Audit Ch. 17

An auditor issued an audit report that was dual dated for a subsequent event occur- ring after the date on which the auditor has obtained sufficient appropriate audit evidence but before issuance of the financial statements. The auditor's responsibility for events occurring subsequent to the date on which the auditor has obtained sufficient appropriate audit evidence was a. Limited to the specific event referenced. b. Extended to include all events occurring since the date on which the auditor has obtained sufficient appropriate audit evidence. c. Extended to subsequent events occurring through the date of issuance of the report. d. Limited to events occurring up to the date of the last subsequent event referenced.

A

Final analytical procedures are generally intended to a. Provide the auditor with a final, overall evaluation of the relationships among financial statement balances. b. Test transactions to corroborate management's financial statement assertions. c. Gather evidence concerning account balances that have not yet been investigated. d. Retest control activities that appeared to be ineffective during the assessment of control risk.

A

Define what is meant by contingent liability. What three categories are used to classify a contingent liability? Give four distinct examples of contingent liabilities.

A contingent liability is "an existing condition or set of circumstances involving uncertainty about a possible loss that will ultimately be resolved when some future event occurs or fails to occur" (p. 562). The three categories used to classify a contingent liability are as follows: probable, reasonably possible, and remote. These categories assess "the likelihood that the future event will result in a loss" (p. 562). Probably means that "the future event is likely to occur" (p. 562). Reasonably possible means that "the chance of the future event occurring is more than remote but less than likely." (p. 562). Remote means that "the chance of the future event occurring is slight" (p. 562). Four examples of contingent liabilities follow below. First, "if an oil refining company experiences an explosion and some of its workers are hurt, lawsuits will likely result" (p. 562). While the lawsuit is unresolved, the company faces uncertainty about the resulting loss. Thus, the company must decide how to account for this in their financial statements. Second, income tax disputes can result in contingent liabilities. Third, product warranties or defects can result in contingent liabilities. Fourth, agreements to repurchase receivables that have been sold can result in contingent liabilities.

What information does the auditor ask the attorney to provide on pending or threatened litigation?

A legal letter is sent to the entity's attorneys which "corroborat[es] information provided by management to the auditor about litigation, claims, and assessments" (p. 565). The auditor requests the following information from the entity's attorneys: "a list of any pending or threatened litigation or any probable but as yet unasserted claims to which the attorney has devoted substantial attention or for which an unfavorable outcome is reasonably possible" (p. 565) "a request that the attorney describe and evaluate each pending or threatened litigation; this should include the progress of the case, the action the entity plans to take, the likelihood of an unfavorable outcome, and the amount or range of the potential loss" (p. 565) "a request that the attorney identify any pending or threatened litigation or claims not included in management's list or a statement that the list is complete" (p. 565) "a request that the attorney comment on unasserted claims where his or her views differ from management's evaluation" (p. 565) "a request that the attorney indicate if his or her response is limited in any way and the reasons for such limitations" (p. 565)

Which of the following procedures would an auditor most likely perform to obtain evidence about the occurrence of any changes in internal control that might affect financial reporting between the end of the reporting period and the date of the auditor's report? a. Review a fire insurance settlement during the subsequent period. b. Examine relevant internal audit reports issued during the subsequent period. c. Inquire of the entity's legal counsel concerning litigation, claims, and assess- ments arising after year-end. d. Confirm bank accounts established after year-end.

B

An auditor would be most likely to identify a contingent liability by obtaining a(n) a. Accounts payable confirmation. b. Bank confirmation of the entity's cash balance. c. Letter from the entity's general legal counsel. d. List of subsequent cash receipts.

C

Which of the following events occurring after the issuance of a set of financial statements and the accompanying auditor's report would be most likely to cause the auditor to make further inquiries about the financial statements? a. A technological development in the industry that could affect the entity's future ability to continue as a going concern. b. The entity's sale of a subsidiary that accounts for 30 percent of the entity's consolidated sales. c. The discovery of information regarding a contingency that existed before the financial statements were issued. d. The final resolution of a lawsuit explained in a separate paragraph of the auditor's report.

C

An auditor should request that an audited entity send a letter of inquiry to those attorneys who have been consulted concerning litigation, claims, or assessments. The primary reason for this request is to provide a. The opinion of a specialist as to whether loss contingencies are possible, probable, or remote. b. A description of litigation, claims, and assessments that have a reasonable possibility of unfavorable outcome. c. An objective appraisal of management's policies and procedures adopted for identifying and evaluating legal matters. d. Corroboration of the information furnished by management concerning litigation, claims, and assessments.

