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Exercises, Problems,
and Simulations
1.
1, 2, 3, 4
2.
5, 6, 7
3.
8, 9, 10, 11
4.
5.
6.
21, 22, 23
57, 58
7.
24, 25
61
McGraw-Hill/Irwin
Auditing and Assurance Services, Louwers et al., 2/e
The four primary time periods in an audit examination and the tasks and activities that fall within each time
period are:
1.
Between the beginning of the year and end of year: Interim tests of controls and substantive
procedures.
2.
Between the end of the year and the last day of fieldwork: (1) roll-forward work; (2)
examination of revenue and expense accounts; (3) attorney letters; (4) management
representations; (5) adjusting journal entries; (6) audit documentation review.
3.
Between the last day of fieldwork and issuance of reports: subsequent events.
4.
Following issuance of the reports: (1) subsequent discovery of facts; (2) omitted audit procedures;
(3) management letters; (4) audit committee communications.
11.2
Revenue and Expense
Account
Transaction Cycle
Receivables
Revenue/Collection
Receivables, Investments
Finance/Investment
Production
Finance/Investment
Inventories
Acquisition/Expenditure
Interest expense
Liabilities
Acquisition/Expenditure
Finance/Investment
11.3
In addition to work with the related balance sheet accounts and transaction cycles, the auditor (1) uses
analytical procedures to examine the revenue and expense accounts and (2) scans revenue and expense
accounts for large and unusual entries.
11.4
Miscellaneous, other, and clearing accounts may represent adjustments made by the client to meet
analysts earnings expectations (or earnings management).
11.5
a.
The responsibilities of client management are to (1) respond to the auditors inquiries regarding
litigation, claims, and assessments; (2) provide the auditor with a listing, description, and
evaluation of litigation, claims, and assessments; and, (3) send letter to attorney (attorney letter)
that includes information related to litigation, claims, and assessments.
b.
The responsibilities of the auditor are to (1) inquire of client regarding the existence of litigation,
claims, and assessments; (2) perform various audit procedures regarding litigation, claims, and
assessments; and, (3) initiate the request to the client for the attorney letter.
c.
The responsibilities of the attorney are to respond to the auditor regarding the clients description
of litigation, claims, and assessments.
McGraw-Hill/Irwin
Auditing and Assurance Services, Louwers et al., 2/e
11.6
11.7
11.8
A description of each item, including the nature of the case and management responses or intended
responses to the case.
In addition to attorney letters, the auditor would ordinarily perform the following with respect to litigation,
claims, and assessments:
Examine documents in the clients possession regarding litigation, claims, and assessments,
including correspondence and invoices from attorneys.
Obtain assurance from management that it has disclosed all material unasserted claims the
attorney has advised them of probable litigation.
Read contracts, loan agreements, leases, and correspondence from taxing or other governmental
agencies.
Review the legal expense account and cash disbursements records and invoices related to legal
services.
The purpose of management representations is to impress upon management its primary responsibility for
establishing and maintaining effective internal control over financial reporting and for the fairness of the
financial statements. In addition, management representations may establish an auditors defense if a
question of management integrity arises later.
The following representations must appear in all management representations:
1.
2.
Availability of all financial records and related data and completeness of the minutes of meetings
of stockholders, directors, and important committees.
3.
4.
5.
Information concerning fraud involving management, employees who have significant roles in
internal control, or cases where the fraud could have a material effect on the financial statements.
McGraw-Hill/Irwin
Auditing and Assurance Services, Louwers et al., 2/e
11.9
If the company is subject to the requirements of AS 2, the auditor should obtain the following management
representations related to internal control over financial reporting:
Management has performed an assessment of the effectiveness of internal control over financial
reporting based on criteria (for example, criteria established in Internal Control Integrated
Framework issued by the Committee on Sponsoring Organizations of the Treadway Commission, or
COSO criteria).
Managements conclusion with respect to the effectiveness of its internal control over financial
reporting at year-end.
No control deficiencies communicated to the audit committee from prior engagements have not been
properly resolved.
There are no subsequent changes in internal control over financial reporting or other factors that may
significantly affect internal control over financial reporting.
