Completing the Audit

1. Completing the Audit CPA Alfred Lagat

2. Learning Objective 1 Conduct a review for contingent liabilities and commitments.

3. An internal auditor for a manufacturing company was concerned about the anomalies in stock levels. He thought someone might be pinching stock but he couldn’t prove it. He had his eye on one shifty looking individual who everyday drove his old truck out of the factory with the load covered by tarpaulin. Time after time the auditor stopped the bloke, made him remove the tarpaulin and then inspected the load. On every occasion there was only scrap metal on the truck which the driver said he was taking to the tip. On 3 occasions the auditor made the driver offload the scrap metal in suspicion that something was hidden beneath but there was nothing. The auditor later got a better offer and resigned. A few weeks later, he was drinking in a pub when the shifty looking character walked in. On an impulse the auditor walked up to him and asked, “Look, I've left the company, I'm not interested in taking up the matter, but I just have to know. What were you taking?” and the bloke said “Tarpaulins.”

4. Phase III Perform analytical procedures and tests of details of balances. Phase II Perform tests of controls and substantive tests of transactions. Phase IV Complete the audit and issue an audit report. Summary of the Audit Process Phase I Plan and design an audit approach.

5. Evaluate results. Review for subsequent events. Issue audit report. Accumulate final evidence. Communicate with audit committee and management. Phase IV – Completing the Audit Review for contingent liabilities.

6. Contingent Liabilities A contingent liability is a potential future obligation to an outside party for an unknown amount resulting from activities that have already taken place.

7. Likelihood of occurrence of event Financial statement treatment Remote (slight chance) No disclosure necessary Reasonably possible Footnote disclosure is necessary Probable (likely to occur) Adjust financial statements or note disclosure Likelihood of Occurrence and Financial Statement Treatment

8. Auditor’s Concerns • Pending litigation for patent infringement, product liability, or other actions • Income tax disputes • Product warranties • Notes receivable discounted • Guarantees of obligations of others • Unused balances of outstanding letters of credit

9. Audit Procedures for Finding Contingencies Inquire of management (orally and in writing) about the possibility of unrecorded contingencies. Review current and previous years’ internal revenue reports for income tax settlements. Review the minutes of directors’ and stockholders’ meetings for indications of lawsuits or other contingencies.

10. Audit Procedures for Finding Contingencies Analyze legal expenses and review invoices and statements from legal counsel. Obtain a letter from each major attorney of the client as to the status of pending litigation. Review audit documentation for any information that may indicate a potential contingency. Examine letters of credit in force.

11. Learning Objective 2 Obtain and evaluate letters from the client’s attorneys.

12. Inquiry of Client’s Attorneys A list including (1) pending threatened litigation and (2) asserted or unasserted claims or assessments with which the attorney has had involvement. A request that the attorney furnish information or comment about the progress of each item listed.

13. Inquiry of Client’s Attorneys A request for the identification of any unlisted pending or threatened legal action or a statement that the client’s list is complete. A statement informing the attorney of the attorney’s responsibility to inform management of legal matters requiring disclosure in the financial statements and to respond directly to the auditor.

14. Sarbanes-Oxley Act In the USA, Congress included provisions in this act directing the SEC to issue rules requiring attorneys serving public companies to report material violations by the company of federal securities laws. The American Bar Association amended its attorney-client confidentiality rules to permit attorneys to breach confidentiality if a client is committing a crime or fraud.

15. Learning Objective 3 Conduct a post-balance-sheet review for subsequent events.

16. Client’s ending balance sheet date Audit report date Date client issues financial statements 12-31-05 3-11-06 3-26-06 Period to which review for subsequent events applies Period for processing the financial statements Period Covered by Subsequent Events Review

17. Those that have a direct effect on the financial statements and require adjustment 1 Those that have no direct effect on the financial statements but for which disclosure is advisable 2 Types of Subsequent Events

18. Requiring Adjustment • Declaration of bankruptcy by a customer with an accounts receivable balance • Settlement of a litigation at an amount different from the amount recorded on the books • Disposal of equipment not being used in operations at a price below the current book value • Sale of investments at a price below recorded cost

