Audit of the Capital

Acquisition and
Repayment Cycle
Chapter 20

2008 Prentice Hall Business Publishing, Auditing 12/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.

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

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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.

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

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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.

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

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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

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

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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

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

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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

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

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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

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

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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

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

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Learning Objective 2
Design and perform audit tests
of notes payable and related
accounts and transactions.

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

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Notes Payable
A note payable is a legal obligation to a creditor
It may be unsecured or secured by assets

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

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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

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

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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
2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

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.

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

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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.

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

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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

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

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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

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

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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.

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

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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

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

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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
2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

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Learning Objective 3
Identify the primary concerns
in the audit of owners equity
transactions.

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

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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

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

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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
2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

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

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

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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.

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

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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.

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

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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.

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

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Audit of Dividends
1. Occurrence:
Recorded dividends occurred.
2. Completeness:
Existing dividends are recorded.
3. Accuracy:
Dividends are accurately recorded.

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

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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.

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

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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

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

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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 appropriate evidence
2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

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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 appropriate evidence

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

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Types of Audit Tests

Retained
Earnings

Dividends
Payable
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 appropriate evidence
2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

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End of Chapter 20

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

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