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Audit Finalization

EVENTS AFTER THE BALANCE SHEET DATE: Events after the balance sheet date:

These are events happening in the period after the balance sheet date up to the date the directors authorise the financial statements for issue

Adjusting events are those which relate to conditions existing at the balance sheet date requiring the revision / adjustment of estimates used at the balance sheet date


Debts going bad which were not provided for at the balance sheet date

Proceeds for sale of inventories

Proceeds of sale of non-current assets

Insurance claim proceeds

Non-adjusting events do not relate to conditions existing at the balance sheet date and do not require the revision of estimates, but are so material that they require to be disclosed by way of note for members’ better appreciation of the company’s affairs


Destruction of assets

Changes in a company’s status

Becoming a subsidiary or acquiring another company

Proceeds of a share issue

Subsequent Events:

The auditor must consider the following periods:

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Period 1:

Active audit work must be performed

This will include scrutiny of the following records to detect adjusting and non – adjusting events

Cash payments

Cash receipts

Accounts receivable

Accounts payable


Correspondence files

Obtaining management representations

Period 2:

The audit completed – therefore no active work should be performed but the auditor should remain receptive to material events, which, if known at the balance sheet date, would have required adjustment. Thus:

If such events arise, they should be discussed with management

Revision of the financial statements should be recommended

If no action taken, consider speaking on the matter at the AGM

Period 3:

The financial statement have been issued – no active work is necessary but if material events come to light which affect the financial statements reported on,


The auditor should recommend revision of the financial statements

Treat as prior year adjustment in next year’s financial statements



A provision is a liability of uncertain timing or amount

It should be recognised only when 3 conditions are met:

An entity has a present legal or constructive obligation as a result of a past event

It is possible that a transfer of economic benefits will be required to settle the obligation

A reliable estimate can be made of the amount of the obligation

If these obligations are met, no provision should be made:

The measurement of a provision should be the best estimate of the expenditure required to settle the present obligation at the balance sheet date – discounted to the present value

Contingent Liabilities are either:

A possible obligation that arises from past events and whose existence will be confirmed only by the occurrence or non-occurrence of one or more certain future events not wholly within the entity’s control


A present obligation that arises from past events but it is not recognised because it is not probable that an outflow of resources will be required to settle the obligation, or the amount cannot be measured with sufficient reliability

These are not recognised but disclosed by way of note giving:

A brief description

An estimate of the financial effect

An indication of the uncertainties relating to the amount or timing of any outflow

The possibility of any reimbursement

If these are not predictable, this should be stated

Contingent assets:

These are possible assets that arise from past events and whose existence will be confirmed only by the occurrence or non-occurrence of one or more uncertain future events not wholly within the entity’s control

These are not recognized but disclosed by way of note – as for contingent liabilities

Audit problems

Since provisions and contingencies relate to the future, the nature of audit evidence available will lack reliability and will be persuasive only, not conclusive

Sources of evidence could include :

Management representations, lawyers’ opinions, past experience, post balance sheet events, bank confirmation letters, contracts and agreements.


Work can usually be restricted to:

Checking brought forward balances in the records

Checking balances B/F contain no errors affecting the financial statements

Checking consistency of accounting policies

Additional considerations

If previous audit report qualified :

Where the matter has been satisfactorily resolved, no reference in this year’s report

If not resolved and still material :

Qualify on grounds of disagreement or uncertainty e.g. – if a debt considered bad last year has still not been provided for – disagreement

If the firm was not the auditor last year or no audit was performed last year:

Audit work this year may confirm the opening figures

Review system and records last year

Perform substantive tests on opening figures

Review previous auditor’s working papers

If unable to verify an opening figure (e.g. stock was not counted ):

Qualify this year’s opinion on grounds of limitation in scope


The IASB’s framework for the preparation and presentation of financial statements and IAS 1 presentation of financial statements required financial statements to show comparative figures for the previous year

Whilst the audit report does not specifically refer to the comparatives, the opinion does cover such comparative since the financial statement must be prepared in accordance with accounting standards (eg IAS 1)

if there were material misstatements in the preceding financial statements but no audit report qualification was issued:

Where the financial statements were revised, check comparatives this year and if properly stated, an unqualified opinion can be given with an emphasis of matter

Where no revision, but this year’s comparatives adjusted, no qualification of opinion this year – but an emphasis of matter may be appropriate

Where no revision and comparatives not restated, qualify this year’s opinion on grounds that the financial statements were not properly prepared in accordance with IAS 1

· If the prior period financial statements were not audited, the audit report should state that fact

State how you deal with the following situations in the audit reports of the companies concerned:

  1. The balance sheet of a diamond merchant includes an amount due from a Canadian customer which is material in the light of the results for the year and the balance sheet figures. The directors believe that the debt will be recovered in full and the accounts have been drawn up on that basis. However, the auditor is firmly of the opinion that full provision should be for the debt.
  2. In the accounts of a shoe manufacturer, the directors do not provide for deprecation of a factory owned by the company which is included in the balance sheet at cost. The depreciation charge, if based on a 50 year life, would be material to the income statement
  3. Approximately 10% of the sales of a glassware manufacturing company are for cash. The letter of representation gives assurances on cash sales because the internal control system over cash sales is department upon the close involvement of the directors.
  4. The financial statements of a wine and spirit merchant include a number of significant amounts which are based on estimates because, as stated in a note to the accounts, a fire at the company’s computer centre destroyed many of the accounting records.
  5. The accounts of a transport company do not reveal that a bridging loan of £30,000 was made to a director during the year. The loan was repaid within 6 weeks.
  6. The directors’ report of a computer manufacturing company states that the company made a trading profit for the year. The financial statements reveal that the company made a trading loss for the year which was turned into an overall surpluses by a profit on the sale of land


Since financial statements are prepared on the assumption of going concern per IAS 1, it is essential for the auditor to give positive consideration to the appropriateness of management’s use of the going concern basis both at the planning stage and throughout the audit

Risk evaluation and finding during the audit may uncover indicators of going concern problems:

Trading problems

trading losses

forced reduction in operations

loss of key supplier or customers

dependence on one product

Funding problems

negative operating cash flows

net current liabilities

exceeding borrowing limits

loan defaults

cancellation of capital projects

inability to pay debt as and when due

refusals to renew / extend overdraft limits

Personnel problems

loss of key personnel

prolonged industrial disputes

This list is not exhaustive

If such indicators are detected, the auditor should seek evidence to support the going concern assumption ( but such evidence will be limited in reliability ) :

Profit and cash projections covering the period at least 12 months from the date the directors approve the financial statement

Reliability of such evidence is limited in that it is internally generated and originates from management

Order received and contracts signed

Reliability of such evidence is again limited in that these are short term and not necessarily indicative of trends covering 12-15 months after the balance sheet date

Holding company or bank support

Reliability is again limited in that such undertaking is statements of intent and not legally binding – they can be withdrawn at short notice

Reporting Effects

If there are doubts as to going concern, it will be an uncertainty

If the matter is material, and is adequately disclosed, the auditor should include an extra emphasis of matter paragraph referring to the note but emphasizing that the opinion is not qualified in this respect

If no or inadequate disclosure is made the auditor should qualify the report giving a qualified (except for ) opinion or adverse opinion

If the auditor knows the entity is not a going concern or considers the or will not be able to continue as a going concern, an adverse opinion should be expressed if the financial statements have been prepared on a going concern basis.


The unaudited information contained in the annual report could contain inconsistencies or misstatements which could undermine the financial statements and the audit report

Other information will include the director’s report, the chairman’s statement, management commentary on operations, financial summaries, 5 or 10 year summaries, financial ratios, employee/ employment reports etc.

