S12 - Financing Cycle Ch15 Flashcards by Gabriel Roberge

Auditing long-term debt

For the vast majority of entities, what type of testing strategy is it more efficient to follow and why?

A substantive strategy because the long-term debt cycle consists of a FEW and MATERIAL transaction balances

For entities frequently engaging in financing activities, a reliance strategy would be followed.

How well did you know this?

Not at all

Perfectly

What is usually the inherent risk assessment on bonds and notes, and why?

Usually low to moderate risk since
- The volume of transactions is low
- The accounting is pretty simple
- 3rd parties provide statements or amortization tables

How well did you know this?

Not at all

Perfectly

What is usually the inherent risk assessment on sophisticated instruments (that contain debt and equity), and why?

The inherent risk is usually high since they are more complex and the amounts are usually large

The chapter focuses on notes and bonds

How well did you know this?

Not at all

Perfectly

Hybrid Securities are a _______ risk of material misstatement than ‘plain vanilla’ bonds

greater

How well did you know this?

Not at all

Perfectly

When a substantive strategy is followed for long-term debt, why does theauditor still need a sufficient understandingof the entity’s internal control system over debt? (2)

Because the client’s own IC may be weak due to:
1. infrequency and
2. complexity of transactions within this cycle

How well did you know this?

Not at all

Perfectly

What are the 5 assertions that are of primary concern for the auditor regarding the control risk assessment for long term debt?

Occurence
Authorization
Completeness
Valuation
Disclosure / Classification

How well did you know this?

Not at all

Perfectly

Assertions and Related Control Activities

Occurence and Authorization

What are the 3 steps to ensure that long-term financing have properly been initiated by authorized individuals?

Adequate documentation must verify that a note or bond was properly authorized (Read the minutes)
Any significant debt commitments should be approved by the board of directors or by executives who have been delegated this authority (Strong controls here)
Need to ensure that those in charge with governance understand the debt instruments

How well did you know this?

Not at all

Perfectly

Assertions and Related Control Activities

Completeness

What can the entity do to ensure that long-term debt information is complete?

The entity should maintain a subsidiary ledger that contains information about all the long-term debt owed by the entity.

The debt amount recorded in the subsidiary ledger should be reconciled to the general ledger control account regularly.
(Think of it as the “big total” line item that should equal the sum of all the little pieces in the subledger)

How well did you know this?

Not at all

Perfectly

Assertions and Related Control Activities

Valuation

How are notes and bonds valued, and how does it impact control activities?

Notes and bonds are recorded at their face value less any unamortized discount or plus any unamortized premium.
The EIR method should be used to amortize discounts and premiums. This is known as the Amortized Cost basis and is the most common measurement basis

Be aware of Fair Value option for Debt instruments as this is an option chosen by financial institution type
Specialists may be needed here

How well did you know this?

Not at all

Perfectly

Assertions and Related Control Activities

Classification

What is the major issue with the proper classification of notes and bonds?

Ensure that controls are in place so the portion of long-term debt that is due in the next year is properly classified as a short-term liability.

Debt contracts and agreements specify both TIMING and AMOUNT of contractual cashflows. These are critical to this assertion

How well did you know this?

Not at all

Perfectly

Assertions and Related Control Activities

Classification

What are 2 critical components to this assertion?

Debt contracts and agreements specify:
TIMING
AMOUNT
of contractual CFs

How well did you know this?

Not at all

Perfectly

For substantive procedures of long-term debt, what is the main thing the auditor should do (3)?

Examine new debt agreements,
Determine the status of prior debt agreements,
Confirm balance + other info with related parties

How well did you know this?

Not at all

Perfectly

What type of procedure is useful for substantive procedures of long term debt, and why?

Analytical procedures are useful
because of
the direct relationship between interest expense and the amount of long-term debt.

How well did you know this?

Not at all

Perfectly

Substantive Procedures of Long-Term Debt

Occurence

What are 2 examples of a substantive test of transaction?

Examine copies of new note, bond, or financing lease agreements.

Examine board of directors’ minutes for approval of new lending agreements

How well did you know this?

Not at all

Perfectly

Substantive Procedures of Long-Term Debt

Completeness

What are 4 examples of a substantive test of transaction?

Trace large cash receipts and payments to source documents and the general ledger.

Review interest expense for payments to debt holders not listed on the debt analysis schedule.

Review notes paid or renewed after the balance sheet date to determine if there are unrecorded liabilities at year-end.

Evaluate lease contracts to determine if leases are properly accounted for as an operating or financing lease.

How well did you know this?

Not at all

Perfectly

Substantive Procedures of Long-Term Debt

Accuracy

What is an example of a substantive test of transaction?

Test a sample of receipts and payments.

How well did you know this?

Not at all

Perfectly

Substantive Procedures of Long-Term Debt

Cutoff

What is an example of a substantive test of transaction?

Review debt activity for a few days before and after year-end to determine if the transactions are included in the proper period.

Substantive Procedures of Long-Term Debt

Classification

What is an example of a substantive test of transaction?

Trace contract dates and due dates on notes or bonds to schedules and analyses supporting classification between current and long-term debt.

Substantive Procedures of Long-Term Debt

Presentation

What is an example of a substantive test of transaction?

Review disclosure checklist and related disclosures for relevance and completeness.

Substantive Procedures of Long-Term Debt

Existence

What is an example of a test of details of account balances?

Confirm the notes or bonds directly with the creditor

Substantive Procedures of Long-Term Debt

Rights and obligation

What is an example of a test of details of account balances?

