Chapter 11: Completing the Audit (Connect Practice)

Which of the following statements is most likely to be included in an attorney letter?

"Please furnish to our auditors such explanation, if any, that you consider necessary to supplement the foregoing information." Explanation: The attorney letter would request that the attorney furnish this information to auditors.

Subsequent Events--Two Types Read the overview below and complete the activities that follow. Oftentimes a CPA's opinion on the fairness of the financial statements may be changed by subsequent events. Subsequent events are events that happen after the balance sheet date but before the financial statements are issued. Auditors have responsibility for evidence not available at the close of the period but which becomes available before the auditors finish their fieldwork and issue their opinion. Subsequent events are divided into two categories: Type 1 are those providing additional evidence about facts existing on or before the balance sheet date and Type 2 are those involving facts coming into existence after the balance sheet date. CONCEPT REVIEW: Accounting standards divide subsequent events into two categories--those that provide more information about facts that already existed at the balance sheet date (Type 1) and those that involve facts after the balance sheet date (Type 2).

1. The CPA's opinion on the ______of the financial statements may be changed by subsequent events. ----->fairness 2. Many subsequent events may involve the settling of ________. ----->litigation 3. Type 2 subsequent events come into existence _____ the balance sheet date. ----->after 4. Subsequent events need to be disclosed in the financial statements; otherwise, the financial statements would be_______. ----->misleading 5. Type 1 subsequent events require the financial statements to be _______ if needed. ----->adjusted Explanation: 1. CPAs decide whether financial statements are fair based on subsequent event disclosure. 2. Litigation being settled is a common type of subsequent event. 3. Type 2 subsequent events occur after the balance sheet date. 4. Subsequent event disclosure is required to ensure the financial statements are not misleading. 5. Type 1 subsequent events require adjustment of the financial statements as needed.

Ambrose is auditing the financial statements of Mays (dated December 31, 2020). The date of the auditor's report is February 17, 2021, and the audit report release date is February 20, 2021. For which of the following matters would Ambrose have the least responsibility?

A major loss due to a catastrophe that occurred and was known by Ambrose on March 1, 2021. Explanation: Because this event occurred following the release of Ambrose's report, he would not have responsibility for this event because it relates to the 2021 audit.

Hart, an assistant accountant with the firm of Better & Best, CPAs, is auditing the financial statements of Tech Consolidated Industries Inc. The firm's audit plan calls for the preparation of written representations. Determine if the following statements are True or False.

A. Auditors are required to obtain written representations in all audits conducted under generally accepted auditing standards. (True) B. The major categories of items covered by written representations are: 1. Management's responsibilities for the financial statements and internal control over financial reporting. (True) 2. Management's description of pending or threatened litigation, claims, or assessments currently outstanding. (False) 3. Management's statement that the financial statements are prepared according to U.S. generally accepted accounting principles. (False) 4. Management's belief that the effects of uncorrected misstatements are immaterial to the financial statements. (True) 5. Management's statement that all financial records and related data were made available. (True) C. Written representations should be addressed to management and dated as of the date of the report release date. (False) D. Written representations should be signed by members of management whom the auditors believe are responsible and knowledgeable about matters covered by the representations (usually the CEO or CFO). (True) E. Written representations replace some of the necessary audit work performed by the auditors. (False) Explanation: a. Auditors are required to obtain written representations in all audits conducted under generally accepted auditing standards. b. The major categories of information contained in written representations are: 1. The entity's financial statements, including: - Management's responsibilities for the financial statements and internal control over financial reporting. - The appropriate disclosure, presentation, and reasonableness of certain items (accounting estimates, related parties, subsequent events, and litigation and claims). - A statement that uncorrected misstatements are immaterial to the financial statements taken as a whole. 2. Information provided to the auditors, both in general and related to sensitive areas (fraud, noncompliance with laws and regulations, litigation, and related-party transactions). 3. Internal control over financial reporting (for audits of public entities). c. Written representations should be addressed to auditors and dated as of the date of the auditor's reports (audit completion date). d. Written representations should be signed by members of management whom auditors believe are responsible and knowledgeable about matters covered by the representations (usually the chief executive officer, chief financial officer, treasurer, or controller). Their refusal to sign the representations would constitute a scope limitation that would preclude the issuance of an unqualified opinion. e. Obtaining written representations does not relieve auditors from their responsibility for planning and performing the audit. As a result, auditors must still perform all usual procedures to corroborate representations made by management.

