ACTIVITIES REQUIRED IN COMPLETING A QUALITY AUDIT

1. AuditingA Risk-Based Approach To Conducting A Quality Audit 10th edition Karla M. Johnstone | Audrey A. Gramling | Larry E. Rittenberg Chapter 14 ACTIVITIES REQUIRED IN COMPLETING A QUALITY AUDIT

2. Learning Objectives • Review, summarize, and resolve detected misstatements and identified control deficiencies • Review and assess the appropriateness of the client’s accounting for and disclosure of loss contingencies • Review and assess the appropriateness of the client’s significant accounting estimates • Review the adequacy of disclosures • Review and assess the implications of noncompliance with laws and regulations

3. Learning Objectives • Review the appropriateness of the going-concern assumption using relevant professional guidance • Perform review analytical procedures • Review management representations in certifications required under the Sarbanes-Oxley Act (for public clients) and describe the contents of a management representation letter • Review subsequent events and subsequently discovered facts and assess proper treatment

4. Learning Objectives • Identify the procedures and documentation required to perform an engagement quality review • Determine how to address situations in which omitted audit procedures come to the auditor’s attention after the audit report has been issued • Identify issues to communicate to the audit committee • Identify issues to communicate to management via a management letter

5. THE AUDIT OPINION FORMULATION PROCESS

6. Learning objective 1 Review, summarize, and resolve detected misstatements and identified control deficiencies

7. Reviewing, Summarizing, and Resolving Detected Misstatements • Misstatement may be: • Difference between the amount reported in the financial statements and what should be reported under Generally Accepted Accounting Principles (GAAP) • Omission of an amount that should be disclosed in accordance with GAAP

8. Categories of misstatements

9. Resolving Detected Misstatements • Audit firms use a schedule to: • Accumulate known and projected misstatements • Carryover effects of prior-year uncorrected misstatements • Immaterial misstatements are waived (left uncorrected) • Materiality of a misstatement is based on: • Quantitative amount of the misstatement • Nature of misstatement to determine the qualitative features that would make it material

10. Learning objective 2 REVIEW AND ASSESS THE APPROPRIATENESS OF THE CLIENT‘S ACCOUNTING FOR AND DISCLOSURE OF LOSS CONTINGENCIES

11. Reviewing Contingencies • Categories of potential losses • Probable • Reasonably possible • Remote • Management is responsible for designing and maintaining policies and procedures to identify, evaluate, and account for contingencies • Auditor is responsible for determining that client has identified, accounted for, and disclosed contingencies • Will obtain a Letter of Audit Inquiry

12. Learning objective 3 REVIEW AND ASSESS THE APPROPRIATENESS OF THE CLIENT‘S SIGNIFICANT ACCOUNTING ESTIMATES

13. judgmental estimates included in Financial statement balances • Fair value of many assets • Net realizable values of inventory and receivables • Property and casualty insurance loss reserves • Revenues from contracts accounted for by percentage-of-completion method • Warranty expenses and associated liabilities • Depreciation and amortization methods • Impairment of depreciable assets and goodwill • Useful lives and residual values of productive facilities, natural resources, and intangibles • Valuation and classification of financial instruments, pensions, other postretirement benefits • Compensation in stock option plans

14. Reviewing Significant Estimates • Auditor should focus on factors and assumptions that are: • Significant to accounting estimate • Sensitive to variations • Deviations from historical patterns • Subjective and susceptible to misstatement and bias • Inconsistent with current economic trends

15. Learning objective 4 Review the adequacy of disclosures

16. Reviewing the Adequacy of Disclosures • Auditor’s report must indicate if disclosures are not reasonably adequate • Disclosures can be made: • On face of financial statements • In form of classifications or parenthetical notations • In notes to statements

17. Reasonable assurance that auditors should have When assessing adequacy of disclosures • Disclosed events and transactions have occurred and pertain to the entity • All disclosures that should have been included are included • Disclosures are understandable to users • Information is disclosed accurately and at appropriate amounts

18. Learning objective 5 Review and assess the implications of noncompliance with laws and regulations

19. AUDITORS’ RESPONSIBILITIES REGARDING CLIENTS’ NONCOMPLIANCE WITH LAWS AND REGULATIONS • Noncompliance: Acts of omission or commission, either intentional or unintentional, contrary to prevailing laws or regulations • Limitations in an auditor’s ability to detect material misstatements • Information systems relating to financial reporting may not capture noncompliance

20. AUDITORS’ RESPONSIBILITIES REGARDING CLIENTS’ NONCOMPLIANCE WITH LAWS AND REGULATIONS • Management may: • Act to conceal noncompliance • Override controls • Intentionally misrepresent facts to the auditor • Legal implications of noncompliance are ultimately a matter for legal authorities to resolve • FCPA is an important law for companies with securities listed on the US markets • Noncompliance with FCPA can be costly for companies

21. Learning objective 6 Review the appropriateness of the going-concern assumption using relevant professional guidance

22. Evaluating the Going-Concern Assumption • Responsibility of management - Assessing company’s going concern status for a reasonable period of time • Reasonable period of time: A period of time not to exceed one year beyond the date of the financial statements being audited • Responsibility of auditor - Evaluating appropriateness of that assessment • Use of bankruptcy prediction models to analyze whether a particular client might have a going-concern problem

23. Indicators of Potential Going-Concern Problems • Negative trends • Internal and external matters • Significant changes in: • Competitive market and competitiveness of client’s products • Altman Z-scores: Series of ratios that have predictive power in indicating the likelihood of bankruptcy

24. Mitigating Factors for a going-concern problem • Identify and assess management’s plans to overcome this problem • Identify factors most likely to resolve the problem and gather independent evidence to determine success of such plans • Consider, and independently test, adequacy of support for major assumptions • Evaluate reasonableness of other assumptions made by the management

