Transcript Chapter 16
Auditing Operations and Completing the Audit
Wrapping Up Field Work
Evaluating Remaining Accounts in the Financial Statements
© The McGraw-Hill Companies, Inc., 2006
Slide 16- 1
Relationships Between Balance Sheet and Income Statement Accounts Balance Sheet Item Revenue Accounts receivable Notes receivable Securities and investments Sales Interest Interest, dividends, gains, investor’s income Expenses Uncollectible accounts Uncollectible notes Losses Inventories Property, plant and equip. Intangible assets Prepaid expenses Accrued liabilities Interest-bearing debt Rent, gains Royalties Purchases, cost of goods sold, and payroll Depreciation; repairs Amortization Various expenses Various expenses Interest
© The McGraw-Hill Companies, Inc., 2006
Slide 16- 2
Substantive Tests Selling, General & Admin Expenses
Perform Analytical Procedures
Develop an expectation of the A/C balance
Determine difference from expectation that can be accepted without investigation
Compare actual A/C balance with expectation
Investigate significant deviations from expectation
© The McGraw-Hill Companies, Inc., 2006
Slide 16- 3
Substantive Tests Selling, General & Admin Expenses
Perform Analytical Procedures
Develop an expectation of the A/C balance
Determine difference from expectation that can be accepted without investigation
Compare actual A/C balance with expectation
Investigate significant deviations from expectation
Obtain or prepare analyses of selected A/Cs
© The McGraw-Hill Companies, Inc., 2006
Slide 16- 4
Substantive Tests Selling, General & Admin Expenses
Perform analytical procedures
Develop an expectation of the A/C balance
Determine difference from expectation that can be accepted without investigation
Compare actual A/C balance with expectation
Investigate significant deviations from expectation
Obtain or prepare analyses of selected A/Cs
Obtain or prepare analyses of critical expenses in the income tax return
© The McGraw-Hill Companies, Inc., 2006
Slide 16- 5
Payroll Internal Controls
Segregation of Duties
HR and Employment Data
Timekeeping & Labor Distribution
Payroll Preparation
Distribution of Pay
Application Controls
Reasonableness Checks
Employee Validity Checks Slide 16- 6
Data Accuracy Checks Such as: HR Table, Timekeeping
© The McGraw-Hill Companies, Inc., 2006
Substantive Tests Salaries, Wages, Compensation
•
Perform Analytical Procedures & Investigate Fluctuations in Various Components
•
Obtain Officer Compensation Data & Trace to Authorization
•
Test Year-end Accrued Payroll
•
Test/Evaluate Special Compensation:
Fair Value Accounting for Stock Options
Profit Sharing & Bonus Plans
Commissions
Deferred Compensation
Pension Expense & Liabilities Slide 16- 7 [ SFAS 123(R) ]
© The McGraw-Hill Companies, Inc., 2006
Audit Procedures Completed Near the End of Field Work
Search for unrecorded liabilities
Review minutes of Bd of Dir meetings
Perform final analytical procedures
Identify loss contingencies
© The McGraw-Hill Companies, Inc., 2006
Slide 16- 8
Loss Contingencies
Reflected in F.S. amounts when:
It is probable (> 50/50 chance) that a loss had been sustained as of B.S. date and
Amount of loss can be reasonably estimated
Only disclosed in notes to F.S. when it is at least reasonably possible that a loss has been sustained as of B.S. date or probable but cannot be estimated.
No amount or disclosure in F.S. when the possibility of loss is remote.
© The McGraw-Hill Companies, Inc., 2006
Slide 16- 9
Identifying Loss Contingencies
Ask Client Plus Mgmt Rep Letter
Review client correspondence with major customers & regulators for disputes and financial institutions for endorsements made
Past Experience
Subsequent Events
Board of Director Minutes
Review Lawyer Invoices (undisclosed cases)
Letter to Outside (+ internal?) Legal Counsel
© The McGraw-Hill Companies, Inc., 2006
Slide 16- 10
Letter to Legal Counsel
Client Letter - Prepared & Sent by Auditor
Ask for: 1.
List of all pending or recently settled litigation 2.
For all identified litigation and those audit procedures identified: a. Period in which the underlying cause for legal action occurred b. Probability of an unfavorable outcome c. Amount or range of potential loss Slide 16- 11
© The McGraw-Hill Companies, Inc., 2006
Excessive Commitments
•
Usually relates to acquisition of scarce raw material/goods or from monopolistic source.
•
Information on commitments must be disclosed in F.S. when deemed beyond current normal needs.
•
Client must disclose description and extent of commitments and risks involved.
