UNIT 8: Completing the Audit

Adrias. Alberto. Arellano. Banez. Benedicto

Provisions and contingencies

L11.65 Subsequent Events and Contingent Liabilities.
Crankwell Inc. is preparing its annual financial statements and annual report to
stockholders. Management wants to be sure that all of the necessary and proper
disclosures have been incorporated into the financial statements and the annual
report. Two classes of items that have an important bearing on the financial
statements are subsequent events and contingent liabilities. The financial
statements could be materially inaccurate or misleading if proper disclosure of these
items is not made.

a. with respect to subsequent events

1. Define what is meant by a subsequent event.

A subsequent event is an event or transaction
that occurs after the date of the financial
statements but prior to the date of the auditors
report.

2. Identify two types of subsequent events and explain the

appropriate financial statement presentation of each type.
Two types of subsequent events
Events that provide additional evidence about conditions that existed at the
date of the financial statements. Because the condition existed at the date of
the financial statements, this type of subsequent event requires adjustment of
amounts included in the financial statements.
Events that provide evidence of conditions that arose following the date of the
financial statements. These events should be disclosed in the financial
statements.

3. What are the procedures that should be performed to

ascertain the existence of subsequent events?
Obtaining an understanding of the procedures performed by
management to identify subsequent events.
Inquiring of management and those charged with governance as to the
existence of subsequent events (and subsequently corroborate this
inquiry through written representations).
Reading minutes of meetings of owners, management, or those charged
with governance held after the date of the financial statements.
Reviewing the entitys latest interim financial statements (if applicable).

B. with respect to contingent liabilities

1. Identify the essential elements of a contingent liability.
A contingent liability is an existing condition, situation, or set of
circumstances involving uncertainty as to a possible loss that
will ultimately be resolved when one or more future events
occur or fail to occur.

2. Explain how a contingent liability should be disclosed in the

financial statements.
A contingent liability should be accrued only if information available prior to
issuance of the financial statements indicates that it is probable that a liability has
been incurred at the date of the financial statements and the amount of the loss can
be reasonably estimated.
A contingent liability should be disclosed in a note when it is probable that a liability
has been incurred but the amount cannot be estimated. A contingent liability for
which it is only reasonably possible that a liability has been incurred should be
disclosed in a note. When the probability that a liability has been incurred is remote,
no disclosure is required.

C. Explain how a subsequent event may relate to a contingent liability. Give an

example to support your answer

Subsequent events may provide new and important information about known or
unknown loss contingencies as of the date of the financial statements. The
subsequent event may very well modify the circumstances surrounding the
contingent loss, thereby changing the reporting method from no disclosure to note
disclosure or accrual. For example, a contingent loss may have been recorded as a
note disclosure because at the date of the financial statements, the entity had only a
reasonable possibility that a loss could be incurred. If a subsequent event occurs
that (in the auditors judgment) makes it probable that a liability has been incurred,
the contingent liability will now have to be accrued in the financial statements
(assuming that an amount can be estimated).

L11.52: Written Representations

Hart, an assistant accountant with the firm of Better & Best,
CPAs, is auditing the financial statements of Tech Consolidated Industries Inc. The
firms audit plan calls for the preparation of written representations.
Required:
a. In an audit of financial statements, in what circumstances are auditors required to
obtain written representations?
Auditors are required to obtain written representations in all audits
conducted under generally accepted auditing standards.

L11.52: Written Representations

b. What are the major categories of items covered by written representations?
The major categories of information contained in written representations are:
1. The entitys financial statements, including:
Managements responsibilities for the financial statements and internal
control over financial reporting.
The appropriate disclosure, presentation, and reasonableness of certain
items (accounting estimates, related parties, subsequent events, and litigation
and claims).
A statement that uncorrected misstatements are immaterial to the
financial statements taken as a whole. (cont...)

L11.52: Written Representations

(...cont)
2. Information provided to the auditors, both in general and related
to sensitive areas (fraud, noncompliance with laws and regulations,
litigation, and related-party transactions).
3. Internal control over financial reporting (for audits of public
entities).

