Chapter 24 Completing the Audit

1
Chapter 24Completing the Audit
2
Presentation Outline

1. Review for Contingent Liabilities
2. Review for Subsequent Events
3. Accumulate Final Evidence
4. Evaluate Results
5. Issue Audit Report
6. Communicate with Audit Committee and Management
7. Subsequent Discovery of Facts

3
I. Review for Contingent Liabilities

1. Contingent Liability Conditions
2. Likelihood of Occurrence and Financial Statement
   Treatment
3. Commitments
4. Common Audit Procedures for Contingencies
5. Inquiry of Clients Attorney
6. Sarbanes-Oxley and Attorneys

4
A. Contingent Liability Conditions

• Three conditions are required for a contingent
  liability to exist
• There is a potential future payment to an outside
  party or the impairment of some other asset that
  would result from an existing condition.
• There is uncertainty about the amount of the
  future payment or impairment.
• The outcome will be resolved by some future
  event(s).

Note Page 712 contains examples of possible
contingencies.
5
B. Likelihood of Occurrence and Financial
Statement Treatment
Likelihood of Occurrence of Event Financial Statement Treatment
Remote (slight chance) No disclosure is necessary
Reasonably possible (more than remote, but less than probable) Footnote disclosure is necessary
Probable (likely to occur) If the amount can be reasonably estimated, financial statement accounts are adjusted. If the amount cannot be reasonably estimated, footnote disclosure is necessary.
6
C. Commitments

• In a commitment, the most important
  characteristic is the agreement to commit the
  firm to a set of fixed conditions in the future
  regardless of what happens to profits or the
  economy as a whole.
• All commitments are ordinarily either described
  together in a separate footnote or combined in
  the contingencies footnote.

7
D. Common Audit Procedures for Contingencies

• Inquire of client management about unrecorded
  contingencies.
• Review current and prior year revenue agent
  reports for income tax settlements.
• Review of board of director minutes.
• Analysis of legal expense and related invoices
  from legal counsel.
• Obtain a letter from clients legal counsel.
• Review of bank confirmations and notes.

8
E. Inquiry of Clients Attorney

• The standard inquiry to the clients attorney
  should include the following
• A list including (1) pending threatened
  litigation and (2) asserted and unasserted claims
  with which the attorney as had significant
  involvement.
• A request that the attorney furnish information
  about the progress of each item listed.
• A request for the identification of any unlisted
  pending or threatened legal actions or a
  statement that the clients list is complete.
• A statement informing the attorney of their
  responsibility to inform client management of
  legal matters requiring disclosure in the
  financial statements and to respond directly to
  the auditor.

Note Page 715 contains an example of the letter.
9
F. Sarbanes-Oxley and Attorneys

• The Sarbanes-Oxley Act directed the SEC to issue
  rules requiring attorneys to report material
  violations of the federal securities laws to the
  chief legal officer, CEO, and possibly the audit
  committee.
• Previously, attorneys only reported crimes when
  there was a threat of physical harm or death or
  the release of hazardous materials or defective
  products.

The American Bar Assoc. has amended the
attorney-client confidentiality rules to permit
breach of confidentiality for crime and fraud
of an audit client.
10
II. Review for Subsequent Events

1. Time Period of Auditor Responsibility
2. Subsequent Events Requiring Adjustment
3. Subsequent Events Requiring Disclosure
4. Audit Tests for Subsequent Events
5. Dual Dating for Subsequent Events

11
A. Time Period of Auditor Responsibility

• The auditors responsibility for reviewing
  subsequent events is normally limited to the
  period beginning with the balance sheet date and
  ending with the date of the auditors report.

Clients ending balance sheet date
Audit report date
Date client issues financial statements
12-31-02
3-11-03
3-26-03
Period to which review for subsequent events
applies
Period for processing the financial statements
12
B. Subsequent Events Requiring Adjustment

• Subsequent events require financial statement
  adjustment if they provide additional information
  regarding conditions that
• Existed at the balance sheet date, and
• Affect the fair presentation of account balances.

13
C. Subsequent Events Requiring Disclosure

• Subsequent events of this type provide evidence
  of conditions that did not exist at the balance
  sheet date, but are so significant that they
  require disclosure. Page 718 provides some
  examples.

14
D. Audit Tests for Subsequent Events

• Inquiry of key client management.
• Correspondence with attorneys
• Review of internal client statements and other
  records prepared subsequent to the balance sheet
  date
• Examine minutes of board of director meetings
• Obtain a letter of representation from client
  management

15
E. Dual Dating for Subsequent Events

• Occasionally, the auditor determines that an
  important subsequent event occurred after the
  field work was completed but before the audit
  report was issued.
• The auditor may chose to (1) extend the date of
  field work to cover the discovery, or (2) issue a
  dual-dated audit report. For this 2nd option,
  the first date would be for the completion of
  field work except for a specific exception. The
  next date would cover the date of the discovery
  of the subsequent event after the field work date.

16
III. Accumulate Final Evidence

1. Perform Final Analytical Procedures
2. Evaluate Going-Concern Assumption
3. Obtain Client Management Representation Letter
4. Consider Information Accompanying the Basic
   Financial Statements
5. Read Other Information in the Annual Report

17
A. Perform Final Analytical Procedures

• Analytical procedures done during the completion
  of the audit are useful as
• A final review for material misstatements or
  financial problems not noted during other
  testing.
• Providing a final objective look at the financial
  statements.

