13.2 Flashcards
Which of the following events requires adjustment to the financial statements for the year ended December 31, Year 1?
Loss on an accounts receivable as the result of a customer suffering a deteriorating financial condition that led to bankruptcy filing in January Year 2.
A loss is probable because an asset (a receivable) was impaired at the balance sheet date as a result of the bankruptcy filing in January Year 2. A loss is accrued if it can be reasonably estimated. A loss must be disclosed in the notes if it is probable and reasonably possible.
Which of the following procedures would an auditor most likely perform to obtain evidence about the occurrence of subsequent events?
Investigate changes in debt recorded after year end.
The auditor should perform procedures with respect to material events or transactions that occur after the balance sheet date but prior to the date of the auditor’s report. Procedures that should be performed include inquiring of management and those charged with governance about whether (1) increases in capital or issuances of debt have occurred, e.g., an issue of new shares or bonds, or (2) an agreement about a merger or liquidation has been made (AU-C 560).
A CPA has received legal counsel’s letter in which no significant disagreements with the client’s assessments of contingent liabilities were noted. The resignation of the client’s legal counsel shortly after receipt of the letter should alert the auditor that
Undisclosed unasserted claims may have arisen.
Legal counsel may be required to resign from an engagement (under his or her Code of Professional Responsibility) if the client disregards advice about financial accounting and reporting for litigation, claims, and assessments. Because the response to the letter of inquiry stated that the client’s assessment of contingent liabilities was satisfactory, the source of disagreement may be undisclosed, unasserted claims.
After year end but before completion of the audit, a major investment adviser issued a pessimistic report on Investee Co.’s long-term prospects. The market price for its common stock subsequently declined significantly. What is the effect of this event on the year-end statements?
No financial statement disclosure is necessary.
The market price of common stock is not a financial event that affects the fairness or interpretation of the financial statements. Accordingly, no revision of the statements is necessary for changes in the market price of the securities.
Harvey, CPA, is preparing an audit plan to determine the occurrence of subsequent events that may require adjustment or disclosure essential to a fair presentation of the financial statements in accordance with U.S. GAAP. Which one of the following procedures is least appropriate for this purpose?
Confirm as of the date of the auditor’s report accounts receivable that have increased significantly from the year-end date.
The confirmation of accounts receivable that have increased significantly from year end is not among the typical subsequent events procedures that should be performed by the auditor listed in AU-C 560. 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 the entity’s legal counsel; and (6) obtaining an understanding of management’s procedures for identifying subsequent events.
Which of the following documentation is required for an audit in accordance with generally accepted auditing standards?
A management representation letter.
AU-C 580 requires that the auditor obtain certain written representations from management. The written representations confirm certain matters (e.g., oral representations) or support other audit evidence. They complement other audit procedures but do not provide sufficient appropriate evidence or affect the other procedures.
Kirk Keller, CPA, was about to express an unmodified opinion on the audit of Lupton Television Broadcasting Company when he received a letter from Lupton’s independent counsel. The letter stated that the Federal Communications Commission has notified Lupton that its broadcasting license will not be renewed because of some alleged fraud in its broadcasting practices. Lupton cannot continue to operate without this license. Keller has also learned that Lupton and its independent counsel plan to take all necessary legal action to retain the license. The letter from the independent counsel, however, states that a favorable outcome of any legal action is highly uncertain. Based on this information, Keller should
Express an unmodified opinion with disclosure of the event in a separate emphasis-of-matter paragraph of his report.
According to AU-C 570, an evaluation should be made as to whether substantial doubt exists about the entity’s ability to continue as a going concern for a reasonable period of time. For U.S. GAAP, the reasonable period is 1 year after the date that the financial statements are issued or are available to be issued. If the auditor reaches this conclusion after identifying conditions and events that create such doubt and after evaluating management’s plans to mitigate their effects, (s)he should consider the adequacy of disclosure and include an emphasis-of-matter paragraph (after the opinion paragraph) in the report. This paragraph should use the phrases “substantial doubt” and “going concern,” but it should not contain conditional language. If the entity’s disclosure is inadequate, the material misstatement requires modification of the opinion. By itself, however, the substantial doubt does not require a modified opinion or a disclaimer of opinion. But AU-C 570 does not preclude issuing a disclaimer of opinion in cases involving uncertainties.
