8.

0 CLOSING THE AUDIT

Learning objectives:

1. List and apply the steps involved in assessing the going-concern assumptions
2. Evaluating Management Representation
3. Summarize and resolve possible audit adjustments
4. Review and assess the appropriateness of the client`s accounting for and disclosure of
loss contingencies.
5. Review and assess the appropriateness of the client`s significant accounting estimates
6. Evaluate the adequacy of disclosures.
7. Conduct a final analytical review of the financial statements.
8. Identify the issues to communicate to management via a management letter.
9. Identify issues to communicate to the audit committee
10. Review subsequent events that occur after the balance sheet date and assess proper
treatment.

8.1 Going-concern assumption

This is an assumption that the entity will continue in operation and in existence for the
foreseeable future and has no intention nor the necessity of liquidation ceasing trading or seeking
protection from creditors.

8.1.1 consequences of going concern / implications of going concern in the financial

statements.

The going concern assumption means that assets and liability are recorded on the basis that the
entity will be able to realize its assets and discharge its liability in the normal course of
business.i.e.

1. Assets are recognized and measured on the basis that the enterprise expects to recover
through use or realization of the recorded amounts. It means that for instant, the plant and
machinery is expected to be used for many years in the future
 2. Liabilities are recognized and measured on the basis that they will be discharged in the
normal course of the business i.e. balance sheet shows the creditors due after twelve
months and due in less than twelve months.

The break up basis i.e the abandonment of the going -concern basis means

a. The net assets will be valued at net realizable value (NPV)

b. All liabilities will be shown at amounts due

8.1.2 Director`s responsibilities in relation to the going concern

The director of an entity should review the going concern and its continued use in the
preparation of financial statements. For this case, the directors should review:

i. Nature of the business

ii. Riskiness of the company or industry

iii. External factors

iv. The budgets and strategic plan

v. Other factors threatening the going concern.

8.1.3 Threats to going concern

These are factors that would indicate that the going concern assumption is threatened,
compromised, put into question etc. They include

1) Financial indicator

I. Excessive reliance on short term borrowings

II. Fixed term borrowing approaching maturity with no realistic prospects of reviewing
them or making them good

III. Adverse key financial issues

IV. Dividends falling in arrears

2) Non-financial/operating indicator – this includes

i. High turnover rate of key staff and management

ii. Loss of major customers, suppliers, market or license

iii. Fundamental changes in the market or technology

iv. Excessive dependence on one or a few product lines

8.1.4 Mitigators of Going Concern Problems

These are arrangements made by the directors of an entity which is facing going concern
problems in order to counter or induce or eliminate such problems. Where such mitigators exist,
the auditors have a responsibility of ascertaining their viability. Examples of such mitigations
include;

i. Negotiating with the shareholders to put in more share capital for purposes of bailing
out the entity. Where this arrangement is in place, the auditor should obtain copies of
resolutions passed by the shareholders in accepting to put in more capital.

ii. Sale of Fixed Assets-The directors may also arrange to sale some of the company`s
Fixed assets in order to solve Going concern problems. Where such arrangements are in
place, the auditor should confirm that the assets are not heavily utilized e,g for production
or are idle assets. The auditor should also confirm that such assets have reasonable
market values.

iii. Negotiating with creditors and suppliers-where the company may have disagreed with
its original suppliers, the directors may consider negotiating with new suppliers to replace
them in order to ensure continuity in operation. The directors will also negotiate with the
creditors to be able to defer the payments of the out-siding services. In such situations the
auditor should confirm with both the new and old suppliers as well as the creditors that
they are agreeable to the terms.

iv. Letter of support- In some situations, one company within a group of companies may be
facing a going concern problem while the other companies may be operating normally. In
 such a situation director of the suffering company may obtain a letter of support from the
directors of the company that is doing well indicating their willingness to provide
financial support. In such a situation the auditor should obtain copies of such letters and
confirm their commercial viability and whether they have the capacity to provide such
support.

v. Rescue package-in some situations the director of the company facing going-concern
problem may negotiate with creditors to convert into shareholders thereby reducing the
burden and pressure on the company. In such a situation, the auditor should be concerned
with the resolutions passed by the creditors agreeing to convert to shareholders.

