Chapter 17 Flashcards
(21 cards)
Contingent Liability
An existing condition or set of circumstances involving uncertainty about a possible loss that will ultimately be resolved when some future event occurs or fails to occur.
What are the 3 categories of contingent liabilities?
- Probable: The future event is likely to occur.
- Reasonably possible: The chance of the future event occurring is more than remote but less than likely.
- Remote: The chance of the future event occurring is slight.
* *look at chart on Pg. 1 of notes**
What are some examples of contingent liabilities?
Pending or threatened litigation.
Actual or possible claims and assessments.
Income tax disputes.
Product warranties or defects.
Guarantees of obligations to others.
Agreements to repurchase receivables that have been sold.
What are the specific additional steps to identify contingent liabilities?
- Inquiry of and discussion with management regarding the entity’s policies and procedures for identifying, evaluating, and accounting for contingent liabilities.
- Examining documents in the entity’s records such as correspondence and invoices from attorneys for pending or threatened lawsuits.
- Obtaining a legal letter that describes and evaluates any litigation, claims, or assessments.
- Obtaining a written representation from management that all litigation, asserted and unasserted claims, and assessments have been disclosed
What is a legal letter?
An audit inquiry sent to the entity’s attorneys in order to obtain or corroborate information about litigation, claims, and assessments.
Management should request that the attorneys provide information about a number of items, including the following:
A. A list of any pending or threatened litigation or any probable but as yet unasserted claims to which the attorney has devoted substantial attention or for which an unfavorable outcome is reasonably possible
B. A request that the attorney describe and evaluate each pending or threatened litigation; this should include the progress of the case, the action the entity plans to take, the likelihood of an unfavorable outcome, and the amount or range of the potential loss
C. A request that the attorney identify any pending or threatened litigation or claims not included in management’s list or a statement that the list is complete
D. A request that the attorney comment on unasserted claims where his or her views differ from management’s evaluation
E. A request that the attorney indicate if his or her response is limited in any way and the reasons for such limitations
What if attorneys won’t talk?
Refusal by an entity’s attorney to furnish information in a legal letter is a limitation on the scope of the audit that is potentially sufficient to preclude an unqualified opinion.
What is a subsequent event?
An event or transaction that occurs after the balance sheet date but prior to the issuance of the financial statements and the auditor’s reports that may materially affect the financial statements.
What is a Type I (Recognized) subsequent event?
Events that provide additional evidence about conditions that existed at the date of the balance sheet and that affect the amounts or estimates involved in the financial statement preparation process. Type I events require adjustment of the numbers in the financial statements.
What is a type II (Unrecognized) subsequent event?
Events that provide evidence about conditions that did not exist at the date of the balance sheet but that arose subsequent to that date. Type II events usually require disclosure in the notes to the financial statements. In some instances where the effect of the Type II event or transaction is very significant, pro forma financial statements may be required in order to prevent the financial statements from being misleading.
The audit report is dated as of…
The last day of fieldwork.
Auditing standards indicate that the auditor’s report should be dated:
A. no earlier than the date on which the auditor has obtained sufficient appropriate audit evidence on which to base an opinion on the financial statements.
B. All significant audit documentation must have been reviewed and approved, all of the financial statements, including related notes, must have been prepared
C. Management must have explicitly taken responsibility for the financial statements.
What are the 2 options for if a subsequent event is discovered AFTER the Audit Report Date but BEFORE the financial statements are issued? Which so auditors prefer?
A. “dual date” the report, using wording such as “February 15, 2016, except for Note 10, which is as of March 1, 2016” or
B. use the date of the subsequent event (later date).
-Auditors prefer dual dating - The auditor’s report is dual dated when a subsequent event occurs after the date on which the auditor has obtained sufficient appropriate audit evidence but before the financial statements are issued.
When facts are encountered that may affect the auditor’s previously issued report, the auditor should:
A. Consult with his or her attorney because legal implications may be involved and actions taken by the auditor may involve confidential entity–auditor communications.
B. Discuss the matter with an appropriate level of management and, when appropriate, those charged with governance. C. Determine whether the financial statements are in error and the audit report is affected. If so, he or she should request that the entity issue an immediate revision to the financial statements. The reasons for the revisions should be described in the footnotes to the revised financial statements. If the effect on the financial statements cannot immediately be determined, the entity should notify persons known to be relying on the financial statements and the accompanying auditor’s report. If the stock is publicly traded or subject to regulatory jurisdiction, the entity should contact the SEC, stock exchanges, and other regulatory agencies as appropriate.
If the entity refuses to cooperate and make the necessary disclosures, the auditor should notify the board of directors and take the following steps, if possible:
- Notify the entity that the auditor’s report must no longer be associated with the financial statements.
- Notify any regulatory agencies having jurisdiction over the entity that the auditor’s report can no longer be relied upon.
- Notify each person known to the auditor to be relying on the financial statements. (Notifying a regulatory agency such as the SEC is often the only practical way of providing appropriate disclosure.)
What are the final audit steps before deciding on the appropriate audit report?
A. Search for unrecorded contingent liabilities
B. Review for subsequent events
C. Perform final analytical procedures
D. Obtain a management representation letter
E. Review working papers
F. Final evaluation of audit results
G. Evaluation of financial statement presentation and disclosure
H. Obtain an independent review of the engagement
I. Evaluate the entity’s ability to continue as a going concern
What are final analytical procedures?
Auditing standards require that the auditor perform analytical procedures both in planning and at the final review stage of the audit
What is a representation letter?
A letter that corroborates oral representations made to the auditor by management or by other auditors and documents the continued appropriateness of such representations.
- Representation letter is addressed to the auditor
- Typically signed by the chief executive officer (CEO) and the chief financial officer (CFO).
- Same date as the auditor’s report.
Management’s refusal to provide a representation letter would result in…
A scope limitation that is sufficient to preclude an unqualified opinion and, in fact, is ordinarily sufficient to cause an auditor to disclaim an opinion or withdraw from the engagement.
What is an engagement quality review?
A review by a quality review partner of the financial statements and audit report to ensure the audit was properly conducted and an appropriate report issued. The engagement quality reviewer is a partner who is not associated with the details of the engagement and is expected to provide an independent, objective review.
The FASB recently issued Accounting Standards Update 2014–15, Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern:
A. An entity’s management must first evaluate the entity’s ability to continue in existence as a going concern, and
B. Auditors then make an independent assessment to evaluate the adequacy of management’s going concern disclosures.
