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UNIT 9

COMPLETING THE AUDIT


Estimated Time: 1.5 HOURS
Discussion Questions 9-1:
Match each statement or description (1-5) with the term (A-F) to which it is most likely
related.
A. Interim audit work
B. Management representations
C. Second-partner review
D. Attorney letters
E. Communication with individuals charged with governance
F. Management letter
___ 1. Audit documentation and financial statements, including footnotes, are
given a final review on large engagements.
___ 2. Based on the facts, known to us, after a full investigation, it is our opinion
that no liability will be established against this entity.
___ 3. Audit procedures performed several weeks or months before the balance
sheet date.
___ 4. There have been no irregularities involving management or employees
who have significant roles in the client's internal control.
___ 5. We discussed the following recommendation for streamlining the receiving
department document flow with Ms. Phyllis Cook, receiving department
supervisor.
___ 6. Includes statements regarding auditors' judgment of the quality of the
client's accounting principles.
* Note: Each term is associated with only one statement.
Discussion Questions 9-2: Multiple Choice Case type (choose the best answer)
Michael Ewing is auditing the financial statements of Dallas Company for the year
ended December 31, 2008. In concluding the process of gathering sufficient
appropriate evidence, Michael has asked to meet with his supervisor on the audit
(John Ross) to discuss responsibility for events occurring after the balance sheet
date.
(1) Which of the following statements is not correct:
a. A subsequent event is an event or transaction that occurs after the
balance sheet date but prior to the audit report release date (and the
issuance of the entitys financial statements).
b. Michaels responsibility for subsequent events depends upon when he
learns of these events. If he learns of a subsequent event prior to the
audit report release date, he is responsible for these events until the audit
report release date. If he learns of these events following the audit report
release date, his responsibility is limited to the audit completion date.
c. Type I subsequent events provide new information about a condition that
existed at the balance sheet date that requires adjustment of amounts
included in the financial statements.
d. 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 (FS) and, for particularly significant
subsequent events, pro forma FS should be prepared (these statements
present the entire FS as if the event had occurred on the balance sheet
date).
e. Type II subsequent events should only be disclosed in the financial
statements and pro forma FS are never prepared.
Auditing Practice II
Workbook

Third Term, AY 2015-2016


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(2) The following procedures can assist Michael in identifying subsequent events,
except:
a. Reading the latest interim financial statements and comparing them with
the financial statements being reported upon.
b. 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.
c. Reading minutes of meetings of shareholders, directors, and appropriate
committees.
d. Obtaining an attorney letter from any legal counsel engaged by the client
and obtaining management representations.
e. None of the above.
(3) Assume that on Jan 8, 2009, Dallas Co. agreed to acquire Houston, Inc. in a
significant transaction. Michaels audit completion date was Feb 7, 2009, and
Dallas issued their financial statements (and Michaels reports on its financial
statements and internal control over financial reporting) on Feb 14, 2009.
Which of the following statements is not correct?
a. If Michael became aware of the SE on Jan 10, 2009, he could evaluate
the disclosure of this event without additional considerations, since he
became aware of the transaction prior to the audit completion date.
b. If on March 2, 2009, Dallas Co. announced that it will also acquire San
Antonio Co., Michael needs to disclose the acquisition in the 2008 audit.
c. If Michael became aware of the SE on Feb. 10, 2009, he could evaluate
the disclosure of this event, since his reports (and the FS) have not been
issued. However, since he became aware of the SE following the audit
completion date, he would ordinarily dual date the auditors report to limit
his responsibility beyond the audit completion date to the disclosure
related to the SE.
d. If Michael became aware of the SE on Feb. 20, 2009, he should request
that Dallas Cos management to disclose the facts and their impact on the
FS to persons relying on the FS if the following conditions exist: (a) the
facts are reliable and existed at the report date; (2) the facts affect the FS
and auditors reports; and, (c) persons are continuing to rely on the FS
and auditors reports.
e. If on March 2, 2009, Dallas Co. announced that it will also acquire San
Antonio Co., Michael has no responsibility with respect to this acquisition
in the 2008 audit.
Case Study
Case 1
Paul and John, CPAs, have completed the field work for the SARS Deli audit, and
are considering the impact on SARS Delis audited financial statements of certain
events occurring between the balance sheet, December 31, 2015, and the date of
field work completion, February 12, 2016. SARS Delis audited net income for 2015
was P19.8 million. The following occurrences are the subject of consideration.
1. On Jan. 22, 2016, SARS Deli settled a lawsuit filed by a consumer who was
made ill by SARS Deli salami bar that somehow had been tainted. The
customer consumed the salami in 2015 and brought legal action in June of
that year. The original lawsuit asked for medical reimbursement and damages
totaling P23 million. The January settlement was for P1.46 million.
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Workbook

