Chapter 17 - Completing the audit engagement

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1.

2.

3.

Are analytical procedures required

as part of the final overall review of
the financial statements? What is the
purpose of such analytical
procedures?

Auditing standards (AU 520, PCAOB AS No. 14), require that the auditor perform analytical
procedures at the final review stage of the audit. The objective of conducting final 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.

List the three overall steps in the

going-concern evaluation process.

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.

Provide two examples of

commitments. Under what
conditions may such commitmens
result in the recognition of a loss in
the financial statements.

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 purchase contract, the entity will have to recognize a loss on a long-term
commitment even though there has been no exchange of goods.

4.

What are the two

types of subsequent
events relevant to
the financial
statement audit?

The two types of subsequent events that require consideration by management and evaluation by the auditor
relevant to financial statement audits are
Type I 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.
Type II 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 disclosure in the notes to the financial statements.
In some instances, where the effect of the event or transaction is very significant, pro forma financial statements
may be necessary in order to prevent the financial statements from being misleading.
Examples of Type I events or conditions 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 Type II events or conditions 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.
The two types of subsequent events that require consideration by management and evaluation by the auditor
relevant to the audit of internal control over financial reporting are
1. Control events that reveal information about a material weakness that existed as of the end of the reporting
period. If the event reveals information about a material weakness, the auditor should issue an adverse opinion
regarding the effectiveness of internal control over financial reporting. If the auditor is unable to determine the
effect of the subsequent control event on the effectiveness of the company's internal control, the auditor should
disclaim an opinion.

2. Control events that create or reveal information about a new condition that did not exist as of the end of the
reporting period. If the information has a material effect on the company, the auditor should include an
explanatory paragraph describing the event and its effects or directing the reader's attention to the event and its
effects as disclosed in management's report.
Examples of the control events or conditions (relating to both before and after the reporting period) are
Relevant internal audit reports (or similar functions, such as loan review in a financial institution) issued
during the subsequent period.
Independent auditor reports (if other than the primary auditor's) of significant deficiencies or material
weakness.
Regulatory agency reports on the company's internal control over financial reporting.
Information about the effectiveness of the company's internal control over financial reporting obtained through
other engagements.

5.

What information does

the auditor ask the lawyer
to provide on pending or
threatened litigation?

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 description and evaluation of 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.
Additions to the list provided by management or a statement that the list is complete.
Comments 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.
Indication 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.

6.

what is meant by a
contingency? Give
examples.

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. FASB ASC Topic 450, "Contingencies," 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

7.

What major categories of

events of conditions may
indicate going-concern
problems?

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

8.

Why does the auditor

obtain a representation
letter from management?

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.