Chapter 13: Completing the audit

Review questions

13.11 Identify the audit procedures normally associated with subsequent events.

Reviewing procedures that management has established to ensure that subsequent events
are identified
Enquiring of management and, where appropriate, those charged with governance, as to
whether any subsequent events have occurred which might affect the financial report
Reading minutes of the meetings of shareholders, those charged with governance, audit
and executive committees held after the reporting date, and enquiring about matters
discussed at meetings for which minutes are not yet available
Reading the entity’s latest available interim financial statements and, as considered
necessary and appropriate, budgets, cash flow forecasts and other related management
reports
Enquiring of the entity’s lawyers.

13.13 How would you define the two types of events that occur after the reporting period?
What are the potential accounting effects of each type?

Conditions existing at the reporting date (adjusting events)

Events that provide additional evidence with respect to conditions that existed at the date
of the balance sheet and affect the estimates inherent in the process of preparing the
financial report. These events may require adjustment of the financial report.

Conditions arising after the reporting date (non-adjusting events)

Events that provide evidence with respect to conditions that did not exist at the date of the
balance sheet but arose subsequent to that date. These events require disclosure, and in
very material cases, by attaching pro-forma data to the financial report.

13.14 What procedures should the auditor perform when a question arises regarding going
concern?

The auditor performs most of these procedures during the period of completion of the audit
(ASA 570.16), such as:

Analysing and discussing cash flow, profit and other relevant forecasts with
management.
Analysing and discussing the entity’s latest available interim financial report.
Reading the terms of debentures and loan agreements and determining whether any
have been breached.
Reading minutes of the meetings of shareholders, those charged with governance and
relevant committees for reference to financing difficulties.
Enquiring of the entity’s legal counsel regarding the existence of litigation and claims
and the reasonableness of management’s assessments of their outcome and the
estimate of their financial implications.
Confirming the existence, legality and enforceability of arrangements to provide or
maintain financial support with related and third parties and assessing the financial
ability of such parties to provide additional funds.
Evaluating the entity’s plans to deal with unfilled customer orders.
Performing audit procedures regarding subsequent events to identify those that either
mitigate or otherwise affect the entity’s ability to continue as a going concern.
Confirming the existence, terms and adequacy of borrowing facilities.
Obtaining and reviewing reports of regulatory actions.
Determining the adequacy of support for any planned disposals of assets.
13.15 What are the objectives of the management representation letter? Under what
circumstances are management representations considered acceptable audit evidence?

The objectives of the management representation letter include:

 confirmation of oral representations given to the auditor
 document the continuing appropriateness of representations
 reduce the possibility of misunderstandings concerning management’s
representations
 support other audit evidence relevant to the financial report or specific assertions
in the financial report
 acknowledge management’s responsibility for the preparation of the financial
statements in accordance with the applicable financial reporting framework
 acknowledge management’s responsibility for the completeness of the
information provided to the auditor.

Management representations are considered acceptable audit evidence only where other
sufficient appropriate audit evidence cannot reasonably be expected to exist. However, it
is still prudent to consider management representations to be supporting rather than
primary evidence.

13.21 Subsequent events 

You are an audit assistant allocated to perform the audit of Topporene Ltd for the
year ended 30 June 2017. The managing director of Topporene is interested in the
audit responsibilities for identifying subsequent events. The audit partner would
like you to document these responsibilities in a memo to the managing director. The
detailed audit work is expected to be completed by 31 August 2017. It is planned
that:
• the auditor’s report will be signed on 15 September 2017
• the financial statements will be sent to shareholders on 30 September 2017.

Required
(a) In your memo, explain the auditor’s responsibilities for identifying subsequent
events in the following periods:
· 30th June 2017 to 31st August 2017
· 1st September 2017 to 15th September 2017
· 18th September 2017 to 30th September 2017
· 1st October 2017 onwards

Memo

To: Managing Director – Topporene Ltd

30 June 2017 to 31 August 2017

Events occurring up to the date of the audit report
The auditor is required to perform procedures to identify and evaluate all events that
might require adjustment or disclosure in the financial report up until the date the audit
report is signed. This responsibility is discharged by the auditor in the following two
ways: (1) by being alert for subsequent events in performing year-end substantive
procedures (such as cut-off tests and the search for unrecorded liabilities); and (2) by
performing the auditing procedures specified in ASA 560.10 (ISA 560.07) at or near the
completion of the examination (discussed below in (b).
If the audit procedures identify events that could affect the financial report, the auditor
should carry out further procedures to assess whether such events are appropriately
reflected in the financial statements. At this point the auditor needs to consider the
appropriate accounting treatment of the event.

