Learning Objectives

Financial Indications

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  Net liability or net current liability position.
  
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  Fixed-term borrowings approaching maturity without realistic prospects of renewal or repayment, or excessive reliance on short-term borrowing to finance long-term assets.
  
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  Indications of withdrawal of financial support by debtors and other creditors.
  
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  Negative operating cash flows indicated by historical or prospective financial statements.
  
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  Adverse key financial ratios.
  
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  Substantial operating losses or significant deterioration in the value of assets used to generate cash flows.
  
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  Arrears or discontinuance of dividends.
  
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  Inability to pay creditors on due dates.
  
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  Difficulty in complying with the terms of loan agreements.
  
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  Change from credit to cash-on-delivery transactions with suppliers.
  
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  Inability to obtain financing for essential new product development or other essential investments.
  

Operating Indications

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  Loss of key management without replacement.
  
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  Loss of major market, franchise, license or principal supplier.
  
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  Labor difficulties or shortages of important supplies.
  

Other indications

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  Non-compliance with capital or other statutory requirements.
  
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  Pending legal proceedings against the entity that may, if successful, result in judgments that could not be met.
  
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  Changes in legislation or government policy expected to adversely affect the entity.
  

The auditor’s responsibility is to consider the appropriateness of management’s use of the going concern assumption in the preparation of the financial statements, and consider whether there are material uncertainties about the entity’s ability to continue as a going concern that need to be disclosed in the financial statements.

MATTERS FOR ATTENTION OF PARTNERS (MAPS)

• 
  Doubt Of Entity’s Ability to Continue as a Going Concern
  

When events or conditions have been identified which may cast significant doubt on the entity’s ability to continue as a going concern, the auditor should: ⁴⁷

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  review management’s plans for future actions based on its going concern assessment;
  
• 
  seek written representations from management regarding its plans for future action;
  
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  gather sufficient appropriate audit evidence to confirm or dispel whether or not a material uncertainty exists through carrying out procedures considered necessary.
  

• 
  Procedures to Gather Audit Evidence
  

Procedures to gather sufficient appropriate audit evidence may include:

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  analyzing and discussing cash flow, profit and other relevant forecasts with manage- ment;
  
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  analyzing and discussing the entity’s latest available interim financial statements;
  
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  reviewing the terms of debentures and loan agreements and determining whether any have been breached;
  
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  reading minutes of the meetings of shareholders, the board of directors and important committees for reference to financing difficulties.
  
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  asking the company’s lawyer about the existence of litigation and claims and the reasonableness of management’s assessments of their outcome and the estimate of their financial implications;
  
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  confirming the existence, legality and enforceability of arrangements to provide or maintain financial support with related and third parties and assessing the financial ability of such parties to provide additional funds;
  
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  considering the entity’s plans to deal with unfilled customer orders;
  
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  reviewing events after period end to identify those that either mitigate or otherwise affect the entity’s ability to continue as a going concern.
  

If, based on the audit evidence obtained, the auditor determines a material uncertainty exists related to events or conditions that alone or in aggregate, may cast significant doubt on the entity’s ability to continue as a going concern, disclosure and a possible modifi- cation of the audit opinion might occur. This will be discussed in Chapter 12 Audit Reports and Communication.


Matters for Attention of Partners (MAPs)

Matters for Attention of Partners (MAPs) ⁴⁸ is a report by audit managers to the partner or director detailing the audit decisions reached and the reasons for those decisions.

There is not one standard type of MAP report because the way in which an auditing firm identifies and disposes of issues affecting the audit opinion will vary. In general the MAP (or an equivalent report referred to by a different name) documents significant matters on which an initial decision has been made by the audit manager or an audit partner and details of the eventual resolution of matters that the audit partner decided

should be taken up with the client, including the reasoning involved in their resolution. Examples of decisions made and reported in MAP is whether an item is sufficiently material to require adjustment of or disclosure in the accounts. Typically the audit manager prepares the MAP and each item is read and commented on by the partner or director.

The areas discussed in the MAP relate to difficult questions of principle where there is a possibility that the auditor’s judgment may subsequently be questioned, particularly by a third party. It is therefore important that the working papers record all those relevant facts available at the time the decision was made. This will allow determination at some future time of the reasonableness of the conclusion reached based on the facts.

