Chapter 18, Completing the Audit


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Chapter 18, Completing the Audit

  1. 1. Review for Contingencies (Especially Contingent Losses) <ul><li>Definition – “an existing condition, situation or circumstance involving uncertainty as to possible gain or loss… that will ultimately be resolved when one or more future events occur or fail to occur.” </li></ul><ul><li>Why focus on contingent losses, rather than gains? </li></ul><ul><li>GAAP is still specified by SFAS #5 (accruals, disclosure) </li></ul><ul><li>Audit procedures </li></ul><ul><ul><li>Inquiries of management and other client personnel (regarding lawsuits, legal exposure, etc.) – corroborate w/ “lawyer’s letter” </li></ul></ul><ul><ul><li>Read minutes of board meetings </li></ul></ul><ul><ul><li>Review contracts, loan agreements, etc. (restrictive covenants?) </li></ul></ul>
  2. 2. Inquiry of a Client’s Lawyer Concerning Litigation, Claims, & Assessments (SAS 12) <ul><li>Procedures to identify lawyers used </li></ul><ul><ul><li>Inquire of management (primary source) </li></ul></ul><ul><ul><li>Vouch to relevant invoices (for legal expenses) </li></ul></ul><ul><ul><li>Review minutes of board meetings </li></ul></ul><ul><li>Send “attorney letter” to those lawyers who rendered non-trivial legal services to client -- to corroborate management’s responses to the auditor’s inquiries </li></ul>
  3. 3. 2 Categories of Legal Matters Are Important to “Lawyer Letter” <ul><li>About asserted claims & active litigation --lawyer should tell the auditor directly about any omissions of such matters </li></ul><ul><li>About unasserted claims & potential litigation -- lawyer CANNOT divulge omissions directly to auditors (but should advise client to discuss it with auditors!) </li></ul><ul><ul><li>Must be probable that claim will be filed </li></ul></ul><ul><ul><li>Must have at least a reasonable possibility of an unfavorable outcome </li></ul></ul>
  4. 4. Review for “Subsequent Events” <ul><li>Definition – after B/S date, before report issued </li></ul><ul><ul><li>Type I: Require F/S adjustment </li></ul></ul><ul><ul><li>Type II: Require F/S disclosure </li></ul></ul><ul><li>Audit procedures </li></ul><ul><ul><li>Inquiries of management </li></ul></ul><ul><ul><li>Lawyer’s letter regarding legal issues </li></ul></ul><ul><ul><li>Read minutes of board meetings </li></ul></ul><ul><ul><li>Scan journals & ledgers for any “unusual items” </li></ul></ul>
  5. 5. “Management Representations” (SAS 85) <ul><li>Must obtain written representations from management to corroborate their responses </li></ul><ul><ul><li>Addressed directly to the auditors </li></ul></ul><ul><ul><li>Signed by both the CEO & CFO </li></ul></ul><ul><ul><li>Dated no later than the date of the audit report (usually the last day of fieldwork) </li></ul></ul><ul><li>Management’s unwillingness to sign the letter would be a MAJOR scope limitation! </li></ul><ul><li>The representation letter should cover all periods encompassed by the auditor’s report </li></ul>
  6. 6. Specific Representations Depend on the Circumstances -- Usually: <ul><li>Regarding the financial statements </li></ul><ul><ul><li>Management takes responsibility for the F/S </li></ul></ul><ul><ul><li>Belief that F/S are consistent with GAAP </li></ul></ul><ul><li>Regarding completeness of information </li></ul><ul><ul><li>All financial records made available </li></ul></ul><ul><ul><li>Minutes complete and made available </li></ul></ul><ul><ul><li>No communications from regulators about deficiencies related to financial reporting </li></ul></ul><ul><ul><li>No known material unrecorded transactions </li></ul></ul>
  7. 7. Typical Representations (Cont’d) <ul><li>Regarding recognition, measurement, & disclosure </li></ul><ul><ul><li>No fraud (by mgt or others affecting I/C) </li></ul></ul><ul><ul><li>No plans affecting carrying values in F/S </li></ul></ul><ul><ul><li>Related party transactions -- properly reported </li></ul></ul><ul><ul><li>Contingent losses properly accounted for </li></ul></ul><ul><ul><li>Significant estimates & material concentrations properly disclosed (Re: AICPA SOP) </li></ul></ul><ul><ul><li>No violations of laws, regulations or contracts having F/S effects </li></ul></ul>
  8. 8. Typical Representations (Cont’d) <ul><li>Regarding recognition, measurement, & disclosure (continued) </li></ul><ul><ul><li>No unasserted claims or assessments which the client's lawyer has directed management to discuss with the auditors </li></ul></ul><ul><ul><li>Satisfactory title held to assets; no encumbrances (not used as collateral) </li></ul></ul><ul><li>Subsequent events -- no events after B/S date warrant adjustment/disclosure to F/S </li></ul><ul><li>Other circumstances -- as deemed necessary </li></ul>