11.10
These communications are obtained near the end of fieldwork and dated on or near the audit report date to
ensure that the most current information has been considered and evaluated by the auditor.
11.11
If the client refuses to furnish management representations, the auditor may either qualify or disclaim an
opinion, as with other scope limitations. However, because of the importance of this communication, the
auditor should be very skeptical if the client refuses to furnish management representations.
11.12
Adjusting entries and note disclosures are labeled proposed because it is ultimately the clients
responsibility to adjust the financial statements for these items.
11.13
A waived adjustment is a proposed adjustment the auditors decide not to insist that the client make because
it does not have a material effect on the financial statements. Auditors are required to communicate all
adjustments and misstatements detected during the audit to the clients audit committee, regardless of the
materiality of these adjustments to the clients financial statements.
11.14
1.
Upon completion, the audit documentation is reviewed by an audit supervisor and, sometimes,
audit manager. The purpose of this review is to ensure that all appropriate steps in the audit
program were performed, the referencing among audit documentation is clear, and the
explanations contained in the audit documentation are understandable.
2.
Once this initial review has been completed, the audit manager and audit partner review the audit
documentation to ensure that the overall scope of the audit is appropriate and determine whether
the overall conclusions in the audit documentation are sufficient to provide support for the opinion
on the financial statements.
3.
Finally, the audit documentation is reviewed by a partner who has not been involved with the audit
(known as a reviewing partner). The purpose of this review is to ensure that the quality of audit
work and reporting is consistent with the firms quality standards.
11.15
A second partner review is a review of audit documentation by a partner who is not involved with the audit.
The purpose of this review is to ensure that the quality of the work and reporting is in keeping with the
quality standards of the firm.
McGraw-Hill/Irwin
Auditing and Assurance Services, Louwers et al., 2/e
11.16
To ensure the audit is conducted in accordance with generally accepted auditing standards.
To provide the firm with an opportunity to evaluate the overall quality of the firms audit practice.
To allow the firm to adhere to the first standard of fieldwork (that the work is adequately planned
and assistants, if any, are properly supervised).
11.17
A subsequent event is an event occurring between the balance sheet date and the last day of fieldwork.
11.18
11.19
Reading the latest interim financial statements and comparing them with the financial statements
being reported upon.
Inquiring of officers and other executives having responsibility for financial and reporting matters
about contingent liabilities or commitments; significant changes in capital stock, long-term debt,
or working capital since the balance sheet date; and unusual adjustments since the last balance
sheet date.
Obtaining an attorney letter from any legal counsel engaged by the client.
A Type I subsequent event provides new information about a condition that existed at the balance sheet
date. Because the condition existed at the balance sheet date, a Type I subsequent event requires adjustment
of amounts already included in the clients financial statements.
A Type II subsequent event involves occurrences that had both their cause and manifestation after the
balance sheet date. These events should be disclosed in the financial statements and, for particularly
significant subsequent events, pro forma financial statements should be prepared (these statements present
the entire financial statements as if the event had occurred on the balance sheet date).
11.20
Dual dating an audit report provides a means of inserting important information in the financial statements
and footnote disclosures learned by the auditor after the last day of fieldwork. A significant advantage of
dual dating the report is that the auditors liability for events after the last day of fieldwork is limited to the
event specifically identified in the report date.
11.21
A subsequent event is an event occurring between the balance sheet date and last day of fieldwork.
Depending upon the type of subsequent event, the auditor will either adjust the financial statements or
disclose the subsequent event in the financial statements
A subsequent discovery of facts occurs when the auditor learns of events that existed at the balance sheet
date following the issuance of the reports. The auditor should require the client to disclose the facts and
their impact on the financial statements to persons relying on the financial statements if certain conditions
exist.
McGraw-Hill/Irwin
Auditing and Assurance Services, Louwers et al., 2/e
11.22
If the client consents to the disclosure, the auditor should take actions to ensure that persons who are
continuing to rely on the financial statements and auditors reports are properly notified of the facts.
If the client refuses to make the appropriate disclosures, the auditor should notify each member of the board
of directors that they will be notifying regulatory agencies having jurisdiction over the client (such as the
Securities and Exchange Commission) as well as other persons who are relying on the reports.
