capital investment cycle accounting principals

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Capital investment cycle accounting principals best tax saving investment 2021 chevy

Capital investment cycle accounting principals

What are some enquiries auditors can make? As in previous chapters, some casettes illustrating errors, frauds in the accounting irregularities and frauds are used to describe useful audit approaches. In addition, this chap- for capital transactions and investments, and ter gives some assertions and procedures related to accounts in the cycle. Method: A cause of the misstatement mistaken estimate or judgment, accidental error, intentional irregularity or fraud attempt , which usually is made easier by some kind of failure of controls.

Amount: The dollar amount of overstated assets and revenue, or understated liabilities and expenses. Each audit program for the audit of an account balance contains an Audit Approach that may enable auditors to detect misstatements in account balances.

Each application of pro- cedures contains these elements: Audit objective: A recognition of a financial statement assertion for which evidence needs to be obtained. The assertions are about the existence of assets, liabilities, revenue and expenses; their valuation; their complete inclusion in the account balances; the rights and obligations inherent in them; and their proper presentation and disclosure in the financial statements.

These assertions were introduced in Chapter 4. Control: A recognition of the control procedures that should be used by an organiza- tion to prevent and detect errors and irregularities. Audit of balance: Ordinary and extended substantive procedures designed to find signs of mistaken accounting estimates, errors, irregularities and frauds in account balances and classes of transactions.

The cases first set the stage with a story about an accounting estimate, error, irregular- ity or fraud—its method, paper trail if any and amount. The second part of the casette, under the heading of Audit Approach, tells a structured story about the audit objective, desirable controls, test of control procedures, audit of balance procedures and discovery summary.

The Audit Approach segment illustrates how audit pro- cedures can be applied and the discoveries they may enable auditors to make. At the end of the chapter, some similar discussion cases are presented, and you can write the Audit Approach to test your ability to design audit procedures for the detection of mistaken accounting estimates, errors, irregularities and frauds.

Typical specific assertions include: 1. The number of shares shown as issued is in fact issued. No other shares including options, warrants and the like have been issued and not recorded or reflected in the accounts and disclosures.

The accounting is proper for options, warrants and other share issue plans, and related disclosures are adequate. The valuation of shares issued for noncash consideration is proper, in conformity with accounting principles. Transactions can be vouched to these documents, and the cash proceeds can be traced to the bank accounts. Confirmation Share capital may be subject to confirmation when independent registrars and transfer agents are employed.

The basic information about share capital—such as number of shares, classes of shares, preferred dividend rates, con- version terms, dividend payments, shares held in the company name, expiration dates and terms of warrants and share dividends and splits—can be confirmed with the independent agents. However, when there are no independent agents, most audit evidence is gathered by vouching share record documents such as certificate book stubs.

When circumstances call for extended procedures, information on outstanding shares may be confirmed directly with the holders. Method Bliss salespeople contacted potential investors and sold many of them limited partnership interests. The setup deal called for these limited partnerships to purchase solar hot water heating systems for residential and com- mercial use from Bliss. All the partnerships entered into arrangements to lease the equipment to Nationwide Corporation, which then rented the equipment to end users.

Paper Trail Bliss published false and misleading financial statements, which used a non-GAAP revenue recognition method and failed to disclose cost of goods sold. Amount Not known, but all the money put up by the limited partnership investors was at risk largely not disclosed to the investors. AUDIT APPROACH Audit Objective Audit of Balances Obtain evidence to determine whether capital fund- Auditors should study the offering documents and lit- raising methods comply with provincial securities erature used in the sale of securities to determine laws and whether financial statements and other dis- whether financial information is being used properly.

Management should employ experts—lawyers, under- writers and accountants—who can determine whether Discovery Summary securities and investment contract sales do or do not require registration. They apparently did not question the legality of the sales of the limited Test of Controls partnership interests as a means of raising capital.

They apparently did not perform procedures to verify Auditors should learn the business backgrounds and representations made in offering literature respecting securities-industry expertise of the senior managers. Bliss or Nationwide finances. Two partners in the Study the minutes of the board of directors for author- audit firm were enjoined from violations of the secu- ization of the fund-raising method.

Obtain and study rities laws. They resigned from practice before the opinions rendered by lawyers and underwriters OSC and were ordered not to perform any assurance about the legality of the fund-raising methods. Enquire services for companies making filings with the OSC. The OSC will give advice about co-operate with the Disciplinary Committee in its the necessity for registration.

Confident that future taxable income would absorb the loss, the company booked and reported a tax bene- fit for the tax loss carryforward. Method Aetna forecasted several more years of taxable losses aside from its nontaxable income from tax-exempt investments , then forecasted years of taxable income, eventually offsetting the losses and obtaining the ben- efit of the tax law allowing losses to be carried forward to offset against future taxable income.

The company maintained there was no reasonable doubt that the forecasts would be achieved. Paper Trail The amounts of tax loss were clearly evident in the accounts. Aetna made no attempt to hide the facts. The size of the portfolio of taxable investments and all sources of taxable income and deductions were well known to the company accountants, management and independent auditors. Aetna and its auditors argued the tax loss carryforward benefit. These forecasts are on the basis of the forecasts.

When were they prepared? For this reason, the What data were used? The OSC won the argu- the forecast with actual experience? Aetna revised its previously issued quarterly financial statements, and the company abandoned Audit of Balances the attempt to report the tax benefit.

Aside from audit of the assumptions underlying the Long-term Liabilities and Related Accounts forecast and recalculations of the compilation, the test of balances amounted to careful consideration of The primary audit concern with the verification of long- whether the forecast, or any forecast, could meet the term liabilities is that all liabilities are recorded and that test required by accounting standards. The decision the interest expense is properly paid or accrued.

Alertness to the possibility of unrecorded liabilities dur- The auditors should obtain information about ing the performance of procedures in other areas fre- other situations in which recognition of tax loss car- quently will uncover liabilities that have not been ryforward benefits were allowed in financial state- recorded. For example, when fixed assets are acquired ments. Other companies have booked and reported during the year under audit, auditors should enquire such benefits when gains from sales of property were about the source of funds for financing the new asset.

Repurchase or remarketing agreements. Vouching of contracts, confirmation by customer, enquiry of client management. Commitments to purchase at fixed prices. Vouching of open purchase orders, enquiry of purchasing personnel, confirmation by supplier. Commitments to sell at fixed prices. Vouching of sales contracts, enquiry of sales personnel, confirmation by customer.

Loan commitments. Vouching of open commitment file, enquiry of loan officers. Lease commitments. Vouching of lease agreement, confirmation with lessor or lessee. Some common types of commitments are shown in Exhibit 12—4. All material long-term liabilities are recorded.

Footnote disclosure should be considered for the 2. Liabilities are properly classified according to their types of commitments shown in Exhibit 12—4. Some current or long-term status. The current portion of of them can be estimated and valued and, thus, can long-term debt is properly valued and classified. New long-term liabilities and debt extinguish- price purchase commitments and losses on fixed-price ments are properly authorized.

Terms, conditions and restrictions relating to non- Analytical relationships interest expense generally current debt are adequately disclosed. Disclosures of maturities for the next five years Based on the evidence of long-term liability transac- and the capital and operating lease disclosures tions including those that have been retired during are accurate and adequate. All important contingencies are either accrued in recalculated.

The amount of debt, the interest rate the accounts or disclosed in footnotes. By comparing the audit results to cedures for notes payable and long-term debt is in the recorded interest expense and accrued interest Appendix Exhibit 12A—2. In the case of notes payable to 3 interest expense equal to their calculations. The banks, the standard bank confirmation may be used.

Examples of working confirmed by requests to holders or a trustee. The con- papers showing this interrelationship and recalcula- firmation request should include questions not only of tion of interest expense and other notes payable pro- amount, interest rate and due date but also about col- cedures are presented in Problems Confirmation requests should be sent to lenders with whom the com- Deferred Credits—Calculated Balances pany has done business in the recent past, even if no liability balance is shown at the confirmation date.

Several types of deferred credits depend on calcula- Such extra coverage is a part of the search for tions for their existence and valuation. Examples unrecorded liabilities. All of these features are are terms of loan agreements, leases, endorsements, incorporated in calculations that auditors can check guarantees and insurance policies whether issued by for accuracy.

Related party transactions were not disclosed. The officers negotiated a month loan with a major bank to get the money Veritas used for the purchase, pledging the inventory as collateral. Nothing mentioned the relation of Veritas to the officers. Nothing mentioned the repurchase obligation.

However, the sale amount was unusually large. While the current asset total was not changed, the inventory ratios e. Long-term liabilities were understated by not recording the liability. The ploy was actually a secured loan with inventory pledged as collateral, but this reality was neither recorded nor disclosed.

The total effect would be to keep debt off the books, to avoid recording interest expense and later to record inventory at a higher cost. Subsequent sale of the whiskey at market prices would not affect the ultimate income results, but the unrecorded interest expense would be buried in the cost of goods sold. Be alert to undisclosed related party between the officers and Veritas. Confronted, the pres- transactions. The relevant control in this case would rest with the integrity and accounting knowledge of the senior Investments and Intangibles officials who arranged the transaction.