Inconsistencies may arise when comparing :

Figures appearing in both the audited financial statements and the other information
Figures in the audited financial statements with summaries of those figures in the other information
Figures in the audited financial statements compared with a native interpretation in the other information

ISA 720 requires the auditor:

To read the other information to identify material inconsistencies with the audited financial statements

If material inconsistencies are identified, the auditor should determine whether:

The audited financial statement should be amended – if they are not, a qualified opinion will required

The other information should be amended – if it is not, the auditor should draw attention to it in an emphasis of matter paragraph

In extreme situations, if the other information is seriously misleading or inconsistent and the directors refuse to amend it, the auditor must consider resignation, after taking legal advice – this is because the auditor may have lost confidence in the integrity of the directors , and the auditor should never allow his/her report to be associated with misleading or inconsistent information



Part of obtaining sufficient appropriate evidence

Reduction of misunderstanding over any oral representations obtained

Legal significance

in many countries, it is an offence in company legislation to mislead the auditor

Form of representations

Letter from directors to the auditor

Letter from the auditor to the directors requesting confirmation of the auditor’s understanding of management representations

Obtain a copy of the minutes of the directors meeting approving the representations

Contents should be confined to:

Matters of fact known only to management

Matters involving judgment / opinion

Audit procedures

Seek corroborative evidence

Evaluated reasonableness of the representations by reference to the other evidence

Consider seniority of those making the representations and whether well – informed

Reporting effects

If satisfied (i.e. representation are supported/not contradicted by other evidence)

no reference is necessary in the audit report

If evidence expected to be available in support is not available

Limitation in scope

If evidence expected to be available in support is not available

Limitation in scope

If management refuses to give representations

Limitation in scope

Comprehensive Questions

1. International Standard on Auditing 560 Subsequent Events explain the audit work required in connection with subsequent events.


List the audit procedures that can be used prior to the auditor’s report being signed to identify events that may require adjustment or disclosure in the financial statements.

(b) You are the auditor of Oil Rakers, a limited liability company which extracts, refines and sells oil and petroleum related products.

The audit of Oil Rakers for the year ended 30 June 2005 had the following events:



15 August 2005

Bankruptcy of major customer representing 11% of the trade receivables on the balance sheet.

21 September 2005

Financial statements approved by directors.

22 September 2005

Audit work completed and auditor’s report signed.

1 November 2005

Accidental release of toxic chemicals into the sea from the company’s oil refinery resulting in severe damage to the environment. Management had amended and made adequate disclosure of the event in the financial statements.

23 November 2005

Financial statements issued to members of Oil Rakers.

30 November 2005

A fire at one of the company’s oil wells completely destroys the well. Drilling a new well will take ten months with a consequent loss in oil production during this time.

Required:For each of the following three dates:

15 August 2005;

1 November 2005; and

30 November 2005

(i) State whether the events occurring on those dates are adjusting or non-adjusting according to IAS 10 Events after the Balance Sheet Date, giving reasons for your decision;

(ii) Explain the auditor’s responsibility and the audit procedures that should be carried out.

Audit procedures to be used prior to the audit report being signed include:

Reviewing procedures established by management to try to ensure that subsequent events are identified.

Reading minutes of the meetings of directors, the audit committee and shareholders and enquiring into unusual items.

Obtaining and reading the company’s latest interim accounts as well as any budgets and cash flow forecasts.

Obtaining additional evidence if possible from the company’s lawyers concerning litigation and claims.

Asking management as to whether any subsequent events have occurred such as

New borrowing commitments

Significant sales of assets

New shares or debentures issued

Assets being destroyed by flood fire etc or impounded by the government

Unusual accounting adjustments made or being contemplated

Checking whether any events have occurred that could call into question the validity of the going concern assumption.

(a) 15 August 2005

The bankruptcy of a major customer provides additional evidence of conditions existing at the balance sheet date. The customer will not be able to pay debts due, therefore receivables are overstated and the bad debt provision on the profit and loss account is understated. An adjustment for the amount of the receivable should be made in the financial statements.

The bankruptcy of the major customer takes place after the end of the year but before the financial statements and the auditor’s report are signed. As the auditor’s report has not been signed, the auditor is responsible for identifying material events that affect the financial statements. This means that audit procedures should be carried out which are designed to identify this event.

