Friday, May 17, 2019

Chapter 19 Solutions

Chapter 19 complementary the Audit / Post visit Responsibilities Learning Check 19-1. The three categories of activities in finish the take stock ar (a) completing domain work, (b) evaluating the bring forthings, and (c) communicating with the knob. 19-2. The activities involved in completing the field work be (a) making consequent takingss examine, (b) schooling minutes of wagerings, (c) set roughlying evidence concerning litigation, claims, and assessments, (d) engendering thickening representation garner, and (e) execute analytical procedures. 19-3. a.Subsequent returns argon accompaniments that overstep between the relief winding-clothes regard and the exit experience of the tenders story (which is non the same as the find bug out of the topic) that whitethorn affect the fiscal statements on which the bill is r termin routinered. The subsequent resultant roles finish extends from the sleep bed tatter lead to the end of field work on the liaison. b. The types are event 1 consists of those events that suffer extra evidence with take none to actors that existed at the reckon of the balance carpenters plane and affect the estimates inherent in the process of preparing pecuniary statements. Type 2 consists of those events that provide evidence with respect to sort outs that did non exist at the date of the balance sheet but arose subsequent to that date. Type 1 events pick up adjustment of the fiscal statements. Type 2 events demand apocalypse, and in very cloth cases, by attaching pro-form info to the pecuniary statements. c. The meeter is involve by GAAS to await for and to evaluate subsequent events up to the date of the attenders account, which should be as of the end of field work.This account cogency is fulfil by (1) creation alert for subsequent events in performing year-end substantive tests aft(prenominal) the balance sheet date, and (2) performing specific procedures at or near th e completion of field work. 19-4. a. Regarding litigation, claims, and assessments (LCA), the attendee should go for evidential matter on The existence of a condition, situation, or set of circumstances indicating an uncertainty as to the possible loss to an entity arising from the LCA. The diaphragm in which the central ca social occasion for legal action occurred. The degree of prospect of an unfavorable outcome. The amount or range of potential loss. b. A earn of visit inquiry is a letter sent by perplexity to the compeverys outside legal counsel requesting the attorney to send stipulate nurture directly to the tender round(predicate) LCA against the comp either. The letter is the attendants primary means of obtaining evidence about LCA. c. When the lawyer fails to respond, the canvasor has a scope limitation.Depending on frameworkity, the meeter will deliver either a subject opinion or a disclaimer of opinion. 19-5. a. The objectives of a rep letter are (1 ) confirm unwritten representations given to the auditor, (2) document the continuing tolerateness of such(prenominal) representations, and (3) chasten the possibility of misunderstandings concerning centerings representations. b. When the auditor is unable to obtain a rep letter or support a counseling representation that is cloth to the monetary statements by other audit procedures, there is a scope limitation.Depending on materiality, the auditor will express either a qualified opinion or a disclaimer of opinion 19-6. a. The objectives of an over every(prenominal) in both review are to assist the auditor in (1) assessing conclusions r from all(prenominal) oneed in the audit and (2) evaluating the fiscal statement presentation taken as a whole. b. The review should be made by an individual having comprehensive knowledge of the nodes vexation and industry. Normally, either the furnish in charge of the audit or the top manager on the utilization nets the review. c.A nalytical procedures performed during the last-place stages of the audit should be Applied to critical audit areas identified during the audit. Based on pecuniary statement selective selective education after all audit adjustments and reclassifications stick been recognized. As in other cases, the data may be compared to (1) expected comp each results, (2) available industry data, and (3) relevant non monetary data. 19-7. a. The two objectives in evaluating the findings are determining (1) the type of opinion to be expressed and (2) whether GAAS has been met in the audit. . Four steps in meeting these objectives are Making a final assessment of materiality and audit risk. Making a technical review of pecuniary statements. Formulating an opinion and drafting the audit sketch. Making final review(s) of the working papers. 19-8. a. The purposes of the auditors final assessment of materiality and audit risk are to determine whether (1) the auditors preliminary judgments concerning materiality own been met and (2) audit risk is at an acceptable aim to warrant the expression of an opinion. . Known misstatement is an uncorrected misstatement in an look identified done substantive tests of detail of transactions and balances. Likely misstatement is the total error in an key out resulting from (1) known misstatements, (2) projected uncorrected misstatements estimated through audit sampling techniques, and (3) estimated misstatements detected through analytical procedures and quantified by other auditing rocedures. Aggregate likely misstatement is the sum of likely misstatements in all accounts. 