24-1
Chapter 24
Completing the Audit
Concept Checks
P. 776
1. The auditor is particularly concerned with whether management has
the financial statements and accompanying footnotes. This helps
audit objective.
2. A contingency is a potential future obligation to an outside party for an
unknown amount resulting from activities that have already taken place.
There is uncertainty about the amount of the future payment or
impairment
3. The first type of subsequent event is one that has a direct effect on
the financial statements and requires adjustment. Examples of this
type of subsequent event are as follows:
Declaration of bankruptcy by a customer with an outstanding
accounts receivable balance due to the deteriorating financial
condition
The second type of subsequent event is one that has no direct
effect on the financial statements but for which disclosure is advisable.
Examples include the following:
Issuance of bonds or equity securities
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P. 788
1. A client letter of representation is a written communication from the client
to the auditor formalizing statements that the client has made about
are to:
Impress upon management its responsibility for the financial
statements
the financial statements
Document responses from management to inquiries about various
aspects of the audit
1. Financial statements
with generally accepted accounting principles
principles
2. Completeness of information
stockholders, directors, and committees of directors
Absence of unrecorded transactions
3. Recognition, measurement, and disclosure
Management’s belief that the effects of any uncorrected
financial statement misstatements are immaterial to the
Information concerning fraud involving (1) management, (2)
employees who have significant roles in internal control, or
Information concerning related party transactions and
in accordance with accounting standards
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Concept Check, P. 788 (continued)
assets, and assets pledged as collateral
4. Subsequent events
Bankruptcy of a major customer with an outstanding account
receivable at the balance sheet date
For audits of public companies, PCAOB auditing standards require
the auditor to obtain specific representations from management about
are noted below:
5. Internal controls
Management’s acknowledgement of its responsibility for
establishing and maintaining effective internal controls over
financial reporting.
Auditors of accelerated filer public companies may obtain a
2. A summary of unadjusted misstatement schedule is used by the auditor to
accumulate any misstatements identified during the audit that may not be
individually material, but may be material when aggregated. In addition,
the auditor considers the impact on the current year financial statements
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Concept Check, P. 788 (continued)
If the auditor concludes that an account or financial statement
category is materially misstated after aggregating individually immaterial
misstatements, the auditor will request that the client correct at least
Review Questions
24–1 There are four presentation and disclosure–related audit objectives:
PRESENTATION AND
DISCLOSURE–RELATED
AUDIT OBJECTIVES
DESCRIPTION
Occurrence and rights and
obligations
Account–related information as described in the
footnotes exists and represents the rights and
obligations of the company.
Completeness
All required disclosures are included in the financial
statement footnotes.
Accuracy and valuation
Footnote disclosures are accurate and valued
correctly.
Classification and
understandability
Account balances are appropriately classified and
related financial statement disclosures are
understandable.
The auditor performs many of the procedures to address presentation and
disclosure–related audit objectives in conjunction with other tests. For example,
A financial statement disclosure checklist is an audit tool that summarizes all
disclosure requirements contained in accounting standards. Auditors use the
disclosure checklist to determine that all required disclosures are completely
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24–2 The auditor would be interested in a client’s future commitments to
24–3 A contingent liability is a potential future obligation to an outside party
for an unknown amount resulting from activities that have already taken place.
Some examples would be:
Pending litigation
Income tax disputes
would be:
Notes payable
Accounts payable
Accrued interest payable
Income taxes payable
Payroll withholding liabilities
Accrued salaries and wages
file for communication with attorneys. This might give an indication that the
potential for a liability exists even though no actual litigation has begun. Finally,
following up on patent disputes noted in prior years would indicate whether the
dispute was resolved or is still outstanding.
letters of confirmation about contingencies (attorney letters) from attorneys to
whom payment was made.
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Copyright © 2017 Pearson Education, Inc.
24–6 Pyson should determine the materiality of the lawsuits by requesting
from Merrill’s attorneys an assessment of the legal situations and the probable
liabilities involved. In addition, Pyson may have his own attorney assess the
situations. Proper disclosure in the financial statements will depend on the
attorneys’ evaluations of the probable liabilities involved. If the evaluations
indicate highly probable, material amounts, footnote disclosure will be
necessary, assuming the amount of the probable material loss cannot be
reasonably estimated. If the client refuses to make adequate disclosure of the
contingencies, a qualified or adverse opinion may be necessary.
