Completing the Audit

Chapter 24

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 24 - 1

 Learning Objective 1

Conduct a review for contingent

liabilities and commitments.

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 24 - 2

 Summary of the Audit Process

Phase
PhaseIIIIII
Phase
PhaseI I Perform
Performanalytical
analytical
Plan
Planand
anddesign
designan
anaudit
audit procedures
proceduresand andtests
tests
approach.
approach. of
ofdetails
detailsof ofbalances.
balances.

Phase
PhaseIIII Phase
PhaseIVIV
Perform
Performtests
testsof
ofcontrols
controls Complete
Completethetheaudit
auditand
and
and
andsubstantive
substantivetests
tests issue
issuean
anaudit
auditreport.
report.
of
oftransactions.
transactions.

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 24 - 3

 Phase IV – Completing the Audit

Review
Reviewfor forcontingent
contingent Evaluate
Evaluateresults.
results.
liabilities.
liabilities.

Review
Reviewfor
for Issue
Issueaudit
auditreport.
report.
subsequent
subsequentevents.
events.

Communicate
Communicatewith
with
Accumulate
Accumulatefinal
final audit
auditcommittee
committee
evidence.
evidence. and
andmanagement.
management.
©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 24 - 4
 Contingent Liabilities

AAcontingent
contingentliability
liabilityisisaapotential
potentialfuture
future
obligation
obligationto
toan
anoutside
outsidepartypartyfor
foran
an
unknown
unknownamount
amountresulting
resultingfrom
fromactivities
activities
that
thathave
havealready
alreadytaken
takenplace.
place.

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 24 - 5

 Likelihood of Occurrence and
Financial Statement Treatment
Likelihood of Financial statement
occurrence of event treatment
Remote
Remote No
Nodisclosure
disclosure
(slight
(slightchance)
chance) necessary
necessary

Reasonably
Reasonably Footnote
Footnotedisclosure
disclosureisis
possible
possible necessary
necessary

Probable
Probable Adjust
Adjustfinancial
financialstatements
statements
(likely
(likelyto
tooccur)
occur) or
ornote
notedisclosure
disclosure
©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 24 - 6
 Auditor’s Concerns

Pending
Pendinglitigation
litigationfor
forpatent
patentinfringement,
infringement,
product
productliability,
liability,or
orother
otheractions
actions
Income
Incometax
taxdisputes
disputes
Product
Productwarranties
warranties
Notes
Notesreceivable
receivablediscounted
discounted
Guarantees
Guaranteesof ofobligations
obligationsof
ofothers
others
Unused
Unusedbalances
balancesof ofoutstanding
outstandingletters
lettersof
ofcredit
credit

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 24 - 7

 Audit Procedures for Finding
Contingencies
Inquire
Inquireof
ofmanagement
management(orally
(orallyand
andin
in
writing)
writing)about
aboutthe
thepossibility
possibilityof
of
unrecorded
unrecordedcontingencies.
contingencies.

Review
Reviewcurrent
currentand
andprevious
previousyears’
years’internal
internal
revenue
revenuereports
reportsfor
forincome
incometax
taxsettlements.
settlements.

Review
Reviewthe
theminutes
minutesofofdirectors’
directors’and
and
stockholders’
stockholders’meetings
meetingsfor
forindications
indications
of
oflawsuits
lawsuitsor
orother
othercontingencies.
contingencies.

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 24 - 8

 Audit Procedures for Finding
Contingencies
Analyze
Analyzelegal
legalexpenses
expensesand
andreview
reviewinvoices
invoices
and
andstatements
statementsfrom
fromlegal
legalcounsel.
counsel.

Obtain
Obtainaaletter
letterfrom
fromeach
eachmajor
majorattorney
attorneyof ofthe
the
client
clientas
asto
tothe
thestatus
statusof
ofpending
pendinglitigation.
litigation.

Review
Reviewaudit
auditdocumentation
documentationforforany
anyinformation
information
that
thatmay
mayindicate
indicateaapotential
potentialcontingency.
contingency.

Examine
Examineletters
lettersof
ofcredit
creditin
inforce.
force.
©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 24 - 9
 Learning Objective 2

Obtain and evaluate letters from

the client’s attorneys.

