Completing

the Audit
Engagement
 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.
Examples
Probable: The future event is likely to occur.
• Pending or threatened litigation
Reasonably Possible: The chances of the
• Actual or possible claims and
assessments
future event occurring is more than remote
but less than probable.
• Income tax disputes
• Product warranties or defects Remote: The chance of the future event
• Guarantees of obligations to
occurring is slight.
others
• Agreements to repurchase
receivables that have been sold
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Audit Procedures for Identifying
Contingent Liabilities
Read minutes of meetings
of the board of directors,
committees of the board,
and stockholders.
Review contracts, loan
agreements, leases, and
correspondence from
government agencies.

Review tax returns, IRS

reports, and schedules
supporting the client’s
income tax liability.

Confirm or otherwise Inspect other documents for

document guarantees and possible guarantees or
letters of credit. other similar arrangements.

3
 Audit Procedures for Identifying
Contingent Liabilities
Specific Audit Procedures Conducted Near
Completion of Audit
Inquire and discuss with
Examine documents in the entity’s
management about its policies and
records such as correspondence
procedures for identifying,
and invoices from attorneys for
evaluating, and accounting for
pending or threatened lawsuits.
contingent liabilities.

Obtain written representation from

management that all litigation,
Obtain a legal letter that describes
asserted and unasserted claims,
and evaluates any litigation, claims,
and assessments have been
or assessments.
disclosed in accordance with FASB
ASC Topic 450.
4
 Legal Letters
A letter of audit inquiry (legal letter) sent to the
client’s attorneys is the primary means of
obtaining or corroborating information about
litigation, claims, and assessments.

5
 LO# 3

Example of Legal Letter

6
Example of Legal Letter

Source: Arens, Elder & Beasley (2012)

7
 Commitments
Long-term contracts to purchase
raw materials or sell their
products at a fixed price

To secure the
To obtain a favorable
availability of raw
pricing arrangement
materials

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 the
financial statements. 8
 Subsequent Events
 Sometimes events occur after the balance sheet
date but before the issuance of the financial
statements that materially affect the financial
statements. Such events are called subsequent
events.
 An auditor has a duty to actively perform
procedures to detect subsequent events up
through the date of the auditor’s report.
 An auditor is not required to perform procedures
to detect subsequent events occurring after the
report date and prior to the issuance of the
report. However, such events may come to
his/her attention, and appropriate consideration
must be given to them.
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Review for Subsequent Events for
Audit of Financial Statements
Balance
Sheet Date
Type I Event Type II Event
Conditions existed Conditions did not
before the balance exist at the balance
sheet date and affect sheet date and do not
estimates that are part affect the accuracy of
of financial statements the financial statements

Require adjustment of Require disclosure and

the financial possibly pro forma
statements financial statements
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Subsequent Events: Dating the Report

11
 Dual Dating
When a subsequent event is recorded or disclosed
in the financial statements after sufficient,
appropriate audit evidence has been obtained
but before the issuance of the financial
statements, the auditor considers the following
options for dating of the auditor’s report:
(1) “Dual date” the report (original date of report
plus date of subsequent event—limits liability)
(2) Change the date of the auditor’s report to the
date of the subsequent event—extends liability

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Audit Procedures to Look for
Subsequent Events
Examples of audit
Inquire of procedures
Management
Read Interim
Financial
Read Minutes Statements
of Meetings Examine the
Books of
Inquire of Original Entry
Legal Counsel

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 Final Evidential
Evaluation Processes
Perform final analytical Obtain a Review working
procedures. representation letter. papers.

Evaluate financial Obtain an independent

Assess final audit
statement presentation review of the
results.
and disclosure. engagement.

Evaluate entity’s ability

to continue as a going
concern.

