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Completing the Audit
Items to consider
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Contingent liabilities
Commitments
Legal confirmation
Subsequent events
Final evidence accumulation
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Analytical procedures
Going concern assumption
Client representation letter
CAS 720 – The annual report
Management discussion and analysis (MD&A)
Sufficiency of information
Unadjusted items
Auditor communications
Management letter
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Contingent Liabilities
• What is a contingency?
• An example of a contingent liability
• What information does the auditor need to obtain?
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Searching for Contingent Liabilities
• Following are a few examples that auditors can use
to search for contingent liabilities:
• What other techniques could the auditor use?
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Evaluating Known Contingent Liabilities
• Management’s disclosure needs to be evaluated
• Based upon the likelihood of the event
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Financial Statement Treatment of
Contingencies
Financial Statement Treatment of Contingencies
Unlikely to occur
No disclosure
Not determinable
Footnote
Likely to occur and the amount can be estimated
Financial statements are adjusted
Likely to occur and the amount cannot be estimated
Footnote
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Commitments
• What is a commitment?
• Where are they are usually disclosed?
• The procedures
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The Importance of Contingencies and
Commitments
• GAAP
• Why?
• Also future cash flows
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Legal Confirmation
• Also called
• A specific format
• Used to evaluate two categories of lawsuits:
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Legal Confirmation Letter Example
ABC Company Ltd.
123 Main Street
Toronto, Ontario
31 January, 201Y
Such & Such
Barristers and Solicitors
765 John Street
Toronto, Ontario
To Whom It May Concern:
In connection with the preparation and audit of our financial statements for the fiscal period ended 31 December 201X we have made the following evaluations of
claims and possible claims with respect to which your firm's advice or representation has been sought:
Description
Evaluation
(Name of entity, name of other party, nature,
amount claimed and current status)
(Indicate likelihood of loss (or gain) and estimated amount of
ultimate loss (or gain), if any; or indicate that likelihood is not
determinable or the amount is not reasonably estimable.)
Would you please advise us, as of (effective date of response), on the following points:
a.
Are the claims and possible claims properly described?
b.
Do you consider that our evaluations are reasonable?
c.
Are you aware of any claims not listed above which are outstanding? If so, please include in your response letter the names of the parties and the amount
claimed.
This enquiry is made in accordance with the Joint Policy Statement of January 1978 approved by The Canadian Bar Association and the Auditing Standards Committee
of the Canadian Institute of Chartered Accountants.
Please address your reply, marked "Privileged and Confidential", to this company and send a signed copy of the reply directly to our auditor, GHW & Co. Llp, 321
Yonge Street, Toronto, Ontario
Yours truly,
John James, President
c.c. GHW & Co
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Analyzing Legal Expense
• Why analyze legal expenses?
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Subsequent Events
• What are subsequent events?
• Up to what date does the auditor examine
subsequent events?
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Subsequent Events Time Period
Required to obtain evidence for subsequent
events
Balance sheet
date
Field work
completed
Directors approve and
sign financial
statements
Audit report signed
Not required to
obtain evidence *
Audited financial
statements
released to the
public
* But if auditor becomes aware of a fact that existed at the date of the audit report
And if the auditor had known at that date that this fact could have caused them to modify
the report, the auditor should:
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Types of Subsequent Events
• Types of subsequent events:
• Type 1
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Events providing additional evidence with respect to
conditions
Type 2
• Events providing evidence with respect to conditions
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• Type 1
• Such events may affect the estimates inherent in the
financial statements or indicate that a going concern
assumption is not appropriate
• How to treat this item?
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• Type 2
• Those events that do not result in changes to amounts in the
financial statements
• However they can be of such significance that disclosure in the
financial statements is required.
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Subsequent Events Evidence
• Management
• Law firms
• Internal financial statements
• Minutes
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Final Evidence Accumulation
The auditor has to gather some final evidence besides
the examination of
1.Analytical procedures
2.Evaluation and conclusions regarding going concern concept
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3. Client representation letter
4. The annual report and CAS 720
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This relates to other information in the annual report of which the financial
statement are part
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5. Management discussion and analysis (MD&A)
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Working Paper Review
• When is a working paper review performed?
• Who performs the final review?
• For a high risk engagement
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Sufficiency of Evidence
• Who is responsible for this?
