Chapter 16: Auditing Operations Review the Minutes of Meetings

auditors should review the minutes of various committee meetings through the

and Completing the Audit date of the audit report

all minutes should be reviewed and written representation should be

obtained from management stating that all minutes have been made
Course ACC5400 available

Status Done Perform Final Analytical Procedures

should be performed as pert of the auditors risk assessment as well as at the
Completing the Audit end of the audit

the auditors report should not be dated prior to the date that they have those performed at the end of the audit assist the auditors in assessing the
gathered sufficient appropriate evidence validity of the conclusions reached including the opinion to be issued

to be effective certain audit procedures cannot be completed before the professional standard specifically require auditors to evaluate whether
end of the audit such as analytical procedures performed as substantive procedures or in overall
review stage indicate a previously unrecognized risk of material
search for unrecorded liabilities
misstatement due to fraud
review of the minutes of meetings
Perform Procedures to Identify Loss Contingencies
perform final analytical procedure
audit problems with respective to loss contingencies are two fold
perform procedures to identify loss contingencies
the auditors should determine the existence of the loss contingencies
perform the review of subsequent events
they dont appear in accounting records due to overarching uncertainty
obtain the representation letter
the auditors should appraise the probability that a loss has been incurred
communicate misstatements to management
and its amount
evaluate audit findings
under FASB, losses should be reflected in the account records when both fo
the folliwng conditions are met
Search for Unrecorded Liabilities
information available prior to the issuance of the FS indicate that is is
the search for unrecorded liabilities includes procedures performed near the
probable that a loss has been sustained before the BS date
date of the auditors reports such as examining cash disbursements
the amount of the loss can be reasonably estimated
these procedures are designed to detect liabilities that existed at year end
but were omitted from the liabilities recorded in the clients financial recognition can be in the form of a liability of loss of an asset
statements
 generally only contingent liabilities such as notes receivable discount and
guarantee endorsements with remote possibility should be reported in the FS 
other items are only reported if they are reasonably possible

Litigation

most common form of loss contingency

audit procedures to identify litigation, claims and assessment that may give
rise to a risk of material misstatement include the following

inquiring about these matter with management and others such as the in
house legal counsel

obtaining a description and evaluation of this events from management

reviewing the minutes of meetings of those charged with governance, Income Tax Disputes
documents and correspondence with legal counsel
in addition to the taxes relating to CY income, uncertainty often exists
reviewing legal expense accounts and invoices from legal counsel concerning the amount payable for PY

when actual or. potential litigation is identified, relevant evidence identifying dispute between IRS and the client may create contingent liabilities not
the course, degree of unfavorable outcome and the mount of potential losses settled for several more years
are ascertained
auditors should determine whether the IRS agents have examined any returns
a letter or inquiry is sent to the legal counsel prepared by management to of the client since the preceding audit and whether any additional taxes have
keep the auditors up to date with the latest information regarding the been assessed
situation
as well as any correspondence between the parties
generally limited to only material information which the auditor and
Accommodation Endorsements and other Guarantees of Indebtedness
management have agreed with
Small business owners sometimes guarantee loans or debts for others (called
letter of inquiry should also include a list of unasserted claims which
accommodation endorsements).
should be included if it is
These guarantees are usually not recorded in the accounting books but
probable that a claim will be assertion
may show up in minutes from board or directors' meetings.
reasonably possible that a loss will result
Auditors should ask owners or partners if any such guarantees or contingent
alternate procedures should be performed if the legal counsel or management liabilities exist.
is uncooperative and if that is not possible the option should be modified
Auditors should also ask if any collateral was given to protect the
Illustration of disclosure company.
 They may choose to confirm guarantees with banks or other financial does not need to be disclosed in the FS
institutions using special confirmation letters.
The Auditors Procedures for Loss Contingencies
Accounts Receivable Sold or Assigned with Recourse
review the minutes of directions meeting to the date of the completion of
when AR is sold or assigned with recourse, a guarantee of collectibility. is fieldwork
given
send a letter of inquiry to the clients lawyer requesting
authorization of such transaction should be revealed in minutes and with
a description of the nature of pending and threatened litigation and tax
correspondence with financial institutions
disputes
confirmation by direct communication with purchased or assignee is
an evaluation of the likelihood of an unfavorable outcome in the matters
necessary for any receivables sold or assigned
described
Environemtal Issues
an estimate of the probable loss or range of loss or a statement that an
environmental remediation liability laws can lead to both contingent and estimate cannot be made
accrued liabilities
an evaluation of managements description of any unasserted claims that,
Commitments if asserted, have a reasonable possibility of na adverse outcome

