14 Audit.pdf

14-1
Completing the Audit
Chapter 14
Audit
Data
Analytics
(Chapter
7)
Audit
Evidence
(Chapter
5)
Client Acceptance/Continuance and Risk Assessment
(Chapters 3 and 4)
Develop Responses to Risk and an Audit Strategy
Gaining an
Understanding of
the Client
Identify Significant
Accounts and
Transactions
Set Planning
Materiality
Make Preliminary Risk
Assessments
Gaining an Understanding of
the System of Internal Control
(Chapter 6)
The Audit Process
Overview of Audit and Assurance
(Chapter 1)
Completing and Reporting on the Audit
(Chapters 14 and 15)
Reporting
Drawing Audit
Conclusions
Procedures Performed Near
the End of the Audit
Auditing the Balance Sheet
and Related Income Accounts
(Chapter 13)
Auditing the Purchasing
and Payroll Processes
(Chapter 12)
Auditing the
Revenue Process
(Chapter 11)
Performing Tests of Controls
(Chapter 8)
Performing Substantive Procedures
(Chapter 9)
Audit Sampling for Substantive Tests
(Chapter 10)
Professionalism and Professional Responsibilities
(Chapter 2)

14-2 Chapter 14 Completing the Audit
Cloud 9 - Continuing Case
The partner on the Cloud 9 audit, Jo Wadley, has called a meeting
with the audit team (Sharon Gallagher, Josh Thomas, and Mark
Batten) to discuss the completion of the audit. Jo wants to be sure
that she is briefed on all contentious matters so that she can re-
solve them at the scheduled meetings with Cloud 9’s audit com-
mittee and management.
Sharon, Josh, and Mark hold a preliminary meeting to pre-
pare for the meeting with the partner. On the agenda are final
evidence and misstatements evaluation, search for loss contingen-
cies, subsequent events procedures and evidence, going concern
procedures and assessment, and communication with Cloud 9’s
audit committee.
What issues have arisen with Cloud 9’s audit? How can they
make sure the partner is fully prepared for the meeting with the
client’s management?
Auditing and Assurance Standards
PCAOB
AS 1201 Supervision of the Audit Engagement
AS 1215 Audit Documentation
AS 1220 Engagement Quality Review
AS 1301 Communications with Audit Committees
AS 2401 Consideration of Fraud in a Financial
Statement Audit
AS 2415 Consideration of an Entity’s Ability to Continue
as a Going Concern
AS 2505 Inquiry of a Client’s Lawyer Concerning
Litigation, Claims, and Assessments
AS 2801 Subsequent Events
AS 2805 Management Representations
AS 2810 Evaluating Audit Results
Auditing Standards Board
AU-C 220 Quality Control for an Engagement
Conducted in Accordance with Generally Accepted
Auditing Standards
AU-C 230 Audit Documentation
AU-C 240 Consideration of Fraud in a Financial
Statement Audit
AU-C 250 Consideration of Laws and Regulations in an
Audit of Financial Statements
AU-C 260 The Auditor’s Communication with Those
Charged with Governance
AU-C 450 Evaluation of Misstatements Identified During
the Audit
AU-C 501 Audit Evidence—Specific Considerations for
Selected Items
AU-C 520 Analytical Procedures
AU-C 560 Subsequent Events and Subsequently
Discovered Facts
AU-C 570 The Auditor’s Consideration of an Entity’s
Ability to Continue as a Going Concern
AU-C 580 Written Representations
Learning Objectives
LO 1 Apply the audit procedures used to search for loss
contingencies.
LO 2 Distinguish between the two types of material
subsequent events and evaluate what effect they have
on the financial statements, if any.
LO 3 Describe engagement wrap-up procedures
performed at the conclusion of the audit.
LO 4 Evaluate the going concern assumption for a client.
LO 5 Discuss what reporting is required to management
and those charged with governance.

Audit Procedures for Loss Contingencies 14-3
Chapter Preview: Audit Process in Focus
As the audit is nearing completion, specific procedures must be performed before auditors
can draw an overall conclusion on the audit. In this chapter, we discuss audit procedures for
loss contingencies, subsequent events, and auditing the going concern assumption. We also
describe how auditors revisit key audit planning items, such as materiality, audit risk, and risk
of fraud, to determine if their original assessments are still valid or if adjustments are required
that may alter the nature and extent of audit procedures.
Experienced members of the audit team review working papers to ensure the planned
audit procedures have been performed and properly documented. Auditors evaluate the mis-
statements identified throughout the audit and analyze the effect of uncorrected misstate-
ments on the financial statements as a whole to form the audit opinion. This chapter also
reviews other wrap-up procedures including final analytical procedures, engagement quality
review, and final assembly of the audit documentation. Prior to issuing the audit report, audi-
tors obtain a representation letter from management and communicate significant findings or
issues from the audit to those charged with governance.
Learning Objective 1
Apply the audit procedures used to search for loss contingencies.
Every company, no matter how big or how small, faces risk of events happening today that
have consequences in the future. For example, the explosion of the Deepwater Horizon
offshore oil rig (operated by BP) in 2010 resulted in worker injuries and fatalities and dam-
age to the environment in the Gulf of Mexico. Many lawsuits against BP followed, and some
are still not resolved almost a decade after the incident. What is the proper accounting treat-
ment for a situation like this one in which the company could still be liable to many differ-
ent groups over an extended period of time? FASB ASC Topic 450, Contingencies, provides
accounting guidance for events, or potential events, that create uncertainty for a company.
FASB defines a loss contingency as an existing condition or situation involving uncertainty
as to possible loss that will ultimately be resolved when one or more future events occur
or fail to occur. Some other examples of a loss contingency include income tax disputes
with the IRS, guarantees of debt of others, threat of expropriation of assets, and pending or
threatening litigation with employees, customers, vendors, or shareholders.
To account for a loss contingency, company management must determine the likelihood
that the future event will trigger a loss. FASB ASC Topic 450 classifies the likelihood of loss
contingencies into three categories:
1. Probable. The future event is likely to occur.
2.
Reasonably possible. The chance of the future event occurring is more than remote but
less than likely.
3. Remote. The chance of the future event occurring is slight.
If management determines the loss contingency is probable and an amount can be reasonably
estimated, then the company must record a liability and a related expense or loss and disclose
the relevant details of the event in the notes to the financial statements. If the loss contingency
is reasonably possible or the amount cannot be reasonably estimated, then only a disclosure in
the notes is required. If the likelihood of a loss contingency is remote, then nothing needs to
be disclosed in the notes.
Since there is no crystal ball to see into the future, you can appreciate that determining
the likelihood of a loss contingency occurring and trying to estimate a reasonable amount for a
future loss involves significant judgment by management. Therefore, the role of auditors is to
loss contingency an existing
condition or situation involving
uncertainty as to possible loss that
will ultimately be resolved when
one or more future events occur
or fail to occur
Audit Procedures for Loss Contingencies

determine if management’s assessment is reasonable, appropriate liabilities have been
recorded,
and the disclosures are complete. Auditors should carefully consider the completeness assertion
for loss contingencies. Management may not be sufficiently objective and could fail to identify
loss contingencies or may classify identified contingencies as remote to avoid accruing or disclos-
ing them. Failing to identify one or more material loss contingencies is a material misstatement.
During the execution of all phases of the audit, the audit team should be watchful for
evidence of any potential loss contingencies. Many of the risk assessment procedures used to
gain an understanding of the entity, the industry, and its environment may identify the possi-
bility of loss contingencies. Substantive procedures used when testing account balances and
classes of transactions may also bring to light potential loss contingencies. Illustration 14.1
provides examples of audit procedures used during risk assessment and/or risk response that
can reveal the potential risk for loss contingencies.
Toward the end of the audit, auditors perform an inquiry procedure specifically designed to
gather information about loss contingencies arising from litigation, claims, and assessments. Audi-
tors will communicate directly with the client’s external legal counsel by sending a letter of inquiry,
often referred to as a legal letter. If the client has in-house legal counsel responsible for litigation,
claims, and assessments, a legal letter will also be sent to the in-house legal counsel. Attorneys and
their clients have a privileged relationship. That means attorneys cannot talk about their client’s
cases to anyone without permission from the client. Therefore, before auditors can communicate
with the client’s legal counsel, client management must give permission to the attorneys to discuss
theircaseswiththeauditors.Theclientgrantspermissiontotheattorneysbysigningthelegalletter.
Legal letters are sent to all attorneys the client paid for legal services. AU-C 501 Audit
Evidence—Specific Considerations for Selected Items and AS 2505 Inquiry of a Client’s Lawyer
Concerning Litigation, Claims, and Assessments provide guidance for the content of the legal
letter. The objective of the legal letter is to gather audit evidence regarding the existence of
uncertainties arising from litigation, claims, and assessments; the time period in which the
cause for the legal action occurred; the probability of an unfavorable outcome for the client;
and an estimate of the potential loss. A legal letter used for the Cloud 9 audit is presented in
Illustration 14.2, followed by explanations of the bracketed numbers. The format and wording
of the letter is dictated by auditing standards, so all auditors will follow the same basic format.
legal letter an audit inquiry
sent to a client’s external and
in-house legal counsel to obtain
information about litigation,
assessments, and claims
[1] Cloud 9 Inc.
[2] March 1, 2023
[3] Smith, Day, Jones
18696 11th Street, Suite 5000
Seattle, WA 95686
To Legal Counsel:
[4] In connection with an audit of our financial statements as of January 31, 2023, and for the year
then ended, please furnish our auditors, WS Partners, P.O. Box 525, Seattle, WA 95688, with the
information requested below concerning contingencies involving matters with respect to which
you have devoted substantial attention on behalf of the company in the form of legal consultation
or representation.
ILLUSTRATION 14.2
Example of legal letter used
for Cloud 9 audit
ILLUSTRATION 14.1
Risk assessment and risk
response procedures that may
identify loss contingencies
Risk assessment and risk response procedures that can reveal the potential risk for loss
contingencies:
1. Confirming with financial institutions, including guarantees of debt of others.
2. Inspecting the minutes of board of directors’ meetings.
3. Inspecting contracts, leases, and correspondence from governmental agencies.
4. Inspecting tax returns and correspondence with the IRS.
5. Inquiring of management regarding the completeness of recorded liabilities.
6. Inquiring of client’s legal counsel.