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 Perform Final Analytical
Review Procedures
 Analytical Review is required in the final
review stages of the audit.
 The procedures will use “final” financial
statement amounts (after adjustments).
 Typically performed at a high level (senior
manager or partner)
 Auditor considers whether the financial
statement amounts make sense given the
auditor’s knowledge gained during the
audit.
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 Obtain a Letter of
Representations
 Commonly called a ‘rep letter’
 Puts in writing all significant
representations that management made
to the auditors
 Drafted by the auditors, but it is typed on
client’s letterhead and signed by the CEO
and CFO (and perhaps others)
 If client refuses to sign a rep letter, it
would constitute a scope limitation

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Example Rep Letter

17
Example Rep Letter (cont’d)

18
Example Rep Letter (cont’d)

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Example Rep Letter (cont’d)

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 Working Paper Review
 Each working paper should be reviewed by
an audit team member who is senior to
the person preparing the working papers.
 For example:
– A senior would review staff working papers
– A manager would review the senior’s working
papers and probably staff working papers, too.
– A partner typically reviews the critical working
papers, and any prepared by the manager.
 The partner needs to ensure that the
working papers support the audit opinion.
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 Assessing Final Results:
Estimating Likely Misstatements

22
 Independent Engagement
Quality Review
 Most firms require an engagement quality
review for publicly traded companies and
for privately held companies whose
financial statements will be widely
circulated.
 Performed by a partner who has not
otherwise participated on the engagement
 Will review/scrutinize significant findings
and critical judgments

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 Archiving and Retention
Sarbanes-Oxley Act and PCAOB’s Documentation Standard:
• Require audit firms to archive their public-company audit files for
retention within 45 days following the time the auditor grants permission
to use the auditor’s report in connection with the issuance of the
company’s financial statements.
• Require audit firms to retain audit documentation for 7 years from the
date of completion of the engagement, as indicated by the date of the
auditor’s report, unless a longer period of time is required by law.
• Require audit firms to retain all documents that “form the basis of the
audit or review.”
• Require audit firms to include in the audit file for significant matters any
document created, sent, or received, including documents that are
inconsistent with a final conclusion. Significant changes in audit plans or
conclusions must also be documented.

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 Evaluation of Going Concern
 What is a going concern?
 When going concern is an issue, consider
management’s plans to address the issue
(e.g. sell stock, dispose of assets, etc.)
 Auditor considers the entity’s ability to
continue as a going concern for one year
from the balance sheet date
 Factors that may be considered when
evaluating going concern 

25
Going Concern Considerations

26
Going Concern Considerations

27
 Evaluation of Going Concern
 After evaluating evidence and
management’s plans with regard to going
concern, 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 (one year), the
auditor should:
– Consider the adequacy of disclosure in the
footnotes to the financial statements
– Add an explanatory paragraph to the auditor’s
report
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 Communications with:
“Those Charged with Governance”
 Required by the auditing standards
 For public companies, “those charged with
governance” would normally be the board
of directors, and the audit committee in
particular.
 Intent of this requirement is to promote a
healthy dialog between the auditors and
those charged with governance about the
financial reporting matters.
 Will occur at various times during the
audit process 29
 Communications with:
“Those Charged with Governance”

30
 Subsequent Discovery of Facts Existing at
the Date of the Auditor’s Report

 Auditor has no obligation to conduct audit

procedures after the audit report is issued
 However, if facts existing at the date of
auditor’s report come to the attention of
the auditor after the report has been
issued that could have affected the
financial statements or the auditor’s
opinion, the auditor has an obligation to
investigate and take appropriate action.

31
 Subsequent Discovery of Facts Existing at
the Date of the Auditor’s Report
 Auditor’s attorney should probably be
consulted due to the legal liability involved
 If financial statements were in error, the
auditor should request that the client issue
an immediate revision of the financial
statements, if possible.
 If immediate revision is not possible, the
client should notify all people believed to
be relying on the statements that they
should stop relying on the financial
statements.
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Subsequent Discovery of Facts Existing
at the Date of the Auditor’s Report

If the client refuses to cooperate:

Notify the client that the

auditor’s report must no
longer be associated with
Notify any regulatory
the financial statements.
agency having jurisdiction
over the client that the
Notify each person known auditor’s report can no
to the auditor to be relying longer be relied upon.
on the financial statements.
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McGraw-Hill/Irwin
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Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.