Audit of SHE Concepts
Audit of SHE Concepts
Auditing equity is usually one of the easiest parts of an audit. For some equity accounts,
you agree the year-end balances to the prior year ending balance, and you’re done. For
instance, paid-in-capital seldom changes. Often, the only changes in equity are from
current year profits and owner distributions. And testing those equity additions and
reductions in equity takes only minutes.
Equity walkthroughs
Common stock
Paid in capital
Preferred stock
Treasury stock
Noncontrolling interests
Classification
When a company reflects equity on its balance sheet, it is asserting that the balance exists and
that the equity transactions occurred. For example, if common stock is sold, the balance of the
account is based upon the actual sale of stock and the monies received. In other words, the
balance is not fraudulently or erroneously stated.
Equity instruments also have certain rights and obligations. For example, common stock
provides rights to retained earnings. Also, some classes of stock provide voting privileges.
Others do not.
Additionally, the classification of equity balances is important. Determining how to present
equity is usually easy, but classification issues arise when an entity has convertible stock (is it
debt or equity?). Another example of a classification issue is noncontrolling interests (how much
of the profits go to this account?).
Keep these assertions in mind as you perform your transaction cycle walkthroughs.
Equity Walkthroughs
Early in your audit, perform a walkthrough of equity to see if there are any control weaknesses.
As you perform this risk assessment procedure, what questions should you ask? What should you
observe? What documents should you inspect? Here are a few suggestions.
As you perform your equity walkthrough ask or perform the following:
What types of equity does the entity have? What are the rights of each class?
How many shares are authorized? How many shares have been issued?
Read the minutes to determine if any new equity has been issued.
Minutes reflecting the approval of new equity or the retirement of existing equity
A summary of equity activity (beginning balances plus new equity less equity
distributions and ending balance)
In summary, we’ve reviewed the keys to auditing equity. Those keys include risk
assessment procedures, determining relevant assertions, performing risk assessments, and
developing substantive procedures. The most important issues to address are usually (1)
equity accounting (especially when there are more complex types of equity transactions)
and (2) the classification of equity.
Stockholders’ equity represents the claim that the corporation’s shareholders have to the
company’s net assets. As an auditor you have to account for net assets. Stockholders’
equity has three common components: paid-in capital, treasury stock, and retained
earnings.
NOTES: It is not appropriate to record any sort of gain or loss on treasury stock
transactions. Per generally accepted accounting principles (GAAP), this is a balance sheet
transaction that affects stockholders’ equity and cash.
Retained earnings: Retained earnings show a company’s total net income or loss from
the first day it is in business to the date on the balance sheet you’re auditing.
NOTES: Items other than net income or loss can affect retained earnings. Paying
dividends and correcting prior period errors are two of the most common events that
increase or decrease retained earnings.
DEFINITION OF TERMS:
Outstanding Shares
Amount of money paid for shares of stock above the stated par value, known
as additional paid-in capital (APIC).
This figure is derived from the difference between the par value of common and preferred
stock and the price each has sold for, as well as shares that were newly sold.
APIC only occurs when an investor buys shares directly from a company.
It represents the additional amount an investor pays for a company's shares over the face
value of the shares during a company's initial public offering (IPO).
You can find the APIC figure in the equity section of a company's balance sheet.
Retained Earnings
The number of shares that have been repurchased from investors by the company.
A company will hold its own stock in its treasury for later use.
It might sell the stock at a later date to raise capital or it might use it to prevent a hostile
takeover.
Treasury stock is a contra account. DEBIT- normal balance.
This figure is subtracted from a company's total equity, as it represents a smaller number
of available shares for investors once it is repurchased.
A company lists its treasury stock as a negative number in the equity section of its
balance sheet.
Treasury stock can also be referred to as "treasury shares" or "reacquired stock."
When a corporation buys back some of its issued and outstanding stock, the transaction
affects retained earnings indirectly.
Share Premium
Difference between the par value of a company’s shares and the total amount a company
received for shares recently issued.
It is credited for money paid, or promised to be paid, by a shareholder for a share, but
only when they pay more than the cost of a share.
It is a reserve that cannot be distributed.
It is usually utilized to pay off equity expenses, which include underwriter fees.
The account can also be used in the issuance of bonus shares and for costs or expenses
related to this issuance.
Same as to Additional Paid in Capital (APIC)