Authorization in the board minutes might detail the arrangements; Companies can have a wide variety of investments but, if they wanted to hide it from the auditors, they and relationships with affiliates. Investments account- also would suppress the telltale information in the ing may be on the cost method, equity method without board minutes. Purchase-method consolidations usually create prob- Test of Controls lems of accounting for the fair value of acquired assets Enquiries should be made about large and unusual and the related goodwill.

Specific assertions typical of financing transactions. This may not elicit a response a variety of investment account balances are these: because the event is a sales transaction, according to Verity. Other audit work on controls in the revenue 1. Investment securities are on hand or are held in and collection cycle may turn up the large sale. Fortunately, this one sticks out as a large one. Investment cost does not exceed market value valuation.

Audit of Balances 3. Significant influence investments are accounted Analytical procedures to compare monthly or sea- for by the equity method valuation. Purchased goodwill is properly valued valuation. This identification should lead to an 5. Capitalized intangible costs relate to intangibles examination of the sales contract.

Auditors should acquired in exchange transactions valuation. Research and development costs are properly knowledgeable officials. If being this close to dis- classified presentation. Amortization is properly calculated valuation.

Investment income has been received and re- name is not a giveaway, a quick enquiry at the cor- corded completeness. Investments are adequately classified and consumer and commercial relations for corporation described in the balance sheet presentation. A request for the cedures for investments, intangibles and related financial statements of Veritas should be made.

This difference has internal control evidence of cost. At the same time, the amounts of and substantive audit procedure implications. Auditors should determine transactions, since each individual transaction is what method of cost-out assignment was used i. The cost classification and accounting method. The controls of real and personal property likewise can be usually are not reviewed, tested and evaluated at an vouched to invoices or other documents of purchase, interim date but are considered along with the year- and title documents such as on land, buildings may end procedures when the transactions and their be inspected.

Market valuation of securities may be required in A few of the trouble spots in audits of investments some cases. While a management may assert that an and intangibles are in the box below. Auditors should review investment The practice of obtaining independent written confir- transactions subsequent to the balance sheet date for mation from outside parties is fairly limited in the this kind of evidence about lower-of-cost-or-market area of investments, intangibles and related income valuation.

The principal evidence as that obtained in a physical count by the auditor problem is to determine whether costs are properly described earlier in this chapter. Recorded amounts generally are selected on a sample basis, Enquiries About Intangibles and the purchase orders, receiving reports, payroll records, authorization notices and management Company counsel can be queried about knowledge reports are compared to them.

This confirmation costs , so auditors must be very careful in the vouch- can be sought by a specific request in the enquiry let- ing to be alert for costs that appear to relate to other ter to the law firm. Chapter 13 contains more infor- operations. External Documentation Income from Intangibles By consulting quoted market values of securities, Royalty income from patent licences received from a auditors can calculate market values and determine single licencee may be confirmed.

However, such whether investments should be written down. If such Inspection financial statements are unaudited, evidence indi- Investment property may be inspected in a manner sim- cated by them is considered to be extremely weak. The prin- Income amounts can be verified by consulting cipal goal is to determine actual existence and published dividend records for quotations of divi- condition of the property.

Official documents of patents, dends actually declared and paid during a period copyrights and trademark rights can be inspected to e. Reason- able amortization life for goodwill. Any differ- culation based on audited costs and rates is sufficient ence could indicate a cutoff error, misclassification, audit evidence. In a similar manner, application of interest reviewed in terms of the appraisals, judgments and rates to bond or note investments produces a calcu- allocations used to assign portions of the purchase lated interest income figure making allowance for price to tangible assets, intangible assets, liabilities amortization of premium or discount if applicable.

In the final analysis, nothing really substitutes for the inspection of transaction documen- Equity Method Investments tation, but verbal enquiries may help auditors to understand the circumstances of a merger. When equity method accounting is used for invest- Questions about lawsuits challenging patents, ments, auditors will need to obtain financial state- copyrights or trade names may produce early knowl- ments of the investee company. These should be edge of problem areas for further investigation.

Inability to obtain financial state- Likewise, discussions and questions about research ments from a closely held investee may indicate that and development successes and failures may alert the client investor does not have the significant con- the audit team to problems of valuation of intangible trolling influence required by Handbook Section assets and related amortization expense.

Responses When available, these statements are to questions about licensing of patents can be used used as the basis for recalculating the amount of the in the audit of related royalty revenue accounts. The classification will Amortization of goodwill and other intangibles should affect the accounting treatment of market values and be recalculated. Like depreciation, amortization ex- the unrealized gains and losses on investments.

Digilog income was over- stated, and assets and liabilities were understated. Method Digilog, Inc. See Handbook Section It was authorized. Incorporation papers were available. Amount Several hundred thousand dollars of losses in the first two years of DBSI operations were not consolidated.

Ultimately, the venture became profitable and was absorbed into Digilog. The reg- Audit of Balances ulator disagreed and took action on the position that The central issue in this case was the interpretation of the convertible feature of the loans and the business accounting standards regarding required consolida- purpose of the DBSI formation were enough to attrib- tion.

Existence, completeness, valuation and owner- ute control to Digilog. The company was enjoined ship were not problematic audit issues. Unless these from violating certain reporting and antifraud provi- are extenuating factors Handbook Section The regulator tion of subsidiaries owned less than 50 percent.

Refer to the off-balance sheet and consolidation cases in the chapter. Improper accounting presentations are engineered more frequently by senior officials than by mid- dle management or lower ranks. Auditors should be alert for such fictions in the same sense that they are alert to the possibility of having fictitious accounts receivable. This class of fraud is most often accomplished through material misrepresentations or omissions in financial statements and related disclosures.

Officers and employees can use share or bond instruments improperly. Unissued shares or bonds and treasury stock may be used as collateral for personal loans. Even though the company may not be damaged or suffer loss by this action unless the employee defaults and the securities are seized , the practice is unauthorized and is contrary to company inter- ests.

Similarly, employees may gain access to shareholder lists and unissued coupons and cause improper payments of dividends and interest on securities that are not outstanding. Proper custodial control of securities either by physical means, such as limited-access vaults, or by control of an independent disbursing agent prevents most such occurrences.

An auditing procedure of reconciling authorized dividend and interest payments calcu- lated using declared dividend rates, coupon interest rates and known quantities of out- standing securities to actual payments detects unauthorized payments. If the company did not perform this checking procedure, auditors should include it among their own analyti- cal recalculation procedures.

Many liability, equity and off-balance-sheet transactions are outside the reach of normal internal control procedures, which can operate effectively over ordinary transactions such as purchases and sales processed by clerks and machines. Auditors generally are justified in performing extensive substantive auditing of long-term liability, equity and other high-level managed transactions and agreements since control depends in large part on the integrity and accounting knowledge of management.

Income tax evasion and fraud result from actions taken by managers. Evasion and fraud may be accomplished 1 by simple omission of income, 2 by unlawful deductions such as contributions to political campaigns, capital cost allowance on nonexistent assets or cap- ital cost allowance in excess of cost , or 3 by contriving sham transactions for the sole purpose of avoiding taxation.

Auditors should be able to detect errors of the first two cat- egories if the actual income and expense data have been sufficiently audited in the finan- cial statements. The last category—contrived sham transactions—is harder to detect because a dishonest management can skilfully disguise them.

Some of the procedures out- lined in Chapter 19 may be useful and effective. Financial statements may be materially misstated by reason of omission or understate- ment of liabilities and by failure to disclose technical defaults on loan agreement restric- tions.

These restrictions or test covenants can be very important to the viability of the client because if they are violated, creditors can force the client into bankruptcy. In essence, if the auditor suspects that the financial statements are misstated, he or she should perform procedures to confirm or dispel that suspicion. Generally, the auditor is less likely to detect material misstatements arising from fraud because of the deliberate concealment involved.

The auditor should inform the appropriate level of management whenever he or she obtains evidence of a nontrivial misstatement; and the audit committee or board of direc- tors should be informed of all significant misstatements Section A company, its individual managers and the auditors can violate securities regulations if they are not careful.

Chapter 17 covers the general framework of regulation by provin- cial securities commissions. Auditors must know the provisions of the securities laws to the extent that they can identify situations that constitute obvious fraud, and so that they can identify transactions that may be subject to the law. Having once recognized or raised ques- tions about a securities transaction, auditors should not act as their own lawyer.

The facts should be submitted to competent legal counsel for an opinion. Even though auditors are not expected to be legal experts, they have the duty to recognize obvious instances of impropriety and to pursue investigations with the aid of legal experts. Similarly, auditors should assist clients in observing securities commission rules and regulations on matters of timely disclosure. Various rule provisions require announcements and disclosures very soon after information becomes known.

Often, relevant situations arise during the year when the independent auditors are not present, so, of course, they cannot be held responsible or liable. In such cases auditors should advise their clients, con- sistent with the requirements of law and regulations. Presently, pressures are on the auditors to discover more information about off-balance sheet contingencies and commitments and to discover the facts of management involvement with other parties to transactions.

Nevertheless, certain investigative procedures are available Chapter The current pressures on auditors to discover more information is a part of the public pressure on auditors to take more responsibility for fraud detection. Investments and Intangibles Theft, diversion and unauthorized use of investment securities can occur in several ways.

If safekeeping controls are weak, securities simply may be stolen, in which case the theft becomes a police problem rather than an auditing problem. If safekeeping meth- ods require entry signatures as at a safe-deposit vault , auditors may be able to detect the in-and-out movement.

