Inventory and warehousing cycle: the transaction cycle that involves the physical flow of goods through the

Compare total balance in notes payable, interest expense, and accrued interest with prior years
organization, as well as related costs Analytical Procedures for notes payable (substantive)
1) Recalculate approximate interest expense on the basis of average interest rates and overall monthly notes
payable
2) Compare individual notes outstanding with prior years.
Tests of Details of Balances: Note Payable
- Normal starting point for the audit of notes payable is a schedule of notes payable and accrued interest
obtained from the client.
- Uses a schedule. Should include beginning and ending balances for notes and interest payable, and
descriptive information about the notes, such as the due date, the interest rate and the assets pledged as
disclosure.
- Test for presentation and disclosure
Common Tests of Details of Balances Procedures: Notes payable in the schedule exist (existence)
Part of audit Cycle in which tested - Confirm notes payable
- Examine duplicate copy of notes for authorization
- Examine corporate minutes for loan approval
Acquire and record Acquisition and pay payment plus payroll and personnel Common Tests of Details of Balances Procedures: The company has an obligations to pay the notes payable
raw materials, labor, (rights & obligations)
and overhead Examine notes to determine whether the company has obligation for payment
Internally transfer assets and costs Inventory and warehousing Common Tests of Details of Balances Procedures: Existing notes payable are included in the notes payable
schedule and in the GL (completeness)
Ship goods and record revenue and costs Sales and collection - Examine notes paid after year-end to determine whether they were liabilities at the balance sheet date
- Obtain a standard bank confirmation that includes specific reference to the existence of notes payable from
all financial institutions with which the client does business
Physically observe inventory Inventory and warehousing - Review the bank reconciliation for new notes credited directly to the bank account by the bank
- Obtain confirmations from creditors who have held notes from the client in the past and are not currently
Price and compile inventory Inventory and warehousing included in the notes payable schedule.
- Analyze interest expense to uncover a payment to creditor who is not included in the notes payable
schedule. Examine paid notes for cancellations to make sure they are not still outstanding
- Review the minutes of BOD for authorized but unrecorded notes
- Foot the notes payable list for notes payable and accrued interest
- Trace the totals to the GL
- Trace the individual notes payable to the master file
Common Tests of Details of Balances Procedures: Notes payable and accrued interest on the schedule are
accurate and included in the correct period (accuracy & allocation)
- Examine duplicate copies of notes for principal and interest rates
- Confirm notes payable, interest rates, and last date for which interest has been paid with holders of notes
- Recalculate accrued interest
- Examine duplicate copies of notes to determine whether notes were dated on or before the balance sheet
date
Common Tests of Details of Balances Procedures: Notes payable in the schedule are properly classified, and
fully and clearly disclosed (classification, completeness and understandability)
- Examine due dates on duplicate copies of notes to determine whether all or part of the notes are a
noncurrent liability
- Review notes to determine whether any are related-party notes or AP
Most Important Balance-Related Audit Objectives for Notes Payable
- Existing notes are included (Completeness)
- Notes payable in the schedule are accurately recorded (accuracy)
-Notes payable are fully and clearly presented and disclosed (Completeness and understandability)
Closely Held Corporations
corporations whose stock is not publicly traded; typically there are only a few shareholders and few, if any,
capital stock account transactions during the year; also known as private corporations
Publicly Held Corporations
Corporations whose stock is publicly traded; typically, there are many shareholders and frequent changes in
ownership of the stock
Equity Instruments
Contracts that have the characteristics of equity
Objectives of Auditor's Examination of Owners' Equity is to determine whether:
- Internal controls over capital stock and related dividends are adequate
- Owners' equity transactions are recorded properly as defined by the transaction-related audit objectives
- Owners' equity balances are properly presented and disclosed as defined by the balance-related and
presentation and disclosure-related audit objectives for owners' equity accounts
Internal Controls for Owners' Equity
1) Proper authorization of transactions
2) Proper record keeping and adequate segregation of duties between maintaining owners' equity records and
handling cash and stock certificates
- Should also be well defined policies for preparing share certificates and recording share transactions and
independent verification of both transactions details and amounts
3) The use of an independent registrar and share transfer agent
Independent Registrar
an outside person or organization engaged by a corporation to ensure that its stock is issued in accordance
with capital stock provisions in the corporate charter and authorizations by the BOD
Share Transfer Agent
an outside person or organization engaged by a corporation to maintain the shareholder records and often to
disburse cash dividends
Audit procedures: timing, sample size, selection of items Risks for Fraud and Error: Owners' Equity
1) Misclassifying equity as debt, or misclassifications between current and long-term
2 Recording equity transactions in the wrong period
Perpetual inventory master file: a continuously updated computerized record of inventory items purchased, 3) Incorrect or inaccurate disclosure of terms or amounts
used, sold, and on hand for merchandise, raw materials, and finished goods 4) Equity issues or dividends violate debt covenants
inventory red flags 5) Stock options are backdated
-inventory increases faster than sales 6) Dividends are paid to wrong parties or at incorrect amounts
-decreasing inventory turnover 7) Deliberate misclassification of equity as revenue or other fraudulent manipulations
-shipping costs decreasing as a percentage of inventory 4 Main Concerns in Auditing Capital Stock (objectives, 4)
-inventory rising faster than total assets move up 1) Existing share capital transactions are recorded (completeness).
-falling costs of sales as a percentage of sales 2) Recorded share capital transactions exist and are accurately recorded (occurrence and accuracy).
-COGS on the books not agreeing with tax returns 3) Share capital is accurately recorded (accuracy)
business functions in the cycle and related documents and records 4) Capital stock is fully presented and clearly disclosed (completeness and understandability)
-process purchase orders -receive raw materials -store raw materials -process the goods -store finished Most important Objectives Considering Dividends Payable
goods -ship finished goods - Recorded dividends occurred (occurrence)
audit of inventory - Existing dividends are recorded (completeness)
1. acquire and record raw materials, labour, and overhead - Dividends are accurately recorded (accuracy)
2. internally transfer assets and costs - Dividends that exist prepaid to shareholders (existence)
3. ship goods and record revenue and costs - Dividends payable are recorded (completeness)
4. physically observe inventory - Dividends payable are accurately recorded (accuracy)
5. price and compile inventory
physical observation of inventory
-timing -sample size -selection of items -obsolete inventory
selection of items
-observe the counting of the most significant items and a representative sample of typical inventory items
-inquire about items that are likely to be obsolete or damaged
-discuss with management the reasons for excluding any material items
standard costs records
indicate variances in material, labor, and OH costs are helpful to evaluate the reasonableness of production
records if management has procedures in place to keep the standards updated

