Module 10 - Capital Acquisitions/repayment

Question 1

What are the 4 characteristics of the capital acquisition/repayment cycle that influence the audit?

Answer 1

• Relatively few transactions affect the account balance; each transaction is highly material
  
  • ​_{Common for auditors to verify each transaction of current year}
• The exclusion/misstatement of a single transaction can be material
• A legal relationship exists between client and holder of stock/bond/ownership doc.
  
  • _{auditor should ensure legal requirements have been met}
• A direct relationship exists between interest/dividends accounts and debt/equity

Question 2

Accounts included in the capital acquisition/repayment cycle:

Answer 2

_{Also included: Equity accounts; capital stock, retained earnings, partner capital…}

Question 3

What are the phases of the audit of the capital acquisition/repayment cycle?

Answer 3

Phase 1: Identify business risks, set performance materiality, assess inherent risk, assess control risk

Phase 2: Design and perform tests of controls and substantive tests of transactions

Phase 3: Design and perform analytical procedures (if necessary) and tests of details of account balances

Question 4

Explain the relationship of performance materiality, control risk, inherent risk, substantive evidence, and test of balances for cap. acq/repayment cycle:

Answer 4

Performance materiality: Set at low level; usually can completely audit all transactions/balance.

inherent risk: Set as low due to ease in determining accuracy of amounts

Control risk and Substantive evidence: Less important due to low number of transactions; easy to test balances

Test of balances: Most important for providing evidence

Question 5

What is a note payable?

Answer 5

Legal obligation to a creditor, which may be secured/unsecured by assets, and bears interest

• Typically issued between one month and a year, but may be longer

Question 6

Use this card to understand the transactions that affect notes payable and related interest account balances:

Answer 6

Question 7

What are the main objectives of the audit of notes payable?

Answer 7

• Internal controls over notes payable are adequate
• Transactions for principal and interest are properly authorized and recorded
• The liability and related expenses (interest) are properly stated
• Disclosures related to notes payable and interest expense follow presentation/disclosure objectives

Question 8

What are 4 controls important over notes payable?

Answer 8

1. Proper authorization for issue of new notes
2. Adequate controls over the repayment of principal and interest
3. Proper documents and records
4. Periodic independent verification

Question 9

Explain this control procedure over notes payable:

Proper authorization for the issue of new notes

Answer 9

Review of details and issuance of new notes should be vested in board of directors or high-level management.

• Renewal of notes subject to same authorization procedures as issuance

Question 10

Explain this control procedure over notes payable:

Adequate controls over repayment of principal/interest

Answer 10

• Accounting department should receive copy of note
  
  • Copy of note provides supporting document for payments
• A/P department should automatically issue checks for notes when due

Question 11

Explain this control procedure over notes payable:

Proper documents/records

Answer 11

Subsidiary records

• control over blank and paid notes by an authorized person
• Paid notes should be cancelled and retained by authorized official

Question 12

Explain this control procedure over notes payable:

Periodic independent verification

Answer 12

• Detailed note records should be reconciled with general ledger and compared to note holders’ records
  
  • S.O.D: should be performed by employee not responsible for maintaining records
• At same time, recalculate interest expense

Question 13

Explain the importance of analytical procedures in the capital acquisition/repayment cycle:

Answer 13

• Rare for analytical procedures to be performed for notes payable balances
  
  • NP balances are not predictable/do not change frequently
• Good for approximating expected interest expense and interest payable
  
  • Information is none in notes records

Question 14

What analytical procedure may be performed for interest expense/interest payable?

How about notes payable (weak analytic)?

Answer 14

Interest expense/payable

Recalculate approximate interest expense on the basis of average interest rates and overall monthly notes payable

Notes Payable

Compare individual notes outstanding with those of prior year

Question 15

What are the major balance-related audit objectives in Notes Payable?

Answer 15

1) Completeness

• Risk: Liabilites have been omitted
• objective: All payables have been recorded

1) Accuracy

• Risk: contract stipulations may make amounts difficult to record
• Objective: Notes payable are recorded at correct amounts

Question 16

What actions should the auditor take when gathering evidence for the roll-forward schedule of notes payable?

