Auditing Operations and Completing the Audit

Auditing Operations and Completing the Audit • Wrapping Up Field Work • Evaluating Remaining Accounts in the Financial Statements

Balance Sheet Item Revenue Expenses Relationships Between Balance Sheet and Income Statement Accounts Uncollectible accounts Uncollectible notes Losses Accounts receivable Notes receivable Securities and investments Sales Interest Interest, dividends, gains, investor’s income Purchases, cost of goods sold, and payroll Inventories Property, plant and equip. Intangible assets Prepaid expenses Accrued liabilities Rent, gains Royalties Depreciation; repairs Amortization Various expenses Various expenses Interest-bearing debt Interest

Substantive TestsSelling, General & Admin Expenses • Perform Analytical Procedures • Develop an expectation of the A/C balance • Determine difference from expectation that can be accepted without investigation • Compare actual A/C balance with expectation • Investigate significant deviations from expectation

Substantive TestsSelling, General & Admin Expenses • Perform Analytical Procedures • Develop an expectation of the A/C balance • Determine difference from expectation that can be accepted without investigation • Compare actual A/C balance with expectation • Investigate significant deviations from expectation • Obtain or prepare analyses of selected A/Cs

Substantive TestsSelling, General & Admin Expenses • Perform analytical procedures • Develop an expectation of the A/C balance • Determine difference from expectation that can be accepted without investigation • Compare actual A/C balance with expectation • Investigate significant deviations from expectation • Obtain or prepare analyses of selected A/Cs • Obtain or prepare analyses of critical expenses in the income tax return

Payroll Internal Controls • Segregation of Duties • HR and Employment Data • Timekeeping & Labor Distribution • Payroll Preparation • Distribution of Pay • Application Controls • Reasonableness Checks • Employee Validity Checks • Data Accuracy Checks Such as: HR Table, Timekeeping

Substantive TestsSalaries, Wages, Compensation • Perform Analytical Procedures & Investigate Fluctuations in Various Components • Obtain Officer Compensation Data & Trace to Authorization • Test Year-end Accrued Payroll • Test/Evaluate Special Compensation: • Fair Value Accounting for Stock Options[SFAS 123(R)] • Profit Sharing & Bonus Plans • Commissions • Deferred Compensation • Pension Expense & Liabilities

Audit Procedures Completed Near the End of Field Work • Search for unrecorded liabilities • Review minutes of Bd of Dir meetings • Perform final analytical procedures • Identify loss contingencies

Loss Contingencies • Reflected in F.S. amounts when: • It is probable (> 50/50 chance) that a loss had been sustained as of B.S. dateand • Amount of loss can be reasonably estimated • Only disclosed in notes to F.S. when it is at least reasonably possible that a loss has been sustained as of B.S. date or probable but cannot be estimated. • No amount or disclosure in F.S. when the possibility of loss is remote.

Identifying Loss Contingencies • Ask Client Plus Mgmt Rep Letter • Review client correspondence with major customers & regulators for disputes and financial institutions for endorsements made • Past Experience • Subsequent Events • Board of Director Minutes • Review Lawyer Invoices (undisclosed cases) • Letter to Outside (+ internal?) Legal Counsel

Letter to Legal Counsel • Client Letter - Prepared & Sent by Auditor • Ask for: • List of all pending or recently settled litigation • For all identified litigation and those audit procedures identified: • Period in which the underlying cause for legal action occurred • Probability of an unfavorable outcome • Amount or range of potential loss

Excessive Commitments • Usually relates to acquisition of scarce raw material/goods or from monopolistic source. • Information on commitments must be disclosed in F.S. when deemed beyond current normal needs. • Client must disclose description and extent of commitments and risks involved.

Audit Procedures Completed Near the End of Field Work • Search for unrecorded liabilities • Review minutes of Bd of Dir meetings • Perform final analytical procedures • Identify loss contingencies • Review Subsequent Events (What’s happened since the B.S. date?)

Subsequent Events Type 1/Recognized: Evidence as to conditions existing at B.S. date that effect amounts, e.g., better/more data to improve accounting estimates embedded in the F.S. (so AJE needed). Primary Examples: • Large bad debt realized • Large recovery or significant recoveries where we had significant allowance for uncollectibility • Settlement of litigation or Closer Estimate

Subsequent Events Type 2/Non-Recognized: Relates to things occurring after the B.S. date, which, if not disclosed, would make the F.S. misleading to many users for projection purposes (hinder continued performance)(so only disclosure): • Significant merger/acquisition • Major facility destruction or forced closure • Major change in financial position. • Significant pension change requiring large payment

Responsibility for Subsequent Events

Identifying Subsequent Events • Review latest available financial statements and minutes of the board and selected committees. • Review lawyer’s letter & Invoices. • Ask management (including matters dealt with at meetings for which minutes are not available). • Obtain representations from management. (Note: Similar steps to ID Loss Contingencies)

Audit Procedures Completed Near the End of Field Work • Search for unrecorded liabilities • Review minutes of Bd of Dir meetings • Perform final analytical procedures • Identify loss contingencies • Review subsequent events • Obtain Client Representation Letter

Mgmt Representation Letter • Mgmt responsibility for fairness of F.S. • Mgmt’s belief that F.S. are fairly stated/GAAP • Completeness of provided records(minutes, communications with regulatory agencies, unrecorded transactions) • Known fraud • Plans impacting classification or values of assets or liabilities • Related party transactions and balances

Mgmt Rep Letter (con’t) • Loan guarantees • Significant estimates/concentrations(SOP 94-6) • Actual/Possible violations of laws or regs • Gain/Loss contingencies or unasserted claims (SFAS 5) • Satisfactory title to assets or rights limitations • Compliance with contractual agreements • Subsequent events

