22-1
Chapter 22
Concept Checks
P. 720
1. The characteristics of the liability accounts in the capital acquisition and
repayment cycle that result in a different auditing approach than the
There is a legal relationship between the client entity and the
holder of the stock, bond, or similar ownership document.
and debt and equity.
2. The most important controls the auditor should be concerned about in the
audit of notes payable are:
The proper authorization for the issuance of new notes (or
renewals) to insure that the company is not being committed to debt
arrangements that are not authorized.
Controls over the repayment of principal and interest to insure that
P. 727
1. The primary objectives in the audit of owners’ equity accounts are to
determine whether:
a. The internal controls over capital stock and related dividends are
adequate.
the following six transaction–related audit objectives:
Occurrence
Completeness
Accuracy
22-2
Concept Check, P. 727 (continued)
following balance–related audit objectives:
Detail tie–in
Existence
objectives:
Occurrence and Rights and Obligations
Completeness
2. The duties of a stock registrar are to make sure that stock is issued by a
corporation in accordance with the capital authorization of the board of
and in some cases, disburse cash dividends to shareholders.
The use of the services of a stock registrar improves the effectiveness
the hands of an independent organization.
Review Questions
balance sheets are:
1. Notes payable
These liabilities have the following characteristics in common:
transaction is often highly material in amount.
2. The exclusion of a single transaction could be material in itself.
22-3
22–1 (continued)
4. There is a direct relationship between interest and dividend accounts
and debt and equity.
These liabilities differ in what they represent and the nature of their respective
liabilities.
same time, the likelihood of omitting a note from notes payable for which
interest has been paid is minimized. When there are a large number of notes or
22–3 The most important analytical procedures used to verify notes payable
to uncover unrecorded notes payable are:
1. Examine the notes paid after year–end to determine whether they
2. Obtain a standard bank confirmation that includes specific reference
the bank account by the bank.
4. Obtain confirmation from creditors who have held notes from the
6. Review the minutes of the board of directors for authorized but
unrecorded notes.
22-4
22–5 The primary purpose of analyzing interest expense is to uncover a
payment to a creditor who is not included on the notes payable schedule. The
primary considerations the auditor should keep in mind when doing the analysis
are:
22–6 The tests of controls and substantive tests of transactions for liability
accounts in the capital acquisition and repayment cycle consists of tests of the
controls and substantive tests over the payment of principal and interest and
the issuance of new notes or other liabilities, whereas the tests of details of
22–7 Four types of restrictions long–term creditors often put on companies in
granting them a loan are:
1. Financial ratio restrictions
The auditor can find out about these restrictions by examining the
loan agreement and related correspondence associated with the loan, and
22–8 Although the corporate charter and bylaws are legal documents, their
legal nature is not being judged by the auditor. They are being used only to
22–9 The major internal controls over owners’ equity are:
1. Proper authorization of transactions
2. Proper record keeping
22-5
22–10 The audit of owners’ equity for a closely held corporation differs from
that for a publicly held corporation in that the amount of time spent in verifying
owners’ equity in a closely held corporation is usually minimal because of the
The audits are not significantly different in regard to whether the
transactions in the equity accounts are properly authorized and recorded and
22–12 Because it is important to verify that properly authorized dividends have
been paid to owners of stock as of the dividend record date, a comparison of a
random sample of cancelled dividend checks to a dividend list prepared by
management would be inadequate. Such an audit step is useless unless the
to valid shareholders.
22–13 If a transfer agent disburses dividends for a client, the total dividends
declared can be verified by tracing the amount to a cash disbursement entry to
used.
22–14 The major emphasis in auditing the retained earnings account should
be on the recorded changes that have taken place during the year, such as net
earnings for the year; dividends declared; prior period adjustments; extraordinary
authorization and accuracy of the underlying transactions.
22–15 For auditing owners’ equity and calculating earnings per share, it is
standards.
Multiple Choice Questions From CPA Examinations
22–16 a. (1) b. (2) c. (3)
22–17 a. (4) b. (1) c. (1)
22–18 a. (3) b. (1) c. (3)
Discussion Questions and Problems
22–19
a.
PURPOSE OF
CONTROL
b.
POTENTIAL FINANCIAL
STATEMENT
MISSTATEMENT
c.
AUDIT PROCEDURE
TO DETERMINE
EXISTENCE
OF MATERIAL
MISSTATEMENT
1. To insure that all
note liabilities are
actual liabilities of
the company.