19-9. a. Professional standards establish a office for the auditor to evaluate whether there is comforting doubt about the guests top executive to insure as a dismission concern for a valid period of clipping, non to draw whiz year beyond the date of the fiscal statements being audited (generally one year from balance sheet date).Ordinarily, infor mation that would raise substantial doubt about the going concern assumption relates to the entitys inability to continue to meet its obligations as they become due without substantial disposition of assets outside the ordinary course of military control, restructuring of debt, outwardly forced revisions of its unconscious processs, or similar actions. b. The auditor patternly evaluates whether there is substantial doubt about the clients ability to continue as a going concern based on the results of recipe audit procedures performed in planning, in gathering evidence to support various audit objectives, and in completing the audit. . If the auditor concludes that substantial doubt exists, he or she should consider the need for the following divine revelations Pertinent conditions and events free rise to the assessment of substantial doubt about the entitys ability to continue as a going concern for a reasonable period of time. The possible do of such conditions and events. Managements e valuation of the significance of those conditions and events and any mitigating factors. Possible discontinuance of operations. Managements plans (including relevant prospective financial information). n3 Information about the recoverability or classification of recorded asset amounts or the amounts or classification of liabilities. d. If, after considering identified conditions and managements plans, the auditor concludes that substantial doubt about the entitys ability to continue as a going concern for a reasonable period of time remains, the audit report is normally an unqualified audit opinion with an instructive carve up about the uncertainty (following the opinion paragraph) to reflect that conclusion.The auditors conclusion about the entitys ability to continue as a going concern should be expressed through the use of the phrase substantial doubt about its (the entitys) ability to continue as a going concern. If the auditor concludes that the entitys r evelations with respect to the entitys ability to continue as a going concern are inadequate, a de wear outure from generally accepted write up principles exists. This may result in either a qualified (except for) or an adverse opinion. 19-10.The technical review of the financial statements embroils matters pertaining to the form and content of each of the basic statements as well as to needed disclosures. Most certified public accountant firms use separate checklists for SEC and non-SEC clients. The auditor who performs the initial review of the financial statements completes the checklists. The manager and furnish in charge of the engagement (in the case of a publicly held client then review the checklists, a henchman who was non a member of the audit aggroup) reviews them again. 19-11. a. The opinion to be expressed is determined by the partner in charge of the engagement.The decision is made on the basis of the findings made by the audit team during the audit. b. Proposed adjustments and disclosures are discussed with the client and differences are resolved. Ordinarily, agreement is reached and an unqualified opinion can be expressed. 19-12. a. The primary reviewers and the constitution of their reviews are Reviewer Nature of Review Manager Reviews working papers vigilant by seniors and reviews just about or all of the working papers reviewed by seniors. Partner in charge Reviews working papers secured by managers and reviews other working papers on a of engagement selective basis. b. The engagement partners review of the working papers is designed to obtain self-confidence that The work done by subordinates has been sinless and thorough. The judgments exercised by subordinates were reasonable and appropriate in the circumstances. The audit engagement has been completed in accordance with the conditions and wrong specified in the engagement letter. All noneworthy accounting, auditing, and reporting questions raised during the audit take a leak been powerful resolved. The working papers support the auditors opinion. Generally accepted auditing standards and the firms quality prevail policies and procedures form been met. c. The second partner may be more objective than the partner on the engagement. Thus, the second partner review provides surplus assurance that GAAS have been met. Second partner reviews are mandatory for SEC registrants. 19-13.The auditors communications with the client at the conclusion of the audit involve the audit delegation of the dining table of directors (or the board directly) and management. 19-14. a. Reportable conditions represent crucial deficiencies in the design or operation of the ingrained halt social anatomical structure, which could adversely affect the organizations ability to record, process, summarize, and report financial data consistent with the assertions of management in the financial statements. The magnitude of a reportable condition determines whether it is also a material weakness.A material weakness is outlined as a reportable condition in which the design or operation of the specific inner(a) control structure elements does not reduce to a relatively low level the risk that misstatements in amounts that would be material in sexual affinity to the financial statements being audited may occur and not be detected inwardly a incidentally period by employees in the normal course of performing their assigned duties. b. A report issued on reportable conditions should Indicate that the purpose of the audit is to report on the financial statements and not to provide assurance on the internal control structure. Include the definition of reportable conditions. Include the restriction on diffusion (e. g. restricted to the audit committee, management, and others within the organization). In addition, the reportable conditions should be described in one or more separate paragraphs. 19-15. When the auditor separately identifies and describes material weaknesses in his or her report, two additive paragraphs are required. The first paragraph should contain a definition of the term material weakness and a definition of the reportable conditions that are material weaknesses.The second additional paragraph should describe the limitations of the auditors work, noting specifically that the auditors consideration of the internal control structure would not necessarily disclose all matters considered to be material weaknesses. 