COMPLETING THE AUDIT AND

POST – AUDIT
RESPONSIBILITIES
CHAPTER 20
AUDIT INQUIRY LETTER TO CLIENT’S LAWYER
Lawyers may be aware of two sources of contingencies their clients face:
1. Pending litigation, claims and assessments, and
2. Unasserted claims.
Pending litigation, claims and assessments, are situations in which a
claimant has stated that it has suffered a loss and plans to seek
remuneration, as well as situations in which a claimant has filed a lawsuit.
An unasserted claim is a potential legal claim that has not yet been made
by a claimant: For example, a manufacturer knowingly selling a faulty
automobile may have unasserted claims from accident victims who have
not yet filed them.
AUDIT INQUIRY LETTER TO CLIENT’S LAWYER

A letter is prepared, signed by the client and sent to the lawyers who are requested to respond shortly
after year-end. The lawyer is generally given two to four weeks within which to reply. The letter should
include a section on each of the following:

1. Pending or threatened litigation, claims, and assessments

 A list prepared by management that describes and evaluates pending or threatened
litigation, claims, and assessments to which the lawyer has devoted substantive
attention. (Alternatively, the lett er may request the lawyer to prepare the list.
 A request that the lawyer furnish information about or comment about each pending or
threatened litigation, claim or assessment on the list. The list should ask the lawyer to
address the progress of the case, describe the action the company plans to take,
evaluate the likelihood of an unfavorable outcome, and estimate (it possible) the range
of any potential loss.
 A request that the lawyer confirm that the list is complete and identify any items that
have been omitted.
AUDIT INQUIRY LETTER TO CLIENT’S LAWYER
2. Unasserted claims and assessments

 A list prepared by management describing and evaluating the items that the lawyer has
devoted substantive attention to, management considers to be probable of assertion, and
that, if asserted, would have a reasonable possibility of an unfavorable outcome.
 A request that the lawyer comment if his or her views differ from managements description
and evaluation of the listed unasserted claim and assessments.
 A statement that the lawyer has a responsibility while performing services to inform the
client of any matter recognized to involve an unasserted claim or assessment that may call
for financial statement disclosure.
 A request that the lawyer confirm his or her responsibility to inform the client of unasserted
claims or assessments that should be disclosed in the financial statements.
AUDIT INQUIRY LETTER TO CLIENT’S LAWYER
3. Other matters

•A request that the lawyer specifically identify the nature of and any reasons for any
limitation on his or her response and reasons for those limitations.

Generally, a lawyer may identify an asserted claim not identified in the inquiry letter but may not
disclose an unasserted claim. Because an asserted claim (a legal claim made by a claimant) is
usually general knowledge, the lawyer is not revealing a confidential matter about client when
reporting information about asserted claims. Although the lawyer may not disclose an unasserted
claim to the auditor, she or he is expected to call to the client's attention any unasserted claims
that should be disclosed. If the client fails to inform the auditor about unasserted claim (by means
of the inquiry letter), the lawyer is required to consider resigning as the client's counsel.
Therefore, a lawyer's resignation after receiving an inquiry letter should notify an auditor of the
possibility of inadequate disclosure.
Sometimes lawyers prefer not to respond to the inquiry letter. Their
reasons may be that they have not pursued a legal matter sufficiently to
respond or that their policy is not to respond to audit inquiry letters.
Auditors must obtain a response from the lawyer that enables them to
evaluate the accounting for and disclosure of contingencies, or they must
modify their audit report. Because they pay a fee to lawyers, clients can
generally persuade their lawyers to respond. Not being involved with any
lawsuits or other matters relating to the client is an acceptable reason for
a lawyer to decline to respond.
Audit Inquiry Letter to Lawyers
4. Evaluation of Going Concern Assumption
PSA 570, "Going Concern” establishes the standards and provides guidance on the auditor's
responsibility in the audit of financial statements with respect to the going concern assumption
used in the financial statements including considering management's assessment the entity's
ability to continue as a going concern.

When planning and performing audit procedures and in evaluating the results thereof, the
auditor should consider the appropriateness of management's use of the going concern
assumption in the preparation of the financial statements.

