Chapter 22 Audit of the Capital Acquisition and Repayment Cycle

22.1 Learning Objective 22-1

1) Which of the following statements is correct regarding the capital acquisition and payment
cycle?
A) Bonds are frequently issued by companies in small amounts.
B) There are relatively few transactions and each transaction is typically highly material.
C) A primary emphasis in auditing debt is on existence.
D) Audit procedures for notes payable and interest income are often performed simultaneously.

2) The capital acquisition and repayment cycle does not include

A) payment of interest.
B) payment of dividends.
C) payment of vendor invoices.
D) acquisition of capital through interest-bearing debt.

3) Which of the following statements regarding the capital acquisition and repayment cycle is
most correct?
A) A relatively few transactions affect the cycle, and most are smaller amounts.
B) A large numbers of transactions affect the cycle, and most are smaller amounts.
C) A relatively few transactions affect the cycle, and most are highly material.
D) A large number of transaction affect the cycle, and most are highly material.

4) The primary audit objectives to focus on when auditing accounts in the capital acquisition and
repayment cycle are
A) accuracy and completeness.
B) accuracy and existence.
C) completeness and valuation.
D) accuracy and valuation.

5) Performance materiality is often set at a(n) ________ level for notes payable.
A) high
B) moderate
C) low
D) unknown

6) When auditing interest-bearing debt, the auditor should ________ verify the related interest
expense and interest payable.
A) not
B) attempt to
C) simultaneously
D) never

7) Assessed control risk and results of substantive tests of transactions are normally unimportant
for designing tests of details of balances for which of the following accounts?
A) accounts receivable
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B) inventory
C) accounts payable
D) notes payable

8) In the audit of the transactions and amounts in the capital acquisition and repayment cycle, the
auditor must take great care in making sure that the significant legal requirements affecting the
financial statements have been properly fulfilled and
A) any violations are reported to the SEC.
B) are adequately disclosed in the financial statements.
C) must issue a disclaimer if they haven't been fulfilled.
D) any departures from the agreements are made with management's knowledge and consent.

9) All corporations must have

A) preferred stock.
B) capital stock.
C) paid-in capital in excess of par.
D) dividends payable.

10) List the four characteristics of the capital acquisition and repayment cycle that make it
unique from other cycles.
11) List six accounts in the capital acquisition and repayment cycle commonly found on balance
sheets of corporations. What characteristics do these accounts have in common that distinguish
them from other accounts?

True false
12) One unique characteristic of the capital acquisition and repayment cycle is that relatively few
transactions affect the account balances, but each transaction is often highly material in amount.

13) Auditors seldom learn about the capital acquisition and repayment cycle when gaining an
understanding of the client's business and industry.
14) When auditing the capital acquisition and repayment cycle, it is common to verify each
transaction taking place in the cycle for the entire year as a part of verifying the balance sheet
accounts.

15) There is an indirect relationship between the interest and dividends accounts and debt and
equity.

22.2 Learning Objective 22-2

1) Which of the following is not an objective of the auditor's examination of notes payable?
A) to determine whether internal controls are adequate
B) to determine whether client's financing arrangements are effective and efficient
C) to determine whether transactions regarding the principal and interest of notes are properly
authorized
D) to determine whether the liability for notes and related interest expense and accrued liabilities
are properly stated
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2) Responsibility for the issuance of new notes payable would normally be vested in the
A) board of directors.
B) purchasing department.
C) accounting department.
D) accounts payable department.
3) An auditor is determining whether an issuance of notes payable for cash was correctly
recorded. Her best course of action would be to
A) confirm with the bond trustee as to the amount of bonds issued.
B) confirm with the underwriter as to the appropriate market yield on the bonds.
C) trace the cash received from the proceeds to the accounting records.
D) verify that the amount was included in a footnote disclosure.

4) The auditor's independent estimate of interest expense from notes payable uses average
interest rates and
A) average notes payable outstanding.
B) year-end notes payable outstanding.
C) only notes payable above the level of materiality.
D) only notes payable to major lenders.

5) The tests of details of balances procedure which requires the auditor to trace the totals of the
notes payable list to the general ledger satisfies the audit objective of
A) accuracy.
B) existence.
C) detail tie-in.
D) completeness.

6) The audit objective to determine that notes payable in the schedule actually exist is verified by
the test of details of balances procedure to
A) foot the notes payable list.
B) confirm notes payable.
C) recalculate interest expense.
D) examine the balance sheet for proper disclosure of noncurrent portions.

7) Actual interest expense is significantly higher than the auditor's estimate. This would most
likely lead the auditor to conclude that the client has not
A) recorded all long-term interest bearing debt in the accounting records.
B) recorded all interest expense paid or accrued.
C) properly accounted for the discount of bonds payable account.
D) properly recorded interest income.

