Completing the Audit

Chapter 24

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 24 - 1

 Learning Objective 1

Conduct a review for contingent

liabilities and commitments.

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 24 - 2

 Summary of the Audit Process

Phase III
Phase I
Perform analytical
Plan and design an audit
procedures and tests
approach.
of details of balances.

Phase II
Phase IV
Perform tests of controls
Complete the audit and
and substantive tests
issue an audit report.
of transactions.

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 24 - 3

 Phase IV Completing the Audit

Review for contingent

Evaluate results.
liabilities.

Review for
Issue audit report.
subsequent events.

Communicate with
Accumulate final
audit committee
evidence.
and management.

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 24 - 4

 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.

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 24 - 5

 Likelihood of Occurrence and
Financial Statement Treatment
Likelihood of Financial statement
occurrence of event treatment
Remote No disclosure
(slight chance) necessary

Reasonably Footnote disclosure is

possible necessary

Probable Adjust financial statements

(likely to occur) or note disclosure
2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 24 - 6
 Auditors Concerns

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

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 24 - 7

 Audit Procedures for Finding
Contingencies
Inquire of management (orally and in
writing) 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.

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 24 - 8

 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.

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 24 - 9

 Learning Objective 2

Obtain and evaluate letters from

the clients attorneys.

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 24 - 10

 Inquiry of Clients 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.

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 Inquiry of Clients Attorneys

A request for the identification of any unlisted

pending or threatened legal action or a
statement that the clients list is complete.

A statement informing the attorney of the attorneys

responsibility to inform management of legal matters
requiring disclosure in the financial statements
and to respond directly to the auditor.

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 24 - 12

 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.

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 24 - 13

 Learning Objective 3

Conduct a post-balance-sheet
review for subsequent events.

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 24 - 14

 Period Covered by Subsequent
Events Review
Clients ending Audit Date client
balance sheet report issues financial
date date statements

12-31-05 3-11-06 3-26-06

Period to which review for Period for

subsequent events applies processing
the financial
statements
2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 24 - 15
 Types of Subsequent Events

Those that have a direct effect

1 on the financial statements
and require adjustment

Those that have no direct effect

2 on the financial statements but
for which disclosure is advisable

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 24 - 16

 Requiring Adjustment

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

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 Advisability of Disclosure

Decline in the market value of securities

held for temporary investment or resale
Issuance of bonds or equity securities
Decline in the market value of inventory
as a consequence of government action
barring further sale of a product
Uninsured loss of inventories as a result
of fire
A merger or an acquisition

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 24 - 18

 Audit Tests

Procedures normally integrated as

a part of the verification of year-end
account balances

Procedures performed specifically for

the purpose of discovering events or
transactions that must be recognized
as subsequent events

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 24 - 19

 Audit Tests

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,

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 24 - 20

 Dual Dating

The first date is the date for the

completion of field work except
for a specific exception.

The second date, which is

always later, deals with
the exception.

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 24 - 21

 Learning Objective 4

Design and perform the final steps

in the evidence-accumulation
segment of the audit.

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 24 - 22

 Final Evidence Accumulation

1. Perform final analytical procedures.

2. Evaluate the going-concern assumption.
3. Obtain a management representation letter.
4. Consider information accompanying the
basic financial statements.
5. Read other information in the annual report.

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 24 - 23

 Management Representation
Letter

To impress upon management its responsibility

for the assertions in the financial statements

To document the responses from management

to inquiries about various aspects of the audit

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 24 - 24

 Management Representation
Letter

1. Financial statements
2. Completeness of information
3. Recognition, measurement, and disclosure
4. Subsequent events
5. Internal control

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 24 - 25

 Management Representation
Letter: Internal Control
1. Managements acknowledgment of its
responsibility for establishing and
maintaining effective internal control
over financial reporting
2. Managements conclusion about the
effectiveness of internal control over
financial reporting as of the end of
the fiscal period
3. Disclosure of all deficiencies
4. Managements knowledge of any fraud
2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 24 - 26
 Information Accompanying Basic
Financial Statements
Balance sheet
Income statement Basic Standard
financial auditors
Statement of statements report
cash flows
Footnotes
Detailed comparative Information
statements accompanying
basic financial
Statistical data statements
Schedule of
insurance coverage Separate paragraph
unqualified, qualified,
or disclaimer

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 24 - 27

 Learning Objective 5

Integrate the audit evidence

gathered, and evaluate the
overall audit results.

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 24 - 28

 Evaluate Results

Sufficiency of evidence

Evidence supports auditors opinion

Financial statement disclosures

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 24 - 29

 Evaluate Results

Audit documentation review

Independent review

Summary of evidence evaluation

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 24 - 30

 Completing the Engagement
Checklist
YES NO
1. Examination of prior years audit
documentation
a. Were last years audit files examined
for areas of emphasis in the
current-year audit?
b. Was the permanent file reviewed for
items that affect the current year?

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 24 - 31

 Completing the Engagement
Checklist
YES NO
2. Internal control
a. Has internal control been adequately
understood?
b. Is the scope of the audit adequate in
light of the assessed control risk?
c. Have all major weaknesses been
included as reportable conditions in
a letter to the audit committee or to
senior management?

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 24 - 32

 Completing the Engagement
Checklist
YES NO
3. General documents
a. Were all current-year minutes and
resolutions reviewed, abstracted,
and followed up?
b. Has the permanent file been
updated?
c. Have all major contracts and
agreements been reviewed and
abstracted and copied with all
existing legal requirements?

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 24 - 33

 Evaluating Results and Reaching
Conclusions

Actual audit evidence

(by cycle, account, Evaluate results
and objective) (by account and cycle)

Audit procedures Estimated misstatement

Sample size (by account)
Items to select Achieved audit risk
Timing (by account and cycle)

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 24 - 34

 Evaluating Results and Reaching
Conclusions

Evaluate overall
financial statements
Issue
audit
Estimated misstatement
report
(overall statements)
Achieved audit risk
(overall statements)

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 24 - 35

 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.

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 24 - 36

 Learning Objective 6

Communicate effectively with the

audit committee and management.

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 24 - 37

 Communicate with the Audit
Committee and Management
Communicate fraud and illegal acts
Communicate internal control deficiencies
Other communication with audit committee
Management letters

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 24 - 38

 Learning Objective 7

Identify the auditors

responsibilities when facts
affecting the audit report are
discovered after its issuance.

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 24 - 39

 Period Covered by Subsequent
Events Review
Clients ending Audit Date client
balance sheet report issues financial
date date statements

12-31-05 3-11-06 3-26-06

Period to which Period for Period in which

review for processing subsequent
subsequent the financial discovery of
events applies statements facts is made

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 24 - 40

 End of Chapter 24

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