Chapter14 R1

Final review: post-balance sheet
period, provisions, contingencies,

letter or representation
Chapter 14
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LEARNING OBJECTIVES
After studying this chapter you should be

able to:
• Describe the nature of the work the auditor
performs immediately prior to preparation of
the audit report.
• Detail the specific procedures the auditor
performs in respect of post-balance sheet
events.
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LEARNING OBJECTIVES CONT'D
• Explain the nature of provisions, contingent

liabilities and contingent assets, and detail
audit procedures in respect of them.
• Describe the final working paper review
procedures performed by the auditor prior to
forming the final audit opinion.
• Explain the nature and role of the
management letter of representation, in the
context of the evidence search.
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KEY POINTS – p.533
Stage 18 of the audit process is when auditors

pull together evidence gathered and conclusions
arrived at earlier to form a view on the financial
statements as a whole.
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KEY POINTS – p.533 CONT'D
They also perform the following tasks:

(a) post-balance sheet date work;
(b) audit work on provisions and contingencies;
(c) final working sheet review;
(d) reviews of validity of the going-concern
concept;
(e) review work of other auditors.
Finally, they obtain the management letter of
representation.
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Post-balance sheet events
This is when auditors routinely assess:
• debtors collectability;
• NRV of stocks;
• useful lives of fixed assets;
• potential unrecorded liabilities.
Auditors review the post-balance sheet period to
ascertain whether any matters should be reflected
in the accounts or disclosed in the audit report.
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The period after the balance sheet date may be

subdivided into periods as follows.
Each period has its own characteristics and

problems for auditors:
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(1) between balance sheet date and completion of

draft accounts.
(2) from completion of draft accounts to completion
of audit fieldwork.
(3) from completion of audit fieldwork to date of
issuing financial statements.
(4) after the financial statements have been issued
but before the AGM;
(5) after the AGM.
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KEY POINTS – pp.537–538
Events occurring in periods (1) and (2) are known

by both directors and auditors as they occur before
the signing of the accounts and completion of audit
fieldwork.
Regarding (3), auditors, becoming aware of a
material event, establish if financial statements
need amendment, discuss with directors and
consider the implications for their report.
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KEY POINTS – pp.536–538 CONT'D
Regarding (4), auditors have no obligation to

perform procedures or make enquiries, but if they
become aware of an event that might have caused
them to issue a different report, they consider
whether the financial statements need amendment,
discuss with directors and consider the implications
for their report.
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Regarding (5), auditors will not be expected to be

aware of an event in the period after the AGM, but,
if they do obtain knowledge of it, the matter should
be discussed with the directors and action, if any,
they intend to take, determined.
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Period Covered by Subsequent
Events Review
Client’s ending Audit Date client
balance sheet report issues financial
date date statements
12-31-07 3-11-08 3-26-08
Period to which review for Period for

subsequent events applies processing
the financial
statements
Review for Subsequent Events
and Discovery of Facts
Client’s ending Audit Date client
balance sheet report issues financial
date date statements
12-31-07 3-11-08 3-26-08
Period to which Period for Period in which

review for processing subsequent
subsequent the financial discovery of
events applies statements facts is made
Types of Subsequent Events
 Those that have a direct effect

on the financial statements
and require adjustment
 Those that have do not have a direct
effect on the financial statements
but for which disclosure is required
Requiring Adjustment
 Declaration of bankruptcy by a customer

with an accounts receivable balance
 Settlement of a litigation at an amount
different from the amount recorded
on the books
 Disposal of equipment not being used in
operations at a price below the current
book value
 Sale of investments at a price below
recorded cost
Advisability of Disclosure
 Decline in the market value of securities

held for temporary investment or resale
 Issuance of bonds or equity securities
 Uninsured loss of inventories as a result
of fire
 A merger or an acquisition
Audit Tests
Two categories of audit procedures

for the subsequent events review:
1. Procedures normally integrated as
a part of the verification of year-end
account balances.
2. Procedures performed specifically for
the purpose of discovering events or
transactions that must be recognized
as subsequent events.
Audit Tests
 Inquire of management
 Correspond with attorneys
 Review internal statements prepared
subsequent to the balance sheet date
 Review records prepared subsequent
to the balance sheet date
 Examine minutes issued subsequent
to the balance sheet date
 Obtain a letter of representation
Dual Dating
 The first date is the date for the completion

of field work except for a specific exception
 The second date, which is always later,

deals with the exception
Provisions, contingent liabilities and contingent

assets
Some events, occurring either before or after

the balance sheet date, have uncertain outcomes
– provisions and contingencies as defined by
FRS 12.
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• Is there a legal or constructive obligation,

the latter evidenced by policies or other
authoritative statements from management in
the past, and whether the company is taking
any action in respect of the event;
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• The auditor should determine if a reliable

