Auditing Lecture 10

Completing The Audit Engagement

 Previously in our lecture

• Audit purchasing process

• Major function
– Purchase requisition, purchase order, receiving goods, invoice processing,
payment settlement, booking assets, expenses, related liability
– Key accounts?
• How to audit?
– Risk assessment
– Test of controls
– Substantive test
• Relevant assertation level

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Major Phases of an Audit – where are we?
Client Acceptance and Continuance

Preliminary Engagement Activities

Plan the audit

Consider Internal Control

Audit Business Processes

Complete the audit

Evaluate results, issue report

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Major Phases of an Audit – where are we?

Before determining the audit report, auditors need to consider a

few additional issues that could impact entity’s financials

• Review for contingencies

• Review for commitments
• Subsequent events
• Final evaluation of audit evidence
• Communication with those charged with governance and
management

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 Specific Learning Outcomes

Understand
• Audit issues related to contingencies.
• Audit issues related to a legal letter.
• Understand why the auditor must be concerned with
commitments.
• Auditor’s responsibility regarding subsequent events.
• Understand how auditors identify and assess going-concern.
• Understand the auditor’s communication with those charged with
governance and management and the matters that should be
addressed.
 Contingency

A contingency is a liability that is uncertain

because the possible outflow of resources from
the entity will ultimately be resolved when some
future event occurs or fails to occur.

Examples
• Pending or threatened litigation Probable: The future event is
• Actual or possible claims and “more likely than not” to occur.
assessments Neither probable nor remote: The
• Income tax disputes chance of the future event is less
likely than not to occur but the
• Product warranties or defect;
chance is more than slight.
• Guarantees of obligations to
others
Remote: The chance of the future
event occurring is slight.
• Agreements to repurchase
receivables that have been sold
 In-class activity-- What about in HK?

Discuss with your neighbours

• Relevant accounting standards?
• Summarize the key points
• Are those consistent with IAS 37?

PollEv.com​/maggiekang697

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Audit Procedures for Identifying Contingencies

Read minutes of meetings Review contracts, loan

of those charged with agreements, leases and
governance, e.g. the board correspondence from
of directors. government bodies.

Review tax returns, tax

liability and tax authorities’
reports.

Confirm or otherwise
Inspect other documents for
document guarantees and
possible guarantees.
letters of credit.
Audit Procedures for Identifying Contingencies

Specific Audit Procedures Conducted

Near Completion of Audit

Inquiry and discussion with

Examine documents in the entity’s
management about its policies
records such as correspondence
and procedures for identifying,
and invoices from lawyers for
evaluating and accounting for
pending or threatened lawsuits.
contingencies.

Obtain written representation from

management that all litigation,
Obtain a legal letter that
asserted and unasserted claims,
describes and evaluates any
and assessments have been
litigation, claims or
disclosed in accordance with the
assessments.
applicable financial reporting
framework.
 Legal Letters
A letter of audit inquiry (legal letter) sent to the entity’s
external legal counsel is the primary means to obtain
corroborating evidence regarding litigation, claims and
assessments.

Table 17–1 Examples of Types of Litigation

Example of Legal Letter
Exhibit 17–2 Example of a Legal Letter

(continued)
 Example of Legal Letter
(Exhibit 17-2 continued)
 Commitments
Long-term contracts to
purchase raw materials or
sell their products at a fixed
price.

To obtain a
To secure the
favourable
availability of raw
pricing
materials.
arrangement.

Long-term commitments are usually identified through inquiry of

client personnel during the audit of the revenue and purchasing
processes. In most cases, such commitments are disclosed in a note
to the financial statements.
 Review for Subsequent Events
Subsequent events are events occurring between the date of the financial
statements and the date of the auditor’s report, and facts that become known to
the auditor after the date of the auditor’s report, and may require adjustment or
disclosure in the financial statements.
Balance
Sheet Date
Type I Event Type II Event
Conditions existed at the Conditions did not exist at the
balance sheet date and balance sheet date and do not
affect estimates that are affect the accuracy of the
part of financial statements financial statements

Require adjustment of the Require financial

financial statements. statement disclosure.
 Auditor’s Responsibilities Regarding
Subsequent Events
Figure 17–1 Subsequent-Events Period for EarthWear Clothies
Subsequent Events after the Date of the Audit
Report

• The auditor is not responsible for making any

inquiries or conducting any audit procedures after
the date of the audit report.
• However, facts may come to the auditor’s
attention after the date of the audit report that
might have affected the audit report had the
auditor known about them.

• Auditing standards (HKSA 560) provide guidance

to auditors in this exceptional circumstance.
 Class Discussion

• You have just completed collecting audit evidence on your

client and are in the process of preparing the draft audit
report when you get a phone call from the client’s
management informing you of a material event that
occurred after the year-end. The management has told you
that since it occurred after the year-end it does not need
disclosing in the accounts. What should you do?

