Auditing: The Art and Science of Assurance Engagements: Fifteenth Canadian Edition

Auditing: The Art and Science of Assurance
Engagements
Fifteenth Canadian Edition
Chapter 17
Completing the Audit
Copyright © 2022 Pearson Canada Inc. 17 - 1

Learning Objectives
1. Perform final analytical procedures
2. Complete a financial statement disclosure checklist
3. Review and assess contingencies and commitments
– Review legal letters
4. Review and assess subsequent events

5. Obtain a management representation letter
6. Evaluate going concern assumption
7. Assess the materiality of misstatements
8. Evaluate other information
9. Communicate with those charged with governance
10. Conduct an Engagement Quality Control Review

Perform Final Analytical Procedures
• Analytical procedures are required as part of:
– Planning the audit
 Allow the auditor to understand the client’s business
 Identify high-risk areas
 E.g., a 20% increase in gross margin from prior year driven by
a decrease in inventory costs; the auditor need to investigate
whether this is reasonable
– At the completion of the audit
 Serve as a final review for material misstatements and overall
reasonableness of financial statements
 E.g., a 20% increase in gross margin from prior year driven by
a decrease in inventory costs; the auditor documents: “We
have obtained evidence validating a decrease in inventory
costs. Refer to the inventory working papers D-1, D-3.”
Perform Additional Tests for Presentation
Assertions
• The auditor must determine whether management has
disclosed all required information.
• As part of the final review for financial statement
disclosure, many public accounting firms require the
completion of a financial statement disclosure
checklist.

https://assets.kpmg/content/dam/kpmg/es/pdf/2020/10/2020-disclosure-
checklist.pdf
Review for Contingent Liabilities and
Commitments
• A contingent liability is a potential obligation to an outside
party for an unknown amount resulting from activities that
have already taken place. Three conditions are required for
a contingent liability to exist:
– 1. There is a potential future payment to an outside
party that resulted from an existing condition.
– 2. There is uncertainty about the amount of the future
payment.
– 3. The outcome will be resolved by some future event
or events.
• Most common example: Pending litigation for patent
infringement, product liability, or other actions.
Example: Tesla Annual Report
• https://www.sec.gov/Archives/edgar/data/1318605/000095017022000
796/tsla-20211231.htm
• Note 15 – Commitments and Contingencies
– Litigation Relating to the SolarCity Acquisition
– Litigation Relating to 2018 CEO Performance Award
– Litigation Related to Directors’ Compensation
– Litigation Relating to Potential Going Private Transaction
– Litigation and Investigations Relating to Alleged Race
Discrimination
– Certain Investigations and Other Matters
– “If an unfavorable ruling or development were to occur, there
exists the possibility of a material adverse impact on our business,
results of operations, prospects, cash flows, financial position and
brand.”
Contingent Liabilities Under IFRS
& disclose
Substantive Procedures
• Inquire of management regarding the possibility of unrecorded
contingencies.
• For tax disputes, review current and previous years’ Canada
Revenue Agency notices of assessment.
• Review working papers, minutes of directors’ and shareholders’
meetings for indications of lawsuits or other contingencies.
• Analyze legal expense for the period under audit, and review
invoices from the client’s law firms for indications of ongoing
lawsuits and contingent liabilities
• Obtain a confirmation from all major law firms performing legal
services for the client as to the status of pending litigation or
other contingent liabilities.
• Obtain a management representation letter
Review for Contingent Gains / Assets
• Contingent gains / assets are not recognized until they
are realized.
• A contingent asset should be disclosed if it is probable
that the economic benefits will be realized.

Review for Commitments
• Commitments are agreements that the entity will hold
to a fixed set of conditions at a future date, regardless
of what happens to profits or to the economy as a
whole.
– E.g., purchase raw materials or to lease facilities at a
certain price
• Commitments must be recorded as a liability for an
entity for the accounting period they occur in, and they
must be disclosed in the notes to the financial
statements.

Example: Tesla – Note 15
• Operating Lease Arrangement in Shanghai, China
• We have an operating lease arrangement for an initial term of 50 years
with the local government of Shanghai for land use rights where we
are constructing Gigafactory Shanghai. Under the terms of the
arrangement, we are required to spend RMB 14.08 billion in capital
expenditures by the end of 2023 and to generate RMB 2.23 billion of
annual tax revenues starting at the end of 2023. If we are unwilling or
unable to meet such target or obtain periodic project approvals, in
accordance with the Chinese government’s standard terms for such
arrangements, we would be required to revert the site to the local
government and receive compensation for the remaining value of the
land lease, buildings and fixtures. We expect to meet the capital
expenditure and tax revenue requirements based on our current level
of spend and sales.

