CHAPTER23

COMPLETINGTHEAUDITAND
POSTAUDITRESPONSIBILITIES
Questions
1.

Many of the revenue and expense accounts are not material in relation to the
financial statements and may be combined with other accounts in the financial
statements. These accounts can be audited through analytical procedures. Such
procedures compare the account balance to related statement of financial
position accounts, to sales, to industry averages or to a multiple-year trend to
ascertain whether any unusual fluctuations are present. Unusual or unexpected
items would have to be investigated and material items vouched to supporting
documents.

2.

The primary purpose of the client representation letter is to impress upon

management its ultimate responsibility for the adequacy of the financial
statements and related disclosures.
With respect to receivables, such letters typically state that all receivables are
valid and include proper amounts; also stated is the amount written off in the
past year and the current provision for uncollectibles.
In connection with inventories, the client represents that the peso amount of
inventories reflects physical quantities determined by a count and priced by a
stated accounting method. The client also represents that provision has been
made by the company for all obsolete and damaged inventory.
In regard to minutes, the client represents that all minutes of meetings of
stockholders, directors, and executive committees which have been transmitted
to the auditor are complete and authentic records for the period under audit
(including the subsequent period).
The client letter of representation should state whether any events occurred
subsequent to the date of the financial statements that, in the clients opinion,
require adjustment or disclosure in the statements.

3.

In addition to the attorneys letter, other procedures that are used to gather
evidence regarding contingencies include:

Standard bank confirmation.

23-2 Solutions Manual Public Accountancy Profession

4.

Inquiry of client management.

Reading of the minutes of the board of directors.
Vouching to purchase and sales contracts.
Vouching to lease agreements, confirmation with lessor or lessee.
There are two types of subsequent events:
1.

The first type consists of those events that provide additional evidence with
respect to conditions that existed at the date of the statement of financial
position and affect the estimates inherent in the process of preparing
financial statements. The use of the evidence requires an adjustment to the
financial statements.

2.

The second type consists of those events that provide evidence with respect
to conditions that did not exist at the date of the statement of financial
position being reported on but arose subsequent to that date. These events
should not result in an adjustment of the financial statements. However,
disclosure may be required to prevent the financial statements from being
misleading. In some cases, pro forma financial statements may be required
to ensure adequate disclosure.

5.

The purpose of dual dating is twofold: (1) To provide a means of inserting

important information in the financial statements even when learned after field
work is complete, while at the same time (2) to inform users that the auditor
takes full responsibility for subsequent events only up to the end of the field
work and for the specifically identified later event, but does not take
responsibility for other events which may have occurred after the end of field
work and before the date of the specifically identified subsequent event.

6.

Loss contingencies from litigation, claims, and assessments can be accrued or

disclosed, depending on the events likelihood. When a loss contingency
involves an unasserted claim or assessment, disclosure is not required if no
evidence exists that the assertion of a claim is probable. When an unasserted
claim probably will be asserted and an unfavorable outcome is a reasonable
possibility, disclosure is required. When a loss contingency is likely and the
amount can be estimated, the contingency should be accrued.

7.

When substantial doubt exists about the ability of an entity to continue in

operation for a year following the financial statements, an auditor should add a
paragraph calling attention to the fact that the statements have been prepared
assuming that the entity will continue as a going concern. If an auditor fails to
modify the report, however, and an entity ceases to exist as a going concern
within one year following the date of the audit, this does not in itself indicate
inadequate performance by the auditor.

8.

Managements refusal to sign a representation letter would typically result in a

disclaimer of opinion because audit evidence was restricted by management.

Completing the Audit and Post-Audit Responsibilities

9.

23-3

At the completion of the audit, an auditor must reconsider materiality and

determine an amount for materiality to be used in evaluating the estimated errors
in the financial statements. Also, an auditor should reconsider the audit risk.
As errors are found during the audit, the auditor generally shares them with the
client, and the client makes adjusting entries for material errors. If the client
refuses to correct a material error, the auditor must consider the materiality of
the combined known errors and likely errors. Known errors are individual
errors specifically identified by an auditor, whereas likely errors are an auditors
best estimate of other errors based on a projection of errors detected during
sampling. An auditor should compare projected error to materiality, both on an
account level and in the aggregate.