19-16. a. The communication may be oral or written, and it may occur during or shortly after the audit. b. The communication with the audit committee may include such matters as Auditors responsibilities under GAAS. Significant accounting policies. Management judgments and accounting estimates. Significant audit adjustments. Disagreements with management. Consultation with other accountants. Major issues discussed with management prior to retention. Difficulties in performing the audit. In addition, the auditor essential communicate reportable conditions. 19-17. a. The purpose of a management letter is to provide management with recommendations for improving the efficiency and authority of its operations. b. A management letter may include comments on familiar control matters that are not considered to be reportable conditions. Management of resources such as cash, inventories, and investments. Other value-added recommendations on how to improve organization performance. Tax cogitate matters. 19-18. a. The auditor has no responsibility to make inquiry or to perform any auditing procedures on subsequent events occurring after field work but before issuance of the report. When a situation comes to the auditors attention, he or she is required to evaluate the item and consider its effect on the report that is being issued. b. The auditor may use the event date as the date of the auditors report provided all subsequent events review procedures are performed for the period between the original report date and the event date.Alternatively, the auditor may use dual dating in which the report contains two dates (1) the original date of the report, and (2) a date that refers to the subsequent event that has occurred between the original date of the report and the date of its issuance. In this case, it is not needed to extend performance of all subsequent events review procedures through the later date except as to the particular event giving rise to the dual dating. 19-19. a. The auditor has no responsibility for the postaudit recovery of facts existent at the date of the audit report.However, when the auditor becomes aware of such facts and the facts may have affected the report that was issued, he or she must ascertain the reliability of the information. b. When the client refuses to make the necessary disclosures, the auditor should notify each member of the board of directors of such refusal and take the following steps to balk further reliance on the audit report advertise the client that the audit report must no longer be associated with the financial statements. Notify the regulative agencies having jurisdiction over the client that the report should no longer be relied on. Notify (generally via the regulatory agency) each individual known to be relying on the statements that the report should no longer be relied on. 19-20. a. When the auditor has been able to make a satisfactory investigating and has determined that the information is reliable, he or she should describe the effects the subsequently acquired information would have had on the financial statements and the auditors report. b.When the client has not cooperated and the auditor has been unable to make a satisfactory investigation, without disclosing the specific information, the auditor should (1) indicate the lack of cooperation and (2) state that if the information is true, the audit report should no longer be relied on. 19-21. a. The auditor has no responsibility to make any retrospective review of his or her work. However, when knowledge is obtained of possible omitted procedures, the auditor should assess their importance to his or her ability to support the previously expressed opinion. b.The auditor may find that he or she (1) can support the opinion or (2) cannot support the opinion. In the latter case, the auditor should perform the omitted procedures and if necessary prevent further reliance on the report. Objective Questions 19-22. 1. b 2. a 3. c 19-23. 1. a 2. b 3. b 4. c 19-24. 1. a 2. c 3. b Comprehensive Questions 19-25. (Estimated time 20 minutes) . The first type of subsequent events includes those events that provide additional evidence concerning conditions that existed at the balance sheet date and affect the estimates inherent in the process of preparing financial statements. This type of subsequent events requires that the financial statements be modify by any stirs in estimates resulting from the use of such additional evidence. The second type of subsequent events consists of those events that provide evidence concerning conditions that did not exist at the balance sheet date but arose subsequent to that date.These events should not result in adjustment to the financial statements but may be such that disclosure is required to keep the financial statements from being mis conducting. b. The auditing procedures Green should consider performing to gather evidence concerning subsequent events include the following Compare the latest available interim statements with the financial statements being audited. Ascertain whether the interim statements were vigilant on the same basis as the audited financial statements. Inquire whether there was any significant change in the capital stock, long-term debt, or working capital to the date of inquiry. Inquire about the original status of items in the audited financial statements that were accounted for on the basis of tenta tive, preliminary, or inconclusive data. Inquire about any unusual adjustments made since the balance sheet date. Read or inquire about the minutes of meetings of stockholders or the board of directors. Inquire of the clients legal counsel concerning litigation, claims, and assessments. have a management representation letter, dated as of the date of Greens report, as to whether any subsequent events would require adjustment or disclosure. Make such additional inquiries or perform such additional procedures as Green considers necessary and appropriate. 19-26. (Estimated time 30 minutes) a. 1. A subsequent events review is utilise to provide reasonable assurance that the auditor is aware of significant events that have a material effect on financial statements. These are events that have occurred after the date of the financial statements but before the issuance of the audit report. 