Audit Procedure for Share Capital
What is Share Capital?
Share capital stands as a fundamental pillar within a company’s financial structure, encapsulating the funds acquired through the issuance of common or preferred stock. It plays a pivotal role in fortifying a company’s financial backbone, serving as a reservoir for necessary resources to fuel operations, investments, and overall growth. The composition of share capital involves both common stock, typically entailing voting rights, and preferred stock, which often grants certain privileges such as priority in dividend payments.
One key facet of share capital is the concept of authorized share capital. This represents the maximum amount of capital that a company is legally sanctioned to issue to the public through the sale of its shares. This predetermined limit is explicitly outlined in the company’s constitutional documents and can be subject to alteration through the approval of shareholders.
When a company decides to go public, venturing into the realm of public offerings becomes imperative. This involves tapping into the authorized share capital and conducting an Initial Public Offering (IPO), where a portion of the authorized shares is made available to external investors. This strategic move is pivotal in transforming the company into a publicly traded entity.
Companies may choose to augment their share capital by opting for a new offer of stock. The rationale behind this decision varies, encompassing objectives such as funding expansion initiatives, retiring debt, or reinforcing the company’s overall financial standing. This approach entails issuing additional shares and injecting more equity into the company’s balance sheet.
Accounting for Share Capital
Accounting for share capital involves recording the issuance, repurchase, and retirement of shares in a company’s financial records. Below is a simple example of a journal entry for the issuance of common stock:
Issuance of Common Stock: Suppose XYZ Corporation issues 1,000 common shares at $10 per share, receiving the full payment in cash. The par value is $1 per share
- Journal Entry:
Account Debit Credit Cash 10,000 Common Stock 1,000 Additional Paid-in Capital 9,000
- Explanation:
- Cash (Asset): Represents the cash received from the issuance of shares.
- Common Stock (Equity): Represents the par value of the shares issued (1,000 shares * $1 par value).
- Additional Paid-in Capital (Equity): Represents the excess amount received over the par value per share.
This journal entry reflects the increase in the company’s cash and equity accounts, specifically in the Common Stock and Additional Paid-in Capital accounts.
Repurchase of Common Stock: Now, let’s consider a scenario where XYZ Corporation decides to repurchase 200 shares of its own common stock at $12 per share.
- Journal Entry:
Account Debit Credit Treasury Stock 2,400 Cash 2,400
- Explanation:
- Treasury Stock (Equity): Represents the cost of repurchasing the company’s own shares.
- Cash (Asset): Reflects the cash payment made for the repurchase.
This entry reduces both cash and equity, specifically increasing the Treasury Stock account, which is a contra-equity account representing shares that the company has repurchased.
Retirement of Common Stock: Suppose XYZ Corporation decides to retire 100 shares of its own common stock.
- Journal Entry:
| Account | Debit | Credit |
|---|---|---|
| Treasury Stock | 1,200 | |
| Common Stock | 100 | |
| Additional Paid-In Capital | 1,100 |
- Explanation:
- Treasury Stock (Equity): Decreases the Treasury Stock account to reflect the retirement of shares.
- Common Stock (Equity): Reduces the par value of the retired shares.
- Additional Paid-in Capital (Equity): Adjusts for any remaining capital more than the par value.
Audit Risk for Share Capital
When auditing a company’s share capital, auditors must be vigilant about potential risks that could compromise the reliability of financial statements. Two key areas of concern are existence and completeness, which could be affected by various factors related to the issuance and recording of shares.
- Existence: The risk of shares being incorrectly issued or not recorded poses a threat to the existence assertion. Auditors must carefully scrutinize the documentation supporting share issuances, such as board minutes and resolutions, to ensure proper authorization and compliance with regulatory requirements.
- Completeness: Incomplete recording of share transactions could lead to a misrepresentation of the company’s financial position. Auditors must perform thorough procedures, including reconciling the share registry with the general ledger and confirming the existence of issued shares with external registrars, to validate the completeness of recorded share capital.
