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Chapter 16
Auditing Operations and Completing the Audit
McGraw-Hill/Irwin Copyright © 2014 by The McGraw-Hill Companies, Inc. All rights reserved.
Auditing OperationsAuditing Operations
Corporate earnings are considered as an extremely important indicator of health and well-being of corporations
Measurement of income is generally regarded as the single most important function of accounting
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Objectives for audit of revenue and Objectives for audit of revenue and expensesexpenses
1. Use the understanding of the client and its environment to consider inherent risks, including fraud risks, related to revenues and expenses.
2. Consider internal control over revenues and expenses.
3. Assess the risks of material misstatement of revenues and expenses and design further audit procedures that:
a. Establish the occurrence of recorded revenue and expense transactions.
b. Determine the completeness of recorded revenue and expense transactions.
c. Establish the accuracy of revenue and expense transactions.
d. Verify the cutoff of revenue and expense transactions.
e. Determine that the presentation and disclosure of revenue and expense accounts are appropriate, including the proper classification of amounts and the proper presentation of earnings-per-share data.
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Audit of Statement of Cash FlowsAudit of Statement of Cash Flows
Amounts are audited in conjunction with the audit of balance sheet and income statement accounts
Presentation and disclosure important audit objective is important Operating Investing Financing
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Audit Procedures Completed Audit Procedures Completed Near the End of Field WorkNear the End of Field Work
Search for unrecorded liabilities Review the minutes of meetings Perform final analytical procedures Perform procedures to identify loss
contingencies Perform the review for subsequent
events Obtain the representation letter
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Loss ContingenciesLoss Contingencies
Loss contingencies should be reflected in the financial statement amounts when:
It is probable that a loss had been sustained before the balance sheet date
The amount of the loss can be reasonably estimated
Loss contingencies should be disclosed in the notes to the financial statements when it is at least reasonably possible that a loss has been sustained
Loss contingencies need not be disclosed when the possibility of loss is remote
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LitigationLitigation
Most common loss contingency – pending or threatened litigation Letter of inquiry to client’s legal counsel
• Evidence of pending and threatened litigation• Unasserted claims - need to be disclosed if
probable and reasonably possible SAS 12
• Auditors should obtain from management a list describing and evaluating threatened or pending litigation
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Other ContingenciesOther Contingencies
Income tax disputes Accommodation endorsements and other
guarantees of indebtedness Accounts receivable sold or assigned with
recourse Environmental issues Commitments General risk contingencies
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Audit Procedures for Loss ContingenciesAudit Procedures for Loss Contingencies
1. Review the minutes of directors’ meetings to the date of completion of fieldwork.
2. Send letter of inquiry to client’s lawyer
3. Send confirmation letters to financial institutions to request information on contingent liabilities of the company.
4. Review correspondence with financial institutions for evidence of accommodation endorsements, guarantees of indebtedness, or sales or assignments of accounts receivable.
5. Review reports and correspondence from regulatory agencies to identify potential assessments or fines.
6. Obtain a representation letter from the client indicating that all liabilities known to officers are recorded or disclosed.
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Procedures to Identify Subsequent EventsProcedures to Identify Subsequent Events
Review latest available financial statements and minutes of the board and selected committees
Inquiry about matters dealt with at meetings for which minutes are not available
Inquiry of management Obtain lawyer’s letter Obtain representations from management
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Obtain Representation LetterObtain Representation Letter
Purpose is to have the client’s principal officers acknowledge that they are primarily responsible for the fairness of the financial statements
Dated as of the date of the audit report Not a substitute for application of
necessary audit procedures
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MisstatementsMisstatements
Known misstatements Specific misstatements identified during the
course of the audit Likely misstatements
Due to extrapolation from audit evidence or differences in accounting estimates
Evaluation Material misstatements must be corrected
• Quantitative and qualitative factors
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Review the EngagementReview the Engagement
Review of work of audit staff accomplished through review of audit working papers
Typically performed by seniors Review of working papers not completed until
near (of after) completion of fieldwork Partner and manager devote attention to
accounts with higher risk of material misstatement
Second partner review prior to issuance of audit report
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Reporting on Other Information with the Reporting on Other Information with the Financial StatementsFinancial Statements
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Required Communication with Required Communication with Those Charged with GovernanceThose Charged with Governance
Auditor responsibility under generally accepted auditing standards (e.g., to form and express an opinion, and management’s responsibilities)
An overview of the planned scope and timing of the audit
Significant findings from the audit Qualitative aspects of accounting practices Audit difficulties encountered Uncorrected misstatements Disagreements with management Management consultations with other accountants Auditor independence issues Other issues.
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Post-Audit ResponsibilitiesPost-Audit Responsibilities
Auditor subsequent discovery of facts existing at date of report Advise client to make appropriate disclosure
of the facts to anyone actually or likely to be relying upon the audit report and financial statements
If client refuses to make disclosure, CPA should inform each member of board and notify regulatory agencies
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Subsequent Discovery of Subsequent Discovery of Omitted Audit ProceduresOmitted Audit Procedures
Discovered during peer review or other subsequent review of working papers
Assess importance of omitted procedures to their previously issued opinion If omission impairs ability to support issued
opinion and report being relied upon by third parties, attempt to perform omitted procedure or appropriate alternative procedure
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