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Auditing Operations and Completing the Audit

www.buec.udel.edu/jenkinsd/Powerpoint/Chp16.ppt

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Outline

Auditing operations» Miscellaneous revenue» Miscellaneous SG&A expenses

Auditing payroll Completing the audit Evaluating audit findings Post-audit responsibilities

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Relationships Between Balance Sheet and Revenue Accounts

Relationship of Revenue to Balance Sheet Accounts

Balance Sheet Item Revenue

Accounts receivable Sales

Notes receivable Interest

Securities and other investments Interest, dividends, gains on sales, share of investee’s income

Property, plant and equipment Rent, gains on sale

Intangible assets Royalties

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Miscellaneous Revenue

Mixture of minor or non-recurring revenue transactions.

Items that may be misclassified as miscellaneous revenue.» Collection on previously written-off receivables» Write-offs of old outstanding checks» Proceeds from sale of scrap» Refunds or rebates of insurance premiums» Proceeds from sales of plant assets

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Relationships Between Balance Sheet and Income Statement

Accounts

Relationship of Expenses to Balance Sheet Accounts

Balance Sheet Item Expenses

Accounts and notes receivable Uncollectible accounts and notes expense

Inventories Purchases, cost of goods and payroll

Property, plant and equipment Depreciation and repairs and maintenance

Intangible assets Amortization

Accrued liabilities Commissions, fees, bonuses, product warranty expenses, etc.

Interest-bearing debt Interest

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Substantive Tests for Selling, General and Administrative

Expenses

Perform analytical procedures» Develop an expectation of the account balance» Determine the amount of difference from the expectation that

can be accepted without investigation» Compare the company’s account balance with the expected

account balance» Investigate significant deviations from the expected account

balance

Obtain or prepare analyses of selected expense accounts

Obtain or prepare analyses of critical expenses in the income tax return

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The Audit of Payroll

Payroll is often a company’s largest operating cost.

Potential payroll frauds» Fictitious employees» Overpaying employees» Continuing to pay employees after

termination

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Payroll Functions

Human resources» Authorized pay rate» Employment papers / payroll deductions

Timekeeping» Electronic clocks» Supervisor oversight of timekeeping

Payroll preparation and recordkeeping» Time cards» Payroll journals» Labor distributions» Employee earnings records

Distribution of paychecks» Paymaster» Imprest account / regular reconciliation» Proof of identity / employee signature

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Audit Program for Payroll

Obtain an understanding of internal control over payrolls

Perform tests of controls as necessary» Compare name, wage rates, and payroll

deductions to HR records.» Compare time on payroll to time reports approved

by supervisors.» Test extensions and footing of payroll.» Compare payroll total to total of checks issued.» Observe the use of time clocks.» Observe the distribution of paychecks.

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Audit Program for Payroll

Perform substantive tests of payroll

Substantive Tests Audit Objectives

Perform analytical procedures

Investigate fluctuations in payroll

Obtain a summary of amounts of officers’ compensation and trace to authorization.

Existence/occurrence

Completeness

Valuation

Test compensation from profit-sharing or bonus plans.

Test commission earnings

Test pension obligations

Valuation

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Audit Procedures Completed Near the End of Field Work

Search for unrecorded liabilities Review the minutes of meetings Perform final analytical procedures Perform procedures to identify loss

contingencies Perform the review for subsequent events Obtain the representation letter

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Loss Contingencies

Def.: A possible loss stemming from past events that will be resolved as to existence and amount by some future event.

Loss contingencies should be reflected in the financial statement amounts when:

» It is probable that a loss had been sustained before the balance sheet date

» The amount of the loss can be reasonably estimated

Loss contingencies should be disclosed in the notes to the financial statements when it is at least reasonably possible that a loss has been sustained

Loss contingencies need not be disclosed when the possibility of loss is remote

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Loss Contingencies

Types of loss contingencies» Litigation» Income tax disputes» Guarantees of indebtedness» Accounts receivable sold or assigned with recourse» Environmental issues» Commitments» General risk contingencies

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Loss Contingencies

Procedures for loss contingencies» Review minutes of BOD meetings.» Send letter of inquiry to client’s attorneys.» Send confirmation letters to financial institutions requesting

information on contingent liabilities.» Review correspondence with financial institutions for

evidence of guarantees of indebtedness, or sales or assignments of accounts receivable.

» Review reports and correspondence with regulatory agencies to identify potential fines or assessments.

» Obtain a representation letter from management indicating that all liabilities known to officers are recorded or disclosed.

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Subsequent Events

Covers period between balance sheet date to date of auditor’s report (last day of fieldwork).

Type I subsequent event» Involves conditions that existed on or before

balance sheet date– Must adjust financial statement amounts to reflect event

Type II subsequent event» Involves conditions coming into existence after the

balance sheet date.– Must disclose in footnotes if omission would cause

financial statements to be misleading.

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Subsequent Events

Examples of Type I subsequent events» Large receivable at balance sheet date

proves to be uncollectible due to subsequent bankruptcy of debtor.

» Customer check included in ending cash subsequently proves to be uncollectible.

» Settlement of pending litigation.

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Subsequent Events

» Business combination– Pro forma results often disclosed

» Substantial casualty losses» Significant changes in financial

position or financial structure

» Major personnel changes» Product line changes» Labor strikes

Examples of Type II subsequent events

Disclosure generally required

Disclosure generally not required

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Subsequent Events

Audit procedures relating to subsequent events» Review latest interim financial statements

and minutes of BOD meetings.» Inquiries to appropriate client officials.» Letter of inquiry to client’s attorneys.» Representation from management in

representation letter.

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Evaluating Audit Findings

Overall review of the audit» Evaluate sufficiency and competency of evidence

in the workpapers.» Evaluate total likely misstatement

– Known misstatements– Projected misstatements– Other estimated misstatements

» Review the sufficiency of disclosures– Disclosure checklists

» Client approval of adjusting entries and disclosures

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Required Communication With the Audit Committee

Significant deficiencies in internal control The auditors’ responsibilities for the audit and other

information included with the financial statements Significant audit adjustments made Proposed audit adjustments evaluated by management as

immaterial Disagreements with management or other difficulties The auditors’ viewpoint on an accounting or auditing matter

if management contacted other auditors about the matter A discussion of the quality of accounting principles and

estimates

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Post-Audit Considerations

Subsequent discovery of facts existing at the date of the audit report» Auditor must immediately investigate» If material, auditor should advise client to make

appropriate disclosures to anyone relying on the financial statements.

» If management refuses, auditor should contact BOD members, any regulatory agencies, and if practicable any persons relying on the statements.

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Post-Audit Considerations

Subsequent discovery of omitted procedures» Auditor should assess importance of omitted

procedures to audit opinion.» If opinion is impaired, the auditor should attempt to

perform the omitted procedures or appropriate alternative procedures.

» Auditor should consult legal counsel.