Unit 10 - Completing the Audit

Question 1

Define loss contingency as defined by the Finacial Accounting Standards Board (FASB)

Answer 1

An existing condition or situation involving uncertainty as to possible loss that will ultimately be resolved when one or more future events occur or fail to occur

Question 2

FASB ASC Topic 450 classifies the likelihood of loss contingencies into what three categories?

Answer 2

1) Probable - the future even is likely to occur

2) Reasonably possible - the chance of the future even occurring is more than remote but less than likely

3) Remote - the chance of the future event occurring is slight

Question 3

If management determines the loss contingency is probable and an amount can be reasonably estimated, what is the company expected to do?

Answer 3

The company must record a liability and a related expense or loss, and disclose the relevant details of the event in the notes to the financial statements.

Question 4

If management determines the loss contingency is reasonably possible, or the amount cannot be reasonably estimated, what is the company expected to do?

Answer 4

The company is only expected to record a disclosure in the notes.

Question 5

When it comes to loss contingencies, what is the role of the auditor?

Answer 5

The role of auditors is to determine if management’s assessment is reasonable, appropriate liabilities have been recorded, and the disclosures are complete.

Question 6

What are the two types of subsequent events?

Answer 6

Type 1: event that provides evidence of conditions that existed at the date of the financial statements. A type 1 event requires an adjustment to the financial statements

Type 2: event that provides evidence of conditions that arose after the date of the financial statements. No adjustment to the financial statements is approriate

Question 7

What are the three categories of misstatements?

Answer 7

Factual misstatements: misstatements that are known with certainty

Judgmental misstatements: typically involve accounting estimates in which uncertainty is a factor

Projected misstatements: the result of audit sampling

Question 8

What is a Management Representation Letter?

Answer 8

A management representation letter is a letter from management to the auditor acknowledging management’s responsibility for the preparation of the financial statements and details of any verbal representations made by management during the course of the audit.

A written statement by management provided to the auditor to confirm certain matters or to support other audit evidence.

Auditors are required to obtain a management representation letter as a final piece of audit evidence.

Question 9

Define asserted claims

Answer 9

Pending or threatened litigation

Lawyer should tell the auditor directly about any omissions of such matters from the letter of inquiry

Question 10

Define unasserted claims

Answer 10

Potential litigation

Lawyer cannot divulge omissions from the letter of inquiry directly to auditors (but should advise management to discuss it with auditors)

Question 11

What are the two categories of legal matters that could affect the audit?

Answer 11

1. ) Asserted claims

2.) Unasserted claims

Question 12

An auditor should request that an audit client send a letter of inquiry to those attorneys who have consulted concerning litigation, claims, or assessments. The primary reason for this request is to provide:

Answer 12

The corroboration of the information furnished by management concerning litigation, claims, and assessments.

Question 13

When is an auditor not required to obtain a lawyer’s letter?

Answer 13

If audit procedures indicate that no actual or potential litigation-related issues may cause a risk of material misstatement

Question 14

The date of the management representation letter should coincide with the date of the

Answer 14

auditors report.

Question 15

Which assertion should auditors carefully consider concerning loss contingencies?

Answer 15

Completeness assertion

The completeness assertion is of particular concern when assessing loss contingencies as it assures that disclosures that should have been included in the financial statements have been included.

Question 16

An auditor is reviewing an audit client’s records in order to identify any potential loss contingencies. The audit client’s management has stated that all loss contingencies have a remote change of triggering an actual loss. The auditor intends to test this assertion by searching for any potential contingencies that are considered to be more than remote.

Which document should this auditor review?

a) A note payable to the client’s bank

b) An invoice for materials purchased from one of the client’s suppliers

c) A dividend that was declared by the client’s board of directors

d) A notice that the IRS will audit the client’s most recent corporate income tax return

Answer 16

d) A notice that the IRS will audit the client’s most recent corporate income tax return

The outcome of this matter is uncertain and might result in a liability or loss depending upon the outcome of the audit.