IQ # 5

Chapter 11

Completing the Audit

4 major periods

1. beginning of year

2. year end BS date (date of FS)

3. date of auditors report (audit completion date)

4. audit report release date

beginning of year (jan 1, 2023)

Interim testing

test of controls

Substantive procedures prior to year end

year-end date (date of the financial statements) (dec 31, 2023)

- Continue to perform other tests and gather evidence

- attorney’s letters, going concern, adjusting JE

- review of audit documentation

- preparation of the financial statements and related disclosure

- management's assertion that they take responsibility for the financial statements and disclosures.

date of auditors report (audit completion date) (feb 15, 2024)

Subsequently discovered facts

audit report release date (feb 17, 2024)

- Subsequently discovered facts

- Omitted audit procedures

- Management letter

- Communications with those charged with governance

procedures performed during fieldwork

roll forward procedures

analytical procedures

roll forward procedures

- Roll the conclusions forward to the year end date under audit

- Examining material account transactions that occur between interim testing data and date of the financial statements

• obtain evidence through date of financial stmtn

analytical procedures

During planning to assist auditors in planning NET of other auditing procedures (required).

Near the end of the audit as an overall review of the financial information to assess the conclusions reached and evaluate the overall financial statement presentation (required).

As part of substantive testing, to obtain audit evidence about particular assertions related to account balances or classes of transactions (optional).

review of account estimates

Auditors cannot audit or verify accounting estimates BUT should consider if reasonable in circumstances, ensure it is consistent with historical data and industry data

examples of account estimates

Income taxes

Equipments useful life

future cash clows in impairment

ADA for receivablles

Commitments and contingencies

Receivables collections

contingency

situation involving uncertainty as to possible gain or loss that will be resolved when a future event occurs or fails to occur

loss contingencies examples

Pending threaten litigation

Environmental remediation liabilities

Estimated warranty costs

Disputed income tax deductions

recognize loss contingency if

Liability probably incurred AND loss estimable (valuation)

report/ disclose if

- Liability probability incurred and NOT estimable OR

- Liability not probable but is reasonably possible

when it comes to contingencies auditors should ensure

- All contingencies have been appropriate identified

- Any client disclosure of contingencies reflects the most current information and all recent developments

Two important issues relating to pending litigations or claims

1. Have been disclosed to auditors

2. Property presented and disclosed in client financial statements

procedures for loss contingences

Inquiry of clients

Review minutes of meetings of stockholders, directors, and committees

Review contracts, loan agreements, and correspondence from taxing and governmental agencies

Obtain information concerning guarantees from bank confirmations

Review documentation related to legal services

Attorneys letters

attorney letter steps

1. Auditors request client to prepare a letter

2. Attorney receives the letter mailed by the auditor asking attorney to respond to letter

3. Attorney response should be provided directly to auditors for purpose of control and explain the matters

unasserted claims

Represents that no formal lawsuit/ claim has been filed, BUT that circumstances could result in a suit/claim being filed in the future

Auditors must rely on an attorney to inform the client if an unasserted claim must be disclosed

Written Representations primary purpose

provided by management to auditors

dated — audit completion date

impress upon management its primary responsibility for financial statements

purpose of management representation letter is to reduce

possibility of misunderstanding concerning managements responsibility for the financial statements

written representation goals

Obtain evidence that is unavailable by other audit procedures

Establish the auditor’s defense if a question related to inquiries subsequently arises

content of written representations

• Management’s responsibility for FS and ICFR

• appropriate disclosure, presentation

• stmt of uncorrected misstmt are IMmaterial

going concern definition

ability to remain a viable company for the next year

Evidence of going concern issues

Poor operating results and trends

Liquidity problems

Obsolescence

Employee turnover and morale

Regulatory threats

Debt covenants

Managers resist going concerned with audit report modifications why?

Don't want investors to know they may not continue next year

continue as a going concern?

