Department of Accounting Education

Mabini Street, Tagum City

Davao del Norte
Telefax: (084) 655-9591, Local 116

Big Picture E

Week 10–12: Unit Learning Outcomes (ULO): At the end of the unit, you are
expected to:
a. Discuss the audit of investing cycle.
b. Apply substantive test of investments.
c. Apply substantive test of property, plant and equipment.
d. Apply substantive test of intangible assets.

Big Picture in Focus: ULOa. Discuss the audit of investing cycle.

Metalanguage
Please proceed immediately to the “Essential Knowledge”.

Essential Knowledge

To perform the aforesaid big picture (unit learning outcomes), you need to fully
understand the following essential knowledge that will be laid down in the succeeding
pages. Please note that you are not limited to exclusively refer to these resources.
Thus, you are expected to utilize other books, research articles and other resources
that are available in the university’s library e.g. ebrary, search.proquest.com etc.

1. AUDIT OF THE INVESTING AND FINANCING CYCLE COMPLIANCE TEST OF

CONTROLS AND SUBSTANTIVE TEST OF TRANSACTIONS: AUDIT OF THE
INVESTING CYCLE

1.1 Audit Objectives and Procedures

The three operative objectives of internal accounting control are applicable to

the investing cycle. These objectives consist of proper.
1. Executing of transactions
2. Recording of transactions
3. Custody of assets.

The specific control objectives for each function in this cycle are as follows:

1.1.1 Existence or Occurrence/ Rights and Obligations: Investing cycle

transactions (i.e., purchasing, selling of securities, receipt of periodic
revenue) actually occurred.
1. Purchase of property and equipment, securities and intangibles are
made in accordance with management’s authorizations.
2. Sales of property and equipment, securities and intangibles are
made in accordance with management’s authorizations.

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 Department of Accounting Education
Mabini Street, Tagum City
Davao del Norte
Telefax: (084) 655-9591, Local 116

3. Dividend and interest checks from investments are promptly

deposited intact.
4. Access to property and equipment, securities and intangibles are
restricted to authorized personnel.
5. Recorded balances are compared with existing assets at
reasonable intervals.
1.1.2 Valuation/ Completeness/ Classification: Investing cycle
transactions are properly recorded.
1. Transactions and events are correctly recorded as to amount,
classification, and accounting period.
2. Transactions are promptly and correctly posted to individual
investment accounts.

2. AUDIT OF THE FINANCING CYLE

2.1 Audit Objectives and Procedures

Each of the three operative objectives on internal accounting control such as
proper execution, recording and custody of assets are applicable to the
financing cycle. In order to meet these objectives, it is useful to identify the
following specific accounting control objective:

2.1.1 Existence or Occurrence/ Rights and Obligations: Financing

cycle transactions actually occurred.
1. Issuance of long-term notes, bonds, and share capitals are made in
accordance with board of directors’ authorizations and legal
requirements and proceeds are promptly deposited intact.
2. Payments of bond interest and cash dividends are made to proper
payees in accordance with board of directors or management
authorizations.
3. Redemption and reacquisition of bonds and share capital
transactions are executed in accordance with board of directors’
authorizations.
4. Cancellation of notes when they are paid to avoid double payment.
5. Recorded balances are periodically verified with bondholders and
shareholders.
2.1.2 Valuation/ Completeness/ Classification: Financing cycle
transactions are properly valued and recorded.
1. Transactions and events are correctly recorded as to amount
classification, and accounting period.
2. Transactions are promptly and correctly posted to individual
accounts.
2.2 The following are procedures typically performed by auditors to determine
that adequate internal control exists over property and equipment, securities
and intangible and the related expenses and revenue from these investments:

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 Department of Accounting Education
Mabini Street, Tagum City
Davao del Norte
Telefax: (084) 655-9591, Local 116

2.2.1 Trace transactions for purchases and sales of property and

equipment, securities and intangibles though the system.
Selected transactions for purchase or sale of property and
equipment, securities and intangibles will be traced through the
system to verify that the controls are being followed in actual
practice. For example, a purchase of securities should be
approved in minutes of the meetings of the investment
committee, and documents from the share brokerage firm
should show receipt of the order and its execution. Other
evidence will be the broker’s month-end statement, the share
certificate acquired, the entry in the subsidiary ledger for
securities and the monthly report of the treasurer showing all
purchases, sales, current holdings and revenue received from
investments.