Quiz
• Which of the following scenarios regarding a lawsuit filed
against a client by a third party would qualify as a "contingent
liability"?
• A) A lawsuit has been filed but not yet resolved.
• B) A lawsuit was filed and concluded with the client winning.
• C) A lawsuit was filed and concluded with a third party winning
an award of $100,000, but the client hasn't paid yet.
• D) A lawsuit was filed and concluded with a third party winning
an award of $100,000, which the client paid after the balance
sheet date but before the statements were issued.

Quiz
• Which of the following scenarios regarding a lawsuit filed
against a client by a third party would qualify as a "contingent
liability"?
• A) A lawsuit has been filed but not yet resolved.
• B) A lawsuit was filed and concluded with the client winning.
• C) A lawsuit was filed and concluded with a third party winning
an award of $100,000, but the client hasn't paid yet.
• D) A lawsuit was filed and concluded with a third party winning
an award of $100,000, which the client paid after the balance
sheet date but before the statements were issued.

Quiz
• When the proper disclosure in the financial statements of
material contingencies is through footnotes, the footnote
should describe the nature of the contingency to the extent
it is known and
• A) the auditor's opinion as to the expected outcome.
• B) the opinion of legal counsel or management as to the
expected outcome.
• C) an estimate of the amount or a statement that the
amount cannot be estimated.
• D) the steps the client has taken to ensure that it doesn't
recur.
Quiz
• When the proper disclosure in the financial statements of
material contingencies is through footnotes, the footnote
should describe the nature of the contingency to the extent
it is known and
• A) the auditor's opinion as to the expected outcome.
• B) the opinion of legal counsel or management as to the
expected outcome.
• C) an estimate of the amount or a statement that the
amount cannot be estimated.
• D) the steps the client has taken to ensure that it doesn't
recur.
Obtain Confirmations from Client’s
External and/or In-House Legal Counsel
• The standard letter of confirmation to the client’s external legal
counsel or the in-house legal counsel (legal inquiry letter),
should include the following:
– A list, prepared by management, of outstanding and
possible claims.
– A description of the nature and the current status of each
claim and possible claim.
– An indication of management’s evaluation of the amount
and likelihood of loss or gain for each claim.
– A request that the lawyer reply to the client, with a signed
copy going to the public accounting firm, advising whether
management’s descriptions and evaluations of the
outstanding and possible claims are reasonable.
Limited or Nonresponses from Law Firms
• Refusal to respond due to a lack of knowledge about
matters involving contingent liabilities and the refusal to
disclose information that the lawyer regards as
confidential.
– When the nature of the lawyer’s legal practice does not
involve contingent liabilities, the lawyer’s refusal to
respond causes no audit problems.
• When a lawyer refuses to provide information that is
within the lawyer’s jurisdiction and may directly affect the
fair presentation of financial statements, the auditor’s
opinion would be qualified due to the lack of available
evidence.
Obtain Confirmations from Client’s
External and/or In-House Legal Counsel
• Lawyers are not required to mention any omission of
possible claims in their response to the inquiry letter
and, thus, do not directly notify the auditor of them.
• CAS 501.12 requires the auditor to obtain a letter of
representation from management that it has disclosed
all known outstanding and possible claims.

Review for Subsequent Events
• The auditor’s responsibility for reviewing for
subsequent events is normally limited to the period
beginning with the balance sheet date and ending
with the date of the auditor’s report.
• The date of the auditor’s report corresponds with the
approval of the financial statements by the board of
directors or other executive management.
• The subsequent events review is completed near the
end of the engagement.

Period Covered by Subsequent Events
Review

Types of Subsequent Events
• Two types of subsequent events require consideration
by management and evaluation by the auditor:
1. those that have a direct effect on the financial
statements and require adjustment
2. those that have no direct effect on the financial
statements but for which disclosure is required.

• Subsequent events that have a direct effect on the
financial statements and require adjustment
– Declaration of bankruptcy by a customer with an
outstanding accounts receivable balance
because of the customer’s deteriorating financial
condition
– Settlement of litigation at an amount different from
the amount recorded on the books

• Subsequent events that have no direct effect on the
financial statements but for which disclosure is
required.
– Decline in the market value of securities held for
temporary investment,
– Issuance or purchases of bonds or shares,
– Uninsured loss of inventories as a result of fire, or
– The purchase of a business or trademark.

