CHAPTER 19 COMPLETING THE AUDIT / POSTAUDIT RESPONSIBILITIES

Learning Check
19-1. The three categories of activities in completing the audit are (a) completing field work, (b) evaluating the findings, and (c) communicating with the client.

19-2. The activities involved in completing the field work are (a) making subse uent events review, (b) reading minutes of meetings, (c) obtaining evidence concerning litigation, claims, and assessments, (d) obtaining client representation letter, and (e) performing anal!tical procedures. 19-". a. #ubse uent events are events that occur between the balance sheet date and the issuance date of the auditor$s report (which is not the same as the date of the report) that ma! affect the financial statements on which the report is rendered. The subse uent events period e%tends from the balance sheet date to the end of field work on the engagement. The t!pes are& T!pe 1 consists of those events that provide additional evidence with respect to conditions that e%isted at the date of the balance sheet and affect the estimates inherent in the process of preparing financial statements. T!pe 2 consists of those events that provide evidence with respect to conditions that did not e%ist at the date of the balance sheet but arose subse uent to that date. T!pe 1 events re uire ad'ustment of the financial statements. T!pe 2 events re uire disclosure, and in ver! material cases, b! attaching pro-form data to the financial statements. The auditor is re uired b! ())# to search for and to evaluate subse uent events up to the date of the auditor$s report, which should be as of the end of field work. This responsibilit! is discharged b! (1) being alert for subse uent events in performing !ear-end substantive tests after the balance sheet date, and (2) performing specific procedures at or near the completion of field work.

b.

c.

19-*.

a.

+egarding litigation, claims, and assessments (,-)), the auditor should obtain evidential matter on The e%istence of a condition, situation, or set of circumstances indicating an uncertaint! as to the possible loss to an entit! arising from the ,-). The period in which the underl!ing cause for legal action occurred. The degree of probabilit! of an unfavorable outcome. The amount or range of potential loss. ) letter of audit in uir! is a letter sent b! management to the compan!$s outside legal counsel re uesting the law!er to send specified information directl! to the auditor about ,-) against the compan!. The letter is the auditor$s primar! means of obtaining evidence about ,-). .hen the law!er fails to respond, the auditor has a scope limitation. /epending on materialit!, the auditor will e%press either a ualified opinion or a disclaimer of opinion. The ob'ectives of a 1rep1 letter are& (1) confirm oral representations given to the auditor, (2) document the continuing appropriateness of such representations, and (") reduce the possibilit! of misunderstandings concerning management$s representations. .hen the auditor is unable to obtain a rep letter or support a management representation that is material to the financial statements b! other audit procedures, there is a scope limitation. /epending on materialit!, the auditor will e%press either a ualified opinion or a disclaimer of opinion. )lso, depending upon the engagement letter, management2s refusal to furnish written representations ma! be sufficient to cause a breach of contract and allow the auditor to withdraw from the engagement. The ob'ectives of an overall review are to assist the auditor in (1) assessing conclusions reached in the audit and (2) evaluating the financial statement presentation taken as a whole. The review should be made b! an individual having comprehensive knowledge of the client$s business and industr!. 4ormall!, either the partner in charge of the audit or the top manager on the engagement makes the review. )nal!tical procedures performed during the final stages of the audit should be )pplied to critical audit areas identified during the audit. 5ased on financial statement data after all audit ad'ustments and reclassifications have been recogni6ed. )s in other cases, the data ma! be compared to (1) e%pected compan! results, (2) available industr! data, and (") relevant nonfinancial data. The two ob'ectives in evaluating the findings are determining (1) the t!pe of opinion to be e%pressed and (2) whether ())# has been met in the audit.

b.

c.

19-0.

a.

b.

19-3.

a.

b.

c.

19-7. a.

b.

#i% steps in meeting these ob'ectives are& 1. 8aking a final assessment of materialit! and audit risk. 2. 9valuating whether there is substantial doubt about the entit!2s abilit! to continue as a going concern. ". 8aking a technical review of financial statements. *. :ormulating an opinion and drafting the audit report. 0. :ormulating opinion and drafting audit report on internal controls over financial reporting (for public companies). 3. 8aking final review(s) of the working papers. ()uthors note& The uestion asked for * steps, !et the te%tbook lists si% important steps. #i% are listed here to be consistent with the te%t.)

