Chapter 17 – Completing the Audit Engagement
17-1
CHAPTER 17
COMPLETING THE AUDIT ENGAGEMENT
Answers to Review Questions
17-1 A contingent liability is defined as an existing condition, situation, or set of
circumstances involving uncertainty as to possible loss to an entity that ultimately will be
but less than likely.
3. Remote: The chance of the future event occurring is slight.
Examples of contingent liabilities include
• Pending or threatened litigation
• Actual or possible claims and assessments
17-2 The auditor requests that the attorney provide the following information on pending or
threatened litigation:
• A list and evaluation of any pending or threatened litigation to which the attorney has
devoted substantial attention. The client may provide the list.
• Comments on unasserted claims where his or her views differ from management’s
evaluation.
• Indication if his or her response is limited and the reasons for such limitations.
17-3 Two examples of long-term commitments are the purchase of raw materials or the sale of
products at a fixed price. When the fair market value of the good is less than the purchase
17-4 The two types of subsequent events that require consideration by management and
evaluation by the auditor relevant to financial statement audits are
Type I Events that provide additional evidence about conditions that existed at the date
Chapter 17 – Completing the Audit Engagement
17-2
of the balance sheet and affect the estimates that are part of the financial
statement preparation process. These types of events require adjustment of the
instances, where the effect of the event or transaction is very significant, pro
forma financial statements may be necessary in order to prevent the financial
statements from being misleading.
Examples of Type I events or conditions are
• An uncollectible account receivable resulting from continued deterioration of a
Examples of Type II events or conditions are
• Purchase or disposal of a business by the entity after the balance sheet date.
The two types of subsequent events that require consideration by management and
evaluation by the auditor relevant to the audit of internal control over financial reporting
(ICFR) are
1. Control events that reveal information about a material weakness that existed as of
the end of the reporting period. If the event reveals information about a material
Chapter 17 – Completing the Audit Engagement
17-3
Chapter 17 – Completing the Audit Engagement
17-4
2. Control events that create or reveal information about a new condition that did not
exist as of the end of the reporting period. If the information has a material effect on
the company, the auditor should include an explanatory paragraph describing the
event and its effects or directing the reader’s attention to the event and its effects as
disclosed in management’s report.
Examples of the control events or conditions (relating to both before and after the
reporting period) are
• Relevant internal audit reports (or similar functions, such as loan review in a financial
reporting obtained through other engagements (AS5).
17-5 The auditor would consider dual dating the audit report when a subsequent event is
recorded or disclosed in the financial statements after the date on which the auditor has
17-6 Auditing standards (AU 520, PCAOB AS No. 14), require that the auditor perform
analytical procedures at the final review stage of the audit. The objective of conducting
final analytical procedures near the end of the engagement is to help the auditor assess
17-7 The auditor obtains a representation letter in order to corroborate significant oral
representations made to the auditor and to document the continued appropriateness of
17-8 A quality review partner is generally not associated with the details of the engagement
and is expected to provide an independent review of the audit. The quality review partner
can protect the firm from an inappropriate or non-independent relationship between the
audit partner and the client. The engagement quality control reviewer performs an
17-5
17-9 Three overall steps in the going concern evaluation process are as follows:
1. Consider whether the results of audit procedures performed during the planning,
performance, and completion of the audit indicate whether there is substantial doubt
consider the adequacy of the disclosures about the entity’s ability to continue and
include an explanatory paragraph in the audit report
17-10 The four major categories of events or conditions that may indicate going concern
problems and examples of each are
Financial conditions:
• Recurring operating losses
• Current-year deficit
• Accumulated deficits
Other financial difficulties:
• Default on loans
• Dividends in arrears
Internal matters:
• Work stoppages
17-6
17-11 The items to be communicated are organized into three categories: appointment and
retention of the auditor, obtaining information relevant to the audit and communicating
as fraudulent activities by senior management, the auditor would normally contact those
charged with governance immediately.
17-12 Generally, when previously issued financial statements contain material misstatements
due to unintentional or intentional actions by management, the financial statements will
require revision. If the client refuses to cooperate and make the necessary disclosures, the
auditor should notify the board of directors and take the following steps, if possible:
1. Notify the client that the auditor’s report must no longer be associated with the
way to provide appropriate disclosure.