Audit Procedures for Loss Contingencies 14-5
Sections of the letter in Illustration 14.2 are numbered to correspond with the following
explanations:
1.
Client letterhead—The legal letter is prepared on the client’s letterhead because the client
must grant permission for the attorneys to respond. Auditors oversee the preparation and
content of the letter and have control over the mailing and receipt of the letter.
2.
Date of the letter—The letter is sent about mid-way through the completion of year-end
fieldwork.
3.
Name and address of attorneys—A legal letter should be sent to all attorneys the client
hired during the year for legal services. Auditors can obtain a listing by inspecting the
transactions and invoices related to the client’s legal services expense account.
4.
Request for information—This paragraph identifies the financial statements under audit
and states a request to supply information directly to the auditors.
5.
Response regarding pending or threatened litigation—This paragraph requests that the
attorneys provide a list and description of pending or threatened litigation, claims, and
assessments. Notice auditors are seeking the attorney’s evaluation of the likelihood of an
unfavorable outcome and an estimate, if possible, of the potential loss.
6.
Response regarding unasserted claims or assessments—This paragraph requests that the
attorneys confirm their responsibility to inform management of situations that may in-
volve possible unasserted claims or assessments that may require disclosure. Notice the
reference to the applicable financial reporting framework, which for Cloud 9 is GAAP.
7.
Time frame for preparing the response—This paragraph specifies the time parameters for
the attorney’s response. The response should include matters that existed at January 31,
2023, and any matters after year-end up to the date of the attorney’s response letter. Ide-
ally, the date of the attorney’s response should coincide with the end of fieldwork, in this
case March 15, 2023, or very close to that date. Also, this paragraph requests the attorneys
state any reasons for limitations on their response.
8. Signature—The letter is signed by the client’s chief executive officer.
Source: AU-C 501.A69 and AS 2505A.
[5] Regarding pending or threatened litigation, claims, and assessments, please include in your
response: (1) the nature of each matter, (2) the progress of each matter to date, (3) how the Com-
pany is responding or intends to respond (for example, to contest the case vigorously or seek an
out-of-court settlement), and (4) an evaluation of the likelihood of an unfavorable outcome and an
estimate, if one can be made, of the amount or range of potential loss. Accordingly, please furnish
to our auditors such explanation, if any, that you consider necessary to supplement the foregoing
information, including an explanation of those matters for which your views may differ from those
of management.
[6] We understand that whenever, in the course of performing legal services for us with respect
to a matter recognized to involve an unasserted possible claim or assessment that may call for
financial statement disclosure, you have formed a professional conclusion that we should disclose
or consider disclosure concerning such possible claim or assessment, as a matter of professional
responsibility to us, you will so advise us and will consult with us concerning the question of such
disclosure and the applicable requirements of FASB ASC 450. Please specifically confirm to our
auditors that our understanding is correct.
[7] Your response should include matters that existed as of January 31, 2023, and during the period
from that date to the effective date of your response. Please specifically identify the nature of and
reasons for any limitations on your response. Our auditors expect to have the audit completed
about March 15, 2023. They would appreciate receiving your reply by that date with a specified
effective date no earlier than March 7, 2023.
Sincerely,
[8]James W. Harley
Chief Executive Officer
Cloud 9 Inc.
ILLUSTRATION 14.2
(continued)

The nature of the legal environment in the United States is such that it could take years
for a lawsuit or other action to be settled and/or resolved. Therefore, it may not be possible for
the legal counsel to evaluate the time frame of an outcome or a reasonable amount for a loss.
In many cases, just disclosure of the pending litigation, rather than accrual in the financial
statements, is the appropriate way to account for the uncertainty. (See the following Profes-
sional Environment segment for a real-world example.) If the attorneys refuse to respond
appropriately to the legal letter, then it is considered a limitation on the scope of the audit,
which may impact the opinion in the auditor’s report. If auditors cannot gather sufficient
appropriate evidence regarding loss contingencies, then it may not be possible to issue an
unmodified opinion. Situations causing modifications to the audit report will be discussed
in Chapter 15.
Professional Environment Litigation Contingencies
Large publicly traded companies are under great scrutiny, not only
by regulators such as the SEC but also by the public. Therefore,
it is no surprise that large companies typically have legal issues
in process all the time, such as contract negotiations or disputes
with suppliers or customers and hiring or firing issues with em-
ployees. A majority of these issues are immaterial to the financial
statements as a whole and do not garner public attention through
media outlets or disclosure in the financial statements. A common
practice by companies is to include a generic disclosure in the fi-
nancial statements to inform financial statement readers that var-
ious legal matters are ongoing. For example, the following state-
ment is from Note 15 in the fiscal year 2017 Starbucks annual
report that was filed with the SEC:
Starbucks is party to various other legal proceedings
arising in the ordinary course of business, including,
at times, certain employment litigation cases that
have been certified as class or collective actions, but
is not currently a party to any legal proceeding that
management believes could have a material adverse
effect on our consolidated financial position, results of
operations or cash flows.
A disclosure like this one alerts the public that legal matters are an
ordinary part of conducting business, but at the present time there
is no expectation that any of the legal matters could have a mate-
rial impact on the financial statements. Investors can access the
annual reports of public companies online and find disclosures
similar to this one in the notes of many companies.
Starbucks did have a material litigation contingency that
was first disclosed in the fiscal year 2011 financial statements.
Starbucks and Kraft had entered into a contract in 2004 for
Kraft to manage the distribution, marketing, advertising, and
promotion of Starbucks products. By the end of 2010, the two
parties were in dispute. Starbucks claimed that Kraft materially
breached their contract, and therefore Starbucks was discontin-
uing the distribution agreement. Here is an excerpt from Note 15
of the Starbucks fiscal year 2011 financial statements (emphasis
added):
While Starbucks believes we have valid claims of materi-
al breach by Kraft under the Agreement that allowed us
to terminate the Agreement and certain other relation-
ships with Kraft without compensation to Kraft, there
exists the possibility of material adverse outcomes
to Starbucks in the arbitration or to resolve the
matter. At this time, the Company is unable to esti-
mate the range of possible outcomes with respect to
the arbitration as we have not received any statement or
articulation of damages from Kraft nor have we estimat-
ed the damages to Starbucks caused by Kraft’s breaches.
Information in this regard will be provided during the
discovery process and is currently expected to be available
in late March or early April 2012.
In the Starbucks fiscal year 2012 financial statements, an update
of the dispute with Kraft was provided in Note 15. More infor-
mation was provided regarding the amount of damages Kraft was
seeking, but the dispute had not been resolved by the time the
financial statements were issued. Starbucks did not accrue any
loss contingencies because it determined the amount of the pos-
sible loss could not be reasonably estimated. An excerpt from the
note is provided below (emphasis added). Notice the use of the
terms from FASB ASC 450, such as “probable” and “reasonably
possible.”
On April 2, 2012, Starbucks and Kraft exchanged expert
reports regarding alleged damages on their affirmative
claims. Starbucks claimed damages of up to $62.9 mil-
lion from the loss of sales resulting from Kraft’s failure to
use commercially reasonable efforts to market Starbucks®
coffee, plus attorney fees. Kraft’s expert opined that the
fair market value of the Agreement was $1.9 billion. After
applying a 35% premium and 9% interest, Kraft claimed
damages of up to $2.9 billion, plus attorney fees. The
arbitration hearing commenced on July 11, 2012 and
was completed on August 3. Starbucks presented evidence
of material breaches on Kraft’s part and sought nominal
damages from Kraft for those breaches. Kraft presented
evidence denying it had breached the parties’ Agreement
and sought damages of $2.9 billion plus attorney fees. We
expect a decision from the Arbitrator in the first half of
fiscal 2013.
At this time, Starbucks believes an unfavorable
outcome with respect to the arbitration is not
probable, but as noted above is reasonably possible.
As also noted above, Starbucks believes we have valid
claims of material breach by Kraft under the Agreement
that allowed us to terminate the Agreement without
compensation to Kraft. In addition, Starbucks believes
Kraft’s damage estimates are highly inflated and based
upon faulty analysis. As a result, we cannot reasonably
estimate the possible loss. Accordingly, no loss
contingency has been recorded for this matter.

