Review the Lecture Notes and Reading Materials, Ask in the Tutorial

Auditing & Ethics Issues

Tutorial 24

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Tutorial 24:Review of Events after the Balance Sheet Date and Provisions, contingent liabilities and contingent assets

Review the lecture notes and reading materials, ask in the tutorial if you do not understand.

Part IMultiple Choice and short Questions

1.When auditing contingent liabilities, which of the following procedures would be least effective?

a.Reading the minutes of the board of directors.

b.Reviewing the bank confirmation letter.

c.Examining customer confirmation replies.

Examining invoices for professional services.

2.When obtaining evidence regarding litigation against a client, the CPA would be least interested in determining

a.An estimate of when the matter will be resolved.

b.The period in which the underlying cause of the litigation occurred.

c.The probability of an unfavorable outcome.

An estimate of the potential loss.

3.Which of the following subsequent events will be least likely to result in an adjustment to the financial statements?

a.Culmination of events affecting the realization of account receivable owned as of the balance sheet date.

b.Culmination of events affecting the realization of inventories owned as of the balance sheet date.

c.Material changes in the settlement of liabilities which were estimated as of the balance sheet date.

d.Material changes in the quoted market prices of listed investment securities since the balance sheet date.

4.Subsequent events for reporting purposes are defined as events which occur subsequent to the

a.Balance sheet date.

Date of the auditor's report.

c.Balance sheet date but prior to the date of the auditor's report.

d.Date of the auditor's report and concern contingencies which are not reflected in the financial statements.

5.Which of the following material events occurring subsequent to the balance sheet date would require an adjustment to the financial statements before they could be issued.

a.Sale of long-term debt or capital stock.

b.Loss of a plant as a result of a flood.

c.Major purchase of a business which is expected to double the sales volume.

d.Settlement of litigation, in excess of the recorded liability.

6.Which of the following expressions is least likely to be included in a client's representation letter?

a.No events have occurred subsequent to the balance sheet date that requires adjustment to, or disclosure in, the financial statements.

b.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.

c.Management acknowledges responsibility for illegal actions committed by employees.

Management has made available all financial statements and related data.

Short Questions

As part of an audit, a CPA often requests a representation letter from the client. What is a valid purpose of such a letter?

8.In the course of the examination of financial statements for the purpose of expressing an opinion thereon, the auditor will normally prepare a schedule of unadjusted differences for which the auditor did not propose adjustment when they were uncovered. What is the primary purpose served by this schedule?

Part II Long Questions

9.Misconceptions of Auditing

(a)The objective of auditing is to detect fraud.

(b)Auditors examine all, or most, business transactions to ensure correctness of financial statements.

(c)The audit of the financial statements relieves management of its responsibilities for preparing and presenting the financial statements.

(d)Auditors should conduct an audit in accordance with Statements of Standard Accounting Practice.

(e)On recurring auditors, auditors cannot revise the terms of engagement; this would be a breach of contract.

(f)Once the engagement partner has approved the audit plan and the audit programme, no one can revise either of these things.

(g)The client pays for the audit; thus the working papers are the client’s property.

(h)The higher the assessment of inherent and control risks, the smaller the importance that the auditors should obtain sufficient appropriate audit evidence from the performance of substantive procedures.

(i)If they are unable to obtain sufficient appropriate audit evidence, the auditors should express a qualified (except for disagreement) opinion or a disclaimer of opinion.

(j)The auditors should date the auditors’ report as of the date on which the directors approved the financial statements.

Required:

Correct the misconceptions from items (a) to (j) above.(20 marks)

10.Consider each of the following independent and material situations.

In each case:

The balance sheet date is 31 January 2001.
The fieldwork was completed on 5 March 2001.
The financial statements and the auditors’ report were signed on 12 March 2001.
The financial statements and the auditors’ report mailed to the members on 20 March 2001.

a)Your client, MM Mining, owns a mineral exploration license in central China. At 31 January 2001, this license was valued by an independent expert at HK$50M. This valuation is reflected in the financial statements. On 8 March 2001, MM Mining received notice that a claim was being lodged under the new government legislation returning property back to its original owners, (i.e. prior 5to the revolution) for land which included that subject to the exploration license. If the claim is successful the exploration license will be worthless.

b)Same facts as in a) but MM Mining receives the notice on 14 March 2001.

c)Your client BF Limited derives approximately 10% of revenues from selling aviary supplies to city-based bird breeders.

A government report, leaked to the press and reported in the media on 11 February 2001, recommends that strict limits be placed on the number of birds allowed to be kept in suburban areas. BF Limited estimates that if the recommendations are enacted, about 70% of its customers will have to cut their flocks by 50% or more. This would affect future sales.

d)Your client, GP Limited made an out-of-court settlement on 1 March 2001 of HK$300,000. The settlement was in relation to a litigation case dating back to 1996. A provision of HK$150,000 was recorded in the financial statements for the year ended 31 January 2001.

e)Same facts as e), except that the settlement was made on 18 March 2001.

f)On 14 March 2001, you discover a debtor of your client, CP Limited, was placed in provisional liquidation on 8 March 2001. The debtor owed HK$600,000 as at 31 January 2001; a specific provision of HK$300,000 of this amount was made at this date. On very preliminary information the likely payout to unsecured creditors is zero.

g)A flood occurred in the warehouse of your client, PP Limited, on 2 February 2001. Inventory valued at HK$2M was destroyed. The directors believe only half of this value will be recovered from the insurers.

h)Same facts as g), but the insurance company decides to replace the entire inventory destroyed. The new inventory is at the premises of PP Limited on 6 March 2001.