Audit Procedures for Subsequent Events
• Procedures performed specifically for the purpose of
discovering events or transactions that must be
recognized as subsequent events include:
– Inquiry of management
– Correspondence with law firms
– Review of internal financial statements or records
prepared subsequent to the balance sheet date
– Examination of minutes prepared subsequent to the
balance sheet date
– Acquisition of letter of representation

Quiz
• Which of the following can illustrate a subsequent
event that requires disclosure but not adjustment?
• A. Settlement of long outstanding litigation.
• B. Collection of a customer debt that had been written
off.
• C. Loss of inventory as a result of a flood occurring
after year-end.
• D. An additional tax assessment on prior income.

Quiz
• Which of the following can illustrate a subsequent
event that requires disclosure but not adjustment?
• A. Settlement of long outstanding litigation.
• B. Collection of a customer debt that had been written
off.
• C. Loss of inventory as a result of a flood
occurring after year-end.
• D. An additional tax assessment on prior income.

Quiz
• A client acquired 25% of its outstanding capital stock after
year-end and prior to completion of the auditor's fieldwork.
The auditor should
• A) advise management to adjust the balance sheet to
reflect the acquisition.
• B) issue pro forma financial statements giving effect to the
acquisition as if it had occurred at year-end.
• C) advise management to disclose the acquisition in the
notes to the financial statements.
• D) disclose the acquisition in the opinion paragraph of the
auditor's report.
Quiz
• A client acquired 25% of its outstanding capital stock after
year-end and prior to completion of the auditor's fieldwork.
The auditor should
• A) advise management to adjust the balance sheet to
reflect the acquisition.
• B) issue pro forma financial statements giving effect to the
acquisition as if it had occurred at year-end.
• C) advise management to disclose the acquisition in
the notes to the financial statements.
• D) disclose the acquisition in the opinion paragraph of the
auditor's report.
Obtain a Client Representation Letter
• Many specific matters should be included, when
applicable, in a management representation letter:
– Management’s acknowledgment of its responsibility for
the fair presentation of the financial statements.
– Management has made available of all financial records
and related data and all minutes of meetings of
shareholders, directors, and committees of directors.
– Management has provided information concerning
contingencies and subsequent events.
– Signed by high-level corporate officials, usually the
president and chief financial officer

Example: Management Representation
Letter
• (Entity Letterhead)
• (To Auditor) (Date)
• This representation letter is provided in connection with your
review of the balance sheet of ABC Entity as of March 31, 20X1
and the related statements of income, changes in equity and
cash flows for the three-month period then ended and a
summary of the significant accounting policies and other
explanatory notes for the purposes of expressing a conclusion
whether anything has come to your attention that causes you to
believe that the interim financial information does not give a true
and fair view of the financial position of ABC Entity as at March
31, 20X1, and of its financial performance and its cash flows in
accordance with the International Financial Reporting
Standards.
Example: Management Representative
Letter
• We acknowledge our responsibility for the fair presentation of
the interim financial information in accordance with the
International Financial Reporting Standards.
• We confirm, to the best of our knowledge and belief, the
following representations:
– The interim financial information referred to above has been
prepared and presented in accordance the International Financial
Reporting Standards.
– We have made available to you all books of account and
supporting documentation, and all minutes of meetings of
shareholders and the board of directors.
– There are no material transactions that have not been properly
recorded in the accounting records underlying the interim financial
information.
– There has been no known actual or possible noncompliance with
laws and regulations that could have a material effect on the
interim financial information in the event of noncompliance.
– We acknowledge responsibility for the design and implementation
of internal control to prevent and detect fraud and error.
– We have disclosed to you all significant facts relating to any
known frauds or suspected frauds that may have affected the
entity.
– We have recorded or disclosed, as appropriate, all liabilities, both
actual and contingent.
• To the best of our knowledge and belief, no events have
occurred subsequent to the balance sheet date and through the
date of this letter that may require adjustment to or disclosure in
the aforementioned interim financial information.
• (Senior Executive Officer)
• (Senior Financial Officer)
Evaluate the Going Concern Assumption
• CAS 570 requires the auditor to obtain sufficient
appropriate evidence regarding whether management’s
use of the going concern assumption is appropriate.
• If the auditor concludes that there is substantial doubt of
a going concern, then the auditor must inquire of
management and consider actions they are taking.
• If there are material uncertainties that can cast
significant doubt on the entity’s ability to continue as a
going concern, these need to be disclosed.