Examine copies of note, bond, and financing lease agreements.

Substantive Procedures of Long-Term Debt

Completeness

What are 5 example of a test of details of account balances?

Obtain an analysis of notes and bonds payable, and accrued interest; foot schedule and agree totals to the general ledger.

Obtain a standard bank confirmation requesting specific information on notes from banks.

Confirm notes or bonds with creditors.

Inquire of management about “off-balance sheet” activities.

Review board meeting minutes for debt-related activities.

Substantive Procedures of Long-Term Debt

Accuracy, Valuation, and Allocation

What are 3 example of a test of details of account balances?

Examine new debt agreements to ensure that they were recorded at the proper value.

Confirm the outstanding balance for notes or bonds and the last date on which interest has been paid. Recompute accrued interest payable.

Verify computation of the amortization of premium or discount.

Substantive Procedures of Long-Term Debt

Classification

What are 2 example of a test of details of account balances?

Obtain an analysis of notes and bonds payable; foot schedule and examine the due dates for proper classification between current and long-term debt and agree totals to the general ledger.

Examine an analysis of lease liabilities for proper classification between financing and operating leases and between current and long-term debt.

Substantive Procedures of Long-Term Debt Presentation What are 2 example of a test of details of account balances?

Review disclosure checklist and related disclosures for relevance and completeness. Review loan contracts for restrictive loan covenants.

What are the 3 types of transactions that are important for the auditor when auditing Shareholders' Equity

ISSUANCE of share including transactions such as sale of share for cash; the exchange of share for assets, services, or convertible debt; and issuance of share in share splits. REPURCHASE of share including both the reacquisition of share and retirement of share. PAYMENTS of dividends including cash and share dividends.

What are the inherent risk assessment with equity transactions and why?

Equity transactions and balances may present an elevated inherent risk of material misstatement because: - Individually Material given rights of shareholders - Hybrid Securities may contain an Equity component and this may be complex to capture

Control Risk Assessment What type of strategy is used to audit shareholders' equity and why?

A substantive strategy is often used to audit shareholders’ equity because the number of transactions is usually small and often the value is large. However, the auditor must still understand the types of controls that are in place to prevent the misstatement of equity transactions

What helps with reducing the risk for the equity cycle of large publicly traded companies?

They use an independent registrar, transfer agent, and dividend-disbursing agent to process and record equity transaction. Relevant information about equity transactions may be confirmed with those parties. I.e. Large companies hire outside parties to handle their stuff, so auditors can ask confirmation from these external and neutral parties extra: Tracking who owns their stock (that’s the registrar), Transferring shares when people buy/sell (that’s the transfer agent), And paying dividends to shareholders (that’s the dividend-disbursing agent).

Auditing Capital-Share Accounts (equity) Occurence and completeness What can the auditor do when outside agents are used?

The auditor can confirm information relevant to the year end amounts.

Auditing Capital-Share Accounts (equity) Occurence and completeness What can the auditor do when outside agents are NOT used (4)?

Trace the transfers of shares between shareholders to the share register and/or share certificate book. Foot the shares outstanding in the share register and/or share certificate book and agree them to the total shares outstanding in the general ledger Examine any canceled share certificates Account for and inspect any unissued share certificates in the share certificate book.

Auditing Capital-Share Accounts (equity) Valuation What is the test done for the valuation of shares issued for cash?

When shares are issued for cash, the valuation is straightforward. Trace the proceeds from the sale of shares to the cash receipt records Share dividends may also create complex auditing issues. The auditor must recompute the share dividend and trace the entries to the general ledger.

Auditing Capital-Share Accounts (equity) Valuation What type of equity transactions increase the risk here? (4)

When shares are exchanged for property, goods, or services, the valuation issue is more complex. (Non-monetary exchanges) Share dividends may also create complex auditing issues. The auditor must recompute the share dividend and trace the entries to the general ledger. Hybrid securities Related party transactions

Auditing Capital-Share Accounts (equity) Completeness and disclosure What are 5 items that should be disclosed?

Number of shares authorized, issued, and outstanding for each class of share Call privileges, prices, and dates of preferred share Share option or purchase plans Restrictions on retained earnings and dividends Any completed or pending transactions that may affect shareholders’ equity such as share subscriptions

What is the main thing about auditing dividends?

All dividends declared and paid will be audited because of - concerns of violations of corporate bylaws or - debt covenants

Auditing dividends What can the auditor do when an independent dividend-disbursing agent is used?

The auditor can confirm the amount disbursed with the agent. This amount is agreed with the amount authorized by the board of directors.

Auditing dividends What can the auditor do when an independent dividend-disbursing agent is NOT used?

The auditor can recomputed the amount of the dividend authorized by the board of directors and trace the amount to cash disbursements or dividends payable

What are the 3 critical dates/events for Dividends?

1. Declaration date 2. Record date (The company checks who owns the shares as of this date. No journal entry — just figuring out who gets the money.) 3. Payment date

When is the dividend liability created and settled?

1. Declaration date 2. Payment date

What is the source of reliable audit evidence for the main dividend events? Declaration: Report: Payment:

Declaration Date: Board minutes / resolutions (shows formal authorization) Record Date: Stockholder records from the transfer agent or registrar Payment Date: Bank statements, cleared checks, or cash disbursement journal

Auditing Retained Earnings Under normal circumstances, retained earnings are affected by the current year’s income or loss and the dividends declared and or paid. What are the 4 major exceptions?

1. Existence of prior period adjustments 2. Correction of error 3. Share retirement 4. Change in appropriation of R/E