Unit Six

UNIT SIX:
AUDITING CAPITAL AND REPAYMENT

CYCLE
Together We Can! 11/06/2023 1

The audit of cycle, which concerns the acquisition of
capital resources through interest-bearing debt and
owners’ equity and the repayment of the capital. This
cycle also includes the payment of interest and
dividends.
4 ch/tics of this influence the audit of these accounts:
1. Relatively few transactions affect the account
balances, but each transaction is often highly
material.
2. The exclusion or misstatement of a single transaction
can be material.
 so, the auditor’s primary emphasis in auditing these
accounts is often on the completeness and accuracy

balance-related audit objectives.

3. A legal relationship exists between the client entity
and the holder of the stock, bond, or similar ownership
document.
 In the audit of the transactions and amounts in the
cycle, the auditor must take great care to make sure

the significant legal requirements affecting the
financial statements have been met and adequately
presented and disclosed in the statements.
 4. A direct relationship exists between the interest and
dividends accounts and debt and equity.

 In the audit of interest-bearing debt, auditors should
simultaneously verify the related interest expense and

interest payable. This is also true for owners’ equity,
dividends declared, and dividends payable.
Accounts and classes of transactions

AUDIT OF NOTES PAYABLE AND
RELATED INTEREST EXPENSE
A note payable is a legal obligation to a creditor,
which may be unsecured or secured by assets, and
bears interest.
 Principal & interest payment as per term of
agreement
 For short-term=> @ due date
 For notes over 90 days=> interest calls monthly or
quarterly.
 Audit includes the repayment of interest &
principal.

The objectives of the audit of notes payable are to
determine whether:
 Internal controls over notes payable are adequate.
 Transactions for principal and interest involving
notes payable are properly authorized and

recorded in accordance with the six transaction-
related audit objectives.
 The liability for notes payable and the related
interest expense and accrued liability are properly

stated as defined by seven of the eight balance-
related audit objectives.

Internal Controls
There are four important controls over notes
payable:
1. Proper authorization for the issue of new notes
(BoD, hihgh level mgt.)
2. Adequate controls over the repayment of
principal and interest.
3. Proper documents and records.
4. Periodic independent verification. (reconcile
detail to GL).

TESTS OF DETAILS BALANCES
 The normal starting point for the audit of notes
payable is a schedule of notes payable and accrued
interest, which the auditor obtains from the client.
 The two most important balance-related audit
objectives in notes payable are:

 Existing notes payable are included (completeness).
 Notes payable in the schedule are accurately recorded
(accuracy).

These objectives are vital because
a misstatement can be material if
even one note is omitted or
incorrect.
When ICs over notes payable are
deficient, auditors may need to
perform extended procedures to
test for omitted notes payable.
(confirm from cr/tor, analyze interest
expense).

Auditing Stockholders’ Equity
 The audit for stockholders’ equity is
essential part of financial statement audit
in corporations.
 Auditor is directly responsible to report to
stockholders.
INTERNAL CONTROL OVER STOCKHOLDERS’
EQUITY
 Stockholders’ equity includes common stock,
preferred stock, paid-in capital, and retained

earnings.

 Recently, numerous financial instruments having both
debt and equity ch/tics are affect the audit of
stockholders’ equity.
 Various stock options and compensation plans also
impact the audit of stockholders’ equity.

 Following are the three major types of transactions
that occur in stock holders’ equity:

 Issuance of stock: includes such as sale of stock for
cash, the exchange of stock for assets, services, or

convertible debt and issuance of stock splits.
 Repurchase of stock: reacquisition of stock (referred
to as treasury stock) and the retirement of stock.

 Payment of dividends: the payment of cash dividend
or issuance of stock dividends

Following are the major internal controls for
stockholders’ equity.
 Verify that stock and dividend transactions
comply with the corporate charter.

 Verify that stock and divided transactions have
been properly approved.

 Verify that stock and dividend transactions have
been properly valued.

 Verify that all stock and dividend transactions
have been properly posted and summarized in the

accounting record.