2.If the subsequent event is one that provides additional evidence concerning conditions existi ng at the date of the financial statements, then the financial statements must be adjusted. If the subsequent event is one that provides evidence concerning conditions that arose after the date of the financial statements, disclosure is required. b. 1. The auditor obtains written representations from the client as part of the evidence gathered to meet the third standard of field work. The purpose of these written representations by management is to Confirm oral representations given to the auditor. Impress on management that it has the primary responsibility for the financial statements. 2. The client representation letter may include statements concerning the following matters Completeness and availability of the accounting records and minutes of meetings of shareholders, directors, and committees. Absence of live(a) transactions and errors and irregularities in the financial statements. Existence of related party transactions or contingencies. Plans or purposeions that may affect the carrying value of assets and liabilities. . 1. The purpose of the management letter is to communicate to management the auditors recommendations regarding improvements in the efficiency and the effectiveness of matters that came to the auditors attention during the audit. 2. Three major subjects that may be addressed in the management letter include the following. Internal control structure weaknesses that are considered immaterial. Improvements to the accounting and information system. Improvements to the internal controls related to achieving the objectives of the organization. 9-27. (Estimated time 25 minutes) Item No. Required Disclosure or Audit Procedures Entry and Reasons 1. Goods in-transit would be detected in the course of the The receipt of the goods provides additional evidence with auditors review of the year-end crosscut of gets.The respect to conditions that existed at the date of the balance auditor would examine receiving reports and purch ase invoicessheet and hence the financial statements should be adjusted to to make certain that the liability to suppliers had been take into account such additional information. recorded for all goods included in inventory, and that all goods for which the client was liable at year end were recorded in inventory. 2. Settlements of litigation would be revealed by requesting Settlements of litigation would require an adjustment of the from the companys legal counsel a commentary and evaluationfinancial statements since the events that gave rise to the of any litigation, impending litigation, claims, and litigation had taken place prior to the balance sheet date. contingent upon(p) liabilities of which he or she has knowledge that existed at the date of the balance sheet being reported upon, together with a commentary and evaluation of any additional matters of a like nature which come to his or her attention up to the date the information is furnished.A review of cash disbursements for the period between the balance sheet date and completion of field work may also reveal evidence of the settlement. 3. The purchase would normally be Revealed in general The purchase of a new business is not an event that provides conversations with the client and would further be detected evidence with respect to conditions existing at the balance by cultivation the minutes of meetings of stockholders, sheet date hence, it does not require adjustments in the directors, and appropriate committee.In addition, because financial statements. However, such an event would normally be the amount paid is likely to be unusually large in relation of such importance that disclosures of it is required to keep to other cash disbursements, a review of cash disbursements the financial statements from being misleading. If the for the period between the balance sheet date and completion acquisition is significant en ough, it dexterity be advisable to of field work is likely to reveal such an extraordinary supplement the diachronic statements with pro-forma statements transaction.Moreover, because a purchase of a business indicating the financial results if the two firms had been usually requires a formal purchase agreement, the letter fromconsolidated for the year ending December 31, 19XO. Otherwise, the firms legal counsel would probably have revealed the disclosure in footnotes to the financial statements would be purchase. adequate. Occasionally, a situation of this type may have such a material impact on the entity that the auditor may wish to include in the audit report an explanatory paragraph directing the readers attention to the event and its effect. 4. Inventory losses attributable to a make full would be brought to Losses attributable to floods subsequent to the balance sheet the auditors attention through inquires and discussions withdate to not provide in fo rmation with respect to conditions corporate policemans and executives. Moreover, the auditor that existed at the balance sheet data hence, adjustment in would know the location of the plants and warehouses of the financial statements is not required. However, because the clients and upon becoming aware of any major floods in such alosses are material, they should be revealed in footnotes to location, he or she would check over to determine if the the financial statements. Occasionally, situation of this type clients facilities had suffered any damage. may have such a material Impact on the entity that the auditor may wish to include in the audit report an explanatory paragraph directing the readers attention to the event and its effect. 