COMPLETING THE AUDIT ENGAGEMENT
Answers to Review Questions
A contingent liability is defined as an existing condition, situation, or set of circumstances involving uncertainty as to possible loss to an entity that ultimately will be resolved when some future event occurs or fails to occur. FASB ASC Topic 450, “Contingencies,” classifies uncertainties into three categories: 1.
Probable: The future event is likely to occur.
Reasonably possible: The chance of the future event occurring is more than remote but less than likely. 3.
Remote: The chance of the future event occurring is slight. Examples of contingent liabilities include:
Pending or threatened litigation
Actual or possible claims and assessments
Income tax disputes
Product warranties or defects
Guarantees of obligations to others
Agreements to repurchase receivables that have been sold
The auditor requests that the attorney provide the following information on pending or threatened litigation: •
A list and evaluation of any pending or threatened litigation to which the attorney has devoted substantial attention. The client may provide the list. •
A listing of unasserted claims and assessments considered by management to be probable of assertion and reasonably possible of unfavorable outcome. •
A request that the attorney describe and evaluate the outcome of each pending or threatened litigation. This should include the progress of the case, the action the entity plans to take, the likelihood of unfavorable outcome, and the amount or range of potential loss. •
A request for additions to the list provided by management or a statement that the list is complete. •
A request that the attorney comment on unasserted claims where his or her views differ from management's evaluation. •
A statement by management acknowledging an understanding of the attorney's professional responsibility involving unasserted claims and assessments. •
A request that the attorney indicate if his or her response is limited and the reasons for such limitations. •
A description of any materiality levels agreed upon for the purposes of the inquiry and response.
An unasserted claim or assessment is one in which the injured party or potential claimant has not yet notified the entity of a possible claim or assessment. Attorneys may be reluctant to provide the auditor with information about the unasserted claims because of client-attorney privilege. Attorneys may also be concerned that disclosure of the unasserted claim may itself result in lawsuits.
Two examples of long-term commitments are the purchase of raw materials or the sale of products at a fixed price. When the fair market value of the good is less than the purchase price included in the purchase contract, the entity will have to recognize a loss on a long-term commitment even though there has been no exchange of goods.
The two types of subsequent events that require consideration by management and evaluation by the auditor relevant to financial statement audits are: Type I
Events that provide additional evidence about conditions that existed at the date of the balance sheet and affect the estimates that are part of the financial statement preparation process. These types of events require adjustment of the financial statements. Type II
Events that provide evidence about conditions that did not exist at the date of the balance sheet but arose subsequent to that date. These types of events usually require disclosure in the notes to the financial statements. In some instances, where the effect of the event or transaction is very significant, pro forma financial statements may be necessary in order to prevent the financial statements from being misleading. Examples of Type I events or conditions are:
An uncollectible account receivable resulting from continued deterioration of a customer's financial condition leading to bankruptcy after the balance...
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