19-;. a.

The purposes of the auditor$s final assessment of materialit! and audit risk are to determine whether (1) the auditor$s preliminar! 'udgments concerning materialit! have been met and (2) audit risk is at an acceptable level to warrant the e%pression of an opinion. <nown misstatement is an uncorrected misstatement in an account identified through substantive tests of details of transactions and balances. ,ikel! misstatement is the total error in an account resulting from (1) known misstatements, (2) pro'ected uncorrected misstatements estimated through audit sampling techni ues, and (") estimated misstatements detected through anal!tical procedures and uantified b! other auditing procedures. )ggregate likel! misstatement is the sum of likel! misstatements in all accounts. =rofessional standards establish a responsibilit! for the auditor to evaluate whether there is substantial doubt about the client2s abilit! to continue as a going concern for a reasonable period of time, not to e%ceed one !ear be!ond the date of the financial statements being audited (generall! one !ear from balance sheet date). >rdinaril!, information that would raise substantial doubt about the going concern assumption relates to the entit!$s inabilit! to continue to meet its obligations as the! become due without substantial disposition of assets outside the ordinar! course of business, restructuring of debt, e%ternall! forced revisions of its operations, or similar actions. The auditor normall! evaluates whether there is substantial doubt about the client2s abilit! to continue as a going concern based on the results of normal audit procedures performed in planning, in gathering evidence to support various audit ob'ectives, and in completing the audit. ?f the auditor concludes that substantial doubt e%ists, he or she should consider the need for the following disclosures& =ertinent conditions and events giving rise to the assessment of substantial doubt about the entit!$s abilit! to continue as a going concern for a reasonable period of time. The possible effects of such conditions and events.

b.

19-9.

a.

b.

c.

 d.

8anagement$s evaluation of the significance of those conditions and events and an! mitigating factors. =ossible discontinuance of operations. 8anagement$s plans (including relevant prospective financial information). ?nformation about the recoverabilit! or classification of recorded asset amounts or the amounts or classification of liabilities.

?f, after considering identified conditions and management$s plans, the auditor concludes that substantial doubt about the entit!$s abilit! to continue as a going concern for a reasonable period of time remains, the audit report is normall! an un ualified audit opinion with an e%planator! paragraph about the uncertaint! (following the opinion paragraph) to reflect that conclusion. The auditor$s conclusion about the entit!$s abilit! to continue as a going concern should be e%pressed through the use of the phrase 1substantial doubt about its (the entit!$s) abilit! to continue as a going concern.1 ?f the auditor concludes that the entit!$s disclosures with respect to the entit!$s abilit! to continue as a going concern are inade uate, a departure from generall! accepted accounting principles e%ists. This ma! result in either a ualified (e%cept for) or an adverse opinion.

19-1@. The technical review of the financial statements includes matters pertaining to the form and content of each of the basic statements as well as to re uired disclosures. 8ost -=) firms use separate checklists for #9- and non-#9- clients. The auditor who performs the initial review of the financial statements completes the checklists. The manager and partner in charge of the engagement (in the case of a publicl! held client then review the checklists, a partner who was not a member of the audit team) reviews them again. 19-11. a. The opinion to be e%pressed is determined b! the partner in charge of the engagement. The decision is made on the basis of the findings made b! the audit team during the audit. -ommunication of the auditor2s opinion is made through the independent auditor2s report. =roposed ad'ustments and disclosures are discussed with the client and differences are resolved. >rdinaril!, agreement is reached and an un ualified opinion can be e%pressed. The opinion to be e%pressed is determined b! the partner in charge of the engagement. The decision is made on the basis of the findings made b! the audit team during the audit about internal controls over financial reporting. The auditor2s opinion is communicated through an audit report on internal controls over financial reporting. The auditor cannot resolve problems in the same wa! material misstatements in the financial statements are discussed and resolved. ?f a material misstatement is found in the financial statements the client ma! correct the misstatement and receive an un ualified opinion. ?f a material weakness in internal controls e%ists at !ear-end it cannot be corrected so that the client will

b.