L11.52: Written Representations

c. To whom should the representations be addressed and as of
what date should they be dated?
Written representations should be addressed to auditors
and dated as of the date of the auditors reports (audit
completion date).

L11.52: Written Representations

d. Who should sign the representations and what would be the effect of a refusal to
sign them?
Written representations should be signed by members of management whom
auditors believe are responsible and knowledgeable about matters covered by the
representations (usually the chief executive officer, chief financial officer, treasurer,
or controller). Their refusal to sign the representations would constitute a scope
limitation that would prevent the issuance of an unqualified opinion.

L11.52: Written Representations

e. In what respects may auditors other responsibilities be
relieved by obtaining written representations?
Obtaining written representations does not relieve
auditors from their responsibility for planning and performing
the audit. As a result, auditors must still perform all usual
procedures to corroborate representations made by
management.

Exhibit 11.3 (Louwers): Sample Written Representation

Exhibit 11.3 (Louwers): Sample Written Representation

Exhibit 11.3 (Louwers): Sample Written Representation

L11.64 Subsequent Events and Subsequently Discovered Facts

Michael Ewing is auditing the financial statements of Dallas Company for the year
ended December 31, 2014. In concluding the process of gathering sufficient
appropriate evidence, Ewing has asked to meet with his supervisor on the audit
(John Ross) to discuss responsibility for events occurring after the date of the
financial statements.

A.

What is a subsequent event? During what time period is Ewing responsible for
subsequent events?

Subsequent Events are events occurring between the date of the financial statements and
the date of the auditors report, while facts that become known to auditors after the date
of the auditors report that, had they been known at that time, may have caused the
auditors to revise their report, are known as subsequently discovered facts.

(PSA 560; Louwers Ch11 p 478-479)

The auditor shall perform audit procedures designed to obtain sufficient

appropriate audit evidence that all events occurring between the date of the financial
statements and the date of the auditors report that require adjustment of, or
disclosure in, the financial statements have been identified. The auditor is not,
however, expected to perform additional audit procedures on matters to which
previously applied audit procedures have provided satisfactory conclusions. (PSA
560, par 6)

B. List some procedures that Ewing may perform to assist him in identifying
subsequent events.
(a) Obtaining an understanding of any procedures management has established to
ensure that subsequent events are identified.
(b) Inquiring of management and, where appropriate, those charged with
governance as to whether any subsequent events have occurred which might affect
the financial statements.

(c) Reading minutes, if any, of the meetings of the entitys owners, management and
those charged with governance that have been held after the date of the financial
statements and inquiring about matters discussed at any such meetings for which
minutes are not yet available.
(d) Reading the entitys latest subsequent interim financial statements, if any.
(PSA 560, par7)

C. What are two types of subsequent events? How should information related to
these types of subsequent events be reflected in Dallass financial statements?
Events that provide additional evidence of conditions that existed at the date of
the financial statements
-Adjustment to FS
Events that provide evidence of conditions that arose following the date of the
financial statements
-Disclosure of the information in the FS
(PSA 560, par 6-8; Louwers Ch11 p 479)

D. Assume that on January 8, 2015, Dallas Company agreed to acquire Houston Inc.,
in a significant transaction. The date of Ewings report was February 7, 2015, and
Dallas issued its financial statements (and Ewings reports on its financial
statements and internal control over financial reporting) on February 14, 2015. How
would Ewing proceed if he became aware of this subsequent event on the following
dates?
1. January 10, 2015.
2. February 10, 2015.
3. February 20, 2015.

1.

January 10, 2015 (SE known before Audit Report date)

2.

February 10, 2015 (SE known after Audit Report date but before FS issuance)

3.

Non-adjusting event, Disclosure needed as per PAS 10

Audit Report - modify as necessary
PSA 560 par 6-8
Non-adjusting event, Disclosure needed as per PAS 10
Audit Report - follow provisions as per PSA 560 par 10-13

February 20, 2015 (SE known after FS issuance)

Non-adjusting event, Disclosure needed as per PAS 10

Audit Report - follow provisions as per PSA 560 par 14-17

E. On March 2, 2015, Dallas announced that it also will acquire San Antonio
Company in a significant transaction. What is Ewings responsibility with respect to
this acquisition in the audit of Dallass financial statements for the year ended
December 31, 2014?
No responsibility.