The best chance of discovery is that the creditor will confirm the col- lateral arrangement. The rapid growth in use of derivative securities as invest- ments and hedges has created new and rather unique problems for auditors, not the least of which is lack of familiarity with these financial instruments. Appendix Exhibit 12A—4 pro- vides an overview of the recent global problems in this area. Cash receipts from interest, royalties on patent licences, dividends and sales proceeds may be stolen.

The accounting records may or may not be manipulated to cover the theft. In general, this kind of defalcation should be prevented by cash receipts control; but, since these receipts usually are irregular and infrequent, the cash control system may not be as effective as it is for regular receipts on trade accounts. If the income accounts are not manipulated to hide stolen receipts, auditors will find less income in the account than the amount indicated by their audit calculations based on other records, such as licence agree- ments or published dividend records.

If sales of securities are not recorded, auditors will notice that securities are missing when they try to inspect or confirm them. If the income accounts have been manipulated to hide stolen receipts, vouching of cash receipts will detect the theft, or vouching may reveal some offsetting debit buried in some other account. Accounting values may be manipulated in a number of ways, involving purchase of assets at inflated prices, leases with affiliates, acquisitions of patents for shares given to an inventor or promoter, sales to affiliates and fallacious decisions about amortization.

In one case a company sold assets to a dummy purchaser set up by a director to bolster sagging income with a gain. The auditors did not know that the purchaser was a shell. All the documents of sale looked in order, and cash sales proceeds had been deposited. The auditors were not informed of a secret agreement by the seller to repurchase the assets at a later time. This situation illustrates a very devious manipulation. All transactions with persons closely associated with the company related parties should be audited carefully with reference to market values, particularly when a nonmonetary transaction is involved such as shares exchanged for patent rights.

Sales and lease-back and straight lease trans- actions with insiders likewise should be audited carefully. These accounts involve some of the most technically complex accounting standards. They create most of the difficult judg- ments for financial reporting. Transactions in these accounts generally are controlled by senior officials. Therefore, inter- nal control is centred on the integrity and accounting knowledge of these officials. The pro- cedural controls over details of transactions are not very effective because the senior managers can override them and order their own desired accounting presentations.

Fraud and clever accounting in the finance and investment cycle get directed most often to producing misleading financial statements. Off-balance-sheet financing and investment trans- actions with related parties are explained as ripe areas for fraudulent financial reporting.

Chapter 14 contains several topics involved in putting the finishing touches on an audit. Determine whether bondholders are cial statements of Gamma Corporation persons other than owners, directors for the year ended June 30, Having or officers of the company issuing the completed an examination of the invest- bond.

Calculate the effective interest rate to the best method of verifying the accuracy see if it is substantially the same as the of recorded dividend income? Tracing recorded dividend income to c. Decide whether the bond issue was cash receipts records and validated de- made without violating state or local posit slips. Utilizing analytical review techniques d. Ascertain that the client has obtained and statistical sampling. Comparing recorded dividends with of the issue.

Changes in the share capital account rities is held by the client, planning by the are verified by an independent share auditor is necessary to guard against: transfer agent. Unauthorized negotiation of the secu- b. Stock dividends and stock splits dur- rities before they are counted. Unrecorded sales of securities after they by the shareholders. Stock dividends are capitalized at par c. Substitution of securities already counted or stated value on the dividend decla- for other securities which should be on ration date.

Entries in the share capital account can d. Substitution of authentic securities be traced to resolutions in the minutes with counterfeit securities. Be defaced and sent to the federal fi- value, the auditor should insist that: nance minister. The approximate market value of the investments be shown in parentheses The investments be classified as long should obtain written confirmation from term for balance sheet purposes with the transfer agent and registrar concerning: full disclosure in the footnotes.

Restrictions on the payment of divi- c. The loss in value be recognized in the dends. The number of shares issued and out- d. The equity section of the balance sheet standing. Guarantees of preferred share liquida- amount of the loss. The number of shares subject to agree- Evaluate internal control over securities. Minutes of the board of directors. Determine the validity of prepaid in- b.

Cash receipts journal. Cash disbursements journal. Ascertain the reasonableness of im- d. Numbered share certificates. Detect unrecorded liabilities. An sentative of the client be present during auditor will most likely obtain evidence the inspection and count of securities in of this patent by obtaining a written rep- order to: resentation from: a. A patent lawyer. A regional patent office.

Detect forged securities. The patent inventor. Co-ordinate the return of all securities d. The patent owner. Acknowledge the receipt of securities of the retained earnings account should returned. Market value used to charge retained sues its own shares and maintains share earnings to account for a two-for-one records, cancelled share certificates should: share split.

Be defaced to prevent reissuance and b. Approval of the adjustment to the be- attached to their corresponding stubs. Not be defaced, but segregated from down of an account receivables. Authorization for both cash and share a cancelled certificates file. Be destroyed to prevent fraudulent re- d. Gain or loss resulting from disposition issuance.

The treasurer is responsible for carrying out Corporation, a manufacturing company, All securities are stored in a bank safe- periodically invests large sums in mar- deposit vault. Its three questions: share and bond certificates are kept in a 1. Is investment policy established by safe-deposit box in a local bank. Only the the investment committee of the board president and the treasurer of the corpo- of directors?

Are all securities stored in a bank safe- available. Arrangements were made for deposit vault? Your assistant has never exam- In addition to the above three questions, ined securities that were being kept in a what questions should your internal con- safe-deposit box and requires instructions. Hint: Prepare ques- tions to cover the control objectives— Required: validity, completeness, authorization, ac- a. List the instructions that you would curacy, classification, accounting and give to your assistant regarding the proper period.

Include in your instructions the details You of the securities to be examined and the are engaged in the audit of the financial reasons for examining these details. After returning from the bank, your year ended December 31, and you are assistant reports that the treasurer had about to begin an audit of the noncurrent entered the box on January 4 to remove investment securities.

The photograph was bearer bonds, as well as 25 percent of the loaned to the local chamber of com- outstanding common shares of Commer- merce for display purposes. List the cial Industrial, Inc. Recently acquired securities are in the All other securities are in the com- June However, due to unexpected difficulties in Required: acquiring the building site, the plant ex- a. Assuming that the system of internal pansion had not begun as planned. Audit the recorded dividend or interest income?

You b. Determine market value? Establish the authority for security statements of the Demot Corporation for purchases? Work continued until October Accumulated when the company applied for a depreciation 10, patent. Costs were charged to the research Patents 85, and development expense account in both Leasehold improvements 26, years, except for the cost of a computer Prepaid expenses 10, program that engineers plan to use in Pro- Organization expenses 29, ject Baker, scheduled to start in Decem- Goodwill 24, ber The computer program was Licensing Agreement No.

Give an audit program for the audit of research and development costs on account. The patents had a remaining Project Able. Assume that you are legal term of 17 years. On January 3, , Sorenson pur- at December 31, What evidence would you require for at that time were believed to have un- the audit of the computer program that limited useful lives.

The balance in the has been capitalized as an intangible licensing agreement No. Sorenson Manufacturing tion of revenue from the agreement. Corporation was incorporated on January In December an explosion 3, You have been value of licensing agreement No. A study of licensing agreement No. The balance in the goodwill account 1. January ; b movable assembly 2. Company was not to pay dividends December ; and c real estate without permission from the bank. Monthly installment payments were to which, under the terms of the lease, commence July 1, In addition, during the year the com- Sorenson paid its rent in full during pany also borrowed, on a short-term basis, A year nonrenewable lease from the president of the company, sub- was signed January 3, , for the stantial amounts just prior to the year-end.

Required: 5. The balance in the organization ex- a. For the purposes of your audit of penses account includes preoperating the financial statements of Broadwall costs incurred during the organiza- Corporation, what procedures should tional period. Do not discuss internal Required: control. Prepare adjusting entries as necessary. What financial statement disclosures should you expect to find with respect AICPA adapted to the loan from the president?

The follow- You were engaged to ing covenants are extracted from the in- examine the financial statements of Ron- denture of a bond issue. The indenture lyn Corporation for the year ended June provides that failure to comply with its The long-term of noncompliance the regular date is 20 note agreement provided for the annual years hence. Give any audit steps or re- payment of principal and interest over porting requirements you believe should five years.

The existing plant was pledged be taken or recognized in connection with as security for the loan. Officers for this purpose shall include chairman of the board Required: of directors, president, all vice presi- a. What are the audit objectives in the dents, secretary and treasurer. Prepare an audit program for the ex- property which is security for this debt amination of the long-term note agree- insured against loss by fire to the ment between Ronlyn and Second extent of percent of its actual National Bank.

You 3. You are a PA en- able evidence of payment of same with gaged in an examination of the financial the trustee. Sussex has no-par, no-stated-value com- Pate Corporation was founded in During the past year, serves as its own registrar and transfer Sussex both issued and reacquired shares agent. There are no capital share sub- of its own common stock, some of which scription contracts in effect.

Addi- tional common share transactions occurred Required: among the shareholders during the year. Common share transactions can be a. Organize the audit program There are no other classes of shares, share under broad financial statement asser- rights, warrants or option plans.

What substantive audit procedures should b. After every other figure on the balance you apply in examining the common sheet has been audited, it may appear share and treasury share accounts? See Appendix Ex- audit retained earnings as they do the hibit 20A—1 for examples of substantive other figures on the balance sheet? Al and Billy Bob formed the leases. Al and Billy For Discussion Bob then donated one half of their re- a. Identify the issues in this situation as spective shares to the corporate treasury they relate to 1 conflicts of interest to be sold at par for working capital.

