Mcconnell Auditing Chapter 24 Minitest

Front 1

Contingent liability

Back 1

Potential future obligation to an outside party for an unknown amount resulting from activities that have already taken place. Material liabilities must be disclosed in the fotnotes.

Front 2

Three conditions are required for a contingent liability to exist

Back 2

1. There is potential future payment to an outside party or the impairment of an asset that resulted from a existing condition
2. There is uncertainty about the amount of the future payment or impairment.
3. The outcome will be resolved by some future event or events

Front 3

What is an example of a contingent liability?

Back 3

A lawsuit that has been filed but not yet resolved meets all three conditions.

Front 4

What can be said about the uncertainty of future payments?

Back 4

Can vary from extremely likely to highly unlikely

Front 5

How many levels of likelihood of occurrence are there?

Back 5

3

Front 6

What must the auditor do to evaluate whether the client has applied the correct treatment?

Back 6

Auditor must use considerable professional judgement.

Front 7

What should contingency footnotes do?

Back 7

Should describe the nature of the contingency to the extent it is known and the opinion of legal counsel or management as to the expected outcome.

Front 8

3 event occurrence standards

Back 8

1. Remote (Slight chance)
2. Reasonably possible (more than remote but less than possible)
3. Probable (likely to occur)

Front 9

Remote

Back 9

slight change - no disclosure necessary

Front 10

Reasonably possible

Back 10

More than remote but less than possible footnote disclosure is necessary

Front 11

Probable

Back 11

likely to occur
1. IF amount can be estimated financial statements are adjusted.
2. If amount cannot be estimated footnote disclosure is necessary.

Front 12

Auditors are especially concerned with certain contingent liabilities:

Back 12

1. Pending litigation for patent infringement, product liability, or other actions.
2. Income tax disputes
3. Product warranties
4. Notes receivable discounted
5. Guarantees of obligations of others
6. Unused balances of outstanding letters of credit.

Front 13

What is management responsible for in regards to contingent liabilities?

Back 13

Management, not the auditor, is responsible for identifying and deciding the appropriate accounting treatment for contingent liabilities.

Front 14

What are auditor's primary objectives in verifying contingent liabilities:

Back 14

1. Evaluate the accounting treatment of known contingent liabilities to determine whether management has properly classified the contingency (Classification presentation and disclosure).
2. Identify to the extent practical any contingencies not already identified by management (completeness presentation and disclosure objective)

Front 15

Commitments

Back 15

Include agreements to purchase raw materials or to lease facilities at a certain price and to sell merchandise at a fixed price, as well as bonus plans, profit-sharing, and pension and royalty agreements.

Front 16

what is the most important characteristic of a commtment?

Back 16

The agreement to commit the firm to a set of fixed conditions in the future regardless of what hapens to profits or the economy as a whole. Entity agrees to commitments to better their own interests, but hey may turn out to be less or more adventageous than originally anticipated.

Front 17

Where are commitments described?

Back 17

Either in a separate footnote or combined with a footnote related to contingencies.

Front 18

When are audit procedures for finding contingencies performed?

Back 18

Many are verified as an integral part of various sgements of the audit rather than as a separate activity near the end of the audit.

Front 19

Even if contingencies are verified separately when are tests performed?

Back 19

Tests are usually performed well before the last days of the audit to ensure their proper verification.

Front 20

What are tests of contingencies at the end of the audit?

Back 20

In actuallity these are more of a review than an initial search.

Front 21

Once an auditor knows contingencies exist, what must they do?

Back 21

Evaluate their materiality and the footnote disclosures can ordinarily be satisfactorily resolved.

Front 22

Audit procedures commonly used to search for contingent liabilities:

Back 22

1. INquire of management about possibility of unrecorded contingencies.
2. REview current and prev internal rev agent reports for income tax settlements. Report may contain areas in which there are unsettled disagreements.
3. Review the minutes of directors' and stockholders' meetings for indications of lawsuits or other contingencies.
4. Analyze legal expense for period under audit and review invoices and statements about contingencies esp lawsuits and pending tax assessments.
5. Obtain a latter from each major attorney performing legal services for the client as to the status of pending litigation or contingent liabilities.
6. Review audit documentation for any info that may indicate a potential contingency
7. Examine letters of credit in force as of the balance sheet date and obtain a confirmation of the used and unused balances.