© The McGraw-Hill Companies, Inc., 2006
Slide 16- 12
Audit Procedures Completed Near the End of Field Work
Search for unrecorded liabilities Review minutes of Bd of Dir meetings Perform final analytical procedures Identify loss contingencies
Review Subsequent Events
(What’s happened since the B.S. date?)
© The McGraw-Hill Companies, Inc., 2006
Slide 16- 13
Subsequent Events
Type 1/Recognized : Evidence as to conditions existing at B.S. date that effect amounts, e.g., better/more data to improve accounting estimates embedded in the F.S. (so AJE needed). Primary Examples:
Large bad debt realized
Large recovery or significant recoveries where we had significant allowance for uncollectibility
Slide 16- 14 Settlement of litigation or Closer Estimate
© The McGraw-Hill Companies, Inc., 2006
Subsequent Events
Type 2/Non-Recognized : Relates to things occurring after the B.S. date, which, if not disclosed, would make the F.S. misleading to many users for projection purposes (hinder continued performance)(so only disclosure):
Significant merger/acquisition
Major facility destruction or forced closure
Major change in financial position.
Significant pension change requiring large payment Slide 16- 15
© The McGraw-Hill Companies, Inc., 2006
Responsibility for Subsequent Events
Identifying Subsequent Events
Review latest available financial statements and minutes of the board and selected committees.
Review lawyer’s letter & Invoices.
Ask management (including matters dealt with at meetings for which minutes are not available).
Obtain representations from management.
(Note: Similar steps to ID Loss Contingencies ) Slide 16- 17
© The McGraw-Hill Companies, Inc., 2006
Audit Procedures Completed Near the End of Field Work
Search for unrecorded liabilities Review minutes of Bd of Dir meetings Perform final analytical procedures Identify loss contingencies Review subsequent events
Obtain Client Representation Letter
© The McGraw-Hill Companies, Inc., 2006
Slide 16- 18
Mgmt Representation Letter
Mgmt responsibility for fairness of F.S.
Mgmt’s belief that F.S. are fairly stated/GAAP
Completeness of provided records(minutes, communications with regulatory agencies, unrecorded transactions)
Known fraud
Plans impacting classification or values of assets or liabilities
Related party transactions and balances Slide 16- 19
© The McGraw-Hill Companies, Inc., 2006
Mgmt Rep Letter (con’t)
Loan guarantees
Significant estimates/concentrations (SOP 94-6)
Actual/Possible violations of laws or regs
Gain/Loss contingencies or unasserted claims (SFAS 5)
Satisfactory title to assets or rights limitations
Compliance with contractual agreements
Subsequent events Slide 16- 20
© The McGraw-Hill Companies, Inc., 2006
Audit Procedures Completed Near the End of Field Work
Search for unrecorded liabilities Review minutes of Bd of Dir meetings Perform final analytical procedures Identify loss contingencies Review subsequent events Obtain client representation letter
Assess Cumulative Materiality of Individual Adjustments & Uncorrected Misstatements from Previous Year
© The McGraw-Hill Companies, Inc., 2006
Slide 16- 21
Audit Procedures Completed Near the End of Field Work
Search for unrecorded liabilities Review minutes of Bd of Dir meetings Perform final analytical procedures Identify loss contingencies Review subsequent events Obtain client representation letter Assess cumulative materiality of Individual adjustments & Uncorrected Misstatements from Previous Year
Review Subordinate W/Ps & Conduct Concurring or 2 nd Partner Review
Final Review of F.S. Disclosure Adequacy
© The McGraw-Hill Companies, Inc., 2006
Slide 16- 22
Communicating with Those Charged with Governance
Early in the Audit
Obtain Information About the Entity
Share Overall Planned Audit Scope & Timing of the Audit and Auditor Responsibilities
Representations to be Asked of Management
Factors, if any, Potentially Having a Bearing on Auditor Independence.
© The McGraw-Hill Companies, Inc., 2006
Slide 16- 23
Communicating with Those Charged with Governance
(con’t) During or at End of Audit
Significant Accounting Policies, Accounting Estimates, F.S. Disclosures, Uncertainties, Unusual/Non-Recurring Transactions
Significant Difficulties Encountered
Mgmt’s Consultation with Other Auditor
Significant Uncorrected Misstatements or Other Disagreements with Mgmt
Significant Findings, Misstatements & Issues
© The McGraw-Hill Companies, Inc., 2006
Slide 16- 24
Communicating with Those Charged with Governance
(con’t) During or at End of Audit
Significant Internal Control Deficiencies & Material Weaknesses.
Detected Fraud & Illegal Acts
Substantial Doubt – Going Concern
Format
Oral or in Writing (Usually Based on Significance)
But All Must be Documented
© The McGraw-Hill Companies, Inc., 2006
Slide 16- 25
Key Additions for Public Companies
•
Engagement letter.