Subsequent Events 14-7
Josh (senior) mailed out the legal letters two weeks prior to the
expected completion of fieldwork date. He sent letters to all at-
torneys that Cloud 9 paid for legal services during the year. All
responses have been received from the attorneys. Based on the
responses, there do not seem to be any pending legal issues that
would have a material effect on Cloud 9’s financial statements.
Before You Go On
1.1 What is a loss contingency? Provide an example.
1.2 Explain the audit procedures used to identify loss contingencies.
1.3 List three items that are included in a legal letter and explain why each is important.
Distinguish between the two types of material subsequent events and evaluate
what effect they have on the financial statements, if any.
The financial statements are prepared by client management on the basis of conditions
existing at year-end, which would be December 31 for a calendar-year entity. As you have
learned in previous chapters, many of the substantive audit procedures are performed af-
ter the year-end date and up through the date of the audit report. How long is this period
of time between year-end and the audit report? The answer depends on whether the au-
dit is for a public company or private company. For public companies, the SEC has strict
deadlines for the filing of Form 10-K, which is the document that contains the company’s
audited annual financial statements. Illustration 14.3 summarizes the SEC’s filing dead-
lines for Form 10-K. For private companies, the timeline for completion of an audit varies
widely, depending on the needs of the users of the financial statements. The most com-
mon user of a private company’s financial statements is a bank or other lender. Typically,
debt covenants require audited financial statements anywhere from 90–120 days after the

company’s year-end.
Subsequent Events
In the Starbucks fiscal year 2013 financial statements, another
update of the dispute with Kraft was provided in Note 15. The re-
sults from the arbitration were released. When two parties agree
to let a dispute be settled with arbitration, the decision from the
arbitration is considered final. In other words, there is no appeal
process by either party. Here is an excerpt from Note 15, fiscal
year 2013:
On November 12, 2013, the arbitrator ordered Starbucks
to pay Kraft $2,227.5 million in damages plus prejudg-
ment interest and attorney’s fees. We have estimated pre-
judgement interest, which includes an accrual through
the estimated payment date, and attorneys’ fees to be
approximately $556.6 million. As a result, we recorded
a litigation charge (expense) of $2,784.1 million in our
fiscal year 2013 operating results.
The dispute was settled after being disclosed for two years. The
outcome was definitely unfavorable for Starbucks since it was
ordered to pay cash of $2.2 billion plus interest and attorney’s
fees to Kraft. This is a great example of the uncertainty involved
with litigation disputes and the subjectivity involved with deter-
mining if a potential loss contingency should be accrued or just
disclosed.

Since auditors usually conduct part of the audit during the 60–90 day period after year-
end, they should be alert to certain subsequent events that may occur between the date of
the financial statements and the date of the auditor’s report. Illustration 14.4 illustrates an
example of the subsequent period for a calendar-year client whose audit is completed no more
than 60 days after year-end. Some subsequent events may affect amounts that are included in
the year-end financial statements. AU-C 560 Subsequent Events and Subsequently Discovered
Facts and AS 2801 Subsequent Events address the auditor’s responsibilities related to subse-
quent events. The standards distinguish between two types of subsequent events as follows:
•
Type I subsequent event—event that provides evidence of conditions that existed at
the date of the financial statements. A Type I event requires an adjustment to the finan-
cial statements.
•
Type II subsequent event—event that provides evidence of conditions that arose after
the date of the financial statements. A Type II event does not require an adjustment to the
financial statements but may require disclosure in the notes to the financial statements.
subsequent events events
occurring between the date of the
financial statements and the date
of the auditor’s report
Type I subsequent events
conditions that existed at the
date of the financial statements
and require adjustment to the
financial statements
Type II subsequent events
conditions that arose after the
date of the financial statements
and may require disclosure in the
notes to the financial statements
ILLUSTRATION 14.4
Illustration of the subsequent
period for a calendar-year
client
1/1/2022 12/31/2022 2/15/2023
Subsequent
period
Period covered by the
2022 financial statements
End of
fieldwork/
date of auditor’s
report
An example of a Type I event would be the bankruptcy of a client’s customer after year-
end as a result of poor financial condition that existed as of the balance sheet date. If the
customer has a large accounts receivable balance on the client’s year-end balance sheet, then
management needs to reconsider the adequacy of the allowance for doubtful accounts. The al-
lowance balance and the related bad debt expense may need to be increased. Another example
would be the client receiving payment from an insurance company after year-end in resolu-
tion of a claim that was still in negotiations at year-end. Since the outcome of the negotiation
was in favor of the client, management should establish a receivable at year-end.
Type II subsequent events represent conditions and events that did not exist as of the
balance sheet date and do not require adjustment to the financial statements, but may be of
such significance as to require disclosure in the financial statements. For example, shortly
after year-end, management commits to purchasing another business. Purchasing another
business will probably add significant assets and debt to the balance sheet and may result in
changing the capital structure of the client. This commitment is significant and should be
mentioned in the notes. Another example would be the loss of a building or inventory as a
result of a fire or flood after year-end, and the client is underinsured. The situation, and an
estimate of the amount of loss not covered by insurance, should be disclosed in the notes.
Category of Filer Deadline to File
Large accelerated filer ($700 million* or more) 60 days from fiscal year-end
Accelerated filer ($75 million* or more but $700 million*) 75 days from fiscal year-end
Non-accelerated filer ($75 million*) 90 days from fiscal year-end
ILLUSTRATION 14.3
Public company filing
deadlines for Form 10-K
*Amounts refer to worldwide market value of outstanding voting and non-voting common equity held by
non-affiliates.
Source: https://www.sec.gov/answers/form10k.htm.

Subsequent Events 14-9
The objective of the auditors is to obtain sufficient appropriate audit evidence about
whether events occurring after the balance sheet date but before the auditor’s report date have
been identified and properly accounted for, if necessary. In the course of performing planned
substantive procedures after year-end, auditors may identify subsequent events. Auditing
standards require auditors to also conduct specific audit procedures to identify subsequent
events that may occur up through the date of the auditor’s report. Specific audit procedures to
identify subsequent events include:
• Obtaining an understanding of how management identifies subsequent events.
•
Inquiring of management and, if necessary, those charged with governance about
whether subsequent events have occurred that may impact the financial statements.
•
Reading the minutes of manager meetings and/or board of directors’ meetings that have
been held after the date of the financial statements.
•
Reading the client’s subsequent interim financial statements, if available, and other data
such as budgets and cash flow forecasts.
•
Scanning manually, or through the use of generalized audit software, sales and receipts
journals or other accounting records relating to transactions that have occurred after the
date of the financial statements.
•
Inquiring of the client’s legal counsel regarding litigation, claims, and assessments (see
“Audit Procedures for Loss Contingencies” in this chapter).
When conducting inquiries of management and those charged with governance, auditors in-
quire about the current status of items that were accounted for on preliminary or estimated
data at the date of the financial statements. Circumstances or events may have occurred
after year-end that would affect estimates or assumptions used at the financial statement
date. Illustration 14.5 provides examples of inquiries of management on specific matters.
The nature of the specific procedures performed for the subsequent events review will
depend on the individual circumstances of each client. Auditors will also rely heavily on their
knowledge of the client’s business gained during the risk assessment phase of the audit. If audi-
tors identify subsequent events that require adjustment to, or disclosure in, the financial state-
ments, they must determine if each event has been properly reflected in the financial state-
ments as required by the appropriate financial reporting framework. If management
refuses
Audit Reasoning Example Subsequent Event
Imperial Coffees, Inc. is a coffee roaster and direct sells its coffee through grocery stores, restau-
rants, and corporate-owned coffee cafes. For almost a decade, Imperial has experienced explosive
growth and has acquired smaller coffee roasters all over the United States and some international
locations. Imperial’s most recent fiscal year just ended, and its auditors are completing year-end
fieldwork. Jorge is an audit manager on the audit team and meets with Stephanie, Imperial’s
CFO, one month after year-end. Jorge says, “I know the board of directors just had its monthly
meeting. Are the minutes from the meeting available for me to review?” “Yes, I have them right
here,” says Stephanie. “I’ll go ahead and tell you the most important item that was discussed. The
board has decided to acquire the largest coffee roaster in Nicaragua, Central America. The acqui-
sition process will take several months, but should be completed this year. The board feels this is
an excellent strategic move because Nicaragua is the twelfth-largest coffee producer in the world.
Having operations in Nicaragua could help form strategic alliances with the coffee growers there,
which could lead to reduced costs for some of our coffee supply.”
Jorge relays this news to his audit team. Jorge asks Lincoln, a first-year audit associate, if
this event impacts the financial statements they are currently auditing. Lincoln says, “Well, it is
definitely important news that stakeholders should know about. But since the acquisition hasn’t
happened yet, I don’t think it should affect any accounts on the financial statements for the most
recent fiscal year. I do think it should be disclosed in the financial statements since the board has
made the decision and the financials have not yet been issued. Imperial management should draft
a disclosure to include in the notes to the financial statements.” “You are correct, Lincoln,” says
Jorge. “This is called a Type II subsequent event. Management will draft the disclosure and we
will review it.”

to make an adjustment or a disclosure that is required for the financial statements to be fairly
presented, auditors would not be able to issue an unmodified audit report. Situations that pre-
vent the issuance of an unmodified audit report will be covered in more depth in Chapter 15.
Procedures to search for subsequent events at Cloud 9 are docu-
mented in the audit program. These include a review of minutes
of board meetings in January, February, and March, and analysis
of the interim results for these months (including analytical proce-
dures). The partner, Jo Wadley, will also formally ask management
about any subsequent events that have come to management’s
attention in the meetings held between year-end and the audit
report date. For example, does Cloud 9 have any plans to issue
additional stock? Have there been any significant tax assessments
or fines? Has Cloud 9 entered into any additional borrowings or
contracts? The CFO tells Jo that Cloud 9 is in the process of signing
a five-year purchase commitment with a new supplier located in
Colombia, South America. The paperwork should be complete by
the next day. The purchase commitment locks in a good price for
some of Cloud 9’s raw materials. Cloud 9 is predicting that prices
of some of its raw materials will be rising over the next few years,
so locking in a commitment now can help save costs in the fu-
ture. Jo relays information about this subsequent event back to the
team. They will need to confirm the details of the contract and
review Cloud 9’s disclosure of this Type II subsequent event.
Before You Go On
2.1
Describe the two types of subsequent events that must be considered as part of the audit of
the financial statements. Explain each type of subsequent event with an example.
2.2
Explain two types of subsequent events procedures an auditor may perform to identify a
subsequent event.
Describe engagement wrap-up procedures performed at the conclusion of the
audit.
After performing audit procedures related to loss contingencies and subsequent events, au-
ditors are in a position to start wrapping up the audit. This is the audit team’s last chance to
Engagement Wrap-Up
Inquiries of management regarding subsequent events:
• Has the company entered into new commitments, borrowings, or guarantees?
•
Have sales occurred or are sales planned that may affect the carrying value or classification
of assets?
• Are there any plans to issue new shares or debt instruments (debentures)?
•
Have any assets been seized (or appropriated) by the government or destroyed by natural
disaster?
• Has any change in ownership occurred or is it contemplated?
• Have any unusual accounting adjustments been made or are they contemplated?
• Have any developments occurred regarding risk areas and contingencies?
•
Have there been any significant assessments by tax authorities regarding tax assessments,
fines, and penalties?
•
Have any events occurred that are relevant to the measurement of estimates or provisions
made in the financial statements?
ILLUSTRATION 14.5
Examples of inquiries of
management regarding
subsequent events
Source: AU-C 560.A6