11.23
11.24
11.25
Verify that (1) the omitted procedure is important in supporting the auditors opinion and (2)
individuals are currently relying on the clients financial statements and reports.
2.
If both of the above conditions exist, the auditor should perform the omitted procedure or alternative
procedures. If both do not exist, no further action is necessary.
3.
If performing the omitted or alternative procedures allow the auditor to support the previouslyexpressed opinion, no further action is necessary. However, if they do not, the auditor should
formally withdraw the original reports, issue revised reports, and inform persons currently relying
on the financial statements.
The auditor should communicate the following information to the audit committee:
Methods used to account for significant, unusual transactions and transactions in a controversial or
emerging area with a lack of authoritative guidance or consensus.
The auditors judgment about the quality of the clients accounting principles.
The auditors responsibility for other information in documents containing the financial
statements.
Issues discussed with management in conjunction with the initial or recurring retention of the
auditor.
Management letters contain a summary of recommendations to allow the client to improve the effectiveness
and efficiency of its operations. They are not required by generally accepted auditing standards.
McGraw-Hill/Irwin
Auditing and Assurance Services, Louwers et al., 2/e
11.27
a.
b.
Incorrect
Correct
c.
Incorrect
d.
Incorrect
a.
Incorrect
b.
c.
Incorrect
Incorrect
d.
Correct
11.28Note to Instructor: Since this question asks students to identify which audit procedure is not used to obtain
evidence about contingencies, the response labeled correct is not used to obtain evidence about
contingencies and those labeled incorrect are used to obtain evidence about contingencies.
a.
b.
c.
Correct
Incorrect
Incorrect
d.
Incorrect
a.
b.
c.
Incorrect
Incorrect
Correct
d.
Incorrect
a.
b.
Incorrect
Correct
c.
d.
Incorrect
Incorrect
11.31
a.
b.
c.
d.
Incorrect
Incorrect
Incorrect
Correct
11.32
a.
Correct
b.
c.
d.
Incorrect
Incorrect
Incorrect
11.29
11.30
McGraw-Hill/Irwin
Auditing and Assurance Services, Louwers et al., 2/e
11.33
a.
Incorrect
b.
c.
Incorrect
Correct
d.
Incorrect
11.34Note to Instructor: Since this question asks students to identify which party would not participate in writing
the management letter, the response labeled correct would not participate in writing the management
letter and those labeled incorrect would participate in writing the management letter.
11.35.
11.36
11.37
a.
Correct
b.
Incorrect
c.
Incorrect
d.
Incorrect
a.
Incorrect
b.
c.
Incorrect
Incorrect
d.
Correct
a.
Incorrect
b.
c.
Incorrect
Incorrect
d.
Correct
Note to Instructor: Since this question asks students to identify which procedure is least likely to be
performed, the response labeled correct would not be performed and those labeled incorrect would be
performed. .
a.
Incorrect
b.
Correct
c.
Incorrect
d.
Incorrect
McGraw-Hill/Irwin
Auditing and Assurance Services, Louwers et al., 2/e
11.38
11.39
11.40
11.41
11.42
a.
Incorrect
b.
Incorrect
c.
Incorrect
d.
Correct
a.
Incorrect
b.
Incorrect
c.
Correct
d.
Incorrect
Note to Instructor: Since this question asks students to identify which statement is not true with respect to
management representations, the response labeled correct would not be true and those labeled
incorrect would be true. .
a.
Correct
b.
Incorrect
c.
Incorrect
d.
Incorrect
a.
Incorrect
b.
Incorrect
c.
Correct
d.
Incorrect
a.
Incorrect
b.
Incorrect
c.
d.
Incorrect
Correct
McGraw-Hill/Irwin
Auditing and Assurance Services, Louwers et al., 2/e
11.43
11.44
11.45
11.46
a.
Correct
b.
Incorrect
c.
Incorrect
d.
Incorrect
a.
Incorrect
b.
Correct
c.
Incorrect
d.
Incorrect
a.
Incorrect
b.