24–8 If an attorney refuses to provide the auditor with information about
material existing lawsuits or likely material unasserted claims, auditing standards
require that the audit opinion be modified to reflect the lack of available
24–9 The major considerations the auditor should take into account in
determining the extent of the subsequent events review are:
The company’s financial strength and stability of earnings
completion of the audit
Changes in key personnel
PCAOB auditing standards require auditors of public companies to
also inquire about changes in internal control over financial reporting
subsequent events are:
Perform cutoff and valuation tests of various balances and related
transactions; e.g., sales cutoff tests
Inquire of management about any subsequent events
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24–10 (continued)
subsequent to the balance sheet date
Obtain a letter of representation
24–11 This is a subsequent discovery of facts as the financial statements and
audit opinion were issued five months ago. The auditor has an obligation to
If the auditor’s original opinion on internal controls concluded that
controls were effective, then they would evaluate the new information related to
the material weakness to determine whether the material weakness existed as
of the balance sheet date. If it is determined internal controls over financial
disclose the material weakness.
24–12 The weakness in Lawson’s approach is the danger of discovering an
inadequacy in one audit area that could affect other areas of the audit. For
example, if misstatements were discovered as part of the tests of controls for
assets are used as collateral.
Another difficulty with Lawson’s approach is that there is no combining
of the misstatements in different audit areas to determine if the combined
misstatements are material. If the combined misstatements are
considered material, it may be necessary to expand the testing in certain areas
or require adjusting entries to some balances.
aggregated and disclosed on the financial statements.
Examples where adequate disclosure could depend heavily upon the
accumulation of evidence are:
The disclosure of declines in inventory values below cost
The segregation of current from noncurrent receivables
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24–13 (continued)
from affiliates
The disclosure of contingent liabilities that the auditor has not been
informed of by the client
Examples where audit evidence does not normally significantly affect
the adequacy of the disclosure are:
an extraordinary item
differences in the nature and purposes of these communications, most auditors
prefer to send the management letter separately.
Items that might be included in a management letter are recommendations
such as to:
Switch inventory valuation methods
Install a formal security system
Prepare more timely bank reconciliations
Segregate duties
24–15 Information accompanying basic financial statements is any and all
information prepared by management for outside users included with the basic
financial statements. Examples include detailed comparative statements supporting
control totals in the basic statements, supplementary information required by
24–16 A regular audit documentation review is the one that is done by someone
who is knowledgeable about the client and the unique circumstances in the
audit.
The purposes of this review are to:
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24–16 (continued)
Evaluate the performance of inexperienced personnel
performance
To counteract the bias that frequently enters into the auditor’s
judgment.
An independent review is one done by a completely independent person
who has no experience on the engagement. The purpose is to have a competent
review are:
A number of small adjustments waived that should have been
accumulated into an adjusting journal entry due to materiality
Too narrow and too biased of a scope in an audit area
Inadequate disclosure of contingencies
accepted accounting principles that have been discussed with
management, ramifications of the use of such alternative disclosures
As the audit of the public company is completed, the auditor should
determine that the audit committee is informed about the initial selection of and
changes in significant accounting policies or their application during the current
audit period. When changes have occurred, the auditor should inform the
areas.
24–10
Multiple Choice Questions From CPA Examination
24–18 a. (1) b. (2) c. (3) d. (4)
Discussion Questions And Problems
Knowledge of both contingencies and commitments is
extremely important to users of financial statements because they
represent the encumbrance of potentially material amounts of
resources during future periods, and thus affect the future cash flows
available to creditors and investors. Because of this, accounting
b. Three useful audit procedures for uncovering contingencies that
Johnson would likely perform in the normal conduct of the audit,
even if she had no responsibility for uncovering contingencies, are:
Review internal revenue agent reports of income tax
settlements
stockholders
Confirm used and unused balances of lines of credit
c. Three other procedures Johnson is likely to perform specifically for
the purpose of identifying undisclosed contingencies to help her
objective are:
Make inquiries of management
Analyze legal expenses for indication of contingent liabilities
Request letters from attorneys regarding the existence and
status of litigation and other potential contingent liabilities