Chapter 15


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Chapter 15

  1. 1. Chapter 15 Completing the Audit
  2. 2. Assessing the Quality of the Audit <ul><li>Analytical review </li></ul><ul><li>Required by GAAS </li></ul><ul><li>Do company results make sense in relation to industry and economic trends? </li></ul><ul><li>Concurring partner review </li></ul><ul><li>Independent review by experienced auditor who is not part of audit team </li></ul><ul><li>Sarbanes/Oxley Act requires for audits of public companies </li></ul><ul><li>Partner rotation </li></ul><ul><li>Sarbanes/Oxley Act requires new audit engagement and concurring review partner every 5 years </li></ul><ul><li>Does not apply to CPA firms with less than 10 partners and 5 public company audit clients </li></ul>
  3. 3. Other Considerations in the Final Review Stage of the Audit: Contingencies <ul><li>Contingent losses that are both probable and reasonably estimated should be accrued and disclosed </li></ul><ul><li>Contingent losses that are reasonably possible, and remote contingencies disclosed because of common practice, should be disclosed in the notes to the financial statements </li></ul><ul><li>Contingencies include: </li></ul><ul><li>Collectibility of receivables and loans </li></ul><ul><li>Product warranty liability </li></ul><ul><li>Litigation, claims, and assessments </li></ul><ul><li>Threat of expropriation of assets in a foreign country </li></ul><ul><li>Guarantees of debts of others </li></ul><ul><li>Purchase and sale commitments </li></ul><ul><li>Agreements to repurchase receivables that have been sold </li></ul><ul><li>Obligations of banks under standby letters of credit </li></ul>
  4. 4. Discuss Contingencies <ul><li>Responsibilities </li></ul><ul><li>Management is responsible for identifying, evaluating, and accounting for contingencies </li></ul><ul><li>Auditor is responsible for determining client has properly identified, accounted for, and disclosed material contingencies </li></ul><ul><li>Sources of Evidence </li></ul><ul><li>Primary sources include management and client's legal counsel </li></ul><ul><li>Additional sources include corporate minutes, contracts, correspondence from government agencies, and bank confirmations </li></ul>
  5. 5. What is the letter of audit inquiry? <ul><li>Primary source of corroborative evidence concerning litigation, claims, and assessments is the client's legal counsel </li></ul><ul><li>Letter of inquiry should include </li></ul><ul><li>Management's list that describes and evaluates its contingencies </li></ul><ul><li>A request that the attorney furnish auditor with the following: </li></ul><ul><ul><li>Comment on the completeness of management's list and evaluations </li></ul></ul><ul><ul><li>For each contingency, </li></ul></ul><ul><ul><ul><li>Description of the matter, progress to date, and action client intends to take </li></ul></ul></ul><ul><ul><ul><li>Evaluation of the likelihood of unfavorable outcome and estimate of potential loss, if possible </li></ul></ul></ul><ul><ul><ul><li>Any limitations on the attorney's response </li></ul></ul></ul>
  6. 6. <ul><li>The letter of inquiry is good for establishing completeness of potential liabilities and providing factual information about contingencies </li></ul><ul><li>However, because audit workpapers are not privileged, attorney responses will be less than forthcoming about the likelihood of unfavorable outcomes, and the estimated amount of any potential losses </li></ul><ul><li>An attorney's refusal to provide the requested information is a scope limitation sufficient to preclude issuing an unqualified opinion </li></ul>What is the letter of audit inquiry? (Continued)
  7. 7. Review Adequacy of Disclosures <ul><li>Third standard of reporting states &quot;Informative disclosures in the financial statements are to be regarded as reasonably adequate unless otherwise stated in the report.&quot; </li></ul><ul><li>Auditor must be sure that: </li></ul><ul><li>Disclosed events and transactions occurred and pertain to the client </li></ul><ul><li>All disclosures that should be included are included </li></ul><ul><li>Disclosures are understandable to users </li></ul><ul><li>Disclosures are accurate </li></ul>
  8. 8. Explain Management Representations <ul><li>Management Certification of Financial Statements </li></ul><ul><li>Sarbanes/Oxley Act requires CEO and CFO to certify financial statements are fairly presented in accordance with GAAP </li></ul><ul><li>Auditor should review management's processes for certification </li></ul><ul><li>Management Representation Letter </li></ul><ul><li>Reminds management of its responsibility for the financial statements </li></ul><ul><li>Confirms significant oral responses made by management </li></ul><ul><li>Reduces possibility of misunderstandings between management and auditor </li></ul>