22. Capital Acquisition & Repayment Cycle

the transaction cycle involving the acquisition of capital resources in the form of interest-bearing debt and
owners' equity, and the repayment of capital
4 Unique characteristics of the capital acquisition and repayment cycle
1) Relatively few transactions affect the account balances, but each transaction is often highly material in
amount
2) The exclusion of a single transaction could be material itself
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 interest and dividend accounts and debt and equity
IR are primarily concerned with:
- Authorization of Notes Payable
- Receipt of funds
- Recording of transactions
- Compliance with debt covenants
*IR increases with presence of related parties
Risks of Fraud & Error
1) Errors in calculating Interest Payments, posting such amounts to the wrong period, or omitting them
2) Misclassifying debt as equity or vice versa, or misclassifications between current and long-term
3) Recording debt transactions in the wrong period
4) Incorrect or inaccurate disclosure of terms or amounts
5) Deliberate misclassification of debt as revenue or other fraudulent manipulations
4 Important Controls over Notes Payable
1) Proper authorization for the issue of new notes (existence)
2) Adequate controls over the repayment of principal & interest (accuracy/allocation & completeness)
3) Proper documents and records (existence & completeness)
4) Periodic, independent verification ( accuracy/allocation & completeness)
Analytical Procedures for notes payable (planning)