10. A financial statement disclosure checklist is a checklist an auditor uses to review

the financial statements to check that all necessary disclosures have been
included. In contrast, the auditor uses an engagement checklist to determine that
all auditing procedures have been performed.
11. Subsequent events are material events that occur after the statement of
financial position date but before the end of field work (and thus, before the
audit report date) that require disclosure in the financial statements and related
notes. Auditors (and management) are responsible for gathering evidence on
these subsequent events and evaluating the proposed disclosure.
Subsequent discovery of facts existing at the audit report date is knowledge
gained after the audit report is issued about an event or condition that existed at
the audit report date. Auditors have no responsibility to search for these facts
(as they do for subsequent events); however, once brought to the auditors
attention, their responsibility is to determine if the financial statements (and thus
their report) are misstated and take appropriate action.
12. The actions the partner should take if the client consents to disclose the
information (which existed at the audit report date and materially impacts the
financial statements) is to determine the method and timing of disclosure.
The actions the partner should take if the client refuses to make disclosure are:
Notify the client that the auditors report must no longer be associated with
the financial statements.
Notify regulatory authorities that the auditors report should no longer be
relied upon.
Notify users known to be relying on the financial statements that the
auditors report should no longer be relied upon. Such notification may be
to the SEC and the stock exchanges.

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13. Once auditors have reported on audited financial statements, they have no
responsibility to carry out a retroactive review of their work. However, postissuance review may be made in connection with a firms internal quality
control monitoring program, peer review or otherwise, and the omission of an
auditing procedure may be discovered.
If an omitted procedure is found, the auditors should consult legal counsel and
take the following actions:
Assess the importance of the omitted procedure to the present ability to
support the previously expressed opinion.
Determine if there are persons currently relying or likely to rely on their
report.
If the omitted procedure impairs present ability to support the previously
expressed opinion, the omitted procedure should be applied or alternative
procedures applied that would provide a satisfactory basis for the opinion.
If, as a result of subsequent application of the omitted procedure or
alternative procedures, the auditors become aware of facts that existed at the
date of their report, they should refer to page 927 (Subsequent Discovery of
Facts Existing at the Date of the Auditors Report) for guidance.
14. In a cold review, a partner not otherwise associated with an engagement will
take the report (in draft copy) and all working papers and review the entire
engagement with a fresh start. The purpose of the review is to obtain the
unbiased view of a professional expert who is not committed to a particular
engagement or its problems. It is performed to aid in maintaining high standards
of professional practice.
15. A management letter is an extra audit service. Auditors write to the
management their recommendations about control, tax matters, operating
efficiencies, and other consulting subjects to impress on managers the benefits
of audits in addition to just an audit. The letter also serves to promote and sell
CPAs consulting services.
16. A good management letter can show the client some profit potential, and the
CPA may be hired to do the consulting work.
17. When the auditor learns of information existing at the date of a previously
issued audit report, that it, if known, would have altered the audit opinion, the
following steps are in order:
a. Determine whether the information is reliable and whether the facts existed
at the date of the audit report;
b. Request the client to make necessary disclosure to persons known to be
relying on the statements;
c. If the client refuses, the auditor has a duty to notify those known to be
relying on the audit report that such reliance is no longer justified (notifying