- Accuracy: Auditors must verify the accuracy of share prices, ensuring consistency with relevant accounting standards. Additionally, a meticulous review of share issuances and repurchases, supported by appropriate documentation, is essential to validate the precision of reported figures.
- Valuation: Misvaluations arising from errors in share-related transactions, such as treasury stock activities, can distort the financial picture. Auditors need to confirm the adherence to accounting standards and assess the appropriateness of valuation methods applied to share capital components.
- Ownership: The determination of true ownership, especially in the context of different share classes, demands a careful examination of shareholder agreements and legal documents. Auditors should review these documents to understand the intricacies of the company’s ownership structure.
- Rights: Verification of voting rights linked to various share classes is essential. Auditors should confirm the accuracy of reported voting rights and assess compliance with legal requirements and shareholder agreements.
Audit Assertion
When conducting an audit of share capital, auditors consider various assertions to evaluate the reliability and accuracy of the financial statements. These assertions provide a conceptual framework for assessing different aspects of share capital without delving into specific audit procedures.
- Completeness Assertion: The completeness assertion ensures that all relevant transactions and events related to share capital are appropriately recorded and disclosed in the financial statements.
- Existence Assertion: The existence assertion affirms that the reported share capital truly exists and is valid.
- Rights and Obligations Assertion: This assertion ensures that the entity holds the rights to the reported share capital and is compliant with any obligations associated with share agreements.
- Accuracy Assertion: The accuracy assertion focuses on the correctness of the reported amounts of share capital.
- Valuation Assertion: The valuation assertion ensures that share capital is appropriately valued in accordance with accounting standards.
- Presentation and Disclosure Assertion: This assertion ensures that share capital is properly presented and disclosed in the financial statements.
- Classification Assertion: The classification assertion involves ensuring that share capital is appropriately categorized in the financial statements.
Audit Procedure
- Review of Board Resolutions:
- Objective: Confirm that the issuance of shares is duly authorized.
- Procedure: Examine board minutes and resolutions to verify proper authorization for the issuance of shares. Ensure compliance with the company’s bylaws and legal requirements.
- Confirmation with External Registrars:
- Objective: Confirm the existence and completeness of issued shares.
- Procedure: Obtain confirmation from external registrars regarding the number of shares issued and outstanding. Reconcile this information with the company’s records.
- Examination of Share Certificates:
- Objective: Verify the physical existence of share certificates.
- Procedure: Inspect a sample of share certificates to ensure they are properly executed, and their details match the company’s records.
- Review of Share Repurchase Transactions:
- Objective: Confirm the accuracy of recorded share repurchases.
- Procedure: Examine documentation supporting share repurchases, ensuring that the calculations and accounting treatment comply with relevant accounting standards.
- Validation of Share Prices:
- Objective: Ensure the accuracy of reported share prices.
- Procedure: Independently verify the accuracy of share prices used in financial statements. This may involve obtaining quotes from relevant markets or utilizing an external pricing service.
- Examination of Treasury Stock Transactions:
- Objective: Confirm the proper accounting treatment for treasury stock.
- Procedure: Review documentation related to treasury stock transactions, ensuring compliance with accounting standards. Verify that treasury stock is appropriately classified and disclosed in the financial statements.
- Inspection of Shareholder Agreements:
- Objective: Confirm ownership rights and obligations.
- Procedure: Examine shareholder agreements and other legal documents to understand the ownership structure, voting rights, and any obligations associated with different share classes.
- Testing of Valuation Methods:
- Objective: Ensure share capital is valued correctly.
- Procedure: Review the company’s valuation methods for share capital components, such as common stock and preferred stock. Ensure consistency with accounting standards and industry practices.
- Review of Changes in Share Capital:
- Objective: Confirm accurate presentation and disclosure.
- Procedure: Review financial statement disclosures related to share capital, ensuring that changes in share capital are appropriately presented and disclosed under accounting standards.
- Confirmation of Voting Rights:
- Objective: Verify the accuracy of reported voting rights.
- Procedure: Confirm the voting rights associated with different share classes by examining legal documents and shareholder agreements.