19. Advisability of Disclosure • Decline in the market value of securities held for temporary investment or resale • Issuance of bonds or equity securities • Decline in the market value of inventory as a consequence of government action barring further sale of a product • Uninsured loss of inventories as a result of fire • A merger or an acquisition

20. Procedures normally integrated as a part of the verification of year-end account balances 1 Procedures performed specifically for the purpose of discovering events or transactions that must be recognized as subsequent events 2 Audit Tests Two categories:

21. Audit Tests • Inquire of management. • Correspond with attorneys. • Review internal statements prepared subsequent to the balance sheet date. • Review records prepared subsequent to the balance sheet date. • Examine minutes issued subsequent to the balance sheet date. • Obtain a letter of representation,

22. Dual Dating The first date is the date for the completion of field work except for a specific exception. The second date, which is always later, deals with the exception.

23. Learning Objective 4 Design and perform the final steps in the evidence-accumulation segment of the audit.

24. Final Evidence Accumulation 1. Perform final analytical procedures. 2. Evaluate the going-concern assumption. 3. Obtain a management representation letter. 4. Consider information accompanying the basic financial statements. 5. Read other information in the annual report.

25. To impress upon management its responsibility for the assertions in the financial statements 1 To document the responses from management to inquiries about various aspects of the audit 2 Management Representation Letter Purposes:

26. Management Representation Letter 1. Financial statements 2. Completeness of information 3. Recognition, measurement, and disclosure 4. Subsequent events 5. Internal control

27. Management Representation Letter: Internal Control 1. Management’s acknowledgment of its responsibility for establishing and maintaining effective internal control over financial reporting 2. Management’s conclusion about the effectiveness of internal control over financial reporting as of the end of the fiscal period 3. Disclosure of all deficiencies 4. Management’s knowledge of any fraud

28. Basic financial statements Standard auditor’s report Information accompanying basic financial statements Separate paragraph – unqualified, qualified, or disclaimer Information Accompanying Basic Financial Statements Balance sheet Income statement Statement of cash flows Footnotes Detailed comparative statements Statistical data Schedule of insurance coverage

29. Learning Objective 5 Integrate the audit evidence gathered, and evaluate the overall audit results.

30. Evaluate Results Sufficiency of evidence Evidence supports auditor’s opinion Financial statement disclosures

31. Evaluate Results Audit documentation review Independent review Summary of evidence evaluation

32. YES NO 1. Examination of prior year’s audit documentation a. Were last year’s audit files examined for areas of emphasis in the current-year audit? b. Was the permanent file reviewed for items that affect the current year? Completing the Engagement Checklist

33. YES NO 2. Internal control a. Has internal control been adequately understood? b. Is the scope of the audit adequate in light of the assessed control risk? c. Have all major weaknesses been included as reportable conditions in a letter to the audit committee or to senior management? Completing the Engagement Checklist

34. YES NO 3. General documents a. Were all current-year minutes and resolutions reviewed, abstracted, and followed up? b. Has the permanent file been updated? c. Have all major contracts and agreements been reviewed and abstracted and copied with all existing legal requirements? Completing the Engagement Checklist

35. Actual audit evidence (by cycle, account, and objective) Audit procedures Sample size Items to select Timing Evaluate results (by account and cycle) Estimated misstatement (by account) Achieved audit risk (by account and cycle) Evaluating Results and Reaching Conclusions

36. Evaluate overall financial statements Estimated misstatement (overall statements) Achieved audit risk (overall statements) Issue audit report Evaluating Results and Reaching Conclusions

37. Issue the Audit Report The audit report is the only thing that most users see in the audit process, and the consequences of issuing an inappropriate report can be severe.

38. Learning Objective 6 Communicate effectively with the audit committee and management.

39. Communicate with the Audit Committee and Management • Communicate fraud and illegal acts • Communicate internal control deficiencies • Other communication with audit committee • Management letters

40. Learning Objective 7 Identify the auditor’s responsibilities when facts affecting the audit report are discovered after its issuance.

41. Client’s ending balance sheet date Audit report date Date client issues financial statements 12-31-05 3-11-06 3-26-06 Period to which review for subsequent events applies Period for processing the financial statements Period in which subsequent discovery of facts is made Period Covered by Subsequent Events Review

42. End Thank You Q & A