Answer 16

• Verify dates and face amounts of notes with note record
• Trace beginning balance of notes payable to prior year workpapers
• Obtain supporting documentation (contracts) of addition amounts/timing and verify internal approval
• Vouch payments to source documentation (cash disbursements)
• Foot and confirm (with creditor) ending balances and agree to general ledger

Question 17

What actions should the auditor take when gathering evidence for the roll-forward schedule of interest associated with notes payable?

Answer 17

• Verify interest rates and payment timing with supporting documentation
• Agree beginning accrued interest payable to prior year
• Recalculate interest expense
• Verify payments with cash dirbursements
• Foot the ending balance

Question 18

What are some procedures auditors may do to look for unrecorded notes payable?

Answer 18

• Review current year bank statement for large inflows of cash
• Review subsequent year bank statement for payments of principal/interest
• When sending bank confirmation, inquire about outstanding debt

Question 19

What are the main differences in auditing owner’s equity between a publicly held corporation and closely held corporation:

Answer 19

Publicly Held corporation

• Many shareholders
• Frequent transactions
  
  • Capital/common stock, APIC, RE…

Closely Held Corporation

• Few shareholders
• Occasional, if any transactions, for year
  
  • Likely only transactions are: change in OE for annual earnings/loss and Dividends

Question 20

Use this card to understand transactions affecting the common owner’s equity accounts:

Answer 20

Question 21

What are the 3 main internal controls for Owner’s equity?

Answer 21

• Proper Authorization of Transactions
• Proper Record Keeping and Segregation of Duties
• Independent Registrar and Stock Transfer Agen

Question 22

Explain this internal control of Owner’s Equity:

Proper Autorization of Transactions

Answer 22

Each transactions is typically material and requires authorization of board of directors:

• Issuance of Cap Stock: Authorization of type of equity, # of shares, par value, etc…
• Repurchase of Capital Stock: Authorization of type of equity, timing of repurchase, and amount to pay
• Declaration of Dividends: Authorization of form of dividends (cash/stock), Div per share, and payment dates

Question 23

Explain this internal control of Owner’s Equity:

Proper Record keeping and Segregation of Duties

Answer 23

All functions– record keeping, approval, payment, receipt of cash– should be separated

Key records:

Capital Stock Certificate records: Records issuance/repurchase of stock over life of corp.

Shareholder’s cap. stock master file: Record of outstanding shares at any given time; check on accuracy of certificate and GL

Question 24

Explain this internal control of Owner’s Equity:

Independent Registrar and Stock Transfer Agent`

Answer 24

Both services are third parties; auditor needs a SOC report

Independent registrar:

• Required of public companies
• Ensures stock is issued in accordance of charter and authorization of board of directors

Stock Transfer Agent:

• Part of most large corporations
• Maintains records (issuance, transfer) and can help with dividend payments

Question 25

What are the 4 main concerns in auditing capital stock and paid-in capital:

Answer 25

1. Existing capital stock transactions are recorded (completeness)
2. Recorded capital stock transactions occured and exist (Occurence and existence)
3. Capital stock accurately recorded (accuracy)
4. Capital stock is properly presented and disclosed

Question 26

How do auditors ensure these transaction-related objectives when auditing capital stock and paid-in capital:

Completeness

Occurence and Existence

Answer 26

Completeness:

Trace third-party documents (registrar/transfer agent) to client records

Occurence and Existence:

Vouch from client records to third party records

Question 27

How do auditors ensure these transaction-related objectives when auditing capital stock and paid-in capital:

Accuracy

Answer 27

Accuracy:

• Transfer agent normally provides bulk of evidence
• If no transfer agent, look at issuance records like certificates

Question 28

The most important audit objectives related to audit of dividends:

Answer 28

• Recorded dividends occured (occurence)
• Existing dividends are reocrded (completeness)
• Dividends are accurately recorded
• Dividends are paid to stockholders that exist (occurence)
• Dividends payable are recorded (completeness)
• Dividends payable are accuractely recorded (accuracy)

Question 29

What should auditors do to ensure audit objectives have been met for the audit of dividends?

Answer 29

• Auditors can examine minutes of board of directors for approval of dividend per share(occurence)
• Recalculate dividends based on Div/share and outstanding shares (accuracy)
• Compare recalculation of dividends to recorded dividends payable (completeness)

Question 30

What procedures does auditor take in the audit of retained earnings?

Answer 30

• Agree beginning balance to prior year
• Agree net earnings to income statement
• perform audit procedures for dividends and check for accuracy
• foot ending balance and agree to general ledger/balance sheet