18
B. Evaluate Going-Concern Assumption

• SAS 59 requires the auditor to evaluate whether
  there is substantial doubt about a clients
  ability to continue as a going concern for at
  least one year beyond the balance sheet date.

19
C. Obtain Client Management Representation Letter

• SAS 85 requires the auditor to obtain a letter of
  representation documenting client managements
  most important oral representations during the
  audit.
• Refusal to furnish the letter would require a
  qualified opinion or disclaimer of opinion.
• SAS 85 and PCAOB Standard 2 suggest categories of
  specific matters that should be included in the
  letter. See pages 721-722.

20
D. Consider Information Accompanying the Basic
Financial Statements

• In many cases, the auditor has not performed a
  sufficiently detailed audit to justify an opinion
  on the additional information. Two types of
  opinions are allowed
• A positive opinion indicating a high level of
  assurance.
• A disclaimer indicating no assurance.

Note Page 723 contains examples of report
wording.
21
E. Read Other Information in the Annual Report

• SAS 8 requires the auditor to read other
  information included in annual reports pertaining
  directly to the financial statements.
• Examples are the presidents letter and
  explanations of company activities.
• If the client refuses to modify material
  inconsistencies, the auditor should add an
  explanatory paragraph to the audit report or
  withdraw from the engagement.

22
IV. Evaluate Results

1. The Sufficiency of Audit Evidence
2. Support for the Auditors Opinion
3. Financial Statement Disclosures
4. Audit Documentation Review
5. Independent Review
6. Summary of Evidence Evaluation

23
A. The Sufficiency of Audit Evidence

• As an aid in drawing final conclusions about the
  adequacy of the audit evidence, auditors often
  use a completing the engagement checklist (See
  Figure 24-5 on page 724).
• The auditor has two choices if sufficient
  evidence has not been obtained
• Obtain additional evidence
• Issue a qualified or disclaimer of opinion

24
B. Support for the Auditors Opinion

• It is necessary to combine individually
  immaterial misstatements to evaluate whether the
  combined amount is material. (See Figure 24-6 on
  page 725)
• The auditor has two choices if the financial
  statements are not fairly stated
• Have statements revised to auditor satisfaction.
• Issue a qualified or adverse opinion.

25
C. Financial Statement Disclosures

• Adequate disclosure includes consideration of all
  of the statements, including the related notes.
• Account balance verification also includes
  consistent application of GAAP with the preceding
  year.
• Many CPA firms require the completion of a
  financial statement disclosure checklist. (See
  Figure 24-7 on page 727)

26
D. Audit Documentation Review

• The review of audit documentation generally
  involves three increasing levels of personnel,
  ending with the partner in charge of the audit.
  Three main reasons for review include
• Evaluation of performance of inexperienced
  personnel
• Ensure that audit meets CPA firms standard of
  performance.
• Counteract bias in auditor judgment.

27
E. Independent Review

• At the completion of larger audits, it is common
  to have the financial statements and the entire
  set of audit files reviewed by a completely
  independent reviewer who has not participated in
  the engagement.
• A independent review is required for SEC
  engagements.
• Reviewer takes an adversary position.

28
F. Summary of Audit Evidence

• Auditor evaluates the sufficiency of audit
  evidence by first evaluating achieved audit risk,
  by account and by cycle, and then making the same
  evaluation for the overall financial statements.
• Auditor also (often simultaneously) evaluates
  whether the evidence supports the audit opinion
  by first estimating misstatements in each account
  and then for the overall financial statements.

29
V. Issue the Audit Report

• The auditor should not decide the appropriate
  audit report until all evidence has been
  accumulated and evaluated.
• Because the audit report is the only thing that
  many users see in the audit process and the
  consequences of issuing an inappropriate report
  can be severe, it is critical that the report be
  correct.

30
VI. Communicate with the Audit Committee and
Management

1. Audit Committee Communication
2. Management Communication

31
A. Audit Committee Communication

• SAS 99 and SAS 54 require the auditor to
  communicate all fraud and illegal acts to the
  audit committee, regardless of materiality.
• Auditor must also communicate significant
  deficiencies and material weaknesses in the
  design or operation of internal control.
• SAS 61 states that certain major items be
  communicated to the audit committee for all SEC
  engagements and other audits where there is an
  audit committee or similarly designated body.
  (See page 729)

32
B. Management Communication

• A management letter is intended to inform client
  personnel of the CPAs recommendations for
  improving any aspect of the clients business.
• A management letter is optional and is intended
  to help the client operate its business more
  effectively.

33
VII. Subsequent Discovery of Facts

• If the auditor becomes aware after the financial
  statements have been issued to some information
  included in the statements is materially
  misleading, the auditor has an obligation to make
  certain that users who are relying on the
  financial statements are informed about the
  misstatements.
• Request the client to issue an immediate revision
  of the financial statements containing an
  explanation of the reasons.
• Client should inform the SEC and other regulatory
  agencies of the misleading financial statements.
• If the client refuses to cooperate, the auditor
  must inform the board of directors. Auditor must
  also notify regulatory agencies and, when
  practical, each person who relies on the
  financial statements, that the statements are no
  longer trustworthy.

34
Summary of the Audit Process
Phase I
Phase III
Plan and design an audit approach.
Perform analytical procedures and tests of
details of balances.
Phase II
Phase IV
Perform tests of controls and substantive
tests of transactions.
Complete the audit and issue an audit report.
35
Phase IV Completing the Audit
Review for contingent liabilities
Evaluate results
Issue audit report
Review for subsequent events
Communicate with audit committee and management
Accumulate final evidence