5. The sale of bonds or other securities would require a file Sales of bonds or capital stock are transactions of the type with the SEC in which the auditor would presumably be that do not provide information with espect to co nditions involved. In addition, the sale would be revealed by reading that existed at the balance sheet date hence, adjustment of the minutes of directors and finance committees meetings, bythe financial statements is not required. However, such sales corresponding with the clients attorneys and by examining may be of sufficient importance to require footnote the cash receipts books in the period subsequent to the disclosure. Occasionally, a situation of this type may have balance sheet date for evidence of unusually large receipts. such a material impact on the entity that the auditor may wish to in the audit report an explanatory paragraph directing the readers attention to the event and its effect. 19-28. (Estimated time 15 minutes) The substantive audit procedures that Young should apply when interrogation for loss contingencies relating to litigation, claims, and assessments include the following Read minutes of meetings of stockholders, directors, and comm ittees. Read get under ones skins, loan agreements, leases, and other documents. Read rest with taxing and other governmental agencies. Read correspondence with insurance and bonding companies. Read confirmation replies information concerning guarantees. Discuss with management the entitys policies and procedures for bring outing, valuating, and accounting for litigation, claims, and assessments. Obtain from management or the clients general counsel a description and evaluation of litigation, claims, and assessments. Obtain written assurance from management that the financial statements include all accruals and disclosures required by Statement on fiscal Accounting Standards No. 5. Examine documents in the clients possession concerning litigation, claims, and assessments, including correspondence from lawyers. Obtain an analysis of professional fee expenses and review supporting invoices for indications of contingencies. Request the clients management to prepare for tran smittal a letter of inquiry to those lawyers consulted by the client concerning litigation, claims, and assessments. Compare the lawyers response to the items in the letter of inquiry to the description and evaluation of litigation, claims, and assessments obtained from management. Determine that the financial statements include proper accruals and disclosures of the contingencies. 19-29. (Estimated time 25 minutes) 1. Disagree. Generally letters dumb on particular aspects of the request letter require follow-up.The auditor should contact the attorney and confirm that he or she intended the letter to completely respond to the request letter and was silent because there were no issues to discuss. Documentation of this confirmation should be included in the working papers. 2. Disagree. A useful evaluation is not always possible. For instance, it may include an element difficult to predict or to which the lawyer may not have paid sufficient attention to make an evaluation. If the m atter involved constitutes a material or contingent liability, the auditor will likely conclude there is an uncertainty with effects on the financial statements that cant be determined, and he or she should consider the effects of that uncertainty on the audit report. 3. Disagree.The attorneys opinion is an manakin of a marginally acceptable opinion. If such an opinion is issued on litigation where loss would seriously invalidate the companys operations, the auditor must give a qualified opinion and possibly consider a disclaimer of opinion. 4. Disagree. In some cases, attorneys, auditors, and clients discuss matters involving litigation, and during such informal discussions some attorneys express their opinions as to the outcome of challenge matters. Such oral opinions should be expressed in writing by the attorney, and if they are not lessen to writing, the discussions generally should not be considered audit evidence. 5. Disagree.The law firm derives all or substantially all o f its fees from the client. This is, in essence, analogous to in-house counsel. Evidence from in-house counsel may provide the auditor with the necessary corroboration in some cases. However, since the liability here is gravid, complete reliance on such evidence is not justified. 19-30. (Estimated time 25 minutes) Other matters that Aldermans representation letter should specifically confirm that The financial statements referred to above are jolly presented in conformity with generally accepted accounting principles. We have made available to you all Financial records and related data. Minutes of the meetings of stockholders, directors, and committees of directors, or summaries of actions of recent meetings for which minutes have not yet been prepared. thither are no material transactions that have not been properly recorded in the accounting records underlying the financial statements. There has been no Fraud involving management or employees who have significant roles in internal control. Fraud involving others that could have a material effect on the financial statements. Management believes that the effects of any uncorrected financial statement misstatements aggregated by the auditor during the current engagement and pertaining to the latest period presented are immaterial, both individually and in the aggregate, to the financial statements taken as a whole. The following have been properly recorded or disclosed in the financial statements Related-party transactions, including sales, purchases, loans, transfers, leasing arrangements, and guarantees, and amounts receivable from or payable to related parties. Guarantees, whether written or oral, under which the company is contingently liable. Significant estimates and material concentrations known to management that are required to be disclosed in accordance with the AIcertified public accountants Statement of Position 94-6, Disclosure of Certain Significant Risks and Uncertainties. There are no other liabilities or gain or loss contingencies that are required to be accrued or disclosed by FASB Statement No. 5. The company has satisfactory title to all owned assets, and there are no liens or encumbrances on such assets nor has any asset been assure as collateral. The company has complied with all aspects of contractual agreements that would have a material effect on the financial statements in the event of noncompliance. Debt securities that have been classify as held-to-maturity have been so classified due to the companys intent to hold such securities, to maturity and the companys ability to do so. All other debt securities appropriately have been classified as available-for-sale or trading. Provision has been made to reduce excess or obsolete inventories to their estimated net realizable value. Capital stock reserved for options, warrants, conversions, or other requirements have been properly disclosed. 