MODERN AUDITING 7th Edition William C. Boynton California Polytechnic State University at San Luis Obispo Raymond N. Johnson Portland State University Walter G. Kell University of Michigan Developed by: Gregory K. Lowry, MBA, CPA Saint Paul’s College John Wiley & Sons, Inc.

CHAPTER 19 COMPLETING THE AUDIT/POSTAUDIT RESPONSIBILITIES Completing the Fieldwork Evaluating the Findings Communicating with the Client

CHAPTER 19 COMPLETING THE AUDIT/POSTAUDIT RESPONSIBILITIES Appendix 19A: Examples of Possible Reportable Conditions

Completing the Audit In completing the audit, the auditor frequently works under severe time constraints, particularly as clients seek the earliest possible data for the issuance of the audit report. Although time may not be an ally of the auditor, the auditor must take the time to make sound professional judgments and to express the opinion appropriate in the circumstances. The auditor’s responsibilities in completing the audit are divided into the following 3 categories: 1. completing fieldwork, 2. evaluating the findings, and 3. communicating with the client.

Completing the Fieldwork In completing the fieldwork, the auditor performs specific auditing procedures to obtain additional audit evidence. The procedures are: 1. Making subsequent events review 2. Reading minutes of meetings 3. Obtaining evidence concerning litigation, claims, and assessments 4. Obtaining client representation letter 5. Performing analytical procedures

Completing the Fieldwork Making Subsequent Events Review The auditor’s responsibility for assessing the fairness of a client’s financial statements is not limited to an examination of events and transactions that occur up to the balance sheet date. SAS 1, Codification of Statements on Auditing Standards (AU 560, Subsequent Events), states that the auditor also has specified responsibilities for events and transactions that: 1. have a material effect on the financial statements and 2. occur after the balance sheet date but prior to the issuance of the financial statements and the auditor’s report. These occurrences are referred to as subsequent events.

Completing the Fieldwork Types of Events AU 560.03, and .05 indicate that there are 2 types of subsequent events: 1. Type 1 subsequent events provide additional evidence with respect to conditions that existed at the date of the balance sheet and affect the estimates inherent in the process of preparing financial statements. 2. Type 2 subsequent events provide evidence with respect to conditions that did not exist at the date of the balance sheet but arose subsequent to that date.

Completing the Fieldwork Type 1 events require adjustment of the financial statements; type 2 events require disclosure in the statements, or in very material cases, attaching pro-forma (as if) data to the financial statements. The following examples are illustrative of the 2 types of events:

Completing the Fieldwork Auditing Procedures in the Subsequent Period The auditor should identify and evaluate subsequent events up to the date of the auditor’s report, which should be as of the end of fieldwork. This responsibility is discharged in the following 2 ways: 1. by being alert for subsequent events in performing year-end substantive tests such as cutoff tests and searching for unrecorded liabilities and 2. by performing the following auditing procedures specified in AU 560.12 at or near the completion of fieldwork:  Read the latest available interim financial statements and compare them with the statements being reported on and make other comparisons appropriate in the circumstances.

Completing the Fieldwork  Inquire of management having responsibility for financial and accounting matters as to:  Any substantial contingent liabilities or commitments existing at the balance sheet date or date of inquiry.  Any significant changes in capital stock, long-term debt, or working capital to the date of inquiry.  The current status of items previously accounted for on the basis of tentative, preliminary, or inconclusive data.  Whether any unusual adjustments have been made since the balance sheet date.

Completing the Fieldwork  Read minutes of meetings of directors, stockholders, and other appropriate committees.  Inquire of client’s legal counsel concerning litigation, claims, and assessments.  Obtain letter of representation from client about subsequent events that would, in its opinion, require adjustment or disclosure.  Make additional inquiries or perform additional procedures considered necessary in the circumstances.

Completing the Fieldwork Letter of Audit Inquiry It should be recognized that an auditor normally does not possess sufficient legal skills to make an informed judgment about all LCA. Thus, AU 337.08 indicates that a letter of audit inquiry to the clients lawyer(s) is the auditor’s primary means of obtaining corroboration of the information about LCA furnished by management. A letter of audit inquiry is illustrated in Figure 19-2.

Completing the Fieldwork Obtaining Client Representation Letter The auditor is required to obtain certain written representations from management in meeting the third standard of fieldwork. This is accomplished through a client representation letter, commonly referred to as a rep letter. AU 333, Management Representations (SAS 85 and SAS 89), explains that representations are part of evidential matter but they are not a substitute for the application of the auditing procedures necessary to afford a reasonable basis for an opinion.

Completing the Fieldwork Management representations: 1. Confirm oral representations given to the auditor 2. Document the continuing appropriateness of such representations 3. Reduce the possibility of misunderstandings concerning management’s representations

Completing the Fieldwork A rep letter may complement other auditing procedures. The rep letter may also contain management’s statements that LCAs are properly accounted for and that there are no unasserted claims or assessments that require disclosure in the financial statements. If a representation made by management is contradicted by other audit evidence, the auditor should investigate the circumstances and consider the reliability of the representation made.

Completing the Fieldwork Content of Representation Letter AU 333.06 provides guidance on 4 major categories of specific representations that should be included in a rep letter. The rep letter should include representations about: 1. Financial statements 2. Completeness of information 3. Recognition, measurement, and disclosures 4. Subsequent events

Evaluating the Findings The auditor has the following 2 objectives in evaluating the findings: 1. determining the type of opinion to be expressed and 2. determining whether GAAS has been met in the audit.