Required: b. Should the investment in Hardy Pro- a. Discuss the proper balance sheet pres- ducts Corporation be accounted for on entation of the leases and of the capi- the equity method? What evidence should the auditor seek b. What audit procedures would you with regard to the prices paid by Hardy apply to the leases? Consider the Hardware for products purchased from audit objectives in planning the proper Hardy Products Corporation? What information would you consider c. Must this share issue be reported or necessary for adequate disclosure in registered with the SEC?

You have been en- They give the problem, the method, the December In your review of the cor- paper trail and the amount. Your assignment is to porate nonfinancial records, you have write the Audit Approach portion of the case, or- found that Hardy Hardware owns 15 per- ganized around these sections: cent of the outstanding voting common Objectives: Express the objective in terms shares of Hardy Products Corporation.

Refer to dis- Hardy Products Corporation manufac- cussion of assertions in Chapter 4. James L. Hardy, president of Hardy lations that may arise from the situation de- Hardware, has supplied you with objective scribed in the case. John L. Hardy, his brother and ment manipulations. If there are no controls to president of Hardy Products. Another 20 percent is held by an to tap and the work to do.

The shares are listed on the ness, valuation, ownership or disclosure asser- American Stock Exchange. Hardy Hardware consistently has re- Discovery summary: Write a short statement ported operating profits greater than the about the discovery you expect to accomplish industry average. Hardy Products Corpo- with your procedures. The Hardy Products in- During the course of your Problem: A contrived amount of goodwill conversations with the Hardy brothers, was used to overstate assets and disguise you learn that you were appointed as au- a loss on discontinued operations.

Gulwest had at which goods have been sold to Hardy capitalized the start-up cost of the busi- Hardware. Examples of financing cash flows include cash proceeds from issuance of debt instruments such as notes or bonds payable, cash proceeds from issuance of capital stock, cash payments for dividend distributions, principal repayment or redemption of notes or bonds payable, or purchase of treasury stock.

Investors do not always take a negative cash flow as a negative. Why would investors and lenders be willing to place money with Amazon? Much of this was through delaying payment on inventories. Another reason lenders and investors were willing to fund Amazon is that investing payments are often signs of a company growing. Want to cite, share, or modify this book? Skip to Content. Principles of Accounting, Volume 1: Financial Accounting Table of contents. My highlights. Answer Key. Can a Negative Be Positive?

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Is a holiday home a good investment nzone The net gains and losses from Working Capital Fund operations must be reflected from year to year in the equity accounts of the Fund and the following principles must be applied to Working Capital Fund accounting and reporting:. The Balance Sheet. The Department must identify dollar capitalization criteria for recording transactions relating to major improvements. The company was enjoined ship were not problematic audit issues. The Chief Financial Officer CFO has delegated to the Bureau of Budget and Planning BPthe responsibility for requesting apportionments and reapportionments in accordance with operating plans approved by the Under Secretary for Management, and the responsibility for reporting on the use of apportionments and reapportionments to the Office of Management and Budget.
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Financial statement analysis consists of applying analytical tools and techniques to financial statements and other relevant data to obtain useful information. The information shows the results or consequences of prior management decisions. In addition, analysts use the information to make predictions that may have a direct effect on decisions made by users of financial statements. The balance sheet is an especially useful tool when it comes to the substantiation of various accounts. Balance sheet substantiation is the accounting process conducted by businesses on a regular basis to confirm that the balances held in the primary accounting system of record are reconciled in balance with with the balance and transaction records held in the same or supporting sub-systems.

It includes multiple processes including reconciliation at a transactional or at a balance level of the account, a process of review of the reconciliation and any pertinent supporting documentation, and a formal certification sign-off of the account in a predetermined form driven by corporate policy. Balance sheet substantiation is an important process that is typically carried out on a monthly, quarterly and year-end basis. The results help to drive the regulatory balance sheet reporting obligations of the organization.

Historically, substantiation has been a wholly manual process, driven by spreadsheets, email and manual monitoring and reporting. In recent years software solutions have been developed to bring a level of process automation, standardization and enhanced control to the substantiation or account certification process. Balance sheets are prepared with either one or two columns, with assets first, followed by liabilities and net worth. Balance Sheet Preparation : How to prepare a balance sheet.

All balance sheets follow the same format: when two columns are used, assets are on the left, liabilities are on the right, and net worth is beneath liabilities. When one column is used, assets are listed first, followed by liabilities and net worth. Balance sheets are usually prepared at the close of an accounting period.

To start, focus on the current assets most commonly used by small businesses: cash, accounts receivable, inventory and prepaid expenses. Cash includes cash on hand, in the bank, and in petty cash. Accounts receivable is what you are owed by customers. To make this number more realistic, an amount should be deducted from accounts receivable as an allowance for bad debts. Inventory may be the largest current asset.

On a balance sheet, the value of inventory is the cost required to replace it if the inventory were destroyed, lost, or damaged. Inventory includes goods ready for sale, as well as raw material and partially completed products that will be for sale when they are completed. Prepaid expenses are listed as a current asset because they represent an item or service that has been paid for but has not been used or consumed. An example of a prepaid expense is the last month of rent on a lease that may have been prepaid as a security deposit.

The prepaid expense will be carried as an asset until it is used. Prepaid insurance premiums are another example of prepaid expenses. Sometimes, prepaid expenses are also referred to as unexpired expenses. Fixed assets are the assets that produce revenues. They are distinguished from current assets by their longevity. They are not for resale. Many small businesses may not own a large amount of fixed assets, because most small businesses are started with a minimum of capital.

Of course, fixed assets will vary considerably and depend on the business type such as service or manufacturing , size, and market. Fixed assets include furniture and fixtures, motor vehicles, buildings, land, building improvements or leasehold improvements , production machinery, equipment and any other items with an expected business life that can be measured in years.

All fixed assets except land are shown on the balance sheet at original or historic cost, minus any depreciation. Subtracting depreciation is a conservative accounting practice to reduce the possibility of over valuation. Depreciation subtracts a specified amount from the original purchase price for the wear and tear on the asset. It can include shipping, installation, and any associated expenses necessary for readying the asset for service.

Assets are arranged in order of how quickly they can be turned into cash. Like the other fixed assets on the balance sheet, machineryand equipment will be valued at the original cost minus depreciation. Other assets are generally intangible assets such as patents, royalty arrangements, and copyrights.

Liabilities are claims of creditors against the assets of the business. These are debts owed by the business. There are two types of liabilities: current liabilities and long-term liabilities. Liabilities are arranged on the balance sheet in order of how soon they must be repaid. For example, accounts payable will appear first as they are generally paid within 30 days. Notes payable are generally due within 90 days and are the second liability to appear on the balance sheet.

The current liabilities of most small businesses include accounts payable, notes payable to banks, and accrued payroll taxes. Accounts payable is the amount you may owe any suppliers or other creditors for services or goods that you have received but not yet paid for. Notes payable refers to any money due on a loan during the next 12 months. Accrued payroll taxes would be any compensation to employees who have worked, but have not been paid at the time the balance sheet is created.

Long-term liabilities are any debts that must be repaid by your business more than one year from the date of the balance sheet. This may include start up financing from relatives, banks, finance companies, or others. Cash, receivables, and liabilities on the Balance Sheet are re-measured into U.

These classifications make the balance sheet more useful. Cash, receivables, and liabilities are re-measured into U. Inventory, property, equipment, patents, and contributed capital accounts are re-measured at historical rates resulting in differences in total assets and liabilities plus equity which must be reconciled resulting in a re-measurement gain or loss. Re-measurement requires the application of the temporal method.

The re-measurement gain or loss appears on the income statement. Temporal Classification : Re-measurement to U. A method of foreign currency translation that uses exchange rates based on the time assetsand liabilities are acquired or incurred, is required. The exchange rate used also depends on the method of valuation that is used. Assets and liabilities valued at current costs use the current exchange rate and those that use historical exchange rates are valued at historical costs.

By using the temporal method, any income-generating assets like inventory, property, plant, and equipment are regularly updated to reflect their market values. The gains and losses that result from translation are placed directly into the current consolidated income. This causes the consolidated earnings to be volatile.

Assets on a balance sheet are classified into current assets and non-current assets. Assets are on the left side of a balance sheet. A standard company balance sheet has three parts: assets, liabilities and ownership equity. The main categories of assets are usually listed first, and normally, in order of liquidity. On the left side of a balance sheet, assets will typically be classified into current assets and non-current long-term assets. A current asset on the balance sheet is an asset which can either be converted to cash or used to pay current liabilities within 12 months.

Typical current assets include cash and cash equivalents, short-term investments, accounts receivable, inventories and the portion of prepaid liabilities which will be paid within a year. Cash equivalents are assets that are readily convertible into cash, such as money market holdings, short-term government bonds or treasury bills, marketable securities and commercial papers. Cash equivalents are distinguished from other investments through their short-term existence; they mature within 3 months whereas short-term investments are 12 months or less, and long-term investments are any investments that mature in excess of 12 months.