estimate be made of the amount of the
obligation. Potential losses from claims may be
particularly difficult to ascertain.
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Provisions must be properly disclosed in

accordance with FRS 12, sufficient to enable the
reader to understand the nature of the obligation,
the expected timing of transfers of economic
benefits, and the uncertainties about amount or
timing.
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If the event does not give rise to a present

obligation, or there is no probable outflow of
economic benefits or it is not possible to evaluate
the timing and amount of the obligation, it may be
treated as a contingency.
FRS 12 and IAS 37 distinguish between
contingent liabilities and contingent assets.
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Contingent liability
(a) A possible obligation that arises from past
events and whose existence will be confirmed
only by the occurrence of one or more
uncertain future events not wholly within the
entity’s control.
(b) A present obligation that arises from past
events but is not recognized.
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In Part (b) the obligation may not be recognized

for the following reasons:
(i) it is not probable that a transfer of economic
benefits will be required to settle an obligation;
(ii) the amount of the obligation cannot be
measured with sufficient reliability
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Contingent asset
A possible asset that derives from past events
and whose existence will be confirmed only by
the occurrence of one or more uncertain future
events not wholly within the entity’s control.
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Contingencies, like provisions, are problematic

because of the varying degrees of certainty from
remote to probable. Note that:
(a) directors consider estimates of outcome and
the financial effect of contingencies;
(b) directors review events occurring after the
balance sheet date up to the date of signing
the financial statements;
(c) accounting treatment of a contingency depends
on its expected outcome and nature.
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Likelihood of Occurrence and Financial
Statement Treatment
Likelihood of Financial Statement

Occurrence of Event Treatment
Remote No disclosure
(slight chance) is necessary
Reasonably Footnote disclosure
possible is necessary
Probable Adjust financial statements
(likely to occur) or note disclosure
Auditor’s Concerns
 Pending litigation for patent infringement,

product liability, or other actions
 Income tax disputes
 Product warranties
 Notes receivable discounted
 Guarantees of obligations of others
 Unused balances of outstanding letters of credit
Audit Procedures for Finding Contingencies
Inquire of management about the possibility

of unrecorded contingencies.
Review current and previous years’ internal

revenue reports for income tax settlements.
Review the minutes of directors’ and

stockholders’ meetings for indications of
lawsuits or other contingencies.
Audit Procedures for Finding Contingencies
Analyze legal expenses and review invoices

and statements from legal counsel.
Obtain a letter from each major attorney of the

client as to the status of pending litigation.
Review audit documentation for any information

that may indicate a potential contingency.
Examine letters of credit in force.

Going concern
During the final review period the auditor considers
the validity of assuming that the company is a
going concern.
See also Chapter 17.
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Directors’ responsibilities include determining

whether a company is a going concern.
Auditors must satisfy themselves that the going-
concern basis is appropriate and disclosures in the
financial statements are sufficient. They should
determine how directors concluded the company
is a going concern, and assess the logic, rationale
and strength of information used.
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To do so auditors should:
(i) make enquiries of directors and examine
appropriate available financial information;
(ii) having regard to the future period to which the
directors have paid particular attention, plan and
perform procedures specifically designed to
identify any material matters that could indicate
concern about the entity’s ability to continue as
a going concern.
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Indicators that might suggest going-concern

problems are:
• negative cash flows;
• significant losses;
• substantial debts difficult to service;
• substantial overdraft and overdraft limit
exceeded;
• net current liabilities;
• loan repayments or overdraft facilities
renegotiated;
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• reduction in dividends;
• longer creditor payment period;
• company has made employees redundant
and/or has had to reorganize/rationalize its
operations;
• declining market and/or out-of-fashion products;
• forced sale of fixed assets.
Auditors obtain written confirmation of directors’

representations about going concern.
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Where financial statements are prepared on a

going-concern basis, the entity is assumed to
continue in existence for the foreseeable future, the
extent of which varies from entity to entity influenced
by the nature of the entity’s business, its business
risk and external influences.
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Directors judge what is an appropriate period for

them to look into the future. If this period is less
than one year, additional disclosures in the financial
statements may be required, and the auditors refer
to this in the audit report even where there is little
doubt about going-concern status.
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If there is no doubt, neither directors nor auditors

need refer specifically to going concern in the
financial statements or audit report.
However, the Combined Code states that
‘the directors should report that the business
is a going concern, with supporting
assumptions or qualifications as necessary’.
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Where there are doubts, auditors will consider if

the directors have included sufficient appropriate
disclosures such that the financial statements give
a true and fair view.
If so, they need not issue a qualified audit opinion,
even where there is fundamental uncertainty, but
include an explanatory paragraph on the going-
concern problems, referring to the note disclosure
in the audit report.
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Audit work to detect post-balance sheet events

and contingencies
(a) determine company procedures to detect
material post-balance sheet events/
contingencies;
(b) examine minutes of meetings: shareholders,
directors and audit/executive committee;
(c) examine management accounts/accounting
records;
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(d) examine profit and cash flow forecasts;

(e) Enquire of legal department and external legal
representatives
(f) review known risk areas;
(g) review correspondence/memoranda;
(h) confirmation from third parties;
(i) review information in the public domain;
(j) management interviews.
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Final Evidence Accumulation
1. Perform final analytical procedures.

