1. Chapter 17 Completing the Audit Engagement McGraw-Hill/IrwinCopyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

2. Review for Contingent Liabilities A contingent liability is defined as an existing condition, situation, or set of circumstances involving uncertainty as to possible loss to an entity that will ultimately be resolved when some future event occurs or fails to occur. Probable: The future event is likely to occur. Reasonably Possible: The chances of the future event occurring is more than remote but less than probable. Remote: The chance of the future event occurring is slight. Probable: The future event is likely to occur. Reasonably Possible: The chances of the future event occurring is more than remote but less than probable. Remote: The chance of the future event occurring is slight. Examples Pending or threatened litigation Actual or possible claims and assessments Income tax disputes Product warranties or defects Guarantees of obligations to others Examples Pending or threatened litigation Actual or possible claims and assessments Income tax disputes Product warranties or defects Guarantees of obligations to others LO# 1 17-2

3. Audit Procedures for Identifying Contingent Liabilities Read minutes of meetings of the board of directors, committees of the board, and stockholders. Review contracts, loan agreements, leases, and correspondence from government agencies. Confirm or otherwise document guarantees and letters of credit. Inspect other documents for possible guarantees or other similar arrangements. Review tax returns, IRS reports, and schedules supporting the clients income tax liability. LO# 2 17-3

4. Audit Procedures for Identifying Contingent Liabilities Inquire and discuss with management about its policies and procedures for identifying, evaluating, and accounting for contingent liabilities. Examine documents in the entitys records such as correspondence and invoices from attorneys for pending or threatened lawsuits. Obtain a legal letter that describes and evaluates any litigation, claims, or assessments. Obtain written representation from management that all litigation, asserted and unasserted claims, and assessments have been disclosed in accordance with FASB ASC Topic 450. Specific Audit Procedures Conducted Near Completion of Audit LO# 2 17-4

5. Legal Letters A letter of audit inquiry (legal letter) sent to the clients attorneys is the primary means of obtaining or corroborating information about litigation, claims, and assessments. LO# 3 17-5

6. Example of Legal Letter LO# 3 17-6

7. Commitments Long-term commitments are usually identified through inquiry of client personnel during the audit of the revenue and purchasing processes. In most cases, such commitments are disclosed in a footnote to the financial statements. Long-term contracts to purchase raw materials or sell their products at a fixed price To obtain a favorable pricing arrangement To secure the availability of raw materials LO# 4 17-7

8. Review for Subsequent Events for Audit of Financial Statements Balance Sheet Date Type I Event Conditions existed before the balance sheet date and affect estimates that are part of financial statements Type II Event Conditions did not exist at the balance sheet date and do not affect the accuracy of the financial statements Require adjustment of the financial statements Require disclosure and possibly pro forma financial statements LO# 5 17-8

9. Review of Subsequent Events for Audit of Financial Statements Figure 17-1 LO# 5 17-9

10. Dual Dating When a subsequent event is recorded or disclosed in the financial statements after sufficient, appropriate audit evidence has been obtained but before the issuance of the financial statements, the auditor considers the following options for dating of the auditors report: (1) Dual date the report (original date of report plus date of subsequent eventlimits liability so almost always this is what the CPA firm does) (2) Change the date of the auditors report to the date of the subsequent eventextends liability LO# 6 17-10

11. Audit Procedures to Look for Subsequent Events Inquire of Management Read Interim Financial Statements Examine the Books of Original Entry Examples of audit procedures Read Minutes of Meetings Inquire of Legal Counsel LO# 7 17-11

12. Review of Subsequent Events for Audit of Internal Control over Financial Reporting Auditors of public companies with $75,000,000 market cap must report on any changes in internal control that might affect financial reporting between the end of the reporting period and the date of the auditors report. LO# 7 Internal audit reports Independent auditor reports of reportable conditions Regulatory agency reports on ICFR Information obtained from audit of ICFR 17-12

13. Final Evidential Evaluation Processes Perform final analytical procedures. Evaluate entitys ability to continue as a going concern. Obtain a representation letter. Review working papers. Assess final audit results. Evaluate financial statement presentation and disclosure. Obtain an independent review of the engagement. LO# 8 17-13 The AICPAs requirement is SQCS 10.38 The PCAOBs requirement is AS No. 7

14. Estimating Likely Misstatements LO# 8 17-14

15. Archiving and Retention Sarbanes-Oxley Act and PCAOBs Documentation Standard (note that SAS 103 is similar but a bit less stringent): Require audit firms to archive their public-company audit files for retention within 45 days following the time the auditor grants permission to use the auditors report in connection with the issuance of the companys financial statements. Require audit firms to retain audit documentation for 7 years (5 years if a privately held company and thus governed by SAS 103) from the date of completion of the engagement, as indicated by the date of the auditors report, unless a longer period of time is required by law. Require audit firms to retain all documents that form the basis of the audit or review. Require audit firms to include in the audit file for significant matters any document created, sent, or received, including documents that are inconsistent with a final conclusion. Significant changes in audit plans or conclusions must also be documented. LO# 8 17-15

16. Going Concern Considerations LO# 9 17-16

17. Going Concern Considerations LO# 9 17-17

18. Communications to the Audit Committee LO# 10 17-18

19. Communications to the Audit Committee (cont.) In addition to the communications noted on the previous slide, some re internal control are required In addition to the communications noted on the previous slide, some re internal control are required If public company with $75,000,000 market cap, as we noted in Ch. 7, AS 7 says significant deficiencies must be communicated to the audit committee If public company with $75,000,000 market cap, as we noted in Ch. 7, AS 7 says significant deficiencies must be communicated to the audit committee If private (or small public) company, the auditor does not have to look for IC problems (other than for the purpose of performing an effective audit of the financials). However, SAS 115 says the auditor, if he learns of them, must communicate both material weaknesses and significant deficiencies to the audit committee (if there is no audit committee, then to others charged with governance). Also, auditor must communicate all this to management. If private (or small public) company, the auditor does not have to look for IC problems (other than for the purpose of performing an effective audit of the financials). However, SAS 115 says the auditor, if he learns of them, must communicate both material weaknesses and significant deficiencies to the audit committee (if there is no audit committee, then to others charged with governance). Also, auditor must communicate all this to management.

20. Subsequent Discovery of Facts Existing at the Date of the Auditors Report Notify the company that the auditors report must no longer be associated with the financial statements. If a public company, make sure the SEC is notified that the auditors report and the financial statements can no longer be relied upon. If a private company, notify persons known to the auditor to be relying on the financial statements (e.g. banks, other creditors). LO# 11 17-20

21. End of Chapter 17 17-21