AUDITINGCHAPTER 17

Completing the AuditByDavid N. Ricchiute

GBW 8th ed., Ch. 172

TOPICS

Testing revenue, expensesEstimates, losses, contingenciesRelated party transactionsLegal mattersManagement representation letter, opinion, & other communicationsSubsequent discoveries & omitted procedures

GBW 8th ed., Ch. 173

SUBSTANTIVE TESTS FOR REVENUE & EXPENSES

Analytical tests for reasonablenessTests details if Control risk maximum Transaction volume low;

account needs special attention Analytical procedures reveal

unusual, unexpected results

GBW 8th ed., Ch. 174

ACCOUNTING ESTIMATES

Examples Warranty claims Uncollectible accounts Depreciation, amortization Airline passenger revenue;

subscription income Percentage of completion income Loss contingencies

GBW 8th ed., Ch. 175

AUDITING ACCOUNTING ESTIMATES

Objectives Management developed all material

estimates Estimates reasonable & in accord with

GAAP

Procedures Review test process for developing ratios Develop independent estimate to

compare Review subsequent events

GBW 8th ed., Ch. 176

CONSIDERATION OF LOSS CONTINGENCIES

Examples Pending, threatened litigation Guaranties of 3rd party obligations Discounted, factored A/R Disputed income tax deductions

GBW 8th ed., Ch. 177

ACCOUNTING TREATEMENT: Loss ContingenciesSFAS 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

GBW 8th ed., Ch. 178

FINDING LOSS CONTINGENCIES

Inquire of managementRead minutes of board, shareholders’ meetingsRead contracts, loan, lease agreements, etc.Review IRS reportsAnalyze legal expenses, documentationReview work papers for possible contingencies

GBW 8th ed., Ch. 179

PROCEDURES TO COMPLETE AUDIT

Review for related party transactionsReview for subsequent eventsInquire of client’s legal counselObtain management representation letterForm opinion

GBW 8th ed., Ch. 1710

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

GBW 8th ed., Ch. 1711

PROCEDURES: RELATED PARTY TRANSACTIONS

Review Minutes for authorized transactionsProxy material for related partiesManagement’s conflict-of-interest statements Extent, nature business with major customers, suppliers, borrowers, lendersInvoices from law firmsLoan confirmations for guarantees

GBW 8th ed., Ch. 1712

AUDITOR’S EVALUATION: Related Party Transactions

Objectives Assess purpose, nature, extent of

transactions Effects of transactions on financial

statements

Additional procedures Inquire of management Examination documentation Ensure authorization

GBW 8th ed., Ch. 1713

SUBSEQUENT EVENTSType 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

GBW 8th ed., Ch. 1714

PROCEDURES FOR SUBSEQUENT EVENTS

Read interim statements, board, shareholders’ minutesInquire Contingent liabilities, commitments Changes in capital structure, indebtedness,

working capital Changes in estimates; unusual adjustments

Obtain lawyers’ letters, management representation letter

GBW 8th ed., Ch. 1715

DISCLOSURE: Subsequent Events

Type 1 Adjust financial statements

Type 2 Explanatory note Parenthetical explanation Reference Do not issue unqualified opinion

GBW 8th ed., Ch. 1716

INQUIRIES OF CLIENT’S LEGAL COUNSEL

Inquiry of Client’s Lawyer, SAS 12 (required)Management prepares list of legal issuesInformation requested Description, evaluation of outcome,

completeness of list for Pending, threatened litigation Unasserted claims, assessments

GBW 8th ed., Ch. 1717

MANAGEMENT REPRESENTATION LETTERManagement’s representations,

SAS 85 (required)Financial statement responsibility, conformity with GAAPComplete information available to auditorRecognitions, measurement, disclosureSubsequent events

GBW 8th ed., Ch. 1718

FORMING AN OPINIONProcedures Overall review through analytical

procedures (SAS 56) Relationships, account balances

reasonable Workpaper review

Considers documented fair presentation all accounts

Technical review by another (concurring) partner

GBW 8th ed., Ch. 1719

COMMUNICATIONS WITH AUDIT COMMITTEES (SAS 61)

Responsibilities under GAASSignificant accounting policies, judgments, estimatesSignificant audit adjustmentsDisagreements with managementDifficulties

GBW 8th ed., Ch. 1720

COMMON QUESTIONS BY AUDIT COMMITTEE

Revenue recognition Asset valuationContingenciesReserves

GBW 8th ed., Ch. 1721

COMMON QUESTIONS: Problematic Accounting Policies

No authoritative GAAPAlternative methodsControversial, uncommon transactions

GBW 8th ed., Ch. 1722

COMMON QUESTIONS: New Areas, Events

ReservesChanges in principleEstimateDeferrals, accrualsPrior-period adjustments

GBW 8th ed., Ch. 1723

COMMON QUESTIONS: Management Imposed Problems

Uncorrected weaknesses in internal controlUnavailable, uncooperative personnelInadequate schedules from clientUnavailable evidence

GBW 8th ed., Ch. 1724

SUBSEQUENT DISCOVERY OF FACTS

For facts existing at report date, consider whether Information reliable Facts did exist Audit report would have been

affected if known Important to those relying on report

GBW 8th ed., Ch. 1725

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

GBW 8th ed., Ch. 1726

AUDITOR RESPONSE IF DISCLOSURE REFUSED

If client refuses to make disclosure of subsequent facts auditor will Notify board Notify regulatory agencies

GBW 8th ed., Ch. 1727

OMITTED PROCEDURES

Discovered after report date (SAS 46)Objective Determine if report still supported Consider persons relying on report

GBW 8th ed., Ch. 1728

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