Audit Procedures Completed Near the End of Field Work • Search for unrecorded liabilities • Review minutes of Bd of Dir meetings • Perform final analytical procedures • Identify loss contingencies • Review subsequent events • Obtain client representation letter • Assess Cumulative Materiality of Individual Adjustments & Uncorrected Misstatements from Previous Year

Audit Procedures Completed Near the End of Field Work • Search for unrecorded liabilities • Review minutes of Bd of Dir meetings • Perform final analytical procedures • Identify loss contingencies • Review subsequent events • Obtain client representation letter • Assess cumulative materiality of Individual adjustments & Uncorrected Misstatements from Previous Year • Review Subordinate W/Ps & Conduct Concurring or 2nd Partner Review • Final Review of F.S. Disclosure Adequacy

Communicating with Those Charged with Governance Early in the Audit Obtain Information About the Entity Share Overall Planned Audit Scope & Timing of the Audit and Auditor Responsibilities Representations to be Asked of Management Factors, if any, Potentially Having a Bearing on Auditor Independence.

Communicating with Those Charged with Governance(con’t) During or at End of Audit Significant Accounting Policies, Accounting Estimates, F.S. Disclosures, Uncertainties, Unusual/Non-Recurring Transactions Significant Difficulties Encountered Mgmt’s Consultation with Other Auditor Significant Uncorrected Misstatements or Other Disagreements with Mgmt Significant Findings, Misstatements & Issues

Communicating with Those Charged with Governance(con’t) During or at End of Audit Significant Internal Control Deficiencies & Material Weaknesses. Detected Fraud & Illegal Acts Substantial Doubt – Going Concern Format Oral or in Writing (Usually Based on Significance) But All Must be Documented

Key Additions for Public Companies Engagement letter. Overall audit strategy, timing & significant risks (early). Audit Committee must approve all services. Use by auditor of specialized skills, internal auditors or non-employees or CPA firms (early). Details of client critical accounting policies, practices and accounting estimates AND auditor’s assessment.

Key Additions for Public Companies (con’t) Assessment of quality of financial reporting. Difficult or contentious issues requiring consultation beyond audit team. Auditor’s evaluation of going concern. Any deviations from a standard audit report. All communications MUST be prior to report issuance.

Auditor Responsibility for Other Information Included with the F.S. Other Non-GAAP-Required Information • READ to identify inconsistencies with the audited F.S. • If none found, no further effort or reporting. • If found, ask client to revise. • If client refuses, add explanatory paragraph to audit report (no change to opinion on F.S.) or withhold release of audit report or withdraw from engagement . (Note: If F.S. is incorrect & material, propose adjustment or modify opinion. )

Auditor Responsibility for Other Information Included with the F.S. GAAP-Required Supplementary Information • Inquire of management about methods of preparing information, following prescribed guidelines, whether changed from the prior period, and any significant assumptions or interpretations. • Compare information for consistency with (1) management’s responses to the inquiries, (2) basic F.S. and (3) auditor’s knowledge obtained during the F.S. audit. • Obtain written representationsfrom management acknowledging (1) its responsibility that the information, (2) is measured & presented per prescribed guidelines, (3) whether methods have changed & (4) significant assumptions or interpretations. • Discussed in the F.S. audit report in an emphasis of a matter paragraph after the opinion paragraph – no impact on F.S. opinion, even if found to be incorrect or omitted. (No mention in report under PCAOB standards)

Auditor Responsibility for Other Information Included with the F.S. Offering Assurance for Supplementary Information AICPA Standards: • Auditor could be asked to provide assurance with separate opinion. Auditors perform procedures to provide assurance on whether supplemental information is fairly stated, in all material respects, in relation to the F.S. as a whole. Supplementary must be derived from, & relate directly to, underlying accounting & other records. • Emphasis of a Matter paragraph would include opinion that would not alter F.S. audit opinion. PCAOB Standards (AS 17): • Also optional, very similar procedures as AICPA, but requires testing info accuracy, unlike AICPA, must be done in conjunction with the F.S. audit and can be a separate report.

Responsibilities After Report Date • Should we have any? Of Course; Why Not? • Discovery of Unknown Information, Which Was Available, at Audit Report Date • Learning of Omitted, but Necessary, Audit Procedures

Subsequent Discovery of Facts Existing at Audit Report Date Auditor Action is Required Unless he/she Can Conclude (Document) that Information: • Is Unreliableor • Did NOT Exist at the Audit Report Date or • Would NOT Have Effected Audit Report or • No Persons who would attach importance to the information are Currently, or Likely to be, Relying on the Previously Audited F.S.

Subsequent Discovery of Facts Existing at Audit Report Date Auditor actions to prevent further reliance on the previous auditor’s report: • Advise client to disclose the information and/or restate the F.S. or include in about to be released subsequent period F.S. & tell SEC. • If client refuses, Auditor should: • Notify each Bd of Dir member of refusal and planned auditor actions • Notify Client That Auditor’s Report Should No Longer Be Associated With the F.S. • Notify SEC & Each Party Known to be Relying on the F.S. that the Audit Report Should No Longer be Relied Upon.

Discovery of Omitted Audit Procedures After Report Date If the Omitted Procedures were important to expressing the opinion, and are still important in supporting the previously reported opinion, AND parties are currently, or likely to be, relying on the audit report: • Attempt to perform the procedures or alternate ones. • If results alter original conclusions, treat as discovery of new facts and take similar notification action to that on previous slide. • If unable to perform, consult attorney as to actions to satisfy responsibilities to client, SEC and persons relying on the auditor’s report.

Auditing Operations and Completing the Audit