Front 23

Inquiry of management

Back 23

can be orally or writing about possibility of unrecorded contingencies. In these inquiries, the auditor must be specific in describing the different kinds of contingencies that may require discolsure as reminders to management of disclosures they overlooked or do not fully understand. At completion of the audit, auditors typically ask management to make a written statement as a part of the letter of representation that is aware of no undisclosed contingent liabilities.

Front 24

If auditors conclude there are contingent liabilities what must they do?

Back 24

They must evaluate the significance of the potential liability and the nature of the disclosure needed in the financial statements to obtain evidence about the occurrence and rightes and obligations presentation and disclosure objecteive.

Front 25

What sometimes happens in regards to contingent liabilities? What happens other times?

Back 25

Sometimes the potential liability is sufficiently well known to be included in the statements as an actual liability. In other instances, disclosure may be unnecessary if the contingency is highly remote or immaterial

Front 26

Why do CPA firms sometimes obtain a separate evaluation of potential contingencies from its own legal council?

Back 26

They sometimes don't want to rely on management's attorneys because they are advocates for the client, the client's attorneys may lose perspective in evaluating the likelihood of losing the case and the amount of the potential judgement

Front 27

What does auditor do in regards to the footnotes?

Back 27

The auditor reviews the draft footnote to ensure that the disclosed info is understandable and fiarly states the conditions of the contingency.

Front 28

Audit procedures for finding commitments

Back 28

Usually performed as a part of the audit of each audit area. For example, in verifying sales transactions, the auditor should be alert for sales commitments. Auditor should also be aware of the possibility of commitments when reading minutes contracts and correspondence files.

Front 29

Inquiry of the client's attorneys

Back 29

Major procedure auditors rely on for evaluating known litigation or other claims against the client and identifying additional ones. Auditor relies on attorney's expertise and knowledge of client's legal affairs to provide a professional opinion about expencted outcome of lawsuits and likely amount of liability, incuding court costs. The attorney also liekly to know of pending litigations and claims management may have overlooked.

Front 30

Many CPA's analyze legal expense for _____ and have_____

Back 30

the entire year and have the client send a standard inquiry letter to every attorney the client has been involved with in the current or preceding year plus any attorney the firm occasionally engages.

Front 31

Standard inquiry to clients attorney is written on _____ and includes____

Back 31

the client's letterhead and signed by one of the company's officials.

Front 32

What should the inquiry to client's attorney include?

Back 32

1. A list including 1. pending threatened litigation and 2. asserted or unasserted claims or assessments with which the attorney has had significant involvement.
2. A request that the attorney furnish information or comment about the progress of each item listed. Desired info includes legal action client intends to take, likelihood of unfavorable outcome, estimate of the amount or range of potential loss.
3. REquest of the law firm to identify unlisted pending or threatened litigation.
4. A statement informing the attorney of the attorney's responsibility to inform management of legal matters requiring disclosure in the financil statements and to respond directly to the auditor.

Front 33

The nature of refusals by auditors to provide auditors with complete information about contingent liabilities falls into 2 categories:

Back 33

1. The attorneys refuse to respond due to a lack of knowledge about matters involving contingent liabilities.
2. The attorneys may refuse to disclose information that they consider confidential.

Front 34

Unasserted claim

Back 34

attorney may be aware of a violation of a patent agreement that could result in a significant loss to the client if it were known. this would fall under atterney refusing to disclose confidential information

Front 35

What happens if attorney fails to provide auditor with information about material existing lawsuits or unasserted claims?

Back 35

Auditors must modify their audit report to reflect the lack of available evidence (A scope limitation which requires a qualified or disclaimer of opinion.)

Front 36

Rules require attorneys serving public companies to report material violations of

Back 36

federal securities laws. An attorney must report violations to the PC's chief legal council or CEO. IF they fail to appropriately respond, attorney must report to company's audit committee

Front 37

Amended attorney client confidentiality agreement

Back 37

permits attorneys to breach confidentiality if a client is committing a crime or fraud

Front 38

review for subsequent events

Back 38

an auditor must review transactions and events that occurred after the balance sheet date to determine whether any of these transactions or events affect the fair presentation or disclosure of the current period statements.

