Q1:You are an auditor on an engagement. You are assigned to audit stockholder’s equity.
What types of transactions would you expect to see affecting the stockholder’s equity account(s)?
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Three transactions affect stakeholder’s equity account (s). These include the sale of stock to investors, the declaration of cash dividends to shareholders, and the recognition of periodic net income/loss. For instance, suppose that the management of Wal-Mart decides to issue additional shares worth five million of stock investors. And the market price per share of stock is $80. In this case, Wal-Mart would receive $400 million shares in total. This transaction will increase invested capital and cash by $400 million. This type of transaction is an example of sales of stock to investors.
Another critical transaction that affects stockholder’s equity account is the recognition of periodic net income or loss. Business companies have to find out the amount of net income or loss from their operations. The net income or loss is a representation of the increase or decrease in the company’s shareholder net assets, equity, as a result of its revenues, gains, expenses, and losses in the course of operations. Finally, investors have to specify the date of record and the dividend paid to these investors during the particular date. This transaction helps during the declaration and the payment of cash dividends.
Q2:You are an auditor on an engagement. You are assigned to audit your client’s debt obligations.
What are some of the inherent risks related to debt obligations?
Inherent risks refer to the risks that are posed by the omission or error in the financial statement as a result of factors apart from internal control’s failure. Inherent risks, in financial auditing, would occur mostly in situations that need a higher degree of judgment concerning financial estimates. Besides, they are most likely to happen when carrying out complex transactions. Some of these inherent risks related to debt obligations are:
Inappropriate classification of debt, whether as long or short term
Lack of proper authorization of debt
Not properly disclosing debt covenants
Improper accruing of interest expense
Another example of an inherent risk occurs when a firm releases what is known as the forward-looking financial statement. This statement may be issued either to the whole public or investors. This kind of financial statement relies on the value judgment and estimates of the company. As a result, it results in an inherent risk.
Q3: You are an auditor on an engagement. You are assigned to audit your client’s stockholders’ equity.
What might be some inherent risks related with stockholders’ equity transactions?
These types of inherent risks vary as a result of different activities. They include stock sales and issuances, purchase of treasury stock, dividends, stock options, and warrants, among others. One of the examples of an inherent risk associated with stock sales and issuance may involve the sale or issuance of stock without the authorization by the company’s bylaws. Also, the sales or issuance may be recorded in the wrong period. As a result, it leads to the equity transactions not being appropriately disclosed as per the GAAP. In the case of the purchase of treasury stock, an inherent risk may occur as a result of failure to record the repurchase of all the stock. Also, an inherent risk may arise when the retired treasury stock is not correctly allocated among the relevant accounts.
Q4: You are an auditor on a new client working on testing internal controls. You request the client’s narratives/flowcharts regarding internal controls over owners’ equity. What types of controls would you expect to see?
As an auditor on a new client, testing internal controls is very important. This is because it helps in meeting the objectives related to the owner’s equity. From the client’s narratives/flowcharts concerning internal controls over the owner’s capital, there are different types of controls I would expect to see. These controls include proper record keeping, proper authorization of transactions, and independent registrar and stock transfer.
In the case of proper authorization, the board of directors must be the ones who approve these activities. They include such transactions as the declaration of dividends, issuance of capital stock, and the repurchase of capital stock. In the case of segregation of duties and proper record-keeping, the internal controls must be adequate in ensuring that actual stock owners are recognized in the company records, minimizing the potential asset misappropriation; and that the correct amount of dividends is paid to the owners of stock.