audits may discover any of the following types of commitment s a statement of the amount of any unbilled legal fees

inventory purchase commitment send confirmation letters to financial institutions to request information on
contingent liabilities of the company
commitments to sell merchandise at a specified price
review correspondence with financial institutions for evidence of
contracts for construction
accommodation endorsements, guarantees of indebtedness, or sales or
pension or profit sharing plans assignments of AR
long-term operating leases review reports and correspondence from regulatory agencies to identify
employee stock option plans/employment contracts with key officers potential assessments or fines

can lead to losses if the commitment turns out to be unfavorable for the obtain a rep letter fr0m the client indicating that all liabilities known to officers
company are recorded and disclosed

all classes of material commitments may be described in a single note to the Perform the Review for Subsequent Events
FS
events occurring after the BS date can significantly alter the fairness of the FS
General Risk Contingencies and thus the opinion of the auditor
all business face the risk of loss from numerous factors called general risk FASB defines subsequent events into two broad categories
contingencies
those providing additional evidence about the facts existing on or
represents a loss that might occur in the future before the bs date - recognized subsequent events
 those involving facts coming into existence subsequent to the bs date Audit Procedures Relating to Subsequent Events

Type 1 Subsequent Events auditors should perform audit procedures to obtain sufficient appropriate
evidence that all subsequent events have been identified
this type of subsequent event requires that the FS amounts be adjusted to
reflect the changes in the estimates resulting from additional evidence auditors should also

unclaimable checks obtain an understanding of management procedures to endure that

subsequent events are identified
union contract affecting the cost of a long term project
inquire of management about whether subsequent event have occurred
litigation that has been settled
read available minutes of committee meeting that have been held after the
Type 2 Subsequent Events
date of FS and inquire about matters discussed at any such meetings for
these events do not require adjustment to the dollar amounts shoes in the FS which minutes are not yet available
but should be disclosed in the financial statements if the statements would
read the companies latest subsequent interim FS is any
otherwise be misleading
if the auditors write the report but before publishing something comes up, they
sale of a bond of capital stock
may add a note of that event and dual date it or delay the process and use the
a business combination with another company later date
settlement of litigation when the event giving rise to the claim took place latter option requires reconsideration of every items until that later date
after the BS date

loss of plant or inventories due to a fire

losses on receivables resulting from conditions arising after the Bs date

changes in the fair value of assets or liabilities or foreign exchange rate

in this case auditors may choose to add an emphasis of matter paragraph to

the AR

Pro Forma Statements as a Means of Disclosure

occasionally, subsequent event may be so material that supplementary pro-

froma financial statements should be prepared giving effect toe th events as if
they occurred as of the BS date

usually only if the event is large enough such as a business combination

Distinguishing between the two types of Subsequent Events

the auditor should carefully consider when the underlying conditions came
into existence
The Auditorsʼ S1 Review in an SEC Registration misstatements for which there is no doubt

The Securities Act of 1933 Section 11[a]) makes auditors liable for errors in judgmental misstatements
financial statements included in SEC registration filings.
arise from differences between the judgements of management and
The effective date is when the securities can be sold to the public — often the auditors concerning accounting estimates or the selection or
weeks or months after the audit is done. application of accounting policies that the auditor considers
inappropriate
Because of this delay, auditors must return near the effective date to perform
an S1 review. the amount of judgmental misstatement is the difference between
managements amount and the closest amount that the auditor
An S1 review involves checking the Form S1 registration statement (used for
considers to be reasonable
new securities offerings).
projected misstatement
Auditors must:
auditors estaimate of misstatement arising from situations in which
Review the full prospectus and key parts of the registration statement.
they used audit sampling to draw conclusions concerning the
Check for subsequent events that could affect the financials. population
Ask officers and executives if anything happened after the audit that because the projected misstatement includes the amount of actual
needs to be updated to avoid misleading investors. errors discovered in the sample, the projected amount should be
decreased by the amount of these factual misstatement
Obtain Representation Letter
if after considering all misstatement the auditors conclude that the risk of
the primary purpose of the rep letter is to have the clients principal officers
material misstatement of the financial statement is too high
acknowledge that they are primarily responsible for the fairness of the FS
they should request that management record the adjustments needed to
rep letters should be dated as of the date of the audit report
correct all factual misstatements other than those considered trivial
rep letters do not serve as evidence and are not substitute for audit
for judgmental misstatements, assumptions and methods should be
procedures
reviewed again and alternate procedures can be performed to confirm

