Chapter 24Solution Manual.docx
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Chapter 24Solution Manual.docx
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Chapter24SolutionManual
Chapter24
CompletingtheAudit
ReviewQuestions
24-1Therearefourpresentationanddisclosure-relatedauditobjectives:
PRESENTATIONANDDISCLOSURE-RELATEDAUDITOBJECTIVES
DESCRIPTION
Occurrenceandrightsandobligations
Account-relatedinformationasdescribedinthefootnotesexistsandrepresentstherightsandobligationsofthecompany.
Completeness
Allrequireddisclosuresareincludedinthefinancialstatementfootnotes.
Accuracyandvaluation
Footnotedisclosuresareaccurateandvaluedcorrectly.
Classificationandunderstandability
Accountbalancesareappropriatelyclassifiedandrelatedfinancialstatementdisclosuresareunderstandable.
24-2Afinancialstatementdisclosurechecklistisanaudittoolthatsummarizesalldisclosurerequirementscontainedinaccountingstandards.Auditorsusethedisclosurechecklisttodeterminethatallrequireddisclosuresarecompletelypresentedanddisclosedinthefinancialstatementsandaccompanyingfootnotes.Thishelpstheauditorobtainsufficientappropriateevidenceaboutthecompletenessobjectiveforthepresentationanddisclosure-relatedauditobjective.
24-3Acontingentliabilityisapotentialfutureobligationtoanoutsidepartyforanunknownamountresultingfromactivitiesthathavealreadytakenplace.Someexampleswouldbe:
Pendinglitigation
Incometaxdisputes
Productwarranties
Notesreceivablediscounted
Guaranteesofobligationsofothers
Unusedbalancesofoutstandinglettersofcredit
24-3(continued)
Anactualliabilityisarealfutureobligationtoanoutsidepartyforaknownamountfromactivitiesthathavealreadytakenplace.Someexampleswouldbe:
Notespayable
Accountspayable
Accruedinterestpayable
Incometaxespayable
Payrollwithholdingliabilities
Accruedsalariesandwages
24-4Ifyouareconcernedaboutthepossibilityofcontingentliabilitiesforincometaxdisputes,therearevariousproceduresyoucoulduseforanintensiveinvestigationinthatarea.Oneapproachwouldbeananalysisofincometaxexpense.Unusualornonrecurringamountsshouldbeinvestigatedtodetermineiftheyrepresentsituationsofpotentialtaxliability.AnotherhelpfulprocedureforuncoveringpotentialtaxliabilitiesistoreviewthegeneralcorrespondencefileforcommunicationwithattorneysorIRSagents.Thismightgiveanindicationthatthepotentialforaliabilityexistseventhoughnoactuallitigationhasbegun.Finally,anexaminationofinternalrevenueagentreportsfromprioryearsmayprovidethemostobviousindicationofdisputedtaxmatters.
24-5Theauditorwouldbeinterestedinaclient'sfuturecommitmentstopurchaserawmaterialsatafixedpricesothatthisinformationcouldbedisclosedinthefinancialstatements.Thecommitmentmaybeofinteresttoaninvestorasitiscomparedtothefuturepricemovementsofthematerial.Afuturecommitmenttopurchaserawmaterialsatafixedpricemayresultintheclientpayingmoreorlessthanthemarketpriceatafuturetime.
24-6Theanalysisoflegalexpenseisanessentialpartofeveryauditengagementbecauseitmaygiveanindicationofcontingentliabilitieswhichmaybecomeactualliabilitiesinthefutureandrequiredisclosureinthecurrentfinancialstatements.Sinceanysinglecontingencycouldbematerial,itisimportanttoverifyalllegaltransactions,eveniftheamountsaresmall.Aftertheanalysisoflegalexpenseiscompleted,theattorneystowhompaymentwasmadeshouldbeconsideredforlettersofconfirmationforcontingencies(attorneyletters).
24-7PysonshoulddeterminethematerialityofthelawsuitsbyrequestingfromMerrill'sattorneysanassessmentofthelegalsituationsandtheprobableliabilitiesinvolved.Inaddition,Pysonmayhavehisownattorneyassessthesituations.Properdisclosureinthefinancialstatementswilldependontheattorneys'evaluationsoftheprobableliabilitiesinvolved.Iftheevaluationsindicatehighlyprobable,materialamounts,disclosurewillbenecessaryintheformofafootnote,assumingtheamountoftheprobablemateriallosscannotbereasonablyestimated.Iftheclientrefusestomakeadequatedisclosureofthecontingencies,aqualifiedoradverseopinionmaybenecessary.
24-8Anassertedclaimisanexistinglegalactionthathasbeentakenagainsttheclient,whereasanunassertedclaimrepresentsapotentiallegalaction.Theclient'sattorneymaynotrevealanunassertedclaimforfearthatthedisclosureofthisinformationmayprecipitatealawsuitthatwouldbedamagingtotheclient,andthatwouldotherwisenotbefiled.
