Auditing 4

• Auditor may submit list of pending matters or ask lawyer to prepare list
• Lawyer should inform auditor about any omitted asserted claims
• Lawyer should inform management of unasserted claims probable to be asserted with a reasonable possibility of an unfavorable outcome

To corroborate management's responses to auditor inquiries about legal contingencies

• Inquiry of management
• Identify significant lawyers
• Review board minutes
• Send an attorney letter to significant lawyers

Scope limitation sufficient to prevent unqualified opinion

Entity has exposure to litigation but has received no official filing and has no knowledge of anyone's intention to sue

• Addressed to auditors
• Signed by at least the CEO and CFO
• Same date as auditor's report

Documentation of verbal responses regarding: 1) financial statements; 2) completeness of information; 3) recognition, measurement, and disclosure; 4) subsequent events; 5) other industry or company-specific circumstances

Scope limitation probably resulting in disclaimer or withdrawal

All periods included in audit report

• Verify mathematical accuracy
• Recalculate account balances
• Trace to subsequent cash receipts and disbursements
• Review client's estimates for reasonableness

• Confirmation
• Observation
• Vouch to underlying documents

• Cutoff tests
• Analytical procedures

• Inquire of applicable client personnel
• Examine authorization of transactions (for unusual stipulations)

1) Obtain understanding of business purpose of transaction; 2) Determine if transaction authorized by board of directors; 3) Examine reasonableness of amounts to be disclosed

Primary concern with adequacy of disclosure about transactions with related parties

• Review minutes of board of directors' meetings for activities with related parties
• Inquire of management as to such transactions
• Examine underlying documents for unusual or large transactions, especially investment transactions

1) Unusual or large transactions; 2) Transactions with terms or conditions that are inconsistent with prevailing market conditions

• Inquire of management as to related entities
• Review prior year's audit documentation
• Review any applicable SEC filings
• Inquire of predecessor auditors if applicable
• Review stockholder listings of closely held companies to identify major stockholders

Relates to circumstances arising after balance sheet date and requires disclosure

Subsequent period

Relates to estimate already in financial statements and requires adjustment

1) Management inquiry; 2) Review of minutes of directors' meetings; 3) Review of lawyers' letters; 4) Scan of transactions subsequent to year end

Events or transactions that occur after the balance sheet date and before the issuance of the auditor's report which have a material effect on the financial statements and, therefore, require either financial statement adjustment or disclosure

Indicators of "substantial doubt" related to "going concern" issues

Internal matters raising doubts about "going concern" issues

To identify if there is doubt about the entity's ability to continue as a going concern

Negative trends raising doubts about "going concern" issues

To those charged with governance: 1) nature of conditions identified; 2) possible effect on financial statements and disclosures; 3) effect on auditor's report

Segregation, comparison, access, records, and execution

Schedule used to verify that transfers are recorded properly and to detect kiting

• Review and test bank reconciliations
• Prepare and test schedule of transfers if more than one bank account
• Prepare proof of cash if fraud suspected
• May count petty cash
• Inquire about restrictions on cash balances

Compares the beginning balance per the bank plus deposits minus checks clearing the bank versus the beginning balance per the books plus receipts minus disbursements according to the books

Verifies existence and ownership of bank accounts

Short period bank statement obtained directly from the bank

An overstatement of the true cash balance at year-end caused by recording the receipt, while failing to record the disbursement, associated with a transfer between cash accounts

Perform cutoff test of sales

An attempt to cover up a theft of receipts, where a clerk might try to apply a later receipt to the prior customer's account (and so on) until the scam ends by writing off someone's account as uncollectible

Examine the shipping documents for the last few shipments before year-end and the first few shipments after year-end; compare these shipping documents with the related sales invoices to assess whether the sales were recorded in the appropriate period

• Inquire about receivables pledged as collateral
• Inquire about shipments on consignment

• Review aged trial balance for large delinquent items
• Estimate uncollectible accounts based on time outstanding
• Review receivers after year end for sales returns
• Review adjusting journal entries

• Verify subsidiary ledger agrees with control account in general ledger
• Confirm material accounts
• Investigate exceptions from confirmations
• Complete alternate procedures for unreturned confirmations

