Ch. 11 HW Solutions - Edward Lynch PDF

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CHAPTER 11Completing the AuditLEARNING OBJECTIVESReview CheckpointsMultiple ChoiceExercises, Problems, and Simulations Identify major activities performed by auditors in completing the substantive procedures following the date of the financial statements. 1, 2, 3, 4, 5 31, 40, 41 Understand the role...

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CHAPTER 11 Completing the Audit LEARNING OBJECTIVES

Review

Multiple

Checkpoints

Choice

Exercises, Problems, and Simulations

1.

Identify major activities performed by auditors in completing the substantive procedures following the date of the financial statements.

1, 2, 3, 4, 5

31, 40, 41

2.

Understand the role of attorney letters in evaluating litigation, claims, and assessments.

6, 7, 8

33, 43, 47, 50, 51

56, 57, 62, 65(*), 72, 73

3.

Explain why auditors obtain written representations and list the key components of written representations.

9, 10, 11, 12

32, 45, 46

52, 53, 54, 55, 71(*)

4.

Identify the final steps in the completion of an audit.

13, 14, 15, 16, 17, 18, 19, 20, 21

5.

Understand auditors’ responsibility for subsequent events and subsequently discovered facts.

22, 23, 24, 25, 26, 27

34, 35, 36, 37, 42, 48, 49

61, 63(*), 64, 65(*), 66, 67, 68, 70(*), 71(*)

6.

Identify important activities and communications following the completion of the audit and audit report release date.

28, 29, 30

38, 39, 44

63(*), 69, 70(*), 71(*)

58, 59, 60, 71(*), 74

(*) Item relates to multiple learning objectives

© 2018 by McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Auditing and Assurance Services, Louwers et al., 7/e 11-1

SOLUTIONS FOR REVIEW CHECKPOINTS 11.1

The four primary periods in an audit examination and the tasks and activities that fall within each time period are: 1. Between the beginning of the year and date of the financial statements: interim tests of controls and substantive procedures. 2. Between the date of the financial statements and the date of the auditor’s report: (1) completing substantive procedures, (2) obtaining attorneys’ letters, (3) obtaining written representations, (4) making going-concern assessment, (5) evaluating the need for adjusting journal entries, (6) reviewing audit documentation, (7) identifying and evaluating subsequent events. 3. Between the date of the auditor’s report and audit report release date: subsequently discovered facts. 4. Following the audit report release date: (1) subsequently discovered facts, (2) omitted audit procedures, (3) management letters, (4) communications with those charged with governance.

11.2

Roll-forward procedures are additional procedures performed by auditors to extend the conclusions from an interim date to the date of the financial statements. Common roll-forward procedures include examining material account transactions that occur between the interim testing date and the date of the financial statements.

11.3

Near the end of the audit, analytical procedures are used to (1) evaluate the adequacy of evidence gathered in response to unexpected account balance or relationships among account balances identified during the audit and (2) identify unusual or unexpected account balances or relationships among account balances that were not previously identified in earlier parts of the audit.

11.4

“Miscellaneous,” “other,” and “clearing” accounts may represent adjustments made by the client to meet analysts’ earnings expectations (or earnings management).

11.5

Auditors are responsible for evaluating management’s process for developing estimates as well as the overall reasonableness of management’s estimates.

11.6

a.

The responsibilities of client management are to (1) respond to auditors’ inquiries regarding litigation, claims, and assessments, (2) provide auditors with a listing, description, and evaluation of litigation, claims, and assessments, and, (3) prepare letter to attorney (attorney letter) that includes information related to litigation, claims, and assessments.

b.

The responsibilities of auditors are to (1) inquire of client regarding the existence of litigation, claims, and assessments, (2) perform various audit procedures regarding litigation, claims, and assessments, (3) initiate the request to the client for the attorney letter, and (4) mail attorney letter prepared by client.

c.

The responsibility of the client’s attorneys is to respond to auditors regarding the client’s description of litigation, claims, and assessments.

© 2018 by McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 11-2 Solutions Manual

11.7

11.8

11.9

Attorney letters ordinarily contain the following information: 

A list of pending or threatened litigation, claims, or assessments.



A description of each item, including the nature of the case and management responses or intended responses to the case.



An evaluation of the likelihood of an unfavorable outcome.



An estimate of the range of potential loss.

In addition to attorney letters, auditors would ordinarily perform the following with respect to litigation, claims, and assessments: 

Obtain from management a description of litigation, claims, and assessments.



Examine documents in the client’s possession regarding litigation, claims, and assessments, including correspondence and invoices from attorneys.



