Professional Documents
Culture Documents
Review Questions
24-1
PRESENTATION AND
DISCLOSURE-RELATED
AUDIT OBJECTIVES
DESCRIPTION
Completeness
Classification and
understandability
24-2
A financial statement disclosure checklist is an audit tool that
summarizes all disclosure requirements contained in generally accepted
accounting principles. Auditors use the disclosure checklist to determine that all
required disclosures are completely presented and disclosed in the financial
statements and accompanying footnotes. This helps the auditor obtain sufficient
appropriate evidence about the completeness objective for the presentation and
disclosure-related audit objective.
24-3
A contingent liability is a potential future obligation to an outside party
for an unknown amount resulting from activities that have already taken place.
Some examples would be:
Pending litigation
Income tax disputes
Product warranties
Notes receivable discounted
Guarantees of obligations of others
Unused balances of outstanding letters of credit
24-1
24-3 (continued)
An actual liability is a real future obligation to an outside party for a
known amount from activities that have already taken place. Some examples
would be:
Notes payable
Accounts payable
Accrued interest payable
Income taxes payable
Payroll withholding liabilities
Accrued salaries and wages
24-4
If you are concerned about the possibility of contingent liabilities for
income tax disputes, there are various procedures you could use for an
intensive investigation in that area. One good approach would be an analysis of
income tax expense. Unusual or nonrecurring amounts should be investigated
further to determine if they represent situations of potential tax liability. Another
helpful procedure for uncovering potential tax liabilities is to review the
general correspondence file for communication with attorneys or internal
revenue agents. This might give an indication that the potential for a liability
exists even though no actual litigation has begun. Finally, an examination of
internal revenue agent reports from prior years may provide the most obvious
indication of disputed tax matters.
24-5
The auditor would be interested in a client's future commitments to
purchase raw materials at a fixed price so that this information could be
disclosed in the financial statements. The commitment may be of interest to an
investor as it is compared to the future price movements of the material. A future
commitment to purchase raw materials at a fixed price may result in the client
paying more or less than the market price at a future time.
24-6
The analysis of legal expense is an essential part of every audit
engagement because it may give an indication of contingent liabilities which may
become actual liabilities in the future and require disclosure in the current
financial statements. Since any single contingency could be material, it is
important to verify all legal transactions, even if the amounts are small. After the
analysis of legal expense is completed, the attorneys to whom payment was
made should be considered for letters of confirmation for contingencies (attorney
letters).
24-7
Pyson should determine the materiality of the lawsuits by requesting
from Merrill's attorneys an assessment of the legal situations and the probable
liabilities involved. In addition, Pyson may have his own attorney assess the
situations. Proper disclosure in the financial statements will depend on the
attorneys' evaluations of the probable liabilities involved. If the evaluations
indicate highly probable, material amounts, disclosure will be necessary in the
form of a footnote, assuming the amount of the probable material loss cannot be
reasonably estimated. If the client refuses to make adequate disclosure of the
24-2
24-3
24-8
An asserted claim is an existing legal action that has been taken against
the client, whereas an unasserted claim represents a potential legal action. The
client's attorney may not reveal an unasserted claim for fear that the disclosure
of this information may precipitate a lawsuit that would be damaging to the client,
and that would otherwise not be filed.
24-9
If an attorney refuses to provide the auditor with information about
material existing lawsuits or likely material unasserted claims, the audit opinion
would have to be modified to reflect the lack of available evidence. This is
required by AU 337, and has the effect of requiring management to give its
attorneys permission to provide contingent liability information to auditors and to
encourage attorneys to cooperate with auditors in obtaining information about
contingencies.
24-10 The first type of subsequent event is one that has a direct effect on the
financial statements and requires adjustment. Examples of this type of
subsequent event are as follows:
The second type of subsequent event is one that has no direct effect on
the financial statements but for which disclosure is advisable. Examples
include the following:
24-11 Malano's approach does not take into consideration the need to obtain
letters from attorneys as near the end of field work as possible. If the letters are
received near the balance sheet date, the period from the balance sheet to the
end of the auditor's field work will not be included in the attorneys' letters. His
procedure would not obtain the most current information regarding contingent
liabilities, and would not provide adequate information for disclosure of pertinent
subsequent events.
24-4
24-12 The major considerations the auditor should take into account in
determining how extensive the subsequent events review should be are:
24-14 Subsequent events occurring between the balance sheet date and the
date of the auditor's report are those transactions and events which might
affect the financial statements being audited (either adjustment, disclosure, or
both). Examples of these types of events would be:
24-5
24-14 (continued)
24-6
24-16 (continued)
Examples where adequate disclosure could depend heavily upon the
accumulation of evidence are:
Completeness of information
24-7
24-17 (continued)
3.
4.
Subsequent events
Internal controls
24-17 (continued)
A management letter is a letter directed to the client to inform
management of certain recommendations about the business which the CPA
believes would be beneficial to the client.
Items that might be included in a management letter are:
Examples of important
documentation review are:
potential
findings
in
Incorrect computations
Inadequate scope
Lack of proper documentation for audit decisions
24-9
regular
audit
24-20 (continued)
An independent review is one done by a completely independent person
who has no experience on the engagement. The purpose is to have a competent
professional from within the firm who has not been biased by the ongoing
relationship between the regular auditors and the client perform an independent
review. Examples of important potential findings in an independent review are:
24-22
a.
(2)
b.
(3)
c.
(1)
24-23
a.
(4)
b.
(2)
c.
(4)
24-24
a.
(3)
b.
(4)
c.
(1)
24-25
a.
(4)
b.
(3)
c.
(2)
24-10
24-26
a.
b.
c.
d.
24-11
24-27
a.
b.