8) You are auditing the long-term notes payable account for a client. Which of the following
audit procedures would you most likely employ?
A) Compare interest expense recorded by the client with the notes payable account for
reasonableness.
B) Confirm bonds payable with individual bond holders.
C) Perform analytical procedures on the bond discount or premium account.
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D) Examine bond documents for the presence of hybrid securities.

9) The two most important balance-related audit objectives for notes payable are
A) completeness and detail tie-in.
B) completeness and valuation.
C) accuracy and valuation.
D) accuracy and completeness.

10) Which of the following audit tests would provide evidence regarding the balance-related
audit objective of existence for an audit of notes payable?
A) Examine due dates on duplicate copies of notes.
B) Examine balance sheet for proper presentation and disclosure of notes payable.
C) Examine corporate minutes for loan approval.
D) Foot the notes payable list for notes payable and accrued interest.

11) Which of the following balance-related audit objectives is not applicable to the audit of notes
payable?
A) realizable value
B) detail tie-in
C) cutoff
D) classification

12) When there are not numerous transactions involving notes payable during the year, the
normal starting point for the audit of notes payable is
A) a schedule of notes payable and accrued interest prepared by the audit team.
B) a schedule of notes payable and accrued interest obtained from the client.
C) a schedule of only those notes with unpaid balances at the end of the year prepared by the
client.
D) the notes payable account in the general ledger.

13) The tests of details of balances procedure which requires the auditor to examine notes paid
after year-end to determine whether they were liabilities at the balance sheet date is an attempt to
satisfy the audit objective of
A) existence.
B) completeness.
C) accuracy.
D) classification.

14) The audit objective that requires that existing notes payable be included in the notes payable
schedule is satisfied by performing which of the following audit procedures?
A) Confirm notes payable.
B) Trace the total of the notes payable schedule to the general ledger.
C) Review the notes payable schedule to determine whether any are related parties.
D) Review the bank reconciliation for new notes credited directly to the bank account by the
bank.

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15) The audit objective that requires the auditor to determine that notes payable on the notes
payable schedule are properly classified can be tested by performing the procedure to
A) confirm notes payable.
B) examine corporate minutes for loan approval.
C) examine notes, minutes, and bank confirmations for restrictions.
D) review the notes to determine whether any are with related parties.

16) During the course of an audit, a CPA observes that the recorded interest expense seems to be
excessive in relation to the balance in the long-term debt account. This observation could lead
the auditor to suspect that
A) long-term debt is understated.
B) discount on bonds payable is overstated.
C) long-term debt is overstated.
D) premium on bonds payable is understated.

17) To determine if notes payable are included in the proper period, the auditor should
A) trace the cash received from the issuance to the accounting records.
B) examine duplicate copies of notes to determine whether the notes were dated on or before the
balance sheet date.
C) examine duplicate copies of notes for principal and interest rates.
D) trace the individual notes payable to the master file.

18) In the audit of notes payable, it is common to include tests of principal and interest payments
as a part of the audit of the acquisitions and payment cycle because the payments are in the cash
disbursements journal that is being sampled. It is also normal to test these transactions as part of
the capital acquisitions and repayment cycle because
A) it is not unusual for the auditor to duplicate a process, thereby gathering a larger quantity of
evidence.
B) replicating the evidence will provide the auditor with a higher level of assurance.
C) the tests done in the acquisitions and payments cycle will look only at the cash credit side so
the tests done in the capital acquisitions and repayment cycle will look at the debit side of the
transaction.
D) due to the infrequency of these transactions, in many cases no transactions involving notes
payable are included in the sample tests of acquisitions and payments.

19) Which of the following is not an important control over notes payable?
A) There is proper authorization over the issuance of new notes payable.
B) Notes payable are issued when the business climate is favorable.
C) Adequate controls exist over repayment of interest and principal.
D) There exist proper documents and records.

20) Which of the following is an accurate statement regarding the audit of the capital acquisition
and repayment schedule?
A) When internal controls over notes payable are deficient, auditors are required to confirm the
notes payable.
B) As auditors perform tests of details of balances for balance-related audit objectives, the
evidence obtained helps satisfy the notes payable presentation and disclosure requirements.
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C) The normal starting point for the audit of notes payable is a list of fixed asset acquisitions.
D) The schedule of notes payable and accrued interest must be prepared regardless of the number
of transactions involved.

21) Which balance-related audit objective is important for uncovering both errors and fraud?
A) completeness
B) existence
C) accuracy
D) detail tie-in

22) Why are substantive analytical procedures essential for notes payable?

23) What are the two most important balance-related audit objectives in notes payable?

24) Identify three substantive analytical procedures commonly performed for notes payable.
25) The starting point for the audit of notes payable is a schedule of notes payable and accrued
interest. Discuss the information typically included in the schedule.