24-9Ifanattorneyrefusestoprovidetheauditorwithinformationaboutmaterialexistinglawsuitsorlikelymaterialunassertedclaims,theauditopinionwouldhavetobemodifiedtoreflectthelackofavailableevidence.Thisisrequiredbyauditingstandards,andhastheeffectofrequiringmanagementtogiveitsattorneyspermissiontoprovidecontingentliabilityinformationtoauditorsandtoencourageattorneystocooperatewithauditorsinobtaininginformationaboutcontingencies.
24-10Thefirsttypeofsubsequenteventisonethathasadirecteffectonthefinancialstatementsandrequiresadjustment.Examplesofthistypeofsubsequenteventareasfollows:
Declarationofbankruptcybyacustomerwithanoutstandingaccountsreceivablebalanceduetothedeterioratingfinancialcondition
Settlementofalitigationforanamountdifferentfromtheamountrecordedonthebooks
Disposalofequipmentnotbeingusedinoperationsatapricebelowthecurrentbookvalue
Saleofinvestmentsatapricebelowrecordedcost
Saleofrawmaterialasscrapintheperiodsubsequenttothebalancesheetdate
Thesecondtypeofsubsequenteventisonethathasnodirecteffectonthefinancialstatementsbutforwhichdisclosureisadvisable.Examplesincludethefollowing:
Declineinthemarketvalueofsecuritiesheldfortemporaryinvestmentorresale
Issuanceofbondsorequitysecurities
Declineinthemarketvalueofinventoryasaconsequenceofgovernmentactionbarringfurthersaleofaproduct
Uninsuredlossofinventoriesasaresultoffire
24-11Malano'sapproachdoesnottakeintoconsiderationtheneedtoobtainlettersfromattorneysasneartheendoffieldworkaspossible.Ifthelettersarereceivednearthebalancesheetdate,theperiodfromthebalancesheettotheendoftheauditor'sfieldworkwillnotbeincludedintheattorneys'letters.Hisprocedurewouldnotobtainthemostcurrentinformationregardingcontingentliabilities,andwouldnotprovideadequateinformationfordisclosureofpertinentsubsequentevents.
24-12Themajorconsiderationstheauditorshouldtakeintoaccountindetermininghowextensivethesubsequenteventsreviewshouldbeare:
Thecompany'sfinancialstrengthandstabilityofearnings
Theeffectivenessofthecompany'sinternalcontrols
Thenumberandsignificanceoftheadjustmentsmadebytheauditor
Thelengthoftimebetweenthebalancesheetdateandthecompletionoftheaudit
Changesinkeypersonnel
AuditorsofpubliccompaniesshouldbeawarethatPCAOBStandard5requiresthemtoalsoinquireaboutchangesininternalcontroloverfinancialreportingoccurringsubsequenttotheendofthefiscalperiodthatmightsignificantlyaffectinternalcontroloverfinancialreporting.
24-13Auditproceduresnormallyperformedasapartofthereviewforsubsequenteventsare:
Cutoffandvaluationtestsofvariousbalancesandrelatedtransactions;e.g.,salescutofftests
Inquireofmanagement
Correspondwithattorneys
Reviewinternalstatementspreparedsubsequenttothebalancesheetdate
Reviewrecordspreparedsubsequenttothebalancesheetdate
Examineminutesofmeetingsofboardofdirectorsandstockholderssubsequenttothebalancesheetdate
Obtainaletterofrepresentation
24-14Subsequenteventsoccurringbetweenthebalancesheetdateandthedateoftheauditor'sreportarethosetransactionsandeventswhichmightaffectthefinancialstatementsbeingaudited(eitheradjustment,disclosure,orboth).Examplesofthesetypesofeventswouldbe:
Declarationofbankruptcybyacustomerwithanoutstandingaccountsreceivablebalanceduebecauseofadeterioratingfinancialcondition
Settlementofalitigationforanamountdifferentfromtheamountrecordedonthebooks
Disposalofequipmentnotbeingusedinoperationsatapricebelowthecurrentbookvalue
Saleofinvestmentsatapricebelowrecordedcost
Saleofrawmaterialasscrapintheperiodsubsequenttothebalancesheetdate
Declineinthemarketvalueofsecuritiesheldfortemporaryinvestmentorresale
24-14(continued)
Issuanceofbondsorequitysecurities
Declineinthemarketvalueofinventoryasaconsequenceofgovernmentactionbarringfurthersaleofaproduct
Uninsuredlossofinventoriesasaresultoffire
Iftheseeventsandtransactionshaveamaterialeffectonthefinancialstatements,theymayrequireadjustmentofthecurrentperiodfinancialstatementsordisclosure.Auditorsoflargerpubliccompaniesshouldalsobealertforsubsequentchangesininternalcontroloverfinancialreporting.
Thesubsequentdiscoveryoffactsexistingatthedateoftheauditor'sreportoccurswhentheauditorbecomesawarethatsomeinformationincludedinthefinancialstatementswasmateriallymisleadingaftertheauditedfinancialstatementshavebeenissued.Someexamplesofsuchfactswouldbe:
Subsequentdiscoveryoftheinclusionoffraudulentsales
Subsequentdiscoveryofthefailuretowrite-offobsoleteinventory
Omissionofanessentialfootnote
Insuchcaseswhentheauditordiscovers
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