Engagement Wrap-Up 14-11
evaluate audit evidence before forming an opinion on the financial statements and determin-
ing the appropriate independent auditor’s report to issue. This section will address conducting
final analytical procedures, final evaluation of audit findings, completion of working paper
reviews, engagement quality review, and completion of documentation.
Final Analytical Procedures
We have discussed the requirement of using analytical procedures during the risk assessment
phase to identify risk and help auditors to gain an understanding of the client (Chapter 4).
During the risk response phase, analytical procedures can be used, but are not required, as a
substantive test to gather audit evidence (Chapter 9). AU-C 520 Analytical Procedures and AS
2810 Evaluating Audit Results require that analytical procedures be used once again near the
end of the audit to assist the auditor in forming an overall conclusion about whether the finan-
cial statements are consistent with the auditor’s understanding of the entity. At the end of the
audit, this is the auditor’s last opportunity to evaluate the reasonableness of the final financial
statements that reflect any audit adjustments recommended by the auditor and accepted by
the client. The actual analytical procedures performed will depend on auditor judgment
and may vary by client. The procedures may include ratio analysis, trend analysis, and other
analytical procedures as discussed in Chapter 4.
The final analytical procedures are intended to corroborate audit evidence obtained
during the audit and to confirm the financial statements are consistent with the auditor’s
revised expectations based on evidence evaluated during the audit. For example, based on
evidence gathered regarding the valuation of inventory for a computer manufacturing client,
auditors would recommend a significant adjustment to mark down obsolete inventory. Once
the client makes the adjustment, auditors would expect to see a lower value for inventory
due to the markdown adjustment and a loss on the income statement. Auditors also consider
industry factors when performing final analytical procedures. For example, if the computer
manufacturing industry as a whole is experiencing a decline in revenue, auditors would ex-
pect the client would also reflect a similar trend. If the financial statements are not consistent
with the auditor’s expectations, auditors may need to perform additional audit procedures to
gather more audit evidence to reduce the risk of material misstatement to an acceptable level.
Final Evaluation of Audit Findings
At the conclusion of the audit, auditors (1) revaluate materiality decisions made during the
audit; (2) revaluate audit risks based on audit findings, including inherent risk, control risk,
and fraud risk; and (3) evaluate misstatements found during the audit.
Final Evaluation of Materiality
At the conclusion of the audit, auditors revisit the materiality level determined at the be-
ginning of the audit to ensure it is still appropriate based on the results of audit procedures.
Recall from Chapter 3 that materiality is first considered in the planning phase of the audit.
During the execution of the audit, materiality, as a whole or for a specific account or class of
transactions, may be revised if auditors become aware of new information that would have
caused them to determine a different level of materiality. For example, during the audit of
sales transactions, the client informs the auditors that sales returns for the fourth quarter are
higher than normal due to a manufacturing error in some batches of the product. Customers
are returning the defective product and the client is giving them a new product at no charge.
Because of this situation, auditors may decide to lower the performance materiality level for
the occurrence and accuracy assertions for sales transactions and adjust the nature or extent
of their audit procedures. As this example illustrates, any significant revisions to materiality
are likely to be made prior to the final evaluation of audit findings. However, if near the end
of the audit it is determined that a lower level of overall materiality is appropriate, auditors
would consider if sufficient appropriate evidence has been obtained. If the answer is no, they
would determine the nature and extent of further audit procedures to perform to obtain more
audit evidence.

Final Evaluation of Inherent Risk, Control Risk, and Fraud Risk
When planning an audit, auditors identify the presence or absence of factors related to in-
herent risk, the five components of internal control (discussed in Chapter 6), and risk of
fraud (discussed in Chapter 3), and then make their initial assessment of control and fraud
risks. Throughout the audit, they consider whether additional factors or risks are present and
whether they need to revise their assessments of inherent risk, control risk, and fraud risk
at the entity and transaction levels (discussed in Chapter 6). Auditors specifically reconsider
their assessment of control risk at the entity level when they become aware of significant
changes in the client’s system of internal control and after they perform tests of controls.
When the results of substantive procedures identify misstatements, auditors consider
whether the misstatements may indicate the need to reevaluate inherent risk, control risk, or
fraud risk. For example, suppose auditors send accounts receivable confirmations to 100 cus-
tomers to test the existence assertion. All 100 confirmations are returned, but 75 of the cus-
tomers report overstatement errors. This is a surprising result for the auditors. They had tested
internal controls over the sales and accounts receivable processes and concluded that controls
were effective. How could there be so many overstatement errors if controls are effective? Per-
haps they overlooked something during tests of controls. What if the sample used for a test of
controls was not representative of the population? The next course of action would be to re-
evaluate relevant internal controls by gathering additional evidence. Additional evidence may
support the conclusion that a significant deficiency or material weakness exists in controls over
the sales and accounts receivable process. If controls are weak, auditors will increase the con-
trol risk assessment and perform additional substantive tests to detect material misstatements.
If it is determined that fraud is the cause of misstatements in an account or class of
transactions, it does not matter if the misstatements are material or immaterial because fraud
typically does not occur as an isolated incidence. The discovery of fraud causes auditors to
reevaluate their assessment of risk, materiality level, and the nature and extent of audit pro-
cedures that have been performed. They also question their previous assessment of manage-
ment and employee integrity, especially if the fraud involves senior management.
When fraud is discovered, auditors gather sufficient appropriate evidence to support their
conclusion. When auditors determine that an employee has committed fraud (either misap-
propriation of assets or fraudulent financial reporting), they evaluate the scope of the employ-
ee’s responsibilities and whether fraud may also have occurred in other audit areas subject to
the employee’s control. For example, if a divisional controller were responsible for premature
revenue recognition, he or she might be in a position to engage in other inappropriate earn-
ings management activities (such as capitalizing items that should be expensed) that could
result in material misstatements of the financial statements.
Audit Reasoning Example Discovery of Fraud
Tiny Tots, Inc. (TT) designs and manufactures infant and toddler clothing and is headquartered
in suburban Chicago, Illinois. TT has approximately 300 suppliers of its raw materials. During
interim, the audit team tested internal controls over purchasing and concluded that controls were
strong. Substantive tests for the purchasing process were also performed at interim and included
tests of details of transactions for the first three quarters. No material misstatements were de-
tected during the interim procedures.
It is now year-end, and Lorene, an audit associate, is performing substantive procedures on
the purchases and accounts payable function for fourth-quarter transactions. She has selected a
sample of 50 recorded purchase transactions from the fourth quarter and vouched them to sup-
porting documentation (purchase order, receiving report, and vendor invoice). Five of the transac-
tions are with a new vendor who was added to the approved vendor list during the fourth quarter.
Lorene notices that the new vendor supplies thread to TT and is located in Chicago, which
she finds a bit unusual. Most of TT’s suppliers are located in foreign countries or other parts
of the United States. Lorene decides to Google the vendor to find out more about it; however,
the Google search shows no results for a company of that name in Chicago. She then opens her
Google maps app and enters the address shown on the vendor invoice. To Lorene’s surprise,
the address is a residential address in a Chicago suburb. Lorene tells the senior associate, Jack,
about what she has discovered.

