Bus 426 - Lecture 9.docx

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Business Administration
BUS 426
Michael Favere- Marchesi

Lecture 9 Contingent Liabilities (CL) Commitments © Subsequent Events (SE) Contingent Liabilities  CLs are existing conditions or situation that will be resolved at some future time – eg. Lawsuit  How to Search for CL o Enquire of management o Review minutes of shareholders  Board of Director meetings o Read contracts, agreements + related correspondence o Legal inquiry most important  Legal Inquiry = Legal confirmation o Confirmation letter in a specific format (fig. 21-1, p. 694)  Requesting information about pending litigation or other relevant information with respect to legal claims  2 Categories of Claims o Outstanding or Asserted Claims  Client has been notified of the suit or the suit has already been filed o Possible or Unasserted Claims  Client is aware of a situation that could lead to claims  Legal Expenses o Analysis to get indication of contingent liabilities o Identify law firms where confirmations are required o Identify events that need to be confirmed by law firms  Evaluate Known Contingent Liabilities o Once the CL has been identified and documented, then management’s disclosure of the CL needs to be evaluated o Based on the likelihood of event  CL may require an adjustment (likely to occur and amount can be determined)  CL need to be in footnotes (likely to occur but amount is not determinable OR the likelihood cannot be estimated)  CL need not to be disclosed (unlikely to occur) Commitments  Commitments are certain, as opposed to CL where there is uncertainty with respect to the outcome  Usually disclosed in the footnotes  Use the same procedures to identify and document the commitments as we did for the contingent liability  Together, CL + C are very important because o They represent encumbrances of potentially material amount of future resources (especially cash) o Potentially will affect future cash flows o GAAP requires their disclosure Subsequent Events  Transactions and events that occur after the balance sheet date  Auditor must examine subsequent events up to the audit report date  2 Types of Subsequent Events o Those that require adjustment to the financials o Those that require only disclosure in footnotes  Subsequent Events requiring Adjustments (Hindsight) o Subsequent Events have a direct effect on financial declaration of bankruptcy by a customer with a large outstanding accounts receivable balance o Settlement of a litigation for an amount =/= than the amount recorded in the books o Disposal of equipment not in operation at a price below current book value o Sale of investment below recorded cost  Very important to distinguish between conditions that existed at the balance sheet date from those conditions that came into being after the balance sheet date o Sale of raw material inventory as scrap after year end if obsolescence took place before year end  Adjust inventory value o Sale of raw material inventory as scrap after year end if obsolescence took place after year end  Not adjust inventory value  Subsequent Events requiring only Disclosure o These subsequent events have no direct, or indirect effect on financials o E.g.: A decline in the market value of securities held for temporary investments or for resale o Issuance of bonds or stock  How to get Subsequent Events Evidence o Discussion with management o Legal letters o Examination of subsequent internal financials or other internal documents o Review of shareholders meetings or directors minutes o Letter of representation from management o Cutoff timing Final Evidence Accumulation  Analytical Procedures  Evaluate and conclude on the going-concern assumption  Obtain client representation letter (or management representation letter) o Confirms the information provided to the auditor in the course of the audit o Auditor is required to obtain  Annual report o Aside from financial statements... CAS 720 says that “The primary responsibility of auditor is to ensure financial statements and the related footnotes and the auditor’s report are accurately and faithfully reproduced in the annual report” o However, auditor must ensure that other financial information contained in the annual report is consistent with information on the financial statements and reported footnotes  Management Discussion and Analysis Sufficiency of Evidence  Audit partner responsible for overseeing evidence in the context of engagement risks and client profile risk  Detailed review to ensure that all fieldwork has been completed and outstanding queries have been cleared Final Analytical Review  Useful as a final review for material misstatements or financial problem not noted during other testing  Final objective look at financials after adjustment  Required Evaluation of Going Concern Consumption  Results of analytical review and financial state
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