Chapter 24: Completing the Audit

Type 1: require an adjustment of account balances in the current year's financial statements if the amounts are material:

1. Declaration of bankruptcy by a customer with an outstanding accounts receivable balance because of the customer's deteriorating financial condition 2. Settlement of litigation at an amount different from the amount recorded on the books 3. Disposal of equipment not being used in operations at a price below the current book value

Dual Dating Extending the audit

1. Expand all subsequent events tests to the new date 2. Restrict the subsequent events review to matters related to the new subsequent event

Measuring a contingency

1. Fair value 2. Probability threshold Remote to probable

Categories of representation letter

1. Financial statements • Management's acknowledgment of its responsibility for the fair presentation of the financial statements Management's belief that the financial statements are fairly presented in conformity with applicable accounting standards 2. Completeness of information • Availability of all financial records and related data • Completeness and availability of all minutes of meetings of stockholders, directors, and committees of directors • Absence of unrecorded transactions 3. Recognition, measurement, and disclosure • Management's belief that the effects of any uncorrected financial statement misstatements are immaterial to the financial statements (a summary of these items should be included in or attached to the letter) • Information concerning fraud involving (a) management, (b) employees who have significant roles in internal control, or (c) others where the fraud could have a material effect on the financial statements • Information concerning related party transactions and amounts receivable from or payable to related parties • Unasserted claims or assessments that the entity's lawyer has advised are probable of assertion and must be disclosed in accordance with accounting standards 4. Subsequent events • Bankruptcy of a major customer with an outstanding account receivable at the balance sheet date • A merger or acquisition after the balance sheet date

Audit procedure for Subsequent events

1. Procedures normally integrated as a part of the verification of year-end account balances 2. Procedures performed specifically for the purpose of discovering events or transactions that must be recognized as subsequent events.

existence of contingent liability

1. There is a potential future payment to an outside party or the impairment of an asset that resulted from an existing condition 2. There is uncertainty about the amount of the future payment or impairment 3. The outcome will be resolved by some future event or events

Other Communications with audit Committee 4 principle purposes

1. To communicate auditor responsibilities in the audit of financial statements. 2. To provide an overview of the scope and timing of the audit. 3. To provide those charged with governance with significant findings arising during the audit. 4. To obtain from those charged with governance information relevant to the audit.

Audit documentation review

1. To evaluate the performance of inexperienced personnel. 2. To make sure that the audit meets the CPA firm's standard of performance. 3. To counteract the bias that often enters into the auditor's judgment.

Managements representation letter: usage

1. To impress upon management its responsibility for the assertions in the financial statements. 2. To remind management of potential misstatements or omissions in the financial statements. 3. To document the responses from management to inquiries about various aspects of the audit.

audit procedure for contingent liability

1. inquires with the client 2. Review current and previous years' internal revenue agent reports for income tax settlements. 3. Review the minutes of directors' and stockholders' meetings for indications of lawsuits or other contingencies. 4. Analyze legal expense for the period under audit and review invoices and statements from legal counsel for indications of contingent liabilities, especially lawsuits and pending tax assessments. 5. Obtain a letter from each major attorney performing legal services for the client as to the status of pending litigation or other contingent liabilities. 6. Review audit documentation for any information that may indicate a potential contingency. 7. Examine letters of credit in force as of the balance sheet date and obtain a confirmation of the used and unused balances.

Letter from management to attorney

A list including (1) pending threatened litigation and (2) asserted or unasserted claims or assessments with which the attorney has had significant involvement. This A request that the attorney furnish information or comment about the progress of each item listed. A request of the law firm to identify any unlisted pending or threatened legal actions or a statement that the client's list is complete. A statement informing the attorney of the attorney's responsibility to inform management of legal matters requiring disclosure in the financial statements and to respond directly to the auditor.

perform Final analytical procedures

Auditing standards require auditors to perform analytical procedures during the completion of the audit. Results from final analytical procedures may indicate that additional audit evidence is necessary. If this is the case, the auditor should perform additional testing to obtain sufficient appropriate evidence that the affected accounts are fairly stated.

Communicate Fraud and Illegal acts

Auditing standards require the auditor to communicate all fraud and illegal acts to the audit committee or similarly designated group, regardless of materiality.

evaluate GoingConcern assumption

Auditing standards require the auditor to evaluate whether there is a substantial doubt about a client's ability to continue as a going concern for at least one year beyond the balance sheet date.

Consider Supplementary Information in relation to Financial Statements as a Whole

Auditors must clearly distinguish their audit and reporting responsibility for the primary financial statements and for supplementary information.

PCAOB auditing standards require the auditor to obtain written representations from management about its responsibility for internal control over financial reporting and management's conclusion about the effectiveness of internal control over financial reporting as of the end of the fiscal period.

Auditors of public companies may obtain a combined representation letter for both the audit of the financial statements and the audit of internal control.

auditing standards require: other information included in annual reports pertaining directly to the financial statements.

It usually takes auditors only a few minutes to make sure that the nonfinancial statement information is consistent with the statements. If auditors conclude that a material inconsistency exists, they should request the client to change the information. If the client refuses, which would be unusual, the auditor should include an explanatory paragraph in the audit report or withdraw from the engagement.

Dual Dating

Occasionally, the auditor determines that a subsequent event that affects the current period financial statements occurred after the date of the audit report but before the audit report was issued.

