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Chapter 15


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  • 1. Chapter 15 Completing the Audit
  • 2. Assessing the Quality of the Audit
    • Analytical review
    • Required by GAAS
    • Do company results make sense in relation to industry and economic trends?
    • Concurring partner review
    • Independent review by experienced auditor who is not part of audit team
    • Sarbanes/Oxley Act requires for audits of public companies
    • Partner rotation
    • Sarbanes/Oxley Act requires new audit engagement and concurring review partner every 5 years
    • Does not apply to CPA firms with less than 10 partners and 5 public company audit clients
  • 3. Other Considerations in the Final Review Stage of the Audit: Contingencies
    • Contingent losses that are both probable and reasonably estimated should be accrued and disclosed
    • Contingent losses that are reasonably possible, and remote contingencies disclosed because of common practice, should be disclosed in the notes to the financial statements
    • Contingencies include:
    • Collectibility of receivables and loans
    • Product warranty liability
    • Litigation, claims, and assessments
    • Threat of expropriation of assets in a foreign country
    • Guarantees of debts of others
    • Purchase and sale commitments
    • Agreements to repurchase receivables that have been sold
    • Obligations of banks under standby letters of credit
  • 4. Discuss Contingencies
    • Responsibilities
    • Management is responsible for identifying, evaluating, and accounting for contingencies
    • Auditor is responsible for determining client has properly identified, accounted for, and disclosed material contingencies
    • Sources of Evidence
    • Primary sources include management and client's legal counsel
    • Additional sources include corporate minutes, contracts, correspondence from government agencies, and bank confirmations
  • 5. What is the letter of audit inquiry?
    • Primary source of corroborative evidence concerning litigation, claims, and assessments is the client's legal counsel
    • Letter of inquiry should include
    • Management's list that describes and evaluates its contingencies
    • A request that the attorney furnish auditor with the following:
      • Comment on the completeness of management's list and evaluations
      • For each contingency,
        • Description of the matter, progress to date, and action client intends to take
        • Evaluation of the likelihood of unfavorable outcome and estimate of potential loss, if possible
        • Any limitations on the attorney's response
  • 6.
    • The letter of inquiry is good for establishing completeness of potential liabilities and providing factual information about contingencies
    • However, because audit workpapers are not privileged, attorney responses will be less than forthcoming about the likelihood of unfavorable outcomes, and the estimated amount of any potential losses
    • An attorney's refusal to provide the requested information is a scope limitation sufficient to preclude issuing an unqualified opinion
    What is the letter of audit inquiry? (Continued)
  • 7. Review Adequacy of Disclosures
    • Third standard of reporting states "Informative disclosures in the financial statements are to be regarded as reasonably adequate unless otherwise stated in the report."
    • Auditor must be sure that:
    • Disclosed events and transactions occurred and pertain to the client
    • All disclosures that should be included are included
    • Disclosures are understandable to users
    • Disclosures are accurate
  • 8. Explain Management Representations
    • Management Certification of Financial Statements
    • Sarbanes/Oxley Act requires CEO and CFO to certify financial statements are fairly presented in accordance with GAAP
    • Auditor should review management's processes for certification
    • Management Representation Letter
    • Reminds management of its responsibility for the financial statements
    • Confirms significant oral responses made by management
    • Reduces possibility of misunderstandings between management and auditor
  • 9.
    • Letter is prepared by auditor on client letterhead, addressed to the auditor, and normally signed by CEO and CFO
    • Letter is dated as of the audit report date (end of fieldwork)
    • Because management representations are not strong evidence, the auditor should perform procedures to corroborate the information in the letter
    • Management's failure to provide this letter is a scope limitation sufficient to preclude issuance of unqualified opinion
    Explain Management Representations (Continued)
  • 10. What is the management comment letter?
    • Auditors often notice things that might make the client more profitable
    • Many of these observations related to control deficiencies or operational matters
    • The observations are included in a management comment letter typically delivered to the Board of Directors with the audit report
    • Management letter is not required, but does add value to the audit
  • 11. What is the going concern issue?
    • Auditor is required to evaluate client's ability to remain a going concern for a period not to exceed one year from the balance sheet date
    • Indicators of potential going concern problems include
    • Negative trends in key financial areas like cash flow, sales, profits
    • Internal matters, such as loss of key personnel, and outdated facilities and/or products
    • External matters, such as new legislation, loss of significant customer or supplier, uninsured casualty loss
    • Other matters, such as loan default, inability to pay dividends, attempted debt restructuring
  • 12.