Evaluating the Findings To meet these objectives, the auditor completes the following steps: 1. Making final assessment of materiality and audit risk 2. Evaluating whether there is substantial doubt about the entity’s ability to continue as a going concern 3. Making technical review of financial statements 4. Formulating opinion and drafting audit report 5. Making final review(s) of working papers

Evaluating the Findings Evaluating Going Concern AU 341, The Auditor’s Consideration of an Entity’s Ability to Continue as a Going Concern, establishes a responsibility for the auditor to evaluate whether there is substantial doubt about the client’s ability to continue as a going concern for a reasonable period of time, not to exceed one year beyond the date of the financial statements being audited. Ordinarily, information that would raise substantial doubt about the going concern assumption relates to the entity’s inability to continue to meet its obligations as they become due without substantial disposition of assets outside the ordinary of business, restructuring of debt, externally forced revisions of its operations, or similar actions.

Evaluating the Findings If the auditor believes there is substantial doubt about the entity’s ability to continue as a going concern for a reasonable period of time, he or she should take the following steps: 1. Obtain information about management’s plans that are intended to mitigate the effect of such of such conditions or events, and 2. Assess the likelihood that such plans can be effectively implemented.

Evaluating the Findings If, after evaluating management’s plans, the auditor concludes there is substantial doubt about a going concern, he or she should: 1. consider the adequacy of disclosure about the entity’s possible inability to continue as a going concern for a reasonable period of time, and 2. include an explanatory paragraph (following the opinion paragraph) in the audit report to reflect his or her conclusion.

Evaluating the Findings Making Final Review(s) of Working Papers The first-level review of working by a supervisor is made to evaluate the work done, the evidence obtained, and the conclusions reached by the preparer of the working papers. Additional reviews of the working papers are made at the end of field work by members of the audit team. The levels of review that may be made in completing the audit are shown in the following table:

Communicating with the Client The auditor’s communication with the client at the conclusion of the audit involve the audit committee and management. The communications to the audit committee involve matters pertaining to: 1. the client’s internal controls and 2. the conduct of the audit. The communication to management is made in a management letter.

Communicating with the Client Preparing Management Letter During the course of an audit engagement, auditors observe many facets of the client’s business organization and operations. At the conclusion of an audit, many auditors believe it is desirable to write a letter to management, known as a management letter, that contains recommendations not included in the required communication with the audit committee.

Communicating with the Client Management letters may include comments on: 1. Internal control matters that are not considered to be reportable conditions. 2. Recommendations regarding the management of resources and value- added services noted during the audit. 3. Tax-related matters. A summary of the auditor’s responsibilities in completing the audit is presented in Figure 19-5.

Summary of Auditor’s Responsibilities in Completing the Audit Figure 19-5 COMPLETING THE FIELDWORK EVALUATING THE FINDINGS COMMUNICATING WITH THE CLIENT Communicate internal control matters Make subsequent events review Making final assessment of materiality and audit risk Communicate matters pertaining to conduct of the audit Read minutes of meetings Evaluating substantial doubt about an entity’s ability to continue as a going concern Making technical review of financial statements Obtain evidence concerning litigation, claims, and assessments Prepare management letter Obtain client representation letter Formulating opinion and drafting report Making final review(s) of working papers Perform analytical Procedures

Postaudit Responsibilities Postaudit responsibilities include consideration of: 1. Subsequent events occurring between the date and issuance of the auditor’s report. 2. The discovery of existing facts. 3. The discovery of omitted procedures.

Examples of Possible Reportable Conditions Appendix 19A Deficiencies in Internal Control Design 1. Inadequate overall internal control design. 2. Absence of appropriate segregation of duties consistent with appropriate control objectives. 3. Absence of appropriate reviews and approvals of transactions, accounting entries, or systems output. 4. Inadequate procedures for appropriately assessing and applying accounting principles.

Examples of Possible Reportable Conditions Appendix 19A 5. Absence of other control techniques considered appropriate for the type and level of transaction activity. 6. Inadequate provisions for the safeguarding of assets. 7. Evidence that a system fails to provide complete and accurate output consistent with objectives and current needs because of design flaws.

Examples of Possible Reportable Conditions Appendix 19A Failures in the Operation of Internal Control 1. Evidence of failure of identified controls in preventing or detecting misstatements of accounting information. 2. Evidence that a system fails to provide complete and accurate output consistent with the entity’s control objectives because of the misapplication of control procedures. 3. Evidence of failure to safeguard assets from loss, damage, or misappropriation.

Examples of Possible Reportable Conditions Appendix 19A 4. Evidence of intentional override of the internal control structure by those in authority to the detriment of the overall objectives of the system. 5. Evidence of failure to perform tasks that are part of the internal controls, such as reconciliations not prepared or not timely prepared. 6. Evidence of willful wrongdoing by employees or management.

Examples of Possible Reportable Conditions Appendix 19A 7. Evidence of manipulation, falsification, or alteration of accounting records or supporting documents. 8. Evidence of intentional misapplication of accounting principles. 9. Evidence of misrepresentation by client personnel to the auditor. 10. Evidence that employees or management lack the qualifications and training to fulfill their assigned functions.

Examples of Possible Reportable Conditions Appendix 19A Others 1. Absence of a sufficient level of control consciousness within the organization. 2. Failure to follow up and correct previously identified internal control deficiencies. 3. Evidence of significant or extensive undisclosed related party transactions. 4. Evidence of undue bias or lack of objectivity by those responsible for accounting decisions.

CHAPTER 19 COMPLETING THE AUDIT/POSTAUDIT RESPONSIBILITIES

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