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In this chapter, the learning objectives are Be able to explain the audit issues related to contingent liabilities, know the audit procedures used to identify contingent liabilities, understand the audit issues related to a legal letter, be able to explain why the auditor must be concerned with client commitments.
Chapter Seventeen Completing the Audit Engagement © The McGraw-Hill Companies 2010 Contingency AAcontingency contingency is isaaliability liabilitythat thatis isuncertain uncertain because becausethe the possible possible outflow outflow of ofresources resourcesfrom from the theentity entitywill willultimately ultimately be beresolved resolved when whensome some future futureevent eventoccurs occursor orfails failsto tooccur occur Examples Examples • •Pending Pendingor orthreatened threatenedlitigation litigation • •Actual Actualor orpossible possibleclaims claimsand and assessments assessments • •Income Incometax taxdisputes disputes • •Product Productwarranties warrantiesor ordefect; defect; • •Guarantees Guaranteesof ofobligations obligationsto to others others • •Agreements Agreementsto torepurchase repurchase receivables that receivables thathave havebeen beensold sold © The McGraw-Hill Companies 2010 Probable: Probable:The Thefuture futureevent eventisismore more likely than not to occur likely than not to occur Neither Neitherprobable probablenor norremote: remote: The The chance chanceof ofthe thefuture futureevent eventisisless less likely than not to occur but the likely than not to occur but the chance chanceisismore morethan thanslight slight Remote: Remote:The Thechance chanceof ofthe thefuture future event occurring is slight event occurring is slight Audit Procedures for Identifying Contingencies Read minutes of meetings of those charged with governance, e.g the board of directors Review contracts, loan agreements, leases and correspondence from government bodies Review tax returns, tax liability and tax authorities’ reports Confirm or otherwise document guarantees and letters of credit © The McGraw-Hill Companies 2010 Inspect other documents for possible guarantees Audit Procedures for Identifying Contingencies Specific Audit Procedures Conducted Near Completion of Audit Inquiry and discussion with management about its policies and procedures for identifying, evaluating and accounting for contingencies Examine documents in the entity’s records such as correspondence and invoices from lawyers for pending or threatened lawsuits Obtain a legal letter that describes and evaluates any litigation, claims or assessments Obtain written representation from management that all litigation, asserted and unasserted claims, and assessments have been disclosed in accordance with the applicable financial reporting framework © The McGraw-Hill Companies 2010 Legal Letters A letter of audit inquiry (a legal letter) sent to the client’s lawyers is the primary means of obtaining or corroborating information about litigation, claims and assessments © The McGraw-Hill Companies 2010 Example of Legal Letter © The McGraw-Hill Companies 2010 Commitments Long-term Long-termcontracts contractsto to purchase purchaseraw rawmaterials materialsor or sell selltheir theirproducts productsat ataafixed fixed price price To Toobtain obtainaa favourable favourable pricing pricing arrangement arrangement To Tosecure securethe the availability availabilityof of raw rawmaterials materials Long-term commitments are usually identified through inquiry of client personnel during the audit of the revenue and purchasing processes In most cases, such commitments are disclosed in a note to the financial statements © The McGraw-Hill Companies 2010 Review for Subsequent Events Balance Sheet Date Type I Event Type II Event Conditions existed at the balance sheet date and affect estimates that are part of financial statements Conditions did not exist at the balance sheet date and not affect the accuracy of the financial statements Require adjustment of the financial statements Require financial statement disclosure © The McGraw-Hill Companies 2010 Auditor’s Responsibilities Regarding Subsequent Events © The McGraw-Hill Companies 2010 Subsequent Events after the Date of the Audit Report The auditor is not responsible for making any inquiries or conducting any audit procedures after the date of the audit report However, facts may come to the auditor’s attention after the date of the audit report that might have affected the audit report had the auditor known about them Auditing standards (ISA 560) provide guidance to auditors in this exceptional circumstance © The McGraw-Hill Companies 2010 Audit Procedures to Look for Subsequent Events Examples of audit procedures Inquire of Management Read Minutes of Meetings Read Interim Financial Statements Inquire of Legal Counsel © The McGraw-Hill Companies 2010 Examine the Books of Original Entry Final Evidence Evaluation Processes Perform final analytical procedures Review working papers Evaluate entity’s ability to continue as a going concern Obtain a representation letter Evaluate final of audit results Evaluation of financial statement presentation and disclosure Obtain a quality control review of the engagement © The McGraw-Hill Companies 2010 Going-Concern Considerations © The McGraw-Hill Companies 2010 Going-Concern Considerations © The McGraw-Hill Companies 2010 Representation Letter © The McGraw-Hill Companies 2010 Representation Letter (continued) © The McGraw-Hill Companies 2010 Proposed Adjusting Entries © The McGraw-Hill Companies 2010 Other Final Evidence Evaluation Processes Evaluating Financial Statement Presentation and Disclosure The auditor reviews the financial statements to ensure compliance with the applicable financial reporting framework, proper presentation of accounts, and inclusion of all necessary disclosures Engagement Quality Control Review An engagement quality control reviewer objectively evaluates the significant judgements that the engagement team made and the conclusions it reached in formulating the auditor’s report Archiving Archiving and and Retention Retention ISQC1 ISQC1 requires requires audit audit documentation documentation to to be be retained retained ordinarily ordinarily for for minimum minimum five five years years from from the the date date of of the the auditor’s auditor’s report report © The McGraw-Hill Companies 2010 Communication with those Charged with Governance and Management © The McGraw-Hill Companies 2010 End of Chapter 17 © The McGraw-Hill Companies 2010 ... any audit procedures after the date of the audit report However, facts may come to the auditor’s attention after the date of the audit report that might have affected the audit report had the auditor... about them Auditing standards (ISA 560) provide guidance to auditors in this exceptional circumstance © The McGraw-Hill Companies 2010 Audit Procedures to Look for Subsequent Events Examples of audit. .. objectively evaluates the significant judgements that the engagement team made and the conclusions it reached in formulating the auditor’s report Archiving Archiving and and Retention Retention