Completing the Audit and Post-Audit Responsibilities

23-5

board of directors, SEC, and stock exchange usually satisfies this

requirement).
18. An auditor should investigate the new information as soon as practicable. When
an auditor determines that the information is reliable, that the facts existed at the
date of the report, and that the nature of the information and its effect on the
financial statements are such that the report would have been affected, the
auditor should consider whether persons are relying on the report. If the auditor
must take steps to prevent future reliance on the report, the preferred resolution
is for the client to issue revised financial statements and the auditor to issue a
revised report, unless the issuance of statements for a subsequent period is
imminent. When the effect on the financial statements of the subsequently
discovered information cannot be determined without a prolonged investigation,
the client should notify persons who are known to be relying on or who are
likely to rely on the financial statements and the related report. The clients
notification should state that (1) the statements should not be relied on and (2)
revised financial statements and auditors report will be reissued on completion
of an investigation. If applicable, the client should discuss the matter with the
Securities and Exchange Commission, stock exchanges, and appropriate
regulatory agencies.
19. If the client refuses to disclose the newly discovered facts, the auditor should
consult with his or her attorney and notify each member of the board of directors
of such refusal and of the fact that, in the absence of such disclosure, the auditor
will take steps to prevent future reliance on the audit report. These steps may
include
notifying the client that the audit report must no longer be associated
with the financial statements.
notifying the appropriate regulatory agencies that the audit report
should no longer be relied on.
notifying each person known to the auditor to be relying on the
financial statements that the audit report should no longer be relied on.
If such notification is impracticable, the auditor may request a
regulatory agency having jurisdiction over the client to take whatever
steps it deems appropriate.
20. When an auditor concludes that an auditing procedure considered necessary at
the time of the audit was omitted, auditing standards require the auditor to assess
the importance of the omitted procedure to his or her present ability to support
the previously expressed opinion. An auditor may review the working papers
and discuss the matter with other engagement personnel to evaluate whether
other applied procedures compensate for the omitted procedure. If the auditor
concludes that omission of the procedure impairs his or her present ability to
support the previously expressed opinion, and if persons are currently relying on
or are likely to rely on the report, the auditor should promptly undertake to apply

23-6 Solutions Manual Public Accountancy Profession

the omitted procedure or alternative procedures that would provide a satisfactory
basis for the opinion. If the auditor is unable to do so, he or she should consult a
lawyer to determine the proper course of action.
When performing the omitted procedures supports the opinion that was
previously released, the auditor has no further responsibility. However, if while
performing the procedures the auditor becomes aware that facts regarding the
financial statements existed at the date of the report that would have affected the
report had he or she had been aware of them, the auditor should follow
notification procedures to prevent further reliance on the report.
Multiple Choice Questions
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.

c
b
a
c
d
b
d
d
d
c
d

12.
13.
14.
15.
16.
17.
18.
19.
20.
21.
22.

b
c
a
b
b
b
c
a
b
d
a

23.
24.
25.
26.
27.
28.
29.
30.
31.
32.
33.

a
c
a
a
b
a
a
c
d
c
a

Cases
1.

a.

(1) The objectives of the engagement letter are to:

a.
b.
c.

Make sure that the CPA and his client are in agreement about the
nature of the engagement.
Inform the client about the scope of the CPAs work and what may
be expected to result.
Provide a written record of the responsibilities assumed by the
CPA and those retained by the client. (This understanding protects
both the CPA and his client).

(2) The CPA usually prepares the engagement letter as a follow-up to a

verbal understanding that he and his client have reached. It is desirable
that the client endorse and return an approved copy of the engagement
letter to the CPA. It also is acceptable for the client to prepare his own
letter summarizing his understanding of the nature of the engagement.
(3) Preferably, the engagement letter should be sent at the beginning of the
engagement so that misunderstandings, if any, can be remedied.

Completing the Audit and Post-Audit Responsibilities

23-7

(4) Obviously, the engagement letter will be most useful in clarifying

misunderstanding on a first engagement. But it is desirable that the
letter be renewed periodically. Client personnel or the nature of the
engagement may change, and the resubmission of the letter gives both
parties an opportunity to review the circumstances. Accordingly, for
recurring examinations of financial statements, it is appropriate to
prepare an engagement letter at the start of each examination. For other
continuing engagements, the engagement letter also should be updated
periodically probably on a yearly basis.
b.

(1) The objectives of the clients representation letter are to:

confirm oral representations given to the auditors, indicate and
document the appropriateness of such representations, and reduce
the possibility of misunderstandings.
(2) The clients representation letter should be prepared by the auditors (to
ensure all items are included) and signed by members of management
whom the auditors believe are responsible for and knowledgeable about
matters covered by the representations. Normally, the chief executive
officer and chief financial officer should sign.
(3) The clients representation letter should be obtained at the end of the
audit work and should be dated as of the date of the auditors report
(the date of the end of field work).
(4) The clients representation letter should be prepared for each
examination as the representations apply to one periods financial
statements. The items that need representation will change from one
period or another, as will the people who should sign the letter.

c.