Correct
c.
d.
Incorrect
Incorrect
a.
Correct
b.
Incorrect
c.
Incorrect
d.
Incorrect
McGraw-Hill/Irwin
Auditing and Assurance Services, Louwers et al., 2/e
Management Representations
a.
Auditors are required to obtain management representations in all audits conducted under
generally accepted auditing standards.
b.
The purpose of obtaining management representations is to impress upon management its primary
responsibility for the financial statements. In addition, management representations may establish
an auditors defense if a question of management integrity subsequently arises.
c.
Management representations should be addressed to the auditor and dated as of the date of the
auditors reports (last day of fieldwork).
d.
e.
Obtaining management representations does not relieve the auditor from their responsibility for
planning and performing the audit. As a result, the auditor must still perform all usual procedures
to corroborate representations made by management.
McGraw-Hill/Irwin
Auditing and Assurance Services, Louwers et al., 2/e
Management acknowledgement of its responsibility for the fair presentation in the financial
statements in conformity with U.S. generally accepted accounting principles (or other
comprehensive basis of accounting).
2.
Availability of all financial records and related data and completeness of the minutes of meetings
of stockholders, directors, and important committees.
3.
4.
5.
Information concerning fraud involving management, employees who have significant roles in
internal control, or cases where the fraud could have a material effect on the financial statements.
In addition to the above, which are required without limitation based on materiality, the following matters
should be confirmed in Molars management representations:
Material liabilities or gain or loss contingencies that are required to be accrued or disclosed.
The company has satisfactory title to all owned assets, and whether there are liens or
encumbrances on such assets or any pledging of assets
Related party transactions or related amounts receivable or payable that may need to be disclosed
in the financial statements.
The company has complied with all aspects of contractual agreements that would have a material
effect on the financial statements in the event of noncompliance.
Events have occurred subsequent to the balance sheet date that would require adjustment to, or
disclosure in, the financial statements.
Provision, when material, has been made to reduce excess or obsolete inventories to their
estimated net realizable value.
Provision has been made for any material loss to be sustained in the fulfillment of, or from
inability to fulfill, any sales commitments.
Provision has been made for any material loss to be sustained as a result of purchase commitments
for inventory quantities in excess of normal requirements or at prices in excess of the prevailing
market prices.
McGraw-Hill/Irwin
Auditing and Assurance Services, Louwers et al., 2/e
11.49
Management Representations
1.
Appropriate.
2.
3.
Appropriate.
4.
Inappropriate. The description and evaluation of contingencies would accompany the attorney
letter sent to the clients attorney. While management representations indicate that management is
unaware of unasserted claims or assessments that are required to be disclosed in accordance with
Statement of Financial Accounting Standards No. 5, they would not list contingencies in which
attorneys have participated.
5.
Inappropriate. While management representations will indicate that all deficiencies in the design
or operation of internal control have been disclosed to the auditor, they will not state that no such
deficiencies exist, even in cases where no deficiencies are noted.
6.
Inappropriate. Management letter comments are merely advisory to management, and no action is
required to be taken on these comments. Accordingly, reference to action on previous management
letter comments is not appropriate.
7.
Inappropriate. Managements assessment of internal control over financial reporting will not
provide such a high level of assurance to management; as a result, a reference of this nature in
management representations is not appropriate.
8.
Appropriate.
McGraw-Hill/Irwin
Auditing and Assurance Services, Louwers et al., 2/e
11.50
Management Representations
1.
2.
Not included in management representations. (This would accompany an attorney letter sent from the
client to their attorneys.)
3.
Not included in management representations. (This would be included in a management letter prepared
by the auditor to the client.)
4.
5.
6.
7.
8.
Not included in management representations. (This would be communicated to the clients audit
committee.)
9.
10. Not included in management representations. (Management representations indicate that management
believes the effects of uncorrected misstatements are immaterial to the financial statements but
management representations should not express an opinion on the financial statements.)
McGraw-Hill/Irwin
Auditing and Assurance Services, Louwers et al., 2/e
2.
3.
An estimate, if one can be made, of the amount or range of potential loss of each case is omitted.
4.
