2. 24 - 1 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Completing the Audit Chapter 24

3. 24 - 2 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Learning Objective 1 Conduct a review for contingent liabilities and commitments.

4. 24 - 3 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Summary of the Audit Process Phase I Plan and design an audit approach. Phase II Perform tests of controls and substantive tests of transactions. Phase III Perform analytical procedures and tests of details of balances. Phase IV Complete the audit and issue an audit report.

5. 24 - 4 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Phase IV – Completing the Audit Review for contingent liabilities. Review for subsequent events. Accumulate final evidence. Evaluate results. Issue audit report. Communicate with audit committee and management.

6. 24 - 5 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Contingent Liabilities A contingent liability is a potential future obligation to an outside party for an unknown amount resulting from activities that have already taken place.

7. 24 - 6 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Likelihood of Occurrence and Financial Statement Treatment Reasonablypossible Footnote disclosure is necessary Probable (likely to occur) Adjust financial statements or note disclosure Remote (slight chance) No disclosure necessary Likelihood of occurrence of event Financial statement treatment

8. 24 - 7 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Auditor’s Concerns  Pending litigation for patent infringement, product liability, or other actions product liability, or other actions  Income tax disputes  Product warranties  Notes receivable discounted  Guarantees of obligations of others  Unused balances of outstanding letters of credit

9. 24 - 8 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Audit Procedures for Finding Contingencies Inquire of management (orally and in writing) about the possibility of unrecorded contingencies. unrecorded contingencies. Review current and previous years’ internal revenue reports for income tax settlements. Review the minutes of directors’ and stockholders’ meetings for indications of lawsuits or other contingencies. of lawsuits or other contingencies.

10. 24 - 9 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Audit Procedures for Finding Contingencies Analyze legal expenses and review invoices and statements from legal counsel. Obtain a letter from each major attorney of the client as to the status of pending litigation. Review audit documentation for any information that may indicate a potential contingency. Examine letters of credit in force.

11. 24 - 10 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Learning Objective 2 Obtain and evaluate letters from the client’s attorneys.

12. 24 - 11 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Inquiry of Client’s Attorneys A list including (1) pending threatened litigation and (2) asserted or unasserted claims or and (2) asserted or unasserted claims or assessments with which the attorney assessments with which the attorney has had involvement. A request that the attorney furnish information or comment about the progress of each item listed.

13. 24 - 12 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Inquiry of Client’s Attorneys A request for the identification of any unlisted pending or threatened legal action or a statement that the client’s list is complete. A statement informing the attorney of the attorney’s responsibility to inform management of legal matters requiring disclosure in the financial statements and to respond directly to the auditor.

14. 24 - 13 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Sarbanes-Oxley Act Congress included provisions in this act directing the SEC to issue rules requiring attorneys serving public companies to report material violations by the company of federal securities laws. The American Bar Association amended its attorney-client confidentiality rules to permit attorneys to breach confidentiality if a client is committing a crime or fraud.

15. 24 - 14 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Learning Objective 3 Conduct a post-balance-sheet review for subsequent events.

16. 24 - 15 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Period Covered by Subsequent Events Review Client’s ending balance sheet date12-31-05 Date client issues financial statements3-26-06Auditreportdate3-11-06 Period to which review for subsequent events applies Period for processing the financial statements

17. 24 - 16 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Types of Subsequent Events 1 Those that have a direct effect on the financial statements and require adjustment 2 Those that have no direct effect on the financial statements but for which disclosure is advisable

18. 24 - 17 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Requiring Adjustment  Declaration of bankruptcy by a customer with an accounts receivable balance with an accounts receivable balance  Settlement of a litigation at an amount different from the amount recorded different from the amount recorded on the books on the books  Disposal of equipment not being used in operations at a price below the current operations at a price below the current book value book value  Sale of investments at a price below recorded cost recorded cost

19. 24 - 18 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Advisability of Disclosure  Decline in the market value of securities held for temporary investment or resale held for temporary investment or resale  Issuance of bonds or equity securities  Decline in the market value of inventory as a consequence of government action as a consequence of government action barring further sale of a product barring further sale of a product  Uninsured loss of inventories as a result of fire of fire  A merger or an acquisition

20. 24 - 19 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Audit Tests Procedures normally integrated as a part of the verification of year-end account balances Procedures performed specifically for the purpose of discovering events or transactions that must be recognized as subsequent events

21. 24 - 20 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder  Inquire of management.  Correspond with attorneys.  Review internal statements prepared subsequent to the balance sheet date. subsequent to the balance sheet date.  Review records prepared subsequent to the balance sheet date. to the balance sheet date.  Examine minutes issued subsequent to the balance sheet date. to the balance sheet date.  Obtain a letter of representation, Audit Tests

22. 24 - 21 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Dual Dating The first date is the date for the completion of field work except for a specific exception. The second date, which is always later, deals with the exception.