Summarize, Evaluate, and Resolve
Misstatements
Levels of Misstatements
Factual misstatements Misstatements about which there is no doubt and that are
clearly an error (e.g., posting a sales invoice in the
wrong period).
Judgmental misstatements Differences that arise from management’s judgment
concerning accounting estimates, or the selection or
application of accounting policies that the auditor
considers inappropriate. These may be difficult to
reconcile since they may be a matter of professional
judgment.
Projected misstatements The auditor’s best estimate of misstatements in
populations, involving projection of misstatements
identified in audit samples.
Do NOT need to memorize the definitions

Accumulating Misstatements During the
Audit
• Auditors would request management to correct any factual
misstatements and have discussions with management
about adjustments for judgmental differences.
• Clearly trivial amounts can be ignored when proposing
adjustments to the client management.
– Trivial amounts: Matters that are clearly
inconsequential, whether taken individually or in
aggregate and whether judged by any criteria of size,
nature, or circumstances.”
• The auditor will determine if the remaining uncorrected
misstatements are material, individually or in aggregate.
Assessing the Materiality of Misstatements
• Qualitative factors are important in determining whether a
misstatement is material or not.
– The potential effect of the material misstatement on
trends, especially trends in profitability
– A misstatement that changes a loss into income or vice
versa
– The potential effect of the misstatement on the entity’s
compliance with debt covenants, other contractual
agreements, and regulatory provisions
– A misstatement that has the effect of increasing
management’s compensation

Evaluate Other Information
• Other information is financial or non-financial information that
is not part of published financial statements but is published with
them for which the auditor is responsible.
– E.g., Management’s Discussion and Analysis (MD&A)
• Management is responsible for the preparation of the other
information that is published with the financial statements.
• The auditor is required to evaluate the consistency of other
information with the financial statements.
– E.g., assume that the president’s letter in the annual report
refers to an increase in earnings per share from $2.60 to
$2.93. The auditor is required to compare that information
with what is in the financial statements to make sure that it
corresponds.
Communication with Audit Committee
• Communicate auditor responsibilities in the audit of financial
statements
• Provide an overview of the scope and timing of the audit
• Confirm the auditor’s independence
• Provide significant findings arising during the audit
– Evaluation of significant accounting policies,
– Material weaknesses in the design, implementation, or operating
effectiveness of internal control
– Results of the auditor’s fraud risk assessment and findings;
– Summary of misstatements other than trivial
– Difficulties encountered during the audit.
• Obtain information relevant to the audit
Management Letters
• The auditor’s optional written communication to
management to point out less significant weaknesses
in internal control and possibilities for operational
improvements.

Working Paper Review
• The working papers are to be thoroughly reviewed by an
engagement quality partner at the completion of the
audit:
– To evaluate the performance of inexperienced personnel;
– To make sure that the audit meets the public accounting
firm’s standard of performance; and
– To counteract the bias that frequently enters into the
auditor’s judgment.
• CAS 220 requires that an engagement quality control
review be performed on all audits of listed entities.

Engagement Quality Control Review
(EQCR)
• The EQCR is a risk-based review, with the reviewer paying particular
attention to significant judgments made by the engagement team and
the conclusions reached in formulating the report.
– Evaluating procedures performed by the engagement team to
verify team and firm independence;
– Evaluating the engagement team’s assessment of and responses
to significant risks, including fraud risks;
– Evaluating the rigour applied to determining materiality and
whether adjusted and unadjusted misstatements (including
uncorrected disclosures) have been treated appropriately;
– Evaluating whether audit documentation supports conclusions
reached by the audit team;
– Assessing whether appropriate matters have been communicated
to those charged with governance
Quiz
• Which of the following auditing procedures is
ordinarily performed last?
• A) reading of the minutes of the directors' meetings
• B) confirming accounts payable
• C) obtaining a client representation letter
• D) testing of the purchasing function

Quiz
• Which of the following auditing procedures is
ordinarily performed last?
• A) reading of the minutes of the directors' meetings
• B) confirming accounts payable
• C) obtaining a client representation letter
• D) testing of the purchasing function

Quiz
• CAS 450 requires the auditor to communicate all
misstatements to the audit committee
• A) if the misstatements are slightly material.
• B) if the misstatements are material.
• C) if the misstatements are other than trivial.
• D) regardless of materiality.

Quiz
• CAS 450 requires the auditor to communicate all
misstatements to the audit committee
• A) if the misstatements are slightly material.
• B) if the misstatements are material.
• C) if the misstatements are other than trivial.
• D) regardless of materiality.

Quiz
• When reviewing other information, which of the following is
a primary objective of the auditor?
• A) to report on the financial statements only and not on
other information published with the financial statements
• B) to ensure other information is not published with the
financial statements
• C) to consider whether there is a material inconsistency
between the other information and the financial statements
• D) to encourage a better relationship between the public
accounting firm and management

Quiz
• When reviewing other information, which of the following is
a primary objective of the auditor?
• A) to report on the financial statements only and not on
other information published with the financial statements
• B) to ensure other information is not published with the
• C) to consider whether there is a material
inconsistency between the other information and the
• D) to encourage a better relationship between the public
accounting firm and management

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