The various other pending or threatened litigation on which Young was consulted is not identified
and included.
5.
The unasserted claims and assessments probable of assertion that have a reasonable possibility of
an unfavorable outcome are not identified.
6.
7.
8.
Young is not requested to include matters that existed after December 31, 2006, up to the date of
Youngs response.
9.
There is no inquiry about any unpaid or unbilled charges, services, and disbursements.
OTHER DEFICIENCIES:
10.
The action that Consolidated intends to take concerning each suit (for example, to contest the
matter vigorously, to seek an out-of-court settlement, or to appeal an adverse decision) is omitted.
11.
12.
Young is not requested to identify the nature of and reasons for any limited response.
13.
14.
The reference to Youngs response possibly being quoted or referred to in the financial statements
is inappropriate.
15.
Ambiguous terminology such as slight and some chance is included where remote and
possible are more appropriate.
McGraw-Hill/Irwin
Auditing and Assurance Services, Louwers et al., 2/e
11.52
Attorney Letters
a.
b.
Obtain assurance from management that it has disclosed all material unasserted claims
the lawyer has advised them are likely to be litigated.
Read contracts, loan agreements, leases, and correspondence from taxing or other
governmental agencies.
Review the legal expense account and cash disbursements records and invoices related to
legal services.
Jaworskis responsibilities with respect to litigation, claims, and assessments are to perform the
procedures noted in (a) above and initiate the request to the client for the attorney letter.
Fulbrights responsibilities with respect to litigation, claims, and assessments
are to respond to auditors inquiries regarding litigation, claims, and
assessments; provide the auditor with a listing, description, and evaluation of
litigation, claims, and assessments; and send a letter to the attorney that
includes information related to litigation, claims, and assessments.
Vinsons responsibilities with respect to litigation, claims, and assessments are
to respond to the auditor regarding Fulbrights description of litigation, claims,
and assessments.
c.
d.
1.
The auditor initiates the request for the client to send the attorney letter.
2.
The attorney letter, along with a listing of litigation, claims, and assessments, is sent to
each attorney who has devoted attention to legal matters on behalf of the client.
3.
The attorneys will respond directly to the auditor on the information contained in the
attorney letter.
The following information is typically included in an attorney letter (prepared from the clients
perspective):
A description of each item, including the nature of the case and management responses or
intended responses to the case.
McGraw-Hill/Irwin
Auditing and Assurance Services, Louwers et al., 2/e
McGraw-Hill/Irwin
Auditing and Assurance Services, Louwers et al., 2/e
11.53
Subsequent Events
a.
A subsequent event is an event or transaction that occurs after the balance sheet date but prior to
the issuance of the auditors reports and the companys financial statements. Auditors are
responsible for subsequent events from the balance sheet date to the last day of fieldwork.
b.
Procedures that Michael can perform to assist him in identifying subsequent events include:
c.
d.
e.
Reading the latest interim financial statements and comparing them with the financial
statements being reported upon.
Inquiring of officers and other executives having responsibility for financial and
reporting matters about contingent liabilities or commitments; significant changes in
capital stock, long-term debt, or working capital since the balance sheet date; and unusual
adjustments since the last balance sheet date.
Obtaining an attorney letter from any legal counsel engaged by the client.
Type I subsequent events provide new information about a condition that existed at the
balance sheet date. Because the condition existed at the balance sheet date, a Type I
subsequent event requires adjustment of amounts included in the financial statements.
Type II subsequent events involve occurrences that had both their cause and
manifestation after the balance sheet date. These events should be disclosed in the
financial statements and, for particularly significant subsequent events, pro forma
financial statements should be prepared (these statements present the entire financial
statements as if the event had occurred on the balance sheet date).
1.
Michael could evaluate the disclosure of this event without additional considerations,
since he became aware of the transaction prior to the last day of fieldwork.
2.
Michael could evaluate the disclosure of this event, since his reports (and the financial
statements) have not been issued. However, since he became aware of the subsequent
event following the last day of fieldwork, he would ordinarily dual date the audit report to
limit his responsibility beyond the last day of fieldwork to the disclosure related to the
subsequent event.
