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Completing the Audit By David N. Ricchiute
AUDITING CHAPTER 17 Completing the Audit By David N. Ricchiute
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TOPICS Testing revenue, expenses Estimates, losses, contingencies
Related party transactions Legal matters Management representation letter, opinion, & other communications Subsequent discoveries & omitted procedures GBW 8th ed., Ch. 17
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SUBSTANTIVE TESTS FOR REVENUE & EXPENSES
Analytical tests for reasonableness Tests details if Control risk maximum Transaction volume low; account needs special attention Analytical procedures reveal unusual, unexpected results GBW 8th ed., Ch. 17
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ACCOUNTING ESTIMATES Examples Warranty claims Uncollectible accounts
Depreciation, amortization Airline passenger revenue; subscription income Percentage of completion income Loss contingencies GBW 8th ed., Ch. 17
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AUDITING ACCOUNTING ESTIMATES
Objectives Management developed all material estimates Estimates reasonable & in accord with GAAP Procedures Review test process for developing ratios Develop independent estimate to compare Review subsequent events GBW 8th ed., Ch. 17
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CONSIDERATION OF LOSS CONTINGENCIES
Examples Pending, threatened litigation Guaranties of 3rd party obligations Discounted, factored A/R Disputed income tax deductions GBW 8th ed., Ch. 17
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ACCOUNTING TREATEMENT: Loss Contingencies
SFAS No. 5, “Accounting for Contingencies” Recognize (record) if Liability probably incurred AND Loss estimable Report (footnote disclosure) if Liability probably incurred OR loss estimable OR If reasonable possibility liability incurred GBW 8th ed., Ch. 17
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FINDING LOSS CONTINGENCIES
Inquire of management Read minutes of board, shareholders’ meetings Read contracts, loan, lease agreements, etc. Review IRS reports Analyze legal expenses, documentation Review work papers for possible contingencies GBW 8th ed., Ch. 17
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PROCEDURES TO COMPLETE AUDIT
Review for related party transactions Review for subsequent events Inquire of client’s legal counsel Obtain management representation letter Form opinion GBW 8th ed., Ch. 17
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RELATED PARTY TRANSACTIONS
Legal form may not reflect economic substance Transaction not recorded at “arms length” Increases with incentives to manipulate earnings Maintain favorable earnings trend Overly optimistic earnings forecast Dependency on single/few products Declining industry; many business failures Pending litigation GBW 8th ed., Ch. 17
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PROCEDURES: RELATED PARTY TRANSACTIONS
Review Minutes for authorized transactions Proxy material for related parties Management’s conflict-of-interest statements Extent, nature business with major customers, suppliers, borrowers, lenders Invoices from law firms Loan confirmations for guarantees GBW 8th ed., Ch. 17
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AUDITOR’S EVALUATION: Related Party Transactions
Objectives Assess purpose, nature, extent of transactions Effects of transactions on financial statements Additional procedures Inquire of management Examination documentation Ensure authorization GBW 8th ed., Ch. 17
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SUBSEQUENT EVENTS Type 1: Adjust accounts for events that
Confirm or reveal conditions existing on/before balance sheet date Collectibility receivables, loss realizations Type 2: Disclose information (notes) for events that Reveal conditions arising after balance sheet date Business combinations, new indebtedness, changes in capital structure GBW 8th ed., Ch. 17
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PROCEDURES FOR SUBSEQUENT EVENTS
Read interim statements, board, shareholders’ minutes Inquire Contingent liabilities, commitments Changes in capital structure, indebtedness, working capital Changes in estimates; unusual adjustments Obtain lawyers’ letters, management representation letter GBW 8th ed., Ch. 17
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DISCLOSURE: Subsequent Events
Type 1 Adjust financial statements Type 2 Explanatory note Parenthetical explanation Reference Do not issue unqualified opinion GBW 8th ed., Ch. 17
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INQUIRIES OF CLIENT’S LEGAL COUNSEL
Inquiry of Client’s Lawyer, SAS 12 (required) Management prepares list of legal issues Information requested Description, evaluation of outcome, completeness of list for Pending, threatened litigation Unasserted claims, assessments GBW 8th ed., Ch. 17
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MANAGEMENT REPRESENTATION LETTER
Management’s representations, SAS 85 (required) Financial statement responsibility, conformity with GAAP Complete information available to auditor Recognitions, measurement, disclosure Subsequent events GBW 8th ed., Ch. 17
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FORMING AN OPINION Procedures
Overall review through analytical procedures (SAS 56) Relationships, account balances reasonable Workpaper review Considers documented fair presentation all accounts Technical review by another (concurring) partner GBW 8th ed., Ch. 17
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COMMUNICATIONS WITH AUDIT COMMITTEES (SAS 61)
Responsibilities under GAAS Significant accounting policies, judgments, estimates Significant audit adjustments Disagreements with management Difficulties GBW 8th ed., Ch. 17
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COMMON QUESTIONS BY AUDIT COMMITTEE
Revenue recognition Asset valuation Contingencies Reserves GBW 8th ed., Ch. 17
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COMMON QUESTIONS: Problematic Accounting Policies
No authoritative GAAP Alternative methods Controversial, uncommon transactions GBW 8th ed., Ch. 17
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COMMON QUESTIONS: New Areas, Events
Reserves Changes in principle Estimate Deferrals, accruals Prior-period adjustments GBW 8th ed., Ch. 17
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COMMON QUESTIONS: Management Imposed Problems
Uncorrected weaknesses in internal control Unavailable, uncooperative personnel Inadequate schedules from client Unavailable evidence GBW 8th ed., Ch. 17
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SUBSEQUENT DISCOVERY OF FACTS
For facts existing at report date, consider whether Information reliable Facts did exist Audit report would have been affected if known Important to those relying on report GBW 8th ed., Ch. 17
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AUDITOR RESPONSE TO CLIENT DISCLOSURE
Client makes disclosure If facts can be determined in reasonable period Issue revised statements and opinion if necessary If facts can not be determined in reasonable period Notify all persons known to be relying on financial statements GBW 8th ed., Ch. 17
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AUDITOR RESPONSE IF DISCLOSURE REFUSED
If client refuses to make disclosure of subsequent facts auditor will Notify board Notify regulatory agencies GBW 8th ed., Ch. 17
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OMITTED PROCEDURES Discovered after report date (SAS 46) Objective
Determine if report still supported Consider persons relying on report GBW 8th ed., Ch. 17
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PROCEDURES AFTER REPORT DATE
Assess importance of omitted procedures to financial statements taken as a whole Review workpapers Discuss circumstances with staff Re-evaluate audit scope GBW 8th ed., Ch. 17
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