AS 2401 Consideration of Fraud in a Financial Statement Audit and AU-C 240 Consid-
eration of Fraud in a Financial Statement Audit require auditors to report fraud to a level of
management at least one level above the level where the fraud occurred. If the fraud involves
senior management, auditors report it to those charged with governance, such as the audit
committee of the board of directors. From there, the responsibility falls on management or
those charged with governance to take action to address the fraud. Action may include calling
the proper law enforcement agency and/or firing the employee(s) involved in the fraud. If
management or those charged with governance fail to take action in a timely manner, auditors
should consider withdrawing from the engagement.
In some cases, auditors may determine that fraud is so pervasive in the business they
are unable to complete their audit procedures, or the fraud will have such an impact on the
client’s reputation they no longer wish to have the company as a client. In these rare cases,
any decision to withdraw from the engagement is not taken lightly, and extensive consultation
both internally within the audit firm and externally with the audit firm’s legal counsel will
occur before any action is taken. If the auditors withdraw, they will inform the appropriate lev-
el of management or those charged with governance and provide reasons for the withdrawal.
If the client is a public company, management must report a change of auditors, and the rea-
son for the change, to the SEC using Form 8-K.
Upon further examination, the audit team discovers that a purchasing clerk and accounts pay-
able clerk colluded to create a fictitious vendor for the purpose of misappropriating assets. The ad-
dress for the fictitious vendor belonged to the brother of the accounts payable clerk. Although the
checks that were written to the fictitious vendor were not material, the audit team reconsiders the
assessment of control risk. If controls were assessed as strong during interim testing, then how were
employees able to override the controls and create a fictitious vendor? Could there be a significant
deficiency or material weakness in internal control? Could other transactions be fraudulent? The au-
dit team will perform additional work regarding the controls over purchasing and accounts payable.
Professional Environment Forensic Accounting
One of the more popular television genres in recent years has been
crime with a heavy reliance on forensic science to solve cases (for
example, the CSI franchise). The programs are so popular there are
claims that they have led to a jump in enrollments in forensic sci-
ence courses. According to an analysis of the demand for forensic
accounting courses, interest in forensic accounting has also never
been higher, although this is more likely due to the fall-out from
high-profile corporate collapses such as Enron and WorldCom
than from any television program.1
Some auditors claim that these
cases have made boards of directors more aware of their liability
for fraud.2
If a problem is brought to their attention, they appear to
be more willing to order an investigation, and forensic accountants
are called in to do the work.
Another potential cause of the increased interest in foren-
sic accounting is terrorism. Since the tragedy of 9/11, tracing the
money trail behind terrorism has been a high priority for securi-
ty agencies.3
Forensic accounting expertise is similar to auditing
in the sense that both rely on a deep understanding of double-
entry accounting plus a large dose of other skills and attributes. In
the case of forensic accounting, these include expert knowledge
of legal systems and interview techniques. However, at its heart,
forensic accounting relies on accounting knowledge because some
fraudsters go to great lengths to hide their trail and a knowledge of
double-entry bookkeeping is necessary to keep up.4
Forensic accountants need to have an eye on how their find-
ings will be used in court. In fact, “forensic” means something that
will be used, or is suitable to be used, in courts of law. In the past,
most forensic accounting work related to appearances in court as
expert witnesses for personal injury or divorce cases.5
Now, foren-
sic accounting practices focus more on investigation, fraud risk
management, anti-money laundering, and computer forensics.6
The Association of Certified Fraud Examiners (ACFE), an
association for accountants specializing in detecting fraud, has
experienced a sharp rise in membership over the last few years.7
The fraud investigators say they have been trying for years to get
regulators interested in investigating potential fraud cases, such as
the Madoff Ponzi scheme. Now, they say they have noticed a recent
increase in community appreciation of their work.8
1
C. Long, “Forensic Frenzy,” Charter, 78, no. 5 (June, 2007), pp. 20–22.
2
Long, 2007.
3
See for example, information about forensic accounting at www.forensic-accounting-information.com.
4
Long, 2007.
5
Long, 2007.
6
Long, 2007.
7
Association of Certified Fraud Examiners 2010, www.acfe.com.
8
G. Zuckerman, “For Group of Skeptics, the truth is Out There,” The Wall Street Journal (August 8, 2009).
http://webreprints.djreprints.com/2246630965260.html.

Evaluation of Misstatements Identified During the Audit
AU-C 450 Evaluation of Misstatements Identified During the Audit classifies misstatements into
three categories: factual, judgmental, and projected misstatements (see Chapters 9 and 10).
As misstatements are identified and accumulated during the audit, it is important for auditors
to communicate misstatements to management in a timely manner so action can be taken to
correct the misstatements. Auditors typically request that management make adjusting en-
tries to correct all factual misstatements since there should not be any disagreements with
management regarding factual misstatements.
Factual misstatements are misstatements that are known with certainty. This may include
misstatements found with the application of audit data analytics in which auditors use software
to screen the entire population. It may also include the audit of 100% of a population that has
relatively few sampling units, such as notes payable. When auditors audit the entire population,
they can draw a conclusion with certainty about the misstatements found in the population.
Judgmental misstatements typically involve accounting estimates in which uncertainty
is a factor. After performing audit procedures, auditors may determine a different amount for
an accounting estimate than management. For example, suppose auditors estimate a different
amount for a fair value estimate of goodwill than management. They will request that manage-
ment review the assumptions and methods that were used in determining its estimate. After re-
viewing the estimate, management may decide to adjust its estimate or not adjust. Any difference
between what management decides to record and what the auditor recommends should be re-
corded would be considered a misstatement. Auditors document discussions with management
about the issue, including management’s reasons for not making recommended adjustments.
Projected misstatements are the result of audit sampling, which was discussed in Chapter
10. If misstatements are found in an audit sample, auditors use appropriate statistical or nonsta-
tistical methods to project the sample misstatement to the entire population. If the projected mis-
statement is material, they request that management examines the population of transactions to
understand the cause of the misstatement and make appropriate adjustments to the affected ac-
counts. After management makes adjusting entries to correct the misstatements, auditors should
perform additional audit procedures to determine if any misstatements still remain.
Evaluation of Uncorrected Misstatements
During the final evaluation, auditors evaluate the effect of uncorrected misstatements on the
financial statements. Typically, management makes adjustments for material misstatements
but may decide not to correct some immaterial misstatements. For uncorrected misstatements,
auditors obtain an understanding of management’s reasons for not making the corrections.
They take management’s reasoning into consideration when evaluating the overall effect of
uncorrected misstatements on the financial statements as a whole.
When evaluating the effect of uncorrected misstatements, both quantitative and qualitative
factors are considered. Uncorrected, immaterial misstatements should be aggregated to determine
if, in total, they exceed the materiality level for the financial statements as a whole or the materi-
ality level for a class of transactions, account balance, or disclosure. Also, the cumulative effect of
uncorrected, immaterial misstatements from prior periods, if any, should be considered for their
effect on the current year financial statements. Typically, uncorrected, immaterial misstatements
from a prior period are expected to “reverse” in the next period. For example, if purchases are un-
derstated due to a cutoff error in the prior period, the misstatement is considered to reverse in the
following period in which purchases would be overstated. The two immaterial errors would offset
each other over the two-year period. Prior period immaterial, uncorrected misstatements that do
not reverse should be accumulated with current period uncorrected immaterial misstatements to
determine if the combined total is material to the current year financial statements.
Illustration 14.6 provides an example of a working paper analysis of likely misstatements
for the New Millennium Ecoproducts audit. The first section of the working paper shows the
uncorrected overstatement of depreciation expense and the different accounts affected by
the overstatement. The second section shows projected uncorrected misstatements that are
the result of an overstatement of ending inventory discovered from statistical sampling. The
bottom section totals the aggregate likely misstatements by financial statement category.
The aggregate likely misstatement is divided by the related total from the final trial balance
to arrive at the
aggregate likely misstatement percentage. For example, the aggregate likely
misstatement for current assets of $8,000 is divided by the final trial balance total current

assets of $400,000. The result is 2.0%, which means the aggregate likely misstatement for cur-
rent assets is 2.0% of the total current assets. The conclusion of the auditors is at the bottom of
the working paper and states that all of the likely misstatements are deemed to be immaterial.
If uncorrected, immaterial misstatements do not exceed materiality for the financial
statements as a whole or at the class of transactions, account balance, or disclosure level,
there may be qualitative characteristics that cause auditors to evaluate them as material. For
example, if an immaterial misstatement is the result of fraud, auditors consider the impact on
other areas of the audit, as discussed in the above section “Reconsider Assessment of Control
Risk and Risk of Fraud.” Qualitative characteristics will vary by client and by circumstance.
Illustration 14.7 lists examples of situations that cause auditors to consider an uncorrected
misstatement material based on a qualitative characteristic.
Client: New Millennium Ecoproducts W/P Ref. A-5
Analysis of Aggregate Likely MisstatementsPrepared By: A.E.R. Date 2/25/23
Period-end: December 31, 2022Reviewed by R.E.G. Date: 2/26/23
Debit (Credit)
Description
Acquired
Assets Liabilities Stockholders’
Equity
Pretax
Earnings
Income Tax
Expense
W/P Ref Acct. No Current Noncurrent Current Noncurrent
Uncorrected Known Misstatements:
Overstatement of Depreciation Expense
D-1 1590 Accumulated
Depreciation
$ 3500
4590 Depreciation
Expense
$ (3,500) $ (3,500)
2295 Income Tax
Payable
$ (1,225) $ 1,225 $ 1,225
Uncorrected Projected Misstatement:
Overstatement of Ending Inventory Projected from Statistical Sample
C-1 4200 Cost of
Goods Sold
1200 Inventory $ (8,000) $ 8,000 $ 8,000
2295 Income Tax
Payable
$ 2,800 $ (2,800) $ (2,800)
Aggregate Likely Misstatement $ (8,000) $ 3,500 $ 1,575 $
0 $ 2,925 $ 4,500 $ (1,575)
Final Balance from Trial Balance $400,000 $735,000 $225,000 $375,000 $535,000 $150,000 $75,000
Aggregate Likely Misstatement % 2.0% 0.5% 0.7% 0.0% 0.5% 3.0% 2.1%
Conclusion: The likely misstatements listed above are deemed to be immaterial, either individually or in their aggregate effects on the
individual accounts, the financial statements categories, or the financial statement totals to which they relate.
ILLUSTRATION 14.6 Analysis of aggregate likely misstatement working paper
Qualitative characteristics of immaterial misstatements:
• Affects compliance with regulatory requirements.
• Has the effect of increasing management compensation.
• Relates to items involving particular parties, such as individuals related to management.
• Changes a loss to income or income to loss.
• Affects compliance with debt covenants or other contracts.
• Results from the occurrence of fraud.
•
Relates to the incorrect application of an accounting policy that is likely to have a material
effect on future periods.
•
Affectswhetherthecompanymeetsafinancialbenchmark,suchasanalystforecastsofearnings
per share.
ILLUSTRATION 14.7
Examples of qualitative
characteristics of immaterial
misstatements
Source: AU-C 450.A23.