19-31. (Estimated time 30 minutes) a.The use of overall analytical review at the final stages of an audit has two general advantages to the certified public accountant (1) a broad view is obtained of the date of the financial statements, and (2) the CPAs attention is focused on exceptions or variations in the data. A broad view of the data under audit is needed by the CPA to draw conclusions about the data as a whole. Merely looking at individual transactions may lead the auditor to overlook important variations in the underlying data. The application of analytical procedures to the final data to obtain this broad view requires a discerning analysis of the data, which results in overall conclusions upon which the CPAs audit satisfaction rests. The CPA is thus able to satisfy him or herself as to the reasonableness, validity, and consistency of the data in view of the surround circumstances.The focusing of the CPAs attention on exceptions or variations in the data results in a more cost-efficient and economical audit because there is a r eduction in the amount of detailed testing which would be required, in the absence of overall checks, to uncover these exceptions or variations. Furthermore, manipulations of accounts may be revealed because the double-entry bookkeeping system extends the effects of manipulations to additional accounts, which will then bear a changed relationship to other accounts. In addition, managerial problems and overturn spots will be highlighted for the CPA and may lead to the opportunity to be of additional swear out to the client. b.The ratios that a CPA may compute during an audit as overall checks on balance sheet accounts and related nominal accounts may include the following Accruals of individual expenses to related total expenses. Calculations of the entitys run cycle. Individual components of return on assets and return on equity. The impact of an entitys financing and investing activities. The ability of cash flow from operations to service debt and dividends. Other measure s of the entitys liquidity and solvency. c. 1. The possible reasons for a devolve in the rate of inventory turnover include the following Decline in sales. Increase in inventory quantities, intentional or unintentional. Incorrect computation of inventory because of errors in pricing, extensions, or taking of physical inventory. Inclusion in inventory of slow-moving or obsolete items. Erroneous cutoff of purchases. Erroneous cutoff of sales under the perpetual inventory accounting method. Unrecorded purchases. convert in inventory valuation method. 2. The possible reasons for an increase in the number of days sales in receivable include the following exchange in credit terms. Decreasing sales. Change in the sales mix of products with different sales terms. Change in mix of customers. Improper sales cutoff. Unrecorded sales. Lapping. Slower collections caused by tighter economic conditions or expectant of the quality of the receivables. 19-32. (Estimated time 20 mi nutes) a. Reportable conditions are matters that come to an auditors attention, which, in the auditors judgment, should be communicated to the clients audit committee or its equivalent because they represent significant deficiencies in the design or operation of the internal control structure, which could adversely affect the organizations ability to record, process, summarize, and report financial data consistent with the assertions of management in the financial statements.Material weaknesses are reportable conditions in which the design or operation of specific internal control structure elements do not reduce, to a relatively low level, the risk that errors or irregularities in amounts that would be material in relation to the financial statements being audited may occur and not be detected within a timely period by employees in the normal course of performing their assigned functions. b. An auditor is required to identify reportable conditions that come to the auditors attentio n in the normal course of an audit, but is not obligated to search for reportable conditions. The auditor uses judgment as to which matters are reportable conditions. Provided the audit committee has acknowledged its understanding and consideration of such deficiencies and the associated risks, the auditor may decide certain matters do not need to be reported unless, because of changes in management or the audit committee, or because of the passage of time, it is appropriate to do so.Conditions noted by the auditor that are considered reportable should be reported, preferably in writing. If information is communicated orally, the auditor should document the communication. The report should state that the communication is intended solely for the information and use of the audit committee, management, and others within the organization. The auditor may identify and communicate separately those reportable conditions the auditor considers to be material weaknesses, but may not state tha t no reportable conditions were noted during the audit. Reportable conditions may be communicated during the course of the audit rather than after the audit is concluded. depending on the relative significance of the matters noted and -the sine qua non of corrective follow-up action. 