25. Mitigating Factors for a going-concern problem • Evaluating reasonableness of other assumptions made by the management • Increasing prices or market share is analyzed in relation to current industry developments • Cost savings related to a reduction in work force is recomputed and evaluated • Selling off assets is evaluated in relation to current market prices

26. Learning objective 7 Perform REVIEW analytical procedures

27. Review analytical procedures Objective: Assist the auditor in forming an overall conclusion about whether the financial statements are consistent with the auditor’s understanding of the client Precision of expectation: Less precise than substantive analytical procedures

28. Learning objective 8 Review management representations in certifications required under the Sarbanes-Oxley Act (for public clients) and describe the contents of a management representation letter

29. Certifications Required under Sarbanes-Oxley Act of 2002 (SOX) for Public Companies • Signing officers of publicly traded companies required to certify that financial statements are fairly presented in accordance with GAAP • Management representation letter: Letter to the auditors that the client’s chief executive and chief financial officers are required to sign • Specifies management’s responsibility for the financial statements • Confirms oral responses given to the auditor during the audit

30. management representation letter • Purpose is to help promote audit quality by: • Reminding management of its responsibility for financial statements • Confirming oral responses obtained by auditor • Reducing the possibility of misunderstanding • Management’s refusal to sign the letter: • Implies their untruthfulness in verbal representations • Considered a scope limitation (see Chapter 15)

31. Learning objective 9 Review subsequent events AND SUBSEQUENTLY DISCOVERED FACTS and assess proper treatment

32. Reviewing and assessing Subsequent Events and Subsequently Discovered Facts • Events occurring after balance sheet date that require special audit attention • Those that provide evidence of conditions that existed at the date of financial statements • Those that provide evidence of conditions that arose after the date of financial statements

33. EXHIBIT 14.8 - Subsequent Periods

34. Review of Subsequent Events (period A) • Subsequent events: Occur between the date of the financial statements and date of the auditor’s report • Subsequent events review: Review of events in the period between the balance sheet date and the audit report date to determine their effect on the financial statements • Type I subsequent events: Existed at the balance sheet date (adjustment to financial statements) • Type II subsequent events: Did not exist at balance sheet date (disclosure)

35. Audit Procedures Concerning the Review of Subsequent Events • Cutoff tests • Reviewing subsequent collections of receivables • Searching for unrecorded liabilities • Reading minutes of meetings • Reading and comparing interim financial statements to audited financial statements • Inquire of management concerning: • Significant changes noted in the interim statements

36. Audit Procedures Concerning the Review of Subsequent Events • Existence of significant contingent liabilities or commitments at balance sheet date or date of inquiry • Significant changes in working capital, long-term debt, or owners’ equity • Status of items for which tentative conclusions were drawn earlier in audit • Any unusual adjustments made to accounting records after balance sheet date

37. Dual Dating (period B) • Awareness of an event occurring after audit report date but before report release date • Report release date: Grant of permission to the entity to use the auditor’s report in connection with financial statements • Options for dating the audit report: • Using date of this event as date of audit report • Dual-date the report (less auditor responsibility)

38. Subsequently Discovered Facts That Become Known to Auditor after Report Release Date (period c) • If facts had been know at the report date, then auditor should determine: • Reliability of new information • Whether development or event had occurred by report date • Whether users are likely to still be relying on financial statements • Whether audit report would have been affected had facts been known at report date

39. Learning objective 10 Identify the procedures and documentation required to perform an engagement quality review

40. Performing an Engagement Quality Review • Engagement quality review (Concurring partner review): Review at the end of each audit conducted by an experienced auditor having appropriate competence, independence, integrity, and objectivity • To help make sure that audit and audit documentation are complete and support audit opinion

41. Performing an Engagement Quality Review • Procedures that reviewer should perform as part of the review process • Discussing with audit team significant matters related to financial statements and internal controls • Evaluating judgments about materiality and disposition of corrected and uncorrected identified misstatements • Reviewing evaluation of firm’s independence in relation to engagement

42. Performing an Engagement Quality Review • Reviewing related audit documentation to determine its sufficiency • Reading financial statements, management’s report on internal control, and auditor's report • Confirming with lead audit partner that there are no significant unresolved matters • Determining if appropriate consultations have taken place on difficult or contentious matters

43. Performing an Engagement Quality Review • Evaluating whether: • Auditor documentation supports conclusions reached by engagement team • Appropriate matters have been communicated to audit committee members, management, and other appropriate parties • Appropriate levels of supervision and reviews of individual audit tasks were completed

44. Learning objective 11 DETERMINE HOW TO ADDRESS SITUATIONS IN WHICH OMITTED AUDIT PROCEDURES COME TO THE AUDITOR‘S ATTENTION AFTER THE AUDIT REPORT HAS BEEN ISSUED

45. Consideration of Omitted Procedures Discovered after the Report Date • Omitted procedure: After the audit report has been issued, auditor may discover that an important audit procedure was not performed • If previously issued audit report cannot be supported in light of omitted procedures • Alternative procedures should be promptly performed and documented

46. Learning objective 12 Identify issues to communicate to the audit committee

47. Reasons for External Auditors to Communicate with the Audit Committee • Audit committee serves as an independent subcommittee of board of directors • Audit committee can assist auditor during a disagreement between the auditor and management • Audit committee must be assured that auditor: • Is free of any restrictions • Has not been inappropriately influenced by the management

48. typical communications between the auditor and the audit committee

49. Learning objective 13 Identify issues to communicate to management via a management letter

50. Communicating with Management via the Management Letter • Management letter: From the auditor to the client identifying any problems and suggested solutions to improve management’s efficiency or effectiveness • Used to make significant operational or control recommendations to client