Chapter 16 Auditing Operations and Completing the Audit McGraw-Hill/IrwinCopyright © 2014 by The McGraw-Hill Companies, Inc. All rights reserved.

Auditing Operations  Corporate earnings are considered as an extremely important indicator of health and well-being of corporations  Measurement of income is generally regarded as the single most important function of accounting 16-2

Objectives for audit of revenue and expenses 1. Use the understanding of the client and its environment to consider inherent risks, including fraud risks, related to revenues and expenses. 2. Consider internal control over revenues and expenses. 3. Assess the risks of material misstatement of revenues and expenses and design further audit procedures that: a. Establish the occurrence of recorded revenue and expense transactions. b. Determine the completeness of recorded revenue and expense transactions. c. Establish the accuracy of revenue and expense transactions. d. Verify the cutoff of revenue and expense transactions. e. Determine that the presentation and disclosure of revenue and expense accounts are appropriate, including the proper classification of amounts and the proper presentation of earnings- per-share data. 16-3

Audit of Statement of Cash Flows  Amounts are audited in conjunction with the audit of balance sheet and income statement accounts  Presentation and disclosure important audit objective is important Operating Investing Financing 16-4

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 16-5

Loss Contingencies  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 16-6

Litigation  Most common loss contingency – pending or threatened litigation Letter of inquiry to client’s legal counsel Evidence of pending and threatened litigation Unasserted claims - need to be disclosed if probable and reasonably possible SAS 12 Auditors should obtain from management a list describing and evaluating threatened or pending litigation 16-7

Other Contingencies  Income tax disputes  Accommodation endorsements and other guarantees of indebtedness  Accounts receivable sold or assigned with recourse  Environmental issues  Commitments  General risk contingencies 16-8

Audit Procedures for Loss Contingencies 1.Review the minutes of directors’ meetings to the date of completion of fieldwork. 2. Send letter of inquiry to client’s lawyer 3. Send confirmation letters to financial institutions to request information on contingent liabilities of the company. 4. Review correspondence with financial institutions for evidence of accommodation endorsements, guarantees of indebtedness, or sales or assignments of accounts receivable. 5. Review reports and correspondence from regulatory agencies to identify potential assessments or fines. 6. Obtain a representation letter from the client indicating that all liabilities known to officers are recorded or disclosed. 16-9

Responsibility for Subsequent Events 16-10

Procedures to Identify Subsequent Events  Review latest available financial statements and minutes of the board and selected committees  Inquiry about matters dealt with at meetings for which minutes are not available  Inquiry of management  Obtain lawyer’s letter  Obtain representations from management 16-11

Obtain Representation Letter  Purpose is to have the client’s principal officers acknowledge that they are primarily responsible for the fairness of the financial statements  Dated as of the date of the audit report  Not a substitute for application of necessary audit procedures 16-12

Misstatements  Known misstatements Specific misstatements identified during the course of the audit  Likely misstatements Due to extrapolation from audit evidence or differences in accounting estimates  Evaluation Material misstatements must be corrected Quantitative and qualitative factors 16-13

Review the Engagement  Review of work of audit staff accomplished through review of audit working papers  Typically performed by seniors  Review of working papers not completed until near (of after) completion of fieldwork  Partner and manager devote attention to accounts with higher risk of material misstatement  Second partner review prior to issuance of audit report 16-14

Reporting on Other Information with the Financial Statements Reporting on Other Information with the Financial Statements 16-15

Required Communication with Those Charged with Governance  Auditor responsibility under generally accepted auditing standards (e.g., to form and express an opinion, and management’s responsibilities)  An overview of the planned scope and timing of the audit  Significant findings from the audit Qualitative aspects of accounting practices Audit difficulties encountered Uncorrected misstatements Disagreements with management Management consultations with other accountants Auditor independence issues Other issues

Post-Audit Responsibilities  Auditor subsequent discovery of facts existing at date of report Advise client to make appropriate disclosure of the facts to anyone actually or likely to be relying upon the audit report and financial statements If client refuses to make disclosure, CPA should inform each member of board and notify regulatory agencies 16-17

Subsequent Discovery of Omitted Audit Procedures  Discovered during peer review or other subsequent review of working papers  Assess importance of omitted procedures to their previously issued opinion If omission impairs ability to support issued opinion and report being relied upon by third parties, attempt to perform omitted procedure or appropriate alternative procedure 16-18