8.1.5 Conclusion and reporting

When forming a conclusion on the going concern the auditor should determine whether it is
appropriate or inappropriate

I. Going concern assumption appropriate but a material uncertainty exists.

The auditor should consider whether the financial statements adequately disclose the principal
events or the conditions that give rise to doubts on the entity`s ability to continue as a going
concern. If adequate disclosure is made the auditor should express an unqualified opinion but
modify the report by adding an emphasis of matter paragraph. If adequate disclosure is not made
in the financial statements the auditor should express a qualified or adverse opinion as
appropriate.

II. Going-concern assumption inappropriate. If in the auditor`s judgement the entity will
not be able to continue as a going concern the auditor should express an adverse opinion
if the financial statements have been prepared on the going-concern basis

III. Management unwilling to make or extend its assessment. If management is unwilling

to make or extend its assessment when requested to do so by the auditor, the auditor
should consider the need to modify the auditor`s report as a result of limitations on scope
on the auditor`s work.
8.1.6 Audit Procedures on going concern

This include:

1. Reading of minutes of shareholders meetings and directors for reference to financing

difficulties.

2. Analyzing and discussing the entity`s latest available interim and management reports.

3. analyzing cashflows and profits forecast.

4. Reviewing the terms of debentures and loan agreements to determine whether any has
been breached.

5. Inquiring from the entity`s lawyers regarding the existence of legal suits, their outcome
and estimates of the expected loss.

6. Considering the entity`s plan to deal with unfulfilled customer orders.

7. Confirming the existence, legality and enforceability of arrangements to provide or

maintain financial support with related and third parties.

8. Confirming the events after the period end to identify those that either mitigate or
otherwise affect the entity`s ability to continue as a going concern.

9. Seeking written representation from management regarding its plan for future actions.

The risk of a client not remaining in business needs to be assessed, and any auditor reservations
need to be communicated to financial statement users.

There are more notes on this topic on its own.

8.2 Evaluating Management Representation

Auditors should obtain a management representation letter at the end of each audit. The letter is
a part of audit evidence but is not a substitute for audit procedures that are performed to
corroborate the information contained in the letter. The purpose of the letter are as follows:

1. It reminds management of its responsibility for the financial statements

2. It confirms oral responses obtained by the auditor earlier in the audit and the continuing
appropriateness of those responses.
3. It reduces the possibility of misunderstanding concerning the matters that are the subject
of the representation.

Audit evidence can normally be categorized into three groups namely;

1. Evidence which is not material-in the context of the financial statement which therefore
the auditors may discuss orally with the client`s officials and draw appropriate conclusions.

2. Evidence which is material in the context of the financial statements but which the
auditor can evaluate and confirm using standard audit tests and procedures and therefore be
able to conclude.

3. Evidence which is material in the context of the financial statements but which the
auditor has no way of evaluating and his knowledge may only be vested in the client`s
officials. This third category of audit evidence requires the auditor to obtain written
representation from the client`s management to be retained in the audit working papers for
various purposes.

Letter of Representation

This is a formal document signed by the client`s officials and addressed to the auditor
acknowledging their responsibilities for the financial statements and stating specifically that
all supplementary information e.g contingencies have been fully accounted for and disclosed
as required.

8.2.1 Purpose/Importance

1. The letter may be produced in a court of law by the auditors in defending their position

2. Such a letter constitutes a form of audit evidence which may help the auditors in
supporting their audit opinion.

3. It helps the auditor in ensuring that the assertion of completeness is satisfied by the
client`s officials.
4. It serves to remind the company officials of their primary responsibility for the financial
statements.

8.2.2 Contents of the Letter

1. General Matters

a) An indication by the directors for their responsibility for the financial statements

b) An indication by the directors that they have provided the auditors with all the relevant
records and documents needed during the audit process.

c) An indication by the directors that they have applied suitable accounting policies during
the preparation of the financial statements.

d) An indication that all post balance sheet events have been properly accounted for.

e) Details of any outstanding claims and litigations affecting the entity.

f) Details of any material capital commitments entered into by the entity.

2. Assets

a) A confirmation that the company has satisfactory titles to its assets and where some
assets are charged as security, details of such charges.

b) Details of adequacy of depreciation charge on fixed assets

c) Basis of valuation of stocks distinguishing the values of raw materials, w-i-p and finished
goods.

d) Details of the adequacy of provisions for bad debts.

3. Liabilities

a) An indication that all known liabilities have been fully provided for as at the Balance
sheet.

b) Nature and amounts of all contingent liabilities.

c) Details of disclosures of extra-ordinary and exceptional items in the financial statements.