Cont…
 The individual responsible for issuing,
transferring and canceling stock certificate should
not have any accounting responsibility.
 The individual responsible for maintaining the
detailed stockholders record should be
independent of the maintenance of the general
ledger control account.
 The individual responsible for maintaining the
detailed stockholders records should not also
process each receipts or disbursements.
 Appropriate segregation of duties should be
established among the preparation, recording,
signing and mailing of dividend checks.
THE AUDIT OF OWNERS’ EQUITY
TRANSACTIONS
Closely held Cos VS publicly held Cos.
Closely held Co; =>few s/holders, tr/ction occur
yearly & like ∆ in OwEqu.., dividend..
=> rarely pay divid.
=> auditor spent less time in verifying
owners` Equ. But must test the corporate records.

Publicly held Cos: =>larger No. of
shareholders
=> frequent changes in the
individuals holding the stock.
=> the verification of owners’
equity is more complex
Here we deals with tests for verifying the major
owners’ equity accounts in a publicly held cos,
including:
Capital and common stock
Paid-in capital in excess of par
Retained earnings and related dividends

The objective for each is to determine whether:
 Internal controls over capital stock and related
dividends are adequate

 Owners’ equity transactions are correctly
recorded, as defined by the six transaction-related
audit objectives.
 Owners’ equity balances are properly recorded, as
defined by the eight balance related audit

objectives, and properly presented and disclosed,
as defined by the four presentation and disclosure-
related audit objectives for owners’ equity
accounts

INTERNAL CONTROLS
Several internal controls are important for owners’
equity activities.
1. Proper authorization; by BoDs
The ff. requires specific authorization.
i. issuance of Capital
ii. Repurchase of capital &
iii. Declaration of dividend
2. Proper record keeping & segregation of duties

Ics must be adequate to ensure;
 Actual owners of the stock are recognized in the corporate
records
 The correct amount of dividends is paid to the stockholders
owning the stock as of the dividend record date

 The potential for misappropriation of assets is minimized
When issuing and recording capital stock, the client must

comply with both the state laws governing corporations and
the requirements in the corporate charter. The par value of
the stock, the number of shares the company is authorized to
issue, and state taxes on the issue of capital stock all affect
issuance and recording.
As a control over capital stock, most companies maintain
stock certificate books and a shareholders’ capital stock
master file.

A. A capital stock Certificate Record; records the
issuance & purchase of capital stock for life of
corporation.=> Certificate No., No. of issued
shares, name of person issued for & date
issuance.
B. Shareholders` capital stock Master file; record of
outstanding shares @ given time.
=> acts as a check on accuracy of capital
certificate record & common stock in GL.
=>used as the basis for payment of dividend.

ICs affecting Dividend payments
i. Dividend checks are prepared from the capital
stock certificate record by someone who is not
responsible for maintaining the capital stock
records.
ii. After the checks are prepared, there is
independent verification of the stockholders’
names and the amounts of the checks and a
reconciliation of the total amount of the dividend
checks with the total dividends authorized in the
minutes.

iii. A separate Imprest dividend account is used to
prevent the payment of a larger amount of dividends
than was authorized.
AUDITING CAPITAL STOCK ACCOUNTS

When auditing the capital stock accounts, the
auditor is normally concerned with the validity,
completeness, valuation and disclosure objectives

1. Validity & completeness: approved by BoD
=> so check Minutes of BoDs, confirm total No. of
outstanding shares at the end of the period.
The auditor may perform the ff tests;
o Trace the transfer of shares b/n SHs to stock register
/stock certificate book (Valuation & Completeness).

o Foot the shares outstanding in stock register/ stock
certificate book & agree the to total shares

outstanding in GL paid- stock certificates
(completeness)
o Examine any cancelled Stock cert.(Validity).
o Account for and inspect any uninsured stock
certificates in st.certi book(completeness).

