Auditing Operations and Completing the Audit

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Outline

Auditing operations
Miscellaneous revenue Miscellaneous SG&A expenses

Auditing payroll Completing the audit Evaluating audit findings Post-audit responsibilities

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Relationships Between Balance Sheet and Revenue Accounts Relationship of Revenue to Balance Sheet Accounts
Balance Sheet Item Accounts receivable Notes receivable Securities and other investments Property, plant and equipment Intangible assets
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Revenue Sales Interest Interest, dividends, gains on sales, share of investees income Rent, gains on sale Royalties

Miscellaneous Revenue

Mixture of minor or non-recurring revenue transactions. Items that may be misclassified as miscellaneous revenue.
Collection on previously written-off receivables Write-offs of old outstanding checks Proceeds from sale of scrap Refunds or rebates of insurance premiums Proceeds from sales of plant assets

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Relationships Between Balance Sheet and Income Statement Accounts

Relationship of Expenses to Balance Sheet Accounts
Balance Sheet Item Accounts and notes receivable Inventories Property, plant and equipment Intangible assets Accrued liabilities Interest-bearing debt
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Expenses Uncollectible accounts and notes expense Purchases, cost of goods and payroll Depreciation and repairs and maintenance Amortization Commissions, fees, bonuses, product warranty expenses, etc. Interest

Substantive Tests for Selling, General and Administrative Expenses

Perform analytical procedures

Develop an expectation of the account balance Determine the amount of difference from the expectation that can be accepted without investigation Compare the companys account balance with the expected account balance Investigate significant deviations from the expected account balance

Obtain or prepare analyses of selected expense accounts Obtain or prepare analyses of critical expenses in the income tax return

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The Audit of Payroll

Payroll is often a companys largest operating cost. Potential payroll frauds

Fictitious employees Overpaying employees Continuing to pay employees after termination

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Payroll Functions

Human resources
Authorized pay rate Employment papers / payroll deductions

Timekeeping
Electronic clocks Supervisor oversight of timekeeping

Payroll preparation and recordkeeping

Time cards Payroll journals Labor distributions Employee earnings records

Distribution of paychecks
Paymaster Imprest account / regular reconciliation Proof of identity / employee signature

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Audit Program for Payroll

Obtain an understanding of internal control over payrolls Perform tests of controls as necessary
Compare name, wage rates, and payroll deductions to HR records. Compare time on payroll to time reports approved by supervisors. Test extensions and footing of payroll. Compare payroll total to total of checks issued. Observe the use of time clocks. Observe the distribution of paychecks.

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Audit Program for Payroll

Perform substantive tests of payroll

Audit Objectives

Substantive Tests

Perform analytical procedures Existence/occurrence Investigate fluctuations in payroll Completeness Obtain a summary of amounts of officers Valuation compensation and trace to authorization. Test compensation from profit-sharing or bonus plans. Test commission earnings Test pension obligations
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Valuation

Audit Procedures Completed Near the End of Field Work

Search for unrecorded liabilities Review the minutes of meetings Perform final analytical procedures Perform procedures to identify loss contingencies Perform the review for subsequent events Obtain the representation letter

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Loss Contingencies
Def.: A possible loss stemming from past events that will be resolved as to existence and amount by some future event. Loss contingencies should be reflected in the financial statement amounts when:

It is probable that a loss had been sustained before the balance sheet date The amount of the loss can be reasonably estimated

Loss contingencies should be disclosed in the notes to the financial statements when it is at least reasonably possible that a loss has been sustained Loss contingencies need not be disclosed when the possibility of loss is remote

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Loss Contingencies

Types of loss contingencies

Litigation Income tax disputes Guarantees of indebtedness Accounts receivable sold or assigned with recourse Environmental issues Commitments General risk contingencies

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Loss Contingencies

Procedures for loss contingencies

Review minutes of BOD meetings. Send letter of inquiry to clients attorneys. Send confirmation letters to financial institutions requesting information on contingent liabilities. Review correspondence with financial institutions for evidence of guarantees of indebtedness, or sales or assignments of accounts receivable. Review reports and correspondence with regulatory agencies to identify potential fines or assessments. Obtain a representation letter from management indicating that all liabilities known to officers are recorded or disclosed.

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Subsequent Events

Covers period between balance sheet date to date of auditors report (last day of fieldwork). Type I subsequent event
Involves conditions that existed on or before balance sheet date
Must adjust financial statement amounts to reflect event

Type II subsequent event

Involves conditions coming into existence after the balance sheet date.
Must disclose in footnotes if omission would cause financial statements to be misleading.

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Subsequent Events

Examples of Type I subsequent events

Large receivable at balance sheet date proves to be uncollectible due to subsequent bankruptcy of debtor. Customer check included in ending cash subsequently proves to be uncollectible. Settlement of pending litigation.

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Subsequent Events
Examples of Type II subsequent events
Business combination
Pro forma results often disclosed

Substantial casualty losses Significant changes in financial position or financial structure Major personnel changes Product line changes Labor strikes
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Disclosure generally required

Disclosure generally not required

Subsequent Events

Audit procedures relating to subsequent events

Review latest interim financial statements and minutes of BOD meetings. Inquiries to appropriate client officials. Letter of inquiry to clients attorneys. Representation from management in representation letter.

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Evaluating Audit Findings

Overall review of the audit

Evaluate sufficiency and competency of evidence in the workpapers. Evaluate total likely misstatement
Known misstatements Projected misstatements Other estimated misstatements

Review the sufficiency of disclosures

Disclosure checklists

Client approval of adjusting entries and disclosures

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Required Communication With the Audit Committee

Significant deficiencies in internal control The auditors responsibilities for the audit and other information included with the financial statements Significant audit adjustments made Proposed audit adjustments evaluated by management as immaterial Disagreements with management or other difficulties The auditors viewpoint on an accounting or auditing matter if management contacted other auditors about the matter A discussion of the quality of accounting principles and estimates

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Post-Audit Considerations

Subsequent discovery of facts existing at the date of the audit report

Auditor must immediately investigate If material, auditor should advise client to make appropriate disclosures to anyone relying on the financial statements. If management refuses, auditor should contact BOD members, any regulatory agencies, and if practicable any persons relying on the statements.

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Post-Audit Considerations

Subsequent discovery of omitted procedures

Auditor should assess importance of omitted procedures to audit opinion. If opinion is impaired, the auditor should attempt to perform the omitted procedures or appropriate alternative procedures. Auditor should consult legal counsel.

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