Chapter 15
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    Chapter 15 Chapter 15 Presentation Transcript

    • Chapter 15 Completing the Audit
    • 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
    • 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
    • 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
    • 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
      • 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)
    • 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
    • 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
      • 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)
    • 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
    • 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
      • 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)
      • 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
    • 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
    • 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
    • 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
    • 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
      • 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?
    • 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
    • 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
    • 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