INTEREST BEARING DEBT, NOTES PAYABLE, AND CONTINGENT LIABILITIES I. Major controls over interest bearing debt 1.

Interest bearing obligations should be authorized by the board of directors 2. Banks from which loans are obtainable should be specified by the board of directors 3. An independent trustee should be employed to account for all bond issuances, cancellations, and interest payments 4. When independent trustee is not employed a. Unsigned bonds and notes should be in custody of an officer b. Note and note certificates should be prenumbered c. Surrendered certificates and interest coupons should be canceled and preserved 5. Detail records of interest-bearing debt should be maintained and reconciled to periodic statements of trustee and to the control account 6. Records of collateral pledged for debt should be maintained 7. Paid notes should be canceled and retained Audit objectives Determine that: 1. Adequate internal control exists for interest bearing debt transactions (Control) 2. Items recorded as liabilities are bona fide obligations (Obligations) 3. All liabilities are properly recorded (Completeness) 4. Interest expense and/or amortization was properly computed and recorded (Completeness, Obligation) 5. Client is not in violation of restrictions or requirements imposed on it by terms of loan agreement (Presentation & Disclosure) 6. Authority is given to enter into long-term agreement (Valuation, Completeness) 7. Assets pledged as security are adequately disclosed (Presentation and Disclosure) Audit procedures interest bearing debt A. Review and evaluate internal control over interest bearing debt obtain a description of controls regarding authorization, execution, and recording of interest bearing debt transactions and evaluate internal control weaknesses. 1. Obtain an understanding of internal control for interest bearing debt. 2. Assess control risks for assertions about interest bearing debt. 3. Perform additional tests of controls for those controls on which auditor plans to rely to reduce assessed level of control risks. 4. Reassess control risk and design substantive tests. B. Substantive Tests 1. Obtain or prepare analysis of interest bearing debt accounts 2. Examine copies of notes, mortgages, or trust deed payable 3. Obtain and review a copy of indenture for bonds payable 4. Trace authority to issue long-term debt to the corporate minutes 5. Vouch interest bearing debt transactions to supporting documents 6. Confirm interest bearing debt with appropriate third parties 7. Examine treasury bonds and reconcile to the general ledger

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8. Verify computation of interest expense, interest payable, and amortization of discount or premium 9. Obtain letter of representation 10. Determine proper balance presentation IV. Major controls over notes payable 1. Board of directors or specific officers approve issuance of notes 2. Board of directors has specified sources of borrowing and loan limits 3. Dual signatures should be required to issue notes at least one of which is that of a senior executive 4. Numerical controls of unissued and outstanding notes is maintained 5. Notes payable register should be maintained and balanced with control account periodically 6. Records should be maintained of collateral pledged as security for notes payable 7. Paid notes should be canceled and placed in a paid file 8. Renewal of notes should be subjected to same control procedures as new notes 9. Vouchers for interest payment should be approved in writing by to executives not associated with the borrowing operation Audit procedures notes payable (substantive tests) 1. Prepare or obtain schedule of notes payable 2. Compare schedule with notes payable register 3. Compare total of schedule with total per control account and subsidiary 4. Confirm selected notes payable 5. Analyze notes payable account by using schedule. Tie in interest expense and accrued interest to respective account balances 6. Examine notes paid during audit period and trace payment to disbursement journal 7. Review payments after B.S. date 8. Obtain letter of representation Search for contingent liabilities 1. Inquire of client officers. Obtain letter of representation 2. Inquire of clients banks 3. Inquire of clients lawyers 4. Inquire of clients suppliers and creditors 5. Review minutes 6. Review purchase orders 7. Examine correspondence with financial institutions

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OWNERS EQUITY I. Major controls A. Company should utilize the services of an independent stock register and transfer agent to handle capital stock transactions B. When independent agents are not employer1. Should maintain numerical control of unissued certificates 2. Should retain canceled certificates 3. Officer should maintain custody of unissued certificates C. Stockholders ledgers and transfer journals should be maintained D. Subsidiary records and stock certificate book should be balanced to control account periodically E. Issues and retirements should be authorized by board of directors F. Treasury stock should b maintained in name of company G. Entries in owners equity accounts should be approved by controller H. Separate bank account should be maintained for dividend payments Audit objectives Determine that A. Control - Adequate internal controls exists over owners equity B. Presentation and Disclosure, Valuation - Amounts shown in balance sheet as capital stock, retained earnings and paid in capital are properly classified, described, and stated in accordance with generally accepted accounting principles and are not in conflict with requirements of the corporate charter (also rights and obligation) C. Completeness - Transactions in the owners equity accounts are properly authorized and approved D. Presentation and Disclosure - Adequate disclosure had been made of restrictions on retained earnings, stock subscription rights, stock reservations, stock options, etc. which may be imposed by various authorizations or agreements or by legal requirements Audit procedures A. Review and evaluate internal control for owners equity transactions- obtain description of controls and document, test transactions for proper authorization, execution and recording, note proper segregation of duties, and evaluate internal control weaknesses. 1. Obtain and understanding of internal control of owners equity. 2. Assess control risks for assertions about owners equity. 3. Perform additional tests of controls for those controls on which auditor plans to rely to reduce assessed level of control risk. 4. Reassess control risk and design substantive tests. B. Substantive tests 1. Review articles of incorporation, bylaws, and minutes for provision relating to capital stock 2. Obtain analysis of owners equity accounts 3. Confirm shares outstanding with independent registrar and stock transfer agent

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4. 5. 6. 7.

Trace proceeds from stock issues to cash receipts journal Examine canceled certificates Reconcile stockholders records and stock certificate numbers Inspect treasury shares and reconcile balance to control account