Review on Audit Documentation

- appropriate steps relative to
auditing plan were performed,
references were clear, and
documentation is
understandable.
- Engagement Quality Review:
-

Quality of audit work

Reporting is in keeping with

the accounting firms quality
standards

Review on Audit Documentation (A10)

Practices of Mel Adams (Auditor)
-

Reviews all audit files prior to end of audit

Nearing the end, reviews the audit files
After review, drafts the FS and prepares it
for management approval

Requirement A:
Evaluate the practice of reviewing the
audit files of subordinates on a
continuing basis rather than when the
audit is completed.

Review on a continuing basis:

Enhances the quality of audit
Review on the end of audit: more
susceptible to mistakes (less
accuracy)

Requirement B:
Is it acceptable for Adams to prepare
the financial statements rather than
make the client assume the
responsibility?

Responsibility lies with the

management of the audit client

Requirement C:
Evaluate the practice of not having a
review of the audit documentation by
another partner in the firm.

Requires less process

Not effective management of
detection risk

Omitted Procedures

inspections could reveal situations in which an audit was not performed in

accordance with generally accepted auditing standards
auditors could have failed to perform necessary audit procedures prior to the
audit report release date

Subsequently Discovered Facts

Facts that become known to auditors after the date of the auditors report that,
had they been known at that time, may have caused the auditors to revise their
report

Deloitte

2014 Inspection | Issued May 12, 2015

Ernst & Young

2014 Inspection | Issued June 16, 2015

KPMG

2014 Inspection | Issued October 15, 2015

PwC

2015 Inspection | Issued August 10, 2016

Subsequently Discovered Facts

Requirement A:
What is the auditors responsibility
with respect to subsequently
discovered facts and omitted
procedures?

after the date of the auditors

report but prior to the audit
report release date

Revise prior to issuance

Evaluate appropriate
disclosures
Change the date on the
auditors report to reflect
the new (later) date*
Dual date the report

Subsequently Discovered Facts

Requirement A:
What is the auditors responsibility
with respect to subsequently
discovered facts and omitted
procedures?

after issuance of report

Notify individuals known to be

relying on the financial statements
or likely to rely on the financial
statements that (a) the financial
statements should not be relied
upon and (b) revised financial
statements and a new auditors
report will be issued.

Issue revised financial statements

as soon as practicable with
appropriate disclosure of the
matter related to the subsequently
discovered facts.

Requirement A:
What is the auditors responsibility
with respect to subsequently
discovered facts and omitted
procedures?

Omitted Procedures
If (1) the omitted procedures are
important in supporting the
auditors opinion and (2) individuals
are currently relying on the clients
financial statements (and auditors
reports), auditors should perform
the omitted procedure or alternative
procedure(s), if practicable.

Requirement B:
If one is provided, review and briefly summarize
the firms response to the inspection report
(Appendix C). Comment on whether you believe
the firms response to omitted procedures and
subsequently discovered facts was consistent
with generally accepted auditing standards.

Management Letter

Contains recommendation of auditor to the

management to improve the efficiency and
effectiveness of their operation
From auditors to client
Made after audit
Method: oral or written
Not required by GAAS but important in adding
value to clients beyond provided audit
examination
By-product of audit

A11 - Management Letter

Jerry Schwartz (Auditor)

material weakness in control of
inventory
recommended to the company to
install computer system to improve
this
company accepted this
recommendation

A11 - Management Letter

after several months: the

system failed (master file was
erased)
the company decided to file a
lawsuit against Schwartz.

Requirement A:

to provide appropriate
recommendations

to not omit serious systems

deficiencies

to exercise due care in

management letters

What is Schwartzs legal and professional

responsibility in the issuance of
management letter?

whether the system was

installed according to
Schwartzs instruction

whether the client could have

foreseen the possibility of the
erasure based on their
understanding of the system

whether Schwartz exercised the

appropriate degree of due care

Requirement B:
Discuss the major considerations that will
determine whether he is liable in this
situation?