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 24 - 10

 Inquiry of Client’s Attorneys

AAlist
listincluding
including(1)
(1)pending
pendingthreatened
threatenedlitigation
litigation
and
and(2)
(2)asserted
assertedor
orunasserted
unassertedclaims
claimsor
or
assessments
assessmentswithwithwhich
whichthe
theattorney
attorney
has
hashad
hadinvolvement.
involvement.

AArequest
requestthat
thatthe
theattorney
attorneyfurnish
furnishinformation
information
or
orcomment
commentabout
aboutthe
theprogress
progressofofeach
eachitem
itemlisted.
listed.

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 24 - 11

 Inquiry of Client’s Attorneys

AArequest
requestfor
forthe
theidentification
identificationof ofany
anyunlisted
unlisted
pending
pendingor
orthreatened
threatenedlegal
legalaction
actionor oraa
statement
statementthat
thatthe
theclient’s
client’slist
listisiscomplete.
complete.

AAstatement
statementinforming
informingthetheattorney
attorneyofofthe
theattorney’s
attorney’s
responsibility
responsibilityto
toinform
informmanagement
managementof oflegal
legalmatters
matters
requiring
requiringdisclosure
disclosureininthe
thefinancial
financialstatements
statements
and
andto
torespond
responddirectly
directlyto
tothe
theauditor.
auditor.

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 24 - 12

 Sarbanes-Oxley Act

Congress
Congressincluded
includedprovisions
provisionsininthis
thisact
actdirecting
directing
the
theSEC
SECtotoissue
issuerules
rulesrequiring
requiringattorneys
attorneysserving
serving
public
publiccompanies
companiesto toreport
reportmaterial
materialviolations
violations
by
bythe
thecompany
companyof offederal
federalsecurities
securitieslaws.
laws.

The
TheAmerican
AmericanBar
BarAssociation
Associationamended
amendedits its
attorney-client
attorney-clientconfidentiality
confidentialityrules
rulestotopermit
permit
attorneys
attorneysto
tobreach
breachconfidentiality
confidentialityififaaclient
client
isiscommitting
committingaacrime
crimeor
orfraud.
fraud.

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 24 - 13

 Learning Objective 3

Conduct a post-balance-sheet
review for subsequent events.

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 24 - 14

 Period Covered by Subsequent
Events Review
Client’s ending Audit Date client
balance sheet report issues financial
date date statements

12-31-05 3-11-06 3-26-06

Period to which review for Period for

subsequent events applies processing
the financial
statements
©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 24 - 15
 Types of Subsequent Events

Those
Thosethat
thathave
haveaadirect
directeffect
effect
11 on
onthe
thefinancial
financialstatements
statements
and
andrequire
requireadjustment
adjustment

Those
Thosethat
thathave
havenonodirect
directeffect
effect
22 on
onthe
thefinancial
financialstatements
statementsbutbut
for
forwhich
whichdisclosure
disclosureisisadvisable
advisable

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 24 - 16

 Requiring Adjustment

Declaration of bankruptcy by a customer

Declaration of bankruptcy by a customer
with
withananaccounts
accountsreceivable
receivablebalance
balance
Settlement of a litigation at an amount
Settlement of a litigation at an amount
different
differentfrom
fromthe
theamount
amountrecorded
recorded
on
onthe
thebooks
books
Disposal of equipment not being used in
Disposal of equipment not being used in
operations
operationsat ataaprice
pricebelow
belowthe
thecurrent
current
book
bookvalue
value
 Sale of investments at a price below
Sale of investments at a price below
recorded
recordedcost
cost
©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 24 - 17
 Advisability of Disclosure

Decline in the market value of securities

Decline in the market value of securities
held
heldfor
fortemporary
temporaryinvestment
investmentororresale
resale
Issuance of bonds or equity securities
Issuance of bonds or equity securities
Decline in the market value of inventory
Decline in the market value of inventory
as
asaaconsequence
consequenceof ofgovernment
governmentaction
action
barring
barringfurther
furthersale
saleof
ofaaproduct
product
Uninsured loss of inventories as a result
Uninsured loss of inventories as a result
of
offire
fire
A merger or an acquisition
A merger or an acquisition

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 24 - 18

 Audit Tests

Procedures
Proceduresnormally
normallyintegrated
integratedas
as
aapart
partof
ofthe
theverification
verificationof
ofyear-end
year-end
account
accountbalances
balances

