Chapter 24 – Completing the Audit

Completing the Audit

Chapter 24

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder

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Learning Objective 1

Conduct a review for contingent liabilities and commitments.


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Summary of the Audit 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.


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Phase IV – Completing the Audit

Review for contingent liabilities.

Review for subsequent events.

Evaluate results.

Issue audit report.

Accumulate final evidence.


Communicate with audit committee and management.

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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.


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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 is necessary

Probable

(likely to occur)

Adjust financial statements or note disclosure

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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


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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.


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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.


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Obtain and evaluate letters from the client’s attorneys.


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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.


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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.


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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.


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Conduct a post-balance-sheet review for subsequent events.


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Period Covered by Subsequent

Events Review

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


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Types of Subsequent Events

1

Those that have a direct effect on the financial statements and require adjustment

2

Those that have no direct effect on the financial statements but for which disclosure is advisable


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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


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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


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Audit Tests

Procedures normally integrated as a part of the verification of year-end account balances

Procedures performed specifically for the purpose of discovering events or transactions that must be recognized as subsequent events


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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,


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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.


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

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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.


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Management Representation

Letter

To impress upon management its responsibility for the assertions in the financial statements

To document the responses from management to inquiries about various aspects of the audit

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Letter

1. Financial statements

2. Completeness of information

3. Recognition, measurement, and disclosure

4. Subsequent events

5. Internal control


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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


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Information Accompanying Basic

Financial Statements

Balance sheet

Income statement

Statement of cash flows

Footnotes

Detailed comparative statements

Statistical data

Schedule of insurance coverage

Basic financial statements

Standard auditor’s report

Information accompanying basic financial statements

Separate paragraph – unqualified, qualified, or disclaimer

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Integrate the audit evidence gathered, and evaluate the overall audit results.


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Evaluate Results

Sufficiency of evidence

Evidence supports auditor’s opinion

Financial statement disclosures


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Evaluate Results

Audit documentation review

Independent review

Summary of evidence evaluation


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Completing the Engagement

Checklist

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?

YES NO

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Checklist

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?

YES NO

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Checklist

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?

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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)

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Evaluating Results and Reaching

Conclusions

Evaluate overall financial statements

Estimated misstatement

(overall statements)

Achieved audit risk

(overall statements)


Issue audit report

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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.


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Communicate effectively with the audit committee and management.

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Communicate with the Audit

Committee and Management

 Communicate fraud and illegal acts

 Communicate internal control deficiencies

 Other communication with audit committee

 Management letters


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


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Period Covered by Subsequent

Events Review

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


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End of Chapter 24


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Chapter 24 – Completing the Audit

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