 in this presentation we will take a look at the audit process with first a word from our sponsor well actually these are just items that we picked from the youtube shopping affiliate program but that's actually good for you because these aren't things that we're just given to us from some large corporation which we don't even use in exchange for us selling them to you these are things that we actually researched purchase and use ourselves bayer dynamic not sure if i said that right but this is the dt 770 pro 250 ohm studio reference closed back headphones i wear headphones basically every day for a large part of the day they are important to me therefore i've gone through many different kinds of headphones i've had these for some time and they've worked quite well they fit over my ears but i'm still able to put my glasses on under the headphones the headphones not pinching too tight on the glasses to give me a headache which is nice the quality of the patina is good and it has lasted for some time i've had these for some time now and they haven't gotten all torn up on me or anything like that i also like that i have a cord when i'm doing my recordings as opposed to a usb centered headphone because that frees up a usb port and i find the usb headphones to be less reliable they come with an audio jack that looks like this which is useful for me because that plugs into my audio interface however if you want to use the headphones for some other purpose i believe it's fairly easy to get a converter to other types of audio jacks if you would like a commercial free experience consider subscribing to our website at accounting instruction dot com or accounting instruction dot thinkific dot com where we have many different courses you can purchase one at a time or have a subscription model given you access to all the courses courses which are well organized have other resources like excel files and pdf files to download and no commercials later to retained earnings and dividends now when we consider retained earnings note that we're thinking about the balance sheet we're in the equity section and specifically we are in retained earnings what is retained earnings it's going to be that account that's the accumulation of earnings over time so whenever we close out in essence the income statement the net income you'll recall is going to be increasing retained earnings and retained earnings then going up by the net income down by a loss if the company happened to have a loss and then it's going to be down going down by any dividends that we take out so when we take the dividends and pay the earnings that have been retained from the company for the income that's accumulated over time and been accumulated in the account of retained earnings we then pay it to the owners at some point hopefully in the form of dividends and the dividends then of course are kind of like draws and they would be for a sole proprietor they would be draws kind of like draws for a sole proprietor although they're going to go through some more bureaucratic process in order to have the dividends and their taxable but in the case in their their draws or like draws in that they will be decreasing the retained earnings so given that note that retained earnings shouldn't have a lot of transactions to it because I mean if it's a nothing unusual happened if it's a really kind of plain normal type of year then retained earnings should be what it was at the end of last year nothing should happen to it except for some dividends should be taken out of it which would be a pretty straightforward not too many transactions with regards to dividends decreasing retained earnings and then of course we have the net income that would roll over to it so it's really just rolling over retained earnings and then taking out the dividends that means not many transactions with regards to retained earnings typically should be fairly simple to audit we should be able to basically consider all the transactions that are included in it on more of a kind of a substantive type procedural process primary concern with relation to dividends is primary concern is over violations of corporate bylaws or debt covenants so any kind any kind of violations of the bylaws is going to be our major concern with regards to the dividends and recall that the dividends are going to be the items that are leaving so we're going to be paying out the dividends which will be reducing the retained earnings if and and we're going to be paying them to the owners the stockholders of the organization so they're going to be retained earnings increases we're going to pay them out in the form of dividends dividends being the earnings that have accumulated over time that we're distributing to the owners the owners being the stockholders if an independent dividend dispersing agent is used the auditor will confirm the amount dispersed with the agent the amount is then agreed with the amount authorized by the board of directors so once again if it's a publicly traded company we have this basic bureaucratic kind of process third party individual that we can really use within the auditing process which is kind of a function of it or part of it that we can go to and confirm these transactions with so if an independent dividend disbursement agent is used kind of like a third party individual outside not directly connected to the company therefore good audit evidence to go talk to that individual audit will confirm the amount to disperse dispersed with the agent the amount is then agreed with the amount authorized by the board of directors if an independent agent is not used however so we know what if we don't have that independent agent and if it's a publicly traded company you think you probably would if it's not publicly traded company then it's quite possible we do not in that case order will recompute the amount of the dividend authorized by the board of directors so note when we have the dividends it's one of those kind of key issues that should be authorized by the board of directors and then therefore we can go through the authorization process to make sure that the dividend process was properly authorized and we can re we can recompute what was authorized by the board of directors so we can then the amount of dividends authorized by the board of directors and trace the amount to the cash disbursements or dividends payable. So then of course we'll take that recalculation and trace it out to what actually happened. Now we're going to consider retained earnings. So that's going to be the accumulation of the net income minus the disbursements the dividends retained earnings are generally affected by the current year's income or loss and the dividends declared and or paid. Now note when we consider the dividends that's going to be an important point when we consider the valuation of retained earnings because remember there's basically three time periods that you have a dividend you declare the dividend and then you