Communication with the audit committee and management

Required by the Accounting standards make certain that those charged with governance, which is often the audit committee and senior management, are informed of audit findings and auditor recommendations.

Part 2: of completing the Audit Inquiry of the client's attorneys

is a major procedure auditors rely on for evaluating known litigation or other claims against the client and identifying additional ones.

Type 2: those that Do Not have a Direct effect on the Financial Statements but for Which Disclosure May Be required

Subsequent events of this type are events that provide evidence about conditions that did not exist at the date of the balance sheet being reported on but arose after the balance sheet date and may be significant enough to require disclosure.

review for subsequent events or post-balance-sheet review.

The auditor must review transactions and events that occurred after the balance sheet date to determine whether any of these transactions or events affect the fair presentation or disclosure of the current period statements.

Letter of representation

The letter of representation written by the client's management to the auditor formalizes statements made by management about different matters throughout the audit, including discussions about subsequent events.

financial statement disclosure checklist

These questionnaires are designed to remind the auditor of common disclosure problems in financial statements and to facilitate the final review of the entire audit by an independent partner.

commitments.

They include such things as agreements to purchase raw materials or to lease facilities at a certain price and to sell merchandise at a fixed price, as well as bonus plans, profit-sharing and pension plans, and royalty agreements.

contingent liability

is a potential future obligation to an outside party for an unknown amount resulting from activities that have already taken place. Must be disclosed in the footnotes

management letter

is intended to inform client personnel of the CPA's recommendations for improving any part of the client's business.

nonrecognized subsequent events include:

a decline in the market value of securities held for temporary investment or resale • The issuance of bonds or equity securities • A decline in the market value of inventory as a consequence of government action barring further sale of a product • The uninsured loss of inventories as a result of fire • A merger or an acquisition

subsequent discovery of facts

after the audited financial statements have been issued that the financial statements are materially misstated,or that the opinion on internal controls over financial reporting may not have been appropriate, after they have been issued

The first step in the audit of contingencies is to

determine whether any contingencies exist (occurrence presentation and disclosure objective).

unadjusted misstatement audit schedule

includes both known misstatements that the client has decided not to adjust and projected misstatements, including an allowance for sampling risk, and total possible misstatements for several financial statement categories.

engagement quality review, sometimes referred to as an independent review,

it is common to have the financial statements and the entire set of audit files reviewed by a completely independent reviewer who has not participated in the audit, but is a member of the audit firm doing the audit.

dual-dated audit report,

meaning that the audit report includes two dates: the first date for the completion of audit testing, except for the specific exception, and the second date, which is always later, for the exception.

Part 3: of completing the audit

review for Subsequent events

Procedures for finding subsequent events

review records prepared Subsequent to the Balance Sheet Date review Internal Statements prepared Subsequent to the Balance Sheet Date examine Minutes Issued Subsequent to the Balance Sheet Date Correspond with attorneys Inquire of Management Obtain a Letter of representation Arens, Alvin A.; Elder, Randal J.; Beasley, Mark S.; Hogan, Chris E.. Auditing and Assurance Services (Page 776). Pearson Education. Kindle Edition.

evaluation of Known Contingent Liabilities

search of unknown commitments evaluate sales commissions evaluate commitments for Raw materials

review of audit documentation

should be conducted by someone who is knowledgeable about the client and the circumstances in the audit. Therefore, the auditor's immediate supervisor normally conducts the initial review of audit files prepared by another auditor. The senior's immediate superior, who is normally a supervisor or manager, reviews the senior's work and also reviews, less thoroughly, the schedules of the inexperienced auditor. Finally, the partner assigned to the audit must ultimately review all audit documentation, but the partner reviews those prepared by the supervisor or manager more thoroughly than the others.

As directed by the Sarbanes-Oxley Act, rules require attorneys serving public companies to report material violations of federal securities laws committed by the company.

the American Bar Association subsequently amended its attorney-client confidentiality rules to permit attorneys to breach confidentiality if a client is committing a crime or fraud.

subsequent discovery of facts

the auditor has an obligation to make certain that users who are relying on the financial statements are informed about the misstatements or change in the conclusion on the effectiveness of internal controls.

Communicate Internal Control Deficiencies

the auditor must also communicate in writing significant internal control deficiencies and material weaknesses in the design or operation of internal control to those charged with governance.

Type 1: Subsequent event

those that have a Direct effect on the Financial Statements and require adjustment

Obtain Management representation Letter

usually in a letter of representation documenting management's most important oral representations made during the audit. The letter is prepared on the client's letterhead, addressed to the CPA firm, and signed by high-level corporate officials, usually the president and chief financial officer.

certain contigent liabilities

• Pending litigation for patent infringement, product liability, or other actions • Income tax disputes • Product warranties • Notes receivable discounted • Guarantees of obligations of others • Unused balances of outstanding letters of credit

As part of phase IV of the audit, auditors evaluate evidence they obtained during the first three phases of the audit to determine whether they should perform additional procedures for presentation and disclosure-related objectives.

• Perform procedures to obtain an understanding of controls related to presentation and disclosure objectives as a part of risk assessment procedures. • Conduct tests of controls related to disclosures when the initial assessment of control risk is below maximum. • Perform substantive procedures to obtain assurance that all audit objectives are achieved for information and amounts presented and disclosed in the financial statements.