What does the auditor need to document when there is substantial doubt that a client will continue as a going concern?

All of the choices are correct. (The conditions or events that suggest there is a going concern uncertainty./ Management's plan (or lack thereof) to mitigate the conditions and to continue as a going concern./ The auditor's conclusion on whether, after evaluating management's plan, substantial doubt exists regarding the company's ability to continue as a going concern and whether any report modifications are needed.) Explanation: The auditor should document the conditions or events that suggest a going concern uncertainty, management's plan (or lack of) to mitigate the conditions and to continue as a going concern, and the auditor's conclusion on whether substantial doubt still exists and whether a report modification is needed.

Which of these persons generally does not participate in writing the management letter?

Client's outside attorneys. Explanation: The client's attorneys would not ordinarily participate in drafting the management letter because this letter concerns helpful suggestions to increase the effectiveness and efficiency of the client's operations

Which of the following substantive procedures should auditors ordinarily perform regarding subsequent events?

Compare the latest available interim financial statements with the financial statements being audited. Explanation: Comparing interim financial statements with the financial statements being audited would identify potential subsequent events.

The primary reason auditors request responses to attorney letters is to provide auditors

Corroboration of the information furnished by management about litigation, claims, and assessments. Explanation: The attorney letter requests the attorneys to corroborate information furnished from management.

After the audit report release date, auditors determine that an important auditing procedure was omitted. Which of the following initial courses of action is most appropriate?

Determine whether the omitted procedure is important in supporting the auditors' opinion on the entity's financial statements. Explanation: This is the initial course of action that would be taken upon the discovery of an omitted audit procedure.

A major objective of written representations is to

Impress on management its ultimate responsibility for the financial statements and disclosures. Explanation: This responsibility is explicitly included in the written representations.

Which of the following substantive procedures would auditors most likely perform to obtain evidence about the occurrence of subsequent events?

Investigate changes in shareholders' equity occurring after the date of the financial statements. Explanation: This procedure may provide information about sales and repurchases of the entity's stock.

J. Griffith audited the financial statements of Mets Magnificat Corporation for the year ended December 31, 2020. She completed gathering sufficient appropriate evidence on January 30 and later learned of a stock split voted by the board of directors on February 5. The financial statements were changed to reflect the split, and she now needs to dual date the report on the entity's financial statements. Which of the following is the proper form?

January 30, 2021, except as to Note X, which is dated February 5, 2021. Explanation: The report date is the audit completion date and the dual date is the date related to the specific event.

Which of the following is not required by generally accepted auditing standards?

Management letter. Explanation: Management letters, while helpful, are not required under generally accepted auditing standards.

Hall accepted an engagement to audit the year 1 financial statements of XYZ Company. XYZ completed the preparation of the year 1 financial statements on February 13, year 2, and its auditors began the fieldwork on February 17, year 2. Hall completed gathering sufficient appropriate evidence on March 24, year 2; Hall's report and XYZ's financial statements were released on March 28, year 2. The written representations normally would be dated

March 24, year 2. Explanation: Written representations are dated as of the date of the auditor's report (in this case, March 24, Year 2).

The scope of an audit is not restricted when an attorney letter limits the response to

Matters to which the attorney has given substantive attention in the form of legal representation. Explanation: The attorneys' response should be limited to matters to which they have given substantive attention

Which of the following is ordinarily performed last in the audit examination?

