Chapter 17 - Completing the Audit Engagement Flashcards
ESSAY QUESTION - What is a Contingent Liability?
Represents a potential obligation to outside parties that arose from past events but for which the final resolution is uncertain, depending on the outcome of future events.
Examples of Contingent Liabilities (6)
Pending or threatened litigation
Actual or possible claims or fines stemming from regulatory or disciplinary action
Tax disputes (e.g. income or payroll)
Product warranties or defects
Guarantee of obligations to others
Agreements to repurchase receivables that have been sold
ESSAY QUESTION - What are the criteria used to classify Contingent Liability events or conditions?
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 even occurring is slight
!! What are Type I Subsequent Events? !!
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.
Requires adjustment of the financial statements.
!! What are Type II Subsequent Events? !!
Events that provide evidence about conditions that did not exist at the balance sheet date but arose subsequent to that date. They do not affect the accuracy of the financial statements.
Requires disclosure and possibly separate pro forma financial statements
Audit Procedures to Look for Subsequent Events
Inquire of management
Read minutes of meetings
Read interim financial statements
Inquire of legal counsel
Examine the books of original entry for the subsequent events period and look for unusual transactions or information
!! What are some Audit Procedures that help the auditor identify Contingent Liabilities? (Part 1) !!
- Read the minutes of meetings of the board, committees of the board, and stockholders.
- Review contracts, loan agreements, leases, and correspondence from govt. agencies
- Review tax returns, IRS reports, and schedules supporting the entity’s income tax liability
!! What are some Audit Procedures that help the auditor identify Contingent Liabilities? (Part 2) !!
- Confirm or otherwise document guarantees and letters of credit from financial institutions or other lending agencies
- Inspect other documents for possible guarantees or other similar arrangements
What is a Subsequent Event?
Events or transactions that occur after the balance sheet date but before the issuance of the financial statements that materially affect the financial statements.
!! If a company was going to have issues Continuing as a Going Concern, would we want to know how they were going to mitigate those Issues? !!
The entity’s management is required to evaluate the entity’s ability to continue in existence as a going concern and auditors are to make an independent assessment of the adequacy of management’s going-concern disclosures.
!! Is it Management’s job to tell us how they’re going to fix issues of going concern, or is it the auditor’s job? !!
Management may develop plans to mitigate the risk of being unable to meet its obligations during the look-forward period. Management can consider its plans as sufficient only if it’s probable the plans will be effectively implemented. Auditors simply assess the likelihood that the plans will be successfully implemented.
!! What letter is sent to a client’s attorney’s when the auditor is informed of litigation that may affect the entity? !!
A letter of audit inquiry is sent to the entity’s attorneys to corroborate information provided by management about litigation, claims, and assessments. Sent by management both to in-house (general counsel) and external attorneys.
!! What is an example of a Type 1 Subsequent Event? !!
An uncollectible A/R resulting from deterioration in a customer’s financial condition prior to year-end. The customer declares bankruptcy after the balance sheet date but prior to the issuance of the financial statements.
Settlement of a lawsuit after the balance sheet date for an amount different from the amount recorded in the financial statements as a contingent liability.
!! What is an example of a Type 2 Subsequent Event? !!
Loss of the entity’s manufacturing facility or assets resulting from a disaster
Purchase or disposal of a business after the balance sheet date
Capital stock or bond issuance after the balance sheet date
Losses on receivables caused by conditions such as a customer’s business failure
!! What are the objectives of communications with those charged with Governance? !!
Communicate the auditor’s responsibilities and establish an understanding on the terms of the audit engagement.
Obtain info that is relevant to the audit
Communicate overall audit strategy and timing
Provide timely observations arising from the audit