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Audit Procedures to Look for Subsequent Events

Examples of audit
Inquire of procedures
Management
Read Interim
Read Minutes Financial
of Meetings Statements

Inquire of Examine the

Legal Books of
Counsel Original Entry
 Final Evidence Evaluation Processes

Perform final Evaluate entity’s Obtain a

analytical ability to continue representation
procedures. as a going concern. letter.

Evaluation of
Review working Evaluate final of financial statement
papers. audit results. presentation and
disclosure.

Obtain a quality
control review of
the engagement.
 Going-Concern Considerations
Table 17–2 Financial Conditions and Ratios that Indicate Financial Distress
 Going-Concern Considerations
Table 17–3 Other Conditions and Events Indicating a Going-Concern Problem
KPMG stands by audits of Silicon Valley Bank and
Signature Bank

https://www.ft.com/content/1f21169f-da29-4e74-
af79-0f9230eb873e

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 Audit Procedures
• Consider if there is significant doubt
• If yes, obtain information about management’s plan to mitigate
the going concern problem and assess the likelihood of such
plan
• Conclude, in light of management’s plan, if there is significant
doubt. If yes, consider the adequacy of disclosure. If disclosure
is adequate, include an emphasis of matter paragraph. If not,
issue modified opinion.
 Representation Letter
(Entity Letterhead)
(To Auditor) (Date)

This representation letter is provided in connection with your audit of the financial statements of ABC Company for the year
ended 31 December 20XX for the purpose of expressing an opinion as to whether the financial statements are presented
fairly, in all material respects, (or give a true and fair view) in accordance with Hong Kong Financial Reporting Standards.

We confirm that (, to the best of our knowledge and belief, having made such inquiries as we considered necessary for the
purpose of appropriately informing ourselves):

Financial Statements
• We have fulfilled our responsibilities, as set out in the terms of the audit engagement dated [insert date], for the
preparation of the financial statements in accordance with Hong Kong Financial Reporting Standards; in particular the
financial statements are fairly presented (or give a true and fair view) in accordance therewith.

• Significant assumptions used by us in making accounting estimates, including those measured at fair value, are
reasonable. (HKSA 540)

• Related party relationships and transactions have been appropriately accounted for and disclosed in accordance with the
requirements of Hong Kong Financial Reporting Standards. (HKSA 550)

• All events subsequent to the date of the financial statements and for which Hong Kong Financial Reporting Standards
require adjustment or disclosure have been adjusted or disclosed. (HKSA 560)

• The effects of uncorrected misstatements are immaterial, both individually and in the aggregate, to the financial
statements as a whole. A list of the uncorrected misstatements is attached to the representation letter. (HKSA 450)

• [Any other matters that the auditor may consider appropriate (see paragraph A10 of this HKSA).]
 Representation Letter (continued)
Information Provided
• We have provided you with:
o Access to all information of which we are aware that is relevant to the preparation of the financial
statements, such as records, documentation and other matters;
o Additional information that you have requested from us for the purpose of the audit; and
o Unrestricted access to persons within the entity from whom you determined it necessary to obtain audit
evidence.

• All transactions have been recorded in the accounting records and are reflected in the financial statements.

• We have disclosed to you the results of our assessment of the risk that the financial statements may be
materially misstated as a result of fraud. (HKSA 240)

• We have disclosed to you all information in relation to fraud or suspected fraud that we are aware of and that
affects the entity and involves:
o Management;
o Employees who have significant roles in internal control; or
o Others where the fraud could have a material effect on the financial statements. (HKSA 240)

• We have disclosed to you all information in relation to allegations of fraud, or suspected fraud, affecting the
entity’s financial statements communicated by employees, former employees, analysts, regulators or others.
(HKSA 240)
• We have disclosed to you all known instances of non-compliance or suspected non-compliance with laws and
regulations whose effects should be considered when preparing financial statements. (HKSA 250)
• We have disclosed to you the identity of the entity’s related parties and all the related party relationships and
transactions of which we are aware. (HKSA 550)
• [Any other matters that the auditor may consider necessary (see paragraph A11 of this HKSA).]
__________________________________________________________________________________________
Management Management
 Proposed Adjusting Entries
Exhibit 17–4 Example Working Paper for Evaluating Detected Misstatements
Other Final Evidence Evaluation Processes

Evaluating Financial Statement Presentation and Disclosure

The auditor reviews the financial statements to ensure compliance
with the applicable financial reporting framework, proper
presentation of accounts, and inclusion of all necessary disclosures.

Engagement Quality Control Review

An engagement quality control reviewer objectively evaluates the
significant judgements that the engagement team made and the
conclusions it reached in formulating the auditor’s report.

Archiving and Retention

HKSQC1 requires audit documentation to be retained
ordinarily for minimum five years from
the date of the auditor’s report.
 Communication with those Charged with Governance and
Management
Table 17–4 Examples of Items the Auditor Communicates to Those Charged with
Governance
Exercises and Group Discussion

17-18, 17-20