Specific procedures undertaken include:

Confirming that the customer will not pay to a letter from the receiver or similar authorised person

Confirming the amount due from the customer to invoices raised prior to the year end, and if possible to a positive direct confirmation letter

Auditing the adjustment to the financial statements decreasing the receivable balance and increasing the bad debt write off in the profit and loss account

Including the amount in the management representation letter to confirm no other amounts are due from the customer

1 November 2005

The accidental release of toxic chemicals occurred after the balance sheet date. Assuming that the inventory was not on the balance sheet at the year end, then the spill is indicative of conditions that arose subsequent to the year end. No adjustment appears to be necessary. However, the event may be significant in terms of the operations of the company (a large legal claim could arise) and so disclosure of the event would be expected.

The accidental release of toxic chemicals takes place after the auditor’s report has been signed but before the financial statements are sent to the members. At this stage of the audit, the auditor does not have any responsibility to perform procedures or make inquiries regarding the financial statements. The management of Oil Rakers is responsible for telling the auditor about any significant events, such as this one.

However, as the auditor is now aware of the event and this materially affects the financial statements in terms of disclosure being required, the auditor does have to discuss the event with management.

Specific procedures to be undertaken include:

Obtain information concerning the chemical release from management, reading local press and if possible the company’s lawyers – the latter may be able to indicate whether there is any legal liability.

Discuss the appropriate accounting treatment with the directors, confirming that disclosure is required in the circumstances.

Read the disclosure note to confirm that the matter is adequately explained in the financial statements.

Obtain an updated letter of representation from the directors confirming that there are no other events requiring disclosure.

Amend the auditor’s report to include an emphasis of matter paragraph to draw attention to the full disclosure noted in the financial statements. Date the new auditor’s report no earlier than the date of the amended financial statements.

30 November 2005

The fire at an oil well means that Oil Raker’s oil production and presumably profits will fall in the next financial year. The fire though does not provide additional evidence of conditions existing at the balance sheet date as at this time there was no indication that this would occur. The event is therefore non-adjusting in the financial statements. However, disclosure of the event should be made so that the financial statements do not give a misleading position.

The fire at an oil well takes place after the financial statements have been issued. At this time, the auditor has no obligation to make any inquiry at all regarding the financial statements.

If the auditor becomes aware of the event, then the potential effect on the auditor’s report must be considered.

Specific procedures undertaken include:

 Checking the board minutes, insurance claims and similar documents to ensure that the fire will be covered by insurance and there is no contingent liability for replacing non-current assets or clearing up any environmental damage.

 Inquiring of the directors how the members will be informed of the situation.

If the directors plan to re-issue the financial statements, ensure that appropriate disclosure is made of the event.

If the directors do not intend to amend the financial statements, and you consider the matter to be material to understanding the accounts, consider attempting to contact the members directly, depending on the methods available in your country.

 If necessary, contact the auditor’s lawyers to discuss what action can be taken regarding the lack of disclosure.

(a) Explain the purpose of a management representation letter

(b) You are the manager in charge of the audit of Crighton-Ward, public limited liability company which manufactures specialist cars and other motor vehicles for use in films. Audited turnover is $140 million with profit before tax of $7·5 million.

All audits work up to, but not including the obtaining of management representations have been completed. A review of the audit file has disclosed the following outstanding points:

Lion’s Roar

The company is facing a potential legal claim from the Lion’s Roar Company in respect of a defective vehicle that was supplied for one of their films. Lion’s Roar maintains that the vehicle was not built strongly enough while the directors of Crighton-Ward argue that the specification was not sufficiently detailed. Dropping a vehicle 50 meters into a river and expecting it to continue to remain in working condition would be unusual, but this is what Lion’s roar expected. Solicitors are unable to determine liability at the present time. A claim for $4 million being the cost of a replacement vehicle and lost production time has been received by Crighton-Ward from Lion’s

Roar. The director’s opinion is that the claim is not justified.


