GBW 8th ed., Ch. 172
TOPICS
Testing revenue, expensesEstimates, losses, contingenciesRelated party transactionsLegal mattersManagement representation letter, opinion, & other communicationsSubsequent discoveries & omitted procedures
GBW 8th ed., Ch. 173
SUBSTANTIVE TESTS FOR REVENUE & EXPENSES
Analytical tests for reasonablenessTests details if Control risk maximum Transaction volume low;
account needs special attention Analytical procedures reveal
unusual, unexpected results
GBW 8th ed., Ch. 174
ACCOUNTING ESTIMATES
Examples Warranty claims Uncollectible accounts Depreciation, amortization Airline passenger revenue;
subscription income Percentage of completion income Loss contingencies
GBW 8th ed., Ch. 175
AUDITING ACCOUNTING ESTIMATES
Objectives Management developed all material
estimates Estimates reasonable & in accord with
GAAP
Procedures Review test process for developing ratios Develop independent estimate to
compare Review subsequent events
GBW 8th ed., Ch. 176
CONSIDERATION OF LOSS CONTINGENCIES
Examples Pending, threatened litigation Guaranties of 3rd party obligations Discounted, factored A/R Disputed income tax deductions
GBW 8th ed., Ch. 177
ACCOUNTING TREATEMENT: Loss ContingenciesSFAS No. 5, “Accounting for
Contingencies” Recognize (record) if
Liability probably incurred AND Loss estimable
Report (footnote disclosure) if Liability probably incurred OR loss
estimable OR If reasonable possibility liability incurred
GBW 8th ed., Ch. 178
FINDING LOSS CONTINGENCIES
Inquire of managementRead minutes of board, shareholders’ meetingsRead contracts, loan, lease agreements, etc.Review IRS reportsAnalyze legal expenses, documentationReview work papers for possible contingencies
GBW 8th ed., Ch. 179
PROCEDURES TO COMPLETE AUDIT
Review for related party transactionsReview for subsequent eventsInquire of client’s legal counselObtain management representation letterForm opinion
GBW 8th ed., Ch. 1710
RELATED PARTY TRANSACTIONS
Legal form may not reflect economic substance Transaction not recorded at “arms length” Increases with incentives to manipulate
earnings Maintain favorable earnings trend Overly optimistic earnings forecast Dependency on single/few products Declining industry; many business failures Pending litigation
GBW 8th ed., Ch. 1711
PROCEDURES: RELATED PARTY TRANSACTIONS
Review Minutes for authorized transactionsProxy material for related partiesManagement’s conflict-of-interest statements Extent, nature business with major customers, suppliers, borrowers, lendersInvoices from law firmsLoan confirmations for guarantees
GBW 8th ed., Ch. 1712
AUDITOR’S EVALUATION: Related Party Transactions
Objectives Assess purpose, nature, extent of
transactions Effects of transactions on financial
statements
Additional procedures Inquire of management Examination documentation Ensure authorization
GBW 8th ed., Ch. 1713
SUBSEQUENT EVENTSType 1: Adjust accounts for events that Confirm or reveal conditions existing
on/before balance sheet date Collectibility receivables, loss realizations
Type 2: Disclose information (notes) for events that Reveal conditions arising after balance
sheet date Business combinations, new indebtedness,
changes in capital structure
GBW 8th ed., Ch. 1714
PROCEDURES FOR SUBSEQUENT EVENTS
Read interim statements, board, shareholders’ minutesInquire Contingent liabilities, commitments Changes in capital structure, indebtedness,
working capital Changes in estimates; unusual adjustments
Obtain lawyers’ letters, management representation letter
GBW 8th ed., Ch. 1715
DISCLOSURE: Subsequent Events
Type 1 Adjust financial statements
Type 2 Explanatory note Parenthetical explanation Reference Do not issue unqualified opinion
GBW 8th ed., Ch. 1716
INQUIRIES OF CLIENT’S LEGAL COUNSEL
Inquiry of Client’s Lawyer, SAS 12 (required)Management prepares list of legal issuesInformation requested Description, evaluation of outcome,
completeness of list for Pending, threatened litigation Unasserted claims, assessments
GBW 8th ed., Ch. 1717
MANAGEMENT REPRESENTATION LETTERManagement’s representations,
SAS 85 (required)Financial statement responsibility, conformity with GAAPComplete information available to auditorRecognitions, measurement, disclosureSubsequent events
GBW 8th ed., Ch. 1718
FORMING AN OPINIONProcedures Overall review through analytical
procedures (SAS 56) Relationships, account balances
reasonable Workpaper review
Considers documented fair presentation all accounts
Technical review by another (concurring) partner
GBW 8th ed., Ch. 1719
COMMUNICATIONS WITH AUDIT COMMITTEES (SAS 61)
Responsibilities under GAASSignificant accounting policies, judgments, estimatesSignificant audit adjustmentsDisagreements with managementDifficulties
GBW 8th ed., Ch. 1720
COMMON QUESTIONS BY AUDIT COMMITTEE
Revenue recognition Asset valuationContingenciesReserves
GBW 8th ed., Ch. 1721
COMMON QUESTIONS: Problematic Accounting Policies
No authoritative GAAPAlternative methodsControversial, uncommon transactions
GBW 8th ed., Ch. 1722
COMMON QUESTIONS: New Areas, Events
ReservesChanges in principleEstimateDeferrals, accrualsPrior-period adjustments
GBW 8th ed., Ch. 1723
COMMON QUESTIONS: Management Imposed Problems
Uncorrected weaknesses in internal controlUnavailable, uncooperative personnelInadequate schedules from clientUnavailable evidence
GBW 8th ed., Ch. 1724
SUBSEQUENT DISCOVERY OF FACTS
For facts existing at report date, consider whether Information reliable Facts did exist Audit report would have been
affected if known Important to those relying on report
GBW 8th ed., Ch. 1725
AUDITOR RESPONSE TO CLIENT DISCLOSURE
Client makes disclosure If facts can be determined in
reasonable period Issue revised statements and opinion if
necessary If facts can not be determined in
reasonable period Notify all persons known to be relying on
financial statements
GBW 8th ed., Ch. 1726
AUDITOR RESPONSE IF DISCLOSURE REFUSED
If client refuses to make disclosure of subsequent facts auditor will Notify board Notify regulatory agencies
GBW 8th ed., Ch. 1727
OMITTED PROCEDURES
Discovered after report date (SAS 46)Objective Determine if report still supported Consider persons relying on report