Audit of the Financing and

Investing Cycle: Test of Controls

and Substantive Tests of
Transactions
Nature
▪ Include the responsibilities of planning the cash
needs, raising capital, and investing funds
▪ These cycles embrace the major non-operating
activities of many companies
▪ Every business must raise money to finance the
acquisition of productive assets used to produce
revenue
Financing Cycle Transactions
▪ Borrowing from others excluding open trade
accounts with creditors.
▪ Share capital and dividend transactions share
issuance and reacquisition, shares returned
and dividend declarations are the principal
transactions involving shareholder’s equity
Investing Cycle Transactions
▪ Acquisitions and disposals of
financial assets.
▪ Lending to others, excluding open
trade accounts with customers.
Accounts typically affected by the financing
and investing cycles:

▪ Notes payable – non trade (short term and ▪ Cash in bank

long term)
▪ Interest expense
▪ Bonds payable
▪ Accrued interest payable
▪ Mortgage payable
▪ Paid-in capital in excess of par
▪ Long-term liability under capital lease
▪ Donated capital
▪ Share capital
▪ Retained earnings
▪ Investment in securities (temporary and long
term) ▪ Appropriation of retained earnings
▪ Non-trade accounts receivable ▪ Treasury shares
▪ Property, plant and equipment ▪ Dividends declared
▪ Accumulated depreciation ▪ Proprietorship – capital account
▪ Intangibles and other assets ▪ Partnership – capital account
Documents and Records

▪ Share certificate – an engraved form showing the number of shares

owned by a shareholder in a corporation
▪ Bond certificate – an engraved form showing the number of bonds
owned by a bondholder
▪ Bond indenture – a contract stating the terms of the bond issue
between the bondholder and the issuing entity
▪ Broker’s advice – a statement from a broker specifying the details of
an investing transaction
Auditing the Financing Cycle

Possible errors related to financing activities include:

▪ Failing to make interest accruals, or making them twice
▪ Accruing interest in the wrong period
▪ Making incorrect estimates of allowances for obligations
▪ Failing to recognize that the entity violated a debt agreement
▪ Failing to record dividends that were declared
Internal Control Over Financing Cycle
Transactions

▪ existence or occurrence/ rights and obligations

1. Issuance of long-term notes, bonds , and share capitals are made in
accordance with board of directors’ authorizations and legal requirements
and proceeds are promptly deposited intact
2. Payments of bond interest and cash dividends are made to proper payees
in accordance with the board of directors or management authorizations
3. Redemption and reacquisition of bonds and share capital transactions are
executed in accordance with board of directors’ authorizations
4. Cancellation of notes when they are paid to avoid double payment
5. Recorded balances are periodically verified with bondholders and
shareholders
Valuation / Completeness / Classification

▪ Transactions and events are correctly

recorded as to amount, classification,
and accounting period
▪ Transactions are promptly and correctly
posted to individual accounts
Evaluation of Internal Control over Financial
Cycle Transactions

1. Current liabilities
▪ A system authorization on both as to original transaction resulting in
a liability and as to payment of the liability should be well-defined
and established
▪ Satisfactory system of record keeping with adequate forms and
documentation should be instituted
▪ There should be a plan of organization
Long-term liabilities

▪ Should be properly authorized

▪ There should be proper control over issued and unissued obligations
▪ Redeemed bonds should be cancelled, properly mutilated and
retained
▪ Bond ledger should be used in which details of bonds issued,
cancelled and outstanding are shown
▪ Proper control should be exercised over the payment of interest on
long-term liabilities
Share Capital

▪ Internal control measures and proper accounting

▪ Share certificates should be serially numbered and the authority for
signing and issuing the certificates be designated by the board of
directors
▪ Corresponding records of certificates should be prepared
▪ Cancelled certificates should be mutilated and any necessary
documentary stamps should be attached
▪ Entries for share issuances and transfers should be made by a person
who does not have authority to sign and issue certificated
Auditing the Investing Cycle
▪ Basic considerations:
Audit risk for investing cycle transactions and
balances can generally be kept at a very low level in
most enterprises since:
1. These transactions occur infrequently
2. Effectivity controls can be maintained at relatively
little cost
Internal Control Over Investing Cycle
Transactions

▪ Three operating objectives of internal control

applicable to the investing cycle are:
1. Executing of transactions
2. Recording of transactions
3. Custody of assets
Existence or Occurrence / Rights and
Obligations

▪ Purchases of property and equipment, securities and intangibles are

made in accordance with management’s authorization
▪ Sales of property and equipment, securities and intangibles should
be authorized
▪ Dividend and interest checks from investments are promptly
deposited intact
▪ Access to property and equipment, securities and intangibles are
restricted to authorized personnel
▪ Recorded balances are composed with existing assets at reasonable
intervals
Valuation / Completeness / Classification

▪ Transactions and events are correctly

recorded as to amount, classification and
accounting period
▪ Transactions are promptly and correctly
posted to individual investment accounts
Evaluation of Internal Control Over Investing
Cycle Transactions

1. Internal control over investments

▪ Purchases and sales should be made only on proper authorization
▪ Access to securities should not be vested on one person only
▪ Custodianship and accounting for securities should be separated
▪ Securities must be physically controlled
▪ Revenues received from the investments periodically should be
reconciled with the amounts that should be received
2. Internal control over fixed assets

▪ Proper authorization
▪ Clearly defined and sound policy for differentiation of capital and
revenue expenditures should be established
▪ Fixed assets controlling account should be conducted and supported
by detailed plant records
▪ Physical inspections of fixed assets
▪ Periodic review of adequacy of insurance
▪ Reasonable depreciation policy and must be consistently applied
3. Internal control over intangible assets

▪ Proper authorization
▪ Adequacy and consistency of accounting policies governing
intangible assets should be reviewed periodically
▪ General ledger account should be supported by adequate detailed
records and should be periodically reconciled
▪ Schedules of intangibles should be prepared periodically and be
reviewed by a responsible official
Test of Controls and Substantive Tests of
Transactions: Investing Cycle

1. Trace transactions for purchases and sales of property and

equipment, securities and intangibles through the system
2. Review reports by internal auditors on their periodic inspections to
property and equipment, securities and intangibles
3. Review monthly reports by officer of client company on securities
owned, purchased and sold, and revenue earned
4. Review significant changes in the composition of property and
equipment and related liens and mortgages