Professional Documents
Culture Documents
Audit
1
Copyright © 2007 Pearson Education Canada
Chapter 21 objectives
Describe how the auditor searches for contingent
liabilities
Discuss communication with the client’s law
firms (purpose, format)
Identify procedures used to examine subsequent
events
Provide examples of work completed as part of
the final evidence gathering process
How is overall evidence evaluated?
21-2
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Contingent liabilities
Contingencies are existing conditions or
situations that will be resolved at some
future time (S 3290.02) E.g. lawsuits
The auditor needs to obtain information
about the nature of the contingent liability,
the amount involved, and then assess the
likelihood of the outcome
21-3
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Searching for contingent liabilities
21-4
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Evaluating known contingent
liabilities
Once the contingent liability has been described
and documented, then management’s disclosure
needs to be evaluated
Ref. Table 21-1: based upon the likelihood of the
event, it may not need to be disclosed, may need
to be in the footnotes, or may require an
adjustment to the financial statements
21-5
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Commitments
Commitments are certain (as opposed to
contingent liabilities, where there is
uncertainty with respect to the result)
They are usually disclosed in the notes to
the financial statements
The auditor tends to use similar procedures
to identify and document commitments as
for contingent liabilities
21-6
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Why are contingencies and
commitments important?
Represent the
encumbrance of
potentially material
amounts of future
resources
Potentially affect
future cash flows
GAAP requires
disclosure
21-7
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Practice problem 21-19 (p. 612)
Identify audit
procedures that would
have located
particular
contingencies or
commitments
Do they need to be
disclosed or adjusted?
21-8
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Confirmation from client’s law
firms
Used to evaluate two categories of
lawsuits:
– Outstanding (or asserted) claim: Client has
been notified of the suit or the suit has already
been filed
– Possible (or unasserted) claim: The client is
aware of a situation that could lead to a claim.
Standard format (Figure 21-1) is used
21-9
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Importance of analyzing legal
expense
May give indication of contingent
liabilities
Identifies law firms where confirmation
may be required
Identifies events that may need to be
confirmed with law firms
21-10
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Legal letter
Specific format must
be used
The information that
lawyers can provide is
limited due to their
requirement to hold
information as
confidential
21-11
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Practice problem 21-25 (p. 614)
Examine the
appropriateness of an
approach to sending
legal letters
What should be done
with specific replies?
21-12
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Review for subsequent events
Auditor normally examines subsequent events up
to the audit report date, which is the same as the
date of substantial completion of field work
Several specific types of evidence need to be
gathered
Two types of subsequent events: Those that
require adjustment and those that require
disclosure
21-13
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Subsequent events requiring
adjustment
Have a direct effect on the financial statements
Examples:
– the declaration of bankruptcy due to the
deteriorating financial condition of a customer
with a large outstanding accounts receivable
balance;
– the settlement of a litigation for an amount
different from the amount recorded in the
books.
21-14
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Subsequent events requiring
disclosure
Have no direct effect on the financial statements.
Examples:
– the decline in market value of securities held
for temporary investment or resale;
– the issuance of bonds or equity securities;
– the declaration of bankruptcy by a customer
(with a large outstanding accounts receivable
balance) who was inadequately insured and
lost everything due to a fire
21-15
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Subsequent events evidence
includes:
Notes based on discussions with management
Legal letter(s)
Examination of subsequent internal financial
statements or other internal documents
Review of shareholder and director minutes
Letter of representation
Cutoff testing
21-16
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Final evidence accumulation
Analytical procedures
Evaluation and conclusions regarding
going concern concept
Client representation letter
Annual reports
Management discussion and analysis
(MD&A)
21-17
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Client representation letter
From management
Document’s management’s most important
oral representations
What would these include?
21-18
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Practice problem 21-22 (p. 613)
Discuss the
advantages of a letter
of representation
Identify the
information normally
included
21-19
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Management letter
Prepared by auditor
Informs client of recommendations to
improve business processes or controls
Specific wording limits this – it is a
‘derivative report’ that is a side benefit of
the audit
21-20
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Auditor reading other financial information
in annual reports:
21-21
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Sufficiency of evidence
Use of a planning model that required that
gathering evidence by assertion
Overall review completed by managers
and partners (and discussed with audit
team); ensure targeted assurance achieved
Evidence should support audit opinion
21-22
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Final analytical procedures
Useful as a final review for material
misstatements or financial problems not
noted during other testing
Final objective look at the financial
statements
21-23
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Evaluation of going concern
assumption
Results of analytical review and overall
financial statement review will guide the
auditor with respect to risks of business
failure
Further queries and followup will be used
where liquidity problems surface
21-24
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Sufficiency of evidence
Senior audit staff and the audit partner are
responsible for assessing evidence in the
context of engagement risks and the client
risk profile
Detailed review helps to ensure that all
field work has been completed and
outstanding queries cleared
21-25
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Unadjusted misstatement worksheet
21-26
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Working paper review
Throughout the audit, the working papers
and field work would be reviewed on an
ongoing basis
Final review involves manager/partner
review
For a high risk engagement, standards staff
or a second partner may review the file
prior to audit opinion release
21-27
Copyright © 2007 Pearson Education Canada
Practice problem 21-21 (p. 613)
Evaluate working
paper review
processes
Are they acceptable?
Why or why not?
21-28
Copyright © 2007 Pearson Education Canada
Auditor communications
The auditor may communicate with
management and/or the audit committee
with respect to several matters. The
following communications are required:
Illegal acts
Reportable internal control conditions
(internal control deficiencies that could
lead to material errors)
21-29
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Subsequent discovery of facts
If the auditor becomes
aware of a material
misstatement after the
financial statements
have been issued and
the auditor’s report
released
What should the
auditor do?
21-30
Copyright © 2007 Pearson Education Canada