13.6 Flashcards
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.
The primary reason an auditor requests letters of inquiry be sent to a client’s legal counsel is to provide the auditor with
Corroboration of the information furnished by management about litigation, claims, and assessments.
A letter of inquiry to a client’s external legal counsel is the auditor’s primary means of corroborating information furnished by management about litigation, claims, and assessments. If in-house legal counsel is primarily responsible for the entity’s litigation, claims, and assessments, the auditor should send a similar letter of inquiry to in-house legal counsel. But the letter to in-house legal counsel is not a substitute for direct communication with external legal counsel.
A CPA had the management of Paper Plate Corp. prepare a letter requesting Paper Plate’s external counsel to identify any pending and/or unasserted claims against Paper Plate. The CPA received a letter from the external counsel with the following response:
“We are only aware of the following: Paper Plate was named as the defendant in a class action lawsuit for an alleged defective product manufactured 2 years ago. There is a remote possibility that Paper Plate will suffer any damages, because this firm has successfully defended similar cases in the past. However, similar cases that have been brought against competitors were settled between $1.5 and $2 million.”
Should the CPA accept the letter from the external counsel?
Yes, even though the CPA did not get a specific amount of loss.
No specific amount of loss is required. The external counsel believes the possibility is remote that the company will suffer any damages.
The appropriate date for the client to specify as the effective date in the audit inquiry to legal counsel is
As close to the date of the auditor’s report as possible.
The date of legal counsel’s response should be as close to the date of the auditor’s report as practicable. The auditor is concerned with events occurring through the date of the report that may require adjustment to, or disclosure in, the financial statements. The date of the report is the date on which the auditor obtained sufficient appropriate audit evidence on which to base the opinion. Moreover, the auditor should specify the earliest acceptable effective date of the response and the latest date by which it is to be sent to the auditor. A 2-week period between these dates generally suffices.
An auditor should obtain written representations from management about litigation, claims, and assessments. These representations may be limited to matters that are considered either individually or collectively material provided an understanding on the limits of materiality for this purpose has been reached by
Management and the auditor.
Management’s representations may be limited to matters that are considered individually or collectively material if management and the auditor have reached an understanding about materiality. Such limitations do not apply to certain representations not directly related to amounts in the financial statements, e.g., acknowledgment of responsibility for fair presentation, availability of records, and fraud involving management and persons with significant roles in internal control.
Subsequent to the issuance of the financial statements, the auditor became aware of facts existing at the report date that would have affected the report had the auditor then been aware of such facts The auditor most likely should
Determine whether persons are relying or likely to rely on the financial statements who would attach importance to the information.
If the financial statements have been issued, they have been made available to third parties, along with the auditor’s report. Accordingly, the auditor should (1) discuss the matter with management (and, possibly, those charged with governance); (2) determine whether the statements need revision; and (3) if so, inquire how management intends to address the matter. To determine whether revision is needed, the auditor considers (1) the applicable reporting framework and (2) whether persons are currently relying or likely to rely on the statements who would attach importance to the subsequently discovered facts (AU-C 560).
Which of the following factors should an auditor consider most important upon subsequent discovery of facts that existed at the date of the audit report and would have affected the report?
The client’s willingness to issue revised financial statements or other disclosures to persons known to be relying on the financial statement.
If a subsequently discovered fact becomes known to the auditor, the auditor should (1) determine whether the financial statements need revision, (2) inquire how management intends to address the matter, and (3) determine whether management is willing to issue revised financial statements.
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.
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.
Key Co. plans to present comparative financial statements for the years ended December 31, Year 1 and Year 2, respectively. Smith, CPA, audited Key’s financial statements for both years and plans to report on the comparative financial statements on May 1, Year 3. Key’s current management team was not present until January 1, Year 2. What period of time should be covered by Key’s management representation letter?
January 1, Year 1, through May 1, Year 3.
The auditor is concerned with events occurring through the date of his or her report that may require adjustment of, or disclosure in, the financial statements. Thus, the representations should be made (1) as of a date no earlier than the date of the auditor’s report and (2) for all periods referred to in the report. Moreover, if current management was not present during all periods covered by the auditor’s report, the auditor should nevertheless obtain written representations from current management for all such periods (AU-C 580).
To which of the following matters would materiality limits not apply when obtaining written client representations?
Instances of fraud involving management.
Management’s representations may be limited to matters that are considered individually or collectively material if management and the auditor have reached an understanding about the limits of materiality. Such limitations do not apply to certain representations not directly related to amounts in the financial statements, e.g., acknowledgment of responsibility for fair presentation, availability of records, and knowledge of fraud or suspected fraud affecting the entity involving (1) management, (2) employees with significant roles in internal control, or (3) others if the fraud could materially affect the statements (AU-C 580).
Which of the following is not an audit procedure that the auditor performs with respect to litigation, claims, and assessments?
Confirm directly with the client’s legal counsel that all claims have been recorded in the financial statements.
Legal counsel’s expertise does not extend to accounting matters. Legal counsel evaluates whether claims may be asserted and the likelihood and magnitude of the outcomes. These evaluations bear upon accounting and reporting decisions, for example, whether disclosure only or recognition of a contingent liability is required. But all claims do not necessarily require recognition, and legal counsel does not have information about the content of financial statements that have not been issued.
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.
The scope of an audit is not restricted when legal counsel’s response to an auditor as a result of a client’s letter of inquiry limits the response to
Matters to which the legal counsel has given substantive attention in the form of legal representation.
Two limitations on an entity’s external legal counsel’s response are not scope limitations. The response may be limited to matters to which the legal counsel has given substantive attention in the form of legal consultation or representation. Also, the response may be limited to matters that are individually or collectively material, such as when the entity and the auditor have agreed on materiality limits, and management has stated the limits in the letter of inquiry.
After releasing the auditor’s report, the auditor has no obligation to make any further inquiries with respect to audited financial statements covered by that report unless
New information is discovered concerning undisclosed related party transactions of the previously audited period.
After the date of the auditor’s report, the auditor is not required to perform any further audit procedures with respect to the audited financial statements. However, 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).