• if concerns exits, evaluate management’s plans to mitigate

  • if concern is addressed = no effect

  • if doubt = proper use of going concern basis and modify auditors’ report

Adjusting entries and financial statement disclosure

- Accumulate dollar effects of identified misstatements

- Evaluate material of known misstatement (overall materiality)

- Must propose adjustments if material

- Future audits: consider any uncorrected from prior year

- Communicate all adjustments and misstatements to audit committee (SAD)

rollover method vs iron curtain method

considers current period effects only vs considers aggregate effect of all known misstatements

uncorrected misstatement

auditors have identified and accumulated during the audit that client has not corrected/ adjusted

audit documentation review

Ensure all appropriate steps in the audit plan were performed and explanations contained are understandable

Was work performed with due care?

Audit supervisor role

Have all steps in audit plan been performed

Is reference among documentation clear

Are explanations understandable

Audit manager and partner role

Is the overall scope of audit adequate

Do overall conclusions support opinion

Reviewing partner role

Is quality of audit work and reporting consistent with quality standards of firm

Engagement quality review

PCAOB requires concurring partners agreement

engagement quality review

Ensures quality of audit work and reporting is in keeping with public accounting firms quality standards

benefits of engagement quality review

- ensures that the audit is conducted in accordance with GAAS.

- provides the firm an opportunity to evaluate the overall quality of the firm's audit practices as a method of quality control.

- serves as an important component of the training and evaluation of audit staff members.

subsequent events

Events occurring between the date of the financial statements and date of auditor's report

evidence needed for subsequent events

• Management inquiry

• Review minutes

• Review legal invoices

• Review transactions and account activity after the balance-sheet date

• Consume the news...

Type 1 Subsequent Event

Provides evidence about conditions existing at the BS date

- lawsuit settled for different amount than accrual

- major customer files for bankruptcy during period

adjust fin stmnt to reflect new information

Type 2 Subsequent Event

involves conditions that arose after the date of financial statements

- Uninsured casualty loss occurring after BS date

- Lawsuit initiated for incident occurring after BS date

only disclose if material otherwise DONT adjust

Period A (12/31/2024 —> 3/15/2025)

subsequent to year end, before end of field work

• responsible for subsequent events occurring during this period

Period B (3/15/2025 —> 3/31/2025)

after end of field work, before releasing financial statements

• if event comes to auditors attention after the completion of filed work, can use dual date

Period C (past 3/31/2025)

after releasing the financial statements

• auditor has no responsibility anymore

• if results in revision of FS notify individuals

• then issue revised FS with disclosures

if something arises after releasing financial statments we ask two questions

1. Is the information something the auditor could have known before the audit report date even if the auditor did not actually know at the time

2. Would it have required disclosure or adjustment if it had been known prior to the audit report date?

if both yes, must disclose and restate fin stmt if material

if client refuses, report to SEC

procedures performed to determine whether material subsequent events exist

- Obtain an understanding of procedures management performed to identify material subsequent events.

- Inquire of management and those charged with governance as to the existence of subsequent events.

Subsequently discovered facts

Facts that become known to auditors after date of authors report that may have caused the auditors to revise their report

Dual date

facts discover prior to audit report release but after date of authors report

what must auditors tell audit committee?

• significant difficulties encountered

• uncorrected misstatements

• disagreements with management

• significant deficiencies and material weakness

• material, correct misstatements

procedures following the audit report release date

Omitted procedures

Individuals charged with governance

Management letter

omitted procedures

inadvertent failure of auditors to perform necessary audit procedures prior to the audit report release date

• auditor learrns their work is incomplete

perform omitted procedures if

omitted procedures are important in supporting the auditor's opinion

individuals are currently relying on the client's financial statements (and auditor's reports)

After performing omitted procedures

If previous opinion is supported, no further action necessary

If previous opinion cannot be supported

• Withdraw original report

• Issue revised reports

• Inform users relying on financial statements

individuals charged with governance

people responsible for overseeing the client financial reporting process

• board of directors, audit committees

Communicate misstatements to those charged with governance if they are uncorrected

PRIOR to audit report date - public company

Management letter:

Auditor make a note of matter that can be made as recommendations to client

Letter of constructive advice and feedback to companies management

Allows client to improve efficiency and effectiveness of operations

Chapter 12

Reports on Audited financial statements

primary role of auditors report

address whether the financial statements are presented in accordance to GAAP

all standard (unmodified) reports contain

opinion

basis for opinion

responsibilities of management for financial statements

auditors responsibilities for the audit of financial statements

other elements of unmodified report

• include independent

• addressed to client

• date of auditors report

• signed by firm and location

opinion section

identifies the financial statements and years examined by the audit team

States auditor's opinion on the financial statements.