D

Namiki, CPA, is auditing the financial statements of Taylor Corporation for the year ended December 31, 2015. Namiki plans to complete the fieldwork and sign the auditor's report about March 10, 2016. Namiki is concerned about events and transactions occurring after December 31, 2015, that may affect the 2015 financial statements. Required: a. What general types of subsequent events require Namiki's consideration and evaluation? b. What auditing procedures should Namiki consider performing to gather evidence concerning subsequent events?

Namiki's active responsibility is to consider all subsequent events that happen from the date of the financial statements through the issue of the audit report (March 10, 2015). There are two types of events to be considered. First, is a Type 1 Event. This is an event in which conditions existed before or at the balance sheet date and affect estimates that are part of the financial statements. This type of event requires adjustments to the financial statements. Second, is a Type II Event. This is an event in which conditions did not exist at the balance sheet date (arose later) and do not affect the accuracy of the financial statements. This event requires disclosure in the financial statements. Both of these types of events must be considered by the auditor. Namiki could use the following list of audit procedures to gather evidence concerning subsequent events. Inquire of Management Read Minutes of Meetings Inquire of Legal Counsel Read Interim Financial Statements Examine the Books of Original Entry

Why does the auditor obtain a representation letter from management?

The representation letter serves to "document, in writing, significant oral representations made to the auditor by management" (p. 573). It "also reduces the possibility of misunderstanding between management and the auditor" (p. 573). The letter serves to corroborate information received orally from management as the letter is signed by the client and addressed to the auditor. Some information given by the client may not be able to be verified with other supporting evidence (i.e. management intends to refinance a short-term obligation to long-term and thus classifies it as long-term). Thus, the letter serves as corroborating evidence.

What are the types of subsequent events relevant to financial statement audits? Give one example of each type of subsequent event that might materially affect the financial statements.

There are "two types of subsequent events that require consideration from management and evaluation from the auditor" (p. 568). The first is a Type I or Recognized Event. This is an event that "provide[s] additional evidence about conditions that existed at the date of the balance sheet and that affect the amounts or estimates involved in the financial statement preparation process" (p. 568). This type of event requires adjustment of the financial statements. The second is a Type II or Unrecognized Event. This is an event that "provide[s] evidence about conditions that did not exist at the date of the balance sheet but that arose subsequent to that date" (p. 568). These events typically require "disclosure in the financial statements" (p. 568). Additionally, if "the effect of the Type II event... is very significant, pro forma financial statements may be required in order to prevent the financial statements from being misleading" (p. 568). An example of a Type I event is an uncollectible account receivable resulting from deterioration in a customer's financial condition prior to year end in which the customers declares bankruptcy after the balance sheet date but prior to the issuance of the financial statements, about which the holder of the receivable is unaware (p. 568). An example of a Type II event is "loss of the entity's manufacturing facility or assets resulting from a casualty such as a fire or flood that occurred after the balance sheet date but prior to issuance of the financial statements" (p. 568).

For each of the following items, assume that Josh Feldstein, CPA, is expressing an opinion on Scornick Company's financial statements for the year ended December 31, 2015; that he completed fieldwork on January 21, 2016; and that he now is preparing his opinion to accompany the financial statements. In each item a subsequent event is described. This event was disclosed to the CPA either in connection with his review of subsequent events or after the date on which the auditor has obtained sufficient appropriate audit evidence. Describe the financial statement effects, if any, of each of the following subsequent events. Each of the five items is independent of the other four and is to be considered separately. At its January 5, 2016, meeting, Scornick's board of directors voted to increase substantially the advertising budget for the coming year and authorized a change in advertising agencies.

This has no impact on the prior financial statements and is not a subsequent event.

For each of the following items, assume that Josh Feldstein, CPA, is expressing an opinion on Scornick Company's financial statements for the year ended December 31, 2015; that he completed fieldwork on January 21, 2016; and that he now is preparing his opinion to accompany the financial statements. In each item a subsequent event is described. This event was disclosed to the CPA either in connection with his review of subsequent events or after the date on which the auditor has obtained sufficient appropriate audit evidence. Describe the financial statement effects, if any, of each of the following subsequent events. Each of the five items is independent of the other four and is to be considered separately. On January 15, 2016, R. E. Fogler, a major investment adviser, issued a negative report on Scornick's long-term prospects. The market price of Scornick's com- mon stock subsequently declined by 40 percent.

This has no impact on the prior financial statements and is not a subsequent event.

