CHAPTER 17



CHAPTER 17

COMPLETING THE ENGAGEMENT

Answers to Review Questions

17-1 A contingent liability is defined as an existing condition, situation, or set of circumstances involving uncertainty as to possible loss to an entity that ultimately will be resolved when some future event occurs or fails to occur. SFAS No. 5, "Accounting for Contingencies" (FAS5), classifies uncertainties into three categories:

1. Probable: The future event is likely to occur.

2. Reasonably possible: The chance of the future event occurring is more than remote but less than likely.

3. Remote: The chance of the future event occurring is slight.

Examples of contingent liabilities include:

• 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.

17-2 The auditor requests that the attorney provide the following information on pending or threatened litigation:

• A list and evaluation of any pending or threatened litigation to which the attorney has devoted substantial attention. The client may provide the list.

• A listing of unasserted claims and assessments considered by management to be probable of assertion and reasonably possible of unfavorable outcome.

• A request that the attorney describe and evaluate the outcome of each pending or threatened litigation. This should include the progress of the case, the action the entity plans to take, the likelihood of unfavorable outcome, and the amount or range of potential loss.

• A request for additions to the list provided by management or a statement that the list is complete.

• A request that the attorney comment on unasserted claims where his or her views differ from management's evaluation.

• A statement by management acknowledging an understanding of the attorney's professional responsibility involving unasserted claims and assessments.

• A request that the attorney indicate if his or her response is limited and the reasons for such limitations.

• A description of any materiality levels agreed upon for the purposes of the inquiry and response.

An unasserted claim or assessment is one in which the injured party or potential claimant has not yet notified the entity of a possible claim or assessment. Attorneys may be reluctant to provide the auditor with information about the unasserted claims because of client-attorney privilege. Attorneys may also be concerned that disclosure of the unasserted claim may itself result in lawsuits.

17-3 Two examples of long-term commitments are the purchase of raw materials or the sale of products at a fixed price. When the fair market value of the good is less than the purchase price included in the contract, the entity will have to recognize a loss on a long-term commitment even though there has been no exchange of goods.

17-4 The two types of subsequent events that require consideration by management and evaluation by the auditor are:

1. Events that provide additional evidence about conditions that existed at the date of the balance sheet and affect the estimates that are part of the financial statement preparation process. These types of events require adjustment of the financial statements.

2. Events that provide evidence about conditions that did not exist at the date of the balance sheet but arose subsequent to that date. These types of events usually require financial statement disclosure. In some instances, where the effect of the event or transaction is significant, pro forma financial statements may be necessary in order to prevent the financial statements from being misleading.

Examples of the first type of event or condition are:

• An uncollectible account receivable resulting from continued deterioration of a customer's financial condition leading to bankruptcy after the balance sheet date.

• The settlement of a lawsuit after the balance sheet date for an amount different from the amount recorded in the year-end financial statements.

Examples of the second type of event or condition are:

• Purchase or disposal of a business by the entity.

• Sale of a capital stock or bond issue by the entity.

• Loss of the entity's manufacturing facility or assets resulting from a casualty such as a fire or flood.

• Losses on receivables arising from conditions such as a casualty arising subsequent to the balance sheet date.

17-5 The auditor would consider dual-dating the audit report when a subsequent event is recorded or disclosed in the financial statements after completion of the field work but before the issuance of the financial statements (refer to Figure 17-1 in the text).

17-6 Auditing standards (AU 329), requires that the auditor perform analytical procedures at the final review stage of the audit. The objectives of conducting analytical procedures near the end of the engagement is to help the auditor assess the conclusions reached on the financial statement components and evaluate the overall financial statement presentation.

17-7 The auditor obtains a representation letter in order to corroborate oral representations made to the auditor and to document the continued appropriateness of such representations. The representation letter also reduces the possibility of misunderstanding concerning the responses provided by management to the auditor's inquiries.

17-8 An concurring or second partner is generally not associated with the details of the engagement and is expected to provide an independent review of the audit. The second partner can protect the firm from an inappropriate or nonindependent relationship between the audit partner and the client. In conducting the review, the second partner should understand the audit approach, findings, and conclusions for critical audit areas and should review the audit report, financial statements, and footnotes for consistency.

17-9 Three overall steps in the going-concern evaluation process are as follows:

1. Consider whether the results of audit procedures performed during the planning, performance, and completion of the audit indicate whether there is substantial doubt about the entity's ability to continue as a going concern for a reasonable period of time not to exceed one year.

2. If there is substantial doubt, the auditor should obtain information about management's plans to mitigate the going-concern problem and assess the likelihood that such plans can be implemented.

3. If the auditor concludes, after evaluating management's plans, that there is substantial doubt about the ability of the entity to continue as a going concern, he or she should consider the adequacy of the disclosures about the entity's ability to continue and include an explanatory paragraph in the audit report.

17-10 The four major categories of events or conditions that may indicate going-concern problems and examples of each are:

Financial conditions:

• Recurring operating losses.

• Current-year deficit.

• Accumulated deficits.

• Negative net worth.

• Negative working capital.

• Negative cash flow.

• Negative income from operations.

• Inability to meet interest payments.

Other financial difficulties:

• Default on loans.

• Dividends in arrears.

• Restructuring of debt.

• Denial of trade credit by suppliers.

• No additional sources of financing.

Internal matters:

• Work stoppages.

• Uneconomic long-term commitments.

• Dependence on the success of one particular project.

External matters:

• Legal proceedings.

• Loss of a major customer or supplier.

• Loss of a key franchise, license, or patent.

17-11 The following items should be included in the auditor's communication with an audit committee:

• The auditor's responsibility under GAAS.

• Significant accounting policies.

• Management judgments and accounting estimates.

• Significant audit adjustments.

• Disagreements with management.

• Consultation with other accountants.

• Major issues discussed with management prior to being retained as auditors.

• Difficulties encountered during the audit.

• Fraud involving senior management and fraud that causes material misstatements of the financial statements.

The auditor’s communication with the audit committee would normally take place at or near the end of the engagement. However, if a significant event occurs, such as fraudulent activities by senior management, the auditor would normally contact the audit committee immediately.

17-12 Generally, when previously issued financial statements contain material misstatements due to unintentional or intentional actions by management, the financial statements will require revision.

If the client refuses to cooperate and make the necessary disclosures, the auditor should notify the board of directors and take the following steps, if possible:

1. Notify the client that the auditor's report must no longer be associated with the financial statements.

2. Notify any regulatory agencies having jurisdiction over the client that the auditor's report can no longer be relied upon.

3. Notify each person known to the auditor to be relying on the financial statements. Usually, notification to a regulatory agency such as the SEC is the only practical way to provide appropriate disclosure.

Answers to Multiple-Choice Questions

|17-13 |C | |17-18 |C |

|17-14 |D | |17-19 |A |

|17-15 |C | |17-20 |A |

|17-16 |C | |17-21 |B |

|17-17 |A | | | |

................
................

In order to avoid copyright disputes, this page is only a partial summary.

Google Online Preview   Download