Third Term, AY 2015-2016


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2. On Nov. 20, 2015, JOLLYs Party Store, a SARS Deli competitor, sued SARS
Deli for alleged patent infringement. The infringement relates to a meat
storage process, patented by JOLLYs, for longer and safer storage of meats
and other refrigerated products. SARS Delis defense is that although their
process also provides for longer storage it differs markedly from JOLLYs
process. On Jan. 22, 2016, a judge awarded the plaintiffs P5.5 million in
damages. SARS Delis outside legal counsel, in a letter to the auditors, stated
their intent to appeal the decision and believe the defendant will ultimately
prevail.
3. On Jan. 30, 2016, SARS Deli was forced to recall assorted beefstick and
cheese boxes produced by its Luzon factory and sold in 2015 to wholesale
distributors and retail outlets on East Mindanao. Although the products posed
no health hazard, these had been inadvertently processed without salt. The
products subject to recall had cost SARS Deli P5.0 million and sold for P7.0
million. The meats and cheeses had no residual value and were discarded
upon return to Luzon.
4. On Feb. 5, 2016, SARS Deli acquired MCDY Meats Limited, a Singapore
meat processor. The transaction was completed by exchanging SARS Deli
stock and cash for MCDY stock and was accounted for as purchase.
5. Although in previous years the auditors had never considered the need for a
year-end allowance for adjustment for future sales returns and allowances,
they are seriously considering one for 2015. Their concern arises from the
abnormal incidence of price adjustments occurring in Jan. 2016 and related to
Dec. 2015 sales. An examination of January credit memos issued to
customers revealed total adjustments of P977,000 relating to December
sales.
6. An examination of the Jan. 2016 Board of Directors meeting minutes
disclosed approval of a bonus equal to 12% of audited net income after
bonus.
Required:
a. Assuming the auditors have set the individual item materiality threshold at 5% of
audited net income, classify each of the mentioned subsequent events by writing
Type I as adjusting and Type II as non-adjusting.
b. For Type I events, draft the necessary audit adjustments.
Case 2
Carebears Industries manufactures and sells food products and food processing
machinery. While preparing the December 31, 2015 financial statements for
Carebears, the following information was discovered relating to contingencies and
possible adjustments to liabilities. Carebears 2015 financial statements were issued
on April 1, 2016.
1. On Nov. 12, 2015, a former employee filed a lawsuit against Carebears alleging
age discrimination and asking for damages of P950,000. At Dec. 31, 2015,
Carebears attorney indicated that the likelihood of losing the lawsuit was possible
but not probable. On March 5, 2016, Carebears agreed to pay the former
employee P225,000 in return for withdrawing the lawsuit.

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Workbook

Third Term, AY 2015-2016


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2. After a tax audit of the 2015 return, the BIR has questioned some expenses paid
to a major stockholder. At April 2016, the BIR has not yet made an assessment of
additional taxes, but Carebears feels it will. Carebears accountants and legal
counsel believe the deductions were appropriate but that if an assessment is
made, there is a reasonable possibility that subsequent court action would result
in an additional tax liability of P85,000.
3. Carebears grants a one-year warranty for each processing machine sold. Past
experience indicates that the costs of satisfying warranties are approximately 2%
of sales. During 2015, sales of processing machines totaled P19,400,000. 2015
expenditures for warranty repair costs were P198,000 related to 2015 sales and
P210,000 related to 2016 sales. The Jan. 1, 2015 balance of the warranty liability
account was P280,000.
4. Carebears is the plaintiff in a P600,000 lawsuit filed in 2015 against Bulacan
farms for failing to deliver on contracts for produce. The suit is in final appeal.
Legal counsel advises that it is probable that Carebears will prevail and will be
awarded P300,000.
5. Included with certain food items sold in 2015 were coupons redeemable for a
kitchen appliance at the rate of five coupons per appliance. During 2016, 30,000
coupons were issued and 5,000 coupons were redeemed. Although this is the
first promotion in years, past experience indicates that 70% of the coupons are
never redeemed. An inventory of kitchen appliances is maintained, and a count
shows that 1,000 are on hand at December 31, 2015, with a normal retail value of
P20,000 and a cost to Carebears of P8,500.
Required:
a. Determine the appropriate means of reporting each situation by writing AL if the
company needs to make possible adjustments to liability account, CL if the
company needs to disclose a contingent liability and CA if the company needs to
disclose a contingent assets.
b. For your AL answers, draft the necessary audit adjustments.

Auditing Practice II
Workbook

Third Term, AY 2015-2016


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