Lecture 16 Notes

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Accounting & Financial Management
AFM 451
James Wainberg

Chapter 15 – Completing the Audit Overall Assessment A. Has sufficient appropriate audit evidence been gathered? B. Are there uncorrected misstatements?  management may not correct them due to reasons – we have to think of those reasons C. Is the initial risk assessment made during the planning stage still appropriate?  Was our initial materiality assessment adequate D. Are there internal control deficiencies to communicate?  Internal control deficiencies that we need to speak to mgmt. about Final Analytical Procedures  Used as a final review for material misstatements or financial problems not noted during other testing o Gives auditor a final objective look at the financial statements o Auditor is alert for unusual transactions  Substantive test of details – used in the middle but not required  Analytical Procedures are used at 3 points during the audit: 1. For risk assessment at the planning stage 2. As a substantive test procedure (NOT REQUIRED) 3. During overall evaluation of the F/S at the end of the audit  Using ANALYTICAL PROCEDURES to assess the reasonableness of reported results AFTER most of the audit work has been performed is an effective means of obtaining assurance.  The cash flow statement is prepared after the B/S and I/S are finalized, so it is audited at the completion stage. o Verifying cash flow statements explains the major changes in the B/S accounts and thus provides analytical evidence that the F/S relations are properly presented  These alternative presentations of the financial performance and changes in financial position should be EVALUATED by the auditors in relation to their knowledge of the year’s activity (FOR EXAMPLE: a large financing inflow from new debt should MATCH UP with disclosure about the new loan)  Auditors also verify info presented in the statement of changes in retained earnings and shareholders’ equity at this stage – to ensure that ACCOUNT CLASSIFICATIONS, AGGREGATIONS AND SUMMARIZATIONS are comparable to those of the prior year in an assessment of the consistency of the financial reporting and the overall adequacy of the disclosures Keval Shah Chapter 16 – AFM 451 1  Auditors may use a checklist to ensure all disclosures required by GAAP are considered  Unusual Transactions o Significant audit evidence and reporting problems can arise if mgmt. transactions artificially create earnings. o Usually in REVENUES o “gaps in GAAPs” - loopholes Sequencing of Audit Events  Some audit work might be done at an interim period before the B/S date, followed by completion of the work at later dates  Certain procedures (such as LAWYER’S LETTERS + WRITTEN MANAGEMENT REPRESENTATION LETTERS + SUBSEQUENT EVENTS REVIEWS) are always left to the very final stages of the audit work  Often, they will be completed back at the audit firm’s office – AFTER the field work visit has finished Communication with Auditee’s Lawyers  The lawyer’s letter is one of the most important audit confirmations (CAS 501).  It helps auditor to detect CONTINGENCIES and CLAIMS  These represent encumbrances on future cash flows  Dated at the audit report date o The enquiry is sent from management to their lawyer (note: confirm controls must be maintained)  Last chance to find unusual activity  CAS 501 requires auditors to perform procedures identifying litigation and claims against the auditee  ***Where there is a risk of RMM, auditors MUST communicate DIRECTLY with the auditee’s legal counsel  The objective is to provide audit evidence about any potentially material litigation or claims against the auditee, to determine if management’s estimates of the possible costs of these are reasonable and to ASSESS whether there are any UNRECORDED LIABILITIES that should be recorded in the F/S  The auditor asks management to send ENQUIRY LETTERS TO ALL LAWYERS who performed work for the auditee during the period  This request informs the LAWYER that their client, the auditee, is waiving the privilege of confidentiality of communications b/w the lawyers and the client and gives the lawyer permission to given info to the auditors  Questions about: Keval Shah Chapter 16 – AFM 451 2 o Contingencies o Litigations o Claims o Assessments  ***If the management or its lawyer FAIL to provide adequate information about lawsuit contingencies, the auditor should consider whether this represents a scope limitation on the audit  A serious audit scope limitation requires qualification in the audit report or a DISCLAIMER OF OPINION. Analyze Legal Expenses!  Legal expenses can help uncover unrecorded liabilities o A marked increase in legal expenses usually indicates a legal battle or other litigation needing consideration o Unrecorded Liabilities – Communicate with the auditee’s lawyer – ask the client to put it on their letter – client draws up the document on their letterhead – request from a lawyer – to provide confirmation regarding any outstanding claims against the company – this is where we find out about potential lawsuits, mergers  Also helps to identify law firms where confirmation may be required (new law firm etc…)  Similar to A/R confirmations  Lawyer letter is probably one of the most imp of all audit confirmations  Control over this confirmation process needs to be made  We would do the mailing of the lawyer – the lawyer would send the letter back to us directly  The importance of analyzing legal expenses – UFE style cases  The client may want to put this type of info in the F/S, but if it’s a public company, its required – analyzing legal expenses could open the door to see what work they are doing – open questions to mgmt. – “why have you switched law firms?”, “why are you adding a law firm? i.e. patent infringement lawsuits firms” – can show us red flags Searching for Contingent Liabilities  Contingencies are POTENTIAL obligations that may be incurred as a result of future outcomes (e.g. lawsuits)  Auditor needs to obtain information about the NATURE of the contingent liability, the AMOUNT involved, and then assess the likelihood of the OUTCOME o ** note that favorable contingencies also exist! Keval Shah Chapter 16 – AFM 451 3 o Example: A lawsuit that hasn’t been won against our client – we need to gain an understanding of the contingencies are and what the probability of a win/loss is  A few examples that auditors can use to search for contingent liabilities: o Enquire of management  Asking management whether there are any types of contingencies – HOWEVER - mgmt. can lie o Review minutes of shareholders’ and directors’ meetings  Usually where such info would be kept – BofD would have discussed lawsuits – Lawyers – be careful of what the language they use o Read contracts, agreements, and related correspondence  Should be directed to both the LEGAL COUNSEL and MANAGEMENT because the auditor has the right to expect to be informed by management about all material contingent liabilities  Enquire and discuss with mgmt. the policies and procedures for identifying, evaluating and accounting for litigation, claims and assessment  Obtain from mgmt. a description and evaluation of litigation, claims and assessments, including correspondence and invoices from lawyers  Obtain assurance from management that it has disclosed all material unasserted claims that the lawyer has advised them might result in litigation  Read minutes of meetings of shareholders, directors, and appropriate committees. Read contracts, loan agreements, leases, and correspondence from taxing or other governmental agencies  Obtain information concerning guarantees from bank confirmations Evaluating Known Contingent Liabilities  Once the contingent liability has been identified and documented, then management’s disclosure needs to be evaluated.  Based upon the likelihood of the event, it may o NOT need to be disclosed, o need to be disclosed in the FOOTNOTES, or o require an ADJUSTMENT to the financial statements.  We have to evaluate the extent to which disclosure needs to be made Keval Shah Chapter 16 – AFM 451 4 Commitments  Commitments are CERTAIN and represent encumbrances on future cash flows  These are usually disclosed in F/S footnotes o Multi-year purchase of raw material commit
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