3.
This situation would reflect a subsequent discovery of facts, since Michael became
aware of the transaction after the issuance of the audit reports. Michael should request
that Dallas Companys management disclose the facts and their impact on the financial
statements to persons relying on the financial statements if the following conditions exist:
(a) the facts are reliable and existed at the report date; (2) the facts affect the financial
statements and auditors reports; and, (c) persons are continuing to rely on the financial
statements and auditors reports.
Because the announced acquisition of San Antonio Company did not exist at the report date,
Michael has no responsibility with respect to this acquisition in the 2006 audit.
McGraw-Hill/Irwin
Auditing and Assurance Services, Louwers et al., 2/e
11.54
1.
A subsequent event is an event or transaction that occurs after the balance sheet date but
prior to the issuance of the auditors reports and financial statements (AU 560.01).
2.
3.
b.
Reading the latest interim financial statements and comparing them with the
financial statements being reported upon.
Inquiring of officers and other executives having responsibility for financial and
reporting matters about contingent liabilities or commitments; significant
changes in capital stock, long-term debt, or working capital since the balance
sheet date; and unusual adjustments since the last balance sheet date.
Obtaining an attorney letter from any legal counsel engaged by the client.
1.
2.
McGraw-Hill/Irwin
Auditing and Assurance Services, Louwers et al., 2/e
11.54
Subsequent events may provide new and important information about known or unknown loss
contingencies as of the balance sheet date. The subsequent event may very well modify the
circumstances surrounding the contingent loss thereby changing the reporting method from no
disclosure to note disclosure or accrual. For example, a contingent loss may have been recorded as
a note disclosure because, at the balance sheet date, the company had only a reasonable possibility
that a loss may be incurred. If a subsequent event occurs which (in the accountants judgment)
makes it probable that a liability has been incurred, the contingent liability will now have to be
accrued in the financial statements (assuming that an amount can be estimated).
The purpose of a review for subsequent events is to determine whether there have been any
material transactions or events occurring between the year-end and the last day of fieldwork that
have a significant effect on the financial statements and may require adjustment to or disclosure in
the financial statements. While the review for subsequent events normally ends as of the last day
of fieldwork (February 20), the auditor is responsible for any information of which they become
aware until the delivery of the audit reports (March 12).
b.
Reading the latest interim financial statements and comparing them with the financial
statements being reported upon.
Inquiring of officers and other executives having responsibility for financial and
reporting matters about contingent liabilities or commitments; significant changes in
capital stock, long-term debt, or working capital since the balance sheet date; and unusual
adjustments since the last balance sheet date.
Obtaining an attorney letter from any legal counsel engaged by the client.
McGraw-Hill/Irwin
Auditing and Assurance Services, Louwers et al., 2/e
11.56Subsequent EventsCases
1.
2.
3.
4.
5.
a.
This would have come to the auditors attention through inquiries of client officers and
key personnel, review of the minutes of the meetings of the board of directors and
stockholders, or through local news media.
b.
The details of the construction of the express highway would need to be disclosed in the
footnotes to the financial statements.
a.
It is improbable that the auditor would learn the source of the $25,000 unless it were
revealed in a discussion with the President or his personal accountant, or unless the
auditor prepared the Presidents personal income tax return.
b.
Disclosing the loan in the balance sheet as a loan from an officer would be sufficient. The
source of the funds would not be disclosed because it is the officers personal business
and has no effect upon Olars financial statements.
a.
The additional liability for the ore shipment would have been revealed to the auditor
through scanning of January transactions. The regular examination of transactions and
related documents such as purchase contracts would have caused him to note the item for
subsequent follow-up to determine the final liability. In addition, the management
representations might have mentioned the potential liability.
b.
The liability would not require separate disclosure; however, the inventory and accounts
payable balances would need to be adjusted by amount of the additional charge, $9,064
[[$20,600 x (0.72/0.50)] - $20,600 = $9,064].
a.
The auditor might learn of the agreement to purchase the treasurers stock ownership
through his inquiries of management and legal counsel, examination of the minutes of the
meetings of the board of directors and stockholders and subsequent reading of the
agreement. The physical absence of the treasurer might from Olars headquarters also
arouse the CPAs curiosity.
b.