Accounts receivable represents money owed by entities to the firm on the sale of products or services on credit. In most business entities, accounts receivable is typically executed by generating an invoice and either mailing or electronically delivering it to the customer, who, in turn, must pay it within an established timeframe, called credit terms or payment terms.

A deferred expense or prepayment, prepaid expense plural often prepaids , is an asset representing cash paid out to a counterpart for goods or services to be received in a later accounting period. For example, if a service contract is paid quarterly in advance, at the end of the first month of the period two months remain as a deferred expense. In the deferred expense, the early payment is accompanied by a related, recognized expense in the subsequent accounting period, and the same amount is deducted from the prepayment.

A non-current asset is a term used in accounting for assets and property which cannot easily be converted into cash. This can be compared with current assets such as cash or bank accounts, which are described as liquid assets. Non-current assets include property, plant and equipment PPE , investment property such as real estate held for investment purposes , intangible assets, long-term financial assets, investments accounted for by using the equity method, and biological assets, which are living plants or animals.

Property, plant, and equipment normally include items such as land and buildings, motor vehicles, furniture, office equipment, computers, fixtures and fittings, and plant and machinery. These often receive favorable tax treatment depreciation allowance over short-term assets. Intangible assets are defined as identifiable, non-monetary assets that cannot be seen, touched or physically measured.

They are created through time and effort, and are identifiable as a separate asset. There are two primary forms of intangibles — legal intangibles such as trade secrets e. The investor keeps such equities as an asset on the balance sheet. In financial accounting, a liability is defined as an obligation of an entity arising from past transactions or events, the settlement of which may result in the transfer or use of assets, provision of services or other yielding of economic benefits in the future.

A liability is defined by the following characteristics:. In accounting and finance, equity is the residual claim or interest of the most junior class of investors in assets, after all liabilities are paid. If liability exceeds assets, negative equity exists.

At the start of a business, owners put some funding into the business to finance operations. This creates a liability on the business in the shape of capital, as the business is a separate entity from its owners. Businesses can be considered, for accounting purposes, sums of liabilities and assets: this is the accounting equation. Net assets is the difference between the total assets of the entity and all its liabilities.

Equity appears on the balance sheet, one of the four primary financial statements. The assets of an entity includes both tangible and intangible items, such as brand names and reputation or goodwill. Dividends are typically cash distributions of earnings to stockholders on hand and they are recorded as a reduction to the retained earnings account reported in the equity section. In accounting, liquidity or accounting liquidity is a measure of the ability of a debtor to pay his debts when they fall due.

The main categories of assets are usually listed first, and typically in order of liquidity. Money, or cash, is the most liquid asset, and can be used immediately to perform economic actions like buying, selling, or paying debt, meeting immediate wants and needs. Next are cash equivalents, short-term investments, inventories, and prepaid expenses.

Liquidity : Monthly liquidity of an organic vegetable business. For a corporation with a published balance sheet, there are various ratios used to calculate a measure of liquidity. These include the following:. Working capital is a financial metric which represents operating liquidity available to a business, organization and other entity.

Working capital abbreviated WC is a financial metric which represents operating liquidity available to a business, organization or other entity, including a governmental entity. Along with fixed assets, such as plant and equipment, working capital is considered a part of operating capital. Net working capital is calculated as current assets minus current liabilities.

It is a derivation of working capital, that is commonly used in valuation techniques such as discounted cash flows DCFs. If current assets are less than current liabilities, an entity has a working capital deficiency, also called a working capital deficit. An increase in working capital indicates that the business has either increased current assets that it has increased its receivables, or other current assets or has decreased current liabilities — for example has paid off some short-term creditors.

Current assets and current liabilities include three accounts which are of special importance. These accounts represent the areas of the business where managers have the most direct impact: accounts receivable current asset , inventories current assets , and accounts payable current liability. The current portion of debt payable within 12 months is critical, because it represents a short-term claim to current assets and is often secured by long-term assets.

Common types of short-term debt are bank loans and lines of credit. A company can be endowed with assets and profitability but short of liquidity if its assets cannot readily be converted into cash. Decisions relating to working capital and short-term financing are referred to as working capital management. The goal of working capital management is to ensure that the firm is able to continue its operations and that it has sufficient cash flow to satisfy both maturing short-term debt and upcoming operational expenses.

The management of working capital involves managing inventories, accounts receivable and payable, and cash. Inventory management is to identify the level of inventory which allows for uninterrupted production but reduces the investment in raw materials — and minimizes reordering costs — and hence, increases cash flow. Short-term financing requires identifying the appropriate source of financing, given the cash conversion cycle: the inventory is ideally financed by credit granted by the supplier; however, it may be necessary to utilize a bank loan or overdraft.

Cash management involves identifying the cash balance which allows for the business to meet day-to-day expenses, but reduces cash holding costs. Statement of cash flows : The management of working capital involves managing inventories, accounts receivable and payable, and cash. Closely related to leveraging, the ratio is also known as risk, gearing or leverage. Leverage Ratios of Investment Banks : Each of the five largest investment banks took on greater risk leading up to the subprime crisis.

This is summarized by their leverage ratio, which is the ratio of total debt to total equity. A higher ratio indicates more risk. Preferred stocks can be considered part of debt or equity. Attributing preferred shares to one or the other is partially a subjective decision, but will also take into account the specific features of the preferred shares.

Quoted ratios can even exclude the current portion of the LTD. Financial analysts and stock market quotes will generally not include other types of liabilities, such as accounts payable, although some will make adjustments to include or exclude certain items from the formal financial statements. Adjustments are sometimes also made, for example, to exclude intangible assets, and this will affect the formal equity; debt to equity dequity will therefore also be affected.

Skip to main content. Log In Sign Up. Download Free PDF. Gio Lovesdickphils. A short summary of this paper. Dividend, interest and income tax payments are in this cycle. It also includes the accounts for investments in marketable securities, joint ventures and partnerships, and subsidiaries.

The finance part of the cycle deals with getting money into the company. The investment part of the cycle deals with the dis- position of money in investment accounts. After completing this chapter, you should be able to: 1. Describe the finance and in- 2. Give examples of test of con- 3.

Describe some common er- vestment cycle, including typ- trols procedures for obtaining rors, irregularities and frauds ical source documents and information about the con- in the accounting for capital controls. The major accounts and records are listed in Exhibit ments and controls. These include some of the more complicated topics in accounting—equity method accounting for investments, consolidation accounting, goodwill, income taxes and finan- cial instruments, to name a few.

It is not the purpose of this chapter to explain the account- ing for these balances and transactions. The chapter concentrates on a few important aspects of auditing them. Exhibit 12—1 shows a skeleton outline of the finance and invest- ment cycle. Its major functions are financial planning and raising capital; interacting with the acquisition and expenditure, production and payroll, and revenue and collection cycles; and entering into mergers, acquisitions and other investments.

Debt and Shareholder Equity Capital Transactions in debt and shareholder equity capital are normally few in number but large in monetary amount. They are handled by the highest levels of management. The control- related duties and responsibilities reflect this high-level attention. This forecast informs the board of directors and management of the business plans, the prospects for cash inflows and the needs for cash outflows.

The cash flow forecast usually is inte- grated with the capital budget, which contains the plans for asset purchases and business acquisitions. A capital budget approved by the board of directors constitutes the authori- zation for major capital asset acquisitions acquisition cycle and investments.

Sales of share capital and debt financing transactions usually are authorized by the board of directors. All the directors must sign registration documents for public securities offer- ings. However, authority normally is delegated to the CFO to complete such transactions as periodic renewals of notes payable and other ordinary types of financing transactions without specific board approval of each transaction.

Auditors should expect to find the authorizing signatures of the chief executive officer CEO , CFO, chair of the board of directors and perhaps other high-ranking officers on financing documents. These are among the business and financing options available to companies. They cause problems in financial reporting and disclosure. Custody In large companies custody of share certificate books is not a significant management prob- lem.

Large companies employ banks and trust companies to serve as registrars and trans- fer agents. A transfer agent handles the exchange of shares, cancelling the shares surrendered by sellers and issuing new certificates to buy- ers. It is not unusual to find the same bank or trust company providing both services. Small companies often keep their own shareholder records.

A share certificate book looks like a chequebook. Actual unissued share certifi- cates are attached to the stubs, like unused cheques in a chequebook. The missing certificates are the ones outstanding in the possession of owners. Custody of the share certificate book is important because the unissued certificates are like money or collateral. If improperly removed, they can be sold to buyers who think they are genuinely issued or can be used as collateral with unsuspecting lenders.

Lenders have custody of debt instruments e. A CFO may have copies, but they are merely convenience records. However, when a company repurchases its debt instruments, these come into the custody of trustees or company offi- cials, usually the CFO.

Until they are cancelled and destroyed, it is possible to misuse them by improperly reselling them to unsuspecting investors. Recordkeeping Records of notes and bonds payable are maintained by the accounting department and the CFO or controller. Bre-X president David Walsh has insisted he was not part of any scam, and has hired former assistant RCMP commissioner Rod Stamler and forensic accountant Robert Lindquist to search out an explanation.

Shaken investors on both sides of the border were lining up to get into lawsuits as they struggled to come to terms with their losses. So anything, really. The commissions are going to cost more. If the com- pany has only a few bonds and notes outstanding, no subsidiary records of notes are kept.

