13.4 Flashcards
Which of the following management roles would typically be acknowledged in a management representation letter?
Management has the responsibility for the design of controls to detect fraud.
Management has the responsibility to design, implement, and maintain internal control to prevent and detect fraud. The auditor is required to request that management provide written representations acknowledging this responsibility and disclosing other fraud-related matters (AU-C 580).
“There have been no communications from regulatory agencies concerning noncompliance with, or deficiencies in, financial reporting practices that could have a material effect on the financial statements.” The foregoing passage is most likely from a
Management Representation letter.
The auditor is required to obtain written representations from management and, possibly, those charged with governance. They should be in the form of a representation letter addressed to the auditor. The letter should state that all known or suspected noncompliance with laws and regulations that should be considered when preparing financial statements has been disclosed (AU-C 580).
An auditor should consider which of the following when evaluating the ability of a company to continue as a going concern?
Management’s plans for disposal of assets.
If the auditor believes that a substantial doubt exists, (s)he considers management’s plans for responding to the adverse effects of the conditions and events indicative of a substantial doubt. Among the considerations are (1) disposing of assets, (2) borrowing money or restructuring debt, (3) reducing or delaying expenditures, and (4) increasing ownership equity.
Which of the following events occurring after the issuance of the auditor’s report most likely would cause the auditor to make further inquiries about the previously issued financial statements?
New information regarding significant unrecorded transactions from the year under audit is discovered.
Subsequent events occur between the date of the financial statements and the date of the auditor’s report. Subsequently discovered facts become known to the auditor after the date of the auditor’s report. Had they been known to the auditor at that date, they might have caused the auditor to revise the auditor’s report. The auditor is not required to perform any audit procedures regarding the financial statements after the date of the auditor’s report. However, if a subsequently discovered fact (e.g., unrecorded transactions) becomes known to the auditor, the auditor should (1) discuss the matter with management and, if appropriate, those charged with governance and (2) determine whether the financial statements need revision and, if so, inquire how management intends to address the matter. The auditor has still more responsibilities when the discovery is made after the report release date, especially if unrevised statements have been made available to third parties.
After considering an entity’s negative trends and financial difficulties, an auditor has substantial doubt about the entity’s ability to continue as a going concern. The auditor’s considerations relating to management’s plans for dealing with the adverse effects of these conditions most likely would include management’s plans to
Increase ownership equity.
Once an auditor identifies conditions and events indicating that a substantial doubt exists about an entity’s ability to continue as a going concern, (s)he should consider management’s plans to mitigate their adverse effects. Increasing equity is likely to be a mitigating factor (AU-C 570). Thus, the auditor should consider the feasibility of such a plan, including arrangements to raise capital, and any arrangements to reduce dividends or to accelerate cash receipts from investors or affiliates.
“We have disclosed to you all known instances of noncompliance or suspected noncompliance with laws and regulations whose effects should be considered when preparing financial statements.” The foregoing passage most likely is from a(n)
Management representation letter.
Written representations are written statements by management provided to confirm certain matters or to support other audit evidence. They do not include financial statements, the assertions in them, or supporting books and records (AU-C 580). Among other things, the auditor should request a representation about compliance with laws and regulations.
Subsequent events that provide evidence of conditions that arose subsequent to the date of the financial statements
May require disclosure in notes to the financial statements.
According to U.S. GAAP, subsequent events that provide evidence of conditions arising after the balance sheet date but before the statements are issued or available to be issued are not recognized. However, a nonrecognized subsequent event may be of such a nature that it must be disclosed to keep the statements from being misleading.
Which of the following conditions or events is most likely to cause an auditor to have substantial doubt about an entity’s ability to continue as a going concern?
Cash flows from operating activities are negative.
The significance of conditions or events depends on circumstances, and some conditions or events may be significant only in conjunction with others. Such conditions and events include negative trends, financial difficulties, internal matters, and external matters. Negative cash flows from operating activities provide evidence of negative trends and financial difficulties.
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 disclosure 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.
When considering the use of management’s written representations as audit evidence about the completeness assertion, an auditor should understand that such representations
Complement, but do not replace, substantive procedures designed to support the assertion.
AU-C 580 states that written representations provide necessary audit evidence that complements other audit procedures. However, they do not, by themselves, provide sufficient appropriate evidence about the matters to which they are relevant. Moreover, obtaining reliable written representations has no effect on the nature and extent of other procedures applied regarding (1) fulfillment of management’s responsibilities or (2) specific assertions.
When an audit is made in accordance with auditing standards, the auditor should always
Obtain certain written representations from management.
Written representations are written statements by management provided to confirm certain matters or to support other audit evidence. They do not include financial statements, the assertions in them, or supporting books and records (AU-C 580).
Legal counsel’s response to an auditor’s inquiry about litigation, claims, and assessments may be limited to matters that are considered individually or collectively material to the client’s financial statements. Which parties may reach an understanding on the limits of materiality for this purpose that are stated in the letter of inquiry?
The auditor & the client’s management.
The letter of inquiry is prepared by management and sent by the auditor to the entity’s legal counsel. Among other things, the letter requests a statement about the nature of, and reasons for, any limitation on legal counsel’s response. Legal counsel may limit the response to matters to which (s)he has given substantive attention in the form of legal consultation or representation. Furthermore, legal counsel’s response may be limited to those matters that are considered individually or collectively material to the financial statements, such as when the entity and the auditor have agreed on materiality limits, and management has stated the limits in the letter of inquiry (AU-C 501). NOTE: According to the American Bar Association’s statement of policy, the lawyer may wish to reach an understanding with the auditor about the test of materiality. However, the lawyer need not do so if (s)he assumes responsibility for the criteria.
Krim, president and CEO of United Co., engaged Smith, CPA, to audit United’s financial statements so that United could secure a loan from First Bank. Smith expressed an unmodified opinion on May 20, but the loan was delayed. On August 5, on inquiry to Smith by First Bank, Smith, relying on Krim’s written representation, made assurances that United’s financial status had not changed materially. Krim’s representation was untrue because of a material change after May 20. First relied on Smith’s assurances of no change. Shortly afterward, United became insolvent. If First sues Smith for negligent misrepresentation, Smith will likely be found
Liable, because Smith should have obtained sufficient appropriate audit evidence to verify the status of United.
Written representations are necessary evidence that complements evidence obtained by performing other procedures. But they do not constitute sufficient appropriate evidence about relevant matters. Moreover, the auditor ordinarily has no responsibility for events after the date of the report. If the auditor decides to assume such responsibility, (s)he must comply with GAAS, including AU-C 580. Accordingly, the auditor is liable for negligent misrepresentation. Smith (1) made a false representation (2) of a material fact (3) not known to be false (4) but intended to induce reliance (5) that was reasonably relied upon (6) to the detriment of the plaintiff.
Which of the following statements ordinarily is not included among the written client representations made by the chief executive officer and the chief financial officer?
“Sufficient evidence has been made available to the auditor to permit the expression of an unmodified opinion.”
The sufficiency and appropriateness of audit evidence are determined by the professional judgment of the auditor (AU-C 200).
An auditor believes 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
Postpone expenditures to upgrade its information technology system.
Once an auditor has identified conditions and events indicating that 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 plans to (1) dispose of assets, (2) borrow money or restructure debt, (3) reduce or delay expenditures, and (4) increase equity.