19-12. a.

b.

receive an un ualified opinion. .hile the auditor ma! agree with management2s assessment that a material weakness e%ists, a material weakness in internal control automaticall! results in an adverse opinion on the effectiveness of internal control over financial reporting. 19-1". a. The primar! reviewers and the nature of their reviews are& +eviewer 8anager =artner in charge of engagement b. 4ature of +eview +eviews working papers prepared b! seniors and reviews some or all of the working papers reviewed b! seniors. +eviews working papers prepared b! managers and reviews other working papers on a selective basis.

The engagement partner$s review of the working papers is designed to obtain assurance that The work done b! subordinates has been accurate and thorough. The 'udgments e%ercised b! subordinates were reasonable and appropriate in the circumstances. The audit engagement has been completed in accordance with the conditions and terms specified in the engagement letter. )ll significant accounting, auditing, and reporting uestions raised during the audit have been properl! resolved. The working papers support the auditor$s opinion. (enerall! accepted auditing standards and the firm$s ualit! control policies and procedures have been met. The second partner ma! be more ob'ective than the partner on the engagement. Thus, the second partner review provides additional assurance that ())# have been met. #econd partner reviews are mandator! for #9registrants.

c.

19-1*. The auditor$s communications with the client at the conclusion of the audit involve the audit committee of the board of directors (or the board directl!) and management. 19-10. a. +eportable conditions represent significant deficiencies in the design or operation of the s!stem of internal control. ) significant deficienc! is an internal control deficienc! that adversel! affects the compan!2s abilit! to initiate, record, process or report e%ternal financial data reliabl! in accordance with ())=. ) significant deficienc! could be a single deficienc!, or a combination of deficiencies, that results in more than a remote likelihood that a misstatement of the annual or interim financial statements that is more than inconse uential in amount will not be prevented or detected. The magnitude of a reportable condition determines whether it is also a material weakness. ) material weakness in internal controls over financial reporting is one that has more than a remote chance that a material misstatement could occur in interim or !ear-end financial statements. ) management letter on reportable conditions should&

b.

?ndicate that the purpose of the audit is to report on the financial statements and not to provide assurance on the internal control structure. ?nclude the definition of a significant deficinec!. ?nclude the restriction on distribution (e.g. restricted to the audit committee, management, and others within the organi6ation). ?n addition, the reportable conditions should be described in one or more separate paragraphs. 19-13. .hen the auditor separatel! identifies and describes material weaknesses in his or her report (management letter), two additional paragraphs are re uired. The first paragraph should contain a definition of the term material weakness and a description of the reportable conditions that are material weaknesses. The second additional paragraph should describe the limitations of the auditor$s work, noting specificall! that the auditor$s consideration of internal controls would not necessaril! disclose all matters considered to be material weaknesses. 19-17. a. b. The communication ma! be oral or written, and it ma! occur during or shortl! after the audit. The communication with the audit committee ma! include such matters as )uditor$s responsibilities under ())#. #ignificant accounting policies. )uditor2s 'udgments about the ualit! of the entit!2s accounting principles 8anagement 'udgments and accounting estimates. #ignificant audit ad'ustments. /isagreements with management. -onsultation with other accountants. 8a'or issues discussed with management prior to retention. /ifficulties in performing the audit. ?n addition, the auditor must communicate significant deficiencies in internal control. The purpose of a management letter is to provide management with recommendations for improving the efficienc! and effectiveness of its operations. ) management letter ma! include comments on ?nternal control matters that are not considered to be significant deficiencies. 8anagement of resources such as cash, inventories, and investments. >ther recommendations on how to improve organi6ation performance. Ta% related matters. The auditor has no responsibilit! to make in uir! or to perform an! auditing procedures on subse uent events occurring after field work but before issuance of the report. .hen a situation comes to the auditor$s attention, he or she is re uired to evaluate the item and consider its effect on the report that is being issued.

19-1;. a.

b.

19-19. a.

b.