 8.2.3 Auditors Action where the management refuse to provide representation letters

There situations where the client`s management may refuse to provide representation e.g due
to lack of understanding or due to the assumption that they have provided sufficient
information to the auditors. In such situations the auditor should consider the following
measures:

I. Evaluation of any other evidence available on matters requiring representation.

II. The auditors may make arrangements for meetings between themselves and the client`s
officials where all important matters are discussed and minuted after the auditors can retain
the minutes in their working papers.

III. The auditor may also write down his understanding of all matters requiring to be
documented then persuade the client`s officials to sign on the document by way of
acknowledging which will then be retained by the auditor.

IV. The auditor should also consider the implications of not having all the important matters
recorded which could affect the auditors negatively at a later date.

V. The auditors should consider issuance of a qualified audit report on the basis of
limitations of scope in situations where he is unable to obtain appropriate representations
from the management.

8.3 Audit adjustments

Summarize and resolve possible audit adjustments. Uncorrected misstatements detected during
the audit should be summarized and evaluated to determine whether they would be material in
the aggregate and are the result of a material weakness in internal controls. Misstatements are
likely to be detected that individually are not material, and the auditor may temporarily pass on
asking the client to make those adjustments

8.4 Reviewing Contingencies

Examples of contingencies include the following:

1. Threat of expropriation of assets in a foreign country.

 2. Litigations, claims, and assessments
3. Guarantees of debts of others
4. Obligations of banks under standby letters of credit
5. Agreements to repurchase receivables that have been sold
6. Purchase and sale commitments

8.5 Reviewing Significant Estimates

Financial statements include a number of estimates and judgements, ranging from those
associated with pension liabilities to product warranties to allowances for doubtful
debts/accounts and to obsolescence of inventory. Ultimately the auditor is responsible for
providing reasonable assurance that:

1. Management has an information system to develop all estimates that could be material to
the financial statements
2. The estimates are reasonable
3. The estimates are presented in conformity with GAAP

8.6 Evaluating adequacy of Disclosures

The auditor`s report covers the basic financial statements which include the balance sheet,
income statement, statement of cashflows, statement of changes in shareholders` equity or
retained earnings and the related notes.

According to the third standards of reporting when the auditors determined that informative
disclosures are not reasonably adequate, the auditor must note that fact in the auditor`s report.
Ultimately, the auditor must be sure that:

1. Disclosed events and transactions have occurred and pertain to the entity.
2. All disclosures that should have been included are included.
3. The disclosures are understandable to users.
4. Information is disclosed accurately and at appropriate amounts.

8.7 Performing Analytical Review of the audit and financial statements

Analytical procedures help auditors assess overall presentation of the financial statements.
Auditing standards require the use of analytical procedures in both the planning phase and the
final review phase of the audit to assist in identifying account relationships that are unusual.
Analytical review procedures involve reasoning by the auditors for purposes of determining any
plausible relationship between information from one accounting period to another or by relating
financial information to non-financial information. Such procedures are useful to auditors in
providing additional information and also determining the level of consistence of evidence. They
may also help the auditors to determine the fairness of the information contained in the financial
statements.

8.7.1 Types of Analytical Review Procedures

1. Comparison of financial information and non-financial information e.g comparing the

payroll costs with the number of employees in a particular period.

2. Analyzing the relationship between prospective financial information e.g budgets and
forecast with the actual figures in the financial statements to be able to investigate any
variances.

3. Computing accounting ratios such as profitability, liquidity and turnover ratio etc. from
one accounting period to another or comparing the entity`s ratios to other competitors
within the industry.

4. Carrying out trend analysis e.g by studying the behavior of a particular account over a
given period to be able to determine any material fluctuations which require to be
investigated.

5. Studying any related evidence affecting various accounts e.g relating the depreciation
charge to the various asset accounts or sales to cost of sales.

6. Carrying out reasonableness test e.g by calculating expected values on items and then
checking the records to confirm whether the values calculated are consistent with what is
contained in the records.

8.7.2 Objectives of Analytical Reviews Procedures

1. Such procedures enable the auditor to understand nature of the client`s business.
 2. They may help the auditor in identifying areas of potential risks which may require high
concentration of the audit procedures.

