Chapter 17
Completing the Audit
Engagement
McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
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 probable.
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 probable.
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 to others
• Agreements to repurchase receivables that have been sold
Examples
• Pending or threatened litigation
• Actual or possible claims and assessments
• Income tax disputes
• Product warranties or defects
• Guarantees of obligations to others
• Agreements to repurchase receivables that have been sold
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 of Subsequent Events for Audit of Financial Statements Figure 17-1
LO# 5
17-8
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
17-9
Dual DatingWhen 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)
(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 ReportingAuditors of public companies are responsible to
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
Subsequent Discovery of Facts Existing at the Date of the Auditor’s Report
Notify the client that the auditor’s report must no
longer be associated with the financial statements.
Notify the client that the auditor’s report must no
longer be associated with the financial statements.
Notify any regulatory agency having jurisdiction
over the client that the auditor’s report can no longer be relied upon.
Notify any regulatory agency having jurisdiction
over the client that the auditor’s report can no longer be relied upon.
Notify each person known to the auditor to be relying
on the financial statements.
Notify each person known to the auditor to be relying
on the financial statements.
LO# 11
17-13
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
17-14
PERFORM FINAL ANALYTICAL PROCEDURES
• Required by auditing standards• Identify unusual fluctuations• If you cannot explain unusual
fluctuations you are not done your audit.
OBTAIN A MANAGEMENT REPRESENTATION LETTER
• Letter written by auditor, but worded as if written by management, that lists all important information management told auditor during the audit
• Management signs letter• E.g. pp. 430-431
REVIEW WORKING PAPERS
• Auditors that completed audit will review their working papers
• Complete?• Thorough?• Due-diligence?• Loose ends?
Assess Final Audit ResultsLO# 8
17-18
EVALUATE FINANCIAL STATEMENT PRESENTATION
AND DISCLOSURE
• Are all necessary footnote disclosures present?
• F/S disclosure check list
OBTAIN AN INDEPENDENT REVIEW OF THE ENGAGEMENT
• Another partner in firm not involved in audit
• Working papers should tell the story of the audit
• Complete? Thorough? Due-Diligence? Loose ends?
GOING CONCERN JUDGMENT
• Will the client continue on as a going concern into the foreseeable future?
• Will the client survive for one more year?• Steps in a going concern judgment:
1. Gather evidence 2. If a potential going concern problem, talk
with management about their plans3. Make final going concern judgment
- If you do not think they will survive, add an explanatory paragraph after the opinion paragraph explaining your concern
Going Concern ConsiderationsLO# 9
17-22
Going Concern ConsiderationsLO# 9
17-23
Archiving and RetentionSarbanes-Oxley Act and PCAOB’s Documentation Standard:
• 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 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
17-24
Communications with “Those Charged with Governance”
LO# 10
17-25