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Chapter 18

BUS 426 Chapter Notes - Chapter 18: Contingent Liability, Audit Evidence, Financial Statement

Business Administration
Course Code
BUS 426
Craig Emby

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Chapter 18
Completing the Audit
Presentation and Disclosure
- Auditors evaluate evidence obtained during the earlier phases of the audit to assess whether
additional evidence is needed for the presentation and disclosure objectives
- Concerns
o Whether management has disclosed all required information
- As part of the final review for financial statement disclosure, many PA firms require the completed of
a financial statement disclosure checklist
Review for Contingent Liabilities and Commitments
- Auditor are especially concerned about certain contingent liabilities
o Pending litigation for patent infringement, product liability, or other actions
o Income tax disputes
o Product warranties
o Notes receivable discounted
o Guarantees of obligations of others
o Unused balances in outstanding letters of credit
- The audito’s ojeties i eifyig otiget liailities
o Evaluate the accounting treatment of known contingent liabilities to determine whether
management has properly classified the contingency (classification)
o Identify, to the extent practical, any contingencies not already identified by management
- Process
o Determine whether any contingencies exist (occurrence, presentation and disclosure objective)
o More difficult to discover unrecorded transactions or events than to verify recorded information
o Once the auditor knows that contingencies exist, evaluating their materiality and the footnote
disclosures can ordinarily be satisfactorily resolved
o If the auditor concludes that there are contingent liabilities, the significance of the potential
liabilities and the nature of the disclosure that is necessary in the financial statements must be
Cofiratio fro Cliet’s Law Firs Lawyer’s Letter
- The stadad lette of ofiatio to the liet’s law firm should include
o A list, prepared by management, of outstanding (asserted) and possible (unasserted) claims
o A description of the nature and the current status of each claim and possible claim
o A idiatio of aageet’s ealuatio of the aout ad likelihood of loss or gain for each
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o A request that the lawyer reply to the client, with a signed copy going to the PA firm, advising
hethe aageet’s desiptios ad ealuatios of the outstadig ad possible claims are
- Lawyers are not required to mention any omission of possible claims in their response to the inquiry
letter and do not directly notify the auditor of them
- CAS 501 par. 10 requires the auditor to obtain a letter of representation from management that it has
disclosed all known outstanding and possible claims
- Unless management discloses the existence of possible claims to the auditor, the auditor has no
means of discovering whether or not any such claims exist
Limited or Nonresponses from Law Firms
- When a lawyer refuses to poide ifoatio that is ithi the laye’s juisditio ad ay dietly
affet the fai pesetatio of fiaial stateets, the audito’s opiio ould e ualified due to
the lack of available evidence
- Joint policy statement concerning communications with law firms regarding claims and possible
claims in connection with the preparation and audit of financial statements
o Has the effect of encouraging lawyers to cooperate with auditors in obtaining information about
contingencies, as the law fi’s ofidetial elatioship ith its liets ill ot e iolated
- Agreements that the entity will hold to a fixed set of conditions at a future date, regardless of what
happens to profits or to the economy as a whole
- The search for unknown commitments is usually performed as part of the audit of each audit area
- Auditor should be aware of the possibility of commitments when reading minutes, contracts, and
correspondence files
Review for Subsequent Events
- The transactions and events occurring after the balance sheet date
- Audito’s esposiility
o To determine whether anything occurred that might affect the fair presentation or disclosure of
the statements being audited
o Normally limited to the period beginning with the balance sheet date and ending with the date of
the audito’s epot
- The date of the audito’s epot oespods ith the appoal of the fiaial stateets y the
board of directors or other executive management
Types of Subsequent Events
- Type I
o Have a direct effect on the financial statements and require adjustment
o Provide evidence of a state or event prior to the balance sheet date, but of which no one,
management or auditor, was aware
No implication of wrongdoing or malfeasance on the part of anyone
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