23. 24 - 22 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Learning Objective 4 Design and perform the final steps in the evidence-accumulation segment of the audit.

24. 24 - 23 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 1. Perform final analytical procedures. 2. Evaluate the going-concern assumption. 3. Obtain a management representation letter. 4. Consider information accompanying the basic financial statements. basic financial statements. 5. Read other information in the annual report. Final Evidence Accumulation

25. 24 - 24 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Management Representation Letter To impress upon management its responsibility for the assertions in the financial statements To document the responses from management to inquiries about various aspects of the audit to inquiries about various aspects of the audit

26. 24 - 25 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 1. Financial statements 2. Completeness of information 3. Recognition, measurement, and disclosure 4. Subsequent events 5. Internal control Management Representation Letter

27. 24 - 26 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 1. Management’s acknowledgment of its responsibility for establishing and responsibility for establishing and maintaining effective internal control maintaining effective internal control over financial reporting over financial reporting 2. Management’s conclusion about the effectiveness of internal control over effectiveness of internal control over financial reporting as of the end of financial reporting as of the end of the fiscal period the fiscal period 3. Disclosure of all deficiencies 4. Management’s knowledge of any fraud Management Representation Letter: Internal Control

28. 24 - 27 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Information Accompanying Basic Financial Statements Balance sheet Income statement Statement of cash flows Footnotes Detailed comparative statements Statistical data Schedule of insurance coverage BasicfinancialstatementsStandardauditor’sreport Informationaccompanying basic financial statements Separate paragraph – unqualified, qualified, or disclaimer

29. 24 - 28 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Learning Objective 5 Integrate the audit evidence gathered, and evaluate the overall audit results.

30. 24 - 29 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Evaluate Results Sufficiency of evidence Evidence supports auditor’s opinion Financial statement disclosures

31. 24 - 30 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Evaluate Results Audit documentation review Independent review Summary of evidence evaluation

32. 24 - 31 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Completing the Engagement Checklist YESNO 1.Examination of prior year’s audit documentation a.Were last year’s audit files examined for areas of emphasis in the current-year audit? b.Was the permanent file reviewed for items that affect the current year?

33. 24 - 32 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Completing the Engagement Checklist YESNO 2.Internal control a.Has internal control been adequately understood? b.Is the scope of the audit adequate in light of the assessed control risk? c.Have all major weaknesses been included as reportable conditions in a letter to the audit committee or to senior management?

34. 24 - 33 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Completing the Engagement Checklist YESNO 3.General documents a.Were all current-year minutes and resolutions reviewed, abstracted, and followed up? b.Has the permanent file been updated? c.Have all major contracts and agreements been reviewed and abstracted and copied with all existing legal requirements?

35. 24 - 34 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Evaluating Results and Reaching Conclusions Actual audit evidence (by cycle, account, (by cycle, account, and objective) and objective) Audit procedures Sample size Items to select Timing Evaluate results (by account and cycle) (by account and cycle) Estimated misstatement (by account) (by account) Achieved audit risk (by account and cycle) (by account and cycle)

36. 24 - 35 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Evaluating Results and Reaching Conclusions Evaluate overall financial statements financial statements Estimated misstatement (overall statements) (overall statements) Achieved audit risk (overall statements) (overall statements) Issueauditreport

37. 24 - 36 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder The audit report is the only thing that most users see in the audit process, and the consequences of issuing an inappropriate report can be severe. Issue the Audit Report

38. 24 - 37 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Learning Objective 6 Communicate effectively with the audit committee and management.

39. 24 - 38 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder  Communicate fraud and illegal acts  Communicate internal control deficiencies  Other communication with audit committee  Management letters Communicate with the Audit Committee and Management

40. 24 - 39 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Learning Objective 7 Identify the auditor’s responsibilities when facts affecting the audit report are discovered after its issuance.

41. 24 - 40 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Period Covered by Subsequent Events Review Date client issues financial statements3-26-06 Client’s ending balance sheet date12-31-05 Period to which review for subsequent events applies Period for processing the financial statementsAuditreportdate3-11-06 Period in which subsequent discovery of facts is made

42. 24 - 41 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder End of Chapter 24