Depreciation of specialist production equipment has been included in the financial statements at the amount of 10% pa based on reducing balance. However the treatment is consistent with prior accounting periods (which received an unmodified auditor’s report) and other companies in the same industry and sales of old equipment show negligible profit or loss on sale. The audit senior, who is new to the audit, feels that depreciation is being undercharged in the financial statements.


For each of the above matters:

(i) Discuss whether or not a paragraph is required in the representation letter; and

(ii) If appropriate, draft the paragraph for inclusion in the representation letter. (10 marks)

(c) A suggested format for the letter of representation has been sent by the auditors to the directors of Crighton-Ward. The directors have stated that they will not sign the letter of representation this year on the grounds that they believe the additional evidence that it provides is not required by the auditor.


Discuss the actions the auditor may take as a result of the decision made by the directors not to sign the letter of representation. (5 marks)

(20 marks)


(a) Management representations are a form of audit evidence. They are contained in a letter, written by the company’s directors and sent to the auditor, just prior to the completion of audit work and before the audit report is signed.

Representations are required for two reasons:

Firstly, so the directors can acknowledge their collective responsibility for the preparation of the financial statements and to confirm that they have approved those statements.

Secondly, to confirm any matters, which are material to the financial statements where representations are crucial to obtaining sufficient and appropriate audit evidence.

In the latter situation, other forms of audit evidence are normally unavailable because knowledge of the facts is confined to management and the matter is one of judgment or opinion.

Obtaining representations does not mean that other evidence does not have to be obtained. Audit evidence will still be collected and the representation will support that evidence. Any contradiction between sources of evidence should, as always, be investigated.

(b) Lion’s Roar

The amount of the claim is material being 50% of profit before taxation.

There is also a lack of definitive supporting evidence for the claim. The two main pieces of evidence available are the claim from Lion’s Roar itself and the legal advice from Crighton Ward’s solicitors. However, any claim amount cannot be accurately determined because the dispute has not been settled.

The directors have stated that they believe the claim not to be justified, which is one possible outcome of the dispute. However, in order to obtain sufficient evidence to show how the treatment of the potential claim was decided for the financial statements, the auditor must obtain this opinion in writing. Reference must therefore be made to the claim in the representation letter.

Paragraph for inclusion in representation letter

‘A legal claim against Crighton-Ward by Lion’s Roar has been estimated at $4 million by Lion’s Roar. However, the directors are of the opinion that the claim is not justified on the grounds of breach of product specification. No provision has been made in the financial statements, although disclosure of the situation is adequate. No similar claims have been received or are expected to be received.’


This matter is unlikely to be included in the letter of representation because the auditor appears to have obtained sufficient evidence to confirm the accounting treatment. The lack of profit or loss on sale confirms that the depreciation charge is appropriate – large profits would indicate over-depreciation and large losses, under-depreciation. The amount also meets industry standards confirming that Crighton-Ward’s accounting policy is acceptable. Including the point in the representation letter is inappropriate because the matter is not crucial and does not appear to be based on judgment or opinion. The only opinion here appears to be that of the auditor – unless the ‘feelings’ can be turned into some appropriate audit evidence, the matter should be closed.

(c) Lack of representation letter

The auditor may take the following actions:

Discuss the situation with the directors to try and resolve the issue that the directors have raised. The auditor will need to explain the need for the representation letter again (and note that the signing of the letter was mentioned in the engagement letter).

Ascertain exact reasons why the directors will not sign the letter. Consider whether amendments can be made to the letter to incorporate the directors’ concerns that will still provide the auditor with appropriate and sufficient audit evidence.

The discussion must clearly explain the fact that if the auditor does not receive sufficient and appropriate audit evidence, then the audit report will have to be modified.

The reason for the audit qualification will be uncertainty regarding the amounts and disclosures in the financial statements. An ‘except for’ qualification for the material uncertainty is likely, although a disclaimer may be required, especially if the legal claim is thought to require a provision.

Even if the letter is subsequently signed, the auditor must still evaluate the reliability of the evidence. If, in the auditor’s opinion, the letter no longer provides sufficient or reliable evidence, then a qualification may still be required.


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