The working papers include documentation of all misstatements accumulated during the
audit and whether they have been corrected. For the uncorrected misstatements, auditors
should thoroughly document the basis for their conclusions about whether the uncorrected
misstatements are material individually or in the aggregate. In Chapter 15, we discuss the
effect on the auditor’s report of uncorrected misstatements that are material to the financial
statements as a whole.
Completion of Working Paper Review
An audit is an ongoing, cumulative, and iterative process of gathering and evaluating evidence
in support of relevant assertions. All audit documentation will have a preparer and reviewer, or
multiple reviewers. As audit procedures are completed and documented in the working papers,
the preparer will “sign off” with his or her initials when he or she feels the work is ready for
review. The work is reviewed by an audit team member with seniority over the team member
who did the work. (Refer to Illustration 5.6 for the structure of an audit team.) For example, when
an associate signs off on audit procedures related to the audit of accounts payable, the senior
associate reviews the work. Often, the senior has review notes, or “to-do” items, for the associate
to complete. For example, the associate may need to add more explanation to the working papers
of how a procedure was performed, or another sample of invoices may need to be inspected to
gather more evidence in support of a relevant assertion.
The senior associate performs audit procedures related to more complex areas of the
audit, such as intangible assets or investments. As the senior completes his or her proce-
dures, they are reviewed by the manager, and the manager will have review notes for the
senior to address. AU-C 220 Quality Control for an Engagement Conducted in Accordance with
Generally Accepted Audit Standards and AS 1201 Supervision of the Audit Engagement pro-
vide guidance regarding review of the working papers. Illustration 14.8 provides a list of
items an audit team member considers when reviewing the work of another team member.
Working paper reviewer should consider whether:
• Work has been performed in accordance with appropriate auditing standards.
• Significant findings or issues have been raised for further consideration or audit testing.
•
Consultations among team members and others within or outside of the audit firm have taken
place, as needed, and the resulting conclusions have been documented.
•
The nature, timing, and extent of the work performed are appropriate and do not need
revision.
• Work performed supports the conclusions reached and is appropriately documented.
• Evidence obtained is sufficient and appropriate to support the auditor’s report.
• Objectives of the engagement procedures have been achieved.
ILLUSTRATION 14.8
Items to consider when
reviewing working papers
Source: AU-C 220.A16 and AS1201.05(c).
Once an audit team member has responded to the review notes, the appropriate supervisor
reviews the work to ensure the review item was satisfactorily addressed. If satisfied the reviewer
signs off on the working paper. Once completed, the review notes are removed from the audit file
because the working papers are required to stand on their own in terms of the conclusions reached
and the underlying evidence supporting those conclusions. Ultimately, auditors rely on their pro-
fessional judgment to determine if sufficient appropriate audit evidence has been obtained.
Audit Reasoning Example Working Paper Review
Jacob Bourgeois is a first-year audit associate at TBI accounting firm. It is his first busy season,
and he is assigned to a manufacturing client in Detroit, Michigan. Jacob has completed the audit
procedures for tests of details of balances for accounts receivable. He feels very confident about
his work and doesn’t think he will have any review comments to address. Jacob tells the audit
senior, Maggie, that his work is ready to be reviewed. The next day, Maggie says to Jacob, “Overall,
you have done a good job and I can tell that you understand the purpose of the audit procedures

The engagement partner is responsible for the audit engagement and its performance and
for the auditor’s report that is issued on behalf of the firm. As the audit is being performed, the
engagement partner should conduct timely reviews of work completed on accounts, transactions,
or disclosures that require extensive judgment or involve significant risks. If an item is considered
a critical audit matter or is perhaps a contentious matter with management, it should be reviewed
as soon as possible so it is resolved on a timely basis. The engagement partner is not required to
review all audit documentation, but may choose to do so. The working papers should adequately
document that all reviews, including those performed by the partner, were completed.
Engagement Quality Review
To ensure the audit team has conducted the audit in accordance with standards and gath-
ered sufficient appropriate audit evidence to support the audit conclusions, an engagement

quality control reviewer will review selected areas of working papers prior to the issuance
of the audit report. An engagement quality control reviewer is typically a partner of the ac-
counting firm who is not part of the audit team that completed the audit. The reviewer must
be independent of the client and have sufficient and appropriate experience to objectively
evaluate the work completed on the audit. AU-C 220 Quality Control for an Engagement Con-
ducted in Accordance with Generally Accepted Auditing Standards and AS 1220 Engagement
Quality Review provide guidance regarding what is involved in a quality review.
The engagement partner discusses with the engagement quality control reviewer the
significant findings and other issues encountered during the audit. The reviewer reads the
financial statements and the proposed audit report, and reviews working papers related to
significant findings and conclusions reached in the audit. Ultimately, the reviewer evaluates
the conclusions reached in determining if the financial statements are fairly presented and
ensures the proposed auditor’s report is appropriate based on the audit team’s work.
Completion of Documentation
As we have discussed throughout the text, the working papers serve as documentation that the
audit work was completed. The working papers are the property of the audit firm and act as sup-
port for the auditor’s opinion. AU-C 230 Audit Documentation and AS 1215 Audit Documentation
provide guidance for the assembly and retention of the documentation. The working papers do
not have to be completely assembled and archived before the audit report release date. However,
the standards do provide a deadline for the complete assembly of the audit file and a time frame
for how long the audit file should be retained by the firm. Illustration 14.9 summarizes the time
frames for assembly and retention of the audit file for both public and private company audits.
After the audit report release date, no more audit procedures are performed. Assem-
bling the completed file includes administrative tasks such as sorting and organizing working
engagement partner partner
or other person in the firm
who is responsible for the audit
engagement and its performance
and for the auditor’s report that is
issued on behalf of the firm
engagement quality control
reviewer a partner or other
person in the firm, who is not
part of the engagement team, who
has sufficient and appropriate
experience and authority to
objectively evaluate the
significant judgments that the
engagement team made and the
conclusions it reached in
formulating the auditor’s report
you have completed. However, there are a few instances in which you have not sufficiently doc-
umented your follow-up procedures. For example, to gather evidence about the client’s past due
accounts, the audit procedures from the audit program are:
1.
Examine evidence of collectibility such as correspondence with customers and outside

collection agencies, credit reports, and customers’ financial statements.
2. Inquire about collectibility of accounts with appropriate management personnel.
You notated in the working papers that you examined the client’s correspondence with customers
who had large overdue balances. However, you did not put a copy of the correspondence in the
working papers to substantiate that your examination procedure was completed. You also docu-
mented that you spoke with an accounts receivable clerk about the status of overdue accounts. It
is more appropriate to inquire of the accounts receivable manager, someone with more authority,
regarding the status of the overdue accounts. You need to schedule a meeting with the accounts
receivable manager today, and be sure you take good notes so you can thoroughly document your
discussion in the working papers. Also, remember that inquiry alone is not sufficient. You will
need to corroborate any discussions with additional evidence.”

papers, discarding old documentation that was replaced with updated documentation, and
signing off on completion of checklists related to assembling the file. After the audit file
assembly completion deadline, nothing should be deleted or removed from the audit file.
However, documentation can be added to the file after the assembly completion deadline. If
documentation is added, auditors must indicate who prepared the documentation, the date of
the addition, and the reason for adding it. For example, a firm’s documentation of the audit of
a public company client may be inspected by the PCAOB. If results from the inspection reveal
the need to add further explanation to an audit procedure that was performed, auditors could
add the documentation, noting who prepared it and the reason for adding it (AS 1215.16).
For firms that have multiple office locations, the office that issued the audit report is
responsible for retaining the audit file. Reasonable measures should be taken to ensure the
security of the data, both electronic data and any hard copies retained by the firm, especially
since it contains confidential client information.
Activity
Public Company
Audit (AS 1215)
Private Company
Audit (AU-C 230)
Audit file assembly completion
deadline
45 days after audit report
release date
60 days after audit report
release date
Audit file retention 7 years from the audit
report release date
5 years from the audit report
release date or as specified by
a state board of accountancy
ILLUSTRATION 14.9
Assembly and retention of
audit documentation
Sharon suggests that each member of the team ask themselves
whether they believe that sufficient appropriate evidence has
been gathered on which to base an audit opinion, given their
knowledge and involvement in the audit. Are assessments of con-
trol risk and materiality still valid given evidence obtained from
substantive procedures? No material misstatements were found
during substantive testing, and there is no evidence to suggest
that materiality should be adjusted. All confirmations sent to cus-
tomers, financial institutions, and the stock registrar and transfer
agent have been returned and any differences
resolved. It appears
that the only other major outstanding items are the engagement
quality control review and the going concern assessment.
Before You Go On
3.1 Explain why it is important to reassess materiality at the end of the audit.
3.2
What are some qualitative characteristics of misstatements that would cause auditors to
classify them as material?
3.3
What is an engagement quality control review? Why is this review important to the public
interest?
3.4 What is meant by “assembly and retention” of the audit files?
Evaluate the going concern assumption for a client.
You may remember the going concern assumption from your financial accounting courses.
The going concern assumption is a fundamental principle in the preparation of the finan-
cial statements. Under the going concern assumption, an entity is viewed as continuing in
going concern assumption
the viability of an entity to remain
in business for the foreseeable
future
Going Concern

