Chap017 Revised

8/6/2019 Chap017 Revised

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17-1

Review for Contingent Liabilities

A contingent liability is defined as an existing

condition, situation, or set of circumstances

involving uncertainty as to possible loss to an entity

that will ultimately be resolved when some future

event occurs or fails to occur.

Probable: The future event is likely to occur.

Reasonably Possible: The chances of the

future event occurring is more than remote

but less than probable.

Remote: The chance of the future event

occurring is slight.

Examples

Pending or threatened litigation;

Actual or possible claims and

assessments;

Income tax disputes;

Product warranties or defects;

Guarantees of obligations to

others;

Agreements to repurchase

receivables that have been sold.

LO# 1


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Audit Procedures for Identifying

Contingent LiabilitiesRead minutes of meetings

of the board of directors,

committees of the board,

and stockholders.

Review contracts, loan

agreements, leases, and

correspondence from

government agencies.

Confirm or otherwise

document guarantees and

letters of credit.

Inspect other documents for

possible guarantees.

Review income tax liability,

tax returns, and IRS agents

reports.

LO# 2


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Audit Procedures for Identifying

Contingent Liabilities

Inquiry and discussion with

management about its policies and

procedures for identifying,

evaluating, and accounting for

contingent liabilities.

Examine documents in the entitys

records such as correspondence

and invoices from attorneys for

pending or threatened lawsuits.

Obtain a legal letter that describes

and evaluates any litigation, claims,

or assessments.

Obtain written representation from

management that all litigation,

asserted and unasserted claims,

and assessments have been

disclosed in accordance with FASB

No. 5.

Specific Audit Procedures Conducted Near

Completion of Audit

LO# 2


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Legal Letters

A letter of audit inquiry (a legal letter) sent to the

clients attorneys is the primary means of

obtaining or corroborating information about

litigation, claims, and assessments.

LO# 3


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Commitments

Long-term commitments are usually identified through inquiry of client

personnel during the audit of the revenue and purchasing processes.

In most cases, such commitments are disclosed in a footnote to thefinancial statements.

Long-term contracts to purchase

raw materials or sell their

products at a fixed price.

To obtain a favorable

pricing arrangement.

To secure the

availability of raw

materials.

LO# 4


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17-6

Review for Subsequent Events for

Audit of Financial StatementsBalance

Sheet Date

Type I Event

Affects estimates

that are part of

financial

statements.

Type II Event

Conditions did

not exist at the

balance sheet

date.

Require adjustment of

the financial

statements.

Require disclosure and

possibly pro forma

financial statements.

LO# 5


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Review of Subsequent Events

forAudit of Financial Statements

LO# 5


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Dual DatingWhen a subsequent event is recorded or disclosed

in the financial statements after the date on

which the auditor has obtained sufficient

appropriate audit evidence but before the

issuance of the financial statements, the auditormust consider the following options for dating of

the auditors report:

(1) Dual date the report (limits liability)

(2) Use the date of the subsequent event.

LO# 6


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Audit Procedures for Subsequent

EventsInquire of

Management

Read Interim

FinancialStatements

Examine the

Books of

Original Entry

Examples of audit

procedures

Read Minutes

of Meetings

Inquire of

Legal Counsel

Obtain

Management

Representatio

n Letter

LO# 7


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17-10

Review of Subsequent Events for

Audit of Internal Control over FinancialReporting

Auditors of public companies are responsible to

report on any changes in internal control that

might affect financial reporting between the end

of the reporting period and the date of the

auditors report.

LO# 7


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Final Evidential Evaluation

ProcessesPerform final analytical

procedures.

Evaluate entitys ability

to continue as a going

concern.

Obtain a

representation letter.

Review working

papers.

Final assessment of

audit results.

Evaluation of financial

statement presentation

and disclosure.

Obtain an independent

review of the

engagement.

LO# 8


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Estimating Likely Misstatements

LO# 8


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Archiving and RetentionSarbanes-Oxley Act and PCAOBs Documentation Standard

Requires audit firms to archive their public-company audit files forretention within 45 days following the time the auditor grants permission

to use the auditors report in connection with the issuance of the

companys financial statements.

Retain audit documentation for 7 years from the date of completion of theengagement, as indicated by the date of the auditors report, unless alonger period of time is required by law.

Retain all documents that form the basis of the audit or review.

Include in the audit file for significant matters any document created,

sent, or received, including documents that are inconsistent with a finalconclusion. Significant changes in audit plans or conclusions must also

be documented.

LO# 8


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Going Concern Considerations

LO# 9

Normal Audit Procedures That May Identify Conditions and

Events Indicating Going Concern Problems:

Analytical procedures

Review of subsequent events

Tests for compliance with debt agreementsReading of board ofdirectors and other committee minutes

Inquiry of legal counsel

Confirmation with parties on arrangements to provide or

maintain financial support


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LO# 9

Financial Conditions and Ratios That Indicate Financial Distress

Financial Conditions:

Recurring operating losses

Current-yeardeficit

Accumulateddeficits

Negative net worthNegative working capital

Negative cash flow

Negative income from operations

Inability to meet interest payments

Ratios:Net worth/total liabilities

Working capital from operations/total liabilities

Current assets/current liabilities

Total long-term liabilities/total assets

Total liabilities/total assets

Net income before taxes/net sales


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LO# 9

Other Financial Difficulties:

Default on loans

Dividends in arrears

Restructuring ofdebt

Denial of trade credit by suppliers

No additional sources of financing

Internal Matters:

Work stoppages

Uneconomic long-term commitments

Dependence on the success of one particular project

External Matters:Legal proceedings

Loss of a major customer or supplier

Loss of a key franchise, license, or patent


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Communications with Audit

Committee and

ManagementAuditors are required to communicate to those charged with governance

certain matters related to the conduct of the audit.

Auditors responsibility

under GAAS.

Significant accounting

policies.

Management judgments

and accounting

estimates.

Significant audit

adjustments.

Auditors judgments about

the quality of the entitys

accounting principles.

Disagreements with

management.

Consultation with other

accountants.

Major issues discussed

with management before

the auditor was retained.

Difficulties

encountered during the

audit.

Fraud involving senior management and fraud that

causes material misstatement of the financialstatements.

LO# 10


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Subsequent Discovery of Facts Existing

at theD

ate of theAud

itors ReportNotify the client that the

auditors report must no

longer be associated with

the financial statements.Notify any regulatory

agency having jurisdiction

over the client that the

auditors report can no

longer be relied upon.

Notify each person known

to the auditor to be relying

on the financial statements.

LO# 11

Documents

Chap017 Revised