The details of the agreement would be disclosed in the footnotes to the financial
statements because the use of company cash for the repurchase of stock and the change in
the amount of stock hold by stockholders might have a significant impact on subsequent
years financial statements. Usually, a management change, such as the treasurers
resignation, does not require disclosure in the financial statements. The details underlying
the separation (personal disagreements and divorce) need not be disclosed.
a.
The auditor would learn of the reduced sales and of the strike through inquiries of
management, review of financial statements for January, scanning transactions, and
general observations during the engagement.
b.
Disclosure should be made in the footnotes to the financial statements of these conditions
and the facts available at to date of the reports.
McGraw-Hill/Irwin
Auditing and Assurance Services, Louwers et al., 2/e
1.
If it is discovered that an important audit procedure was omitted, the auditors should
consult legal counsel and take the following actions:
Assess the importance of the omitted procedure to the present ability to support
the previously-expressed opinion.
Determine if any persons are currently relying or likely to rely on their reports.
If the omitted procedure impairs the auditors present ability to support the
previously-expressed opinion, the omitted procedure should be applied or
alternative procedures applied that would provide a satisfactory basis for the
opinion.
2.
If after reviewing the audit documentation auditors determined that procedures were
performed that compensate for the omitted procedure, the omitted procedure would not
have to be performed. The auditors should document their decision and their support for
this decision.
3.
If the auditors become aware of material new information that should have been
disclosed in the financial statements, they should follow the guidelines for subsequent
discovery of facts, which require that they request the client to disclose necessary
information to persons known to be relying on the financial statements and auditors
reports. If the client refuses to do so, the auditor should notify each member of the board
of directors that they will be notifying regulatory agencies having jurisdiction over the
client (such as the Securities and Exchange Commission) as well as other persons who
are relying on the reports.
McGraw-Hill/Irwin
Auditing and Assurance Services, Louwers et al., 2/e
11.58
Case 1: You should document the decision that the specific procedures considered omitted by the
internal inspection reviewers were not considered necessary in the valuation of Wildcats
inventory. You should cite the specific performed procedures that you feel compensate for
the procedure the reviewers thought necessary.
Case 2: You should immediately notify the partners of Arthur Hurdman that the December 31
financial statements of Top Stove are not correct. They should consult legal counsel and
notify the client and ask the client to disclose to users that the financial statements are in
error. The financial statements should be corrected as soon as possible and reissued with
Arthur Hurdmans reports.
b.
This response is too vague for adequate information. More evidence would be required to
support the claim that the plaintiffs will have serious problems establishing Omegas
liability.
2.
3.
4.
Meritorious does not mean strong or adequate. The phrases reasonable chance,
adequate defense, less than the damages claimed all indicate potential issues. More
information is needed.
Plaintiffs counsel would probably assert the merits of the plaintiffs case, suggesting that the
auditors client (defendant) will certainly lose large damages. However, it is important to note that
auditors would not obtain representations from the plaintiffs regarding the outcome of litigation
against a client.
Both of these amounts should be considered with some skepticism. While MALDEF may indeed
seek $250,000 from the city, this amount does not necessarily represent the amount of damages
that will be paid (and the amount at which the liability might be settled). The fact that the attorney
letter indicates that the damages could be between $30,000 and $175,000 provides some evidence
that a negative outcome may occur but does not provide any reliable information as to the amount
of that outcome.
b.
The financial statements should disclose the verdict and mention the possibility of a monetary
settlement. If this litigation had commenced prior to December 31, 2006 (which is highly likely),
it would be treated as a Type I subsequent event and include the most current information as to the
status of the case. If the litigation commenced following December 31, 2006, it would be treated
as a Type II subsequent event and disclosed in the financial statements. However, it does not
appear that any basis exists for including dollar amounts in the disclosure.
McGraw-Hill/Irwin
Auditing and Assurance Services, Louwers et al., 2/e
11.61
Yes
Yes
No
Yes
McGraw-Hill/Irwin
Auditing and Assurance Services, Louwers et al., 2/e