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AUDITING CHAPTER 17

AUDITING CHAPTER 17. Completing the Audit By David N. Ricchiute. TOPICS. Testing revenue, expenses Estimates, losses, contingencies Related party transactions Legal matters Management representation letter, opinion, & other communications Subsequent discoveries & omitted procedures.

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AUDITING CHAPTER 17

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  1. AUDITINGCHAPTER 17 Completing the Audit By David N. Ricchiute

  2. TOPICS • Testing revenue, expenses • Estimates, losses, contingencies • Related party transactions • Legal matters • Management representation letter, opinion, & other communications • Subsequent discoveries & omitted procedures GBW 8th ed., Ch. 17

  3. SUBSTANTIVE TESTS FOR REVENUE & EXPENSES • Analytical tests for reasonableness • Tests details if • Control risk maximum • Transaction volume low; account needs special attention • Analytical procedures reveal unusual, unexpected results GBW 8th ed., Ch. 17

  4. ACCOUNTING ESTIMATES • Examples • Warranty claims • Uncollectible accounts • Depreciation, amortization • Airline passenger revenue; subscription income • Percentage of completion income • Loss contingencies GBW 8th ed., Ch. 17

  5. AUDITING ACCOUNTING ESTIMATES • Objectives • Management developed all material estimates • Estimates reasonable & in accord with GAAP • Procedures • Review test process for developing ratios • Develop independent estimate to compare • Review subsequent events GBW 8th ed., Ch. 17

  6. CONSIDERATION OF LOSS CONTINGENCIES • Examples • Pending, threatened litigation • Guaranties of 3rd party obligations • Discounted, factored A/R • Disputed income tax deductions GBW 8th ed., Ch. 17

  7. ACCOUNTING TREATEMENT: Loss Contingencies SFAS No. 5, “Accounting for Contingencies” • Recognize (record) if • Liability probably incurred AND • Loss estimable • Report (footnote disclosure) if • Liability probably incurred OR loss estimable OR • If reasonable possibility liability incurred GBW 8th ed., Ch. 17

  8. FINDING LOSS CONTINGENCIES • Inquire of management • Read minutes of board, shareholders’ meetings • Read contracts, loan, lease agreements, etc. • Review IRS reports • Analyze legal expenses, documentation • Review work papers for possible contingencies GBW 8th ed., Ch. 17

  9. PROCEDURES TO COMPLETE AUDIT • Review for related party transactions • Review for subsequent events • Inquire of client’s legal counsel • Obtain management representation letter • Form opinion GBW 8th ed., Ch. 17

  10. RELATED PARTY TRANSACTIONS • Legal form may not reflect economic substance • Transaction not recorded at “arms length” • Increases with incentives to manipulate earnings • Maintain favorable earnings trend • Overly optimistic earnings forecast • Dependency on single/few products • Declining industry; many business failures • Pending litigation GBW 8th ed., Ch. 17

  11. PROCEDURES: RELATED PARTY TRANSACTIONS Review • Minutes for authorized transactions • Proxy material for related parties • Management’s conflict-of-interest statements • Extent, nature business with major customers, suppliers, borrowers, lenders • Invoices from law firms • Loan confirmations for guarantees GBW 8th ed., Ch. 17

  12. AUDITOR’S EVALUATION: Related Party Transactions • Objectives • Assess purpose, nature, extent of transactions • Effects of transactions on financial statements • Additional procedures • Inquire of management • Examination documentation • Ensure authorization GBW 8th ed., Ch. 17

  13. SUBSEQUENT EVENTS • Type 1: Adjust accounts for events that • Confirm or reveal conditions existing on/before balance sheet date • Collectibility receivables, loss realizations • Type 2: Disclose information (notes) for events that • Reveal conditions arising after balance sheet date • Business combinations, new indebtedness, changes in capital structure GBW 8th ed., Ch. 17

  14. PROCEDURES FOR SUBSEQUENT EVENTS • Read interim statements, board, shareholders’ minutes • Inquire • Contingent liabilities, commitments • Changes in capital structure, indebtedness, working capital • Changes in estimates; unusual adjustments • Obtain lawyers’ letters, management representation letter GBW 8th ed., Ch. 17

  15. DISCLOSURE: Subsequent Events • Type 1 • Adjust financial statements • Type 2 • Explanatory note • Parenthetical explanation • Reference • Do not issue unqualified opinion GBW 8th ed., Ch. 17

  16. INQUIRIES OF CLIENT’S LEGAL COUNSEL Inquiry of Client’s Lawyer, SAS 12 (required) • Management prepares list of legal issues • Information requested • Description, evaluation of outcome, completeness of list for • Pending, threatened litigation • Unasserted claims, assessments GBW 8th ed., Ch. 17

  17. MANAGEMENT REPRESENTATION LETTER Management’s representations, SAS 85 (required) • Financial statement responsibility, conformity with GAAP • Complete information available to auditor • Recognitions, measurement, disclosure • Subsequent events GBW 8th ed., Ch. 17

  18. FORMING AN OPINION • Procedures • Overall review through analytical procedures (SAS 56) • Relationships, account balances reasonable • Workpaper review • Considers documented fair presentation all accounts • Technical review by another (concurring) partner GBW 8th ed., Ch. 17

  19. COMMUNICATIONS WITH AUDIT COMMITTEES (SAS 61) • Responsibilities under GAAS • Significant accounting policies, judgments, estimates • Significant audit adjustments • Disagreements with management • Difficulties GBW 8th ed., Ch. 17

  20. COMMON QUESTIONS BY AUDIT COMMITTEE • Revenue recognition • Asset valuation • Contingencies • Reserves GBW 8th ed., Ch. 17

  21. COMMON QUESTIONS: Problematic Accounting Policies • No authoritative GAAP • Alternative methods • Controversial, uncommon transactions GBW 8th ed., Ch. 17

  22. COMMON QUESTIONS: New Areas, Events • Reserves • Changes in principle • Estimate • Deferrals, accruals • Prior-period adjustments GBW 8th ed., Ch. 17

  23. COMMON QUESTIONS: Management Imposed Problems • Uncorrected weaknesses in internal control • Unavailable, uncooperative personnel • Inadequate schedules from client • Unavailable evidence GBW 8th ed., Ch. 17

  24. SUBSEQUENT DISCOVERY OF FACTS • For facts existing at report date, consider whether • Information reliable • Facts did exist • Audit report would have been affected if known • Important to those relying on report GBW 8th ed., Ch. 17

  25. AUDITOR RESPONSE TO CLIENT DISCLOSURE • Client makes disclosure • If facts can be determined in reasonable period • Issue revised statements and opinion if necessary • If facts can not be determined in reasonable period • Notify all persons known to be relying on financial statements GBW 8th ed., Ch. 17

  26. AUDITOR RESPONSE IF DISCLOSURE REFUSED • If client refuses to make disclosure of subsequent facts auditor will • Notify board • Notify regulatory agencies GBW 8th ed., Ch. 17

  27. OMITTED PROCEDURES • Discovered after report date (SAS 46) • Objective • Determine if report still supported • Consider persons relying on report GBW 8th ed., Ch. 17

  28. PROCEDURES AFTER REPORT DATE • Assess importance of omitted procedures to financial statements taken as a whole • Review workpapers • Discuss circumstances with staff • Re-evaluate audit scope GBW 8th ed., Ch. 17

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