13.1 Flashcards
A written management representation letter is most likely to be an auditor’s best source of corroborative information of a client’s intention to
Discontinue a line of business.
Written management representations complement, but do not substitute for, other auditing procedures. However, the plan for discontinuing a line of business is an example of a matter about which other procedures may provide little evidence. Accordingly, the written representation may be necessary as confirmation of management’s intent.
The refusal of a client’s legal counsel to provide a representation on the legality of a particular act committed by the client is ordinarily
A scope limitation.
Legal counsel’s refusal either orally or in writing to provide the requested information may be a scope limitation sufficient to preclude an unmodified opinion. The reason is that the letter of inquiry to the client’s legal counsel is the primary means of corroborating management’s representations about litigation, claims, and assessments. However, a statement in the letter such as, “It would be inappropriate for this firm to respond to a general inquiry relating to the existence of unasserted possible claims and assessments,” is not considered a scope limitation. The quoted language is based on the preamble of the American Bar Association’s statement of policy regarding lawyers’ responses to auditors’ requests for information.
Zero Corp. suffered a loss having a material effect on its financial statements as a result of a customer’s bankruptcy that rendered a trade receivable uncollectible. This bankruptcy occurred suddenly because of a natural disaster 10 days after Zero’s balance sheet date but 1 month before the issuance of the financial statements and the auditor’s report. Under these circumstances, the
Financial Statements should be adjusted:
Event requires financial statement disclosure, but no adjustment:
Auditor’s report should be modified for a lack of consistency:
No
Yes
No
Certain subsequent events may provide evidence about conditions at the date of the balance sheet and require adjustment of the statements in accordance with the applicable financial reporting framework. For example, U.S. GAAP require recognition in the statements of the effects of a subsequent event providing additional evidence about conditions at the balance sheet date, including accounting estimates. Other subsequent events provide evidence about conditions not existing at the date of the balance sheet but arising subsequent to that date. These events may require disclosure but do not require adjustment of financial statement balances. In this case, the financial statements should not be adjusted, but disclosure should be made. The report is unaffected if disclosure is made.
Which of the following events occurring after the date of the report most likely will cause the auditor to make further inquiries about the previously issued financial statements?
The discovery of information regarding a contingency that existed before the financial statements were issued.
Facts may be discovered by the auditor after the date of the report that, if known at that date, might have caused the auditor to revise the report. In this case, the auditor should (1) discuss the matter with management and (2) determine whether the statements should be revised and, if so, how management intends to address the matter in the statements (AU-C 560).
After an audit report containing an unmodified opinion on a nonissuer’s financial statements was dated and the financial statements issued, the client decided to sell the shares of a subsidiary that accounts for 30% of its revenue and 25% of its net income. The auditor should
Take no action because the auditor has no obligation to make any further inquiries.
AU-C 560 states, “The auditor is not required to perform any audit procedures regarding the financial statements after the date of the auditor’s report.”
An auditor believes that there is substantial doubt about an entity’s ability to continue as a going concern for a reasonable period of time. In evaluating the entity’s plans for dealing with the adverse effects of future conditions and events, the auditor most likely would consider, as a mitigating factor, the entity’s plans to
Lease rather than purchase operating facilities.
Mitigating factors include plans to (1) dispose of assets, (2) borrow money or restructure debt, (3) reduce or delay expenditures (e.g., by leasing, not purchasing), or (4) increase equity ownership (AU-C 570).
Subsequent events are defined as events that occur subsequent to the
Balance sheet but prior to the auditor’s report.
Subsequent events occur between the date of the financial statements and the date of the auditor’s report. The auditor should perform procedures to determine whether subsequent events that require adjustment of, or disclosure in, the statements are appropriately reflected in the statements in accordance with the applicable financial reporting framework (AU-C 560).
Which of the following procedures will an auditor most likely perform to obtain evidence about the occurrence of subsequent events?
Inquiring of the entity’s legal counsel concerning litigation, claims, and assessments arising after year end.