• This is a detailed review
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Unadjusted Misstatement Worksheet
• Also called a Summary of Unadjusted Items
• What does this worksheet keep track of?
• The primary us of this worksheet?
• What happens if the auditor comes to the conclusion
that there may be a material misstatement?
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Auditor Communications
• Communications with management and/or the audit
committee
• The following are required:
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Management Letter
• The purpose of a management letter
• The focus
• Many auditor combine this with the letter on internal
control
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Problem 21-17, Page 709
In an examination of Marco Corporation as of December 31, 2009, the following
situations exist. No related entries have been made in the accounting records.
1.Marco Corporation has guaranteed the payment of interest on the 10-year, first
mortgage bonds of Chen Corp., an affiliate. Outstanding bonds of Chen Corp.
amount to $150,000 with interest payable at 8 percent per annum, due June 1 and
December1 each year. The bonds were issued by Chen on December 31, 2007,
and all interest payments have been met by that company with the exception of the
payment due December 1, 2009. Marco Corporation states that it will pay the
defaulted interest to the bondholder on January 15, 2010.
2.During the year 2009, Marco Corporation was named as a defendant in a suit by
Dalton Inc. for damages for breach of contract. A decision adverse to Marco
Corporation was rendered, and Dalton Inc. was awarded $40,000 in damages. At
the time of the audit, the case was under appeal to higher court.
3.On December 23, 2009, Marco Corporation declared a common share dividend of
1,000 shares with a stated value of $100,000, payable February 2, 2010, to the
common shareholders of record on December 30, 2009.
REQUIRED:
a)Describe the audit procedures that you would use to learn about each of the
above situations.
b)Describe the nature of the adjusting entries or disclosure, if any, that you would
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require for each of these situations.
Problem 21-18, Page 709
Melanie Adams is a public accountant in a medium sized public accounting firm and takes
an active part in the conduct of every audit she supervises. She follows the practice of
reviewing all working papers of subordinates as soon as it is convenient, rather than
waiting until the end of the audit.
When the audit is nearly finished, Melanie reviews the working papers again to make sure
that she has not missed anything significant. Since she makes most of the major
decisions on the audit, there is rarely anything that requires further investigation. When
she completes the review, she prepares a draft of the financial statements, gets them
approved by management, and has them assembled in her firm’s office. No other public
accountant reviews the working papers because Melanie is responsible for signing the
auditor’s report.
REQUIRED:
a)Evaluate the practice of reviewing the working papers of subordinates on a continuing
basis rather than when the audit is completed.
b)Is it acceptable for Melanie to prepare the financial statements rather than have the
client assume that responsibility?
c)Evaluate the practice of not having a review of the working papers by another public
accountant in the firm.
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Problem 21-19, Page 709
Ruben Chavez, a public accountant, has prepared a management representation letter
for the president and controller to sign. It contains references to the following items:
1.Inventory is fairly stated at the lower of cost or market and includes no obsolete items.
2.All actual and contingent liabilities are properly included in the statements.
3.All subsequent events of relevance to the financial statements have been disclosed.
REQUIRED:
a)Why is it desirable to have a letter of representation from the client concerning the
above matters when the audit evidence accumulated during the course of the
engagement is meant to verify the same information?
b)To what extent is the letter of representation useful as audit evidence?
c)List several other types of information commonly included in a letter of representation.
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Problem 21-22, Page 710
In analyzing legal expense for Boastman Bottle Company, Bart Little, a public
accountant, observes that the company has paid legal fees to three different law
firms during the current year. In accordance with his accounting firm’s normal
operating practice, Bart requires standard confirmation letters as od the balance
sheet date from each of the three law firms.
On the last day of fieldwork, Bart notes that one of the confirmations has not yet
been received. The confirmation from the second law firm contains a statement to
the effect that the law firm deals exclusively in registering patents and refuses to
comment on any lawsuits or other legal affairs of the client. The confirmation letter
from the third law firm states that there is an outstanding bill due from the client and
recognizes the existence of a potentially material lawsuit against the client but
refuses to comment further to protect the legal rights of the client
REQUIRED:
a)Evaluate Bart’s approach to requesting the confirmations and his follow-up on the
responses.
b)What should Bart do about each of the confirmations?
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