Lesson 10: Audit Completion and Auditor's Reports

Final Audit Stage Critical Functions

• a final review of the completed audit work to be sure the financial statements properly reflect the financial condition, results of operations, and cash flows based on the information gathered during the audit and that the audit documentation adequately supports the audit report;

• an assessment of the client's ability to continue as a going concern; and

• a review of subsequent events that indicate the need for adjustments to the financial statements and/or disclosure.

Perform Additional Tests for Presentation Assertions

Determine whether management has disclosed all required information. Many public accounting firms require the completion of a financial statement disclosure checklist that serves to remind the auditor of common disclosure problems and to facilitate the final review of the entire audit by an intendent partner.

Review for Contingent Liabilities and Commitments

Former must be recorded if a liability is likely to be resolved by a future event and can be reasonably estimated. The proper disclosure is through footnotes. The footnote should describe the nature of the contingency to the extent it is known and provide either an estimate of the amount or a statement that the amount cannot be estimated. Note that contingent gain is never accrued, but if it is likely, then it should be disclosed in the notes. A gain could include an item such as a lawsuit, an income tax dispute, a loan guarantee, or a product warranty.

Latter are closely related to former. An agreement to commit the company to a set of fixed conditions in the future, which may or may not turn out as well as expected. May be described in a separate note or as part of the contingent liabilities note. The discovery of unknown commitments occurs while auditing transactions cycles and contingent liabilities.

Results from Search for Unrecorded Liability Tests that can be Useful in Identifying Contingent Liabilities

• Inquire of management

• Review tax assessments from current and prior years.

• Obtain a confirmation letter from each lawyer that deals with the company 

• Analyze legal expenses and invoices

• Obtain confirmation from all major law firms performing legal services for the client.

• Review the existing working paper.

• Obtain letters of credit and confirmation of the used and unused balance

• Read contracts, agreements, and supporting correspondence and documents.

• Review letters of credit and confirmation of the used and unused portions.

• Once a contingent liability has been discovered, the auditor must assess its value.

  Assessment may require additional discussions with management, the board of directors, and legal counsel

Obtain Confirmation from the Client’s External and/or In-House Legal Counsel

Many public accounting firms analyze legal expenses for the entire year and have the client send a standard lawyer’s letter to every law firm with which it has been involved in the current or preceding years. However, lawyers are not required to mention any omission of a possible claim in their response to the inquiry letter and thus do not directly notify the auditor of it.

CAS 501.12 requires that the auditor obtain a letter of representation from management stating that it has disclosed all known outstanding and possible items. In other words, unless management discloses the existence of possible claims to the auditor, the auditor may have no means of discovering whether any such claim exists or not

Review of Subsequent Events

A transaction or event occurring after the balance date. There are two types

1. Direct effect

2. No direct effect

The auditor is responsible for detecting material subsequent events. The test procedures similar to review for contingent liability are performed to identify these events, include:

• Inquiry of management

• Correspondence with law firms

• Review of internal financial statements or records prepared subsequent to the balance sheet date

• Review of records prepared subsequent to the balance sheet date

• Examination of minutes prepared subsequent to the balance sheet date

• Acquisition of a letter of representation

Direct Effect Subsequent Event

An event that gives the auditor evidence about the nature of items included in the financial statements at the end of the year. An example would be the bankruptcy of a client’s major customer two days before the audit report date. Knowledge of this change would certainly affect the estimate for the allowance for doubtful accounts at the year-end date.

No Direct Effect Subsequent Event

Does not give the auditor evidence about the nature of an item at the balance sheet date, but it is, nonetheless, desirable to disclose it in the notes to the financial statements

Accumulate Final Evidence

After completing most of the audit field work, the auditor performs several other tasks, including the following:

• Design and perform final analytical procedures

• Evaluate the Going-Concern Assumption

• Obtaining a client letter of representation to ensure that management takes responsibility for the representations in the financial statements

Design and perform final analytical procedures

Analytical procedures are performed to corroborate conclusions formed during the audit of the financial statements. This assists the auditor to draw reasonable conclusions on which to base the auditor’s opinion.

The results of such analytical procedures may also identify a previously unrecognized RMM. In such circumstances, CAS 315 requires the auditor to revise the auditor’s assessment of the RMM and modify further planned audit procedures accordingly.

