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
2
GBW 8th ed., Ch. 17
SUBSTANTIVE TESTS FOR
REVENUE & EXPENSES
Analytical tests for
reasonableness
Tests details if



3
Control risk maximum
Transaction volume low; account
needs special attention
Analytical procedures reveal
unusual, unexpected results
GBW 8th ed., Ch. 17
ACCOUNTING ESTIMATES
Examples






4
Warranty claims
Uncollectible accounts
Depreciation, amortization
Airline passenger revenue; subscription
income
Percentage of completion income
Loss contingencies
GBW 8th ed., Ch. 17
AUDITING ACCOUNTING
ESTIMATES
Objectives


Management developed all material
estimates
Estimates reasonable & in accord with
GAAP
Procedures



5
Review test process for developing ratios
Develop independent estimate to compare
Review subsequent events
GBW 8th ed., Ch. 17
CONSIDERATION OF LOSS
CONTINGENCIES
Examples




6
Pending, threatened litigation
Guaranties of 3rd party obligations
Discounted, factored A/R
Disputed income tax deductions
GBW 8th ed., Ch. 17
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
7
GBW 8th ed., Ch. 17
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
8
GBW 8th ed., Ch. 17
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
9
GBW 8th ed., Ch. 17
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
10
GBW 8th ed., Ch. 17
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
11
GBW 8th ed., Ch. 17
AUDITOR’S EVALUATION:
Related Party Transactions
Objectives


Assess purpose, nature, extent of transactions
Effects of transactions on financial statements
Additional procedures



12
Inquire of management
Examination documentation
Ensure authorization
GBW 8th ed., Ch. 17
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
13
GBW 8th ed., Ch. 17
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
14
GBW 8th ed., Ch. 17
DISCLOSURE: Subsequent
Events
Type 1

Adjust financial statements
Type 2




15
Explanatory note
Parenthetical explanation
Reference
Do not issue unqualified opinion
GBW 8th ed., Ch. 17
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
16
GBW 8th ed., Ch. 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
17
GBW 8th ed., Ch. 17
FORMING AN OPINION
Procedures

Overall review through analytical
procedures (SAS 56)
 Relationships, account balances reasonable

Workpaper review
 Considers documented fair presentation all
accounts

18
Technical review by another (concurring)
partner
GBW 8th ed., Ch. 17
COMMUNICATIONS WITH
AUDIT COMMITTEES (SAS 61)
Responsibilities under GAAS
Significant accounting policies,
judgments, estimates
Significant audit adjustments
Disagreements with
management
Difficulties
19
GBW 8th ed., Ch. 17
COMMON QUESTIONS BY
AUDIT COMMITTEE
Revenue recognition
Asset valuation
Contingencies
Reserves
20
GBW 8th ed., Ch. 17
COMMON QUESTIONS:
Problematic Accounting Policies
No authoritative GAAP
Alternative methods
Controversial, uncommon
transactions
21
GBW 8th ed., Ch. 17
COMMON QUESTIONS:
New Areas, Events
Reserves
Changes in principle
Estimate
Deferrals, accruals
Prior-period adjustments
22
GBW 8th ed., Ch. 17
COMMON QUESTIONS:
Management Imposed Problems
Uncorrected weaknesses in internal
control
Unavailable, uncooperative personnel
Inadequate schedules from client
Unavailable evidence
23
GBW 8th ed., Ch. 17
SUBSEQUENT DISCOVERY OF
FACTS
For facts existing at report date,
consider whether




24
Information reliable
Facts did exist
Audit report would have been affected if
known
Important to those relying on report
GBW 8th ed., Ch. 17
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
25
GBW 8th ed., Ch. 17
AUDITOR RESPONSE IF
DISCLOSURE REFUSED
If client refuses to make disclosure of
subsequent facts auditor will


26
Notify board
Notify regulatory agencies
GBW 8th ed., Ch. 17
OMITTED PROCEDURES
Discovered after report date (SAS 46)
Objective


27
Determine if report still supported
Consider persons relying on report
GBW 8th ed., Ch. 17
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
28
GBW 8th ed., Ch. 17