BAC 3624

Advanced Auditing

Tutorial 8

Question 1
Explain what are "events after the balance sheet date" as set out in FRS 110 and
how are they accounted for in the financial statements? Give two examples.
ANSWER
Events after the balance sheet date are those events, favourable or
unfavourable, that occur between the balance sheet date and the date when the
financial statements are authorised for issue. Two types of subsequent events
require consideration by directors and evaluation by the auditor:
i. Events that provide additional evidence about conditions that existed at the
date of the balance sheet and affect the estimates that are part of the financial
statement preparation process. These types of events are referred to as
adjusting events and require adjustment of the financial statements.
ii. Events that provide evidence about conditions that did not exist at the date of
the balance sheet but arose subsequent to that date. These are referred to as
non-adjusting events and usually require financial statement disclosure.
Examples of the first type of event or condition are:
An uncollectible account receivable resulting from continued deterioration of a
customer's financial condition leading to bankruptcy after the balance sheet date.
The settlement of a lawsuit after the balance sheet date for an amount different
from the amount recorded in the year-end financial statements,
Examples of the second type of event or condition are:
Purchase or disposal of a business by the entity.
Issues of shares or bonds by the entity.
Loss of the entity's manufacturing facility or assets resulting from a casualty
such as a fire or flood.
Question 2
The following items of subsequent events are unrelated. For each of the following
items, you are to indicate the required accounting treatment of the event. Assume
that the external auditor has completed the field work and is preparing the
auditor's report on the client's financial statements for the year ended 31 July
2013.
i. A large account receivable from a customer, Rahimi Sdn. Bhd. (material to the
financial statement presentation) was considered fully collectible at 31 July 2013.
Rahimi Sdn. Bhd. suffered a plant explosion on 28 August 2013. Because Rahimi
Sdn. Bhd. was uninsured, it is unlikely that the account will be collected.

BAC 3624

Advanced Auditing

Tutorial 8

ii. The court ruled in favour of the client company on 26 September 2013 for a
lawsuit from a customer that involved alleged breach of contract in 2010. The
client had provided for the full amount of the potential liability for the claim. The
customer will not appeal the court's ruling.
iii. On 15 September 2013, the client applied to the Securities Commission for
the issuance of 10 million new ordinary shares of RM 1.00 each. The
proposed new issue represents 10% of the issued and paid up share capital of
the company as at 31 July 2013.
iv. On 22 September 2013, Salleha, a major investment adviser, issued an
unfavourable report on the client company's long-term prospects. The share
price of the company subsequently declined by 25 percent.
v. At its 10 September 2013 meeting, the board of directors decided to increase
substantially the advertising budget for the coming year and authorised a
change in advertising agencies.
ANSWER
i. The explosion in Rahimi's plant which led to the uncollectibility of the accounts
receivable was an event whose conditions did not exist at the balance sheet
date. However, as the effect is material, it would require disclosure in the
financial statements.
ii. The court ruling in favour of the client company is an event whose conditions
existed at the balance sheet date and which involves the revision of an estimate.
The financial statements should be adjusted to reflect the favourable ruling.
iii. This is an event whose conditions did not exist at the balance sheet date. This
event should be disclosed in the financial statements.
iv. This is not an event that is considered a subsequent event for financial
statement purposes.
v. This is not an event that is considered a subsequent event for financial
statement purposes,

BAC 3624

Advanced Auditing

Tutorial 8

Question 3
Explain the purpose of a management representation letter
ANSWER
Management representations are a form of audit evidence. They are contained in
a letter, written by the company's directors and sent to the auditor, just prior to the
completion of audit work and before the audit report is signed.
Representations are required for two reasons:
Firstly, so the directors can acknowledge their collective responsibility for the
preparation of the financial statements and to confirm that they have approved
those statements.
Secondly, to confirm any matters, which are material to the financial statements
where representations are crucial to obtaining sufficient and appropriate audit
evidence.
In the latter situation, other forms of audit evidence are normally unavailable
because knowledge of the facts is confined to management and the matter is one
of judgement or opinion.
Obtaining representations does not mean that other evidence does not have to
be obtained. Audit evidence will still be collected and the representation will
support that evidence. Any contradiction between sources of evidence should, as
always, be investigated.