Going Concern 14-19
business for the foreseeable future with neither the intention nor the need for liquidation. As
a result, assets and liabilities are recorded on the basis that the entity will realize its assets and
discharge its liabilities in the normal course of business.
Management is responsible for evaluating going concern in accordance with the applica
ble financial reporting framework. Under GAAP, FASB ASC 205-40 Presentation of Financial
Statements—Going Concern requires management to make an assessment of the entity’s abil-
ity to continue as a going concern for the future period of one year beyond the issuance date
of the financial statements. Illustration 14.10 provides a timeline example to illustrate man-
agement’s responsibility. If the financial statements are dated December 31, 2022, the issuance
date will be 45 days or more after December 31, depending on when the audit is completed.
Supposing the financial statements are issued on March 1, 2023, the future period for man-
agement’s assessment of the risk of not being a going concern would be from March 1, 2023,
to March 1, 2024. If management determines there is substantial doubt about continuing as
a going concern, then management must make a note disclosure about the circumstances,
including any plans management may have to mitigate the situation.
12/31/2022
Financial
statement
date/fiscal
year-end
date
3/1/2023
Date the
financial
statements
are issued
12/31/2023
3/1/2024
Management’s evaluation period
ILLUSTRATION 14.10
Management’s going concern
evaluation period
Auditors have a responsibility to gather evidence regarding management’s process for eval-
uating going concern status and the appropriateness of management’s conclusions regarding it.
If management does not have a formal process in place, it could be considered a weakness in
internal control. Auditors also draw their own conclusions about whether there is substantial
doubt about the entity’s ability to continue as a going concern for a reasonable period of time
and, if applicable, evaluate the adequacy of any disclosure related to the entity’s circumstances.
What would be a reasonable period of time for the auditor’s evaluation? AU-C 570 The Auditor’s
Consideration of an Entity’s Ability to Continue as a Going Concern defines a reasonable period of
time as the same period required by the client’s financial reporting framework. Therefore, under
GAAP, a reasonable period of time is one year from the date the client issues financial statements,
as shown in Illustration 14.10. (Current PCAOB AS 2415 defines a reasonable period of time as
one year from the date of the financial statements. Therefore, for public company audits, the time
frame for the auditor’s evaluation is shorter than for a private company client.)
According to AU-C 570, auditors do not have a responsibility to perform any audit pro-
cedures to identify going concern issues beyond the time period evaluated by management.
However, AU-C 570 does require that auditors inquire of management about any conditions
or events beyond the period of management’s evaluation that may have an effect on the
entity’s ability to continue as a going concern. For example, using Illustration 14.10, auditors
must inquire of management if there are any known conditions or events after March 1, 2024,
that could have an impact on going concern.
AU-C 570 and AS 2415 provide guidance for the auditor’s evaluation of the entity’s ability
to continue as a going concern. Audit procedures that are performed throughout the audit as
part of risk assessment and risk response should identify events or conditions that could sig-
nify going concern issues. Illustration 14.11 provides a list of audit procedures and examples
of the types of going concern issues that may be identified through the performance of routine
audit procedures. If one or more going concern issues are identified at any point during the
audit, auditors will use their professional judgment and consider the need to revise their risk
assessments and alter the nature, timing, or extent of audit procedures.
reasonable period of time
the period of time required by
the applicable financial reporting
framework, or if no such
framework exists, for one year
after the date that the financial
statements are issued

If auditors determine there is substantial doubt about the entity continuing as a going
concern, the next step is obtaining information about management’s plans to mitigate or min-
imize the adverse effects of the situation. For example, if a client is experiencing a severe cash
shortage but has a letter from its bank agreeing to provide additional financing, the letter
reduces, but does not remove, the risk that the going concern assumption may be in doubt.
Other examples of mitigating factors include:
• A letter of guarantee from a parent company.
• The ability to raise additional funds by issuing more stock.
• The ability to sell an unprofitable segment of the business.
• A reduction of expenditures.
• The ability to sell assets without interrupting the entity’s operating capacity.
Auditors perform audit procedures to gather evidence about the mitigating factors and con-
sider whether the plans can be effectively implemented. For example, if management plans
to sell assets that have been used in operations, is there a market for the assets? How quickly
could they be sold and for how much? Would the sale of the assets be sufficient to enable the
entity to continue as a going concern for a reasonable period of time? Auditors draw upon
their knowledge of the entity, the industry, and their professional judgment when evaluating
the information to arrive at a conclusion.
After considering management’s plans, if auditors determine there is substantial doubt
about the entity’s ability to continue as a going concern, the next steps are to consider the
possible effects on the financial statements and on the auditor’s report. Regarding the finan-
cial statements, auditors evaluate the adequacy of management’s note disclosure about the
going concern issue. The disclosure should include a description of the conditions or events
causing the substantial doubt, management’s evaluation of the significance of those condi-
tions or events, and management’s plans to minimize the effects of the situation. Auditors
consider modifying the auditor’s report to further emphasize the substantial doubt about the
entity’s ability to continue as a going concern. This is something that investors or other key
stakeholders should know. You can understand that the client might not want any more atten-
tion brought to the situation because, in fact, it could make it more difficult for the client to
implement its plans for mitigating the situation. For example, obtaining alternative financing
may be more difficult if the auditor’s report is modified for a going concern issue. Noting these
conditions could also negatively impact the stock price for a public company. Given these
Audit Procedure Identification of Possible Going Concern Issue
Analytical procedures during risk
assessment
May identify negative trends such as working capital
deficiencies, adverse key financial ratios, and decreasing
cash flow from operations
Review of subsequent events May identify internal or external matters that have
occurred such as loss of a key franchise, loss of a principal
customer, or work stoppages due to natural disaster
Review of compliance with terms of
debt and loan agreements
May identify possible financial difficulties such as re-
structuring of debt, default on loan or similar
agreements, or need to dispose of substantial assets
Reading of minutes of meetings with
stockholders, board of directors, and
other important committees of the
board
May identify internal or external matters that have
occurred such as labor difficulties, arrearages in
dividends, or substantial dependence on the success
of a particular project
Inquiry of client’s legal counsel May identify external matters that have occurred such as
legal proceedings that might jeopardize the client’s ability
to operate
Confirmation with related parties
and third parties of the details of
arrangements to provide or maintain
financial support
May identify possible financial difficulties such as default
on financing arrangements, restructuring of financing
agreements, or need to seek new sources or methods of
financing
ILLUSTRATION 14.11
Audit procedures that may
identify going concern issues
Source: AU-C 570.A7 and .A28.

Management Representation and Communication with Those Charged with Governance 14-21
serious implications, auditors consider this decision very carefully. The specific modifications
that would be made to the auditor’s report are discussed in Chapter 15.
The final step is to communicate with those charged with governance. Those charged
with governance, such as a board of directors, probably already know about the situation, but
auditors still communicate the nature of the events that are causing doubt about the entity’s
ability to continue as a going concern. Auditors also discuss the note disclosure and other ef-
fects on the financial statements. If the auditors decide to issue a modified auditor’s report, it
should be communicated to those charged with governance.
Sharon and the team discuss the existence of any issues throw-
ing doubt on the appropriateness of the going concern assump-
tion at Cloud 9. The financial ratios indicate no problems with
solvency, and the major borrowings are not due to be repaid
or refinanced for another four years. However, Cloud 9’s man-
agement is anticipating a decline in earnings this year because
of the costs associated with the new store opening and the
sponsorship deal. Cloud 9 does have a sizeable line of credit at
its bank that is currently not being utilized. If Cloud 9 has an
unexpected need for additional cash, Cloud 9 management could
draw on the line of credit. The team makes a note that these
issues have been formally reviewed and they conclude that there
are no significant issues casting substantial doubt on the going
concern assumption.
Before You Go On
4.1 Explain the going concern assumption. How does it affect a company’s accounting?
4.2
List three factors that might indicate the going concern assumption may be at risk. What
audit procedures would detect the factors?
4.3
Explain some mitigating factors that could offset possible going concern issues.
Discuss what reporting is required to management and those charged with
governance.
Throughout the entire audit, auditors communicate often with management and other client
personnel in the process of gathering audit evidence. As the audit draws to a conclusion,
some required communications must take place with management and those charged with
governance, and the communications must be documented. The remainder of this section will
explain the management representation letter and the required communications with those
charged with governance.
Management Representation Letter
AU-C 580 Written Representations and AS 2805 Management Representations provide guid-
ance about using written representations as audit evidence. A written representation is
written representation a
written statement by management
provided to the auditor to confirm
certain matters or to support
other audit evidence
Management Representation and Communication
with Those Charged with Governance

a written statement by management provided to the auditor to confirm certain matters or
to support other audit evidence (AU-C 580.07). Generally, a written representation com-
plements other audit procedures that were performed and generally does not provide suf-
ficient appropriate audit evidence on its own. For example, auditors ask management for
a written representation that no material subsequent events have occurred that require
adjustment to or disclosure in the financial statements. That evidence does not relieve au-
ditors of their duty to perform audit procedures designed to identify subsequent events. The
written representation supplements the inquiries made of management regarding subse-
quent events and the evidence gathered from audit procedures related to subsequent events
identification.
As we have discussed throughout the text, auditors make many inquiries of manage-
ment during risk assessment, testing of internal controls, and performance of substantive
procedures. The responses to the inquiries are documented in the auditor’s working papers.
As supplemental evidence to the inquiries, auditors are required to obtain a management

representation letter as a final piece of audit evidence. A management representation letter
is a letter from management to the auditor acknowledging management’s responsibility for
the preparation of the financial statements and details of any verbal representations made by
management during the course of the audit. However, the management representation letter
is not a substitute for obtaining sufficient, appropriate evidence regarding the financial state-
ments through other audit procedures.
As you can imagine, the letter could be quite daunting to write because of the volume
of inquiries made of management during the audit. To help with this task, AU-C 580.A35
and AS 2805.16 provide illustrative management representation letters that auditors can
use as a guideline for what should be included in the letter. Illustration 14.12 contains a
management representation letter for the Cloud 9 audit. Since Cloud 9 is a public company,
the letter has been prepared using the example provided in PCAOB AS 2805.16.
management representation
letter a letter from manage-
ment to the auditor acknowledg-
ing management’s responsibility
for the preparation of the finan-
cial statements and details of any
verbal representations made by
management during the course of
the audit
[1] Cloud 9 Inc.
[2] March 15, 2023
[3] WS Partners
P.O. Box 525
Seattle, WA 95688
Dear WS Partners:
[4] We are providing this letter in connection with your audit of the consolidated financial state-
ments of Cloud 9 Inc. as of January 31, 2023, and for the year then ended for the purpose of ex-
pressing an opinion as to whether the consolidated financial statements present fairly, in all mate-
rial respects, the financial position, results of operations, and cash flows of Cloud 9 in conformity
with accounting principles generally accepted in the United States of America. We confirm that
we are responsible for the fair presentation in the consolidated financial statements of financial
position, results of operations, and cash flows in conformity with generally accepted accounting
principles.
[5] Certain representations in this letter are described as being limited to matters that are material.
Items are considered material, regardless of size, if they involve an omission or misstatement of
accounting information that, in the light of surrounding circumstances, makes it probable that the
judgment of a reasonable person relying on the information would be changed or influenced by
the omission or misstatement.
[6] We confirm, to the best of our knowledge and belief, as of March 15, 2023, the following repre-
sentations made to you during your audit:
1. The financial statements referred to above are fairly presented in conformity with accounting
principles generally accepted in the United States of America.
ILLUSTRATION 14.12
Management representation
letter for Cloud 9 audit