Evaluate the Going-Concern Assumption

CAS 570 requires the auditor to obtain sufficient appropriate evidence regarding whether management’s use of the going concern assumption is appropriate. If a going concern problem exists, it must be disclosed in the notes to the financial statements, and a failure by management to do this is considered a GAAP departure, which will lead to a qualified audit opinion

Final Procedure to Ensure Audit is Done

• Review Sufficiency of Evidence

• Summarize, Evaluate, and Resolve Misstatements

• Review of Working Papers

• Engagement Quality Control Review

• Draft the Audit Report

• Evaluate Other Information

Review Sufficiency of Evidence

The reviewer will review the audit programs to make sure that all parts have been accurately completed and documented, and that risks by audit objectives have been addressed. Auditors use completing the engagement checklist to help them draw final conclusion about the adequacy of the audit evidence

Summarize Misstatements

Many auditors use a summary of identified misstatements worksheet to track known and potential misstatements

Evaluate Misstatements Identified

A high level of professional judgment is involved when evaluating the materiality of a misstatement. As per the discussion in the previous Lesson Notes, materiality is not simply a quantitative analysis of the dollar magnitude of the misstatement. In some cases, the dollar amount of misstatements cannot be accurately measured. For example, a client’s unwillingness to disclose an existing lawsuit or the acquisition of a new company subsequent to the balance sheet date is difficult, if not impossible, to measure in terms of dollar amounts.

The following are some features that may cause a quantitatively small misstatement to be material.

• The item is illegal is illegal or fraudulent.

• The item may materially affect some future period, even though it is immaterial when only the current period is considered.

• The item has a "psychic" effect.

• The item may be important in terms of possible consequences arising from contractual obligations.

• The item has an effect of increasing management's bonus.

Evaluate the Uncorrected Misstatements

If the auditor believes that there is sufficient evidence but that the financial statements are materially misstated, the auditor again has two choices:

1. the statements must be revised to the auditor's satisfaction, or

2. a modified audit opinion must be issued (refer to Note 4 and 5 for the different types of audit opinions).

Review of Working Papers

This review is done by another member of the auditing firm; this serves as quality control for the accounting firm. It also evaluates the performance of the auditors on the job, ensures that the audit meets the accounting firm’s standard of performance, and represents an unbiased perspective on the audit.

Engagement Quality Control Review

After the completion of the audit, a review is done by an independent partner who was not involved in the engagement. The audit team members must be able to justify the evidence that they have accumulated and the conclusions that they have drawn. The reviewer focuses on the judgments and conclusions made by the audit team. In some public accounting firms, a technical review of the financial statements is performed by a technical expert. Although this is not required by audit standards, the CPAB has recommended a mandatory technical review for high-risk engagements.

Draft the Audit Report

The auditor should wait to decide the appropriate audit report to issue until all evidence has been accumulated and evaluated, including all the steps for completing the audit so far. It is critical that the report be correct.

Evaluate Other Information

The management is responsible for the preparation of other information that is published with financial statements, which is typically the annual report. It is the auditor’s primary responsibility to ensure that the financial statements and the auditor’s report are accurately reproduced in the annual report.

CAS 720 also requires the auditor to review the additional information that is included in the annual report, such as Management Discussion and Analysis (MD&A), to determine if there is an inconsistency between it and the financial statements.

Significant Findings Leading to Potential Communication from Auditor to Client Personnel

• evaluation of significant accounting policies,

• results of the auditor's fraud risk assessment,

• summary of misstatements (the auditor should report all differences except those considered to be trivial), and

• difficulties encountered during the audit.

CAS Requirements for Auditor’s Communication with Audit Committee and Management

• the auditor must ensure that the appropriate level of management is informed of material weaknesses in the design, implementation, or operating effectiveness of internal control. (CAS 260)

• the auditor should communicate all except clearly trivial misstatements and ask management to correct them. (CAS 450)

• any observed illegal or possibly illegal acts can be communicated to the audit committee or equivalent group on a timely basis. (CAS 250)

• misstatements that indicate significant deficiencies in the design or operation of internal control in its definition of significant misstatements that must be reported to the audit committee. (CAS 240)

Auditor’s Report Consists Of

1. Report Title

2. Addressee

3. Opinion

4. Basis for opinion

5. Key Audit Matters (KAMs)

6. Other Information

7. Responsibilities of Management and Those Charged with Governance (TCWG) for the Financial Statements

8. Responsibilities for the Audit of Financial Statements

9. Report on Other Legal and Regulatory Matters

10. Signature of audit firm

11. Date of the Auditor’s Report

12. Auditor’s Address

Report Title

Independent Auditor's Report

Addressee

• Often either to the shareholders or to those charged with governance (TCWG) such as board of directors or audit committee

Opinion

• States that the auditor has audited the financial statements and lists each financial statement that was audited such as the balance sheet date, the income statement, retained earnings, cash flow and notes, including a summary of significant accounting policies

• States the auditor’s opinion on the financial statement. The phrase “present fairly, in all material respects,” is often used to express an unmodified opinion.