Answers to Multiple-Choice Questions
17-13
c
17-18
a
17-14
d
17-19
a
17-15
a
17-20
a
17-16
b
17-21
c
17-17
a
Solutions to Problems
17-22 Since the events or conditions that should be considered in the financial accounting for
and reporting of litigation, claims, and assessments are matters within the direct
knowledge, and often, control of management of an entity, management is the primary
source of information about such matters. Accordingly, Harper’s audit procedures with
respect to the existence of loss contingencies arising from litigation, claims, and
assessments should include the following:
Chapter 17 – Completing the Audit Engagement
17-7
the period from the balance sheet date to the date the information is furnished,
accounting principles (FASB ASC 450).
• The auditor should request the client’s management to send a letter of inquiry to those
lawyers with whom management consulted concerning litigation, claims, and
assessments.
Examples of other procedures undertaken for different purposes that might also disclose
litigation, claims, and assessments are the following:
• Read minutes of stockholders, directors, and appropriate committee meetings held
17-23 The omissions, ambiguities, and inappropriate statements and terminology in Cao’s letter
are as follows:
• The action that Consolidated intends to take concerning each suit (e.g., to contest the
matter vigorously, to seek an out-of-court settlement, or to appeal an adverse decision)
is omitted.
inappropriate.
• Young is not requested to identify the nature of and reasons for any limited response.
• Young is not requested to include matters that existed after the balance sheet date, up
to the date of Young’s response.
• The date by which Young’s response is needed is not indicated.
Chapter 17 – Completing the Audit Engagement
17-8
17-24 a. For the financial statement audit, the two types of subsequent events that require
Namiki’s consideration and evaluation are
• Events that provide additional evidence concerning conditions that existed at the
balance sheet date and affect the estimates inherent in the process of preparing
statement disclosure.
If Taylor is a public company, the audit of internal control over financial reporting
includes two types of subsequent events that the auditor must consider:
• Control events that reveal information about a material weakness which existed as
of the end of the reporting period. If the event reveals information about a material
describing the event and its effects or directing the reader’s attention to the event
and its effects as disclosed in management’s report.
b. The auditing procedures Namiki should consider performing to gather evidence
concerning subsequent events include the following:
• Compare the latest available interim statements with the financial statements being
audited.
• Inquire about the current status of items in the audited financial statements that
were accounted for on the basis of tentative, preliminary, or inconclusive data.
Chapter 17 – Completing the Audit Engagement
17-9
• Read or inquire about the minutes of meetings of stockholders or the board of
• Examine and/or inquire about findings included in internal audit reports completed
after year end.
17-25 1. The explosion in Agronowitz’s plant that led to the uncollectibility of Scornick
Company’s accounts receivable was an event whose conditions did not exist at the
balance sheet date. Thus, the event is a Type II event, and should be disclosed in the
financial statements of the year just ended.
2. The tax court ruling in favor of Scornick Company is an event whose conditions
purposes.
5. This is not an event that is considered a subsequent event for financial statement
purposes.
17-26 a. An auditor is required to obtain a written management representation letter as part of
every audit performed in accordance with generally accepted auditing standards.
The purposes of obtaining a written management representation letter are to
• Confirm the oral representations given to the auditor, including that management
accepts responsibility for the fair presentation of the financial statements.
• Obtain evidence concerning management’s future plans and intentions (e.g., when
refinancing debt or discontinuing a line of business).
Chapter 17 – Completing the Audit Engagement
17–10
b. The representation letter should be addressed to the auditor and dated as of the date of
the auditor’s report. The letter should be signed by members of management whom the
auditor believes are responsible for and knowledgeable, directly or through others in
17-27 Other matters that Heinrich’s representation letter should specifically confirm include
whether or not
• Management acknowledges responsibility for the fair presentation in the financial
statements of financial position, results of operations, and cash flows in conformity
with generally accepted accounting principles (or other basis of accounting).
• All material transactions have been properly reflected in the financial statements.
• Management is aware of fraud that could have a material effect on the financial
statements or that involve management or employees who have significant roles in the
internal control system.