•
Overall audit strategy, timing & significant risks (early) .
•
Audit Committee must approve all services.
•
Use by auditor of specialized skills, internal auditors or non-employees or CPA firms (early) .
•
Details of client critical practices and accounting estimates AND auditor’s assessment.
accounting policies, Slide 16- 26
© The McGraw-Hill Companies, Inc., 2006
Key Additions for Public Companies (con’t)
•
Assessment of quality of financial reporting.
•
Difficult or contentious issues requiring consultation beyond audit team.
•
Auditor’s evaluation of going concern.
•
Any deviations from a standard audit report.
•
All communications MUST be prior to report issuance.
© The McGraw-Hill Companies, Inc., 2006
Slide 16- 27
Auditor Responsibility for Other Information Included with the F.S.
√
Other Non-GAAP-Required Information READ to identify inconsistencies with the audited F.S.
√
If none found, no further effort or reporting.
√
If found, ask client to revise.
√
If client refuses, add explanatory paragraph to audit report (no change to opinion on F.S.) or withhold release of audit report
or
withdraw from engagement .
(Note: If F.S. is incorrect & material, propose adjustment or modify opinion. )
Slide 16- 28
© The McGraw-Hill Companies, Inc., 2006
Auditor Responsibility for Other Information Included with the F.S.
GAAP-Required Supplementary Information
Inquire of management about methods of preparing information, following prescribed guidelines, whether changed from the prior period, and any significant assumptions or interpretations.
Compare information for consistency with (1) management’s responses to the inquiries, (2) basic F.S. and (3) auditor’s knowledge obtained during the F.S. audit.
Obtain written representations
from management acknowledging (1) its responsibility that the information, (2) is measured & presented per prescribed guidelines, (3) whether methods have changed & (4) significant assumptions or interpretations.
Discussed in the F.S. audit report in an emphasis of a matter paragraph after the opinion paragraph – no impact on F.S. opinion, even if found to be incorrect or omitted.
(No mention in report under PCAOB standards)
Slide 16- 29
© The McGraw-Hill Companies, Inc., 2006
Auditor Responsibility for Other Information Included with the F.S.
Offering Assurance for Supplementary Information AICPA Standards :
Auditor could be asked to provide assurance with separate opinion. Auditors perform procedures to provide assurance on whether supplemental information is fairly stated, in all material respects, in relation to the F.S. as a whole. Supplementary must be derived from, & relate directly to, underlying accounting & other records.
Emphasis of a Matter paragraph would include opinion that would not alter F.S. audit opinion.
PCAOB Standards (AS 17):
Also optional, very similar procedures as AICPA, but requires testing info accuracy, unlike AICPA, must be done in conjunction with the F.S. audit and can be a separate report.
Slide 16- 30
© The McGraw-Hill Companies, Inc., 2006
Responsibilities After Report Date
Should we have any?
Of Course; Why Not?
Discovery of Unknown Information, Which Was Available, at Audit Report Date
Learning of Omitted, but Necessary, Audit Procedures
© The McGraw-Hill Companies, Inc., 2006
Slide 16- 31
Subsequent Discovery of Facts Existing at Audit Report Date
Auditor Action is Required Unless he/she Can Conclude (Document) that Information: 1. Is Unreliable or 2. Did NOT Exist at the Audit Report Date or 3. Would NOT Have Effected Audit Report or 4. No Persons who would attach importance to the information are Currently, or Likely to be, Relying on the Previously Audited F.S.
© The McGraw-Hill Companies, Inc., 2006
Slide 16- 32
Subsequent Discovery of Facts Existing at Audit Report Date
Auditor actions to prevent further reliance on the previous auditor’s report:
Advise client to disclose the information and/or restate the F.S. or include in about to be released subsequent period F.S. & tell SEC.
If client refuses, Auditor should:
Notify each Bd of Dir member of refusal and planned auditor actions
Notify Client That Auditor’s Report Should No Longer Be Associated With the F.S.
Notify SEC & Each Party Known to be Relying on the F.S. that the Audit Report Should No Longer be Relied Upon.
© The McGraw-Hill Companies, Inc., 2006
Slide 16- 33
Discovery of Omitted Audit Procedures After Report Date
If the Omitted Procedures were important to expressing the opinion, and are still important in supporting the previously reported opinion, AND parties are currently, or likely to be, relying on the audit report:
Attempt to perform the procedures or alternate ones.
If results alter original conclusions, treat as discovery of new facts and take similar notification action to that on previous slide.
If unable to perform, consult attorney as to actions to satisfy responsibilities to client, SEC and persons relying on the auditor’s report.
© The McGraw-Hill Companies, Inc., 2006
Slide 16- 34