Basis for Opinion

• States that the audit has been conducted in accordance with established standards such as Canadian GAAS, independence, and other ethical responsibilities

Key Audit Matters (KMAs)

• State the most significant challenges that required significant audit attention such as significant estimates, significant difficulty in obtaining sufficient evidence, and modifications to the planned approach due to control deficiencies. KAMs for listed entity are not mandatory.

Other Information

• States the management's and auditor's responsibilities of other information. This section is required when the entity prepares an annual report

Responsibilities of Management and Those Charged with Governance (TCWG) for the Financial Statements

• Statement management's responsibility for preparing the financial statements according to the applicable accounting framework such as IFRS, and for such internal controls in the company

• State Management's responsibilities for assessing the company's going concern

• State TCWG's responsibilities for the oversight of the financial reporting process

Responsibilities for the Audit of Financial Statements

• Explain the objectives of the auditor are the obtain reasonable assurance that the financial statements are free from material misstatement and issue an auditor's report

• State the auditor's responsibilities for risk assessment, audit procedures, internal control, accounting estimates, going concern, and overall presentation of the financial statements

• Describe the details of the audit which are communicated with TCWG such as audit scope, timing, and significant audit findings including any internal control deficiencies

Report on Other Legal and Regulatory Matters

• States certain matters in the audit report (either in Emphasis of Matter or Other Matter explanatory paragraph) when the auditor issues an unmodified opinion but decides it's necessary to communicate certain matters in the audit report.

Signature of Audit Firm

• The accounting firm name or the personal name (or both)

• The auditor's report must be signed.

Date of the Auditor’s Report

• This date would be the date when the board of directors (or primary shareholder for a small organization) has approved the financial statements.

• This date also indicates that the auditor is responsible for the review of significant events occurring between the date of the financial statements and the date of the auditor's report.

• The auditor's report may also have double dating when a material event occurs after the date of the auditor's report (CAS 560).

Auditor’s Address

• The location where the report was published

Conditions for Main Types of Modification to the Audit Opinion

• GAAP Departure

• Scope Limitation

GAAP Departure

• The auditor can render a Qualified Opinion or an Adverse Opinion, depending on materiality and pervasiveness of the item

Scope Limitation

The auditor can render a Qualified Opinion or a Disclaimer of Opinion, depending on materiality and pervasiveness of the item.

Modified Audit Opinions

1. Qualified Audit Opinion: Financial Statements are Materially Misstated but not Pervasive

2. Qualified Audit Opinion: Scope Limitation That is Material but not Pervasive

3. Adverse Opinion: Material and Pervasive Misstatement

4. Disclaimer of Opinion: Material and Pervasive Scope Limitation

Qualified Audit Opinion: Financial Statements are Materially Misstated but not Pervasive

In this type of opinion, the term except for is used in the opinion paragraph. This implies that the auditor is satisfied that the overall financial statements are correctly stated, except for a particular item. Details of the exception are provided in a separate paragraph entitled “Basis for Qualified Opinion”, which follows the opinion paragraph.

In such an opinion, the financial statements as a whole are not considered to be false or misleading; only some of the items included in them are considered to be. In reality, it is difficult to find a GAAP qualification for public companies because securities legislation only allows qualifications in very rare circumstances

Qualified Audit Opinion: Scope Limitation That is Material but not Pervasive

When the auditor is unable to gather sufficient and appropriate evidence and the effect is material, a scope qualification is appropriate. An example of a scope limitation would be the auditor’s inability to attend an inventory count at the end of the preceding year. Consequently, the auditor cannot verify the impact that the opening inventory has on the cost of goods sold calculation for the current year.

In addition, if the primary auditor is concerned about the other auditors’ work and is unable to perform alternative procedures, then this would be considered a scope limitation, and the primary auditor would go through the same decision process.

Adverse Opinion: Material and Pervasive Misstatement

If the GAAP departure is so pervasive as to render the financial statements as a whole misleading or useless, the auditor should give an adverse opinion, which states that the financial statements have somehow not been prepared in accordance with GAAP. For example, the failure of a company to consolidate the accounts of a major subsidiary would make almost every number on the financial statements incorrect

If both a GAAP departure and a scope limitation exist, the auditor should qualify (or disclaim) the opinion for each condition.

Disclaimer of Opinion: Material and Pervasive Scope Limitation

If the scope limitation is so severe as to lead the auditor to believe that the overall fairness of the financial statements is in question, then the auditor will issue a report that denies an opinion. Such a circumstance occurs when the accounting records of the company are so unreliable that the auditor simply cannot obtain the necessary information to perform an audit. In this case, the scope of the work is not just limited, it is almost non-existent