• Provision, when material, has been made to reduce receivables to their estimated net
realizable value.
• Provision, when material, has been made to reduce excess or obsolete inventories to
17–11
17-28
Solutions to Discussion Cases
17-29 a. FASB ASC Topic 450, “Contingencies,” deals with the accounting for loss
contingencies. The auditor must decide whether an estimated loss from the
contingency is probable and estimable, probable but not estimable, reasonably
possible, or remote. Since the EPA has not initiated a lawsuit or other regulatory
action against Ceramic Crucibles of America (CCA), the potential loss is an unasserted
claim. It is necessary to consider whether the facts would lead to a conclusion about
the probability that a claim will be asserted against CCA and, if so, whether the
paid most of the costs of pollution cleanups and only a fraction of the costs of
pollution cleanups have been borne by industry, it is quite likely that the company may
never have to pay. An unfavorable outcome under these facts might be considered
remote, and no disclosure would be required.
An argument can also be made that, based on the current evidence of pollution on
the site, and the fact that once the EPA has put a site on the NPL and has authorized an
investigation of the site, it is unlikely that they will not assert a claim. In this case, it is
b. In assessing the materiality of an uncertainty it must be recognized that some
uncertainties are unusual in nature or infrequent in occurrence and thus more closely
17–12
related to financial position than to normal, recurring operations (e.g., litigation related
to alleged violations of antitrust or securities laws). In such instances, the auditor
should consider the possible loss in relation to shareholders’ equity and other relevant
balance sheet components such as total assets, total liabilities, current assets, and
current liabilities.
CCA (or EPA) can take action against the other PRPs, it is unlikely that an
unfavorable outcome would be material. It also does not appear that an unfavorable
outcome would have an adverse affect on the company’s financial position.
c. The auditor could obtain and examine a number of additional pieces of evidence,
including the following:
• Copies of any public documents (e.g., the report rating the site as 8.3) that led to
the site being added to the National Priorities List.
the likelihood of a materially adverse outcome. This should be included in the
management representation letter.
d. It is highly unlikely that the investigation would affect the auditor’s report. Thus, a
17-30 This case presents a realistic situation that can arise on an audit engagement. The main
issue of the case is whether the auditor needs to require the client to make adjustments to
the financial statements for possible misstatements that have been identified during the
audit. These proposed adjustments can result in conflicts between the auditor and client.
a. The issue is the possible obsolescence of the specialized computer components for the
special-order optical scanner. The auditors identified these components as possible
obsolete items in the prior year. The client explained that the items could be sold
without a loss. The components were not sold during the prior year or in the year just
ended, and there appear to be no prospects of a future sale. Based on these facts, the
executives’ vacation pay.
17–13
c. It is difficult to provide detailed guidance on how Schmidt should handle the client’s
demands. Schmidt should try to explain to Adams that GAAP requires that such
adjustments are required in order for the financial statements to present fairly. She
17-31 a. Your partner would not require WWM to record the adjustment since the total for the
three-year period ($7,500 + $5,000 + $75,000 = $87,500) is less than materiality of
$100,000 for the current year.
b. With prior years’ items of $22,500 and $15,000, the total ($112,500) would be greater
Solutions to Internet Assignments
17-32 a. Students can find any of a number of reported contingencies—this is a common type
of disclosure. The identified contingency will be disclosed in the financial statements
if it is a Type II contingency, or if it is a Type I contingency but the amount is not
reasonably estimable.
b. Examples of procedures that may help the auditor identify contingent liabilities
include
• Reading the minutes of meetings of the board of directors, committees of the
board, and stockholders.
• Inspecting other documents for possible guarantees or other similar arrangements.
In addition, near the completion of the engagement the auditor conducts specific audit
procedures to identify contingent liabilities. Such procedures include:
• Inquiry of management regarding the client’s policies and procedures for
identifying, evaluating, and accounting for contingent liabilities.
17–14
• Examining documents in the entity’s records such as correspondence and invoices
ASC Topic 450, “Contingencies.”
17-33 The SEC’s EDGAR database search engine is a good source for finding situations where
the auditor has withdrawn an audit report on a company (www.sec.gov). Students will
also find information on news sites (e.g., The Dow Jones Interactive website).