1. Copyright © 2007 Pearson Education Canada 1 Chapter 21: Completing the Audit

2. Copyright © 2007 Pearson Education Canada 21-2 Chapter 21 objectives  Describe how the auditor searches for contingent liabilities  Discuss communication with the client’s law firms (purpose, format)  Identify procedures used to examine subsequent events  Provide examples of work completed as part of the final evidence gathering process  How is overall evidence evaluated?

3. Copyright © 2007 Pearson Education Canada 21-3 Contingent liabilities  Contingencies are existing conditions or situations that will be resolved at some future time (S 3290.02) E.g. lawsuits  The auditor needs to obtain information about the nature of the contingent liability, the amount involved, and then assess the likelihood of the outcome

4. Copyright © 2007 Pearson Education Canada 21-4 Searching for contingent liabilities  Following are a few examples that auditors can use to search for contingent liabilities: – Enquire of management – Review minutes of shareholders’ and directors’ meetings – Read contracts, agreements, and related correspondence  What other techniques could the auditor use?

5. Copyright © 2007 Pearson Education Canada 21-5 Evaluating known contingent liabilities  Once the contingent liability has been described and documented, then management’s disclosure needs to be evaluated  Ref. Table 21-1: based upon the likelihood of the event, it may not need to be disclosed, may need to be in the footnotes, or may require an adjustment to the financial statements

6. Copyright © 2007 Pearson Education Canada 21-6 Commitments  Commitments are certain (as opposed to contingent liabilities, where there is uncertainty with respect to the result)  They are usually disclosed in the notes to the financial statements  The auditor tends to use similar procedures to identify and document commitments as for contingent liabilities

7. Copyright © 2007 Pearson Education Canada 21-7 Why are contingencies and commitments important?  Represent the encumbrance of potentially material amounts of future resources  Potentially affect future cash flows  GAAP requires disclosure

8. Copyright © 2007 Pearson Education Canada 21-8 Practice problem 21-19 (p. 612)  Identify audit procedures that would have located particular contingencies or commitments  Do they need to be disclosed or adjusted?

9. Copyright © 2007 Pearson Education Canada 21-9 Confirmation from client’s law firms  Used to evaluate two categories of lawsuits: – Outstanding (or asserted) claim: Client has been notified of the suit or the suit has already been filed – Possible (or unasserted) claim: The client is aware of a situation that could lead to a claim.  Standard format (Figure 21-1) is used

10. Copyright © 2007 Pearson Education Canada 21-10 Importance of analyzing legal expense  May give indication of contingent liabilities  Identifies law firms where confirmation may be required  Identifies events that may need to be confirmed with law firms

11. Copyright © 2007 Pearson Education Canada 21-11 Legal letter  Specific format must be used  The information that lawyers can provide is limited due to their requirement to hold information as confidential

12. Copyright © 2007 Pearson Education Canada 21-12 Practice problem 21-25 (p. 614)  Examine the appropriateness of an approach to sending legal letters  What should be done with specific replies?

13. Copyright © 2007 Pearson Education Canada 21-13 Review for subsequent events  Auditor normally examines subsequent events up to the audit report date, which is the same as the date of substantial completion of field work  Several specific types of evidence need to be gathered  Two types of subsequent events: Those that require adjustment and those that require disclosure

14. Copyright © 2007 Pearson Education Canada 21-14 Subsequent events requiring adjustment  Have a direct effect on the financial statements  Examples: – the declaration of bankruptcy due to the deteriorating financial condition of a customer with a large outstanding accounts receivable balance; – the settlement of a litigation for an amount different from the amount recorded in the books.

15. Copyright © 2007 Pearson Education Canada 21-15 Subsequent events requiring disclosure  Have no direct effect on the financial statements.  Examples: – the decline in market value of securities held for temporary investment or resale; – the issuance of bonds or equity securities; – the declaration of bankruptcy by a customer (with a large outstanding accounts receivable balance) who was inadequately insured and lost everything due to a fire

16. Copyright © 2007 Pearson Education Canada 21-16 Subsequent events evidence includes:  Notes based on discussions with management  Legal letter(s)  Examination of subsequent internal financial statements or other internal documents  Review of shareholder and director minutes  Letter of representation  Cutoff testing

17. Copyright © 2007 Pearson Education Canada 21-17 Final evidence accumulation  Analytical procedures  Evaluation and conclusions regarding going concern concept  Client representation letter  Annual reports  Management discussion and analysis (MD&A)

18. Copyright © 2007 Pearson Education Canada 21-18 Client representation letter  From management  Document’s management’s most important oral representations  What would these include?

19. Copyright © 2007 Pearson Education Canada 21-19 Practice problem 21-22 (p. 613)  Discuss the advantages of a letter of representation  Identify the information normally included

20. Copyright © 2007 Pearson Education Canada 21-20 Management letter  Prepared by auditor  Informs client of recommendations to improve business processes or controls  Specific wording limits this – it is a ‘derivative report’ that is a side benefit of the audit

21. Copyright © 2007 Pearson Education Canada 21-21 Auditor reading other financial information in annual reports:  CICA Handbook section 7500  Requires auditor to read the annual report  Determine consistency with financial statements  Financial statements should be accurately reproduced

22. Copyright © 2007 Pearson Education Canada 21-22 Sufficiency of evidence  Use of a planning model that required that gathering evidence by assertion  Overall review completed by managers and partners (and discussed with audit team); ensure targeted assurance achieved  Evidence should support audit opinion

23. Copyright © 2007 Pearson Education Canada 21-23 Final analytical procedures  Useful as a final review for material misstatements or financial problems not noted during other testing  Final objective look at the financial statements

24. Copyright © 2007 Pearson Education Canada 21-24 Evaluation of going concern assumption  Results of analytical review and overall financial statement review will guide the auditor with respect to risks of business failure  Further queries and followup will be used where liquidity problems surface

25. Copyright © 2007 Pearson Education Canada 21-25 Sufficiency of evidence  Senior audit staff and the audit partner are responsible for assessing evidence in the context of engagement risks and the client risk profile  Detailed review helps to ensure that all field work has been completed and outstanding queries cleared

26. Copyright © 2007 Pearson Education Canada 21-26 Unadjusted misstatement worksheet  This schedule (or worksheet or spreadsheet) would track the errors or potential errors that an auditor located, as well as client adjustments made because of these errors  Helps to identify whether the financial statements may be materially misstated

27. Copyright © 2007 Pearson Education Canada 21-27 Working paper review  Throughout the audit, the working papers and field work would be reviewed on an ongoing basis  Final review involves manager/partner review  For a high risk engagement, standards staff or a second partner may review the file prior to audit opinion release

28. Copyright © 2007 Pearson Education Canada 21-28 Practice problem 21-21 (p. 613)  Evaluate working paper review processes  Are they acceptable?  Why or why not?

29. Copyright © 2007 Pearson Education Canada 21-29 Auditor communications  The auditor may communicate with management and/or the audit committee with respect to several matters. The following communications are required:  Illegal acts  Reportable internal control conditions (internal control deficiencies that could lead to material errors)

30. Copyright © 2007 Pearson Education Canada 21-30 Subsequent discovery of facts  If the auditor becomes aware of a material misstatement after the financial statements have been issued and the auditor’s report released  What should the auditor do?