2. Valuation: capital stock is issued for cash, the
assessment of proper valuation is straightforward.
The par, or sated, value for the shares issued is assigned
to the respective capital-stock account, while the
difference between the price and par, or stated, values
assigned to each transaction. The proceeds from the sale
of stock are normally traced to the cash receipts records.
The valuation issue is more complex when capital stock
issued in exchange for assets or services, for a merger or
acquisition, for convertible securities, or for a stock
dividend.

3. Presentation & Disclosure: No. of important
disclosures are frequently required for stockholders
equity.
Examples of such disclosures;
 Number of shares authorized, issued and
outstanding
 Call provision, prices, and dates for preferred stock
 Preferred stock sinking fund

 Stock option or purchase plane
 Restriction on retained earnings and dividend
The normal sources of this information include the

corporate chatter, minutes of the board of BoDs`
meetings, and contractual agreements.

AUDIT OF DIVIDENDS
 Emphasis in transactions rather than end balance.
 Except the payable
 The six relative transactions are;
1. Recorded dividends occurred (occurrence).
2. Existing dividends are recorded (completeness).
3. Dividends are accurately recorded (accuracy).
4. Dividends are paid to stockholders that exist

(occurrence).
5. Dividends payable are recorded (completeness).
6. Dividends payable are accurately recorded

(accuracy).

Auditors need to verify the above objectives by
examining related docs. Like
Verify Occurrence by examining minutes of BoDs
*Be alert of unrecorded dividend declared.
Accuracy by recalculating the declared dividend.
Generally all dividend declared and paid should
audited as concerned with violation of corporate
bylaws or debt covenants.
Addisu Z. @ BU AcFn 11/06/2023 27

AUDITING RETAINED EARNINGS
 RE are affected by the current year`s
income/loss and Dividends paid
 But some standards require to include;
 prior period adjustment
Correction of errors
Valuation account for marketable securities and
foreign currency translation etc.

Thank you for your attention!
The End Of unit six!

Unit-Seven
AUDIT OF CASH BALANCE

Unit- seven
Outline
 Introduction
 Cash in Bank & Transaction Cycle
 Audit of The General Cash Accounts
 Audit of Imprest bank account &
 Audit of Petty cash.

7.1. INTRODUCTION
 Cash is important because of its susceptibility to
theft, and cash can also be significantly misstated.
 Cash includes general cash accounts, payroll
accounts, petty cash fund, saving accounts

marketable securities and other cash equivalents
like CD, saving certificate etc..
General cash accounts; for most organizations
virtually all cash receipts and disbursements flow
through this account.
Imprest account: many Cos establish a separate
account for payroll to improve IC over payroll
disbursement.
 Imprest petty cash fund; Not a bank account, but a
present amount of cash kept on hand for incidental
expenses cash on hand.
7.2. Cash in Bank and transaction cycle
Auditors must distinguish between;
 Verifying the client`s reconciliation of the cash
balance and
 Verifying whether cash recorded in the GL correctly
reflects all cash transactions that occurred.

 Some failures/ misstatements that can not be
detected by auditing bank reconciliations;
◦ Failure to bill a customer
◦ An embezzlement of cash by intercepting cash receipts
from customers before they are recorded, with the
account charged off as a bad debt
◦ Duplicate payment of a vendor’s invoice
◦ Improper payments of officers’ personal expenditures
◦ Payment for raw materials that were not received
◦ Payment to an employee for more hours than he or she
worked
◦ Payment of interest to a related party for an amount in
excess of the going rate
Auditor need to trace other cycles to discover the above
misstatements.

7.3. AUDIT OF THE GENERAL CASH ACCOUNT
 the auditor must accumulate sufficient appropriate
evidence to evaluate whether cash, as stated on the
balance sheet, is fairly stated.
Methodology for auditing year-end cash
 Identify Client Business Risks Affecting (Phase I)
 Set Performance Materiality and Assess Inherent Risk (Phase I)
 Assess Control Risk (Phase I)
 Design and Perform Tests of Controls and Substantive Tests of
Transactions (Phase II)
 Design Tests of Details of Cash Balance (Phase III)

