Audit of the Capital

Acquisition and
Repayment Cycle
Chapter 22

2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley

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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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Learning Objective 1
Identify the accounts and the unique
characteristics of the capital
acquisition and repayment cycle.

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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

2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley

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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
Phase I
affecting notes payable
Set tolerable misstatement
and assess inherent Phase I
risk for notes payable
Assess control
risk for
notes payable
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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 proceduresPhase III
for notes payable
Design tests of
details of notes
payable to satisfy
balance-related
audit objectives

Audit procedures
Sample size
Items to select

Phase III

Timing

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

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Notes Payable

Legal
Obligation

2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley

Secured or
unsecured
by assets

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Notes Payable
Objectives of the audit of notes payable:
Internal controls are adequate
Transactions are properly authorized
and recorded
The related liabilities and expenses are
properly stated

2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley

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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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Notes Payable and the

Related Interest Accounts
Notes Payable
PaymentsBeginning balance
of
principal Issue of new notes
Ending balance
Cash in Bank
Issue of Payments of
new notes
principal
Payments of
interest
2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley

Interest Expense
Interest
expense
Interest Payable
Payments Beginning
of
balance
interest
Interest
expense
Ending
balance
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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 a
note payable

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Analytical Procedures for

Notes Payable
Analytical procedure

Possible misstatement

Compare individual notes Omission or

outstanding with those
misstatement of
of the prior year
a note payable
Compare total balance in
notes payable, interest
expense, and accrued
interest with prior-year
balances

Misstatement of interes
expense and accrued
interest or notes
payable

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Major Balance-related Audit

Objectives in Notes Payable
The two most important balancerelated audit objectives in notes
payable are:
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

Payments
of interest
Audited by
TOC, STOT,
and AP

Notes Payable
Payments of principal
Audited by
TOC and STOT
Ending
Issue of new notes
balance
Audited by
Audited by
TOC and STOT
Interest Payable

AP and TDB

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 Audited by
balance 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

Versus

Many shareholders
Frequent transactions

2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley

Closely
held
corporation
Simple, few transactions
Few shareholders
Occasional transactions

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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
RedemptionBeginning
of stock
balance

Issue of
stock

Issue of
stock

Ending
balance

Ending
balance

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Internal Controls
Proper authorization of transactions

Proper record keeping and segregation of dutie

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
Auditor concerns in auditing Capital
Stock and Paid-in-Capital accounts

Completeness

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

2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley

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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.
2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley

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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

2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley

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