    • If there is substantial doubt about ability of client to remain a going concern, auditor should
    • Discuss the situation with management
    • Assess management's plan to overcome problems
    • Consider the effects on the financial statements
      • Auditor should evaluate the adequacy of financial statement disclosure
      • Disclosures might include conditions causing the going concern doubt and management's plan to overcome the problem
    • Consider the effects on the audit report
      • Add explanatory paragraph to the unqualified audit report
      • Disclaim opinion
      • Issue qualified opinion if disclosure is not adequate
    What is the going concern issue? (Continued)
  • 13.
    • Management estimates provide opportunities for the entity to "manage" or even manipulate earnings. The auditor provides reasonable assurance that - Management has information system to develop estimates material to the financial statements
    • Estimates are reasonable
    • Estimates are presented per GAAP
    • In evaluating management estimates, the auditor concentrates on key factors and assumptions that are
    • Significant to the accounting estimate
    • Sensitive to variations
    • Deviations from historical patterns
    • Susceptible to misstatement
    • Inconsistent with current economic trends
    Discuss Review of Significant Estimates
  • 14. Comment on Communicating with the Audit Committee
    • Items the auditor should discuss with the audit committee include
    • Auditor's responsibility under GAAS
    • Management judgments and accounting estimates
    • Audit adjustments
    • Uncorrected misstatements
    • Accounting policies and alternative treatments
    • Major accounting and reporting disagreements with management
    • Difficulties encountered in performing the audit
    • Copies of significant communications between auditor and management
    • Management's discussion with other CPA firms
    • Significant fraud or illegal acts
    • Significant deficiencies in internal control
    • Any independence issues
    • Any other significant matters
  • 15. What are subsequent events?
    • Subsequent events occur after the balance sheet date . Audit procedures used to identify subsequent events include:
    • Read minutes of meetings of the board of directors, stockholders, and other authoritative groups held after year-end
    • Read interim financial statements; investigate significant changes
    • Inquire of management about
      • Significant changes in noted in interim statements
      • Significant contingent liabilities
      • Significant changes in working capital, debt, or owners' equity
      • Status of any tentative items
      • Unusual accounting adjustments made after balance sheet date
    • Inquire of management and legal counsel about subsequent events
    • Obtain management representation letter
  • 16. Subsequent Events
    • How an auditor handles a subsequent event depends on two things:
    • Whether the subsequent event provides evidence about conditions that existed at the balance sheet date (type 1), or conditions arising after the balance sheet date (type 2)
    • When the subsequent event occurred: during fieldwork, after fieldwork but before the audit report has been issued, or after the audit report has been issued
  • 17. What are the types of subsequent events?
    • Type 1 subsequent events provide evidence about conditions that existed at the balance sheet date
    • The financial statement numbers should be adjusted to reflect this information; footnote disclosure may also be necessary
    • Examples of type 1 subsequent events:
    • Major customer files for bankruptcy during subsequent period, its deteriorating financial condition existed prior to the balance sheet date
    • Lawsuit settled for different amount than accrual
    • Stock dividend or split during the subsequent period
    • Sale of inventory below carrying value when loss occurred during the subsequent period
  • 18.
    • Type 2 subsequent events provide evidence about conditions that did not exist at the balance sheet date
    • The financial statement numbers should not be adjusted for these events, but they should be considered for disclosure
    • Examples of type 2 subsequent events:
    • Uninsured casualty loss that occurs after the balance sheet date
    • Significant lawsuit initiated for incident occurring after the balance sheet date
    • Significant loss due to natural disaster occurring after the balance sheet date
    • Major decisions made during the subsequent period such as decision to merge, discontinue a line of business, or issue new securities
    • Material change in value of investment securities after the balance sheet date
    What are the types of subsequent events?
  • 19. Subsequent Events
    • If subsequent event occurs after end of fieldwork but before audit report is issued, auditor must decide whether to single or dual date the audit report
    • Single date
      • Date of subsequent event is the audit report date
      • Auditor must make sure there are no other subsequent events prior to report date
    • Dual date
      • Use dates of end of fieldwork and subsequent event
  • 20. Subsequent discovery of facts existing at the date of the auditor's report
    • Auditor must determine
    • Reliability of new information
    • Whether the event had occurred by the audit report date
    • Whether users are likely to still be relying on the financial statements
    • Whether the audit report would have been affected had the facts been known
  • 21. Subsequent discovery of facts existing at the date of the auditor's report
    • If the auditor decides further reliance on the financial statements and audit report is not appropriate, client is advised to make appropriate and timely disclosure of these new facts
    • Appropriate actions:
    • Revise financial statements and audit report
    • Revision and explanation reflected in subsequent period financial statements
    • If revision will take extended period, notify users that statements and audit report should no longer be relied on
    • If client will not cooperate, auditor should
    • Notify client and regulatory agency that the audit report should no longer be associated with the financial statements
    • Notify known users that the audit report should no longer be relied on