Communicate Misstatements to Management for projected misstatements, the auditors should request that management
examine additional items in the account in order to identify and correct
throughout the course of the audit, the auditors accumulate and communicate
other misstatement
to management all identified misstatement other than those believed to be
trivial auditors may also expand the scope of their audit procedures and
reevaluate the reasonableness of the projected misstatement
manage management must decide whether or not to make any
adjustments
Evaluate Audit Findings
Misstatements identified by the auditors may be categorized as:
auditors should evaluate the importance of all uncorrected misstatements
factual misstatements or known misstatements identified individually and in the aggregate
 materiality is evaluated using both qualitative and quantitative factors

auditors make a judgement as to whether the overall effect of individually

immaterial misstatements plus the possibility of undetected misstatement
is material

Materiality  Considering Quantitative Factors

to issue an unmodified opinion, the auditors must conclude that there is a low
level of risk of material misstatement of FS

to do this, auditors reassess materiality to determine whether it remains

appropriate considering the actual audit findings and financial results

then auditors consider uncorrected misstatements both individually and in the

aggregate

if the auditors conclude that an individual uncorrected misstatement is

Materiality  Considering Qualitative Factors
material, they cannot issue and unmodified opinion and the same applies
to if the aggregate misstatement is material auditors should also consider qualitative factors when evaluating the
materiality of such misstatements
because the auditors must conclude there is a low of risk of material
misstatement, their estimate of the total misstatement has to be misstatement may be qualitatively material is they
significantly less than a material amount for the auditors to issue an arise from an item capable of precise measurement rather than from an
unmodified report estimate
if it matches materiality, it is too high mask a change in earnings or other trends
in situation where there is an offsetting, it is not deemed appropriate hide a failure to meet analystsʼ consensus expectations for the company
the auditor may need to reassess the risks of material misstatements change a loss into income or vice versa

concern a particularly important segment or other portion of the

registrants business

affect compliance with regulatory requirements, loan covenants or other

contractual requirements

increase managements compensation

involve concealment of an unlawful transactions

are of an amount that management or the auditors believe would affect the
stocks price
 SEC also requires that management and auditors apply a reasonableness at or near the completion of the fieldwork, auditors should evaluate whether
standard when considering fairness of financial presentation the accumulated results of their procedures and observations affect the
assessment of the RoMMs made earlier
suggests that the need for proper presentation is not entirely a function of
the above types of qualitative consideration the partner should also determine if info indicative of RoMM due to fraud have
been communicated to the audit team members
Materiality  Considering the Effects of PY Uncorrected Misstatements
Review the Financial Statement Disclosures
auditors have been allowed to use either of the two approaches
auditors can use disclosure checklists that list all specific disclosures required
rollover approach
this is completed as a part of the review of the completed FS
considers only the amount of the misstatement originating in the
current year income statement
Review the Engagement
iron curtain approach
the review of the work of the audit staff, which is required, is primarily
considers the balance sheet effect of correcting the total misstatement accomplished through a review of the audit work papers as the papers are
existing at the end of the year regardless of when the misstatement completed
originated
managers and partners generally focus on higher risk items while seniors
SAB 108 requires auditors to evaluate misstatements using both the are the ones reviewing most work of the associates
rollover and iron curtain methods.
final consideration is made of whether the results of the audit affect the going
If either method shows a material misstatement, the financial concern of the firm
statements must be adjusted.
finally, a second partner review if mandated by the firm is performed just prior
Example: A $130,000 misstatement may be broken into: to the issuance of the audit report