 The most important objectives are existence,
completeness, and accuracy.
 In addition to these balance-related objectives, the
auditor also performs tests related to the four
presentation and disclosure objectives, such as review
of minutes and loan agreements to determine if there
are restrictions on cash that must be disclosed.
 the actual audit procedures depend on materiality and
the risks that the auditor has identified in other
parts of the audit.
 The following three procedures merit additional
discussion because of their importance and
complexity:

A. Receipt of a Bank Confirmation;
=>Bank confirmations are not required for audits of
non-public entities or under international auditing
standards.
However, auditors usually obtain a direct receipt of a

confirmation from every bank with which the client
does business, except when there is an unusually
large number of inactive accounts. If the bank does
not respond to a confirmation request, the auditor
should send a second request or ask the client to
communicate with the bank to ask them to complete
and return the confirmation to the auditor.

 After auditors receive the completed bank
confirmation, the balance in the bank account
confirmed by the bank should be traced to the
amount stated on the bank reconciliation.
B. Accessing Cutoff Bank Activity after Year-
end;
=>The purpose of the cutoff bank statement or
electronic access to account information on the
bank’s system is to verify the reconciling items on
the client’s year-end bank reconciliation with
evidence that is not accessible to the client.

 To fulfill this purpose, the auditor requests the
client to have the bank provide a partial-period
statement, or digital access to the information, for 7
to 10 days subsequent to the balance sheet date
directly to the auditor.
 The auditor performs the following verification in
the month subsequent to the balance sheet date:
Foot the lists of all cancelled checks, debit memos,
deposits, and credit memos
Verify that the bank statement balances when the
footed totals are used
Review the items included in the footings to make
sure that they were cancelled by the bank in the
proper period and do not include any erasures or
alterations.
C. Tests of the Bank Reconciliation;
 Auditors test the bank reconciliation to determine;
 whether client personnel have carefully prepared
the bank reconciliation

 to verify whether the client’s recorded bank
balance is the same amount as the actual cash in

the bank
The auditor’s verification of the reconciliation
involves several procedures:

FRAUD-ORIENTED PROCEDURES
 When the Auditor feels there is inadequate IC,
(esp. handling of cash recording of cash
transactions & independency in BR preparation),
he/she must extend the procedure. Use
procedures other than tests of details of cash
balances.
 Such procedures are;
extended tests of the bank reconciliation
proofs of cash, and
tests of interbank transfers.

Extended Tests of the Bank Reconciliation;
This procedure verifies;
 whether all transactions included in the journals
for the last month of the year were correctly

included in or excluded from the bank
reconciliation
 whether all items in the bank reconciliation were
correctly included.
Proof of Cash; Auditors sometimes prepare a

proof of cash when the client has material internal
control weaknesses in cash.

**Auditor uses a proof of cash to determine whether;
 All recorded cash receipts were deposited
 All deposits in the bank were recorded in the
accounting records
 All recorded cash disbursements were paid by the
bank
 All amounts that were paid by the bank were recorded.
A proof of cash includes the following four
reconciliation tasks:

 1. Reconcile the balance on the bank statement
with the general ledger balance at the beginning of
the proof-of-cash period.
 2. Reconcile cash receipts deposited per the
bank with receipts recorded in the cash receipts
journal for a given period.
 3. Reconcile electronic payments and cancelled
checks clearing the bank with those recorded in
the cash disbursements journal for a given period.
 4. Reconcile the balance on the bank
statement with the general ledger balance at the
end of the proof-of-cash period.

Tests of Interbank Transfers
(Test of kiting);
Is the transfer of money from one bank to another and
improperly recording the transfer so that the amount is
recorded as an asset in both accounts.
This practice is used by embezzlers to cover a theft of cash.
Auditor should check the transferred cash using interbank
transferee schedule.
There are several things that should be audited on the
interbank transfer schedule.
 The accuracy of the information on the interbank
transfer schedule should be verified

 The interbank transfers must be recorded in both the
receiving and disbursing banks

Cont….
 The date of the recording of the disbursements

and receipts for each transfer must be in the same
fiscal year.
 Disbursements on the interbank transfer schedule
should be correctly included in or excluded from

year-end bank reconciliations as outstanding
checks.
 Receipts on the interbank transfer schedule
should be correctly included in or excluded from

year-end bank reconciliations as deposits in
transit.

