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