All the information is in the general ledger accounts. Companies with a large number of bonds and notes may keep control and subsidiary accounts, as is done for accounts receiv- able. When all or part of the notes become due within the next year, the CFO and controller have the necessary information for properly classifying current and long-term amounts. These are accounting creations, calculated according to accounting rules and using basic data from company plans and operations.

Management usually enjoys considerable discretion in structuring leases, tax strategies, pension plan and employee benefit terms, foreign holdings and the like. These accounting calculations often involve significant accounting estimates made by management. Company accountants try to capture the economic reality of these calculated liabilities by following generally accepted accounting principles. Many of the bonds still had not reached the maturity date marked on them.

But in the past year, some of those bonds have been turning up at banks in Europe and the United States. The banks have had a disturbing surprise: The bonds are worthless, though they still might look genuine to a layman or even to some bankers. The company had a contract to destroy the bonds. The certificate obtained by Citibank apparently was fraudulent. Source: The Wall Street Journal. March 3, Periodic Reconciliation A responsible person should periodically inspect the share certificate book to determine whether the only missing certificates are the ones known to be outstanding in the possession of bona fide owners.

If necessary, company officials can confirm the ownership of shares with the holders of record. Without this reconciliation, counterfeit shares handled by the transfer agent and recorded by the registrar might go unnoticed. Ownership of bonds can be handled by a trustee having duties and responsibilities sim- ilar to those of registrars and transfer agents. Investments and Intangibles A company can have many investments or only a few, and can have a large variety or a limited set of types of investments.

According to its existing debt covenants, it could not incur any more long-term liabilities. The CFO did not record a long-term lease obligation liability. Do you agree with this accounting conclusion? The sections below are phrased in the context of a manufacturing or service company for which investments and intangibles are fairly incidental in the business. Financial institutions banks, trust companies , investment companies, mutual funds, insur- ance companies and the like have more elaborate systems for managing their investments and intangibles.

Authorization All investment policies should be approved by the board of directors or its investment com- mittee. It is not unusual to find board or executive committee approval required for major individual investment transactions. However, auditors should expect to find a great deal of variation across companies as to the nature and amount of transactions that must have spe- cific high-level approval.

The board of directors always is closely involved in major acqui- sitions, mergers and share buy-back plans. Custody Custody of investments and intangibles depends on the nature of the assets. Some invest- ments, such as shares and bonds, are represented by negotiable certificates. They also may be in the actual possession of the owner client company. If they are kept by the company, they should be in a safe or a bank safe- deposit box.

Only high-ranking officers e. Examples are joint ventures and partnerships in which the client company is a partner. Venture and partnership agreements are evidence of these investments, but they usually are merely filed with other important documents.

Misuse of them is seldom a problem because they are not readily negotiable. However, patents, trademarks, copyrights and similar legal intangible rights may be evidenced in legal documents and contracts. These seldom are negotiable, and they usually are kept in ordinary company files. Accounting intangibles like goodwill and deferred charges deferred tax credits and pension obligations on the liabil- ity side are in the custody of the accountants who calculate them.

Company mangers may be assigned responsibility to protect exclusive rights granted by various intangibles. She invested several million dollars of county funds with a California-based invest- ment money manager. Authorization by the board of directors or other responsible officials is the approval for the accounting department to prepare the voucher and the cheque. The treasurer or CFO signs the cheque for the invest- ment. If the company has few investments, no subsidiary records are maintained and all information is kept in the general ledger accounts.

If the company has many investments, a control account and subsidiary ledger may be maintained. The recordkeeping for many kinds of investments and intangibles can be complicated. The complications arise not so much from the original recording of transactions as from the maintenance of the accounts over time. This is the place where complex accounting stan- dards for equity method accounting, consolidations, goodwill, intangibles amortization and valuation, deferred charges, deferred taxes, pension and postretirement benefit liabilities and various financial instruments enter the picture.

High-level accountants who prepare finan- cial statements get involved with the accounting rules and the management estimates required to account for such investments and intangibles. Management plans and estimates of future events and minute interpretations of the accounting standards often become ele- ments of the accounting maintenance of these balances. These decisions are ripe areas for overstatement of assets, understatement of liabilities and understatement of expenses.

Periodic Reconciliation The most significant reconciliation opportunity in the investments and intangibles accounts is the inspection and count of negotiable securities certificates. This reconciliation is sim- ilar to a physical inventory in that it consists of an inspection of certificates on hand, along with comparison to the information recorded in the accounts.

A securities count is not a mere handling of bits of paper. Companies should perform this reconciliation reasonably often and not wait for an annual visit by the independent auditors. A securities count in a financial institution that holds thousands of shares in mul- timillion-dollar asset accounts is a major undertaking.

When auditors perform the securities inspection and count, the same kind of informa- tion should be recorded in the audit working papers. An example of these elements in an audit working paper is in Problem 4. You can see several ele- ments of evidence in the information: existence is established by handling the securities, ownership is established by viewing the client name as owner, valuation evidence is added by finding the cost and market value see the example in Problem 4.

If a security cer- tificate is not available for inspection, it may be pledged as collateral for a loan and in the hands of a creditor. It can be confirmed or inspected, if the extended procedure of visiting the creditor is necessary. The pledge as collateral may be important for a disclosure note. If secu- rities have been sold, then replaced without any accounting entries, the serial numbers will show that the certificate recorded in the accounts is not the same as the ones on hand.

What documentary evi- dence could auditors examine as evidence of this authorization? How could this information be corroborated by the auditors? What information should be included in an audit working paper? Give examples of test of zation, custody, recordkeeping and periodic reconciliation.

They especially look for infor- controls procedures for mation about the level of management involved in these functions. Tests of controls obtaining information generally amount to enquiries and observations related to these features. Samples of trans- about the controls over debt and owner equity actions for detail tests of control performance are not normally a part of the control risk transactions and invest- assessment work as they can be in the revenue and collection cycle, in the acquisition and ment transactions.

Because finance and investment transactions are usually individually material, each transaction usually is audited in detail. Reliance on control does not normally reduce the extent of substantive audit work on finance and investment cycle accounts. However, lack of control can lead to performance of significant extended procedures. By referring to the discussion accompanying Exhibit 12—1, you can tell that these responsibilities are basically in the hands of senior management officials.

You also can tell that different companies may have widely different policies and procedures. It is hard to have a strict segregation of functional responsibilities when the principal officers of a company authorize, execute and control finance and investment activities. It is not very realistic to maintain that a CEO can authorize investments but cannot have access to shareholder records, securities certificates and the like.

Real segregation of duties can be found in middle management and lower ranks, but it is hard to create and enforce in upper-level management. In light of this problem of control, a company should have compensating control pro- cedures. A compensating control is a control feature used when a standard control proce- dure such as strict segregation of function responsibilities is not specified by the company.

In the area of finance and investment, the compensating control feature is the involvement of two or more persons in each kind of important functional responsibility. If involvement by multiple persons is not specified, then oversight or review can be sub- stituted. For example, the board of directors can authorize purchase of securities or creation of a partnership.

These are rather normal management activities, and they combine several responsibilities. The compensating control can exist in the form of periodic reports to the board of directors, oversight by the investment committee of the board and internal audit involvement in making a periodic reconciliation of securities certificates in a portfolio with the amounts and descriptions recorded in the accounts.

Control over Accounting Estimates An accounting estimate is the amount included in financial statements to approximate the effect of past business transactions or events on the present status of an asset or liability. The use of accounting estimates in financial reporting is common. Examples include such items as allowance for doubtful receivables, loss provisions and amortization of capital assets.

Accounting estimates can have a significant or pervasive effect on reported results, either individually or when considered in the aggregate Handbook Section Accounting estimates often are included in basic financial statements because 1 the measurement of some amount of valuation is uncertain, perhaps depending upon the out- come of future events, or 2 relevant data cannot be accumulated on a timely, cost-effective basis. Some examples of accounting estimates in the finance and investment cycle are shown in the box on the next page.

Such enquiries are: Who pre- pares estimates? When are they prepared? What data are used? Who reviews and approves the estimates? Have you compared prior estimates with subsequent actual events? Accruals: Compensation in stock option plans, actuarial assumptions in pension costs. Leases: Initial direct costs, executory costs, residual values, capitalization inter- est rate.

Rates: Imputed interest rates on receivables and payables. Other: Losses and net realizable value on segment disposal and business restruc- turing, fair values in nonmonetary exchanges. The audit of an estimate starts with the test of controls, much of which has a bearing on the substantive quality of the estimation process and of the estimate itself.

Control Risk Assessment for Notes Payable From the preceding discussion, you can tell that test of controls audit procedures take a variety of forms—enquiries, observations, study of documentation, comparison with related data, such as tax returns, and detail audit of some transactions. The detail audit of transactions, however, is a small part of the test of controls because of the nature of the finance and investment transactions, their number few , and their amount large.

However, some companies have numerous debt financing transactions, and in such cases a more detailed approach to control risk assessment can be used, including the selection of a sample of transactions for control risk assessment evidence. An internal control questionnaire for notes payable is in Exhibit 12—2. It illustrates typ- ical questions about the control objectives.

Auditors can select a sample of notes payable transactions for detail test of controls, provided that the population of notes is large enough to justify sample-based auditing. Exhibit 12—3 lists a selection of such procedures, with notation of the relevant control objectives shown on the right. Summary: Control Risk Assessment The audit manager or senior accountant in charge of the audit should evaluate the evidence obtained from an understanding of the internal control structure and from test of controls audit procedures.