Obtaining signed written representations. Explanation: Written representations would be obtained on the date of the auditor's report.

Which of the following normally occurs earliest in the audit examination?

Review of audit documentation. Explanation: The review of audit documentation occurs after the date of the financial statements but before the date of the auditor's report

What is an auditor's primary method to corroborate information on litigation, claims, and assessments?

Reviewing the response from the client's lawyer to a letter of audit inquiry. Explanation: An attorney's letter is the primary method used to corroborate information on litigation, claims, and assessments.

Which of these substantive procedures is not used to obtain evidence about contingencies?

Scanning expense accounts for credit entries. Explanation: Scanning expenses is unlikely to reveal any information about a contingency.

Subsequent knowledge of which of the following would cause the entity to adjust its December 31 financial statements?

Settlement of litigation in February for $100,000 that had been estimated at $12,000 in the December 31 financial statements. Explanation: Because an estimate had been made as of December 31, the event giving rise to the lawsuit had occurred, and the settlement introduced new information about the actual amount of the liability in February.

Auditors have a responsibility related to management's disclosure of new information related to subsequent events until

The audit report release date. Explanation: Auditors are responsible for ensuring that management properly discloses all information related to subsequent events that are known prior to the audit report release date.

The auditing standards regarding subsequently discovered facts refers to knowledge obtained after

The date of the auditor's report. Explanation: Subsequently discovered facts are identified after the date of the auditor's report.

Which of the following statements is not true with respect to written representations?

The failure of management to furnish them is a significant scope limitation, resulting in either an adverse opinion or a disclaimer of opinion. Explanation: The failure of management to furnish representations would result in either a qualified opinion (not an adverse opinion) or a disclaimer of opinion.

Which of the following best describes the role of analytical procedures near the end of the audit engagement?

To provide an overall review of the financial information and assessment of the adequacy of evidence gathered during the audit engagement. Explanation: Performing analytical procedures near the end of the audit provides the auditors an overall review of the financial statements and allows auditors to assess the adequacy of evidence gathered during the audit.

Subsequent Events--Two Types Read the overview below and complete the activities that follow. Oftentimes a CPA's opinion on the fairness of the financial statements may be changed by subsequent events. Subsequent events are events that happen after the balance sheet date but before the financial statements are issued. Auditors have responsibility for evidence not available at the close of the period but which becomes available before the auditors finish their fieldwork and issue their opinion. Subsequent events are divided into two categories: Type 1 are those providing additional evidence about facts existing on or before the balance sheet date and Type 2 are those involving facts coming into existence after the balance sheet date. CONCEPT REVIEW: Accounting standards divide subsequent events into two categories--those that provide more information about facts that already existed at the balance sheet date (Type 1) and those that involve facts after the balance sheet date (Type 2).

Type 1 * Additional evidence about conditions that existed at the balance sheet date. * During the audit, a customer with a large A/R balance at year-end declares bankruptcy. * A lawsuit that was in progress as of year-end was settled shortly thereafter. A lawsuit that was in progress as of year-end was settled shortly thereafter. Type 2 * Conditions that have come into existence after the balance sheet date. * A flood damages a significant portion of the operating facility after year-end.

Each of the following statements is a communication from management. Indicate whether the inclusion of each statement in written representations is appropriate.

