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Learn how to design and perform audit tests related to presentation and disclosure audit objectives, review contingent liabilities, and evaluate subsequent events for financial statement accuracy.
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Learning Objective 1 Design and perform audit tests related to presentation and disclosure audit objectives.
Presentation and Disclosure Audit Objectives (page 779) Occurrence and rights and obligations: Disclosed events and transactions have occurred and pertain to the entity. Completeness: All disclosures that should have been included in the financial statements have been included.
Presentation and Disclosure Audit Objectives (page 779) Classification and understandability: Financial information is appropriately presented and described and disclosures are clearly expressed. Accuracy and valuation: Financial and other information are disclosed fairly and at appropriate amounts.
Learning Objective 2 Conduct a review for contingent liabilities and commitments.
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.
Likelihood of Occurrence and Financial Statement Treatment Likelihood of Occurrence of Event Financial Statement Treatment Remote (slight chance) No disclosure is necessary Reasonably possible Footnote disclosure is necessary Probable (likely to occur) Adjust financial statements or note 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 for Finding Contingencies Inquire of management 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.
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.
Learning Objective 3 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 of the law firm to identify any unlisted pending or threatened legal actions 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.
Sarbanes-Oxley Act 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.
Learning Objective 4 Conduct a post-balance-sheet review for subsequent events.
Period Covered by Subsequent Events Review Client’s ending balance sheet date Audit report date Date client issues financial statements 12-31-07 3-11-08 3-26-08 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 do not have a direct • effect on the financial statements • but for which disclosure is required
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
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
Audit Tests Two categories of audit procedures for the subsequent events review: 1. Procedures normally integrated as a part of the verification of year-end account balances. 2. Procedures performed specifically for the purpose of discovering events or transactions that must be recognized as subsequent events.
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
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 5 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.
Management Representation Letter Purposes of the letter: 1. To impress upon management its responsibility for the assertions in the financial statements. 2. To remind management of potential misstatements or omissions in the financial statements. 3. To document the responses from management to inquiries about various aspects of the audit.
SAS 85 Four Categoriesof Specific Matters 1. Financial statements 2. Completeness of information 3. Recognition, measurement, and disclosure 4. Subsequent events
Information Accompanying Basic Financial Statements Balance sheet Basic financial statements Standard auditor’s report Income statement Statement of cash flows Footnotes Detailed comparative statements Information accompanying basic financial statements Statistical data Schedule of insurance coverage Separate paragraph – unqualified, qualified, or disclaimer
Learning Objective 6 Integrate the audit evidence gathered and evaluate the overall audit results.
Evaluate Results • Sufficient appropriate evidence • Evidence supports auditor’s opinion • Financial statement disclosures • Audit documentation review • Independent review • Summary of evidence evaluation
Evaluating Results and Reaching 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 and Reaching 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 7 Communicate effectively with the audit committee and management.
Communicate with the Audit Committee and Management • Communicate fraud and illegal acts • Communicate internal control deficiencies • Other communication with audit committee • Management letters
Learning Objective 8 Identify the auditor’s responsibilities when facts affecting the audit report are discovered after its issuance.
Review for Subsequent Events and Discovery of Facts Client’s ending balance sheet date Audit report date Date client issues financial statements 12-31-07 3-11-08 3-26-08 Period to which review for subsequent events applies Period for processing the financial statements Period in which subsequent discovery of facts is made