Subsequent events procedures include (1) reading the latest subsequent interim statements, if any; (2) inquiring of management and those charged with governance about the occurrence of subsequent events and various financial and accounting matters; (3) reading the minutes of meetings of owners, management, and those charged with governance; (4) obtaining a letter of representations from management; (5) inquiring of client’s legal counsel; and (6) obtaining an understanding of management’s procedures for identifying subsequent events.
An auditor finds several misstatements in the financial statements that the client prefers not to correct. The auditor determines that the misstatements are not material in the aggregate. Which of the following actions by the auditor is most appropriate?
Document all misstatements accumulated during the audit and the conclusion about whether uncorrected misstatements are material.
The auditor should document (1) the amount below which misstatements are clearly trivial; (2) all misstatements accumulated during the audit and whether they were corrected; and (3) the conclusion about whether uncorrected misstatements are material, individually or aggregated, and the basis for the conclusion (AU-C 450). Furthermore, the representation letter should have an accompanying list of uncorrected misstatements. The letter should include a sentence stating, “The effects of the uncorrected misstatements are immaterial, both individually and in the aggregate, to the financial statements as a whole.”
If the auditor determines that an inquiry of a client’s external legal counsel is necessary, who should make the inquiry?
Client management.
A letter of inquiry to a client’s legal counsel is the auditor’s primary means of corroborating information furnished by management about litigation, claims, and assessments. Evidence obtained from the client’s legal department may provide the needed corroboration, but it does not substitute for information that external legal counsel may refuse to furnish. Thus, the auditor should request management to send a letter of inquiry to legal counsel with whom management consulted. Without the client’s consent, legal counsel may not respond (AU-C 501).
An auditor should obtain evidence relevant to all the following factors relevant to third-party litigation against a client except the
Jurisdiction in which the matter will be resolved.
The auditor is least interested in determining where the particular matter in litigation will be resolved. The major issue is the effect of the litigation on the fair presentation of the financial statements. Accordingly, the auditor should obtain evidence relevant to (1) the period in which the underlying cause for legal action occurred, (2) the degree of probability of an unfavorable outcome, and (3) the amount or range of potential loss.
Which of the following auditing procedures most likely would assist an auditor in identifying conditions and events that may indicate substantial doubt about an entity’s ability to continue as a going concern?
Confirming with third parties the details of arrangements to maintain financial support.
The procedures typically employed to identify going-concern issues include (1) analytical procedures, (2) review of subsequent events, (3) review of compliance with debt and loan agreements, (4) reading minutes of meetings, (5) inquiry of legal counsel, and (6) confirmation with related and third parties of arrangements for financial support.
A client is a defendant in a patent infringement lawsuit against a major competitor. Which of the following items would least likely be included in legal counsel’s response to the auditor’s letter of inquiry?
An evaluation of the ability of the client to continue as a going concern if the verdict is unfavorable and maximum damages are awarded.
An inquiry letter response from the client’s legal counsel will normally include information or comment about each pending or threatened litigation, claim, or assessment. Legal counsel should (1) address the progress of the case, (2) describe the action the company plans to take, (3) evaluate the likelihood of an unfavorable outcome, and (4) estimate (if possible) the range of any potential loss. Legal counsel does not have the expertise or appropriate information to make a judgment about the client’s ability to continue as a going concern. The auditor normally makes that judgment.
Which of the following matters most likely would be included in a management representation letter?
A confirmation that the entity has complied with contractual agreements.
The auditor should obtain written representations in the form of a management representation letter to complement other auditing procedures. In addition to certain required written representations, the auditor may decide that requesting certain other representations is necessary. These may include aspects of contracts that may affect the statements, including noncompliance (AU-C 580).
After considering management’s plans, an auditor concludes that there is substantial doubt about a client’s ability to continue as a going concern for a reasonable period of time. The auditor’s responsibility includes
Considering the adequacy of disclosure about the client’s possible inability to continue as a going concern.
The auditor considers (1) identified conditions and events in the aggregate that raise going-concern issues, (2) management’s written representations, and (3) management’s plans for coping with their adverse effects. The auditor then may conclude that a substantial doubt exists about the entity’s ability to continue as a going concern for a reasonable period of time. In that case, the auditor should consider the possible effects on the financial statements and the adequacy of disclosure. The auditor also should include an emphasis-of-matter paragraph in the report.