7.4. AUDIT OF IMPREST PAYROLL
BANK ACCOUNTS
 Imprest petty cash fund—a fund of cash
maintained within the company for small cash
acquisitions or to cash employees’ checks; the
fund’s fixed balance is comparatively small and
is periodically reimbursed.
In testing the payroll bank account balances,
auditors must obtain the bank reconciliation, a
bank confirmation, and a cutoff bank statement.
7.5. AUDIT OF IMPREST PETTY CASH
 Petty cash is a unique account.
Many auditors verify petty cash primarily. b/c of the

potential of embezzlement.
Internal Controls Over Petty Cash

 The most important internal control for petty cash
is the use of an imprest fund.
 petty cash funds should not be mingled with other
receipts, and the fund.(in separate)

 There should be limit on Expenditure & total fund.
 Approval of officials and pre-numbered petty cash
form while disbursement.

 When the petty cash balance runs low, a check
payable to the petty cash custodian should be
written on the general cash account for the
reimbursement of petty cash.
 The check should be for the exact amount of the
pre-numbered vouchers that are submitted as

evidence of actual expenditures.
 These vouchers should be verified by the accounts
payable clerk and cancelled to prevent their reuse.
Audit Tests for Petty Cash

 emphasis on verification of IC rather than end
balance.

 Forlow control risk & few reimbursement
payments no need of test for petty cash
fund (immateriality).
The Two most common procedures
are;
 to count the petty cash balance &
to carry out detailed tests of one or two
reimbursement transactions to
determine that they are properly
supported.
/ ////The End of the unit !//////

Unit -8
 Reading Assignment
 Read the Material attached @ your group TG & compile
in short (Not more than 4 pages).
 Use your previous group.
 Submission date => Just After Final Exam.

UNIT -9
Auditing Computerized
Accounting Systems:

An Overview of computerized
accounting System
 In modern business accounting transactions are
processed through computers. Usage of computers
and Information Technology (IT) enables a
business to quickly, accurately and timely access
the information that helps in decision-making.
This sharpens the competitive edge and enhances
profitability. The computer systems works with
the data which is processed by the hardware
commanded by the user through software. The
Computerised Accounting System (CAS) has the
following components:

 Procedure : A logical sequence of actions to
perform a task.
 Data : The raw fact (as input) for any business
application.
 People : Users.
 Hardware : Computer, associated peripherals, and
their network.
 Software : System software and Application
software
These are the five pillars on which Computerised
Accounting System rests.

Impact of Information Technology
on the Audit Process
Effects of general controls on
control risk.
Effects of IT control on control
risks and substantive test

Auditing is less complex in IT
environment.

Controls in a computerized
environment
1. General Controls
 Administration of the IT function
 Separation of IT duties
 Systems development
 Physical and online security
 Backup and contingency planning
 Hardware controls
Administration of the IT function
The perceived importance of

the IT with in an
organization is often
dictated by the attitude of
the board of directors and
senior managers.

Segregation of IT Duties

Systems Development

Physical and Online Security
Physical Controls: Online Controls:

 Keypad entrances  User ID control
 Badge-entry systems  Password control
 Separate add-on
 Security cameras
 Security personnel security software

Backup and Contingency Planning
 One key to a backup and

contingency plan is to make sure
that all critical copies of software
and data files are backed up and
stored off the remises.

Hardware Controls
 Thesecontrols are built into
computer equipment by the
manufacturer to detect and report
equipment failures.

2. Application Controls
 Input controls
 Processing controls
 Output controls

Input Controls
 These controls are designed by an organization to
ensure that the information being processed is

authorized, accurate, and complete.
Batch Input Controls
 Financial total
Cash total
Record count
Processing Controls
 Validation test
 Sequence test
 Arithmetic accuracy test
 Data reasonableness test
 Completeness test

Output Controls
These controls focus on
detecting errors after
processing is completed rather
than on preventing errors

Computer-assisted audit techniques (CAATs)
 CAATs can be defined as any technique that
enables the auditor to use computer systems and
techniques as a source of generating audit
evidence.
 CAATs are often necessary in the audit of
computer-based information systems. because

these systems may not provide an adequate audit
trail.
 allow the auditor to achieve the objective of
Completeness and the accuracy of the process.