The auditor ma! use the event date as the date of the auditor$s report provided all subse uent events review procedures are performed for the period between the original report date and the event date. )lternativel!, the auditor ma! use dual dating in which the report contains two dates& (1) the original date of the report, and (2) a date that refers to the subse uent event that has occurred between the original date of the report and the date of its issuance. ?n this case, it is not necessar! to e%tend performance of all subse uent events review procedures through the later date e%cept as to the particular event giving rise to the dual dating. The auditor has no responsibilit! for the postaudit discover! of facts e%isting at the date of the audit report. Aowever, when the auditor becomes aware of such facts and the facts ma! have affected the report that was issued, he or she must ascertain the reliabilit! of the information. .hen the client refuses to make the necessar! disclosures, the auditor should notif! each member of the board of directors of such refusal and take the following steps to prevent further reliance on the audit report& 4otif! the client that the audit report must no longer be associated with the financial statements. 4otif! the regulator! agencies having 'urisdiction over the client that the report should no longer be relied on. 4otif! (generall! via the regulator! agenc!) each individual known to be rel!ing on the statements that the report should no longer be

19-2@. a.

b.

relied on.
19-21. a. .hen the auditor has been able to make a satisfactor! investigation and has determined that the information is reliable, he or she should describe the effects the subse uentl! ac uired information would have had on the financial statements and the auditor$s report. .hen the client has not cooperated and the auditor has been unable to make a satisfactor! investigation, without disclosing the specific information, the auditor should (1) indicate the lack of cooperation and (2) state that if the information is true, the audit report should no longer be relied on. The auditor has no responsibilit! to make an! retrospective review of his or her work. Aowever, when knowledge is obtained of possible omitted procedures, the auditor should assess their importance to his or her abilit! to support the previousl! e%pressed opinion. The auditor ma! find that he or she (1) can support the opinion or (2) cannot support the opinion. ?n the latter case, the auditor should perform the omitted procedures and if necessar! prevent further reliance on the report.

b.

19-22. a.

b.

Comprehensive Questions
19-27. (9stimated time - 20 minutes)

1.

/isagree. (enerall! letters silent on particular aspects of the re uest letter re uire follow-up. The auditor should contact the attorne! and confirm that he or she intended the letter to completel! respond to the re uest letter and was silent because there were no issues to discuss. /ocumentation of this confirmation should be included in the working papers. /isagree. ) useful evaluation is not alwa!s possible. :or instance, it ma! include an element difficult to predict or to which the law!er ma! not have paid sufficient attention to make an evaluation. ?f the matter involved constitutes a material or contingent liabilit!, the auditor will likel! conclude there is an uncertaint! with effects on the financial statements that can$t be determined, and he or she should consider the effects of that uncertaint! on the audit report. /isagree. The attorne!$s opinion is an e%ample of a marginall! acceptable opinion. ?f such an opinion is issued on litigation where loss would seriousl! impair the compan!$s operations, the auditor must give a ualified opinion and possibl! consider a disclaimer of opinion. /isagree. ?n some cases, attorne!s, auditors, and clients discuss matters involving litigation, and during such informal discussions some attorne!s e%press their opinions as to the outcome of disputed matters. #uch oral opinions should be e%pressed in writing b! the attorne!, and if the! are not reduced to writing, the discussions generall! should not be considered audit evidence. /isagree. The law firm derives all or substantiall! all of its fees from the client. This is, in essence, analogous to in-house counsel. 9vidence from inhouse counsel ma! provide the auditor with the necessar! corroboration in some cases. Aowever, since the liabilit! here is great, complete reliance on such evidence is not 'ustified.

2.

".

*.

0.

19-"@. (9stimated time - "@ minutes) a. 1. 2. ". *. 0. 3. Deficiency ?n completing our audit .e considered its internal control environment 4ot to e%press an opinion The design and effectiveness of the s!stem of internal control +eportable conditions under ())# +eportable conditions involve matters coming to our attention relating to potential weaknesses in the design or operation of internal control that, in our Proper Wording ?n planning and performing our audit we considered internal control 4ot to provide assurance the internal control and its operation significant deficiencies under standards ) significant deficienc! is an internal control deficienc! that adversel! affects the compan!2s abilit! to initiate, record, process or report e%ternal financial data reliabl! in accordance with ())=. ) significant

'udgment, could adversel! affect the organi6ation2s abilit! to prepare financial statements in conformit! with ())=.