(1) The CPAs should obtain an engagement letter when performing

accounting services involving unaudited financial statements, such as in
a compilation or review engagement. The engagement letter is
probably more important in unaudited engagements that in audited
engagements because as there is more likelihood of misunderstanding.
The engagement letter should include: a description of the nature and
limitations of the services to be performed, a description of the report, a
statement that the engagement cannot be relied upon to disclose errors,
irregularities or illegal acts, and that the CPAs will inform the client of
any matters that come to their attention.
(2) The CPAs are not required to obtain a clients representation letter
when performing engagements involving unaudited financial
statements. However, the CPAs may wish to obtain such a letter.

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2.

a.

A subsequent event is an event or transaction that occurs subsequent to the

statement of financial position date but prior to the issuance of the financial
statements and auditors report that has a material effect on the financial
statements and therefore requires adjustment or disclosure in the financial
statements.

b.

The occurrence of subsequent events that provide additional evidence

regarding conditions that existed at the date of the statement of financial
position and affect the estimates inherent in the process of preparing
financial statements necessitate financial statement adjustment. Those
events that provide evidence regarding conditions that did not exist at the
date of the statement of financial position being reported on but arose
subsequent to that date ordinarily would not result in adjustment of the
financial statements.
Some of these latter events, however, may be such that disclosure of them is
required to keep the financial statements from being misleading.
Occasionally such an event may be so significant that disclosure can best be
made by supplementing the historical financial statements with pro forma
financial data giving effect to the event as if it had occurred on the
statement of financial position date.

c.

The specific procedures that should be performed in order to ascertain the

occurrence of subsequent events are these:

Read the latest available interim financial statements, compare

them with the financial statements being reported upon, and make
any other comparisons considered appropriate in the
circumstances. Inquire of officers and other executives having
responsibility for financial and accounting matters whether the
interim statements have been prepared on the same basis as that
used for the statements under examination.

Inquire of and discuss with officers and other executives having

responsibility for financial and accounting matters (limited, where
appropriate, to major locations) regarding:
a.
b.
c.

Whether any substantial contingent liabilities or commitments

existed at the date of the statement of financial position being
reported on or at the date of inquiry.
Whether there was any significant change in the capital stock,
long-term debt, or working capital to the date of inquiry.
The current status of items in the financial statements being
reported on that were accounted for on the basis of tentative,
preliminary, or inconclusive data.

Completing the Audit and Post-Audit Responsibilities

d.

3.

a.

23-9

Whether any unusual adjustments have been made during the

period from the statement of financial position date to the date
of inquiry.

Read the available minutes of meetings of stockholders, directors,

and appropriate committees; inquire about matters dealt with at
meetings for which minutes are not available.

Obtain from the clients legal counsel a description and evaluation

of any litigation, impending litigation, claims, and contingent
liabilities (of which counsel has knowledge) that existed at the date
of the statement of financial position being reported on, together
with a description and evaluation of any additional matters of such
nature that have come to counsels attention up to the date the
information is furnished.

Obtain letter of representation, dated as of the date of the auditors

report, from appropriate officials (generally the chief executive
officer and chief financial officer) regarding whether any events
occurred subsequent to the date of the financial statements being
reported on by the independent auditor that, in the officers
opinion, would require adjustment or disclosure in these
statements.

Make such additional inquiries or perform such procedures as

considered necessary and appropriate to dispose of questions that
arise in carrying out the foregoing procedures, inquiries, and
discussions.

(1) A contingent liability is an existing condition situation, or set of

circumstances, involving uncertainty as to a possible loss to an
enterprise that will ultimately be resolved when one or more future
events occur or fail to occur.
The business enterprise must have already sustained an event which
exposed it to a loss but all aspects of the event have not yet been
concluded. The ultimate effect of the event will not be known with
certainty until the occurrence of some future event which will conclude
the transaction and resolve the current contingency.
(2) A loss contingency should be accrued only if the information available
prior to issuance of the financial statements indicates that it is probable
that a liability has been incurred at the date of the financial statements,
and the amount of the loss can be reasonably estimated.

23-10 Solutions Manual Public Accountancy Profession

A loss contingency should be disclosed in a footnote when it is
probable that a liability has been incurred but the amount cannot be
estimated. A loss contingency for which it is only reasonably possible
that a liability has been incurred and for which no amount can be
estimated should be disclosed in a footnote. Where the probability that
a liability has been incurred is remote, no disclosure is required.
b.

4.