Loss of assets through
payment of excess
interest rates or the
diversion of cash to
unauthorized persons.
Examine note request
forms for proper
authorization and
discuss terms of note
with appropriate
management
personnel.
2. To insure that notes
are not paid more
than once.
Loss of cash.
Examine outstanding
notes and paid notes
for similarities and the
potential for reusing the
notes.
22-19 (continued)
a.
PURPOSE OF
CONTROL
b.
POTENTIAL FINANCIAL
STATEMENT
MISSTATEMENT
c.
AUDIT PROCEDURE
TO DETERMINE
EXISTENCE
OF MATERIAL
MISSTATEMENT
3. To insure that notes
payable transactions
are recorded in full
and in detail.
Improper disclosure or
misstatements in notes
payable through
duplication.
Reconcile detailed
contents of master file
or other records to
control account.
4. To insure that all
note–related
transactions agree
with account
balances.
Misstatement of notes
payable.
Reconcile master file
with outstanding notes
payable.
5. To prevent misuse
of notes and funds
earmarked for notes.
Misstatement of liabilities
and cash.
Perform all substantive
procedures on extended
basis. Trace from paid
notes file to cash
receipts to determine
that the appropriate
amount of cash was
received when the note
was issued.
6. To insure that only
the proper interest
amount is paid and
recorded.
Misstatement of interest
expense and related
accrual.
Recompute interest on
a test basis.
22–20 a.
AUDIT PROCEDURE
PURPOSE
1
To determine if the account balances are reasonable as
related to each other and to examine for unreasonable
changes in the account balances.
2
To obtain independent confirmation of bond
indebtedness and collateral.
3
To determine the nature of restrictions on client as a
means of verifying whether the restrictions have been
met and to insure they are adequately disclosed.
22-8
22-20 (continued)
AUDIT PROCEDURE
PURPOSE
4
To insure that the bonds are not subject to unnecessary
early retirement by bondholders and that proper
disclosures are made.
5
To determine if the calculations are correct and accounts
are accurate.
indenture agreement:
1. Restrictions on payment of dividends
2. Convertibility provisions
met by the following procedures:
1. Audit of payments of dividends
2. Determine if the appropriate stock authorizations are adequate
verified. The monthly premium or discount is then calculated and
multiplied by the number of months still outstanding.
e. The following information should be requested from the bondholder
in the confirmation of bonds payable:
1. Amount of bond
2. Maturity date
3. Interest rate
22-9
22–21
AUDIT PROCEDURE
PRESENTATION AND
DISCLOSURE–RELATED OBJECTIVE
1
Completeness
2
Classification and understandability
3
Accuracy and valuation
4
Occurrence and rights and obligations
5
Classification and understandability
22–22 a. The amounts listed for each type of long–term debt in the beginning
balance column would be verified by examining the ending audited
documenting board of director approval. The auditor would also
verify whether cash was received and deposited in company cash
accounts if the debt was tied to cash financing. For some types
of long–term debt, such as a mortgage, the company would not
c. To obtain evidence about the items in the payments column, the
auditor would review the related debt contract to determine if the
amounts paid are reasonable. The auditor would also verify that
the payment amounts agree with cash disbursement records and
d. The auditor would verify the mathematical accuracy of the summation
of the beginning balances plus additions less payments to ensure it
crossfoots to the ending balance for each long–term debt category
listed on the schedule. The auditor would also recalculate the
the ending balance with the noteholder.
22–10
22–22 (continued)
agreement.
f. The auditor could use the information in the schedule to develop a
substantive analytical procedure related to interest expense. The
auditor could calculate an average long–term debt balance for
of the debt agreements, the interest payment due dates and
interest rates to determine the appropriate period of time for which
interest expense requires accrual. For example, the debt agreement
for the convertible debentures may indicate that interest is due
($131,250) requires accrual as of December 31, 2016 ($10,000,000
times 5.25% divided by 4 = $131,250). That expectation would
be compared to the amount recorded in the general ledger as
accrued interest for that debt type. The auditor would also need to
determine that prior interest payments have been made and
22–23 a. The emphasis in the verification of notes payable in this situation
should be in determining whether all existing notes are included in
the client’s records. The four audit procedures listed do not satisfy
this emphasis.
b.
PURPOSE
1
To determine if the notes payable list reconciles to the general
ledger.
2
To determine if the notes payable on the list are correctly
recorded and disclosed.
3
To verify that all recorded notes payable are properly recorded
and disclosed.
4
To insure that interest expense is properly recorded on the
books.