Chapter 17

Completing the Audit

Engagement

Review for Contingent LiabilitiesA contingent liability is defined as an existing condition, situation, or set of circumstances

involving uncertainty as to possible loss to an entity that will ultimately be resolved when some future

event occurs or fails to occur.

A contingent liability is defined as an existing condition, situation, or set of circumstances

involving uncertainty as to possible loss to an entity that will ultimately be resolved when some future

event occurs or fails to occur.

Probable: The future event is likely to occur.

Reasonably Possible: The chances of the future event occurring is more than remote but less than likely.

Remote: The chance of the future event occurring is slight.

Probable: The future event is likely to occur.

Reasonably Possible: The chances of the future event occurring is more than remote but less than likely.

Remote: The chance of the future event occurring is slight.

Examples

• Pending or threatened litigation

• Actual or possible claims and assessments

• Income tax disputes

• Product warranties or defects

• Guarantees of obligations (such as loans or lines of credit) to others

Examples

• Pending or threatened litigation

• Actual or possible claims and assessments

• Income tax disputes

• Product warranties or defects

• Guarantees of obligations (such as loans or lines of credit) to others

LO# 1

17-2

Audit Procedures for Identifying Contingent Liabilities

Read minutes of meetings of the board of directors, committees of the board,

and stockholders.

Review contracts, loan agreements, leases, and

correspondence from government agencies.

Confirm or otherwise document guarantees and

letters of credit.

Inspect other documents for possible guarantees or

other similar arrangements.

Review tax returns, IRS reports, and schedules supporting the client’s

income tax liability.

LO# 2

17-3

Audit Procedures for Identifying Contingent Liabilities

Inquire and discuss with management about its policies and

procedures for identifying, evaluating, and accounting for

contingent liabilities.

Examine documents in the entity’s records such as correspondence and invoices from attorneys for pending or threatened lawsuits.

Obtain a legal letter that describes and evaluates any litigation, claims,

or assessments.

Obtain written representation from management that all litigation,

asserted and unasserted claims, and assessments have been

disclosed in accordance with FASB ASC Topic 450.

Specific Audit Procedures Conducted Near Completion of Audit

LO# 2

17-4

Legal LettersA letter of audit inquiry (legal letter) sent to the

client’s attorneys is the primary means of obtaining or corroborating information about

litigation, claims, and assessments.

LO# 3

17-5

Example of Legal LetterLO# 3

17-6

Commitments

Long-term commitments are usually identified through inquiry of client personnel during the audit of the revenue and purchasing processes.

In most cases, such commitments are disclosed in a footnote to the financial statements.

Long-term contracts to purchase raw materials or sell their products at a fixed price

Long-term contracts to purchase raw materials or sell their products at a fixed price

To obtain a favorable pricing arrangement

To obtain a favorable pricing arrangement

To secure the availability of raw

materials

To secure the availability of raw

materials

LO# 4

17-7

Review for Subsequent Events for Audit of Financial Statements

Balance Sheet Date

Type I Event

Conditions existed before the balance

sheet date and affect estimates that are part of financial statements

Type II Event

Conditions did not exist at the balance

sheet date and do not affect the accuracy of

the financial statements

Require adjustment of the financial statements

Require disclosure and possibly pro forma

financial statements

LO# 5

17-8

Review of Subsequent Events for Audit of Financial Statements Figure 17-1

LO# 5

17-9

Dual Dating

When a subsequent event is recorded or disclosed in the financial statements after sufficient, appropriate

audit evidence has been obtained but before the issuance of the financial statements, the auditor considers the following options for dating of the

auditor’s report:

(1) “Dual date” the report (original date of report plus date of subsequent event—limits liability so almost always this is what the CPA firm does)

(2) Change the date of the auditor’s report to the date of the subsequent event—extends liability

LO# 6

17-10

Audit Procedures to Look for Subsequent Events

Inquire of Management

Read Interim Financial

StatementsExamine the

Books of Original Entry

Examples of audit procedures

Read Minutes of Meetings

Inquire of Legal Counsel

LO# 7

17-11

Review of Subsequent Events for Audit of Internal Control over Financial Reporting

Auditors of public companies with $75,000,000 market cap must report on any changes in internal control that might affect financial reporting between the end of the reporting period and the date of the auditor’s report.

LO# 7

Internal audit reports

Independent auditor reports of reportable conditions

Regulatory agency reports

on ICFR

Information obtained from audit of ICFR

17-12

Final Evidential Evaluation Processes

Perform final analytical procedures.

Evaluate entity’s ability to continue as a

going concern.

Obtain a representation letter.

Review working papers.

Assess final audit results.

Evaluate financial statement presentation

and disclosure.

Obtain an independent review of the engagement.

LO# 8

17-13

Estimating Likely MisstatementsLO# 8

17-14

Archiving and RetentionSarbanes-Oxley Act and PCAOB’s Documentation Standard (SAS

103 is similar but a bit less stringent):• Require audit firms to archive their public-company audit files for

retention within 45 days following the time the auditor grants permission to use the auditor’s report in connection with the issuance of the company’s financial statements.

• Require audit firms to retain audit documentation for 7 years (5 years if a privately held company and thus governed by SAS 103) from the date

of completion of the engagement, as indicated by the date of the auditor’s report, unless a longer period of time is required by law.

• Require audit firms to retain all documents that “form the basis of the audit or review.”

• Require audit firms to include in the audit file for significant matters any document created, sent, or received, including documents that are inconsistent with a final conclusion. Significant changes in audit plans

or conclusions must also be documented.

LO# 8

17-15

Going Concern ConsiderationsLO# 9

17-16

Going Concern ConsiderationsLO# 9

17-17

Communications with “Those Charged with Governance”

LO# 10

17-18

Subsequent Discovery of Facts Existing at the Date of the Auditor’s Report

Notify the company that the auditor’s report must no

longer be associated with the financial statements.

Notify the company that the auditor’s report must no

longer be associated with the financial statements.

If a public company, make sure the SEC is notified that the auditor’s report and the financial statements can no

longer be relied upon.

If a public company, make sure the SEC is notified that the auditor’s report and the financial statements can no

longer be relied upon.If a private company, notify

persons known to the auditor to be relying on the financial statements (e.g. banks, other creditors).

If a private company, notify persons known to the

auditor to be relying on the financial statements (e.g. banks, other creditors).

LO# 11

17-19

End of Chapter 17

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