2.2.2 Review reports by internal auditors on their periodic inspections

to property and equipment, securities and intangibles.
In large companies, the internal auditors may make inspection of
property and equipment, and securities. The independent
auditor may reconcile the listing of property and equipment,
securities at a given date as prepared by the internal auditors
with the subsidiary ledger for securities and with the CPA firm’s
own working papers from the preceding year’s audit.

2.2.3 Review monthly reports by officer of client company on securities

owned, purchased, and sold, and revenue earned.
In many companies, the treasurer will submit to the investment
committee of the board of directors a monthly report showing
securities owned at the beginning of the month, all purchases,
sales, gains and losses during the month the dividends and
interest received and month-end holdings.

2.2.4 Review significant changes in the composition of property and

equipment and related liens and mortgages.

Self-Help: You can also refer to the sources below to help you
further understand the lesson:
*Cabrera, M.E. (2017). Applied auditing. (2017 ed.). Manila, Philippines: GIC
Enterprises & Co., Inc.

*Roque, G.S. (2018). CPA examination reviewer: auditing problems. (2018-2019

ed.). Manila: GIC Enterprises & Co., Inc.

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 Department of Accounting Education
Mabini Street, Tagum City
Davao del Norte
Telefax: (084) 655-9591, Local 116

Let’s Check
Activity 1. Matching Type. Match each of the listed objectives with the auditing
procedure that best meets the objective.
A. Examine securities and record serial numbers for later comparison with
recorded accountability.
B. Examine audited financial statements of 30% owned subsidiary.
C. Verify by reference to Standard & Poor’s or Moody’s.
D. Inquire of management as to nature of investments and reasons for holding
them.
E. Obtain bank confirmations.
F. Examine minutes of board of directors’ meetings.
G. Recalculate on a test basis.
H. Examine loan agreements.
I. Examine copy of corporate charter in permanent file.
K. Trace from securities count sheets to investment ledger.

_____1. Has dividend revenue been properly reflected in the accounts?

_____2. Are securities properly classified as to current or noncurrent?
_____3. Have liabilities and capital stock transactions been properly authorized?
_____4. Have details relating to preferred and common stock been adequately
disclosed?
_____5. Has unamortized discount on bonds payable been properly determined and
reflected in the financial statements?
_____6. Are securities properly valued using the equity method?
_____7. Have all securities examined been recorded?
_____8. Do the securities purported to be owned by the client exist?
_____9. Have all loans been recorded?
_____10. Do any of the client’s borrowing arrangements impose restrictions on
dividends or on additional borrowing?

Activity 2. Multiple Choice Questions. Encircle the letter that corresponds to your
answer.

1. Which of the following statements regarding the capital acquisition and

repayment cycle is true?
a. Relatively few transactions affect the cycle, and most are smaller amounts.
b. Large numbers of transactions affect the cycle, and most are smaller
amounts.
c. Relatively few transactions affect the cycle, and most are highly material.
d. Large number of transaction affect the cycle, and most are highly material.

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 Department of Accounting Education
Mabini Street, Tagum City
Davao del Norte
Telefax: (084) 655-9591, Local 116

2. The capital acquisition and repayment cycle does not include:

a. payment of interest.
b. payment of dividends.
c. payment of vendor invoices.
d. acquisition of capital through interest-bearing debt.

3. The primary focuses of the audit of debt are:

a. accuracy and completeness.
b. accuracy and existence.
c. completeness and valuation.
d. accuracy and valuation.

4. Which of the following accounts is not audited within the capital acquisition and
repayment cycle?
a. Notes payable.
b. Interest expense.
c. Accounts payable.
d. Bonds payable.

5. A logical substantive test for accrued interest receivable would be to

a. Compare the interest income with published interest- investment records.
b. Verify the interest income by a calculation based on the face amount of notes
and the nominal interest rate.
c. Verify the cost, carrying value, and market value of notes receivable.
d. Recalculate interest earned and compare it to the amounts received.

6. An audit program for the examination of the retained earnings account should
include a step that requires verification of the
a. Market value used to charge retained earnings for a two-for-one stock split.
b. Approval of the adjustment to the beginning balance as a result of a write-down
of an account receivable.
c. Authorization for both cash and stock dividends.
d. Gain or loss resulting from disposition of treasury shares.

