Question

Below are several questions that the auditor must address as part of the audit of stockholders' equity accounts. QUESTIONS AUDITOR MUST ADDRESS AS PART OF AUDIT OF STOCKHOLDERS' EQUITY ACCOUNTS (a) Are issuances of capital stock properly authorized? (b)Are dividends declared by the client actually recorded? (c) Is all information related to stock warrants, options, and rights properly disclosed? (d)Are issuances of capital stock properly recorded? (e) Dorecorded retirements or repurchases ofcapital stock represent legitimate transactions that actually occurred? (f) Are the beginning balances of capital stock and additional paid in capital accounts correct? (g) Do issuances of capital stock result in outstanding shares issued that exceed authorized shares? REQUIRED: () For each of the questions listed, indicate the type of potential financial statement error or fraud that could occur For each of the potential errors or fraud indicated in (1) above, list a specific audit procedure that the auditor can use to determine whether a material error or fraud has occurred. (2)

Answer 1

Because equity is a residual element, satisfactory audit of the asset and liability accounts already provides a level of assurance on the fairness of equity. For this reason, components of equity require the least amount of audit time.

What specific components of equity are audited?

All of the components require audit. There are only a few of the components, really. So it doesn’t take much audit time to examine them.

Specifically, the auditor gathers evidence about the following:

• Contributed capital (stocks issued and outstanding)
• Retained earnings (dividend declarations)

What is the auditor’s primary source of corroborating information?

The auditor shall make inquiries of the corporate secretary regarding transactions affecting equity for the period under audit, and changes to the amounts of capital in the balance sheet.

Issuance of new shares

When new shares are issued, they become outstanding for the first time. Issuance of these shares for cash or other consideration changes the capitalization of the client and affects the percentage holding of a stockholder in terms of ownership, which in turn, changes the way the client is controlled by its stockholders.

An interest of such extent can easily control the client’s operating and financial affairs. Therefore, the auditor needs to look into the corporate minutes and examine whether such issuance has been properly approved by the Board of Directors and/or shareholders in a meeting called for that purpose.

Transfer of shares

When ownership of shares already issued and outstanding is transferred from one stockholder to another, the record of transfer is listed in the stock and transfer book. For significant transfers, the auditor shall inspect this book if the client maintains such record. The corporate secretary is the best officer to contact for this purpose.

Also, the secretary shall be asked to verify the total number of shares issued and outstanding as of the balance sheet date, and whether other changes could warrant disclosure or unique reportorial requirements, like stock split, stock rights and quasi-reorganization.

Although evidence on the total number of shares authorized for the company to issue over its lifetime is permanent in nature, the auditor may, from time to time, inquire as to corporate changes and read the Articles of Incorporation to check for such changes. This, of course, is complementary to inquiry with the corporate secretary.

What if the client pays an outsider to keep its stock records?

Where an independent third party agent is being paid by the client to keep track of its stock issues and transfers, the auditor shall obtain the same evidence sought above by sending letter of confirmation to the agent asking for verification of stock records and transactions.

Important note on stock transfer

Unlike a new issue of share, a transfer of a already issued stocks from one holder to another is a transaction between two persons or entities other than the client corporation. This transfer only effects a change in stockholder and does not increase or decrease the number of shares outstanding.

For this reason, there is no need to read the minutes of meetings for the authorization of BOD because that authorization is not needed for the transfer.

Retained earnings

Every year, the reported net income or net loss changes retained earnings. Once this income (loss) is verified, there is no need to separately audit this component of retained earnings.

The beginning balance of retained earnings

It is important to trace the opening balance of this account to the audited financial statements of last year’s audit to make sure that the client uses correct corresponding figures (beginning balance in this case) for the year.

Dividend declarations

Dividends reduce retained earnings. Like new issue of shares, dividends require the vote of BOD, and in other cases, consent of stockholders. Thus, audit of dividends require to auditor to scan the minutes of meeting for evidence of voting and approval.

As technology increases and the world becomes more reliant on financial data for global interaction then there is a greater risk for financial fraud to be present. The 21^st century has seen the collapse of many large companies such as Enron, and World Com, due to errors in financial reporting and committing overt acts of financial fraud. In 2002, the Sarbanes-Oxley Act was enacted as a direct response to financial fraud. The Sarbanes- Oxley act is also known as the SOX act or the Public Company Accounting Reform and Investor Protection Act. This bill is a direct response to the accounting scandals of the publicly traded companies Enron and WorldCom which were facilitated by the once prestigious accounting firm known as Arthur Anderson. This article is meant to explain causes of fraud, the methods used to commit fraud as well as the consequences that come with committing financial statement fraud.

Fraud can encompass various different types of acts but is generally defined as the intentional misleading of a person or deception of a person in order to cause someone to lose property, money, or some other right. This therefore implies that fraud must be intentional. So theoretically someone can commit an error on the financial statements without it being considered fraud or rather without trying to deceive anyone for personal financial gain.

To Identify Fraud you must have a number of items that are identified first. These items are listed below:

1.) There must be a victim.

2.) There must be a detailed account of the deceptive or fraudulent act.

3.) There must be able a mechanism to identify and quantify the victim's loss.

4.) There must be a person suspected of committing the crime.

5.) There must be evidence that the suspect acted with the intent to commit the crime.

6.) There must be evidence that the suspect profited in some way by the act(s) that were committed.

It is important to note that the indicators and the symptoms of fraud can be separated and differentiated from any errors that might occur as a result of account mistakes by the use of fraud indicators. These fraud indicators help serve as specific clues or "red flags" that could merit further investigation by an auditor into a specific area of the business or a specific activity that the business.

in order to counteract financial fraud and limit the likelihood of a business to engage in fraudulent financial reporting an accounting process known as auditing is used by many companies and in the case of publicly traded companies auditing is required. An audit is defined as an examination of the financial accounts and the reporting of financial activities for business entity that is performed by an individual or company that is independent of the business entity that is being audited. The types of financial reports that our audited include the balance sheet, income statement, statement of stockholders equity, statement of cash flows, and any financial information or notes that summarize or explain the accounting procedures and techniques that are used by a business.

The purpose and goal of an audit is to formulate an opinion based on empirical evidence of whether or not the financial information that a business has presented is accurate. Auditors must follow auditing standards that have been set forth by the FASB, the United States Securities and Exchange Commission, and any other auditing boards that are instrumental in the development of these standards. After an order has examined the financial information of a company and their work is complete they write an audit report explaining what exactly they have done, the techniques they have used, the information that they have evaluated, and then summarize all of this by giving an opinion of whether or not financial statements for business are accurate based upon their findings. It is important to understand that there are multiple types of audits, which an auditor may perform.