11-1 mcgraw-hill/irwin ©2007 by the mcgraw-hill companies, inc. all rights reserved. chapter 11...

McGraw-Hill/Irwin

©2007 by the McGraw-Hill Companies, Inc. All rights reserved.

11-1

Chapter 11

Completing the Audit

“It ain’t over till it’s over.”– Yogi Berra, former catcher for the New York Yankees

McGraw-Hill/Irwin

©2007 by the McGraw-Hill Companies, Inc. All rights reserved.

11-2

Major Activities in Audit

Beginning End of Last day of Issuance

of year year fieldwork of audit reports

Interim testing “Roll-forward” work Subsequent events Subsequent discovery of facts

(tests of controls Revenue and expenses (dual-dating) Omitted audit procedures

and substantive Attorney letters Management letter

procedures) Management representations Audit committee communications

Adjusting entries

Audit documentation review

Subsequent events

McGraw-Hill/Irwin

©2007 by the McGraw-Hill Companies, Inc. All rights reserved.

11-3

Presentation Outline

I. Activities Between End of Year and Last Day of Field Work

II. Activities Following Issuance of Auditor’s Reports

McGraw-Hill/Irwin

©2007 by the McGraw-Hill Companies, Inc. All rights reserved.

11-4

I. Activities Between End of Year and Last Day of Fieldwork

A. Revenue and Expense Accounts

B. Attorney Letters

C. Management Representations

D. Adjusting Journal Entries

E. Audit Documentation Review

F. Subsequent Events

McGraw-Hill/Irwin

©2007 by the McGraw-Hill Companies, Inc. All rights reserved.

11-5

A. Revenue and Expense Accounts

• Substantive procedures for related balance sheet accounts have also audited many income

statement accounts.• Analytical procedures can be applied to other

income statements accounts. Examples include comparison to prior year balances, expected

relationships, statistical estimates, and internal budgets and reports.

• Scan accounts for large and unusual entries that may need additional verification.

• Be aware of “miscellaneous,” “other,” and “clearing” accounts – “earnings management”

McGraw-Hill/Irwin

©2007 by the McGraw-Hill Companies, Inc. All rights reserved.

11-6

B. Attorney Letters

1. Audit Procedures for Litigations, Claims, and Assessments

2. Attorney Letters: Responsibilities

3. Attorney Letters: Contents

McGraw-Hill/Irwin

©2007 by the McGraw-Hill Companies, Inc. All rights reserved.

11-7

1. Audit Procedures for Litigation, Claims, and Assessments

• Inquiry of clients regarding a description and evaluation of litigation, claims, and assessments

• Review minutes of meetings of stockholders, directors, and committees

• Review contracts, loan agreements, and correspondence from taxing and governmental

agencies• Obtain information concerning guarantees from

bank confirmations• Review documentation related to legal services

McGraw-Hill/Irwin

©2007 by the McGraw-Hill Companies, Inc. All rights reserved.

11-8

2. Attorney Letters: Responsibilities(Follow Diagram on p. 402 of text)

• Auditor– Initiate request for attorney letter

• Client– Prepare listing, description, and evaluation of litigation,

claims, and assessments for letter– Send letter to attorney including information related to

litigation, claims, and assessments• Attorney

– Respond to auditor regarding client’s description of litigation, claims, and assessments contained in attorney letter

McGraw-Hill/Irwin

©2007 by the McGraw-Hill Companies, Inc. All rights reserved.

11-9

3. Attorney Letters: Contents(See Sample on p. 403 of Text)

• Listing of pending litigation, claims, and assessments

• Description of each item or case included in the listing

• Evaluation of the likelihood of an unfavorable outcome

• Estimate of the range of potential loss• Understanding regarding unasserted claims

McGraw-Hill/Irwin

©2007 by the McGraw-Hill Companies, Inc. All rights reserved.

11-10

C. Management Representations

1. Purpose of Management Representations

2. Management Representations Required Regardless of Materiality

3. Some Representations Related to Managements’ Assessment of Internal

Control (AS 2)

McGraw-Hill/Irwin

©2007 by the McGraw-Hill Companies, Inc. All rights reserved.

11-11

1. Purpose of Management Representations

• Provided by management to the auditor in the form of a letter (See example on p. 406 of text)

• Dated the last day of fieldwork• Broad purpose

– Impress upon management its primary responsibility for the financial statements

– May establish an auditor’s defense if a question related to inquiries subsequently arises

• Qualify or disclaim an opinion if not provided by the client

McGraw-Hill/Irwin

©2007 by the McGraw-Hill Companies, Inc. All rights reserved.

11-12

2. Management Representations Required Regardless of Materiality

– Management responsibility for the fairness of the financial statements

– Availability of all financial records and data– Management responsibility for design and

implementation of programs and controls related to fraud

– Disclosure of significant deficiencies in internal control

– Information concerning fraud involving the client

McGraw-Hill/Irwin

©2007 by the McGraw-Hill Companies, Inc. All rights reserved.