have a point in time basically when you the people that are holding the dividends that's who's going to get the dividends and then you pay the dividends and the two important points from a financial accounting standpoint is when should we record the dividend even though it's not paid we typically record it when it's declared. So then we're going to record it when it's declared meaning we have a dividend that's going to be a debit and then we're going to credit like a liability just dividends payable. Why because we've committed or the company has committed to giving a dividend therefore we're going to reduce the retained earnings we're going to we're going to show a dividend in the equity section and we're going to show that we have that company has a liability because they have two to the shareholders because they have declared that they will indeed give that dividend then of course they'll pay the dividend at a later point in time at which point they will credit cash decrease in cash and reduce the dividend payable liability account. Now again that's usually that's basically it with regards to retained earnings it's a really important account but really it's basically the net income that's going to roll into it or the loss and the dividends we talked about the auditing process of the dividends and with regards to the net income of course we will audit net income but we're going to audit net income as we audit basically the income statement accounts and notice even the income statement accounts as we'll discuss in future presentations much of the auditing of the income statement actually happens as we audit the accounts on the balance sheet and the processes related to them because as we think about the processes we think about the related accounts that will be both income statement and balance sheet accounts and as we audit things on the balance sheet and consider the processes as we do so we typically do a lot of auditing on the income statement as well so in other words with regards to retained earnings the net income will roll in which comes from the income statement we're going to audit basically the income statement to get to the net income statement and so so we're not going to spend a lot of time thinking about that that transaction with regards to retained earnings because we'll be auditing and thinking about it in terms of the income statement so obviously we're going to tie out and make sure that the net income that's recorded closed out and reported in the books ties out to the income statement that basically being taken care of hopefully by just simply the double entry accounting system that wasn't the case we wouldn't be in balance and then we have the other types of transactions however that could affect retained earnings if they are present we would want to be concerned with them and look into them so prior period adjustments so if there were any like prior period adjustments that got recorded to retained earnings in other words like if there was an adjustment in the in the prior period and we made it this year then that adjustment is going to be something that's going to roll into basically retained earnings going to affect retained earnings because it was in the prior period the prior period was closed out to retained earnings and then we adjusted it so now there's going to be some kind of adjustment some kind adjustment to retained earnings a correction of an error that's another thing that could possibly happen like a you know if there was an error then and it got corrected then if some period was closed out already the adjustment might go to retained earnings if we had to depending on how we correct that error so for example I mean if a check if you cancel the check in the prior time period and and the check was going to an expense account and we said that was an error and then we adjusted it of course and that expense account was rolled over to retained earnings then it could affect basically the retained earning account so we're going to check that item and then the stock retirements so any kind of stock retirements that transaction happens we'll check those items now note in publicly traded companies this should we would expect retained earnings to basically be accounted for to roll forward if there's any kind of adjustments with these items then they would basically be accounted for and we can we can look into them and test them if we're talking about smaller companies and you're talking about a review or something like that the first thing we're probably going to do is check that retained earnings does indeed tie out meaning does the beginning retained earnings you know match what was on last year's financial status the last year's ending retained earnings should be the beginning balance in the retained earnings account in the in the general ledger for the current year and then any transactions that happen you would think would only be things like dividends that would be decreasing it and the net income at the end of the year if how so we're the first thing you want to do in a smaller audit is check and to make the sure that that is indeed the case and if it's not then it could be the case that some kind of prior period adjustment happened some kind of adjustment happened that that closed that adjusted the books in the prior period and then rolled out to the retained earnings so now retained earnings doesn't tie out as it should and if that's the case then you got to go back and think about what you know try to dig dig through and figure out what happened the easiest way to do that is to basically line up line up the balance sheet accounts as they are in the current system for the for the beginning of the time period or the end of last time period and try to match that up to the audited financial statements or the or the completed financial statement or reviewed financial statements in the prior time period and then you can match those up and take the difference and see where the see where the differences are at which accounts are off and then you can go back and see what kind of prior period adjustment happened and whether or not it is correct so again in publicly traded companies we would expect retained earnings to roll forward that to be taken care of and then we if any adjustments in there we just take a look at the transactions and make sure that's the case in small companies if you're working with small companies for reviews or something like that or even tax returns then that's probably checking that retained earnings roll forward correctly is one of the first things you probably want to look at and then you want to consider if there were any prior period adjustments that were made either correctly or incorrectly and and look into that and the best way to do that is to match up the balance sheet accounts as of the end of last year to what's currently in the system hopefully as of the end of last year if you have it and then you can you can see what the differences are