"In our opinion, the financial statements present fairly, in all material respects..."

Basis for Opinion Section

- Conducted a GAAS audit

- Required to be independent and meet other ethical responsibilities

- Audit evidence provides basis for opinion

responsibilities of management for financial statements

management's responsibility for both the fairness of the financial statements and the design, implementation, and maintenance of internal control.

evaluate whether substantial doubt exists about the entity's ability to continue as a going concern.

auditors responsibilities for audit of financial statement

obtain reasonable assurance regarding the fairness of the financial statements, identifies several important components of a GAAS audit, and discusses the audit team's responsibility to communicate matters to those charged with governance.

auditors may issue four types of opinions

1. unmodified

2. qualified

3. adverse

4. disclaimer

Unmodified Opinion

Conclusion is that fin stmt present financial condition and cash flows in accordance with GAAP

Qualified opinion

Conclusion with the exception of one or more non pervasive issues, the financial statements present the financial condition, results of operations, and cash flows in accordance with GAAP

• departure from GAAP and scope of limitation if material

Adverse opinion

financial statements DO NOT present the financial condition, results of operations, and cash flows in accordance with GAAP.

• if departure from GAAP is pervasive

Disclaimer of Opinion

auditor is unable to obtain enough information to determine if the statements conform to GAAP;

do not express an opinion

"we couldn't audit this"

• indepence

• unaudited fin stmt

• going concern & scope limitation if pervasive

Conditions that require modifications to the auditors standard report

departures from GAAP

Scope Limitations

departures from GAAP

Situations in which an entity does not follow GAAP in preparing its financial statements

• if NOT material --> standard report (unmodified)

• if just material --> qualified

• if material and pervasive --> adverse

Scope Limitations

client-imposed scope limitation

circumstance- imposed scope limitation

client-imposed scope limitation

management's deliberate refusal to provide the audit team access to evidence or to otherwise limit the audit team's application of auditing procedures

- client preventing auditors from accessing information

circumstance-imposed scope limitation

circumstances beyond the audit team's and client's control such as the late appointment of the audit team that leads to their inability to perform certain auditing procedures

- natural disaster

• late appointment

scope limitations opinions

if material and procedures availaible —> unmodified

if mateial, no procedures, not pervasive —> qualified

if material, no procedures, and pervasive —> disclaimer

what is pervasive?

if misstatement is

- serious and widespread

- affect overall reliability of fin stmt

affects multiple line items

undermines overall financial reporting

EX: Let's say management refuses to allow the auditor to observe inventory, and inventory makes up 50% of total assets.

critical audit matters

required to be communicated to the audit committee that involves challenging, subjective, or complex audit team judgment relating to material accounts and disclosures.

• higher levels of risk

• significant audit and management judgement

frequent critical audit matters

- revenue recognition

- goodwill

- other intangible assets

- business combinations

Numbers of CAMS and PCAOB

number of CAMS has been decreasing and PCAOB is not happy because they want more since it is important for investors

benefits of CAM

Increase transparency for investors

Provide insight into most judgment heavy parts of audit

auditors reports referencing other matters

- adding an explanatory paragraph

which includes emphasis of matter paragraphs and other matter paragraphs

emphasis of matter paragraph

provide information fundamental to users understanding of entity financial statements

Other-matter paragraphs

provide information relating to users understanding of audit, audit teams responsibilities

Going-concern uncertainties

Most common report → unmodified opinion with separate section Substantial Doubt About the Entity's Ability to Continue as a Going Concern

Identify the footnote or other disclosure that references the going-concern issue and management's plans to address the issue.

Indicate that the opinion on the financial statements is not modified with respect to the going-concern issue.

Types of ICFR Deficiencies

-internal control deficiency

-significant deficiency

-material weakness

internal control deficiency

Design or operation does not allow misstatements to be prevented or detected in timely fashion.

significant deficiency

less severe than a material weakness yet important enough to merit attention by those charged with governance

Material Weakness

Results in reasonable possibility that a material misstatement would not be prevented or detected on a timely basis.

- If material weakness, adverse opinion on ICFR should be issued•

- Report would included a listing of material weakness(es) identified