Completing the Audit Chapter 24 2010 Prentice Hall

Completing the Audit Chapter 24 © 2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley 24 - 1

Learning Objective 1 Design and perform audit tests related to presentation and disclosure audit objectives. © 2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley 24 - 2

Presentation and Disclosure Audit Objectives (page 761) Occurrence and rights and obligations: Disclosed events and transactions have occurred and pertain to the entity. Completeness: All disclosures that should have been included in the financial statements have been included. © 2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley 24 - 3

Presentation and Disclosure Audit Objectives (page 761) Classification and understandability: Financial information is appropriately presented and described and disclosures are clearly expressed. Accuracy and valuation: Financial and other information are disclosed fairly and at appropriate amounts. © 2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley 24 - 4

Learning Objective 2 Conduct a review for contingent liabilities and commitments. © 2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley 24 - 5

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. © 2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley 24 - 6

Likelihood of Occurrence and Financial Statement Treatment Likelihood of Occurrence of Event Financial Statement Treatment Remote (slight chance) No disclosure is necessary Reasonably possible Footnote disclosure is necessary Probable (likely to occur) Adjust financial statements or note disclosure depending on amounts involved © 2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley 24 - 7

Auditor’s Concerns Ø Ø Ø Pending litigation for patent infringement, 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 © 2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley 24 - 8

Audit Procedures for Finding Contingencies Inquire of management about the possibility of 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. © 2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley 24 - 9

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. © 2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley 24 - 10

Learning Objective 3 Obtain and evaluate letters from the client’s attorneys. © 2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley 24 - 11

Inquiry of Client’s Attorneys A list including: (1) pending threatened litigation and (2) asserted or unasserted claims or assessments with which the attorney has had involvement. A request that the attorney furnish information or comment about the progress of each item listed. © 2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley 24 - 12

Inquiry of Client’s Attorneys A request of the law firm to identify any unlisted pending or threatened legal actions 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. © 2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley 24 - 13

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. © 2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley 24 - 14

Learning Objective 4 Conduct a post-balance-sheet review for subsequent events. © 2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley 24 - 15

Period Covered by Subsequent Events Review Client’s ending balance sheet date 12 -31 -09 Period to which review for subsequent events applies © 2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley Audit Date client report issues financial date statements 3 -11 -10 3 -26 -10 Period for processing the financial statements 24 - 16

Types of Subsequent Events Ø Those that have a direct effect on the financial statements and require adjustment Ø Those that have do not have a direct effect on the financial statements but for which disclosure is required © 2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley 24 - 17

Requiring Adjustment Ø Ø Declaration of bankruptcy by a customer with an accounts receivable balance Settlement of a litigation at an amount different from the amount recorded on the books Disposal of equipment not being used in operations at a price below the current book value Sale of investments at a price below recorded cost © 2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley 24 - 18

Advisability of Disclosure Decline in the market value of securities held for temporary investment or resale Ø Issuance of bonds or equity securities Ø Decline in the market value of inventory as a consequence of government action barring further sale of a product Ø Uninsured loss of inventories as a result of fire Ø A merger or an acquisition Ø © 2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley 24 - 19

Audit Tests Two categories of audit procedures for the subsequent events review: 1. Procedures normally integrated as a part of the verification of year-end account balances. 2. Procedures performed specifically for the purpose of discovering events or transactions that must be recognized as subsequent events. © 2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley 24 - 20

Audit Tests Ø Ø Ø Inquire of management Correspond with attorneys Review internal statements prepared subsequent to the balance sheet date Review records prepared subsequent to the balance sheet date Examine minutes issued subsequent to the balance sheet date Obtain a letter of representation © 2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley 24 - 21

Dual Dating Ø The first date is the date for the completion of field work except for a specific exception Ø The second date, which is always later, deals with the exception Example: An auditor returned to the client’s premises to perform audit tests pertaining only to the acquisition and completes those tests on March 31. The audit report will be dual-dated as follows: March 11, 2010, except for note 17, which is dated March 31, 2010. © 2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley 24 - 22

Learning Objective 5 Design and perform the final steps in the evidence-accumulation segment of the audit. © 2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley 24 - 23

Final Evidence Accumulation 1. 2. 3. 4. Perform final analytical procedures. Evaluate the going-concern assumption. Obtain a management representation letter. Consider information accompanying the basic financial statements. 5. Read other information in the annual report. © 2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley 24 - 24

Management Representation Letter Purposes of the letter: 1. To impress upon management its responsibility for the assertions in the financial statements. 2. To remind management of potential misstatements or omissions in the financial statements. 3. To document the responses from management to inquiries about various aspects of the audit. © 2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley 24 - 25

Four Categories in Management Representation Letter 1. Financial statements 2. Completeness of information 3. Recognition, measurement, and disclosure 4. Subsequent events © 2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley 24 - 26

Information Accompanying Basic Financial Statements Balance sheet Income statement Statement of cash flows Basic Standard financial auditor’s statements report Footnotes Detailed comparative statements Statistical data Schedule of insurance coverage © 2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley Information accompanying basic financial statements Separate paragraph – unqualified, or disclaimer 24 - 27

Learning Objective 6 Integrate the audit evidence gathered and evaluate the overall audit results. © 2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley 24 - 28

Evaluate Results Ø Sufficient appropriate evidence Ø Evidence supports auditor’s opinion Ø Financial statement disclosures ØAudit documentation review ØIndependent review ØSummary of evidence evaluation © 2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley 24 - 29

Evaluating Results and Reaching Conclusions Actual audit evidence (by cycle, account, and objective) Evaluate results (by account and cycle) Audit procedures Sample size Items to select Timing Estimated misstatement (by account) Achieved audit risk (by account and cycle) © 2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley 24 - 30

Evaluating Results and Reaching Conclusions Evaluate overall financial statements Estimated misstatement (overall statements) Achieved audit risk (overall statements) © 2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley Issue audit report 24 - 31

Issue the Audit Report 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. © 2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley 24 - 32

Learning Objective 7 Communicate effectively with the audit committee and management. © 2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley 24 - 33

Communicate with the Audit Committee and Management Ø Communicate fraud and illegal acts Ø Communicate internal control deficiencies Ø Other communication with audit committee Ø Management letters © 2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley 24 - 34

Learning Objective 8 Identify the auditor’s responsibilities when facts affecting the audit report are discovered after its issuance. © 2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley 24 - 35

Review for Subsequent Events and Discovery of Facts Client’s ending balance sheet date Audit report date 12 -31 -09 Period to which review for subsequent events applies Date client issues financial statements 3 -11 -10 3 -26 -10 Period for processing the financial statements © 2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley Period in which subsequent discovery of facts is made 24 - 36

End of Chapter 24 © 2010 Prentice Hall Business Publishing, Auditing 13/e, Arens//Elder/Beasley 24 - 37