2. Evaluate the going-concern assumption.
3. Obtain a management representation letter.
4. Consider information accompanying the
basic financial statements.
5. Read other information in the annual report.
Management Representation Letter
Purposes of the letter:

1. To impress upon management its responsibility
for the assertions in the financial statements.
2. To remind management of potential misstatements
or omissions in the financial statements.
3. To document the responses from management
to inquiries about various aspects of the audit.
Information Accompanying
Basic Financial Statements
Balance sheet
Income statement Basic Standard
financial auditor’s
Statement of statements report
cash flows
Footnotes
Detailed comparative Information
statements accompanying
basic financial
Statistical data statements
Schedule of
insurance coverage Separate paragraph –
unqualified, qualified,
or disclaimer
Evaluate Results
 Sufficient appropriate evidence

 Evidence supports auditor’s opinion
 Financial statement disclosures
Audit documentation review
Independent review
Summary of evidence evaluation
Evaluating Results and
Reaching Conclusions
Actual audit evidence

(by cycle, account, Evaluate results
and objective) (by account and cycle)
Audit procedures Estimated misstatement

Sample size (by account)
Items to select Achieved audit risk
Timing (by account and cycle)
Evaluating Results and
Reaching Conclusions
Evaluate overall
financial statements
Issue
audit
Estimated misstatement
report
(overall statements)
Achieved audit risk
(overall statements)
Issue the Audit Report
The audit report is the only thing that most

users see in the audit process, and the
consequences of issuing an inappropriate
report can be severe.
Communicate with
the Audit Committee and Management
 Communicate fraud and illegal acts

 Communicate internal control deficiencies
 Other communication with audit committee
 Management letters
FURTHER READING
ISQC 1 – Quality control for firms that perform

audits and reviews of historical financial
information, and other assurance and related
services engagements.
ISA 220 – Quality control for audits of historical

financial information.
ISA 230 – Audit documentation.
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FURTHER READING CONT'D
ISA 560 – Subsequent events.
ISA 580 – Management representations.
IAS 10 – Events after the balance sheet date.
FRS 12 and IAS 37 – Provisions, contingent

liabilities and assets.
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Final review: post-balance sheet

period, provisions, contingencies,

After studying this chapter you should be

• Explain the nature of provisions, contingent

Stage 18 of the audit process is when auditors

They also perform the following tasks:

The period after the balance sheet date may be

Each period has its own characteristics and

(1) between balance sheet date and completion of

Events occurring in periods (1) and (2) are known

Regarding (4), auditors have no obligation to

Regarding (5), auditors will not be expected to be

12-31-07 3-11-08 3-26-08

Period to which review for Period for

12-31-07 3-11-08 3-26-08

Period to which Period for Period in which

 Those that have a direct effect

 Declaration of bankruptcy by a customer

 Decline in the market value of securities

Two categories of audit procedures

 The first date is the date for the completion

 The second date, which is always later,

Provisions, contingent liabilities and contingent

Some events, occurring either before or after

• Is there a legal or constructive obligation,

• The auditor should determine if a reliable

Provisions must be properly disclosed in

If the event does not give rise to a present

In Part (b) the obligation may not be recognized

Contingencies, like provisions, are problematic

Likelihood of Financial Statement

 Pending litigation for patent infringement,

Inquire of management about the possibility

Review current and previous years’ internal

Review the minutes of directors’ and

Analyze legal expenses and review invoices

Obtain a letter from each major attorney of the

Review audit documentation for any information

Examine letters of credit in force.

Directors’ responsibilities include determining

Indicators that might suggest going-concern

Auditors obtain written confirmation of directors’

Where financial statements are prepared on a

Directors judge what is an appropriate period for

If there is no doubt, neither directors nor auditors

Where there are doubts, auditors will consider if

Audit work to detect post-balance sheet events

(d) examine profit and cash flow forecasts;

1. Perform final analytical procedures.

Purposes of the letter:

 Sufficient appropriate evidence

Actual audit evidence

Audit procedures Estimated misstatement

The audit report is the only thing that most

 Communicate fraud and illegal acts

ISQC 1 – Quality control for firms that perform

ISA 220 – Quality control for audits of historical

ISA 230 – Audit documentation.

ISA 560 – Subsequent events.

ISA 580 – Management representations.

IAS 10 – Events after the balance sheet date.

FRS 12 and IAS 37 – Provisions, contingent

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