Chapter 18, Completing the Audit
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  • 1. Review for Contingencies (Especially Contingent Losses)
    • 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.”
    • Why focus on contingent losses, rather than gains?
    • GAAP is still specified by SFAS #5 (accruals, disclosure)
    • Audit procedures
      • Inquiries of management and other client personnel (regarding lawsuits, legal exposure, etc.) – corroborate w/ “lawyer’s letter”
      • Read minutes of board meetings
      • Review contracts, loan agreements, etc. (restrictive covenants?)
  • 2. Inquiry of a Client’s Lawyer Concerning Litigation, Claims, & Assessments (SAS 12)
    • Procedures to identify lawyers used
      • Inquire of management (primary source)
      • Vouch to relevant invoices (for legal expenses)
      • Review minutes of board meetings
    • Send “attorney letter” to those lawyers who rendered non-trivial legal services to client -- to corroborate management’s responses to the auditor’s inquiries
  • 3. 2 Categories of Legal Matters Are Important to “Lawyer Letter”
    • About asserted claims & active litigation --lawyer should tell the auditor directly about any omissions of such matters
    • About unasserted claims & potential litigation -- lawyer CANNOT divulge omissions directly to auditors (but should advise client to discuss it with auditors!)
      • Must be probable that claim will be filed
      • Must have at least a reasonable possibility of an unfavorable outcome
  • 4. Review for “Subsequent Events”
    • Definition – after B/S date, before report issued
      • Type I: Require F/S adjustment
      • Type II: Require F/S disclosure
    • Audit procedures
      • Inquiries of management
      • Lawyer’s letter regarding legal issues
      • Read minutes of board meetings
      • Scan journals & ledgers for any “unusual items”
  • 5. “Management Representations” (SAS 85)
    • Must obtain written representations from management to corroborate their responses
      • Addressed directly to the auditors
      • Signed by both the CEO & CFO
      • Dated no later than the date of the audit report (usually the last day of fieldwork)
    • Management’s unwillingness to sign the letter would be a MAJOR scope limitation!
    • The representation letter should cover all periods encompassed by the auditor’s report
  • 6. Specific Representations Depend on the Circumstances -- Usually:
    • Regarding the financial statements
      • Management takes responsibility for the F/S
      • Belief that F/S are consistent with GAAP
    • Regarding completeness of information
      • All financial records made available
      • Minutes complete and made available
      • No communications from regulators about deficiencies related to financial reporting
      • No known material unrecorded transactions
  • 7. Typical Representations (Cont’d)
    • Regarding recognition, measurement, & disclosure
      • No fraud (by mgt or others affecting I/C)
      • No plans affecting carrying values in F/S
      • Related party transactions -- properly reported
      • Contingent losses properly accounted for
      • Significant estimates & material concentrations properly disclosed (Re: AICPA SOP)
      • No violations of laws, regulations or contracts having F/S effects
  • 8. Typical Representations (Cont’d)
    • Regarding recognition, measurement, & disclosure (continued)
      • No unasserted claims or assessments which the client's lawyer has directed management to discuss with the auditors
      • Satisfactory title held to assets; no encumbrances (not used as collateral)
    • Subsequent events -- no events after B/S date warrant adjustment/disclosure to F/S
    • Other circumstances -- as deemed necessary