Auditing Operations and Completing the Audit

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Auditing Operations and Completing the Audit
www.buec.udel.edu/jenkinsd/Powerpoint/Chp16.ppt
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Outline

• Auditing operations
• Miscellaneous revenue
• Miscellaneous SGA expenses
• Auditing payroll
• Completing the audit
• Evaluating audit findings
• Post-audit responsibilities

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Relationships Between Balance Sheet and Revenue
Accounts
Relationship of Revenue to Balance Sheet Accounts
Balance Sheet Item Revenue
Accounts receivable Sales
Notes receivable Interest
Securities and other investments Interest, dividends, gains on sales, share of investees income
Property, plant and equipment Rent, gains on sale
Intangible assets Royalties
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Miscellaneous Revenue

• Mixture of minor or non-recurring revenue
  transactions.
• Items that may be misclassified as miscellaneous
  revenue.
• Collection on previously written-off receivables
• Write-offs of old outstanding checks
• Proceeds from sale of scrap
• Refunds or rebates of insurance premiums
• Proceeds from sales of plant assets

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Relationships Between Balance Sheet and Income
Statement Accounts

• Relationship of Expenses to Balance Sheet Accounts

Balance Sheet Item Expenses
Accounts and notes receivable Uncollectible accounts and notes expense
Inventories Purchases, cost of goods and payroll
Property, plant and equipment Depreciation and repairs and maintenance
Intangible assets Amortization
Accrued liabilities Commissions, fees, bonuses, product warranty expenses, etc.
Interest-bearing debt Interest
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Substantive Tests for Selling, General and
Administrative Expenses

• Perform analytical procedures
• Develop an expectation of the account balance
• Determine the amount of difference from the
  expectation that can be accepted without
  investigation
• Compare the companys account balance with the
  expected account balance
• Investigate significant deviations from the
  expected account balance
• Obtain or prepare analyses of selected expense
  accounts
• Obtain or prepare analyses of critical expenses
  in the income tax return

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The Audit of Payroll

• Payroll is often a companys largest operating
  cost.
• Potential payroll frauds
• Fictitious employees
• Overpaying employees
• Continuing to pay employees after termination

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Payroll Functions

• Human resources
• Authorized pay rate
• Employment papers / payroll deductions
• Timekeeping
• Electronic clocks
• Supervisor oversight of timekeeping
• Payroll preparation and recordkeeping
• Time cards
• Payroll journals
• Labor distributions
• Employee earnings records
• Distribution of paychecks
• Paymaster
• Imprest account / regular reconciliation
• Proof of identity / employee signature

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Audit Program for Payroll

• Obtain an understanding of internal control over
  payrolls
• Perform tests of controls as necessary
• Compare name, wage rates, and payroll deductions
  to HR records.
• Compare time on payroll to time reports approved
  by supervisors.
• Test extensions and footing of payroll.
• Compare payroll total to total of checks issued.
• Observe the use of time clocks.
• Observe the distribution of paychecks.

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Audit Program for Payroll

• Perform substantive tests of payroll

Substantive Tests Audit Objectives
Perform analytical procedures Investigate fluctuations in payroll Obtain a summary of amounts of officers compensation and trace to authorization. Existence/occurrence Completeness Valuation
Test compensation from profit-sharing or bonus plans. Test commission earnings Test pension obligations Valuation
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Audit Procedures Completed Near the End of Field
Work

• Search for unrecorded liabilities
• Review the minutes of meetings
• Perform final analytical procedures
• Perform procedures to identify loss contingencies
• Perform the review for subsequent events
• Obtain the representation letter

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Loss Contingencies

• Def. A possible loss stemming from past events
  that will be resolved as to existence and amount
  by some future event.
• Loss contingencies should be reflected in the
  financial statement amounts when
• It is probable that a loss had been sustained
  before the balance sheet date
• The amount of the loss can be reasonably
  estimated
• Loss contingencies should be disclosed in the
  notes to the financial statements when it is at
  least reasonably possible that a loss has been
  sustained
• Loss contingencies need not be disclosed when the
  possibility of loss is remote

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Loss Contingencies

• Types of loss contingencies
• Litigation
• Income tax disputes
• Guarantees of indebtedness
• Accounts receivable sold or assigned with
  recourse
• Environmental issues
• Commitments
• General risk contingencies

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Loss Contingencies

• Procedures for loss contingencies
• Review minutes of BOD meetings.
• Send letter of inquiry to clients attorneys.
• Send confirmation letters to financial
  institutions requesting information on contingent
  liabilities.
• Review correspondence with financial institutions
  for evidence of guarantees of indebtedness, or
  sales or assignments of accounts receivable.
• Review reports and correspondence with regulatory
  agencies to identify potential fines or
  assessments.
• Obtain a representation letter from management
  indicating that all liabilities known to officers
  are recorded or disclosed.

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Subsequent Events

• Covers period between balance sheet date to date
  of auditors report (last day of fieldwork).
• Type I subsequent event
• Involves conditions that existed on or before
  balance sheet date
• Must adjust financial statement amounts to
  reflect event
• Type II subsequent event
• Involves conditions coming into existence after
  the balance sheet date.
• Must disclose in footnotes if omission would
  cause financial statements to be misleading.

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Subsequent Events

• Examples of Type I subsequent events
• Large receivable at balance sheet date proves to
  be uncollectible due to subsequent bankruptcy of
  debtor.
• Customer check included in ending cash
  subsequently proves to be uncollectible.
• Settlement of pending litigation.

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Subsequent Events
Examples of Type II subsequent events

• Business combination
• Pro forma results often disclosed
• Substantial casualty losses
• Significant changes in financial position or
  financial structure
• Major personnel changes
• Product line changes
• Labor strikes

Disclosure generally required
Disclosure generally not required
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Subsequent Events

• Audit procedures relating to subsequent events
• Review latest interim financial statements and
  minutes of BOD meetings.
• Inquiries to appropriate client officials.
• Letter of inquiry to clients attorneys.
• Representation from management in representation
  letter.

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Evaluating Audit Findings

• Overall review of the audit
• Evaluate sufficiency and competency of evidence
  in the workpapers.
• Evaluate total likely misstatement
• Known misstatements
• Projected misstatements
• Other estimated misstatements
• Review the sufficiency of disclosures
• Disclosure checklists
• Client approval of adjusting entries and
  disclosures

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Required Communication With the Audit Committee

• Significant deficiencies in internal control
• The auditors responsibilities for the audit and
  other information included with the financial
  statements
• Significant audit adjustments made
• Proposed audit adjustments evaluated by
  management as immaterial
• Disagreements with management or other
  difficulties
• The auditors viewpoint on an accounting or
  auditing matter if management contacted other
  auditors about the matter
• A discussion of the quality of accounting
  principles and estimates

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Post-Audit Considerations

• Subsequent discovery of facts existing at the
  date of the audit report
• Auditor must immediately investigate
• If material, auditor should advise client to make
  appropriate disclosures to anyone relying on the
  financial statements.
• If management refuses, auditor should contact BOD
  members, any regulatory agencies, and if
  practicable any persons relying on the statements.

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Post-Audit Considerations

• Subsequent discovery of omitted procedures
• Auditor should assess importance of omitted
  procedures to audit opinion.
• If opinion is impaired, the auditor should
  attempt to perform the omitted procedures or
  appropriate alternative procedures.
• Auditor should consult legal counsel.