Three conditions are required for a contingent liability to exist:
There is a potential future payment to an outside party or the impairment of some other asset that would result from an existing condition.
There is uncertainty about the amount of the future payment or impairment.
The outcome will be resolved by some future event(s).
Note: Page 712 contains examples of possible contingencies.
B. Likelihood of Occurrence and Financial Statement Treatment
If the amount can be reasonably estimated, financial statement accounts are adjusted.
If the amount cannot be reasonably estimated, footnote disclosure is necessary.
Probable (likely to occur) Footnote disclosure is necessary Reasonably possible (more than remote, but less than probable) No disclosure is necessary Remote (slight chance) Financial Statement Treatment Likelihood of Occurrence of Event
The Sarbanes-Oxley Act directed the SEC to issue rules requiring attorneys to report material violations of the federal securities laws to the chief legal officer, CEO, and possibly the audit committee.
Previously, attorneys only reported crimes when there was a threat of physical harm or death or the release of hazardous materials or defective products.
The American Bar Assoc. has amended the attorney-client confidentiality rules to permit breach of confidentiality for crime and fraud of an audit client.
The auditor’s responsibility for reviewing subsequent events is normally limited to the period beginning with the balance sheet date and ending with the date of the auditor’s report.
Client’s ending balance sheet date Audit report date Date client issues financial statements Period to which review for subsequent events applies Period for processing the financial statements 12-31-02 3-11-03 3-26-03
Occasionally, the auditor determines that an important subsequent event occurred after the field work was completed but before the audit report was issued.
The auditor may chose to (1) extend the date of field work to cover the discovery, or (2) issue a dual-dated audit report. For this 2 nd option, the first date would be for the completion of field work except for a specific exception. The next date would cover the date of the discovery of the subsequent event after the field work date.
At the completion of larger audits, it is common to have the financial statements and the entire set of audit files reviewed by a completely independent reviewer who has not participated in the engagement.
A independent review is required for SEC engagements.
If the auditor becomes aware after the financial statements have been issued to some information included in the statements is materially misleading, the auditor has an obligation to make certain that users who are relying on the financial statements are informed about the misstatements.
Request the client to issue an immediate revision of the financial statements containing an explanation of the reasons.
Client should inform the SEC and other regulatory agencies of the misleading financial statements.
If the client refuses to cooperate, the auditor must inform the board of directors. Auditor must also notify regulatory agencies and, when practical, each person who relies on the financial statements, that the statements are no longer trustworthy.
Summary of the Audit Process Phase I Phase II Phase III Phase IV Plan and design an audit approach. Perform tests of controls and substantive tests of transactions. Perform analytical procedures and tests of details of balances. Complete the audit and issue an audit report.
Phase IV – Completing the Audit Review for contingent liabilities Review for subsequent events Accumulate final evidence Evaluate results Issue audit report Communicate with audit committee and management