REQUIRED

For each of the above events, a) to h), state the appropriate action i) to v) for the situation and justify your response. The alternative actions are as follows:

i)Adjust the financial statements for the year ended 31 January 2001.

ii)Disclose the information in the notes to the financial statements for the year ended 31 January 2001.

iii)Request the client to amend the financial statements for the year ended 31 January 2001 and plan to issue a new auditors’ report.

iv)Consider whether the financial statements are misleading and whether any further action is required under SAS 150.

v)No action is required.

Part III Revision Questions

Case study 1, page 392 of Chapter 34, Alan Millichamp

Question 1, page 291 of Chapter 18, Teresa Ho

Question 2,page 292 of Chapter 18, Teresa Ho

Tutorial Exercise - Answer

Tutorial 24 Review of Post Balance Sheet Events and Contingencies

7.To satisfy himself or herself by means of other auditing procedures when certain customary auditing procedures are not performed.

8.To satisfy him or her by means of other auditing procedures when certain customary auditing procedures are not performed.

Misconceptions / Corrections
(a)The objective of auditing is to detect fraud. / (a)The objective of an audit is to attest to the truth and fairness of the financial statements.
(b)Auditors examine all, or most, business transactions to ensure correctness of financial statements. / (b)When reporting on financial statements, auditors provide a level of assurance which is reasonable in the context but, cannot be absolute. Therefore auditors need not examine all, or most, business transactions in most cases.
(c)The audit of the financial statements relieves management of its responsibilities for preparing and presenting the financial statements. / (c)Auditors are responsible for forming and expressing an opinion on the financial statements; the responsibility for preparing and presenting the financial statements is that of the management of the entity. The audit of the financial statements does not relieve management of its responsibilities.
(d)Auditors should conduct an audit in accordance with Statements of Standard Accounting Practice. / (d)Auditors should conduct an audit in accordance with Statements of Auditing Standards.
(e)On recurring audits, the auditors cannot revise the terms of engagement; this would be a breach of contract. / (e)On recurring audits, the auditors should consider whether circumstances require the terms of engagement to be revised and whether there is a need to remind the client of the existing terms of the engagement. Revision of the engagement letter would not constitute a breach of contract.
(f)Once the engagement partner has approved the audit plan and the audit programme, no one can revise either of these things. / (f)The overall audit plan and the audit programme should be revised as necessary during the course of the audit. Changes to the overall audit plan or planned audit procedures may be required because of changes in conditions or unexpected results of audit procedures. The reasons for significant changes should be recorded.
(g)The client pays for the audit; thus the working papers are the client’s property. / (g)Working papers are the property of the auditors. Although portions of or extracts from the working papers may be made available to the entity at the auditors’ discretion, they are not a substitute for the entity’s accounting records.
(h)The higher the assessment of inherent and control risks, the smaller the importance that the auditors should obtain sufficient appropriate audit evidence from the performance of substantive procedures. / (h)The level of detection risk relates directly to the auditors’ substantive procedures. Therefore the higher the assessment of inherent and control risks, the greater the importance that the auditors should obtain sufficient appropriate audit evidence from the performance of substantive procedures.
(i)If they are unable to obtain sufficient appropriate audit evidence, the auditors should express a qualified (except for disagreement) opinion or a disclaimer of opinion. / (i)A qualified (except for disagreement) opinion applies only where the auditors disagree with the accounting treatment or disclosure of a matter in the financial statements, and in the auditors’ opinion the effect of that disagreement is material to the financial statements. A qualified (except for limitation) opinion applies where the auditors could not obtain sufficient appropriate audit evidence. s]
(j)The auditors should date the auditors’ report as of the date on which the directors approved the financial statements. / (j)The auditors should date the auditors’ report as of the completion date of the audit. If the date of completion is later than that on which the directors approve the financial statements, the auditors should take such steps as are appropriate to ensure that their procedures for reviewing subsequent events covered the period up to that date.

10Chronology of Events:

31/01/0105/03/0112/03/0120/03/01

Year endAuditFinancialFinancial

completestatements andstatements and

auditors’ reportauditors’ report

signedmailed

PART

/ ACTION / WHY?
a) / ii) / As the claim is only contingent at this stage, it should be disclosed by way of a note to the financial statements.
b) / iii) / On the basis that the client agrees to amend the financial statements, an appropriate disclosure should be made in the notes and a new auditors’ report would be issued and dated not earlier than the date the amended financial statements are approved by the directors.
c) / v) / This event is more likely to be addressed in the Directors’ Report.
The report is unconfirmed and the impact is impossible to predict.
d) / i) / This is a subsequent event which requires adjustment in the financial statements as it occurred prior to the signing of the auditors’ report, and clarifies conditions existing at the balance sheet date.
The provision should be increased by HK$150,000 to reflect full settlement (i.e. liability at year end of HK$300,000)
e) / iii) / This is a subsequent event which requires adjustment in the financial statements as it clarifies conditions existing at the balance sheet date.
On the basis that the client agr4ees to adjust the financial statements, a new auditors; report would be issued and dated not earlier than the date the amended financial statements are approved by the directors.
f) / iii) / This is an adjusting subsequent event. The relevant date is 8 March and an additional provision of HK$300,000 should be made (or the entire HK$600,000 written off).
On the basis that the client agrees to adjust the financial statements, a new auditors’ report would be issued and dated not earlier than the date the amended financial statements are approved by the directors.
g) / ii) / This is a non-adjusting subsequent event. It should be disclosed in a note to the financial statements.
h) / v) / As the inventory is being replaced in full by the insurance company, there is no effect on the financial statements at 31 January 2001.
The event may be disclosed in the Directors’ Report if desired.

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AEI-TE-L24- 2003