3. Such procedures also help the auditors in determining the consistency of evidence from
different sources to be able to draw conclusions

8.7.3 Sources of information for Analytical Reviews

The auditors should normally consider the source and nature of information used to carry out
analytical review procedures in terms of reliability e.g where auditors are dealing with a weak
system. Information such as budgets may not be reliable to be used for analytical review
procedures. The following includes the sources of information:

1. The client`s interim financial statements and the annual financial statements produced for
audit purposes.

2. The client`s other internal reports e.g management accounts and cost accounting records.

3. Any prospective financial information.

4. Industry statistics

5. Any available non-financial information

6. Previous year`s working papers

7. Previous year`s audited financial statements

8. The working papers of internal auditors

8.7.4 Factors That influence Analytical Review Procedure

1. The auditor`s previous knowledge regarding the entity`s operations. Analytical review
techniques will also be suitable where auditors have previous cumulative knowledge
which is contained in working papers which may enable them to compare information
from previous period to information in the current period.

2. The client`s management own use of analytical Review procedures. Some clients use
analytical review procedures for their own decision-making requirements e.g periodic
preparation of budgets and analyzing accounting ratios. Where auditors are dealing with
 such clients, they are likely to get ready information which they can use during the
analytical review procedures.

3. Availability of competent audit staff. Analytical review procedures require auditors to

have the necessary intellectual capacity, competence and experience. The audit firm
should therefore ensure that where such procedures are required to be performed during
an assignment, such work is delegated to the appropriate staff.

4. Cost-Benefit consideration. Auditors should normally consider whether by performing

the analytical review procedures they may be adding value to the audit process. This is
because in certain situations they may have gathered sufficient evidence to be able to
draw conclusions, therefore performing such procedures may not be of additional benefit
to the audit process.

5. Availability of non-financial information in situations where non-financial and industry

statistics information may be available, they may be used by the auditors to perform
analytical review procedures.

6. The nature of the client`s business and operation- Analytical review procedures may be
suitable where auditors are dealing with an entity which has existed for along period to
facilitate comparisons.

8.7.5 Advantages of Analytical Review Procedures

1. Such procedures constitute a source of audit evidence which may be useful in supporting
other evidence gained through other procedures.

2. Such procedures may be considered to be reliable especially where the auditor gets direct
evidence him/herself.

3. In situations where the auditor get available information they may conduct the audit
procedures much faster and gather sufficient information within a short period.

4. When dealing with a strong and reliable system such procedures may generate accurate
information.
 5. The procedures may be applied by the auditors at all stages of the audit making them
more consistent.

6. The procedures may help the auditors to gain an understanding of the nature of the
client’s operations especially during the risk assessment.

8.7.6 Disadvantages of Analytical Review Procedures

1. Some of the techniques may be complicated requiring highly experienced and intelligent
audit staff.

2. Such techniques may create additional costs e.g in terms of time spent to accomplish the
audit process.

3. The techniques may not produce reliable results especially where the auditors are dealing
with a weak system.

4. The techniques may not be appropriate where the auditors are dealing with clients for the
first time and may not have previous knowledge regarding their operations.

5. Lack of relevant information e.g industry statistics, management accounts etc may also
affect such procedures.

8.8 Communicating with management via the management letter

Auditors often notice things that could help management to do a better job. The auditor generally
reports these observations in a management letter as a constructive part of the audit. Such a
letter should not be confused with a management representation letter.

Management Letter

It is a letter written by the auditor of an entity to those charged with governance e.g directors or
managers in form of an advice about the internal control systems and the accounting systems.
The objective of this letter is to assist the managers and directors on proper use of resources,
designing and implementation of internal control system. The title of the letter to management
may vary to include a letter of internal weakness, post audit letter, letter of comments, letter to
those charged with governance, recommendation letter, ICS letter.
Purposes

1. To enable the auditor, give his comments on the accounting records and systems of
control.

2. To enable the auditor to bring to the attention of management areas of weakness that can
be improved.

3. To enable the auditor, communicate matters that have an impact on the future audits.

4. To enable the management to put right matters that may have led to audit report
qualification.

5. To point out areas where management will be more efficient, effective or where they
could take advantage of economies of scale.