• 
  Contents of MAP
  

The items included in the MAP are a cover page signed by audit manager and partners stating the basic conclusions of the audit; general matters; management comments; com- ments on results; discussions of accounts that required special consideration; compliance with statutory laws, ISAs and IASs; comments on accounting systems; comments on management letters; and discussion of any matters that were outstanding at that date.
Results of the audit and discussion of specific accounts may include explanation of findings about inadequate ratios, unusual trends, or decreases in sales or profits. For example, a matter discussed might be: “Decreases in gross margin are attributable to lower pricing necessitated by increased competition from Zego’s Design Rite and General Software’s Room Zoom and increased cost of producing CD ROMs.” Major concerns about the accounts are mentioned. An example would be: “There have been large increases in research and development costs because of the company’s policy of developing a major interactive design software product, code-named Walkabout.”
The Matters for Attention should mention that the accounts have been prepared in accordance with the legal statutes (e.g. the Company Act in the UK). Matters for Attention might mention that all ISAs and IASs have been complied with. Any upgrade or additions to accounting systems (computerized accounting systems especially) would be mentioned for comment. Any matters involving management letters would be mentioned. Finally, any matters outstanding would be presented for comments.


Reports to The Board of Directors

The board of directors has significant influence over accounting and financial policies of the entity. The board also has the responsibility for hiring an independent auditor. The auditor must communicate important findings to the board.

• 
  Matters Discussed With the Board
  

Auditors may attend board of directors’ meetings to discuss accounting and auditing matters. Some matters that might be discussed are the accounting system, internal controls, and impacts of changes in accounting standards, and disclosure. Discussion

REPORTS TO THE BOARD OF DIRECTORS

with the board is essential for matters that cannot be successfully resolved with the executive officers.

Auditors are required by the Security and Exchange Commission ⁴⁹ to report to the audit committee of the publicly traded company:

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  all critical accounting policies and practices to be used;
  
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  all alternative treatments of financial information within generally accepted accounting principles that have been discussed with management officials of the issuer, ramifications of the use of such alternative disclosures and treatments, and the treatment preferred by the registered public accounting firm;
  
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  other material written communications between the registered public accounting firm and the management of the issuer, such as any management letter or schedule of unadjusted differences.
  

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  Long-Form Audit Report
  

In some countries, such as Germany, the board of directors gets a special report that is longer and much more detailed than the audit opinion. It is called the long-form report to the board. It may include a number of items, as there is no standard form. Typical areas of discussion in the report are information that the client has omitted from its notes and the errors the auditor has found in performing his work. Chapter 12 Audit Reports and Communication will discuss the long-form audit report in more detail and also communications with the directors and audit committee.
Illustration 11.14 summarizes the documents to be obtained or reviewed by the auditor, and to be generated by the auditor and audit team, during the course of the audit.





Summary

This chapter describes the fourth and last phase of the audit. The procedures for completing this audit phase are:

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  evaluate governance evidence;
  
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  carry out procedures to identify subsequent events;
  
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  review financial statements and other report material;
  
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  carry out wrap-up procedures;
  
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  prepare Matters for Attention of Partners;
  
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  report to the board of directors and prepare audit report.
  

Presently two IAASB standards apply to audit quality: International Standards on Quality Control (ISQC) and ISA 220, “Quality Control For Audit Work.” IAASB issues International Standards on Quality Control (ISQCs) as the standards to be applied for all services falling under the Standards of the IAASB (i.e. ISAs, International Standards on Assurance Engagements (ISAEs), and International Standards on Related Services (ISRSs)).
The elements of quality control policies adopted by an audit firm normally incorporate policies related to general firm activities and personnel. General firm activities for which quality control policies and procedures are required include leadership responsibilities for quality within the firm, acceptance and retention of clients, engagement performance, and monitoring. Quality controls applied to human resources include ethical requirements. The quality control policies and procedures should be documented and communicated to the firm’s personnel.
The Sarbanes-Oxley Act, which applies to both US audit firms and audit firms throughout the world, addresses overall review procedures required of the auditor such as second partner review, partner rotation, and quality control. It also discusses the client’s audit committee responsibilities and inspection by the Public Company Accounting Oversight Board.
There is important governance evidence that may be acquired any time during the audit, but definitely has to be acquired before the final reporting and evaluation phase (Phase IV of the Audit Process Model). The important governance information to be gathered from the client includes: a legal letter, a management representations letter, information about contingent liabilities and commitments, and identification of related parties.
Review for subsequent events are the auditing procedures performed by auditors to identify and evaluate subsequent events. Subsequent events are transactions and other pertinent events that occurred after the balance sheet date and which affect the fair pre- sentation or disclosure of the statements being audited. Under International Standard on Auditing (ISA) 560, the auditor should consider the effect of subsequent events on the financial statements and on the auditor’s report. There are two types of subsequent events:

1. 
   those that provide further evidence of conditions that existed at period end;
   
2. 
   those that are indicative of conditions that arose subsequent to period end.
   

