CHAPTER 13 Substantive Audit Testing: Financing

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CHAPTER 13Substantive Audit Testing Financing
Investing Cycle Completing the Audit
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What are the major accounts of the capital
acquisition and repayment cycle?
-Long term liabilities - stock accounts - donated
capital - retained earnings and
appropriations - dividends declared and payable
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In auditing the capital acquisition and repayment
cycle, the auditor should consider
Relatively few transactions affect the account
balances, but each transaction is often
highly material in amount.
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In auditing the capital acquisition and repayment
cycle, the auditor should consider
The exclusion of a single transac- tion could be
material in itself.
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In auditing the capital acquisition and repayment
cycle, the auditor should consider
There is a legal relationship be- tween the
client and the holder of the stock, bond, or
similar ownership document.
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In auditing the capital acquisition and repayment
cycle, the auditor should consider
There is a direct relationship be- tween the
interest and divi- dends account and debt and
equity.
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In auditing the internal controls related to
long-term liabilities, the auditor will consider
- proper authorization for issues of notes or
bonds - adequate controls over payment of
interest and principal - adequate documents and
records - periodic independent verification
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What are the primary audit objectives with regard
to long-term liability account balances?
- completeness - accuracy - presentation and
disclosure
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long-term liabilities audit procedures
perform analytical procedures to test the
reasonableness of long-term liabilities and
interest expense
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long-term liabilities audit procedures
inquire of management regarding
- completeness of liabilities - debt-related
restrictions on assets - ability to pay
interest
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long-term liabilities audit procedures
review contractual provisions of long-term
liabilities
- consider pledging of assets related to debt
(disclosure) - determine client adherence to
contractual requirements (payment dates,
working capital, ratios)
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long-term liabilities audit procedures
confirm debt balances, interest payments, and
client compliance with contractual agreements
with the creditors
auditor
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creditor
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long-term liabilities audit procedures
for all long-term liabilities, recalculate
interest expense, interest payable, and
amortizations of discounts or premiums
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long-term liabilities audit procedures
Trace receipt of borrowed amounts from cash
receipts journal to bank statement
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long-term liabilities audit procedures
Trace receipt of borrowed amounts from cash
receipts journal to bank statement to deposit
slips
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long-term liabilities audit procedures
Trace receipt of borrowed amounts from cash
receipts journal to bank statement to deposit
slips to debt agreement.
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long-term liabilities audit procedures
Trace payments of principal and interest from
cash payments journal to bank statement
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long-term liabilities audit procedures
Trace payments of principal and interest from
cash payments journal to bank statement to
cancelled checks to debt agreement.
Bank Statement 11/30/x7
cash payments journal description _
_ November 23, 19x7 interest payment- Wachovia
loan 700
Deposits Payments 11/26 700
Ace Corporation 324
date 11/23/x7
700.00
Wachovia Bank
pay to the order of
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What are the auditors primary concerns with
regard to owners equity?
- authorization - presentation and disclosure -
accuracy
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owners equity audit procedures
perform analytical procedures to test the
reasonableness of owners equity accounts
(including dividends)
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owners equity audit procedures
READ - articles of incorporation, bylaws -
minutes to meetings
Note discussion of dividends, stock options,
stock issues, etc.
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owners equity audit procedures
Confirm shares outstanding with the independent
registrar and the stock transfer agent.
- independent registrar - a third party paid by
the client to ensure that stock is issued in
accordance with the char- ter and boards
directions (required for SEC companies)
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owners equity audit procedures
Confirm shares outstanding with the independent
registrar and the stock transfer agent.
- stock transfer agent - a third party paid by
the client to maintain stockholder records and,
possibly, to disburse dividends
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owners equity audit procedures
If the client does not use an independent
registrar and stock transfer agent, the auditor
must examine the stock certificate records and
test any changes.
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owners equity audit procedures
Trace receipts from stock issues from cash
receipts journal to bank statement to deposit
slips to board minutes.
cash receipts journal description _ _ May
23, 19x7 Joe Ace 23,000
Deposits 5/23 23,000
Deposit Slip 5/23/x7 23,000
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owners equity audit procedures
Trace payments related to dividends and treasury
stock from cash payments journal to bank
statement to cancelled checks to board minutes.
Bank Statement 1/31/x7
cash payments journal description _
_ January 23, 19x7 dividend distribution 4300
Deposits Payments 1/26 4300
Board Minutes
Ace Corporation 324
date 1/23/x7
... declare dividends of 4300...
4300.00
Stockholders
pay to the order of
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owners equity audit procedures
Recalculate dividend distribution to common and
preferred shareholders.
consider features of preferred (cumulative,
participating)
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owners equity audit procedures
Inspect treasury stock recalculate treasury
stock transactions.
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If all other accounts have been audited with
satisfactory results,Is the audit of retained
earnings necessary?
Possibly not, but the audit of retained earnings
is typically not time-consuming and may serve as
a check on the audit of other accounts.
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owners equity audit procedures
Analyze all changes in retained earnings.
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Audit Completion Procedures
Search for unrecorded contingent liabilities.
What is a contingent liability and what are
the related SFAS 5 rules?
a potential future obligation to an outside party
for an unknown amount resulting from activities
that have already taken place
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Audit Completion Procedures
Search for unrecorded contingent liabilities.
probable and reason- ably estimated -
accrual with foot- note disclosure reasonably
possible - footnote disclosure remote - no
financial statement effect
What is a contingent liability and what are
the related SFAS 5 rules?