7. b.

:or the audit committee and others

deficienc! could be a single deficienc!, or a combination of deficiencies, that results in more than a remote likelihood that a misstatement of the annual or interim financial statements that is more than inconse uential in amount will not be prevented or detected. :or the information and use of the audit committee, management, and others

+eportable conditions represent significant deficiencies in the design or operation of the s!stem of internal control. ) significant deficienc! is an internal control deficienc! that adversel! affects the compan!2s abilit! to initiate, record, process or report e%ternal financial data reliabl! in accordance with ())=. ) significant deficienc! could be a single deficienc!, or a combination of deficiencies, that results in more than a remote likelihood that a misstatement of the annual or interim financial statements that is more than inconse uential in amount will not be prevented or detected. The magnitude of a reportable condition determines whether it is also a material weakness. ) material weakness in internal controls over financial reporting is one that has more than a remote chance that a material misstatement could occur in interim or !ear-end financial statements. .hen the auditor separatel! identifies and describes material weaknesses in his or her report (management letter), two additional paragraphs are re uired. The first paragraph should contain a definition of the term material weakness and a description of the reportable conditions that are material weaknesses. The second additional paragraph should describe the limitations of the auditor$s work, noting specificall! that the auditor$s consideration of internal controls would not necessaril! disclose all matters considered to be material weaknesses.

c.

19-"2. (9stimated time - "@ minutes) a. 1. 1--subse uent event during the subse uent event period re uiring ad'ustment. 2. 1--subse uent event during the subse uent event period re uiring ad'ustment. ". 2--subse uent event during the subse uent event period re uiring disclosure. *. 2--subse uent event during the subse uent event period re uiring disclosure 0. 1--subse uent event during the subse uent event period re uiring ad'ustment. 3. *--subse uent event occurring after field work but before issuance of report. 7. *--subse uent event occurring after field work but before issuance of report. ;. 0--postaudit discover! of facts e%isting at date of report.

The date field work is completed is not specificall! given. This answer is based on the customar! practice of dating the audit report as of the end of field work (i.e., :ebruar! 23). b. :or categories (1) and (2) the auditor has the responsibilit! for identif!ing and evaluating subse uent events up to the date of the auditor$s report. ?n discharging this responsibilit!, the auditor should be alert for subse uent events in performing substantive tests, and also perform specific auditing procedures at or near the completion of field work. :or categories (") and (*), the auditor has no responsibilit! to make in uir! or to perform an! auditing procedures during this time period to discover subse uent events. Aowever, if knowledge of such an event comes to the auditor$s attention, he or she should determine whether the event re uires ad'ustment of or disclosure in the financial statements. :or categor! (0), the auditor has no responsibilit! for their discover!. Aowever, if the auditor becomes aware of such facts and the facts ma! have affected the report that was issued, the auditor is re uired to ascertain the reliabilit! of the information. c. ?nformation about the items would be obtained from the following& 1. ?n uir! of managementB client 1rep1 letter. 2. +eview of bad debt write-offs in Canuar!. ". +eading of minutes. *. >bservation of fireB newspaper account of fireB in uir! of management. 0. ?n uir! of managementB law!er$s letterB and client 1rep1 letter. 3. +eading of minutes. 7. 4ewspaper stor! on takeoverB in uir! of management. ;. ?n uir! of managementB law!er$s letterB and client $rep1 letter. ?f the client fails to make re uired disclosure, the auditor should notif! each member of the board of directors of such refusal and take the following steps to prevent further reliance on the audit report and& 4otif! the client that the audit report must no longer be associated with the financial statements. 4otif! regulator! agencies having 'urisdiction over the client that the report should no longer be relied on. 4otif! (generall! via the regulator! agenc!) each individual known to be rel!ing on the statements that the report should no longer be relied on.

d.