Subsequent events may provide new and important information about

known or unknown contingency losses as of the statement of financial
position date.
The subsequent event may very well modify the
circumstances surrounding the contingent loss thereby changing the
reporting method from no disclosure to footnote disclosure or accrual. For
example, a contingent loss may have been recorded as a footnote disclosure
because, at the statement of financial position date, the company had only a
reasonable possibility that a loss may be incurred. A subsequent event
occurs which in the accountants judgment makes it probable that a
contingent liability has been incurred. The contingent liability will now
have to be accrued in the financial statements (provided an amount can be
estimated).

Other matters that J. Cees representation letter should specifically confirm

include whether or not
a.

b.
c.
d.
e.
f.

g.
h.

Management acknowledges responsibility for the fair presentation in the

financial statements of financial position, results of operations, and cash
flows in conformity with financial reporting standards (or other
comprehensive basis of accounting).
All material transactions have been properly reflected in the financial
statements.
There are other material liabilities or gain or loss contingencies that are
required to be accrued or disclosed.
The company has satisfactory title to all owned assets, and whether there
are liens or encumbrances on such assets or any pledging of assets.
There are related party transactions or related amounts receivable or payable
that have not been properly disclosed in the financial statements.
The company has complied with all aspects of contractual agreements that
would have a material effect on the financial statements in the event of
noncompliance.
Events have occurred subsequent to the statement of financial position date
that would require adjustment to or disclosure in, the financial statements.
The accountant has been advised of all actions taken at meetings of
stockholders, board of directors, and committees of the board of directors
(or other similar bodies) that may affect the financial statements.

Completing the Audit and Post-Audit Responsibilities

23-11

i.

Management is aware of irregularities that could have a material effect on

the financial statements or that involve management or employees who
have significant roles in the system of internal control.
j. All financial records and data were made available.
k. Provision, when material, has been made to reduce excess or obsolete
inventories to their estimated net realizable value.
l. Provision has been made for any material loss to be sustained in the
fulfillment of, or from inability to fulfill, any sales commitments.
m. Provision has been made for any material loss to be sustained as a result of
purchase commitments for inventory quantities in excess of normal
requirements or at prices in excess of the prevailing market prices.
5.

The auditors search for subsequent events is an important set of auditing

procedures because certain events, occurring after the statement of financial
position date, may have a significant impact on the audited financial statements.
Litigation in progress at the statement of financial position date, for example,
may be settled following the statement of financial position date, but prior to
completion of the audit field work. If the litigation is decided to the detriment of
the client, and if the judgment against the client is material and not subject to
appeal, an audit adjustment recognizing the loss is in order. Only by
communicating with the clients legal counsel near the end of audit field work,
concerning the current status of litigation, will the auditor become aware of the
settlement. Otherwise, a material loss pertaining to the year under audit will be
incorrectly omitted from the income statement.
A Type I subsequent event (like the one described above) provides further
evidence of conditions that existed at the statement of financial position date,
and, if the related amounts are material, may require adjustment of the financial
statements. Type II subsequent events provide evidence of conditions which did
not exist at the statement of financial position date, and, therefore, do not require
adjustment, but may require footnote disclosure, if considered material.
The following procedures assist the auditor in locating subsequent events:
a.

Obtaining a letter from the clients legal counsel Added information

concerning litigation pending at the statement of financial position date may
provide a basis for an audit adjustment recognizing a loss contingency or a
footnote describing uncertainty.

b.

Reading the minutes of directors meetings held subsequent to the statement

of financial position date may reveal the following subsequent events:
1.
2.
3.
4.

Approval of bonus applicable to year under audit (Type I)

Decision to dispose of a segment (Type II)
Approval of restructuring agreement (Type II)
Approval of major recapitalization plan (Type II)

23-12 Solutions Manual Public Accountancy Profession

c.

Reading the latest interim financial statements may disclose events such as
the following:
1.
2.
3.

6.

Major adjustments correcting for prior years earnings inflation (e.g.,

reversal of fabricated revenue through abnormal sales returns entries)
(Type I)
Major uninsured casualty loss occurring after the statement of financial
position date (Type II)
Reappearance of officers loans purported to have been paid or
collected prior to the statement of financial position date (Type I)

(1) If an omitted procedure is found, the auditors should consult legal counsel
and take the following actions:

Assess the importance of the omitted procedure to the present

ability to support the previously expressed opinion.