The first type requires adjustment to the financial statements and the second type, if material, requires disclosure.

ANSWERS TO CERTIFICATION EXAM QUESTIONS

The final review of the financial statements involves procedures to determine if disclo- sures of financial statements and other required disclosures (for corporate governance, management reports, etc.) are adequate. The auditor is responsible for all information that appears with the audited financial statements, so therefore the auditor must also see if there are any inconsistencies between this other information and the financial statements.

Wrap-up procedures are those procedures done at the end of an audit that generally cannot be performed before the other audit work is complete. Wrap-up procedures include: supervisory review, final analytical procedures, working paper review, evaluating audit findings for material misstatements, client approval of adjusting entries, review of laws and regulation, and evaluation of the company as a going concern.
Assessment of the going concern assumption is particularly important to the auditor. ISA 570 specifies that when performing audit procedures the auditor should consider the appropriateness of the going concern assumption underlying the preparation of the financial statements. The auditor’s responsibility is to consider the appropriateness of management’s use of the going concern assumption in the preparation of the financial statements, and consider whether there are material uncertainties about the entity’s ability to continue as a going concern that need to be disclosed in the financial statements. Matters for Attention of Partners (MAPs) is a report by audit managers to the partner or director detailing the audit decisions reached and the reasons for those decisions. The areas discussed in the MAP relate to difficult questions of principle where there is a possibility that the auditor’s judgment may subsequently be questioned, particularly by a third party. Typically the audit manager prepares the MAP and each item is read and
commented on by the partner or director.
The board of directors has significant influence over accounting and financial policies of the entity. The board also has the responsibility for hiring an independent auditor. The auditor must communicate his important findings to the board.



CHAPTER 11 COMPLETING THE AUDIT


Questions, Exercises and Cases

QUESTIONS

2. 
   Introduction
   

11.1 What are the general procedures for completing the audit as shown in the standard Audit Process Model?

2. 
   Quality Control
   

2. 
   Describe the elements of quality control policies adopted by an audit firm.
   
3. 
   Audit firms are expected to report on the monitoring of its quality control systems at least annually. What is included in that communication? What should supervisory personnel monitor and do in each audit?
   
4. 
   Evaluation of Governance Evidence
   

4. 
   What should be included in the letter from client’s legal counsel?
   
5. 
   What kind of evidence does ISA 580 suggest that the auditor get from management? Where might an auditor find evidence to fulfill this requirement?
   
6. 
   What is a contingent liability? What three conditions must be met for a contingent liability to exist?
   
7. 
   Name the procedures an auditor is required to perform under ISA 550 regarding completeness of related party information provided by management?
   

5. 
   Review for Subsequent Events
   

8. 
   What is a review for subsequent events? What should an auditor do if he becomes aware of facts that existed at the date of the auditor’s report after the financial statements have been issued?
   
9. 
   If the auditor becomes aware of a fact that may materially affect the financial statements after the date of the auditor’s report but before the financial statements have been issued, what should an auditor do and how may this affect the financial statements? What if a material fact is discovered after the financial statements have been issued?
   

5. 
   Review of Financial Statements and Other Report Material
   

10. 
    When reviewing for adequate disclosure, what does an auditor look for? Give some examples.
    
11. 
    When does a material inconsistency exist in information other than the financial state- ments? What other information must an auditor review for material inconsistencies? What should an auditor do if a material inconsistency is found?
    

5. 
   Wrap-Up Procedures
   

12. 
    What are wrap-up procedures? Give some examples.
    
13. 
    What must the audit supervisor do before he can consider the audit work complete?
    
14. 
    What are monetary misstatements? What mistakes can cause a monetary misstatement?
    

5. 
   Going Concern Issues
   

15. 
    What are some indications that the continuance of the company as a going concern may be questionable?
    

466
QUESTIONS, EXERCISES AND CASES

15. 
    What should an auditor do if going concern is questionable? How may this affect the auditor’s report?
    

5. 
   Matters for the Attention of Partners
   

11.17 What is meant by MAP? What items are discussed in MAP and why are they important?

5. 
   Reports to the Board of Directors
   

11.18 What are auditors required to discuss with the board of directors? The audit committee?

PROBLEMS AND EXERCISES

3. 
   Quality Control
   

11.19 Quality Review. Charalambos Viachoutsicos is assigned the responsibility of setting up a quality review program at his St. Petersburg, Russia, audit firm, Levenchuk.