$70,000 affecting the current year (income statement) and

$60,000 carried over from a prior year (balance sheet).
Responsibilities for Other Information
The $70,000 current-year amount should always be corrected
in this year's statements. Other Information Included in Annual Reports
If the $60,000 prior-year amount is material to the current year, other information is financial and non financial information that is included in
the prior year must be restated—even if it wasnʼt material in the an annual report that contains audited FS
past. professional standards require that auditors read this information for
If that $60,000 is not material now, it can just be recorded as inconsistencies with the audited FS
an expense this year, without restating last yearʼs financials. auditors should be alert for any indications that a material misstatement of
Evaluating the Risks of Material Misstatement fact exists or that the other information is otherwise misleading
 if no inconsistencies exist, nothing should be done for public company when so significant exceptions have been identified
while an other information section should be included for nonpublic
AICPA requires the inclusion of a supplementary information section in the
companies
FS AR indicating that the procedures were performed
if misstatements are identified and the client upon asking refuses to
PCOAB does not require the addition of a paragraph though it may be
correct the mistakes, the auditor can
added
withdraw from the engagement
when the supplementary information is omitted or improperly stated
withhold the audit report
both AICPA and PCOAB the situation is explained in a paragraph
add a statement in the AR that the auditor has concluded that the
unless the FS are misstated, the opinion section is not modified
other information is materially misstated and the description of the
misstatement Supplementary Information in Relation to the Financial
possibly also seek legal counsel Statements as a Whole
with this service, auditors perform procedures to allow them to provide
Required Supplementary Information assurance on whether supplementary information is fairly stated in all material
required supplementary information, while not considered a part of the aspects in relation to the financial as a while
general purse of the FS is required to be presented as unaudited
to provide this assurance auditors should perform the follwing procedures
supplementary schedules accompanying the FS
inquire of management about the purpose of the information, inlcuding
authoritative guidance require the auditors to apply the following
whether it com-plies wit any relevant regulatory requirements
procedures to this information
obtain an understand for how the information was prepared
inquire of management about methods of preparing information
including whether it was prepared following prescribed guidelines, compare and reconcile information to the underlying accounting and other
methods of measurement or presentation have changed from the prior reocrds
period and there were any significant assumption r interpretations inquire of management concerning significant assumptions
underlying the measurement or presentation of the information
evaluate the appropriateness and completeness of the information
compare information for consistency with managements responses to
obtain written representations
the inquiries, the basis cFS and other knowledge obtained during the
audit if fairly stated, supplementary information section is added describing the
procedures followed and including an opinion on it
obtain written representations from management acknowledging its
responsibility for the information, about whether the information is paragraph is also added if information is not fairly stated and the opinion
measured within guidelines section is not affected

about whether the methods have changed and about any significant
assumptions of interpretations
 AC shuld be notified unless they are clearly inconsequential

can also be made to management unless management involved is

believed to be true

significant deficiencies

AC should be notified of any sign if any deficiencies in IC

other communications

this communication is aimed at providing information related to

corporate governance matters related to the FS audit that are
significant and relevant for the overseeing the financial reporting
process and includes information one

the auditors responsibility under GAAS and managements

responsibilities

an overview of the planned scope and timing of the audit

significant findings from the audit

generally complex

involves communication of qualitative aspects of the

accounting practices, significant usual transactions, audit
difficulties, difficult issues, consultations required, uncorrected
misstatements, disagreements with management, management
consultations , auditor independence issues, and other
significant issues
Opinion Formulation and Report Issuance
while PCOAB requires this communications to be before the issue of
after the preceding procedures, the auditors will ordinarily be in a position to
the AR, no such requirement exists for AICPA
issue their AR
the AR should also include discussions of critical audit matters for
if everything is in conformity and there are no scope limitations, an
PCOAB and are not require but can be done for AICPA
unqualified opinion can be issued

Additional Communications Post-Audit Responsibilities

the following matter should be communicated with the AC either orally or in
writing The Auditorsʼ Subsequent Discovery of Facts Existing at the Date
of Their Report
Fraud and illegal acts
 after the issuance of its audit report, a CPA firm may encounter evidence
indicating that the clients FS were materially misstated or lacked required
disclosures

auditors should investigate immediately

if found to be true, the auditors should advise the client to make those
information and disclosure available

done through SEC Form 8k

if the client refuses to make changes , the BOD should be notified as well
as the application authoritative bodies

Subsequent Discovery of Omitted Audit Procedures

the omission of a appropriate. audit procedures in a particular engagement
might be discovered during a peer review or other subsequent review of the
auditors working papers

auditors should assess the importance of the omitted procedures

if signifiant, the procedures should be performed

if change is needed and their report can no longer be relied upon,

they should follow the previously mentioned guidance

if the procedures cannot be performed, the should consider legal

counsel