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Audit Completion Procedures
Search for unrecorded contingent liabilities.
What is a contingent liability and what are
the related SFAS 5 rules?
Footnote disclosure should describe the
contingency and the opinion of legal counsel or
manage- ment regarding the expected outcome.
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Audit Completion Procedures
Search for unrecorded contingent liabilities. -
inquire of management - review client
copies of IRS correspondence minutes to
board and stockholder meetings
invoices from client attorneys existing
audit workpapers - obtain letters of confirmation
from all client attorneys
Joe Lawyer
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Jill Auditor, CPA
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Attorney Inquiry (AU 337)
The auditor should ask the client to prepare a
letter (on client letterhead, signed by client
officer) asking the attorney to respond directly
to the auditor concerning - all material pending
threatened litigation, claims, or assessments
with which the attorney has been involved -
all likely, material unasserted claim or
assessments with which the attorney has been
involved - the status of each claim or
assessment - any additional, unlisted legal
actions
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Attorney Inquiry (AU 337)
The clients letter to the attorney should
also remind the law firm that they are
responsible for telling the client when a legal
matter should be disclosed.
The clients letter to the attorney should
request that the law firm describe any reasons
for limiting their response.
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Attorney Inquiry (AU 337)
If an attorney refuses to respond or refuses to
provide adequate information, the audit opinion
will be qualified or disclaimed.
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types of subsequent events
1.events that provide additional evidence
about conditions that existed at the balance
sheet date (e.g., settlement of
liabilities, realiza-
tion of assets)
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types of subsequent events
1.events that provide additional evidence
about conditions that existed at the balance
sheet date (e.g., settlement of
liabilities, realiza-
tion of assets)
Client financial statements for the period under
audit must be adjusted to reflect this subsequent
event information.
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types of subsequent events
2. events that occur after the balance sheet
date and do not relate to condi- tions that
existed at year-end (e.g., bond/stock issue,
acquisition, fire/flood loss, major
customer/vendor
bankruptcy)
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types of subsequent events
2. events that occur after the balance sheet
date and do not relate to condi- tions that
existed at year-end
disclose
These subsequent events must be disclosed in the
footnotes of the period under audit. The auditor
may also consider - pro forma financial
statements - additional paragraph in audit report
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Subsequent Events Auditing Procedures
Near field work completion, auditors should -
read post-balance sheet interim statements -
obtain a management representation letter - read
minutes to board and stockholder meetings that
have occurred since year-end - obtain letter from
clients attorney
Joe Lawyer
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Jill Auditor, CPA
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- the auditor is not responsible for dis-
covering subsequent events during this
period - if, however, auditors learn of a
subsequent event during this period, they are
responsible for its disclosure
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If auditors learn of a subsequent event during
this period, they are responsible for its
disclosure.
The auditors then have two options - expand all
subsequent events tests to the date of the
event and change the report date to the date of
the event (e.g., 2/21) - restrict testing only to
matters relating to the new event and dual-date
the report
Taylor Tower, CPAs February 14, 19x1, except
for Note 3, as to which
the date is February 21, 19x1
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If the answer to any of these questions is no,
the auditors do not need to take any action.
With regard to this information, auditors must
determine - did the information exist at the
report date? - is this information reliable? -
would the audit report have been different if
the informa- tion had been available prior to
the report date? - are persons still relying on
the audit report?
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With regard to this information, auditors must
determine - did the information exist at the
report date? - is this information reliable? -
would the audit report have been different if
the informa- tion had been available prior to
the report date? - are persons still relying on
the audit report?
If the answer to all of these questions is yes,
the auditors must act to prevent future reliance
on the audit report.
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How do auditors prevent future reliance on a
previously-issued audit report?
the client must revise and reissue the financial
statements
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How do auditors prevent future reliance on a
previously-issued audit report?
If the financial statement effect of the
subsequently-discovered information cannot be
determined promptly
the client must notify persons known to be (and
those likely to be) relying on the financial
statements
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What should the auditor do if the client refuses
to reissue the statements or contact those
relying on the auditors report?
- first, notify each board member of
managements refusal - then inform client
management that the audit report may no
longer be associated with the statements
notify regulatory agencies that the audit
report may not be relied upon notify persons
known to be relying on the statements that
the audit report may not be relied upon
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Client Representation Letter (AU 333)
The auditor must obtain a letter from the client
documenting the clients represen- tations during
the engagement. The primary purposes are to -
confirm and document oral statements - reduce
auditor-client misunderstanding The letter
should be signed by the client CFO and CEO and
dated with the field work completion date.
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Client Representation Letter (AU 333)
If the client refuses to give the auditor a
representation letter, the auditor must
qualify or disclaim the opinion.
probable
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Final Audit Steps
1. Incorporating all audit evidence,
materiality, and judgment, the auditor draws
overall conclusions and prepares the audit
report. 2. The auditor prepares the
management letter. 3. The auditor communicates
the results to the audit committee and gives
them the audit report and management
letter.
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AU 380 requires auditors to communicate (oral or
written) to the audit committees of SEC Companies
- the auditors responsibilities under GAAS -
significant accounting policies selected by
management - significant financial statement
adjustments - disagreements with management -
difficulties in performing the audit