Completing the Audit

CPA Alfred Lagat

Learning Objective 1

Conduct a review for contingent

liabilities and commitments.
An internal auditor for a manufacturing company was
concerned about the anomalies in stock levels. He
thought someone might be pinching stock but he
couldn’t prove it. He had his eye on one shifty looking
individual who everyday drove his old truck out of the
factory with the load covered by tarpaulin. Time after
time the auditor stopped the bloke, made him remove the
tarpaulin and then inspected the load. On every
occasion there was only scrap metal on the truck which
the driver said he was taking to the tip. On 3 occasions
the auditor made the driver offload the scrap metal in
suspicion that something was hidden beneath but there
was nothing. The auditor later got a better offer and
resigned. A few weeks later, he was drinking in a pub
when the shifty looking character walked in. On an
impulse the auditor walked up to him and asked, “Look,
I've left the company, I'm not interested in taking up the
matter, but I just have to know. What were you taking?”
and the bloke said “Tarpaulins.”
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.
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.
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.
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
Auditor’s 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
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.
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.

Learning Objective 2

Obtain and evaluate letters from

the client’s attorneys.
Inquiry of Client’s 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.
Inquiry of Client’s Attorneys

A request for the identification of any unlisted

pending or threatened legal action or a
statement that the client’s list is complete.

A statement informing the attorney of the attorney’s

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

In the USA, 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.
Learning Objective 3

Conduct a post-balance-sheet
review for subsequent events.
 Period Covered by Subsequent
Events Review
Client’s 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
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
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
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
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
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,
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.
Learning Objective 4

Design and perform the final steps

in the evidence-accumulation
segment of the audit.
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.
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
Management Representation
Letter

1. Financial statements
2. Completeness of information
3. Recognition, measurement, and disclosure
4. Subsequent events
5. Internal control
Management Representation
Letter: Internal Control
1. Management’s acknowledgment of its
responsibility for establishing and
maintaining effective internal control
over financial reporting
2. Management’s conclusion about the
effectiveness of internal control over
financial reporting as of the end of
the fiscal period
3. Disclosure of all deficiencies
4. Management’s knowledge of any fraud
Information Accompanying Basic
Financial Statements
Balance sheet
Income statement Basic Standard
financial auditor’s
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
Learning Objective 5

Integrate the audit evidence

gathered, and evaluate the
overall audit results.
Evaluate Results

Sufficiency of evidence

Evidence supports auditor’s opinion

Financial statement disclosures

Evaluate Results

Audit documentation review

Independent review

Summary of evidence evaluation

Completing the Engagement
Checklist
YES NO
1. Examination of prior year’s audit
documentation
a. Were last year’s 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?
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?
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?
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)
Evaluating Results and Reaching
Conclusions

Evaluate overall
financial statements
Issue
audit
Estimated misstatement
report
(overall statements)
Achieved audit risk
(overall statements)
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.
Learning Objective 6

Communicate effectively with the

audit committee and management.
Communicate with the Audit
Committee and Management
 Communicate fraud and illegal acts
 Communicate internal control deficiencies
 Other communication with audit committee
 Management letters
Learning Objective 7

Identify the auditor’s

responsibilities when facts
affecting the audit report are
discovered after its issuance.
 Period Covered by Subsequent
Events Review
Client’s 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
 End
Thank You
Q&A