19-33. (Estimated time 30 minutes) a. Deficiency Proper Wording 1. In completing our audit In planning and performing our audit 2. Its internal control environment Its internal control structure 3. Not to express an opinion Not to provide assurance 4. The design and effectiveness The internal control structure and its operation of the system 0f internal control 5. Under GAAS Under standards 6. Potential weaknesses Significant 7. To prepare financial To record, process, summarize, and report financial data consistent statements in conformity with the assertions of management in the financial statements. 8. For the audit committee For the information and use of the audit committee, managem ent, and and others others b. A reportable condition may be of such magnitude as to be a material weakness. Thus, all material weaknesses are reportable conditions, but all reportable conditions are not material weaknesses. The two terms are defined as follows Reportable conditions represent significant deficiencies in the design or operation of the internal control structure, which could adversely affect the organizations ability to record, process, summarize, and report financial data consistent with the assertions of management in the financial statements. A material weakness is a reportable condition in which the design or operation of the specific internal control structure elements does not reduce to a relatively low level the risk that misstatements in amounts that would be material in relation to the financial statements being audited may occur and not be detected within a timely period by employees in the normal course of performing their assigned functions. c. Two addi tional paragraphs are required when the auditor refers to material weaknesses in the audit report. The first paragraph should include a definition of a material weakness and a description of reportable conditions that are material weaknesses.The second paragraph should describe the limitations of the auditors work i. e. , that the work would not necessarily disclose all reportable conditions that are also material weaknesses. 19-34. (Estimated time 20 minutes) a. nonparasitic auditors use a management letter to call to managements attention matters that the auditor has noted during the course of the audit engagement but which did not fall within the scope of the opinion. The management letter provides an excellent fomite for suggesting value-added services that can assist the business in improving organizational performance. A management letter is rendered as a constructive service to suggest improvements as well as point out deficiencies. b.Many types of information can be covere d in a management letter. The major, broad areas which are presented and discussed in the management letter include Suggestions for modifying and improving a clients internal controls. Recommendations for changes and improvements in accounting systems to better meet managements information needs. Suggestions for improving the management of resources such as cash, inventories, and investments. Comments regarding tax related matters. A detailed deterrent example of a suggestion for improving business practices follows We understand that your accounting system offers discounts to customers who purchase in significant volumes.The program that grants these volume discounts as it prices a sales invoice does so after important information on gross margins has been reported to department managers. While sales invoices and underlying accounting information is correct, it does not agree with management information that is provided to sales managers as they make pricing decisions. As soon as possible you need to change the program that calculates the sales discounts so that gross margins and other information used by sales management includes the volume discounts offered customers. (Answer updated from original ICMA answer. ) 19-35. (Estimated time 30 minutes) a. 1. 1subsequent event during the subsequent event period requiring adjustment. 2. 1subsequent event during the subsequent event period requiring adjustment. 3. subsequent event during the subsequent event period requiring disclosure. 4. 2subsequent event during the subsequent event period requiring disclosure 5. 1subsequent event during the subsequent event period requiring adjustment. 6. 4subsequent event occurring after field work but before issuance of report. 7. 4subsequent event occurring after field work but before issuance of report. 8. 5postaudit discovery of facts existing at date of report. The date field work is completed is not specifically given. This answer is based on the usual practice of d ating the audit report as of the end of field work (i. e. , February 26). b.For categories (1) and (2) the auditor has the responsibility for identifying and evaluating subsequent events up to the date of the auditors report. In discharging this responsibility, the auditor should be alert for subsequent events in performing substantive tests, and also perform specific auditing procedures at or near the completion of field work. For categories (3) and (4), the auditor has no responsibility to make inquiry or to perform any auditing procedures during this time period to discover subsequent events. However, if knowledge of such an event comes to the auditors attention, he or she should determine whether the event requires adjustment of or disclosure in the financial statements. For phratry (5), the auditor has no responsibility for their discovery.However, if the auditor becomes aware of such facts and the facts may have affected the report that was issued, the auditor is required to ascertain the reliability of the information. c. Information about the items would be obtained from the following 1. Inquiry of management client rep letter. 2. Review of bad debt write-offs in January. 3. recital of minutes. 4. Observation of fire newspaper account of fire inquiry of management. 5. Inquiry of management lawyers letter and client rep letter. 6. Reading of minutes. 7. Newspaper story on takeover inquiry of management. 