• Price tests
• Test extensions (quantity times cost/unit)
• Perform lower of cost or market (LCM) analysis

• Test cut-off
• Perform analytical procedures

• Determine count will be complete and accurate
• Perform test counts
• Determine all tags properly accounted for
• Be alert for and inquire about obsolete or damaged items

Participate in the client count of inventory or confirm inventory stored in public warehouse

Inquire of management for inventory held on consignment or pledged as collateral

Defensive strategy designed to protect against risk of adverse price or interest rate movements

• 5 components of internal controls that the auditor is obligated to understand - (1) control environment; (2) risk assessment;(3) information and communication system; (4) control activities; and (5)monitoring
• "Control activities" can be recognized by "SCARE"
• The services of a service organization may be part of an entity's information system, having implications to the assessment of control risk ["service organizations" (SAS 70)]

• Complexity of the instrument
• Management's objectives
• Evolving nature of derivatives
• Whether the transaction involves an exchange of cash
• A derivative that is an "embedded feature" is more difficult to detect

The size of the entity; its experience with such derivatives and securities; the types and complexity of the derivatives and securities; and the controls affecting the derivatives and securities (especially controls over segregation of duties, access/custody, recording, and authorization)

Financial instrument or other contract with: 1) 1 or more underlyings and 1 or more notional amounts; 2) requires no initial net investment; and 3) terms require or permit net settlement

• When the valuation is based on cost
• When the valuation is based on the investee's financial results (i.e., the "equity method")
• When the valuation is based on fair value

Audit Procedures for Rights, Obligations, Presentation and Disclosure Assertions

Review repairs and maintenance expense accounts to see if any should have been capitalized

Usually employed to verify changes rather than audit entire ending balance

• Verify that detailed listing supports general ledger account
• Vouch additions to underlying documents
• Trace proceeds from disposals to cash receipts journal

Inspect terms of payables and inquire about any related party transactions

The auditor can compute, in view of the declared dividends/share (per the minutes of board meetings) times the number of shares outstanding

The auditor can compute the estimated accrual, in view of the number of days to be accrued relative to a whole pay period

The auditor can compute an estimate of accrued interest for the time period involved, based on the interest rate (and payment dates) specified in the underlying debt agreements

• Review cash disbursements after year end for unrecorded liabilities
• Examine unpaid invoices at year-end to see if included
• Inquire of management as to completeness

• Compare general ledger control account to supporting detail of payables
• Vouch selected items to vendors' invoices
• May confirm payables

• Trace related cash receipts and disbursements
• Examine underlying loan documents
• Recalculate amortization
• Apply analytical procedures to related expense accounts (interest)

• Obtain copies of new loan agreements for the audit documentation for the auditor's review
• Verify authorization of new debt in board's minutes
• Trace receipts from the accounting records to the bank statement

• Disclose important debt covenant restrictions
• Disclose assets pledged as collateral
• Reclassify current portion of long-term debt as current

• Verify due dates for payments in the loan agreements
• Trace cash disbursements from the accounting records to the bank statement
• Examine canceled notes if paid in full

• Read board minutes
• Account for all certificate numbers

• Review cash receipts and disbursements for changes in stock accounts
• Compare subsidiary ledger to general ledger
• Verify par value

Confirm outstanding shares of stock if external registrar

• Review cash receipts and disbursements for changes in stock accounts
• Compare subsidiary ledger to general ledger

• Review board minutes for transaction authorization
• Review compliance with contracts for employee stock plans
• Disclose any restrictions on retained earnings

• Audit procedures for accuracy and occurrence
• Verify payroll deductions and taxes
• Review outside reports related to pension, other post-retirement benefits and profit-sharing plans

Usually performed only when analytical procedures suggest risk of material misstatement relating to payroll exists

Audit procedures for existence and completeness

• Examine personnel records on a test basis
• Trace selected transactions from payroll register to g/l to payroll bank account
• Recalculate selected entries on the payroll register

• Review time reports and time cards to verify support for production records
• Apply analytical procedures (and recalculation) to verify that the payroll-related accruals at year-end are adequate