Discuss,
specifically,
any
related
party
transactions with management and include
information in letter of representation.
24-12
24-27 (continued)
c.
2.
3.
24-13
24-28
a.
b.
c.
d.
e.
f.
g.
h.
i.
24-29
a.
b.
c.
24-15
24-30
a.
b.
c.
Financial statements
2.
Completeness of information
3.
Information
concerning
fraud
involving
(1)
management, (2) employees who have significant roles
in internal control, or (3) others where the fraud could
have a material effect on the financial statements
24-17
24-30 (continued)
4.
Subsequent events
Internal controls
24-31
a.
b.
24-18
24-32
1.
2.
3.
4.
5.
24-20
24-33
a.
b.
24-34
c.
Item 1
Item 2
Item 3
Item 4
Item 5
Item 6
Item 7
a.
24-34 (continued)
24-35
b.
a.
b.
c.
3.
5.
24-22
24-35 (continued)
d.
e.
Case
24-36
a.
b.
c.
24-23
24-36 (continued)
You should also stress that it would be wise to adjust the
allowance accounts in a year with substantial net income. The
allowance accounts will most likely increase in future years,
especially if entries (5) and (6) are not made in the current year.
Since management cannot be sure that the company will generate
substantial net income in future years, it would be best to adjust
the allowance accounts in the current year and avoid a substantial
reduction to net income in a future year that is not as profitable as
the current year.
d. Your responsibility related to unadjusted misstatements that management
has determined are immaterial individually and in the aggregate is
to determine for yourself whether the combined effect of these
unadjusted misstatements are material for the audit. The combined
effect of the unadjusted misstatements must be compared to
overall materiality. Assuming that the remaining unadjusted
misstatements are well below your materiality threshold, you do not
need to qualify your audit opinion. You should consider having the
client include a summary of this audit schedule in the management
representation letter, along with managements representation that
the uncorrected misstatements are immaterial.
e. Auditors of public companies must evaluate the noted adjustments to
determine their impact on the auditors report on internal control
over financial reporting. As discussed in Chapter 10, the audit of
the financial statements and the audit of internal control over
financial reporting for a public company are to be integrated. Public
company auditors must consider the results of audit procedures
performed to issue the audit report on the financial statements
when issuing the audit report on internal control. For example, if the
possible adjustments identified by Aviary Industries auditor are
deemed to be material misstatements that were not initially identified
by the companys internal controls, the auditor should consider this
as at least a significant deficiency, if not a material weakness for
purposes of reporting on internal control. In this case, the auditors
report on Aviarys financial statements would be unqualified as
long as management corrected the misstatement before issuing the
financial statements. However, the auditors report on internal
control over financial reporting would include an adverse opinion if
the auditor concludes that it is a material weakness.
24-24
24-36 (continued)
a.
Client Name Aviary Industries
SUMMARY OF POSSIBLE ADJUSTMENTS
Year-ended December 31, 2009
Possible Adjustments - Dr (CR)
Description
A/C Dr.
A/C Cr.
24-21
(1) Unrecorded
credit memos*
Sales R&A
A/R
26,451
(2) Unrecorded
inventory
purchases
Purchases
A/P
25,673
Sales
A/R
41,814
Cash
A/P
43,671
(5) Obsolete
inventory**
Loss A/C
Inventory Allow. A/C
15,000
(6) AFDA
understated**
35,000
Totals
Current
Assets
Working capital
Total assets:
Net income:
$ 143,938 decrease
$ 74,594 decrease
$ 143,938 decrease
NonCurrent
Assets
Current
Liabilities
NonCurrent
Liabilities
Beginning
Equity
Income
25,673
(25,673)
41,814
(41,814)
43,671
Expenses
26,451
(26,451)
(43,671)
15,000
(15,000)
35,000
(35,000)
(74,594)
Conclusions:
The net effect of the above items is as follows:
*
**
Total
Amount
(69,344)
68,265
75,673
Opinion as to need for AJE: Preliminary materiality was $100,000. However, revised materiality
based on 5% of actual income before taxes = $1,508,929 x 5% = $75,446.45. Rounded = $75,000.
The combined effect of the above proposed entries on net income exceeds revised materiality. Propose that
all entries be recorded. However, at a minimum, entries (5) and (6) should be recorded in order to decrease
the effect of the above entries to a level below revised materiality of $75,00000. Entry (1) or (2) may also
have to be recorded in order to have some cushion between the net income misstatement and revised
materiality after recording entries (5) and (6).
Entry assumes that items were returned prior to 12-31-09 and counted in inventory at year-end (no COGS/inventory misstatement).
Because entry deals with an accounting estimate, the lower end of the range would be sufficient.
24-1
Audit committees of public companies have many responsibilities in
todays financial reporting environment. Among those responsibilities are hiring
the companys external audit firm, overseeing the companys financial reporting
processes, meeting with management to understand decisions around
accounting and auditing matters and so forth. Microsoft Corporation has made
information about its audit committee available on the companys website
[http://www.microsoft.com/about/company
information/corporategovernance/committees/audit.mspx]. Visit the website
and answer the following questions:
1.
2.
3.
What authority does the committee have in carrying out its responsibilities?
Answer:
According to the companys website: The Committee will have the
resources and authority necessary to discharge its duties and
responsibilities. The Committee has sole authority to retain and
terminate outside counsel or other experts or consultants, as it
deems
24-26
24-27
B.
24-28
helps
the
24-29
audit
committee
D.
(Note: Internet problems address current issues using Internet sources. Because
Internet sites are subject to change, Internet problems and solutions may change.
Current
information
on
Internet
problems
is
available
at
www.pearsonhighered.com/arens.)
24-30