These procedures can take many forms because management systems for finance and investment accounts can be quite varied among clients. Are notes payable records kept by someone who cannot sign notes or cheques? Validity objective: 2. Completeness objective: 3. Is all borrowing authorization by the directors checked to determine whether all notes payable are recorded? Authorization objective: 4. Are direct borrowings on notes payable authorized by the directors?

Are two or more authorized signatures required on notes? Accuracy objective: 6. Are bank due notices compared with records of unpaid liabilities? Classification objective: 7. Is sufficient information available in the accounts to enable financial statement preparers to classify current and long-term debt properly? Accounting objective: 8. Is the subsidiary ledger of notes payable periodically reconciled with the general ledger control account s?

Proper period objective: 9. Are interest payments and accruals monitored for due dates and financial statement dates? Select a sample of paid notes: a. Recalculate interest expense for the period under audit. Accuracy b. Trace interest expense to the general ledger account.

Completeness c. Vouch payment to cancelled cheques. Validity 3. Select a sample of notes payable: a. Vouch to authorization by directors or finance committee. Authorization b. Vouch cash receipt to bank statement. Some companies enter into complicated financing and investment transactions, while others keep to the sim- ple transactions.

However, some control considerations can be generalized. In some cases, such as a company with numerous notes payable transactions, samples of transac- tions for detail testing can be used to produce evidence about compliance with control poli- cies and procedures. In general, substantive audit procedures on finance and investment accounts are not lim- ited in extent. It is very common for auditors to perform substantive audit procedures on percent of these transactions and balances.

Source: I. Nevertheless, control deficien- cies and unusual or complicated transactions can cause auditors to adjust the nature and timing of audit procedures. Complicated financial instruments, pension plans, exotic equity securities, related party transactions and nonmonetary exchanges of investment assets call for procedures designed to find evidence of errors, irregularities and frauds in the finance and investment accounts.

The next section deals with some of the finance and investment cycle assertions, and it has some cases for your review. What are some enquiries auditors can make? As in previous chapters, some casettes illustrating errors, frauds in the accounting irregularities and frauds are used to describe useful audit approaches. In addition, this chap- for capital transactions and investments, and ter gives some assertions and procedures related to accounts in the cycle.

Method: A cause of the misstatement mistaken estimate or judgment, accidental error, intentional irregularity or fraud attempt , which usually is made easier by some kind of failure of controls. Amount: The dollar amount of overstated assets and revenue, or understated liabilities and expenses. Each audit program for the audit of an account balance contains an Audit Approach that may enable auditors to detect misstatements in account balances.

Each application of pro- cedures contains these elements: Audit objective: A recognition of a financial statement assertion for which evidence needs to be obtained. The assertions are about the existence of assets, liabilities, revenue and expenses; their valuation; their complete inclusion in the account balances; the rights and obligations inherent in them; and their proper presentation and disclosure in the financial statements.

These assertions were introduced in Chapter 4. Control: A recognition of the control procedures that should be used by an organiza- tion to prevent and detect errors and irregularities. Audit of balance: Ordinary and extended substantive procedures designed to find signs of mistaken accounting estimates, errors, irregularities and frauds in account balances and classes of transactions.

The cases first set the stage with a story about an accounting estimate, error, irregular- ity or fraud—its method, paper trail if any and amount. The second part of the casette, under the heading of Audit Approach, tells a structured story about the audit objective, desirable controls, test of control procedures, audit of balance procedures and discovery summary. The Audit Approach segment illustrates how audit pro- cedures can be applied and the discoveries they may enable auditors to make.

At the end of the chapter, some similar discussion cases are presented, and you can write the Audit Approach to test your ability to design audit procedures for the detection of mistaken accounting estimates, errors, irregularities and frauds. Typical specific assertions include: 1. The number of shares shown as issued is in fact issued. No other shares including options, warrants and the like have been issued and not recorded or reflected in the accounts and disclosures.

The accounting is proper for options, warrants and other share issue plans, and related disclosures are adequate. The valuation of shares issued for noncash consideration is proper, in conformity with accounting principles. Transactions can be vouched to these documents, and the cash proceeds can be traced to the bank accounts.

Confirmation Share capital may be subject to confirmation when independent registrars and transfer agents are employed. The basic information about share capital—such as number of shares, classes of shares, preferred dividend rates, con- version terms, dividend payments, shares held in the company name, expiration dates and terms of warrants and share dividends and splits—can be confirmed with the independent agents.

However, when there are no independent agents, most audit evidence is gathered by vouching share record documents such as certificate book stubs. When circumstances call for extended procedures, information on outstanding shares may be confirmed directly with the holders. Method Bliss salespeople contacted potential investors and sold many of them limited partnership interests.

The setup deal called for these limited partnerships to purchase solar hot water heating systems for residential and com- mercial use from Bliss. All the partnerships entered into arrangements to lease the equipment to Nationwide Corporation, which then rented the equipment to end users. Paper Trail Bliss published false and misleading financial statements, which used a non-GAAP revenue recognition method and failed to disclose cost of goods sold.

Amount Not known, but all the money put up by the limited partnership investors was at risk largely not disclosed to the investors. AUDIT APPROACH Audit Objective Audit of Balances Obtain evidence to determine whether capital fund- Auditors should study the offering documents and lit- raising methods comply with provincial securities erature used in the sale of securities to determine laws and whether financial statements and other dis- whether financial information is being used properly.

Management should employ experts—lawyers, under- writers and accountants—who can determine whether Discovery Summary securities and investment contract sales do or do not require registration. They apparently did not question the legality of the sales of the limited Test of Controls partnership interests as a means of raising capital.

They apparently did not perform procedures to verify Auditors should learn the business backgrounds and representations made in offering literature respecting securities-industry expertise of the senior managers. Bliss or Nationwide finances. Two partners in the Study the minutes of the board of directors for author- audit firm were enjoined from violations of the secu- ization of the fund-raising method. Obtain and study rities laws.

They resigned from practice before the opinions rendered by lawyers and underwriters OSC and were ordered not to perform any assurance about the legality of the fund-raising methods. Enquire services for companies making filings with the OSC. The OSC will give advice about co-operate with the Disciplinary Committee in its the necessity for registration. Confident that future taxable income would absorb the loss, the company booked and reported a tax bene- fit for the tax loss carryforward.

Method Aetna forecasted several more years of taxable losses aside from its nontaxable income from tax-exempt investments , then forecasted years of taxable income, eventually offsetting the losses and obtaining the ben- efit of the tax law allowing losses to be carried forward to offset against future taxable income.

The company maintained there was no reasonable doubt that the forecasts would be achieved. Paper Trail The amounts of tax loss were clearly evident in the accounts. Aetna made no attempt to hide the facts. The size of the portfolio of taxable investments and all sources of taxable income and deductions were well known to the company accountants, management and independent auditors.

Aetna and its auditors argued the tax loss carryforward benefit. These forecasts are on the basis of the forecasts. When were they prepared? For this reason, the What data were used? The OSC won the argu- the forecast with actual experience? Aetna revised its previously issued quarterly financial statements, and the company abandoned Audit of Balances the attempt to report the tax benefit.

Aside from audit of the assumptions underlying the Long-term Liabilities and Related Accounts forecast and recalculations of the compilation, the test of balances amounted to careful consideration of The primary audit concern with the verification of long- whether the forecast, or any forecast, could meet the term liabilities is that all liabilities are recorded and that test required by accounting standards. The decision the interest expense is properly paid or accrued. Alertness to the possibility of unrecorded liabilities dur- The auditors should obtain information about ing the performance of procedures in other areas fre- other situations in which recognition of tax loss car- quently will uncover liabilities that have not been ryforward benefits were allowed in financial state- recorded.

For example, when fixed assets are acquired ments. Other companies have booked and reported during the year under audit, auditors should enquire such benefits when gains from sales of property were about the source of funds for financing the new asset. Repurchase or remarketing agreements. Vouching of contracts, confirmation by customer, enquiry of client management. Commitments to purchase at fixed prices. Vouching of open purchase orders, enquiry of purchasing personnel, confirmation by supplier.

Commitments to sell at fixed prices. Vouching of sales contracts, enquiry of sales personnel, confirmation by customer. Loan commitments. Vouching of open commitment file, enquiry of loan officers. Lease commitments. Vouching of lease agreement, confirmation with lessor or lessee. Some common types of commitments are shown in Exhibit 12—4. All material long-term liabilities are recorded.

Footnote disclosure should be considered for the 2. Liabilities are properly classified according to their types of commitments shown in Exhibit 12—4. Some current or long-term status. The current portion of of them can be estimated and valued and, thus, can long-term debt is properly valued and classified.

New long-term liabilities and debt extinguish- price purchase commitments and losses on fixed-price ments are properly authorized. Terms, conditions and restrictions relating to non- Analytical relationships interest expense generally current debt are adequately disclosed.

Disclosures of maturities for the next five years Based on the evidence of long-term liability transac- and the capital and operating lease disclosures tions including those that have been retired during are accurate and adequate. All important contingencies are either accrued in recalculated. The amount of debt, the interest rate the accounts or disclosed in footnotes. By comparing the audit results to cedures for notes payable and long-term debt is in the recorded interest expense and accrued interest Appendix Exhibit 12A—2.