7. Two months before the year end, the bookkeeper erroneously recorded the
receipt of a long-term bank loan by a debit to cash and a credit to sales. Which
of the following is the most effective procedure for detecting this type of error?
a. Analyze the notes payable journal.
b. Analyze bank confirmation information.
c. Prepare a year-end bank reconciliation.
d. Prepare a year-end bank transfer schedule.

8. The auditee has just acquired another company by purchasing all its assets. As
a result of the purchase, "goodwill" has been recorded on the auditee's books.
Which of the following comparisons would be the most appropriate audit test for
the amount of recorded goodwill?
a. The purchase price and the book value of assets purchased.
b. The figure for goodwill specified in the contract for purchase.

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 Department of Accounting Education
Mabini Street, Tagum City
Davao del Norte
Telefax: (084) 655-9591, Local 116

c. Earnings in excess of 15% of net assets for the past five years.
d. The purchase price and the fair market value of assets purchased.

9. All corporate capital stock transactions should ultimately be traced to the

a. Minutes of the Board of Directors.
b. Cash receipts journal.
c. Cash disbursements journal.
d. Numbered stock certificates.

10. Hall accepted an engagement to audit the 2002 financial statements of XYZ
Company. XYZ completed the preparation of the 2002 financial statements on
February 13, 2003, and Hall began the field work on February 17, 2003. Hall
completed the field work on March 24, 2003, and completed the report on March
28, 2003. The client's representation letter normally would be dated
a. February 13, 2003 c. February 17, 2003
b. March 24, 2003 d. March 28, 2003

Let’s Analyze

Activity 1. In this activity, you are required to elaborate your answer to each of the
questions below.

Assume that you are the audit manager in charge of the Greg’s Auto Parts audit, and
that Sara Engles, the in-charge senior auditor, has presented you with an "open
items" audit workpaper describing the following unresolved issues:

1. Greg’s Auto Parts, as of March 31, 2003, its fiscal year-end, had inventory on
consignment in the warehouse of its principal customer in Dallas awaiting sale
during the Spring buying season. Engles had the client request the customer to
confirm the existence and ownership of the inventory, but a reply has not been
received as of the close of audit field work, May 17, 2003. The goods represent
11% of the total finished goods inventory.

2. Engles requested a copy of the debt restructuring agreement that would permit
reclassifying certain current liabilities as “short-term obligations expected to be
refinanced.” The copy was not received as of the close of audit field work. If not
reclassified, Greg’s balance sheet will show a current ratio of 1:1 and a quick ratio
of 1:2.

3. A loan to Ben Williams, Greg’s Auto Parts’ chief executive officer, is purportedly
secured by collateral consisting of negotiable securities. As of the close of audit
field work, Engles has yet to examine this collateral. A request for broker’s
confirmation has not been received. The loan is classified as a current asset and
represents 20% of total current assets.

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 Department of Accounting Education
Mabini Street, Tagum City
Davao del Norte
Telefax: (084) 655-9591, Local 116

Required:

a. For each of the open items described above, identify the primary audit risk if the
issue is not satisfactorily resolved.

______________________________________________________________
________________________________________________________________
________________________________________________________________
________________________________________________________________
________________________________________________________________
________________________________________________________________
________________________________________________________________
________________________________________________________________
________________________________________________________________
________________________________________________________________
________________________________________________________________
______________.

b. How would you resolve each item (i.e., what audit procedure(s) would you
recommend?)

______________________________________________________________
________________________________________________________________
________________________________________________________________
________________________________________________________________
________________________________________________________________
________________________________________________________________
________________________________________________________________
________________________________________________________________
________________________________________________________________
________________________________________________________________
________________________________________________________________
______________.

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 Department of Accounting Education
Mabini Street, Tagum City
Davao del Norte
Telefax: (084) 655-9591, Local 116

In a Nutshell
In this part you are going to jot down what you have learned in this unit. The
said statement of yours could be in a form of concluding statements, arguments, or
perspective you have drawn from this lesson.

1. ________________________________________________________.

2. ________________________________________________________.

3. ________________________________________________________.

4. ________________________________________________________.

5. ________________________________________________________.

Q&A
In this section you are going to list what boggles you in this unit. You may
indicate your questions but noting you have to indicate the answers after your question
is being raised and clarified. You can write your questions below.

Questions/Issues Answers

1.

2.

3.

4.

5.

Keywords

 Audit of investing cycle

 Audit of Financing Cycle

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