Determine if there are persons currently relying or likely to rely on

their report.

If the omitted procedure impairs present ability to support the

previously expressed opinion, the omitted procedure should be
applied or alternative procedures applied that would provide a
satisfactory basis for the opinion.

If as a result of subsequent application of the omitted procedure or

alternative procedures, the auditors become aware of facts that
existed at the date of their report, they should refer to page 927
(Subsequent Discovery of Facts Existing at the Date of the
Auditors Report) for guidance.

(2) If after reevaluating the scope of the examination and reviewing the
completed audit workpapers, procedures were found that tend to
compensate for the omitted procedure, the omitted procedure would not
have to be performed. The auditors should document their decision and
their support for this decision.
(3) If in subsequently applying the omitted procedure, the auditors become
aware of material new information that should have been disclosed in the
financial statements, they should follow the provisions of auditing standards
(refer to page 927 subsequent discovery of a fact existing at the date of the
auditors report).
7.

a.

The following accounting changes require a fourth paragraph explaining the

lack of inconsistency, given the change:
1.
2.

Change in accounting principle;

Change in reporting entity;

Completing the Audit and Post-Audit Responsibilities

3.
4.

8.

23-13

Correction of an error in principle;

Change in principle inseparable from change in estimate.

b.

To be in conformity with PFRS, management must demonstrate that the

new principle is preferable to the old. The auditor, therefore, must establish
preferability in evaluating whether the change is justified. If preferability
cannot be established, the auditor should render an except for
qualification on the basis that the financial statements contain a departure
from PFRS.

1.

d.
The management representation letter documents managements
acknowledgment of responsibility for the assertions made in the financial
statements. Typically, one of managements assertions is a statement that
all material transactions have been recorded properly. This statement
relates to the completeness and valuation categories of management
assertions.

2.

i. The audit inquiry letter to legal counsel seeks to confirm with the clients
lawyer assertions furnished by management about pending or threatened
litigation, unasserted claims and assessments, and other contingencies.

3.

d. The management representation letter documents managements

acknowledgement of responsibility for the assertions made in the financial
statements. One of managements assertions may be that a provision has
been made for any material loss to be sustained in the fulfillment of, or from
the inability to fulfill, any sales commitments. This statement relates to the
valuation and presentation and disclosure categories of management
assertions.

4.

c. The audit engagement letter documents the contract between the client
and the auditor. This documentation also includes the basis of fees for
services to be provided.

5.

c. The audit engagement letter documents the contract between the client
and the auditor. The letter should indicate the objective of the engagement.

6.

d. Managements assertions, as documented in the management

representation letter, often deny the existence of any irregularities, such as
those caused by employees, that may cause the financial statements to be
materially misstated.

7.

b. The successor auditor should make specific and reasonable inquiries of

the predecessor auditor regarding matters that the successor believes will
assist him or her in determining whether to accept the engagement. The
inquiries should include specific questions regarding, among other things,
facts that might bear on the integrity of management.

23-14 Solutions Manual Public Accountancy Profession

8.

a. The partners engagement review program is designed to confirm that

the audit was conducted in accordance with PSA. This review program is
also designed to identify any problems that may have arisen during the
audit, such as differences of opinion between an auditor and a specialist or
other consultant.

9.

e. The standard financial institution confirmation request asks the

institution to confirm the accounts and account balances of the client. The
form also allows the institution to include exceptions to managements
assertions, such as the existence of an undisclosed outstanding loan.

10. c. The auditors engagement letter outlines the auditors expectations of

management, including compliance with requests for written
representations.
11. d. Management assertions, as documented in the management
representation letter, often deny the existence of any plans or intentions to
materially alter the financial statements.
12. g. An additional paragraph may be added to the otherwise unmodified
audit report to emphasize a matter, for example, significant transactions
with related parties.
13. f. Any serious difficulty encountered in completing the audit, such as
managements delays in providing information, should be communicated to
the audit committee.
14. j. Accounts receivable confirmations seek to confirm account balances
with a clients debtors and customers. This excerpt is from a negative
confirmation, which requests a reply from a debtor or customer only if a
discrepancy exists.
15. g. Substantial doubt on the part of an auditor about an entitys ability to
continue as a going concern is presented in an explanatory paragraph of the
auditors report.