The auditor should evaluate whether there is a substantial doubt about a client's ability to
continue as a going concern for at least one year after statement of financial position date. This
assessment is initially made as a part of planning but is revised whenever significant new
information is obtained.
Management's assessment of the going concern assumption involves making a judgment, at
a particular point in time, about the future outcome of events or conditions which are
inherently uncertain. The following factors are relevant:

• In general terms, the degree of uncertainty associated with the outcome of an event or
condition increases significantly the further into the future a judgment is being made about
the outcome of an event or condition. For that reason, the financial reporting framework in
the Philippines requiring an explicit management assessment specifies the period for which
management is required to take into account all available information.

• Any judgment about the future is based on information available at the time at which the
judgment is made. Subsequent events can contradict a judgment which was reasonable at
the time it was made.

• The size and complexity of the entity, the nature and condition of its business and the
degree to which it is affected by external factors all affect the judgment regarding the
outcome of events or conditions.
 PSA 570 states that it is not necessary to design audit
procedures solely to identify conditions and events
that, when considered in the aggregate indicate there
could be a substantial doubt about the entity's ability
to continue as a going concern reasonable period of
time. The following are examples of procedures that
may identity such conditions and events
• Analytical procedures
Audit Procedures • Review of subsequent events
• Review of compliance with the terms of debt and
loan agreements
• Reading of minutes of meetings of stockholders,
board of directors, and important committees of the
board
• Inquiring of an entity's legal counsel about
litigation, claims, and assessments
• Confirmation with related and third parties of the
details of arrangements to provide or maintain
financial support
In performing the above-mentioned audit procedures, the auditor may identify information about
certain conditions or events that, when considered in the aggregate, indicate there could be substantial
doubt about the entity's ability to continue as a going concern for a reasonable period of time. Examples
of such conditions and events are as follows:

Financial indications
 Recurring operating losses
 Working capital deficiencies
 Negative cash flows from operating activities
 Adverse key financial ratios
 Net Liability or Net Current Liability portion
 Default on loan or similar agreements
 Arrearages or discontinuance of dividend
 Denial of usual trade credit from suppliers
 Restructuring of debt
 Noncompliance with statutory capital requirements
 Need to seek new sources of financing or to dispose of substantial asset
Operating Indications
 Work stoppages or other labor difficulties
 Uneconomic long-term commitments
 Need to significantly revise operations
 Substantial dependence on the success of a particular project
 Loss of Key Management without Replacement
 Legal proceedings legislation that might jeopardize an entity's ability to operate
 Loss of a key franchise, license, major market
 Loss of a principal customer or supplier
 Underinsured catastrophe such as a drought, flood or earthquake
 
Other
 Non-compliance with capital or other statutory requirements
 Pending legal or regulatory proceedings against the entity that may, if successful, result in claims that
are unlikely to be satisfied
 Changes in legislation or government policy expected to adversely affect the entity
Auditor's Responsibility
The auditor's responsibility is to consider the appropriateness of
management's use of the going concern assumption in the preparation of
the financial statements, and consider whether there are material
uncertainties about the entity's ability to continue as a going concern that
need to be disclosed in the financial statements.
The auditor cannot predict future events or conditions that may cause an
entity to cease to continue as a going concern. Accordingly, the absence of
any reference to going concern uncertainty in an auditor's report cannot
be viewed as a guarantee as to the entity's ability to continue as a going
concern.
Planning Considerations
In planning the audit, the auditor should consider whether there are
events or conditions which may cast significant doubt on the entity's
ability to continue as a going concern.
The auditor should remain alert for evidence of event or conditions which
may cast significant doubt on the entity’s ability to continue as a going
concern throughout the audit. If such events or conditions are identified,
the auditor should, in addition performing the procedures paragraph 26
of PSA 570, consider whether they affect the auditor’s assessments of the
components of audit risk.
Evaluating Management’s Assessment
The auditor should evaluate managements assessment or the entity's
ability to continue as a going concern.
The auditor should consider the same period as that used by management
in making its assessment under the financial reporting framework. If
management's assessment of the entity's ability to continue as a going
concern covers less than twelve months from the statement of financial
position date, the auditor should ask management to extend its
assessment period to twelve months from the statement of financial
position date.
Period Beyond Management’s Assessment
The auditor should inquire of management as to its knowledge of events
or conditions beyond the period of assessment used by management that
may cast significant doubt on the entity's ability to continue as a going
concern.
The auditor is alert to the possibility that there may be known events,
scheduled or otherwise, or conditions that will occur beyond the period of
assessment used by management that may bring into question the
appropriateness of managements use of the going concern assumption
preparing the financial statements. The auditor may become aware of
such known events or conditions during the planning and conduct of the
audit, including subsequent events procedures.
Additional Audit Procedures When Events or
Conditions are Identified
During the course of the audit, the auditor carries out audit procedures designed to obtain audit evidence as
the basis for the expression of an opinion on the financial statements. When a question arises regarding the
going concern assumption, certain of these procedures may take on additional significance or it may be
necessary to perform additional procedures or to update information obtained earlier. Procedures that are
relevant in this connection may include:
• Analyze and discuss cash flow, profit and other relevant forecasts with management.
• Review events after period end for items affecting the entity's ability to continue as a going concern.
• Analyze and discuss the entity's latest available interim financial statements.
• Review the terms of debentures and loan agreements and determine whether any have been breached.
• Read minutes of the meetings of shareholders, the board of directors and important committees for
reference to financing difficulties.
• Inquire of the entity's lawyer regarding litigation and claims.
• Confirm the existence, legality and enforceability of arrangements to provide or maintain financial support
with related and third parties and assess the financial ability of such parties to provide additional funds.
If after considering identified conditions and events and management's
plans, the auditor concludes that substantial doubt about the entity's
ability to continue as a going concern for a reasonable period of time
remains, the auditor should consider the need for disclosure of the
principal conditions and events in the financial statement and the report
should include an explanatory paragraph (following the opinion
paragraph) to reflect the conclusion.
Going Concern Assumption Appropriate but a
Material Uncertainty Exists
If adequate disclosure is made in the financial statements, the auditor should express unqualified
opinion but modify the auditor’s report by adding an emphasis of matter paragraph that highlights the
existence of a material uncertainty relating to the event or condition that may cast significant doubt on
the entity’s ability to continue as a going concern and draws attention to the note in the financial
statements that discloses the matters set out in paragraph 32 of PSA 570. In assessing the adequacy of
the financial statement disclosure, the auditor considers whether the information explicitly draws the
reader’s attention to the possibility that the entity may be unable to continue realizing its assets and
discharging its liabilities in the normal course of business. The following is an example of such a
paragraph when the auditor is satisfied as to the adequacy of the note disclosure:

“Without qualifying our opinion, we draw attention to Note X in the financial statements which
indicates that the Company incurred a net loss of ZZZ during the year ended December 31, 20X3 and,
as of that date the Company’s current liabilities exceeded its total assets by ZZZ. These conditions,
along with other matters as set forth in Note X, indicate the existence of a material uncertainty which
may cast significant doubt about the Company's ability to continue as a going concern.”
In extreme cases, such as situations involving multiple material uncertainties that are significant to
the financial statements, the auditor may consider it appropriate to express a disclaimer of opinion
instead of adding an emphasis of matter paragraph.
If the entity's disclosures with respect to its ability to continue as a going concern for a reasonable
period of time are inadequate, a departure from financial reporting standards exists. This may
result in either a qualified (except for) or an adverse opinion.

If adequate disclosure is not made in the financial statements, the auditor should express a qualified
or adverse opinion, as appropriate (PSA 701 "Modifications to the Independent Auditor's Report”,
paragraph 21). The report should include specific reference to the fact that there is a material
uncertainty that may cast significant doubt about the entity's ability to continue as a going concern.
The following is an example of the relevant paragraphs when a qualified opinion is to be expressed:

"The Company's financing arrangements expire and amounts outstanding are payable on
March 19, 20X4. The Company has been unable to re-negotiate or obtain replacement financing.
This situation indicates the existence of a material uncertainty which may cast significant doubt on
the Company's ability to continue as a going concern and therefore it may be unable to realize its
assets and discharge its liabilities in the normal course of business. The financial statements
(and notes thereto) do not disclose this fact.
In our opinion, except for the omission of the information included in the preceding paragraph, the
financial statements present fairly, in all material respects, the financial position of the Company at
December 31, 20X3 and the results of its operations and its cash flows for the year then ended in
accordance with …”

The following is an example of the relevant paragraphs when an adverse opinion is to be expressed:

"The Company's financing arrangements expired and the amount outstanding was payable on
December 31, 20X3. The Company has been unable to re-negotiate or obtain replacement financing
and is considering filing for bankruptcy. These events indicate a material uncertainty which may
cast significant doubt on the Company's ability to continue as a going concern and therefore it may
be unable to realize its assets and discharge its liabilities in the normal course of business. The
financial statements (and notes thereto) do not disclose this fact.