Procedures
Proceduresperformed
performedspecifically
specificallyfor
for
the
thepurpose
purposeofofdiscovering
discoveringevents
eventsor or
transactions
transactionsthat
thatmust
mustbe
berecognized
recognized
as
assubsequent
subsequentevents
events
©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 24 - 19
 Audit Tests

Inquire of management.
Inquire of management.
Correspond with attorneys.
Correspond with attorneys.
Review internal statements prepared
Review internal statements prepared
subsequent
subsequentto tothe
thebalance
balancesheet
sheetdate.
date.
Review records prepared subsequent
Review records prepared subsequent
to
tothe
thebalance
balancesheet
sheetdate.
date.
Examine minutes issued subsequent
Examine minutes issued subsequent
to
tothe
thebalance
balancesheet
sheetdate.
date.
Obtain a letter of representation,
Obtain a letter of representation,

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 24 - 20

 Dual Dating

The
Thefirst
firstdate
dateisisthe
thedate
datefor
forthe
the
completion
completionof offield
fieldwork
workexcept
except
for
foraaspecific
specificexception.
exception.

The
Thesecond
seconddate,
date,which
whichisis
always
alwayslater,
later,deals
dealswith
with
the
theexception.
exception.

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 24 - 21

 Learning Objective 4

Design and perform the final steps

in the evidence-accumulation
segment of the audit.

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 24 - 22

 Final Evidence Accumulation

1.
1.Perform
Performfinal
finalanalytical
analyticalprocedures.
procedures.
2.
2.Evaluate
Evaluatethe
thegoing-concern
going-concernassumption.
assumption.
3.
3.Obtain
Obtainaamanagement
managementrepresentation
representationletter.
letter.
4.
4.Consider
Considerinformation
informationaccompanying
accompanyingthe the
basic
basicfinancial
financialstatements.
statements.
5.
5.Read
Readother
otherinformation
informationininthe
theannual
annualreport.
report.

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 24 - 23

 Management Representation
Letter

To
Toimpress
impressupon
uponmanagement
managementits itsresponsibility
responsibility
for
forthe
theassertions
assertionsininthe
thefinancial
financialstatements
statements

To
Todocument
documentthetheresponses
responsesfrom
frommanagement
management
to
toinquiries
inquiriesabout
aboutvarious
variousaspects
aspectsof
ofthe
theaudit
audit

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 24 - 24

 Management Representation
Letter

1.
1.Financial
Financialstatements
statements
2.
2.Completeness
Completenessof ofinformation
information
3.
3.Recognition,
Recognition,measurement,
measurement,and anddisclosure
disclosure
4.
4.Subsequent
Subsequentevents
events
5.
5.Internal
Internalcontrol
control

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 24 - 25

 Management Representation
Letter: Internal Control
1.
1.Management’s
Management’sacknowledgment
acknowledgmentof ofits
its
responsibility
responsibilityfor
forestablishing
establishingandand
maintaining
maintainingeffective
effectiveinternal
internalcontrol
control
over
overfinancial
financialreporting
reporting
2.
2.Management’s
Management’sconclusion
conclusionabout
aboutthe
the
effectiveness
effectivenessof ofinternal
internalcontrol
controlover
over
financial
financialreporting
reportingas asofofthe
theend
endofof
the
thefiscal
fiscalperiod
period
3.
3.Disclosure
Disclosureofofall
alldeficiencies
deficiencies
4.
4.Management’s
Management’sknowledge
knowledgeof ofany
anyfraud
fraud
©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 24 - 26
 Information Accompanying Basic
Financial Statements
Balance sheet
Income statement Basic Standard
financial auditor’s
Statement of statements report
cash flows
Footnotes
Detailed comparative Information
statements accompanying
basic financial
Statistical data statements
Schedule of
insurance coverage Separate paragraph –
unqualified, qualified,
or disclaimer

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 24 - 27

 Learning Objective 5

Integrate the audit evidence

gathered, and evaluate the
overall audit results.