8. Inquiry of management lawyers letter and client rep letter.If the client fails to make required disclosure, the auditor should notify each member of the board of directors of such refusal and take the following steps to prevent further reliance on the audit report and Notify the client that the audit report must no longer be associated with the financial statements. Notify regulatory agencies having jurisdiction over the client that the report should no longer be relied on. Notify (generally via the regulatory agency) each individual known to be r elying on the statements that the report should no longer be relied on. Cases 19-36. follow up separate file with answers to the comprehensive case related to the audit of Mt. Hood Furniture that is included with this chapter. air Several revisions were made to this problem to correct printing errors. The revised problem is posted on the disciple resources website. 19-37. (Estimated time 25 minutes) a. and b. 1. The state governments approval of a plan for the construction of an express highway would have come to the CPAs attention through inquiries of officers and key personnel, mental testing of the minutes of the meetings of the board of directors and stockholders, and reading local newspapers. The details of the item would not have to be disclosed as a separate footnote because all fixed assets of the corporation, including the right to the condemnation award, were to be sold as of March 1, 19X1. 2.It is improbable that the CPA would gather up the source of the $25,000 u nless it were revealed in a discussion with the president or his personal accountant, or unless the auditor prepared the presidents personal income tax return, in which case the interest charges would have led to his investigation of the use to which the specie were put. Setting out the loan in the balance sheet as a loan from an officer would be sufficient disclosure. The source from which the officer obtained the funds would not be disclosed because it is the officers personal business and has no effect upon the corporations financial statements. Indeed, disclosure of the funds source cogency be construed as detrimental to the officer. 3. The additional liability for the ore shipment would have been revealed by CPAs scanning of January transactions. The CPAs regular xamination of 19XO transactions and related documents such as purchase contracts would have caused him or her to note the item for subsequent follow-up to determine the final liability. In addition, the clients lette r of representation big businessman have mentioned the potential liability. The item would not require separate disclosure by footnote or otherwise and would be handled by adjusting the financial statement accounts payable by the amount of the additional charge, $9,064 4. The CPA might learn of the agreement to purchase the treasurers stock ownership through inquiries of management and legal counsel, examination of the minutes of the meetings of the board of directors and stockholders, and subsequent reading of the agreement. The absence of the treasurer might also arouse the CPAs curiosity.The details of the agreement would be disclosed in a footnote because the use of company cash for the repurchase of stock and the change in the amount of stock held by stockholders might have a heavy impact on subsequent years financial statements. Usually a management change, such as the treasurers resignation, does not require disclosure in the financial statements. The details underlying the interval (personal disagreements and divorce) should not be disclosed because they are personal matters. 5. Through inquiries of management, review of financial statements for January, scanning of transactions, and observations, the CPA would learn of the reduced sales and of the strike.Disclosure would not be made in the financial statements of these conditions because such disclosure might create doubt as to the reasons therefore and misleading inference might be drawn. 6. The contract with Mammoth Industries would come to the CPAs attention through inquiries of management and legal counsel, reading the minutes of the meetings of the board of directors and stockholders, and examination of the contract. All important details of the contract should be disclosed in a footnote because of the great effect upon the corporations future. The factors contributing to the entry into the contract need not be disclosed in the statements man they might be of interest to readers, hey are by no means essential to make the statements not misleading. 19-38. (Estimated time 25 minutes) The omissions, ambiguities, and inappropriate statements and terminology in Browns letter are as follows The action that fused intends to take concerning each suit (for example, to contest the matter vigorously, to seek an out-of-court settlement, or to appeal an adverse decision) is omitted. A description of the progress of each case to date is omitted. An evaluation of the likelihood of an unfavorable outcome of each case is omitted. An estimate, if one can be made, of the amount or range of potential loss of each case is omitted. The various other pending or threatened litigation on which Young was consulted is not identified and included. The unasserted claims and assessments probable of assertion that have a reasonable possibility of an unfavorable outcome are not identified. Consolidateds understanding of Youngs responsibility to advise Consolidated concerning the disclosure of u nasserted possible claims or assessments is omitted. Materiality (or the limits of materiality) is not addressed. The reference to a limitation on Youngs response due to confidentiality is inappropriate. Young is not requested to identify the nature of and reasons for any limited response. Young is not requested to include matters that existed after December 31, 1992, up to the date of Youngs response. The date by which Youngs response is needed is not indicated. The reference to Youngs response possibly being quoted or referred to in the financial statements is inappropriate. Vague terminology such as slight and some venture is included where remote and possible are more appropriate. There is no inquiry about any unpaid or unbilled charges, services, or disbursements. Research Questions For the reasons specified in the introduction to this manual, solutions are not provided for this category of questions.

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