Auditing and assurance services 14e by arens chapter 22

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.

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

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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
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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
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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
affecting notes payable

Phase I

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 procedures Phase 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

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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
Payments Beginning balance
of
principal Issue of new notes
Ending balance
Cash in Bank
Issue of Payments of
new notesprincipal
Payments of
interest
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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
outstanding with those
of the prior year

Omission or
misstatement of
a note payable

Compare total balance in
notes payable, interest
expense, and accrued
interest with prior-year
balances

Misstatement of interest
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.

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

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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

Issue of new notes
Audited by
TOC and STOT
Interest Payable

Ending
balance
Audited by
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
balance
Audited by
AP and TDB

Audited by
TOC, STOT,
and AP

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

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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
Redemption Beginning

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 duties
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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