For each of the following items, assume that Josh Feldstein, CPA, is expressing an opinion on Scornick Company's financial statements for the year ended December 31, 2015; that he completed fieldwork on January 21, 2016; and that he now is preparing his opinion to accompany the financial statements. In each item a subsequent event is described. This event was disclosed to the CPA either in connection with his review of subsequent events or after the date on which the auditor has obtained sufficient appropriate audit evidence. Describe the financial statement effects, if any, of each of the following subsequent events. Each of the five items is independent of the other four and is to be considered separately. The tax court ruled in favor of the company on January 25, 2016. Litigation involved deductions claimed on the 2012 and 2013 tax returns. In accrued taxes payable, Scornick had provided for the full amount of the potential disallowances. The Internal Revenue Service will not appeal the tax court's ruling.

This is a Type I event because the event provides additional evidence about conditions that existed at the date of the balance sheet and affects the estimates involved in the financial statement preparation process. This requires an adjustment to the financial statements.

For each of the following items, assume that Josh Feldstein, CPA, is expressing an opinion on Scornick Company's financial statements for the year ended December 31, 2015; that he completed fieldwork on January 21, 2016; and that he now is preparing his opinion to accompany the financial statements. In each item a subsequent event is described. This event was disclosed to the CPA either in connection with his review of subsequent events or after the date on which the auditor has obtained sufficient appropriate audit evidence. Describe the financial statement effects, if any, of each of the following subsequent events. Each of the five items is independent of the other four and is to be considered separately. 1. A large account receivable from Agronowitz Company (material to financial statement presentation) was considered fully collectible at December 31, 2015. Agronowitz suffered a plant explosion on January 25, 2016. Because Agronowitz was uninsured, it is unlikely that the account will be paid.

This is a Type II event because the conditions did not exist at the date of the balance sheet but arose subsequent to that date. This requires a disclosure in the financial statements.

For each of the following items, assume that Josh Feldstein, CPA, is expressing an opinion on Scornick Company's financial statements for the year ended December 31, 2015; that he completed fieldwork on January 21, 2016; and that he now is preparing his opinion to accompany the financial statements. In each item a subsequent event is described. This event was disclosed to the CPA either in connection with his review of subsequent events or after the date on which the auditor has obtained sufficient appropriate audit evidence. Describe the financial statement effects, if any, of each of the following subsequent events. Each of the five items is independent of the other four and is to be considered separately. Scornick's Manufacturing Division, whose assets constituted 45 percent of Scornick's total assets at December 31, 2015, was sold on February 1, 2016. The new owner assumed the bonded indebtedness associated with this property.

This is a Type II event because the conditions did not exist at the date of the balance sheet but arose subsequent to that date. This requires a disclosure in the financial statements.

Under what circumstances would the auditor dual date an audit report?

When a subsequent event is recorded or disclosed in the financial statements after the date of the auditor's report, but before the issuance of the financial statements, the auditor may dual date the audit report. Dual dating is when the audit report has the original date of the report plus the date of the subsequent event. This serves to limit the auditor's liability.

Which of the following matters should an auditor communicate to those charged with governance? Signifcant Audit Adjustments (yes/no) Management's Consultations with Other Accountants (yes/no)

Yes; Yes

Arenas, an assistant accountant with the firm of Gonzales & Ramirez, CPAs, is audit- ing the financial statements of Tech Consolidated Industries, Inc. The firm's audit program calls for the preparation of a written management representation letter. Required: a. In an audit of financial statements, in what circumstances is the auditor required to obtain a management representation letter? What are the purposes of obtaining the letter? To whom should the representation letter be addressed, and when should it be dated? Who should sign the letter, and what would be the effect of his or her refusal to sign the letter? In what respects may an auditor's other responsibilities be relieved by obtaining a management representation letter?

a. The auditor always acquires a management representation letter because it serves to reduce the liability of the auditor and it is required by the auditing standards. Not receiving a management representation letter is reason to disclaim opinion or consider withdrawing from the engagement. The management representation letter serves to "document, in writing, significant oral representations made to the auditor by management" (p. 573). It "also reduces the possibility of misunderstanding between management and the auditor" (p. 573). Essentially, the letter serves to corroborate information received orally from management as the letter is signed by the client and addressed to the auditor. Some information given by the client may not be able to be verified with other supporting evidence (i.e. management intends to refinance a short-term obligation to long-term and thus classifies it as long-term). Thus, the letter serves as corroborating evidence. b. The auditor prepares the letter which is then printed on client letterhead and signed by the client (probably CFO or CEO). The letter is addressed to the auditor. If the letter is not signed, the auditor can disclaim their opinion or withdraw from the engagement. Refusal to sign the letter is a scope limitation. The letter is dated the same day as the audit report. c. Nothing.