Bus 426 - Chapter 21

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Business Administration
BUS 426
Michael Favere- Marchesi

Chapter 21 -Completing the Audit Review for Contingent Liabilities and Gains  Contingent Liability: A liability that arises due to an existing condition or situation involving uncertainty as to possible gains or losses o Conditions for the Existence of Contingent Liabilities:  There is a potential future payment to an outside party that results from an existing condition  There is uncertainty about the amount of the future payment  The outcome will be resolved by some future event or events o Management is responsible for identifying and deciding the appropriate accounting treatment for contingent liabilities o Auditor only evaluates the accounting treatment and identify any contingencies not already identified Contingency Treatment Likelihood of Occurrence Financial Statement Treatment Unlikely to Occur No disclosure Not determinable Footnote disclosure Likely to occur and the amount Financial statement accounts are can be estimated adjusted Likely to occur and the amount Footnote disclosure is necessary cannot be estimated  Common Procedures to Search for Contingent Liabilities o Inquire of management o Review current and previous years’ CRA notices of assessment o Review minutes and shareholders’ meetings o Analyze legal expense for the period under audit  Commitments: Agreements that the entity will hold to a fixed set of conditions, such as the purchase or sale of merchandise at a stated price, at a future date, regardless of what happens to profits or to the economy as a whole  Obtain Confirmation from Client’s Law Firms o A way for auditors to evaluate known litigation or other claims against the client o Inquiry of the Client’s Law Firms: A confirmation letter in a specific format from the client’s legal counsel informing the auditor of pending litigation or any other information involving legal counsel that is relevant to financial statement disclosure  If law firms don’t respond, its usually either:  They don't have knowledge of it Chapter 21 -Completing the Audit  Lawyer aware of a significant loss and don’t want to disclose it o Two Types of Law Suits:  Outstanding Claim: A lawsuit that has been brought against a client; also known as an “Asserted claim”  Unasserted Claim: A potential legal claim against a client where the condition for a claim exists but no claim has been filed; also known as a “Possible claim” Review for Subsequent Events  Subsequent Events: Transactions and events occurring after the balance sheet date o Two Types of Subsequent Events:  Those that have a direct effect on the financial statements and require adjustment  Bankruptcy  Sale of investments at a price below recorded cost  Those that have no direct effect on the financial statements but for which disclosure is advisable  Decline in market value of investments  Issuance of bonds or shares  Decline in market value of inventory as a consequence of government action barring further sale of a product  Uninsured loss of inventories as a result of fire or other disaster  Purchase of a business or trademark  Review for Subsequent Events: The auditing proced
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