Audit of the Capital
Acquisition and
Repayment Cycle
Chapter 22
©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder
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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
1
Relatively few transactions affect the
account balances, but each one is
often highly material in amount.
2
The exclusion of a single transaction
could be material in itself.
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Characteristics of the Capital
Acquisition and Repayment Cycle
3
There is a legal relationship between the
client entity and the holder of the stock,
bond, or similar ownership document.
4
There is a direct relationship between
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 for Payroll Liabilities
Phase I
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 for Payroll Liabilities
Phase II
Design and perform tests of controls and
substantive tests of transactions.
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Methodology for Designing Tests
of Balances for Payroll Liabilities
Phase III
Design and perform analytical procedures
for notes payable balance.
Design tests of details of notes payable balance
to satisfy balance-related audit objectives.
Audit
Sample
procedures size
Items to
select
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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
Objectives of the audit of notes payable:
1. The internal controls over notes payable
are adequate.
2. Transactions for principal and interest are
properly authorized and recorded.
3. The liability for notes payable and the
related interest expense and accrued
liability are properly stated .
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Notes Payable and the Related
Interest Accounts
Notes Payable
Payments Beginning balance
of
principal Issue of new notes
Ending balance
Cash in Bank
Issue of Payments of
new notes principal
Payments of
interest
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Interest Expense
Interest
expense
Interest Payable
Payments Beginning
of
balance
interest
Interest
expense
Ending
balance
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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
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Internal Controls
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 possible
interest expense on the
basis of average interest
rates and overall monthly
notes payable.
Misstatement of interest
expense and accrued
interest, or omission
of an outstanding
note payable.
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Analytical Procedures for
Notes Payable
Analytical procedure
Possible misstatement
Compare individual notes
outstanding with those
of the prior year.
Omission or
misstatement of
a note payable.
Compare total balance in
notes payable, interest
expense, and accrued
interest with prior-year
balances.
Misstatement of interest
expense and accrued
interest or notes
payable.
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Major Balance-Related Audit
Objectives in Notes Payable
1
Existing notes payable are
included (completeness).
2
Notes payable in the schedule are
accurately recorded (accuracy).
3
Notes payable are properly presented and
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
Audited by
TOC and STOT
Payments
of interest
Audited by
TOC, STOT,
and AP
Ending
balance
Audited by
AP and TDB
Interest Payable
TOC + STOT + AP + TDB
= Sufficient competent evidence per GAAS
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Types of Audit Tests for
Notes Payable
Interest Payable
Interest Expense
Interest expense
Ending
balance
Audited by
TOC, STOT,
and AP
Audited by
AP and TDB
Ending
balance
Audited by
AP
TOC + STOT + AP + TDB
= 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 –
Common
Redemption Beginning
of stock
balance
Paid-in Capital in Excess
of Par – Common
Redemption Beginning
of stock
balance
Issue of
stock
Issue of
stock
Ending
balance
Ending
balance
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Owners’ Equity and Dividend
Accounts
Cash in Bank
Dividends Payable
Beginning
balance
Payment of
dividends Dividends
declared
Retained Earnings
Beginning
balance
Dividends Net
declared earnings
Ending
balance
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Ending
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
1
Existing capital stock transactions are
recorded (completeness).
2
Recorded capital stock transactions
exist and are accurately recorded
(existence and accuracy).
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Audit of Capital Stock and
Paid-in Capital
3
Capital stock is accurately recorded
(accuracy).
4
Capital stock is properly presented and
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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Types of Audit Tests
Capital Stock and Paid-in
Capital in excess of Par
Cash in
Bank
Issue of stock
Redemption of stock
Both audited by TOC and STOT
Ending Audited by
balance
TDB
TOC + STOT + AP + TDB
= Sufficient competent evidence per GAAS
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Types of Audit Tests
Cash in
Bank
Dividends
Payable
Payment of dividends
Audited by
TOC and STOT
Ending
balance
Audited by
TDB
TOC + STOT + AP + TDB
= Sufficient competent evidence per GAAS
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Types of Audit Tests
Dividends
Payable
Retained
Earnings
Dividends declared
Audited by
TOC and STOT
Net earnings
Audited by
TOC, STOT,
AP, and TDB
Ending
balance
Ending
balance
Audited by
TDB
Audited by
TDB
TOC + STOT + AP + TDB
= Sufficient competent evidence per GAAS
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Learning Objective 5
Identify capital acquisition issues
for technology-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 22
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