Audit of the Capital
Acquisition and
Repayment Cycle
Chapter 22
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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. 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.
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Accounts in the Cycle
Notes payable
 Contracts payable
 Mortgages payable
 Bonds payable
 Interest expense
 Accrued interest
 Appropriations of retained earnings
 Treasury stock
 Dividends declared

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Accounts in the Cycle
Cash in the bank
 Capital stock – common
 Capital stock – preferred
 Paid-in capital in excess of par
 Donated capital
 Retained earnings
 Dividends payable
 Proprietorship – capital account
 Partnership – capital account

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Methodology for Designing Tests
of Balances for Notes Payable
Identify client
business risks
affecting notes payable
Phase I
Set tolerable misstatement
and assess inherent
Phase I
risk for notes payable
Assess control
risk for
notes payable
Phase I
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Methodology for Designing Tests
of Balances for Notes Payable
Design and perform
tests of controls and
substantive tests of
Phase II
transactions for
capital acquisition and
repayment cycle
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Methodology for Designing Tests
of Balances for Notes Payable
Design and perform
analytical procedures Phase III
for notes payable
Design tests of
details of notes
payable to satisfy
balance-related
audit objectives
Audit procedures
Sample size
Phase III
Items to select
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:
 Internal controls over notes payable are adequate
 Transactions for principal and interest are properly
authorized and recorded
 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.
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
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. Completeness:
Existing notes payable are included.
2. Accuracy:
Notes payable in the schedule are
accurately recorded.
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Types of Audit Tests for Capital
Acquisition and Repayment Cycle
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 appropriate evidence
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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 appropriate evidence
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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. Completeness:
Existing capital stock transactions
are recorded.
2. Occurrence and accuracy:
Recorded capital stock transactions
exist and are accurately recorded.
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Audit of Capital Stock and
Paid-in Capital
3. Accuracy:
Capital stock is accurately recorded.
4. Presentation and disclosure:
Capital stock is properly presented and
disclosed.
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Audit of Dividends
1. Occurrence:
Recorded dividends occurred.
2. Completeness:
Existing dividends are recorded.
3. Accuracy:
Dividends are accurately recorded.
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Audit of Dividends
4. Occurrence:
Dividends are paid to stockholders
that exist.
5. Completeness:
Dividends payable are recorded.
6. Accuracy:
Dividends payable are accurately recorded.
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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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End of Chapter 22
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