Two commonly-used types of CAATs are:
 audit software, and
 test data
A. Audit software
 is computer programs used by the auditor to

extract information from a client’s computer-
based information system,
 could be applied in account analysis, like
aged listing of receivables, analytical procedures
(calculating ratios and making comparisons) etc

The main types of audit software include:
i. interrogation programs, which accesses the
client’s files and records and extract data for
auditing
ii. interactive software, for interrogation of on-line
computer systems
iii. ‘resident code’ or ‘embedded software’, to
monitor and review transactions as they are being
processed by the client’s programs. This type of
software is called embedded audit facilities.
iv. Comparison programmes, which compare
versions of a programme.
The main use of audit software is in substantive
audit testing.
B. Test data;
 Used to process a sample of transactions through
the client’s computer based information system,

 also be used to check the controls that prevent
processing of invalid data e.g. an amount, which if

processed will breach customer credit limit could
be entered to check the system reaction to it.
 Test data, thus, is used primarily for tests of
control.
 The technique provides evidence that specific
application controls are operating effectively in a

given system

Dears Read More and more!!!
TH END
 Wish you All the Best for Your

Entire life.

Unit Six

Uploaded by

Document Information

Original Description:

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Unit Six

Uploaded by

Copyright:

Available Formats

UNIT SIX:

AUDITING CAPITAL AND REPAYMENT

Together We Can! 11/06/2023 1

accounts is often on the completeness and accuracy

Together We Can! 11/06/2023 2

cycle, the auditor must take great care to make sure

dividends accounts and debt and equity.

simultaneously verify the related interest expense and

Together We Can! 11/06/2023 4

Together We Can! 11/06/2023 5

notes payable are properly authorized and

interest expense and accrued liability are properly

Together We Can! 11/06/2023 6

Together We Can! 11/06/2023 7

objectives in notes payable are:

Together We Can! 11/06/2023 8

Together We Can! 11/06/2023 9

preferred stock, paid-in capital, and retained

Together We Can! 11/06/2023 11

impact the audit of stockholders’ equity.

that occur in stock holders’ equity:

cash, the exchange of stock for assets, services, or

to as treasury stock) and the retirement of stock.

or issuance of stock dividends

Together We Can! 11/06/2023 12

comply with the corporate charter.

been properly approved.

been properly valued.

have been properly posted and summarized in the

Together We Can! 11/06/2023 13

Together We Can! 11/06/2023 15

Together We Can! 11/06/2023 16

dividends are adequate

defined by the eight balance related audit

Together We Can! 11/06/2023 17

Together We Can! 11/06/2023 18

owning the stock as of the dividend record date

When issuing and recording capital stock, the client must

Together We Can! 11/06/2023 19

Together We Can! 11/06/2023 20

Together We Can! 11/06/2023 21

AUDITING CAPITAL STOCK ACCOUNTS

Together We Can! 11/06/2023 22

/stock certificate book (Valuation & Completeness).

certificate book & agree the to total shares

certificates in st.certi book(completeness).

Together We Can! 11/06/2023 23

Together We Can! 11/06/2023 24

 Preferred stock sinking fund

 Restriction on retained earnings and dividend

The normal sources of this information include the

Together We Can! 11/06/2023 25

 The six relative transactions are;

1. Recorded dividends occurred (occurrence).

2. Existing dividends are recorded (completeness).

3. Dividends are accurately recorded (accuracy).

4. Dividends are paid to stockholders that exist

6. Dividends payable are accurately recorded

Together We Can! 11/06/2023 26

Addisu Z. @ BU AcFn 11/06/2023 27

Together We Can! 11/06/2023 28

The End Of unit six!