Which of the following procedures should an auditor ordinarily perform regarding subsequent events?
Read the latest subsequent interim financial statements.
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.
Wilson, CPA, obtained sufficient appropriate audit evidence on which to base the opinion on Abco’s December 31, Year 1, financial statements on March 6, Year 2, the date of the auditor’s report. A subsequently discovered fact requiring revision of the Year 1 financial statements occurred on April 10, Year 2, and came to Wilson’s attention on April 24, Year 2. If the fact became known prior to the report release date, and the revision is made, Wilson’s report ordinarily should be dated
Using duel-dating.
A subsequently discovered fact (1) becomes known to the auditor after the report date and (2) may cause the auditor to revise the report. The report date is no earlier than the date when sufficient appropriate evidence is obtained. If such a fact becomes known to the auditor before the report release date, the auditor should (1) discuss the matter with management and (2) determine whether the statements need revision (adjustment or disclosure). If management revises the statements, the auditor should perform the necessary procedures on the revision. The auditor also (1) dates the report as of a later date or (2) dual-dates the report. Dual-dating indicates that the procedures performed subsequent to the original date are limited to the revision. Unless the auditor extends subsequent events procedures to a new date (one presumably later than April 24, Year 2, the date when the subsequently discovered fact became known), the auditor should dual-date the report.
When an auditor concludes there is substantial doubt about a continuing audit client’s ability to continue as a going concern for a reasonable period of time, the auditor’s responsibility is to
Consider the adequacy of disclosure about the client’s possible inability to continue as a going concern.
After considering (1) identified conditions and events in the aggregate that raise going concern issues and (2) management’s plans for coping with their adverse effects, the auditor 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.
Under which of the following circumstances would an entity be expected to accrue a loss contingency for the period under audit?
The entity estimated the amount of a claim with a probable adverse outcome before issuance of the audit report.
A loss contingency is an existing condition, situation, or set of circumstances involving uncertainty as to possible loss that ultimately will be resolved when one or more future events occur or do not occur. A material contingent loss must be accrued (debit loss, credit liability or asset valuation allowance) when two conditions are met. Based on information available prior to the issuance (or availability for issuance) of the financial statements (and therefore the auditor’s report issued with the statements), accrual is required if (1) it is probable that, at a balance sheet date, an asset has been impaired or a liability has been incurred and (2) the amount of the loss can be reasonably estimated.
Management should address written representations about a firm’s annual audit to the
Auditor.
The auditor is required to obtain written representations from management. They confirm certain matters or support other evidence and complement other procedures. But they do not provide sufficient appropriate evidence. They also do not affect the nature or effects of other procedures. Written representations should be in a letter addressed to the auditor and dated as of the date of the auditor’s report. The auditor should possess this letter before release of the auditor’s report. The CEO and CFO usually should sign the letter.
Which of the following procedures would an auditor most likely perform in obtaining evidence about subsequent events?
Inquire of management whether new shares have been issued since the year end.
The auditor should perform procedures with respect to material events or transactions that occur after the balance sheet date but prior to the date of the auditor’s report. Procedures that should be performed include inquiring of management and those charged with governance about whether (1) increases in capital or issuances of debt have occurred, e.g., an issue of new shares or bonds, or (2) an agreement about a merger or liquidation has been made (AU-C 560).
To which of the following matters would materiality limits not apply in obtaining written management representations?
The availability of minutes of shareholders’ and directors’ meetings.
Materiality does not apply to representations not directly related to amounts in the financial statements. The availability of minutes of shareholders’ meetings and directors’ meetings is independent of amounts in the financial statements. Thus, materiality limits do not apply.
Davis, CPA, believes there is substantial doubt about the ability of Hill Co. to continue as a going concern for a reasonable period of time. In evaluating Hill’s plans for dealing with the adverse effects of future conditions and events, Davis most likely will consider, as a mitigating factor, Hill’s plans to
Negotiate reductions in required dividends being paid on preferred stock.
Once an auditor has identified conditions and events indicating that a substantial doubt exists about an entity’s ability to continue as a going concern, the auditor should consider management’s plans to mitigate their adverse effects. The auditor should consider managerial actions relating to plans to (1) dispose of assets, (2) borrow money or restructure debt, (3) reduce or delay expenditures, and (4) increase equity. Plans to negotiate reductions in required dividends being paid on preferred stock are intended to increase ownership equity.
