Auditing - Chapter 16

General risk contingency

An element of the business environment that involves some risk of a future loss. Examples include the risk of accident, strike, price fluctuations, or natural catastrophe. General risk contingencies should not be disclosed in financial statements.

Subsequent event

An event occurring after the date of the balance sheet but prior to completion of the audit and issuance of the audit report.

An auditor accepted an engagement to audit the 20X8 financial statements of EFG Corporation. The auditor completed the audit on February 10, 20X9, and delivered the report on February 16, 20X9. The client's representation letter normally would be dated:

February 10, 20X9

Which of the following is the best way for the auditors to determine that every name on a company's payroll is that of a bona fide employee presently on the job?

Make a surprise observation of the company's regular distribution of paychecks on a test basis

What are subsequent events?

The subsequent events refer to events that occur after the date of the balance sheet but prior to the date of the auditors' report. Subsequent events are broken up in two categories, type 1 and type 2.

Disclosure checklist

A list of specific disclosures required by the FASB, the GASB, the FASAC, and the SEC that is used to evaluate the adequacy of the disclosures in a set of financial statements.

A possible loss, stemming from past events that will be resolved as to existence and amounts, if referred to as a(n):

Loss contingency

Obtain representation letter

1) Purpose is to have the client's principal officers acknowledge that they are primarily responsible for the fairness of the financial statements 2) Dated as of the date of the audit report 3) Not a substitute for application of necessary audit procedures.

List the audit procedures that must be completed near the date of the audit report.

1) Search for unrecorded liabilities 2) Review the minutes of meetings 3) Perform final analytical procedures 4) Perform procedures to identify loss contingencies 5) Perform the review for subsequent events 6) Obtain the representation letter

Commitment

A contractual obligation to carry out a transaction at specified terms in the future. Material commitments should be disclosed in the financial statements.

Minutes

A formal record of the issues discussed and actions taken in meetings of stockholders and the board of directors.

Letter of inquiry of the client's lawyer

A letter sent by auditors to a client's legal counsel requesting a description and evaluation of pending or threatened litigation, unasserted claims, and other loss contingencies. The returned letter from the lawyer is referred to as the lawyer's letter.

Emphasis of matter paragraph

A paragraph included in the auditors' report that is required by GAAS or is included at the auditors' discretion, and that refers to a matter appropriately presented or disclosed in the financial statements that, in the auditor's judgement, is of such importance that it is fundamental to users' understanding of the financial statement.

Other matter paragraph

A paragraph included in the auditors' report that refers to a matter other than those presented or disclosed in the financial statements that, in the auditors' judgement, is relevant to users' understanding of the audit, the auditors' responsibilities, or the auditors' report.

Unasserted claim

A possible legal claim of which no potential claimant has exhibited an awareness.

Contingent liability

A possible liability, stemming from past events, that will be resolved as to existence and amount by some future event.

Loss contingency (definition)

A possible loss, stemming from past events, that will be resolved as to existence and amount by some future event. Loss contingencies should be disclosed in notes to the financial statements if there is a reasonable possibility that a loss has been incurred. When loss contingencies are considered probable and can be reasonably estimated, they should be accrued in the accounts.

Representation letter

A single letter or separate letters prepared by officers of the client company at the auditors' request setting forth certain representations about the company's financial position or operations.

Conservatism

An accounting doctrine for asset valuation in which the lower of two alternative acceptable asset valuations is chosen.

SAS 12

Auditors should obtain from management a list describing and evaluating threatened or pending litigation.

When auditing the statement of cash flows, which of the following would an auditor not expect to be a source of receipts and payments?

Capitalization

As a result of analytical procedures, the independent auditors determine that the gross profit percentage has declined from 30 percent in the preceding year to 20 percent in the current year. The auditors should:

Consider the possibility of a misstatement in the financial statements

Which of the following is most likely to be considered a Type 1 subsequent event?

Customer checks deposited prior to year-end, but determined to be uncollectible after year-end

The search for unrecorded liabilities for a public company includes procedures usually performed through the:

Date of the auditors' report

Subsequent to the issuance of the auditor's report, the auditor became aware of facts existing at the report date that would have affected the report had the auditor then been aware of such facts. After determining that the information is reliable, the auditor should next:

Determine whether there are persons relying or likely to rely on the financial statements who would attach importance to the information

Analytical procedures

Evaluations of financial information made by a study of plausible relationships between financial and non financial information.

Supplementary information

Information presented outside the financial statements, excluding required supplementary information, that is not considered necessary for the financial statements to be fairly presented in accordance with the applicable financial reporting framework.

Likely misstatements

Misstatements identified by the auditors during the course of the audit that are due to either extrapolation from audit evidence or differences in accounting estimates.

Litigation

Most common loss contingency - pending or threatened litigation: 1) Letter of inquiry to client's legal counsel 2) SAS 12

Which of the following procedures is most likely to be included in the final review state of an audit?

Perform analytical procedures

Which of the following events occurring on January 5, 20X2, is most likely to result in an adjusting entry to the 20X1 financial statement?

Settlement of litigation

Loss contingencies

Should be reflected in financial statements when: 1) it is probable that a loss had been sustained before the balance sheet date 2) the amount of the loss can be reasonably estimated 3) when it is at least reasonably possible that a loss has been sustained, NOT disclosed when the possibility of loss is remote

Known misstatements

Specific misstatements identified by the auditors during the course of the audit.

Which of the following is least likely to be considered a substantive procedure relating to payroll?

Test whether employee time reports are approved by supervisors

Report release date

The date the auditors grant the client permission to use the audit report in connection with the financial statements. This is sometimes referred to as the date of issuance of the audit report.

Type 1 subsequent event

Type 1 subsequent events provide additional evidence as to the conditions that existed at the balance sheet date, and affects the estimates inherent in the process of preparing financial statements. It is also required that the financial statement amounts be adjusted to reflect the changes in estimates resulting from the additional evidence.

Type 2 subsequent event

Type 2 subsequent events involves conditions coming into existence after the balance sheet date. These events do not require adjustment to the dollar amounts shown in the financial statements, but they should be disclosed in the financial statement notes if the statements otherwise would be misleading.

The aggregated misstatement in the financial statements is made up of:

Yes (known misstatement), Yes (projected misstatements), Yes (other misstatements)