26) You are employing tests of details of balances for notes payable and interest expense.
Describe below specific audit procedures you would perform for the balance-related audit
objectives of detail tie-in and existence. List at least two for each objective.

27) Discuss the four key controls over notes payable.

28) Discuss the overall objectives of the audit of notes payable.

True false questions

29) Notes payable are generally for a period of sixty days or less.

30) When performing substantive analytical procedures for notes payable, if actual interest
expense is materially larger than the auditor's expectation, one possible cause would be interest
payments on unrecorded notes payable.

31) The balance-related audit objective realizable value is not applicable when auditing notes
payable.

32) The three most important balance-related audit objectives for notes payable are existence,
realizable value, and accuracy.

33) The audit procedure "Foot the notes payable list and trace the totals to the general ledger" is
performed when verifying the accuracy objective for notes payable.

34) The audit procedure "Review the notes to determine whether any are related party notes or
accounts payable" is performed when verifying the classification objective for notes payable.

35) If loans require significant restrictions on the activities of the company, they must be
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disclosed in the footnotes.

22.3 Learning Objective 22-3

1) Which of the following would generally not need to be approved by the board of directors?
A) issuing capital stock
B) repurchasing capital stock
C) declaration of a dividend
D) payment of a dividend

2) Which of the following owners' equity transactions usually require specific authorization from
a company's board of directors?
A)
Repurchase of common Issuance of common
stock stock Declaration of dividends
Yes Yes Yes

B)
Repurchase of common Issuance of common
stock stock Declaration of dividends
Yes Yes No

C)
Repurchase of common Issuance of common
stock stock Declaration of dividends
No Yes No

D)
Repurchase of common Issuance of common
stock stock Declaration of dividends
No No Yes

3) When a company maintains its own records of stock transactions and outstanding stock,
internal controls must be adequate to ensure that
A) actual owners are recorded in the bylaws.
B) the correct amount of dividends is paid to stockholders owning the stock on the dividend
record date.
C) the correct amount of dividends is paid to stockholders owning the stock on the declaration
date.
D) actual owners are recorded in the minutes.

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4) The amount of time spent verifying owners' equity is frequently minimal for closely held
corporations because
A) these companies are so small that it is not necessary to audit the capital section.
B) the few owners all have access to the books so the auditor spends more time on accounts like
liabilities, which affect outsiders.
C) there are few if any transactions during the year for the capital stock accounts, except for
earnings and dividends.
D) there is no public interest in these companies.

5) Which of the following types of owners' equity transactions would require authorization by
the board of directors?
A) issuance of capital stock
B) repurchase of capital stock
C) declaration of dividends
D) all of the above

6) The record of the issuance and repurchase of capital stock for the life of the corporation is
maintained in the
A) shareholders' capital stock master file.
B) capital stock certificate record.
C) schedule of stock owners.
D) corporate directory.

7) The record of the outstanding shares at any given time is maintained in the
A) corporate directory.
B) stock certificate books.
C) schedule of stock owners.
D) shareholders' capital stock master file.

8) When a dividend is declared by the board of directors, the source for determining who should
receive dividend checks is the
A) shareholders' capital stock master file.
B) stock certificate books.
C) common stock account in the general ledger.
D) corporate directory.

9) The authorization of an issuance of capital stock normally includes all but which of the
following?
A) type of stock to be issued
B) number of shares to be issued
C) date shares are to be issued
D) amount of dividend to be paid on shares issued

10) Any company with stock listed on a securities exchange is required to engage a(n)
A) equity analyst.
B) stock transfer agent.
C) independent registrar.
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D) equity placement specialist.

11) All of the following are owners' equity accounts except for
A) common stock.
B) paid-in-capital in excess of par.
C) sales.
D) retained earnings.

12) When a company maintains its own records of stock transactions and capital stock
outstanding, its internal controls must be adequate to accomplish three objectives. List them
below.

13) What is the difference between an independent registrar and a stock transfer agent?

14) What are two important internal control procedures that companies should implement to
prevent misstatements in owners' equity when a company maintains its own records of stock
transactions and outstanding stock?

15) Discuss the internal controls related to owners' equity that are of concern to the auditor.

16) Match six of the terms (a-i) used in the capital acquisitions and repayment cycle with the
descriptions provided below (1-6):

a. capital acquisition and repayment cycle

b. capital stock certificate book
c. closely held corporation
d. independent registrar
e. note payable
f. publicly held corporation
g. stock transfer agent
h. schedule of notes payable and accrued interest
i. stock maintenance agent

________ 1. an outside person engaged by a corporation to make sure that its stock is issued in
accordance with capital stock provisions in the corporate charter and authorizations by the board
of directors

________ 2. the normal starting point for the audit of notes payable; includes detailed
information of all transactions related to notes payable that took place during the year

________ 3. a record of the issuance and repurchase of capital stock for the life of the
corporation

________ 4. an outside person engaged by a corporation to maintain the stockholder records, and
often to disburse cash dividends

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________ 5. an entity that is required to engage an independent registrar

________ 6. the cycle that concerns the acquisition of capital resources through interest-bearing
debt and owners' equity and repayment of the capital

True false questions

17) The Securities and Exchange Commission requires companies listed on exchanges to employ
stock transfer agents.