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 24 - 28

 Evaluate Results

Sufficiency
Sufficiencyof
ofevidence
evidence

Evidence
Evidencesupports
supportsauditor’s
auditor’sopinion
opinion

Financial
Financialstatement
statementdisclosures
disclosures

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 24 - 29

 Evaluate Results

Audit
Auditdocumentation
documentationreview
review

Independent
Independentreview
review

Summary
Summaryof
ofevidence
evidenceevaluation
evaluation

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 24 - 30

 Completing the Engagement
Checklist
YES
YES NO
NO
1.1. Examination
Examinationof ofprior
prioryear’s
year’saudit
audit
documentation
documentation
a.a.Were
Werelast
lastyear’s
year’saudit
auditfiles
filesexamined
examined
for
forareas
areasof
ofemphasis
emphasisin inthe
the
current-year
current-yearaudit?
audit?
b.
b.Was
Wasthe
thepermanent
permanentfilefilereviewed
reviewedfor
for
items
itemsthat
thataffect
affectthe
thecurrent
currentyear?
year?

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 24 - 31

 Completing the Engagement
Checklist
YES
YES NO
NO
2.2. Internal
Internalcontrol
control
a.a.Has
Hasinternal
internalcontrol
controlbeen
beenadequately
adequately
understood?
understood?
b.
b.IsIsthe
thescope
scopeof ofthe
theaudit
auditadequate
adequatein in
light
lightof
ofthe
theassessed
assessedcontrol
controlrisk?
risk?
c.c.Have
Haveallallmajor
majorweaknesses
weaknessesbeenbeen
included
includedas asreportable
reportableconditions
conditionsinin
aaletter
letterto
tothe
theaudit
auditcommittee
committeeor orto
to
senior
seniormanagement?
management?

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 24 - 32

 Completing the Engagement
Checklist
YES
YES NO
NO
3.3. General
Generaldocuments
documents
a.a.Were
Wereall
allcurrent-year
current-yearminutes
minutesand and
resolutions
resolutionsreviewed,
reviewed,abstracted,
abstracted,
and
andfollowed
followedup? up?
b.
b.Has
Hasthe
thepermanent
permanentfilefilebeen
been
updated?
updated?
c.c.Have
Haveall
allmajor
majorcontracts
contractsandand
agreements
agreementsbeen beenreviewed
reviewedandand
abstracted
abstractedandandcopied
copiedwith
withall
all
existing
existinglegal
legalrequirements?
requirements?

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 24 - 33

 Evaluating Results and Reaching
Conclusions

Actual
Actualaudit
auditevidence
evidence
(by
(bycycle,
cycle,account,
account, Evaluate
Evaluateresults
results
and
andobjective)
objective) (by
(byaccount
accountand
andcycle)
cycle)

Audit
Auditprocedures
procedures Estimated
Estimatedmisstatement
misstatement
Sample
Samplesize
size (by
(byaccount)
account)
Items
Itemsto
toselect
select Achieved
Achievedaudit
auditrisk
risk
Timing
Timing (by
(byaccount
accountand
andcycle)
cycle)

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 24 - 34

 Evaluating Results and Reaching
Conclusions

Evaluate
Evaluateoverall
overall
financial
financialstatements
statements Issue
Issue
audit
audit
Estimated
Estimatedmisstatement
misstatement report
report
(overall
(overallstatements)
statements)
Achieved
Achievedaudit
auditrisk
risk
(overall
(overallstatements)
statements)

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 24 - 35

 Issue the Audit Report

The
Theaudit
auditreport
reportisisthe
theonly
onlything
thingthat
thatmost
most
users
userssee
seeininthe
theaudit
auditprocess,
process,and
andthe
the
consequences
consequencesof ofissuing
issuingananinappropriate
inappropriate
report
reportcan
canbebesevere.
severe.

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 24 - 36

 Learning Objective 6

Communicate effectively with the

audit committee and management.

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 24 - 37

 Communicate with the Audit
Committee and Management
Communicate
Communicatefraud
fraudand
andillegal
illegalacts
acts
Communicate
Communicateinternal
internalcontrol
controldeficiencies
deficiencies
Other
Othercommunication
communicationwith
withaudit
auditcommittee
committee
Management
Managementletters
letters

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 24 - 38

 Learning Objective 7

Identify the auditor’s

responsibilities when facts
affecting the audit report are
discovered after its issuance.

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 24 - 39

 Period Covered by Subsequent
Events Review
Client’s ending Audit Date client
balance sheet report issues financial
date date statements

12-31-05 3-11-06 3-26-06

Period to which Period for Period in which

review for processing subsequent
subsequent the financial discovery of
events applies statements facts is made

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 24 - 40

 End of Chapter 24

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 24 - 41