In our opinion, because of the omission of the information mentioned in the preceding paragraph,
the financial statements do not present fairly the financial position of the Company as at December
31, 20X3; and of its results of operations and its cash flows for the year then ended in accordance
with... (and do not comply with...:)…”
Going concern Assumption Inappropriate
If, in the auditor’s judgment, the entity will not be able to continue as a going
concern basis. If, on the basis of the additional procedures carried out and the
information obtained, including the effect of the management’s plans, the auditor’s
judgment is that the entity will not be able to continue as a going concern
assumption used in the preparation of the financial statements is inappropriate
and expresses an adverse opinion.
When the entity's management has concluded that the going concern assumption
used in the preparation of the financial statements is not appropriate, the financial
statements need to be prepared on an alternative authoritative basis. If on the
basis of the additional procedures carried out and the information obtained the
auditor determines the alternative basis is appropriate, the auditor can issue an
unqualified opinion if there is adequate disclosure but may require an emphasis of
matter in the auditor’s report to draw the user s attention to that basis.
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 the limitation on the scope of
the auditor’s work. In certain circumstances, such as those described in paragraphs I5-18 and 24 of PSA 570,
the auditor may believe that it is necessary to ask management to make or extend its assessment. If
management is unwilling to do so, it is not the auditor's responsibility to rectify the lack of analysis by
management, and a modified report may be appropriate because it may not be possible for the auditor to
obtain sufficient appropriate evidence regarding the use of the going concern assumption in the preparation
of the financial statements.

In some circumstances, the lack of analysis by management may not preclude the auditor from being
satisfied about the entity's ability to continue as a going concern. For example, the auditor's other procedures
may be sufficient to assess the appropriateness of managements use of going concern assumption in the
preparation of the financial statements because the entity has a history of profitable operations and a ready
access to the financial resources. In other circumstances, however, the auditor may not be able to confirm or
dispel in the absence of management’s assessment whether or not events or conditions exist which indicate
there may be a significant doubt on the entity’s ability to continue as a going concern, or the existence of
plans management has put in place to address them or other mitigating factors. In these circumstances the
auditor’s report as discussed in PSA 701, “Modifications to the Independent Auditor’s Report.”
Significant Delay in the Signature or Approval of
Financial Statements

When there is significant delay in the signature or approval of the

financial statements by management after the statement of financial
position date, the auditor considers the reasons for the delay. When the
delay could be related to events or conditions relating to the going
concern assessment, the auditor considers the need to perform additional
audit procedures, as described in paragraph 26 (PSA 570), as well as the
effect on the auditor’s conclusion regarding the existence of a material
uncertainty, as described in paragraph 30 of PSA 570.
5. Management Representations
PSA 580, “Management Representations” establishes standards and provides
guidance for the use of management representations as audit evidence, the
procedures to be applied in evaluating and documenting management
representations and the action to be taken if management refuses to provide
appropriate representations.

Obtaining appropriate management representation is also a subsequent events

procedure required in an audit examination. The auditor should obtain evidence that
management acknowledges its responsibility for the fair presentation of the financial
statements in accordance with the relevant financial reporting framework, and has
approved the financial statements. The auditor can obtain evidence of management's
acknowledgment of such responsibility and approval from relevant minutes of
meetings of the board directors or similar body or by obtaining a written
representation from management or a signed copy of the financial statements.
The auditor should obtain written representations from management on matters material to the
financial statements when other sufficient appropriate audit evidence cannot reasonably be expected to
exist. The possibility of misunderstandings between the auditor and management is reduced when oral
representations are confirmed by management in writing. Matters which might be included in a letter
from management or in a confirmatory letter to management are contained in the example of a
management representation letter.

During the course of an audit, management makes many representations to the auditor, either
unsolicited or in response to specific inquiries. When such representations relate to matters which are
material to the financial statements, the auditor will need to:

(a) Seek corroborative audit evidence from sources inside or outside the entity;
(b) Evaluate whether the representations made by management appear
reasonable and consistent with other audit evidence obtained including other representations; and
(c) Consider whether the individuals making the representations can be expected to be well informed
on the particular matters.

Representations by management cannot be a substitute for other audit evidence that the auditor could
reasonably expect to be available. For example, a representation by management as to the cost of an
asset is not a substitute for the audit evidence of such cost that an auditor would ordinarily expect to
obtain. If the auditor is unable to obtain sufficient appropriate audit evidence regarding a matter which
has, or may have, a material effect on the financial statements and such evidence is expected to be
available; this will constitute a limitation in the scope of the audit, even if a representation from
management has been received on the matter.