Completing the Audit

Completing the Audit Chapter 23

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

Summary of theAudit Process Phase I Plan and design an audit approach. 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.

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

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

Likelihood of Occurrence and Financial Statement Treatment Likelihood of Financial Statement Occurrence of Event Treatment Remote (slight chance) No disclosure necessary Reasonably possible Footnote disclosure Probable Adjust financial statements OR footnote disclosure

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

Audit Procedures forFinding 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.

Audit Procedures forFinding 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.

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

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.

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.

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

Period Covered bySubsequent Events Review Client’s ending balance sheet date Audit report date Date client issues financial statements 12-31-02 3-11-03 3-26-03 Period to which review for subsequent events applies Period for processing the financial statements

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

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

Requiring Adjustment • 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

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 • consequence of government action barring • further sale of a product • Uninsured loss of inventories as a result of fire • A merger or an acquisition

Audit Tests • Inquiry 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

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.

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

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

Information Accompanying Basic Financial Statements Balance sheet Basic financial statements Income statement Statement of cash flows Footnotes Standard auditor’s report

Information Accompanying Basic Financial Statements Detailed comparative statements Information accompanying basic financial statements Statistical data Schedule of insurance coverage Separate paragraph – unqualified, qualified, or disclaimer

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

Evaluate Results Sufficiency of evidence Evidence supports auditor’s opinion Financial statement disclosures Audit documentation review Independent review Summary of evidence evaluation

Completing theEngagement Checklist 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 theEngagement Checklist 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 theEngagement Checklist YES NO 3. General documents a. Where 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? ___ ___

Evaluating Results andReaching Conclusions 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 andReaching Conclusions Evaluate overall financial statements Estimated misstatement (overall statements) Achieved audit risk (overall statements) Issue audit report

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.

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

Communicate with the Audit Committee and Management Communicate fraud and illegal acts Communicate reportable conditions Other communication with audit committee Management letters

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

Period Covered bySubsequent Events Review Client’s ending balance sheet date Audit report date Date client issues financial statements 12-31-02 3-11-03 3-26-03 Period to which review for subsequent events applies Period for processing the financial statements Period in which subsequent discovery of facts is made

End of Chapter 23

Completing the Audit