the schedule are
2
accurately recorded (accuracy).
Notes payable are properly presented and
3
disclosed (presentation and disclosure).

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 Types of Audit Tests
for Notes Payable

Cash in Bank Notes Payable

Payments of principal
Audited by
TOC and STOT
Issue of new notes Ending
balance
Audited by
TOC and STOT Audited by
Payments AP and TDP
of interest Interest Payable
Audited by
TOC, STOT, TOC + STOT + AP + TDP
and AP = Sufficient competent evidence per GAAS
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 Types of Audit Tests
for Notes Payable

Interest Payable Interest Expense

Interest expense
Ending Audited by Ending
balance TOC, STOT, balance
and AP
Audited by Audited by
AP and TDP AP

TOC + STOT + AP + TDP

= Sufficient competent evidence per GAAS
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 Learning Objective 3

Identify the primary concerns

in the audit of owners’
equity transactions.

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 Owners’ Equity

Publicly held
corporation

Closely held
corporation

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 Owners’ Equity and
Dividend Accounts
Cash in Bank

Capital Stock – Paid-in Capital in Excess

Common of Par – Common
Redemption Beginning Redemption Beginning
of stock balance of stock balance
Issue of Issue of
stock stock
Ending Ending
balance balance
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 Owners’ Equity and
Dividend Accounts
Cash in Bank

Dividends Payable Retained Earnings

Beginning Beginning
Payment of balance balance
dividends Dividends Dividends Net
declared declared earnings
Ending Ending
balance balance
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 Internal Controls

Proper authorization of transactions

Proper record keeping and segregation of duties

Independent registrar and stock transfer agent

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 Learning Objective 4

Design and perform tests of

controls, substantive tests of
transactions, and tests of details
of balances for capital stock
and retained earnings.
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 Audit of Capital Stock
and Paid-in Capital

Existing capital stock transactions are

1
recorded (completeness).
Recorded capital stock transactions
2 exist and are accurately recorded
(existence and accuracy).

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 Audit of Capital Stock
and Paid-in Capital

Capital stock is accurately recorded

3
(accuracy).
Capital stock is properly presented and
4
disclosed (presentation and disclosure).

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 Audit of Dividends

1. Recorded dividends exist (existence).

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

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 Audit of Retained Earnings

Transactions involving retained earnings:

– net earnings for the year
– dividends declared
There may be corrections to:
– prior-period earnings
– prior-period adjustments
– appropriations of retained earnings

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 Learning Objective 5

Identify capital acquisition issues

for Internet-based companies.

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 E-Commerce and
Capital Acquisition

Auditors may identify specific business risks

associated with the method used by start-up
companies to acquire capital.
The complexity of the capital transactions
may create unique financial reporting
and disclosure issues.

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End of Chapter 21

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