NaimExplain

Besides the search for contingent liabilities and the review for subsequent events, the auditor has four important final evidence accumulation responsibilities, all of which are required by current professional auditing standards. Discuss each of these four responsibilities. Answer: • Final analytical procedures performed as a final review for material misstatements or financial problems and to help the auditor take a final objective look at the financial statements. • Evaluate the going concern assumption. • Obtain a client representation letter documenting management’s most important oral representations during the audit. • Read information included in published annual reports pertaining directly to the financial statements.

State three lists or requests that should be included in a standard “inquiry of attorney” letter. Answer: • A list, prepared by management, of (1) pending threatened litigation and (2) asserted or unasserted claims or assessments with which the attorney has had significant involvement. An alternative is for the letter to request the attorney to prepare the list. • A request that the attorney furnish information or comment about the progress of each item listed, the legal action the client intends to take, the likelihood of an unfavorable outcome, and an estimate of the amount or range of the potential loss. • A request for the identification of any unlisted pending or threatened legal actions or a statement that the client’s list is complete. • A statement by the client informing the attorney of his or her responsibility to inform management whenever in the attorney’s judgment there is a legal matter requiring disclosure in the financial statements. The letter of inqui

Provide several representations that auditors of public companies may seek from management regarding internal control. Answer: Possible representations include: • Management’s acknowledgement of its responsibilities for establishing and maintaining effective internal control over financial reporting. • Management’s conclusion about the effectiveness of internal control over financial reporting as of the end of the fiscal period. • Disclosure to the auditor of all deficiencies in the design or operation of internal control over financial reporting. • Management’s knowledge of any material fraud or other fraud involving senior management or other employees who have a significant role in the company’s internal control over financial reporting.

List four specific matters that should be included in a client representation letter. Answer: • Management’s acknowledgment of its responsibility for the fair presentation in the statements of financial position, results of operations, and cash flows in conformity with generally accepted accounting principles or other comprehensive basis of accounting. • Availability of all financial records and related data. • Completeness and availability of all minutes of meetings of stockholders, directors, and committees of directors. • Information concerning related-party transactions and related amounts receivable or payable. • Plans or intentions that may affect the carrying value or classification of assets or liabilities. • Disclosure of compensating balances or other arrangements involving restrictions on cash balances, and disclosure of line-of-credit or similar arrangements.

State the three purposes of the client letter of representation. Answer: • To impress upon management its responsibility for the assertions in the financial statements. • To remind management of potential misstatements or omissions in the financial statements. • To document the responses from management to inquiries about various aspects of the audit.

Discuss the three matters which Sarbanes-Oxley requires auditors of public companies to report to the audit committee. Answer: The three items that must be reported to the audit committee are: • All critical accounting policies and practices to be used. • All alternative treatments of financial information within generally accepted accounting principles that have been discussed with management, ramifications of the use of such alternative disclosures and treatments, and the treatment preferred by the auditor, and • Other material written communications between the auditor and management, such as any management letter or schedule of unadjusted differences.

Discuss three audit procedures commonly used to search for contingent liabilities. Answer: • Inquire of management (orally and in writing) about the possibility of unrecorded contingencies. • Review current and previous years’ internal revenue agent reports for income tax settlements. • Review the minutes of directors’ and stockholders’ meetings for indications of lawsuits or other contingencies. • Analyze legal expense for the period under audit, and review invoices and statements from legal counsel for indications of contingent liabilities. • Obtain a letter from each major attorney performing legal services for the client as to the status of pending litigation or other contingent liabilities. • Review audit files for any information that may indicate a potential contingency. • Examine letters of credit in force as of the balance sheet date and obtain a confirmation of the used and unused balance.

State the two primary types of subsequent events that require consideration by management and evaluation by the auditor, and give two examples of each type. Answer: • Events that have a direct effect on the financial statements and required adjustment. Examples include declaration of bankruptcy by a customer with an outstanding accounts receivable balance due to deteriorating financial condition; settlement of litigation at an amount different from the amount recorded on the books. • Events that have no direct effect on the financial statements but for which disclosure is advisable. Examples include a decline in the market value of securities held for temporary investment or resale during the subsequent period; issuance of bonds or equity securities during the subsequent period.

Characterize the auditor’s role in preparing the financial statements. Answer: The auditor acts in the role of advisor when preparing the financial statements, but management retains the final and ultimate responsibility for approving the issuance of the statements.

List four contingent liabilities that auditors are concerned about in most instances. Answer: Pending litigation for patent infringement, product liability or other actions; income tax disputes; product warranties; notes receivable discounted; guarantees of obligation of others; and unused balances of outstanding letters of credit.

What are the three required conditions for a contingent liability to exist? Answer: 1. There is potential for future payment to an outside party or the impairment of an asset that resulted from an existing condition. 2. There is uncertainty about the amount of the future payment or impairment. 3. The outcome will be resolved by some future event or events.

With what types of contingencies might an auditor be concerned? Answer: The auditor is generally concerned with contingencies arising from pending litigation for patent infringement, income tax disputes, product warranties, notes receivable discounted, guarantees of obligations of others, and unused balances of outstanding letters of credit.

Discuss the purposes of performing analytical procedures during the audit completion phase. Answer: Analytical procedures performed during the completion phase are useful as a final review for material misstatements or financial problems not noted during other testing, and to help the auditor take a final objective look at the financial statements.

Distinguish between contingent liabilities and commitments. Answer: Contingent liabilities are future obligations to an outside party for an unknown amount resulting from activities that have already taken place.  Commitments are agreements to commit the company to a set of fixed conditions in the future regardless of what happens to profits or the economy as a whole.