Front 39

What is the auditors responsibility for reviewing subsequent events normally limted to?

Back 39

The period beginning with the balance sheet date and ending with the date of the auditors report. BEcause the date of the auditors report corresponds to the ocmpleton of the important auditing procedures in the client's office, the subsequent events review should be completed near the end of the audit.

Front 40

2 types of subsequent events

Back 40

1. Those that have a direct effect on the financial statements are require adjustment of current year's financials.
2. Those that have no direct effect on financial statement amounts but for which disclosure is required.

Front 41

Some events provide additional information to management to help them determine

Back 41

fair presentation of account balances. Info in these events helps auditors verifying balances

Front 42

Subsequent period events which require an adjustment of account balances if amounts are material:

Back 42

1. Declaration of bankruptcy by a customer with outstanding A/R balance
2. Settlement of litigation at an amount different from amount on books.
3. Disposal of equipment not used at a price below current book value
4. Sale of investments at a price below cost

Front 43

When subsequent events are used to evaluate amounts included in year end financial statements

Back 43

auditors must distinugish between conditions that existed at balance sheet date and those that came into being after the end of the year. The subsequent info should not be incorporated directly into the statements if the conditions causing the change in valuation took place after year end.

Front 44

Auditors of accelerated filer public companies must inquire about and consider any subsequent events that materially affect

Back 44

effectiveness of internal control. If they conclude events reflecta material weakness that existed at year end they must give an adverse opinion on internal control.

Front 45

Subsequent events that have direct affect but for which disclosure is required

Back 45

These are so significant that they require disclosure even though they do not require saccount adjustment. Ordinarily these events can be adequately disclosed by the use of footnotes

Front 46

Events that may require disclosure rather than adjustment

Back 46

1. DEcline in MV of securities held for temp investment or resale
2. Issuance of bonds or equity securities
3. Decline in MV of inventory as consequence of government action barring further sale of a product.
4. Uninsured loss of inventory as result of fire.
5. A merger of acquisition

Front 47

2 categories of audit procedures for subsequent events review:

Back 47

1. Procedures normally integrated as a part of the verification of year-end account balances.
2. Procedures performed specifically for purpose of discovering events or transactions that must be recognized as subsequent events.

Front 48

Review records prepared subsequent to balance sheet date

Back 48

to determine existence and nature of tx. If journals are not kept up to date, auditors shoudl review documents that will be used to update journals. Auditors of public companies that are accelarated filers must inquire about and examine statements issued during subsequent events period such as relevant internal audit reports and regulatory agency reports on the company's internal control over financial reporting.

Front 49

Review internal statements prepared subsequent to B/S

Back 49

Emphasize changes in business compared to results for same period in year under audit and changes after year end. They should pay careful attention to major change sin the business or environment in wihch the cleitn is operating. SHould idscuss interim statements to determine whehter they are prepared on the same basis as current period staements, and also inquire about significant changes in operating results

Front 50

Examine minutes issued subsequent to balance sheet date

Back 50

to see if there are subsequent events affecting curent financials

Front 51

Inquire of management

Back 51

Normally inculude significant changes in the assets or capital structure of the company after balance sheet date of current status items that were not completely resolved at ablance sheet date and unusual adjustments made subsequent to the balance sheet date. must be done with apporpirate perosnnel to ensure best responses

Front 52

Obtain a letter of representation

Back 52

Letter written by client's management to auditor formalizes statements made by managers about different matters throughout the audit, including discussions about subsequent events. Letter is mandatory

Front 53

After fieldwork completed but before audit report issued, source of info is typically management or the lemdia

Back 53

If an acquisition occured March 23 and last day of fieldwork was March 11 auditor required to extend audit tests of the newly discovered and subsequent event to make sure it is correctly disclosed.

Front 54

What 2 options does the auditor have for expanding subsequent event tests?

Back 54

1. Expand all events tests to new date
2. REstrict subsequent events review to matters related to new subsequent event.

Front 55

Dual dated audit report

Back 55

The audit report includes 2 dates: the first is the date for completion of fieldwork, except for the specific exception, and the second date, which is always later, for the exception.