18) Public companies whose stock is listed on a stock exchange must employ an independent
registrar.

19) The shareholders' capital stock master file is used as the basis for the payment of dividends
and also acts as a check on the accuracy of the common stock balance in the general ledger.

20) Independent registrars commonly disburse cash dividends to shareholders.

21) Few large companies employ stock transfer agents, but small companies commonly do so.

22) Most closely held corporations have numerous transactions during the year for capital stock
accounts.

23) A shareholders' capital stock master file is a record of the issuance and repurchase of capital
stock over the life of the corporation.

24) The board of directors must authorize the amount of the dividend per share and the dates of
record and payment of the dividend.

22.4 Learning Objective 22-4

1) In auditing debits and credits to retained earnings, other than net income and dividends, the
auditors first concern is
A) whether the transactions should have been included in retained earnings.
B) whether the transactions have been accurately recorded.
C) whether the transactions are classified correctly in the footnotes.
D) whether the transactions existed as of the balance sheet date.

2) Which of the following is an important source of information for determining whether the
presentation and disclosure-related objectives for capital stock activities are satisfied?
A) the corporate charter
B) the minutes of board of directors meetings
C) the auditor's analysis of capital stock transactions
D) all of the above

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3) Which of the following audit objectives is least important in the audit of capital stock and
paid-in-capital in excess of par?
A) completeness
B) accuracy
C) rights and obligations
D) presentation and disclosure

4) The primary concern in determining whether retained earnings is correctly disclosed on the
balance sheet is
A) correct calculation of the net income or loss for the year.
B) correct calculation of dividend payments for the year.
C) whether prior-period adjustments have been made correctly.
D) whether there are any restrictions on the payment of dividends.

5) When verifying if capital stock is accurately recorded,

A) the ending balance in the account does not need to verified.
B) the number of shares outstanding at the balance sheet date is verified by examining the
corporate minutes.
C) the recorded par value can be determined by multiplying the number of shares by the market
price of the stock.
D) a confirmation from the transfer agent is the simplest way to verify the number of shares
outstanding at the balance sheet date.

6) What type of audit test will auditors use when testing to see if the amounts of capital stock
transactions are accurately recorded?
A)
Tests of details of Substantive tests of
balances transactions Tests of controls
No Yes Yes

B)
Tests of details of Substantive tests of
balances transactions Tests of controls
Yes No Yes

C)
Tests of details of Substantive tests of
balances transactions Tests of controls
No Yes No

D)
Tests of details of Substantive tests of
balances transactions Tests of controls
Yes No No

7) Which of the following statements is correct regarding the audit of dividends?

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A) The emphasis is on the ending balance in the dividends account.
B) When auditors verify that the dividends are paid to stockholders that exist, they are concerned
with the completeness objective.
C) If the client uses a transfer agent to disburse dividends, the total can be traced to a cash
disbursement entry to the agent and also confirmed.
D) All of the above are correct statements.

8) When conducting the audit of stockholders' equity, it is normal practice to verify all capital
stock transactions
A) only when the client is small.
B) that are in excess of a material amount.
C) if there aren't very many during the year.
D) regardless of the controls in existence, because of their materiality and permanence in the
records.

9) If a company employs a capital stock registrar and/or transfer agent, the registrar or agent, or
both, should be requested to confirm directly to the auditor the number of shares of each class of
stock
A) surrendered and canceled during the year.
B) authorized at the balance sheet date.
C) issued and outstanding at the balance sheet date.
D) sold at a price above par during the year.

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10) State the four most important audit objectives for capital stock and describe how the auditor
typically verifies each of the four objectives.

True false questions

11) Auditing capital stock transactions as part of a merger is challenging because judgment is
often involved.

12) A prior period adjustment may result in a debit or credit to a company's retained earnings
account.

13) Any restrictions on the payment of dividends must be disclosed in the footnotes to the
financial statements.

14) The accuracy of a dividend declaration can be audited by recalculating the amount on the
basis of the dividend per share times the number of shares outstanding.

15) For most companies, the only transactions involving retained earnings are net earnings for
the year and dividends declared.

16) Examining the minutes of the board of directors' meetings for proper authorization ordinarily
tests the existence objective for capital stock transactions.

17) Examining the minutes of the board of directors' meetings for proper authorization ordinarily
tests the occurrence objective for capital stock transactions.

18) The emphasis in the audit of dividends is on the ending balance rather than the transactions.

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