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Part Five

AUDITING ACCOUNTING APPLICATIONS AND RELATED ACCOUNTS

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Chapter 15

CHAPTER 15 AUDITING LONG-TERM LIABILITIES, SHAREHOLDERS' EQUITY, AND INCOME STATEMENT ACCOUNTS

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TYPES OF LONG-TERM DEBT

Common types of long-term debt financing include notes, bonds, and mortgages. More sophisticated types of debt financing include collateralized mortgage obligations, repurchase and reverse repurchase agreements, interest rate swaps, financial futures, derivatives, etc.

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AUDITING LONG-TERM DEBT

The approach to the audit of long-term debt varies depending upon the frequency of the entitys financing activities. For entities that engage in frequent financing activities, the auditor may follow a reliance strategy under which internal control is formally evaluated and tests of controls are performed. For most entities, it is more efficient to follow a substantive strategy.

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CONTROL RISK ASSESSMENT LONG-TERM DEBT

The auditor needs a sufficient understanding of the entity's internal control over debt to be able to anticipate the types of misstatements that may occur and thus plan the substantive tests. The internal control objectives that are of primary concern to the auditor are validity, authorization, completeness, valuation, and classification.

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SUBSTANTIVE TESTS OF LONG-TERM DEBT

Substantive tests for auditing long-term debt involve examining any new debt agreements, determining the status of prior debt agreements, and confirming balances and other relevant information with outside parties. Table 15-1 summarizes the main tests of account balances for long-term debt. Exhibit 15-2 contains an indication of the audit procedures performed on the details of the debt schedule.

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AUDITING SHAREHOLDERS' EQUITY

Shareholders' equity includes common share, preferred share, paid-in-capital, and retained earnings. In recent years, numerous financial instruments have been developed that contain both debt and equity characteristics which affect the audit of shareholders' equity. There has also been a myriad share option and compensation plans that have an impact on the audit of shareholders' equity.

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TYPES OF TRANSACTIONS

Issuance of share Repurchase of share Payment of dividends

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CONTROL RISK ASSESSMENT SHAREHOLDERS EQUITY

A substantive strategy is most often used to audit shareholders' equity because the number of transactions is usually small. Although control risk can then be assessed at the maximum, the auditor must still understand the types of control procedures that are in place to prevent misstatement of equity transactions.

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OUTSIDE AGENTS

Registrar is responsible for insuring that all share issued is in compliance with the corporate charter and for maintaining control totals for shares outstanding. Transfer agent is responsible for preparing share certificates and maintaining adequate shareholders' records. Dividend disbursing agent prepares and mails dividend checks to the shareholders of record.

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CONTROL OBJECTIVES FOR SHAREHOLDERS EQUITY

Verify that share and dividend transactions comply with the corporate charter (validity). Verify that share and dividend transactions have been properly approved (authorization). Verify that share and dividend transactions have been properly valued (valuation). Verify that all share and dividend transactions have been properly posted and summarized in the accounting records (posting and summarization).

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SEGREGATION OF DUTIES FOR SHAREHOLDERS EQUITY

The individuals responsible for issuing, transferring, and canceling share certificates should not have any accounting responsibilities. The individual responsible for maintaining the detailed shareholders' records should be independent of the maintenance of the general ledger control accounts. The individual responsible for maintaining the detailed shareholders' records should not also process cash receipts or disbursements. Appropriate segregation of duties should be established among the preparation, recording, signing, and mailing of dividend checks.
2002 McGraw-Hill Ryerson Limited.

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AUDITING SHARE CAPITAL ACCOUNTS

The share capital accounts include common shares, preferred shares, and contributed surplus. The auditor is normally concerned with the validity, completeness, valuation, and disclosure objectives when auditing the share capital accounts. The audit begins by obtaining a schedule of all activity in the accounts for the current period. The beginning balance is agreed to the prior year's working papers and the ending balance is agreed to the general ledger. The majority of the auditor's work then focuses on the current period activity in each account.
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AUDITING DIVIDENDS

Generally, all dividends which are declared and paid will be audited because of concerns with violations of corporate bylaws or debt covenants. When the entity uses an independent dividend disbursing agent, the auditor can confirm the amount disbursed to the agent by the entity. This amount is agreed with the amount authorized by the Board of Directors. The auditor can recompute the dividend amount by multiplying the number of shares outstanding on the record date by the amount of the per-share dividend approved by the Board of Directors.
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AUDITING RETAINED EARNINGS

The audit of retained earnings begins by obtaining a schedule of the activity in the account for the period. The beginning balance is agreed to the prior year's working papers and financial statements. Net income or loss is traced to the income statement and the amounts for any cash or share dividends are verified. If there are any prior period adjustments, the auditor must ascertain that the transactions satisfy the requirements of the relevant accounting standards.

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AUDITING RETAINED EARNINGS (cont.)

Any new appropriations or changes in existing appropriations, should be traced to the contractual agreement that required the appropriation. The auditor must ensure that all necessary disclosures are made.

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AUDITING INCOME STATEMENT ACCOUNTS

Assessment of the results of testing controls for the various accounting cycles. Assessment of the results of the direct tests of balance sheet accounts and the related income statement accounts. Performance of analytical procedures on income statement accounts. Test of selected income statement accounts.

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2002 McGraw-Hill Ryerson Limited.