11-133. Some Representations Related to Managements’ Assessment of

Internal Control (AS 2)

– Management has performed as assessment of internal control

– Management’s conclusion with respect to the operating effectiveness of its internal control

– No subsequent changes in IC that significantly affect IC

– No control deficiencies from prior engagements have not been properly resolved

McGraw-Hill/Irwin

©2007 by the McGraw-Hill Companies, Inc. All rights reserved.

11-14

D. Adjusting Journal Entries

• Accumulate proposed entries on “score sheet”. (See example on p. 408 of text)

• Consider pre tax and after tax effects.• Require adjustment for all material entries.

• Require adjustment for proposed entries totaling a material amount

• Require adjustment for “qualitatively material” entries

• Recommend adjustment for all other items

McGraw-Hill/Irwin

©2007 by the McGraw-Hill Companies, Inc. All rights reserved.

11-15

E. Audit Documentation Review

• Audit supervisor– Have all steps in audit program been performed?

– Is referencing among documentation clear?– Are explanations understandable?

• Audit manager and partner– Is the overall scope of the audit adequate?

– Do overall conclusions support the opinion?

• Reviewing partner– Are the quality of audit work and reporting consistent

with quality standards of the firm?

McGraw-Hill/Irwin

©2007 by the McGraw-Hill Companies, Inc. All rights reserved.

11-16

F. Subsequent Events

1. Subsequent Period

2. Procedures in Subsequent Period

3. Types of Subsequent Events

4. Timing of Subsequent Events Identification

McGraw-Hill/Irwin

©2007 by the McGraw-Hill Companies, Inc. All rights reserved.

11-17

1. Subsequent Period

Beginning End of Last day of Issuance

of year year fieldwork of reports

Subsequent

Period

Audit Procedures

• Auditor performs procedures to evaluate events that may affect presentation and disclosure in the financial statements

• Events occurring during this period are known as subsequent events

McGraw-Hill/Irwin

©2007 by the McGraw-Hill Companies, Inc. All rights reserved.

11-18

2. Procedures in Subsequent Period

• Review latest interim financial statements

• Inquire of officers and other executives

• Read minutes of meetings of shareholders, directors, and committees

• Obtain attorney letter

• Obtain management representations

McGraw-Hill/Irwin

©2007 by the McGraw-Hill Companies, Inc. All rights reserved.

11-19

3. Types of Subsequent Events

• Type I– Provide new information about conditions existing at

balance sheet date– Adjust financial statements to reflect new information

• Type II– Involve events occurring after balance sheet date

– Disclose in financial statements– Prepare pro forma financial statements as if event has

occurred at beginning of period. Only for significant events.

McGraw-Hill/Irwin

©2007 by the McGraw-Hill Companies, Inc. All rights reserved.

11-20

4. Timing of Subsequent Events Identification

• Prior to last day of fieldwork– Perform audit procedures and ensure proper

disclosure

• Following last day of fieldwork but prior to issuance of reports– Dual date audit report

• Following issuance of audit reports– “Subsequent discovery of facts”

McGraw-Hill/Irwin

©2007 by the McGraw-Hill Companies, Inc. All rights reserved.

11-21

II. Activities Following Issuance of Auditor’s Reports

A. Subsequent Discovery of Facts

B. Omitted Audit Procedures

C. Communication with Audit Committee

D. Management Letters

McGraw-Hill/Irwin

©2007 by the McGraw-Hill Companies, Inc. All rights reserved.

11-22

A. Subsequent Discovery of Facts

• Require disclosure of events if:– Facts are reliable and existed at report date

– Facts affect financial statements and auditor’s report

– Persons are continuing to rely on financial statements and auditor’s reports

• If client refuses disclosure, auditor should inform board that he or she will notify regulatory agencies

and others relying on the reports

McGraw-Hill/Irwin

©2007 by the McGraw-Hill Companies, Inc. All rights reserved.

11-23

B. Omitted Audit Procedures

• Perform procedures if:– Omitted procedures are important– Individuals are currently relying on financial statements and

auditor’s reports

• If previous opinion can be supported, no further action necessary

• If previous opinion cannot be supported– Withdraw the original report– Issue revised reports– Inform persons currently relying on the financial statements

McGraw-Hill/Irwin

©2007 by the McGraw-Hill Companies, Inc. All rights reserved.

11-24

C. Communication with Audit Committee

• Auditor’s responsibility under GAAS

• Initial selection and changes in significant accounting policies

• Methods used to account for significant transactions and transactions in controversial or emerging areas

• Management judgments and estimates

• Audit adjustments• Uncorrected misstatements

• Auditor judgment about quality of accounting principles

• Alternative accounting treatments permissible under GAAP

• Disagreements with management• Issues related to initial or

recurring retention of the auditor• Consultation with other

accountants• Difficulties encountered in

dealing with management during the audit

McGraw-Hill/Irwin

©2007 by the McGraw-Hill Companies, Inc. All rights reserved.

11-25

D. Management Letters

• Not required under GAAS• Are prepared as a by-product of procedures

performed in audit• Provide recommendations to client for improving effectiveness and efficiency of

operations• Delivered by auditor to client following

audit engagement

McGraw-Hill/Irwin

©2007 by the McGraw-Hill Companies, Inc. All rights reserved.

11-26

Summary of Audit Communications