AUDIT OF THE

CAPITAL ACQUISITION
AND REPAYMENT CYCLE
CHAPTER 21 2024

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 CHAPTER 21 LEARNING OBJECTIVES
21-1 Identify the accounts and the unique characteristics of the
capital acquisition and repayment cycle.
21-2 Design and perform audit tests of notes payable and related
accounts and transactions.
21-3 Identify the primary concerns in the audit of owners’ equity
transactions.
21-4 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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 OBJECTIVE 21-1
Identify the accounts and the unique
characteristics of the capital
acquisition and repayment cycle.

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 ACCOUNTS IN THE CYCLE
The capital acquisition and repayment cycle concerns the
acquisition of capital resources through interest-bearing debt
and owners’ equity and the repayment of capital.
Four characteristics of this cycle 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.
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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 ACCOUNTS IN THE CYCLE (CONT.)
The capital acquisition and repayment cycle often includes these
accounts:

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 OBJECTIVE 21-2
Design and perform audit tests of
notes payable and related
accounts and transactions.

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 NOTES PAYABLE
A note payable is a legal obligation to a creditor, which may be
unsecured or secured by assets, and bears interest.
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.
• The liability for notes payable and the related interest expense and accrued
liability are properly stated.
• Disclosures related to notes payable and the related interest expense satisfy
the four presentation and disclosure audit objectives.

Notes payable and the related interest accounts are shown in Figure 21-1.

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 NOTES PAYABLE (CONT.)
Internal Controls: There are four important controls over notes payable:
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.
Tests of Controls and Substantive Tests of Transactions:
• Tests of controls for notes payable should emphasize the internal control
objectives listed above.
• Auditors should also verify the accurate recording of receipts from note
proceeds and payments for principal and interest.

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 NOTES PAYABLE (CONT.)
Substantive Analytical Procedures: Typical analytical procedures for this
cycle are illustrated in Table 22-1.
Tests of Details of Balances:
• The normal starting point for the audit of notes payable is a client-prepared
schedule of notes payable and accrued interest.
• A typical schedule is shown in Figure 22-2.

Details of Tests of Balances: Common audit procedures are summarized in

Table 21-2.
The two most important balance-related audit objectives in notes payable are:
1. Existing notes payable are included (Completeness).
2. Notes payable in the schedule are accurately recorded (Accuracy).

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 OBJECTIVE 21-3
Identify the primary concerns in the
audit of owners’ equity
transactions.

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 OWNERS’ EQUITY

There is an important difference in the audit of owners’ equity

between a publicly held corporation and a closely held
corporation.
Most closely held corporations have few shareholders and only
occasional stockholders’ equity transactions.
Publicly held corporations are more complex and verification of
the following accounts is necessary:
• Capital and common stock
• Paid-in capital in excess of par
• Retained earnings and related dividends
An overview of owners’ equity accounts is provided in Figure 22-3.
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 OWNERS’ EQUITY (CONT.)
Internal Controls: Important controls for owners’ equity activities:
• Proper Authorization of Transactions: Because of their materiality,
these transactions must be approved by the board of directors:
• Issuance of capital stock
• Repurchase of capital stock
• Declaration of dividends
• Proper Record Keeping and Segregation of Duties: Internal controls
must ensure that:
• 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.

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 OWNERS’ EQUITY (CONT.)

Internal Controls (cont.):

• Independent Registrar and Stock Transfer Agent:
• Any company with stock listed on a securities exchange is
required to engage an independent registrar as a control to
prevent the improper issue of stock certificates.
• Most large corporations also employ the services of a stock
transfer agent to maintain the stockholder records, including
those documenting the transfers of stock ownership.
• Many companies also use the transfer agent to disburse cash
dividends, further improving internal controls.

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 OBJECTIVE 21-4
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
Auditors have four main concerns in auditing capital stock and
paid-in capital in excess of par:
1. Existing capital stock transactions are recorded (completeness
transaction-related objective).
2. Recorded capital stock transactions occurred and are accurately
recorded (occurrence and accuracy transaction-related
objective).
3. Capital stock is accurately recorded (accuracy balance-related
objective).
4. Capital stock is properly presented and disclosed (all four
presentation and disclosure objectives).

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Next Lecture:

Chapter 22:
Audit of Cash and
Financial Instruments

2024

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