Contents of the letter

This report will include among other items;

1. A list of weaknesses in the structure of accounting and internal control system.

2. A list of deficiencies in operations, controls and records.

3. Unsuitable accounting policies and practices.

4. Non-compliance with accounting standards and legislations.

5. Explanations of the risks arising from each weakness

6. Comments on inefficiencies

7. Recommendations for improvement.

8.9 Communicating with the Audit committee

There are several items that the auditor should discuss with the audit committee by the end of the
audit to help the audit committee fulfil its responsibility to oversee the financial reporting
processes of the entity.
1. It is important that members of the audit committee understand that audit provide
reasonable, but not absolute, assurance about the fairness of the financial statements.
2. The audit committee needs to be aware of the processes used by management in
developing sensitive estimates and how the auditor determined the reasonableness of
those estimates.
3. The auditor should report any audit adjustments that would have a material effect on the
financial statements and that may not have been detected except through the audit.
4. Immaterial misstatements that are not corrected should be reported to the audit
committee.
5. Members of the audit committee must be informed about the initial selection of and
significant accounting policies during the current period and the reasons therefore.
6. They also need to be informed about the methods used to account for significant unusual
transactions and controversial or emerging areas for which there is a lack of authoritative
guidance.
7. The audit committee is also told about major accounting and reporting disagreements
with management, even if they were eventually resolved.
8. Difficulties encountered in performing the audit should also be reported to the committee.
9. Copies of significant written communications between the auditor and management, such
as the engagement letter, management representation letter, and reports of significant
deficiencies and material weaknesses in internal control over financial reporting should
be shared with the audit committee.

8.10 Assessing Subsequent Events

Review subsequent events that occur after the balance sheet and assess proper treatment.
Three situations relating to events occurring after the balance sheet date that require
special audit attention are:
1. Review of events occurring after the client`s balance sheet date but prior to issuance
of the audit report, which is a normal part of each audit.
2. Subsequent discovery of facts existing at the date of the auditor`s report but not
discovered during the audit.
 3. Consideration of omitted audit procedures that come to the auditor`s attention after
the auditor`s report has been issued.

Two types of events have been identified by the professional literature as subsequent events that
may require monetary adjustments to the financial statement and /or disclosure: Type 1
subsequent events and Type II subsequent events.

8.10.1 Type I Subsequent Events

Type I subsequent event provide evidence about conditions that existed at the balance sheet date.
The financial statement numbers should be adjusted to reflect this information. Footnote
disclosure may also be necessary to provide additional information. The following are examples:

 A major customer files bankruptcy during the subsequent period because of a

deteriorating financial condition, which the client and auditor were unaware of until
learning about the bankruptcy filing. This information should be considered in
establishing an appropriate amount for the allowance o doubtful accounts and in making
an adjustment if the allowance is not sufficient to cover this potential loss.
 A law is settled for a different amount than was accrued.
 A stock dividend or split that takes place during the subsequent period should be
disclosed in addition, earnings per share figures should be adjusted to show the
retroactive effect of the stock dividends or split.
 A sale of inventory below carrying value provides evidence that the net realizable value
was less than cost at year end.

8.10.2 Type II Subsequent Events

Type II Subsequent Events indicate conditions that did not exist at the balance sheet date, but
that may require disclosure. The events that should be considered for disclosure are financial in
nature, material, and normally disclosed. The following are examples;

 An insured casualty that occurred after the balance sheet date causes a customer`s
bankruptcy during the subsequent period. Because the customer was able to pay at the
balance sheet date, the allowance for doubtful debts should not be adjusted, but the
information should be disclosed.
 A significant law suit is initiated relating to an incident that occurred after the balance
sheet date.
 Due to a natural disaster such as fire, earthquake, or flood, a firm loses a major facility
after the balance sheet date
 Major decisions are made during the subsequent period, such as to merge, discontinue a
line of business, or issue new securities.
 A material change occurs in the value of investment securities.

8.10.3 Audit procedures for subsequent Events

Cutoff tests, review subsequent collections of receivables, and the search for unrecorded
liabilities are some of the audit procedures for subsequent events. Additional procedures
related to subsequent events include the following:

 Read the minutes of the meetings of the board of directors, stockholders, and other
authoritative groups. The auditor should obtain written assurance that minutes of all
such meetings through the audit report date have been made available. This can be
included in the management representation letter.
 Read interim financial statements and compare them to the audited financial
statements, noting and investigating significant changes.
 Inquire of management concerning:
-any significant changes noted in the interim statements
-The existence of significant contingent liabilities or commitments at the balance
sheet date or date of inquiry which should be near the audit report date
-any significant changes in working capital, long-term debt, or owner`s equity.
-the status of items for which tentative conclusions were drawn earlier in the audit
-any unusual adjustments made to the accounting records after the balance sheet date.