Obtain assurance from management that it has disclosed all material unasserted claims of probable litigation about which the attorney has advised them.



Read minutes of meetings of stockholders, directors, and appropriate committees.



Read contracts, loan agreements, leases, and correspondence from taxing or other governmental agencies.



Obtain information concerning guarantees from bank confirmations.



Review the legal expense account and cash disbursements records and invoices related to legal services.

The major categories of information contained in written representations are: 1.

The entity’s financial statements, including: 

Management’s responsibilities for the financial statements and internal control over financial reporting.



The appropriate disclosure, presentation, and reasonableness of certain items (accounting estimates, related parties, subsequent events, and litigation and claims).



A statement that uncorrected misstatements are immaterial to the financial statements taken as a whole.

2.

Information provided to the auditors, both in general and related to sensitive areas (fraud, noncompliance with laws and regulations, litigation, and related-party transactions).

3.

Internal control over financial reporting (for audits of public entities).

© 2018 by McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Auditing and Assurance Services, Louwers et al., 7/e 11-3

11.10

If the entity is subject to the requirements of AS 1305, auditors should obtain the following written representations related to internal control over financial reporting: 

Management has performed an assessment of the effectiveness of internal control over financial reporting based on established criteria (i.e., COSO criteria).



Management’s conclusion with respect to the effectiveness of its internal control over financial reporting at year-end.



Management has disclosed all deficiencies in the design or operation of internal control over financial reporting, including separate disclosure of any deficiencies that it believes to be a significant deficiency or material weakness.



There are no subsequent changes in internal control over financial reporting or other factors that may significantly affect internal control over financial reporting.

11.11

These communications are obtained near the end of fieldwork and dated on or near the date of the auditor’s report to ensure that the most current information has been considered and evaluated by auditors. (Written representations must be dated on the date of the auditor’s report).

11.12

If the client refuses to furnish written representations, auditors may either qualify or disclaim an opinion as with other scope limitations. However, because of the importance of this communication, auditors should be very skeptical if the client refuses to furnish written representations.

11.13

Auditors are required to consider whether any evidence that comes to their attention during the audit examination provides substantial doubt about the client’s ability to continue as a going concern for a period not to exceed one year beyond the date of the financial statements being audited.

11.14

Factors that may indicate that substantial doubt exists about the client’s ability to continue as a going concern include:

11.15



Negative trends, such as recurring operating losses, working capital deficiencies, and negative cash flow from operations.



Signals of financial difficulties, such as default on loans, denial of trade credit from suppliers, restructuring of debts, or arrearages in dividends.



Internal matters such as work stoppages or substantial dependence on the success of a particular project or activity.



External matters, such as legal proceedings; loss of a key franchise, license, or patent; or loss of a major customer or supplier.

If evidence suggests that substantial doubt exists about the client’s ability to continue as a going concern, auditors should obtain information about management’s plans to mitigate the effect of these factors and assess the likelihood that these plans can be effectively implemented. If after evaluating this evidence, auditors believe that substantial doubt continues to exist about the client’s ability to continue as a going concern, auditors should ensure that appropriate disclosures are provided in the financial statements and modify their opinion on the client’s financial statements. On the other hand, if auditors conclude that the risk of going-concern uncertainties is low, no disclosures or report modifications are necessary.

© 2018 by McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 11-4 Solutions Manual

11.16

Adjusting entries and note disclosures are labeled “proposed” because it is ultimately the client’s responsibility to adjust the financial statements for these items.

11.17

An uncorrected misstatement is a misstatement that the auditor has identified and accumulated during the audit that has not been corrected (or adjusted) by the client. Auditors are required to communicate all uncorrected misstatements detected during the audit to individuals charged with governance (such as the client’s audit committee), regardless of the materiality of these misstatements to the client’s financial statements. Often, management decides not to make all of the proposed corrections because of materiality or cost-benefit considerations.

11.18

The rollover method considers only the current-period income effect(s) of any misstatements. In contrast, the iron curtain method considers the aggregate effect of the misstatements on the entity’s balance sheet. Staff Accounting Bulletin No. 108 requires auditors to evaluate misstatements using both methods and propose an adjustment if either method indicates that the misstatement exceeds the level of performance materiality.

11.19

1.

Upon completion, the audit documentation is reviewed by an audit supervisor and, sometimes, audit manager. The purpose of this review is to ensure that all appropriate steps in the audit program were performed, the referencing among audit documentation is clear, and the explanations contained in the audit documentation are understandable.

2.

