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Chapter 10 Audit of The Financing Cycle

The document summarizes the key aspects of auditing a company's financing cycle. It discusses the nature of the financing cycle, activities related to debt obligations and shareholders' equity, accounts affected, relevant documents, types of financing, and the phases of auditing the financing cycle including risk assessment and obtaining evidence about internal controls and substantive evidence for debt and equity transactions.

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CASTILLO, MA. CHEESA D.
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666 views17 pages

Chapter 10 Audit of The Financing Cycle

The document summarizes the key aspects of auditing a company's financing cycle. It discusses the nature of the financing cycle, activities related to debt obligations and shareholders' equity, accounts affected, relevant documents, types of financing, and the phases of auditing the financing cycle including risk assessment and obtaining evidence about internal controls and substantive evidence for debt and equity transactions.

Uploaded by

CASTILLO, MA. CHEESA D.
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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CHAPTER 10 AUDIT OF THE FINANCING

CYCLE

CAMPANIA, KYLA R.
CARCUSIA DARILYN
CALUMPANG, LOEGIE A.
CASTILLO, MA CHEESA
CORNADO, MERIJOT G.
NATURE OF THE FINANCING CYCLE

FINANCING CYCLE
- INCLUDES THE PROCESSES, PROCEDURES AND POLICIES FOR AUTHORIZING, EXECUTING AND
RECORDING TRANSACTIONS INVOLVING BANK LOANS, LEASES, BONDS PAYABLE AND EQUITY
SHARE CAPITAL.

- THIS CYCLE INVOLVES THE RESPONSIBILITIES OF PLANNING THE CASH NEEDS AND RAISING
CAPITAL.
ACTIVITIES RELATED TO FINANCING CYCLE

Debt Obligations Shareholders Equity

Bonds Issuance; amortization of Share Issuance


bond discount/premium ( if any)

Issuance of Long-term note/ Purchase / Sale of Treasury Shares


mortgage payable

Refinancing debts of principal Declaration/ payment of dividend


Periodic payments and interest Transfer of net income to retained
expense earnings
ACCOUNTS AFFECTED BY THE FINANCING CYCLE

❖ Notes payable
❖ Paid in capital in excess of capital
❖ Contracts payable
❖ Mortgage payable
❖ Donated capital
❖ Bonds payable ❖ Retained earnings
❖ Interest expense ❖ Appropriations of retained earnings
❖ Accrued interest ❖ Treasury stock
❖ Cash in bank ❖ Dividends declared
❖ Capital stock-common ❖ Proprietorship- capital account
❖ Capital stock- preferred ❖ Partnership- capital account
DOCUMENTS AND
RECORDS
1. SHARE CERTIFICATE
2. BOND CERTIFICATE
3. BOND INDENTURE
4. BROKER’S ADVICE
5. PROMISSORY NOTE
TYPES OF FINANCING
DEBT FINANCING
EQUITY FINANCING
AUDITING THE FINANCING
CYCLE
PHASE I – RISK ASSESSMENT

Possible errors related to financing activities:

▪ Failing to make interest accruals, or making them twice


▪ Accruing interest in the wrong period
▪ Making incorrect estimates of allowances for obligations
▪ Failing to recognize that the entity violated a debt agreement
▪ Failing to record dividend that were declared
A. Performing Risk Assessment for Debt Obligation Transactions
(Debt Financing)

1. Identifying Inherent Risks


o Authorization of Debt
o Recording of debt transactions
o Compliance with any debt covenants

2. Identifying Fraud Risk Factors


o Debt obligations are not properly authorized
o Long-term or short-term debt is misclassified
o Interest expense is recorded in the wrong period, at the wrong amount,
not recorded at all, or misclassified
o Entire loan payments are charged to either principal or interest

3. Identifying Control Risks

4. Performing Preliminary Analytical Procedures


✓ Trend analysis
B. Performing Risk Assessment Procedures for Shareholders’ Equity
Transactions (Equity Financing)

1. Identifying Inherent Risk


Base on specific shareholders’ equity activities:
➢ Sales and Issuance of Equity Shares
➢ Purchase of Treasury Shares
➢ Dividend
➢ Shares Options and Warrants

2. Identifying Fraud Risk Factors


o Sales of Issuance of equity shares that are not authorized
o Dividends are paid to wrong parties or at wrong amounts
o Proceeds from stock sales are misappropriated

3. Identifying Control Risks

4. Performing Preliminary Analytical Procedures


✓ Comparison of account balances (current and prior year)
PHASE II: RISK RESPONSE

I. Obtaining Evidence About Internal Control Operating Effectiveness for Debt


Obligations and Stockholders' Equity Transactions

1. Current Liabilities (other those arising from trade credit and operating expenses)
a. A system authorization on both as to original transaction and as to payment should
be well-defined as established.
b. A satisfactory system of record keeping with adequate forms and documentation
should be instituted.
c. There should be a plan of organization with appropriate diviaion of duties, provision
for fixing responsibility and requiring authorization and approval.
2. Long-term Liabilities
a. Long-term obligations should be properly authorized by the board of directors or by a
required majority of shareholders.
b. Proper control should be exercised over the payment of interest on long-term
liabilities. Payment may be done by an independently engaged interest-paying
agent.
3. Equity Share Capital
a. Internal control measures regarding the issuance of share certificates and proper
accounting for transfer and registration of shares should be established.
b. Share certificates should be serially prenumbered by the printer and that the authority
for signing and issuing the certificates be designated by the board of directors.
c. As individual certificates are issued, corresponding records of the certificates should
be prepared containing the name and address of the shareholders and the number
of shares issued to each.
d. Entries for share issuances and transfers should be made by a person who does not
have authority to sign and issue certificates.
II. Obtaining Substantive Evidence in Auditing Debt Obligations and Shareholders'
Equity Transactions

Substantive Tests of Details: Debt Obligations Transactions


• Reading new loan agreements
• Determining what changes, if any, have been made to prior loan agreements
• Confirming with relevant outside parties the significant factors and transactions
that have occurred

Substantive Tests of Details - Shareholders' Equity Transactions


• The auditor should review a copy of the client's article of incorporation. The
auditor can agree that information to the disclosures included in the client's
financial statements. The auditor will also prepare, or ask the client to prepare an
analysis of all capital stock transactions.
• The auditor will inspect documentation related to the client's record keeping of
capital stock and contributed capital.
• The auditor should review the minutes of the board of directors’ meetings and
examine the stock records books (or confirm with the registrar and transfer agent)
to determine issuance and repurchase of capital stock.
• For those clients with treasury stock, the auditor will examine documentation
supporting changes in the number of shares since the prior year.
• Dividends - The auditor examines the minutes of the board of directors’ meetings for
authorization of the dividends per share amount and the dividend record date. The
auditor will also want to obtain evidence as to whether the payment was made to
the stockholders who owned the stock as of the dividend record date. The auditor
also needs to be aware of restrictions related to dividend payments and determine
that the restrictions are adequately disclosed in the financial statements.
• Retained earnings - The auditor typically examines all transactions recorded in the
retained earnings account during the audit period. The common entries include net
income or loss. These amounts would be tested through substantive audit
procedures related to revenues and expenses.

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