  9. 9. <ul><li>Letter is prepared by auditor on client letterhead, addressed to the auditor, and normally signed by CEO and CFO </li></ul><ul><li>Letter is dated as of the audit report date (end of fieldwork) </li></ul><ul><li>Because management representations are not strong evidence, the auditor should perform procedures to corroborate the information in the letter </li></ul><ul><li>Management's failure to provide this letter is a scope limitation sufficient to preclude issuance of unqualified opinion </li></ul>Explain Management Representations (Continued)
  10. 10. What is the management comment letter? <ul><li>Auditors often notice things that might make the client more profitable </li></ul><ul><li>Many of these observations related to control deficiencies or operational matters </li></ul><ul><li>The observations are included in a management comment letter typically delivered to the Board of Directors with the audit report </li></ul><ul><li>Management letter is not required, but does add value to the audit </li></ul>
  11. 11. What is the going concern issue? <ul><li>Auditor is required to evaluate client's ability to remain a going concern for a period not to exceed one year from the balance sheet date </li></ul><ul><li>Indicators of potential going concern problems include </li></ul><ul><li>Negative trends in key financial areas like cash flow, sales, profits </li></ul><ul><li>Internal matters, such as loss of key personnel, and outdated facilities and/or products </li></ul><ul><li>External matters, such as new legislation, loss of significant customer or supplier, uninsured casualty loss </li></ul><ul><li>Other matters, such as loan default, inability to pay dividends, attempted debt restructuring </li></ul>
  12. 12. <ul><li>If there is substantial doubt about ability of client to remain a going concern, auditor should </li></ul><ul><li>Discuss the situation with management </li></ul><ul><li>Assess management's plan to overcome problems </li></ul><ul><li>Consider the effects on the financial statements </li></ul><ul><ul><li>Auditor should evaluate the adequacy of financial statement disclosure </li></ul></ul><ul><ul><li>Disclosures might include conditions causing the going concern doubt and management's plan to overcome the problem </li></ul></ul><ul><li>Consider the effects on the audit report </li></ul><ul><ul><li>Add explanatory paragraph to the unqualified audit report </li></ul></ul><ul><ul><li>Disclaim opinion </li></ul></ul><ul><ul><li>Issue qualified opinion if disclosure is not adequate </li></ul></ul>What is the going concern issue? (Continued)
  13. 13. <ul><li>Management estimates provide opportunities for the entity to &quot;manage&quot; or even manipulate earnings. The auditor provides reasonable assurance that - Management has information system to develop estimates material to the financial statements </li></ul><ul><li>Estimates are reasonable </li></ul><ul><li>Estimates are presented per GAAP </li></ul><ul><li>In evaluating management estimates, the auditor concentrates on key factors and assumptions that are </li></ul><ul><li>Significant to the accounting estimate </li></ul><ul><li>Sensitive to variations </li></ul><ul><li>Deviations from historical patterns </li></ul><ul><li>Susceptible to misstatement </li></ul><ul><li>Inconsistent with current economic trends </li></ul>Discuss Review of Significant Estimates
  14. 14. Comment on Communicating with the Audit Committee <ul><li>Items the auditor should discuss with the audit committee include </li></ul><ul><li>Auditor's responsibility under GAAS </li></ul><ul><li>Management judgments and accounting estimates </li></ul><ul><li>Audit adjustments </li></ul><ul><li>Uncorrected misstatements </li></ul><ul><li>Accounting policies and alternative treatments </li></ul><ul><li>Major accounting and reporting disagreements with management </li></ul><ul><li>Difficulties encountered in performing the audit </li></ul><ul><li>Copies of significant communications between auditor and management </li></ul><ul><li>Management's discussion with other CPA firms </li></ul><ul><li>Significant fraud or illegal acts </li></ul><ul><li>Significant deficiencies in internal control </li></ul><ul><li>Any independence issues </li></ul><ul><li>Any other significant matters </li></ul>