Once this initial review has been completed, the audit manager and audit partner review the audit documentation to ensure that the overall scope of the audit is appropriate and determine whether the overall conclusions in the audit documentation are sufficient to provide support for the opinion on the financial statements.

3.

Finally, the audit documentation is reviewed by a partner who has not been involved with the audit (known as a reviewing partner). The purpose of this review is to ensure that the quality of audit work and reporting is consistent with the firm’s quality standards.

11.20

An engagement quality review is a review of audit documentation by a partner (or equivalent with the firm) who is not involved with the audit. The purpose of this review is to ensure that the quality of the work and reporting is in keeping with the quality standards of the firm and that the evidence obtained during the audit is sufficient to support the opinion on the client’s financial statements.

11.21

Some of the benefits of audit documentation review are:

11.22



To ensure the audit is conducted in accordance with GAAS.



To provide the firm an opportunity to evaluate the overall quality of the firm’s audit practice.



To provide an important component of the training and evaluation of audit staff members.



To allow the firm to adhere to the performance principle, which requires that auditors adequately plan the work and properly supervise any assistants.

A subsequent event is an event occurring between the date of the financial statements and the date of the auditor’s report.

© 2018 by McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Auditing and Assurance Services, Louwers et al., 7/e 11-5

11.23

11.24

Procedures performed to identify subsequent events include: 

Obtaining an understanding of the procedures performed by management to identify subsequent events.



Inquiring of management and those charged with governance as to the existence of subsequent events (and then corroborate this inquiry through written representations).



Reading minutes of meetings of owners, management, or those charged with governance held after the date of the financial statements.



Reviewing the entity’s latest interim financial statements (if applicable).

The two types of subsequent events are: 

Events that provided additional evidence of conditions that existed at the date of the financial statements. These subsequent events typically require adjustment to the financial statements to reflect the new information.



Events that provide evidence of conditions that arose following the date of the financial statements. These subsequent events require disclosure of the information in the financial statements or footnotes accompanying the financial statements.

11.25

Subsequently discovered facts are facts that become known to auditors after the date of the auditor’s report that, if known by the auditor, could have caused the auditor to revise the auditor’s report.

11.26

a.

If subsequently discovered facts are identified prior to the audit report release date, auditors can evaluate the appropriateness of the disclosure of these events and dual date their report.

b.

If subsequently discovered facts are identified following the audit report release date, auditors should first assess whether (1) these facts would require revision of their report or the financial statements or (2) individuals are continuing to rely on the financial statements, If so, auditors should ensure that clients notify individuals known to be relying on the financial statements of the subsequently discovered facts and issue revised financial statements as soon as possible.

11.27

Dual dating the auditor’s report provides a means of inserting important information in the financial statements and footnote disclosures learned by auditors after the date of the auditor’s report. A significant advantage of dual dating the report is that auditors’ liability for events after the date of the auditor’s report is limited to the event specifically identified in the report date.

11.28

If an omitted procedure is discovered, the following courses of action would be taken: 1. Verify that (a) the omitted procedure is important in supporting the auditors’ opinion and (b) individuals are currently relying on the client’s financial statements and reports. 2. If both of the above conditions exist, auditors should perform the omitted procedure or alternative procedures, if practicable. If both do not exist, no further action is necessary. 3. If performing the omitted or alternative procedures allows auditors to support the previously expressed opinion, no further action is necessary. However, if it does not, auditors should formally withdraw the original reports, issue revised reports, and inform persons currently relying on the financial statements.

© 2018 by McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 11-6 Solutions Manual

11.29

Auditors should communicate the following information to individuals charged with governance:           

11.30

Auditors’ responsibility under generally accepted auditing standards. An overview of the planned scope and timing of the audit. Auditors’ judgment about the quality of the client’s accounting policies, accounting estimates, and financial statement disclosures. Any significant difficulties encountered during the audit. Any uncorrected misstatements, other than those auditors believe to be trivial. Any disagreements with management. Material, corrected misstatements that were brought to the attention of management. Representations requested from the client’s management. Any management consultations with other auditors. Any significant issues arising from the audit that were discussed with management. Other findings or issues that are significant and relevant to those charged with governance.

A management letter contains a summary of recommendations to allow the client to improve the effectiveness and efficiency of its operations. They are not required by generally accepted auditing standards.

SOLUTIONS FOR MULTIPLE-CHOICE QUESTIONS 11.31

11.32

11.33

a.

Incorrect

b.

Incorrect

c.

Incorrect

d.

Correct

a.

Incorrect

b. c.

Incorrect Incorrect

d.

Correct

Analytical procedures are not related to the auditors’ involvement with internal control over financial reporting or identify...