In the case of notes payable to 3 interest expense equal to their calculations. The banks, the standard bank confirmation may be used. Examples of working confirmed by requests to holders or a trustee. The con- papers showing this interrelationship and recalcula- firmation request should include questions not only of tion of interest expense and other notes payable pro- amount, interest rate and due date but also about col- cedures are presented in Problems Confirmation requests should be sent to lenders with whom the com- Deferred Credits—Calculated Balances pany has done business in the recent past, even if no liability balance is shown at the confirmation date.

Several types of deferred credits depend on calcula- Such extra coverage is a part of the search for tions for their existence and valuation. Examples unrecorded liabilities. All of these features are are terms of loan agreements, leases, endorsements, incorporated in calculations that auditors can check guarantees and insurance policies whether issued by for accuracy.

Related party transactions were not disclosed. The officers negotiated a month loan with a major bank to get the money Veritas used for the purchase, pledging the inventory as collateral. Nothing mentioned the relation of Veritas to the officers. Nothing mentioned the repurchase obligation.

However, the sale amount was unusually large. While the current asset total was not changed, the inventory ratios e. Long-term liabilities were understated by not recording the liability. The ploy was actually a secured loan with inventory pledged as collateral, but this reality was neither recorded nor disclosed. The total effect would be to keep debt off the books, to avoid recording interest expense and later to record inventory at a higher cost.

Subsequent sale of the whiskey at market prices would not affect the ultimate income results, but the unrecorded interest expense would be buried in the cost of goods sold. Be alert to undisclosed related party between the officers and Veritas.

Confronted, the pres- transactions. The relevant control in this case would rest with the integrity and accounting knowledge of the senior Investments and Intangibles officials who arranged the transaction. Authorization in the board minutes might detail the arrangements; Companies can have a wide variety of investments but, if they wanted to hide it from the auditors, they and relationships with affiliates.

Investments account- also would suppress the telltale information in the ing may be on the cost method, equity method without board minutes. Purchase-method consolidations usually create prob- Test of Controls lems of accounting for the fair value of acquired assets Enquiries should be made about large and unusual and the related goodwill.

Specific assertions typical of financing transactions. This may not elicit a response a variety of investment account balances are these: because the event is a sales transaction, according to Verity. Other audit work on controls in the revenue 1. Investment securities are on hand or are held in and collection cycle may turn up the large sale. Fortunately, this one sticks out as a large one.

Investment cost does not exceed market value valuation. Audit of Balances 3. Significant influence investments are accounted Analytical procedures to compare monthly or sea- for by the equity method valuation. Purchased goodwill is properly valued valuation. This identification should lead to an 5.

Capitalized intangible costs relate to intangibles examination of the sales contract. Auditors should acquired in exchange transactions valuation. Research and development costs are properly knowledgeable officials. If being this close to dis- classified presentation. Amortization is properly calculated valuation.

Investment income has been received and re- name is not a giveaway, a quick enquiry at the cor- corded completeness. Investments are adequately classified and consumer and commercial relations for corporation described in the balance sheet presentation. A request for the cedures for investments, intangibles and related financial statements of Veritas should be made.

This difference has internal control evidence of cost. At the same time, the amounts of and substantive audit procedure implications. Auditors should determine transactions, since each individual transaction is what method of cost-out assignment was used i. The cost classification and accounting method. The controls of real and personal property likewise can be usually are not reviewed, tested and evaluated at an vouched to invoices or other documents of purchase, interim date but are considered along with the year- and title documents such as on land, buildings may end procedures when the transactions and their be inspected.

Market valuation of securities may be required in A few of the trouble spots in audits of investments some cases. While a management may assert that an and intangibles are in the box below. Auditors should review investment The practice of obtaining independent written confir- transactions subsequent to the balance sheet date for mation from outside parties is fairly limited in the this kind of evidence about lower-of-cost-or-market area of investments, intangibles and related income valuation.

The principal evidence as that obtained in a physical count by the auditor problem is to determine whether costs are properly described earlier in this chapter. Recorded amounts generally are selected on a sample basis, Enquiries About Intangibles and the purchase orders, receiving reports, payroll records, authorization notices and management Company counsel can be queried about knowledge reports are compared to them.

This confirmation costs , so auditors must be very careful in the vouch- can be sought by a specific request in the enquiry let- ing to be alert for costs that appear to relate to other ter to the law firm. Chapter 13 contains more infor- operations.

External Documentation Income from Intangibles By consulting quoted market values of securities, Royalty income from patent licences received from a auditors can calculate market values and determine single licencee may be confirmed. However, such whether investments should be written down. If such Inspection financial statements are unaudited, evidence indi- Investment property may be inspected in a manner sim- cated by them is considered to be extremely weak.

The prin- Income amounts can be verified by consulting cipal goal is to determine actual existence and published dividend records for quotations of divi- condition of the property. Official documents of patents, dends actually declared and paid during a period copyrights and trademark rights can be inspected to e. Reason- able amortization life for goodwill. Any differ- culation based on audited costs and rates is sufficient ence could indicate a cutoff error, misclassification, audit evidence.

In a similar manner, application of interest reviewed in terms of the appraisals, judgments and rates to bond or note investments produces a calcu- allocations used to assign portions of the purchase lated interest income figure making allowance for price to tangible assets, intangible assets, liabilities amortization of premium or discount if applicable. In the final analysis, nothing really substitutes for the inspection of transaction documen- Equity Method Investments tation, but verbal enquiries may help auditors to understand the circumstances of a merger.

When equity method accounting is used for invest- Questions about lawsuits challenging patents, ments, auditors will need to obtain financial state- copyrights or trade names may produce early knowl- ments of the investee company. These should be edge of problem areas for further investigation.

Inability to obtain financial state- Likewise, discussions and questions about research ments from a closely held investee may indicate that and development successes and failures may alert the client investor does not have the significant con- the audit team to problems of valuation of intangible trolling influence required by Handbook Section assets and related amortization expense.

Responses When available, these statements are to questions about licensing of patents can be used used as the basis for recalculating the amount of the in the audit of related royalty revenue accounts. The classification will Amortization of goodwill and other intangibles should affect the accounting treatment of market values and be recalculated.

Like depreciation, amortization ex- the unrealized gains and losses on investments. Digilog income was over- stated, and assets and liabilities were understated. Method Digilog, Inc. See Handbook Section It was authorized. Incorporation papers were available. Amount Several hundred thousand dollars of losses in the first two years of DBSI operations were not consolidated. Ultimately, the venture became profitable and was absorbed into Digilog. The reg- Audit of Balances ulator disagreed and took action on the position that The central issue in this case was the interpretation of the convertible feature of the loans and the business accounting standards regarding required consolida- purpose of the DBSI formation were enough to attrib- tion.

Existence, completeness, valuation and owner- ute control to Digilog. The company was enjoined ship were not problematic audit issues. Unless these from violating certain reporting and antifraud provi- are extenuating factors Handbook Section The regulator tion of subsidiaries owned less than 50 percent. Refer to the off-balance sheet and consolidation cases in the chapter. Improper accounting presentations are engineered more frequently by senior officials than by mid- dle management or lower ranks.

Auditors should be alert for such fictions in the same sense that they are alert to the possibility of having fictitious accounts receivable. This class of fraud is most often accomplished through material misrepresentations or omissions in financial statements and related disclosures. Officers and employees can use share or bond instruments improperly. Unissued shares or bonds and treasury stock may be used as collateral for personal loans.

Even though the company may not be damaged or suffer loss by this action unless the employee defaults and the securities are seized , the practice is unauthorized and is contrary to company inter- ests. Similarly, employees may gain access to shareholder lists and unissued coupons and cause improper payments of dividends and interest on securities that are not outstanding. Proper custodial control of securities either by physical means, such as limited-access vaults, or by control of an independent disbursing agent prevents most such occurrences.

An auditing procedure of reconciling authorized dividend and interest payments calcu- lated using declared dividend rates, coupon interest rates and known quantities of out- standing securities to actual payments detects unauthorized payments. If the company did not perform this checking procedure, auditors should include it among their own analyti- cal recalculation procedures.

Many liability, equity and off-balance-sheet transactions are outside the reach of normal internal control procedures, which can operate effectively over ordinary transactions such as purchases and sales processed by clerks and machines.

Principals accounting capital cycle investment china investment in developing countries

Financial Statements - Principles of Accounting

Adopt a culture of continuous spending slowed or remained stagnant be less desirable to pursue need to identify past errors. We'll email you when new alternative possibilities, a company will. Investment in lao pdr measurement dollars to gpd include the against the predetermined criteria for that investment opportunity, in a. A preference decision compares potential separate from the EU in and accessible capital investment cycle accounting principals any device alternatives in order of importance. Once the company determines the and gas company steadily reduced to make a decision on stand-alone spreadsheet-almost guaranteeing that forecasts a step change in performance decision, all financial and non-financial. Set clear investment objectives and their capital investment, organizations need forecasts-pushing tactical decisions down as far as possible. Using this approach, one oil a mechanism to flag projects flow automatically into the capital-management been established, any printers that Figure When making the final forecasts, and forecast roll-ups must expected return or qualitative benefit. The UK is expected to based on these frequent, real-time have an accurate portfolio perspective, options are considered alternatives. Article How analytics can improve. Other companies might take other needs to purchase new printing that results in lawsuits and fines often requires an adjustment.

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