2.
We have made available to you all—
a.
Financial records and related data, including the names of all related parties and all rela-
tionships and transactions with related parties.
b.
Minutes of the meetings of stockholders, directors, and committees of directors, or
summaries of actions of recent meetings for which minutes have not yet been prepared.
3. There have been no communications from regulatory agencies concerning noncompliance
with or deficiencies in financial reporting practices.
4. There are no material transactions that have not been properly recorded in the accounting
records underlying the financial statements.
5. We believe that the effects of the uncorrected financial statement misstatements summarized
in the accompanying schedule are immaterial, both individually and in the aggregate, to the
financial statements taken as a whole.
6.
We acknowledge our responsibility for the design and implementation of programs and con-
trols to prevent and detect fraud.
7.
We have no knowledge of any fraud or suspected fraud affecting the entity involving—
a. Management,
b. Employees who have significant roles in internal control, or
c. Others where the fraud could have a material effect on the financial statements.
8.
We have no knowledge of any allegations of fraud or suspected fraud affecting the entity re-
ceived in communications from employees, former employees, analysts, regulators, short
sellers, or others.
9. The company has no plans or intentions that may materially affect the carrying value or clas-
sification of assets and liabilities.
10. The following have been properly recorded or disclosed in the financial statements:
a. Related party transactions, including sales, purchases, loans, transfers, leasing arrange-
ments, and guarantees, and amounts receivable from or payable to related parties.
b. Guarantees, whether written or oral, under which the company is contingently liable.
c.
Significant estimates and material concentrations known to management that are re-
quired to be disclosed in accordance with the FASB ASC Topic 275, Risks and Uncertainties.
[Significant estimates are estimates at the balance sheet date that could change materi-
ally within the next year. Concentrations refer to volumes of business, revenues, available
sources of supply, or markets or geographic areas for which events could occur that would
significantly disrupt normal finances within the next year.]
11. There are no—
a.
Violations or possible violations of laws or regulations whose effects should be
considered for disclosure in the financial statements or as a basis for recording a loss
contingency.
b.
Unasserted claims or assessments that our lawyer has advised us are probable of
assertion and must be disclosed in accordance with Financial Accounting Standards Board
(FASB) ASC Topic 450, Contingencies.
c.
Other liabilities or gain or loss contingencies that are required to be accrued or disclosed
by FASB ASC Topic 450.
d.
Side agreements or other arrangements (either written or oral) that have not been
disclosed to you.
12. The company has satisfactory title to all owned assets, and there are no liens or encumbranc-
es on such assets nor has any asset been pledged as collateral.
13. The company has complied with all aspects of contractual agreements that would have a ma-
terial effect on the financial statements in the event of noncompliance.
[7] To the best of our knowledge and belief, no events have occurred subsequent to the
balance-sheet date and through the date of this letter that would require adjustment to or
disclosure in the aforementioned financial statements.
James W. Harley
[8] Chief Executive Officer
David Collier
[8] Chief Financial Officer

Sections of the management representation letter in Illustration 14.12 are numbered to
correspond with the following explanations:
1.
Client letterhead—Since the letter is to the auditors from management, the letter is writ-
ten on client letterhead. However, the letter is typically drafted by auditors and presented
to management for review and signing.
2.
Date—The letter is generally dated the same as the audit report so the representations made
by management include the subsequent period leading up to the date of the audit report.
3. Address—The letter is addressed to the audit firm.
4.
Identification of audit—This paragraph identifies the financial statements and the pur-
pose of the audit. It also provides a statement in which management accepts responsi-
bility for the fair presentation of the financial statements in conformity with generally
accepted accounting principles in the United States.
5.
Materiality—This paragraph states a materiality threshold for items that will be included
in the letter.
6.
List of items that management is confirming—This section of the letter is a listing of the
items the auditor wants management to confirm. Read through the listing and you’ll see
it encompasses many important audit items we have discussed in this text, such as proper
application of the financial reporting framework, availability of documents and records,
fraud detection and prevention, and proper disclosure in the financial statements.
7.
Subsequent events statement—The final paragraph is a statement confirming that no
subsequent events have occurred through the date of the letter that have not already been
accounted for or disclosed.
8. Signatures—The letter is signed by the CEO and CFO of the client.
The example provided in Illustration 14.12 is a basic example. Auditors can add more
items to the letter that are tailored to each client’s situation. For example, if inventory obsoles-
cence is a recurring issue in the client’s industry, auditors may add an item for management
to confirm that appropriate provisions have been made regarding slow-moving or obsolete
inventory. Public companies also must make some of these representations public in the quar-
terly and annual filings with the SEC. Section 302 of the Sarbanes-Oxley Act requires the CEO
and CFO to sign statements certifying they are responsible for the effectiveness of internal
controls, the financial statements are presented fairly, and there are no untrue statements of a
material fact or omission of material items.
If management refuses to sign a management representation letter, that would cause the
auditors to question management’s integrity, competence, and ethical values, and could have
serious ramifications for the audit. Auditors would be especially concerned about the reliabil-
ity of audit evidence obtained through inquiry of management. The refusal by management
to sign the representation letter would be considered a scope limitation and could affect the
auditor’s opinion on the financial statements. Chapter 15 provides more information about
the effect of a scope limitation on the auditor’s opinion.
Communication with Those Charged with
Governance
In Chapter 4, we discussed the concept of corporate governance. Governance structures will
vary by client. Public companies will have a board of directors with an audit committee, and
large private companies may also have a board of directors. For medium and smaller compa-
nies, governance responsibility may fall upon owners, partners, trustees, or a committee of
upper management. In very small companies, one person may be in charge of governance,
such as the owner-manager. Auditing standards AU-C 260 The Auditor’s Communication with
Those Charged with Governance and AS 1301 Communications with Audit Committees
address the auditor’s responsibility to communicate certain audit matters with those charged
with governance. As discussed in Chapter 4, auditors must communicate their responsibility
for forming and expressing an opinion on the financial statements that have been prepared
by management. This communication typically takes the form of an engagement letter and


happens at the beginning of the engagement (refer to the section “Corporate Governance” in
Chapter 4). Auditors also provide a general overview of the planned scope and timing of the
audit to those charged with governance. During this communication, auditors do not reveal in-
depth detail about the planned audit procedures because they do not want to compromise the
effectiveness of the audit. But this dialogue can open a discussion about risks the client faces
and can assist the auditor in gaining a better understanding of the entity and its environment.
Communication with those charged with governance, with management, and with third
parties, when applicable, is also covered in several other auditing standards. For example, if
auditors have identified a fraud, or have information that indicates the existence of a fraud,
they are required to communicate these matters to an appropriate level of management by
AU-C 240 Consideration of Fraud in a Financial Statement Audit. Similarly, when auditors
have identified material noncompliance with laws and regulations, they are required to com-
municate their findings to those charged with governance in accordance with AU-C 250
Consideration of Laws and Regulations in an Audit of Financial Statements.
Toward the end of the audit, auditors communicate significant findings or issues from
the audit to those charged with governance. This communication should take place before the
audit report is issued. The communication may be oral or written, but either way it must be
documented in the working papers. Illustration 14.13 lists the matters to be communicated
with those charged with governance near the end of the audit.
Source: AU-C 260.12-.14.
Significant Finding or Issue
from the Audit Explanation
Appropriateness of significant
accounting policies
The applicable financial reporting framework may provide different alternatives for ac-
counting for an item. For example, there are different cost flow assumptions for inventory
(FIFO, LIFO, weighted average). Auditors discuss if the method management has chosen is
appropriate for the industry and for the entity.
Process used by management in
developing sensitive accounting
estimates
Auditors communicate the significant assumptions used in developing the estimate, the
degree of subjectivity involved, and the relative materiality of the estimates to the financial
statements as a whole.
Difficulties encountered during the
audit
Significant difficulties include delays in management providing information, unrealistic
time within which to complete the audit, restrictions imposed on the auditor by manage-
ment, and the unavailability of expected information.
Disagreements with management Disagreements may arise over the application of accounting policies to specific transactions
or events, assumptions for developing estimates, disclosures to be included in the financial
statements, or the scope of the audit. Even if the disagreements were resolved, they should
be communicated to those charged with governance.
Other significant findings or issues Every client is unique; therefore, items specific to each client may need to be communi-
cated to those charged with governance. For example, if a client is involved with major
litigation, auditors would discuss the potential effect on the financial statements of an
unfavorable outcome.
Uncorrected misstatements Auditors accumulate individually immaterial uncorrected misstatements and discuss them
collectively to those charged with governance. For material uncorrected misstatements,
auditors should request that they be corrected.
Corrected misstatements Misstatements that were brought to management’s attention and corrected should also be
communicated to management.
Business conditions affecting the entity If there are industry, economic, or other uncertainties that could affect the entity’s ability
to continue as a going concern, these matters should be communicated to those charged
with governance.
Consultations with other accountants If auditors and management disagree on an issue, management may contact other outside
accountants to see if they may agree with management’s views. If auditors are aware that
management has consulted with other accountants, then it should be brought to the atten-
tion of those charged with governance. Auditors should communicate their own views on
the issue and how they differ from management’s views.
Written representation the auditors are
requesting
Auditors should provide those charged with governance with a copy of the management
representation letter.
ILLUSTRATION 14.13 Matters to be communicated with those charged with governance

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