a. "Certain representations in this letter are described as being limited to matters that are material." ---> Appropriate b. "No frauds involving management, employees who have significant roles in internal control, or other frauds that could have a material effect on the financial statements have occurred during the year under audit." ---> Inappropriate c. "Based on our assessment, we conclude that the Company has maintained an effective internal control over financial reporting as of December 31, 2020." ---> Appropriate d. "We have prepared a description and evaluation of certain contingencies for which our attorneys have devoted substantive attention on our behalf in the form of legal representation." ---> Inappropriate e. "There are no significant deficiencies, including material weaknesses, in the design or operation of internal controls that could adversely affect our ability to record, process, summarize, and report financial data." ---> Inappropriate f. "Summarized below are important actions taken in response to comments provided by you in the management letter dated March 22, 2021, based on your prior audit." ---> Inappropriate g. "Our assessment of internal control over financial reporting provides us absolute assurance that no material misstatements will occur and be undetected by our internal control." --->Inappropriate h. "We have made available to you all financial records and related data." ---> Appropriate Explanation: b. Inappropriate. While written representations address fraud involving management and employees who have significant roles in internal control, they do not indicate that no frauds that could have a material effect exist. Management's assessment of internal control over financial reporting will not provide management a basis for a statement of this nature. A more appropriate statement would be "we have no knowledge of any fraud...." d. Inappropriate. The description and evaluation of contingencies would accompany the letter sent to the client's attorney. While written representations indicate that management is unaware of unasserted claims or assessments that are required to be disclosed in accordance with Accounting Standards Codification 450, they would not list contingencies in which attorneys have participated. e. Inappropriate. While written representations will indicate that all deficiencies in the design or operation of internal control have been disclosed to auditors, they will not state that no such deficiencies exist even in cases for which no deficiencies are noted. f. Inappropriate. Management letter comments are merely advisory to management, and no action is required to be taken on these comments. Accordingly, reference to action on previous management letter comments is not appropriate. g. Inappropriate. Management's assessment of internal control over financial reporting will not provide such a high level of assurance to management; as a result, a reference of this nature in written representations is not appropriate. A more appropriate statement would be that "we have maintained an effective internal control over financial reporting."

Classify each of the following issues according to whether they will be (1) included in written representations in all audits, (2) included in written representations in audits of public entities (under PCAOB standards), or (3) not included in written representations:

a. Management acknowledgment of its responsibility for the fairness of the financial statements in accordance with U.S. GAAP. ------>Included in written representations in all audits. b. A list of pending or threatened litigation, claims, or assessments currently outstanding against the client. ------>Not included in written representations. c. A description of recommendations that allow the client to improve the efficiency and effectiveness of its operations. ------>Not included in written representations. d. Availability of all financial records and related data. ------>Included in written representations in all audits. e. Information related to the presentation and disclosure of items within the financial statements. ------>Included in written representations in all audits. f. Disclosure of all significant deficiencies and material weaknesses in internal control. ------>Included in written representations in audits of public entities. g. Information concerning fraud involving management and employees who have significant roles in internal control. ------>Included in written representations in all audits. h. Auditors' judgment about the quality of the client's accounting principles. ------>Not included in written representations. i. Management's conclusion about the effectiveness of its internal control over financial reporting. ------>Included in written representations in audits of public entities. j. A statement that the financial statements are prepared according to U.S. generally accepted accounting principles. ------>Not included in written representations. Explanation: b.Not included in written representations. (This would accompany an attorney letter sent from the client to its attorneys.) c.Not included in written representations. (This would be included in a management letter prepared by auditors to the client.) h.Not included in written representations. (This would be communicated to the client's audit committee or those charged with governance.) j.Not included in written representations. (Written representations indicate that management believes the effects of uncorrected misstatements are immaterial to the financial statements and that management has fulfilled its responsibility for the preparation and presentation of financial statements according to GAAP. However, written representations should not express an opinion on the financial statements.)

Lee and Kerzman is the auditor for Nance Corporation. During the course of the audit, the audit team noticed that Nance Corporation showed signs of financial distress. In particular, Nance Corporation was at risk for defaulting on several key loans and had therefore begun the process of restructuring their debt. This, among other indicators, led the audit team to have substantial doubt regarding Nance Corporation's ability to continue as a going concern. The next step the team should take is to:

obtain and discuss with management their plan to continue as a going concern and assess the likelihood the plan will be successful. Explanation: When auditor's suspect there is doubt that an entity will continue as a going concern, they must obtain and discuss with management their plan to continue as a going concern.