  15. 15. What are subsequent events? <ul><li>Subsequent events occur after the balance sheet date . Audit procedures used to identify subsequent events include: </li></ul><ul><li>Read minutes of meetings of the board of directors, stockholders, and other authoritative groups held after year-end </li></ul><ul><li>Read interim financial statements; investigate significant changes </li></ul><ul><li>Inquire of management about </li></ul><ul><ul><li>Significant changes in noted in interim statements </li></ul></ul><ul><ul><li>Significant contingent liabilities </li></ul></ul><ul><ul><li>Significant changes in working capital, debt, or owners' equity </li></ul></ul><ul><ul><li>Status of any tentative items </li></ul></ul><ul><ul><li>Unusual accounting adjustments made after balance sheet date </li></ul></ul><ul><li>Inquire of management and legal counsel about subsequent events </li></ul><ul><li>Obtain management representation letter </li></ul>
  16. 16. Subsequent Events <ul><li>How an auditor handles a subsequent event depends on two things: </li></ul><ul><li>Whether the subsequent event provides evidence about conditions that existed at the balance sheet date (type 1), or conditions arising after the balance sheet date (type 2) </li></ul><ul><li>When the subsequent event occurred: during fieldwork, after fieldwork but before the audit report has been issued, or after the audit report has been issued </li></ul>
  17. 17. What are the types of subsequent events? <ul><li>Type 1 subsequent events provide evidence about conditions that existed at the balance sheet date </li></ul><ul><li>The financial statement numbers should be adjusted to reflect this information; footnote disclosure may also be necessary </li></ul><ul><li>Examples of type 1 subsequent events: </li></ul><ul><li>Major customer files for bankruptcy during subsequent period, its deteriorating financial condition existed prior to the balance sheet date </li></ul><ul><li>Lawsuit settled for different amount than accrual </li></ul><ul><li>Stock dividend or split during the subsequent period </li></ul><ul><li>Sale of inventory below carrying value when loss occurred during the subsequent period </li></ul>
  18. 18. <ul><li>Type 2 subsequent events provide evidence about conditions that did not exist at the balance sheet date </li></ul><ul><li>The financial statement numbers should not be adjusted for these events, but they should be considered for disclosure </li></ul><ul><li>Examples of type 2 subsequent events: </li></ul><ul><li>Uninsured casualty loss that occurs after the balance sheet date </li></ul><ul><li>Significant lawsuit initiated for incident occurring after the balance sheet date </li></ul><ul><li>Significant loss due to natural disaster occurring after the balance sheet date </li></ul><ul><li>Major decisions made during the subsequent period such as decision to merge, discontinue a line of business, or issue new securities </li></ul><ul><li>Material change in value of investment securities after the balance sheet date </li></ul>What are the types of subsequent events?
  19. 19. Subsequent Events <ul><li>If subsequent event occurs after end of fieldwork but before audit report is issued, auditor must decide whether to single or dual date the audit report </li></ul><ul><li>Single date </li></ul><ul><ul><li>Date of subsequent event is the audit report date </li></ul></ul><ul><ul><li>Auditor must make sure there are no other subsequent events prior to report date </li></ul></ul><ul><li>Dual date </li></ul><ul><ul><li>Use dates of end of fieldwork and subsequent event </li></ul></ul>
  20. 20. Subsequent discovery of facts existing at the date of the auditor's report <ul><li>Auditor must determine </li></ul><ul><li>Reliability of new information </li></ul><ul><li>Whether the event had occurred by the audit report date </li></ul><ul><li>Whether users are likely to still be relying on the financial statements </li></ul><ul><li>Whether the audit report would have been affected had the facts been known </li></ul>
  21. 21. Subsequent discovery of facts existing at the date of the auditor's report <ul><li>If the auditor decides further reliance on the financial statements and audit report is not appropriate, client is advised to make appropriate and timely disclosure of these new facts </li></ul><ul><li>Appropriate actions: </li></ul><ul><li>Revise financial statements and audit report </li></ul><ul><li>Revision and explanation reflected in subsequent period financial statements </li></ul><ul><li>If revision will take extended period, notify users that statements and audit report should no longer be relied on </li></ul><ul><li>If client will not cooperate, auditor should </li></ul><ul><li>Notify client and regulatory agency that the audit report should no longer be associated with the financial statements </li></ul><ul><li>Notify known users that the audit report should no longer be relied on </li></ul>