1 September 2017 to 15 September 2017

Post-Audit responsibilities for subsequent events

After the audit report has been signed the auditor has no responsibility to perform
procedures to detect subsequent events or to make any inquiry regarding the financial
report. This is one of the reasons why the date on the audit report is important; the audit
report should be signed on the same day as the directors’ report where possible. However,
if the auditor becomes aware of a fact after the audit report has been signed, it may be
appropriate to take some type of action. The action the auditor should take depends on
whether the fact is discovered after the date of the audit report but before the issuance of
financial statements or after the financial report has been issued.

16 September 2017 to 30 September 2017

Events occurring after the date of the audit report but before the financial report is issued

The auditor has no responsibility to make an inquiry or to perform auditing procedures

during this time to discover any material after-balance-date events. However, during this
period, management is responsible for informing the auditor of any events that may affect
the financial report. The events may relate to conditions existing at reporting date or
conditions existing after reporting date. The need to amend the financial report should be
considered and discussed with management.

If the financial report is amended, the auditor must carry out any necessary auditing
procedures, including extending the review of after-balance-date events, and reissue the
audit report at the date of approval of the amended financial report. If management do not
amend the financial report where the auditor believes it should be amended, and the audit
report has not been released to the entity, the auditor should issue a qualified report in
accordance with ASA 705 (ISA 705). If the financial report has been released to the
entity and management refuses to make the required amendments the auditor should take
action to prevent reliance on the audit report. This can be done, for example, by
exercising the auditor’s right to be heard at the general meeting at which the audited
financial report is presented to members.

1 October 2017 onwards

Facts discovered after the financial report has been issued

An auditor has no responsibility to make an on-going inquiry on the financial report after
it has been issued. This responsibility is essentially the same as during September where
action by the auditor is only required if he or she becomes aware of an event. The key
difference in this period is that the only event that concerns the auditor is something that
he or she missed before signing the audit report that has now come to light. This is in
contrast to September when the auditor must consider whether to take action in relation to
any event that he or she becomes aware of. This limitation from 1 October ensures that
there is an end point to the auditor’s responsibilities in relation to a company’s financial
statements for a particular year.

The main issue for the auditor to consider in assessing the impact of this event is to
determine whether or not, if the event was known at the date of the audit report, the
auditor would have qualified the report.

If the auditor would have qualified the audit report, he or she should consider whether the
financial statements need revision. If management does not agree to the revision, the
auditor should notify the persons ultimately responsible for the overall direction of the
entity that action will be taken by the auditor to prevent future reliance on the audit
report.

The preferred result is the preparation of a revised financial report by the client and the
issue of a revised audit report as soon as practicable. Again, before a revised auditor’s
report is issued, the auditor should extend the review of subsequent events up to the date
of the issuance of the revised report. The new report should include an emphasis of
matter paragraph referring to a note in the financial statements that provides an
explanation for the revision of the previously issued financial report and the earlier audit
report.

The new report should be dated not earlier than the date on which the revised financial
statements are approved. If the issue of the following period’s financial statements is
imminent, then the revised financial statements may not be issued. However, in these
circumstances, appropriate disclosures are required in the following period’s statements.

(b) Discuss the procedures that are involved in identifying subsequent events.
ASA 560.10 (ISA 560.07) suggests some of the following:
Reviewing procedures that management has established to ensure that subsequent
events are identified;
Enquiring of management and where appropriate, those charged with governance,
as to whether any subsequent events have occurred which might affect the
financial report;
Reading minutes of the meetings of shareholders, those charged with governance,
audit and executive committees held after the end of the reporting period, and
enquiring about matters discussed at meetings for which minutes are not yet
available;
 Reading the entity’s latest available interim financial report and, as considered
necessary and appropriate, budgets, cash flow forecasts and other related
management reports;
Enquiring (or adding to previous oral or written inquiries) of the entity’s lawyers;
Enquiring of management as to whether any subsequent events have occurred
which might affect the financial statements. Examples of specific inquiries that
might be made of management include: the current status of items that were
accounted for on the basis of tentative, preliminary or inconclusive data; whether
new commitments, borrowings or guarantees have been entered into; or whether
sales of assets have occurred or are planned.

Case studies

13.30 Subsequent events 

Your client is Queenscorp Ltd, a diversified business operating throughout
Australia. Year-end was 30 June 2017, the auditor’s report was signed on 31 July
2017 and the financial statements were mailed to shareholders on 14 August 2017.
During your subsequent events review, you noted the following independent and
material items.
1. Queenscorp has been involved in a legal dispute with a competitor for a number
of years. The dispute relates to alleged breaches of copyright by Queenscorp.
On 27 July, you discovered that Queenscorp had settled the legal action out of
court on terms more favourable than expected.
2. As for (1) above, except that the legal action was settled on 5 August.
3. On 10 July, one of Queenscorp’s major product lines developed a fault that
rendered the product unusable. Queenscorp became aware of the fault on 30
July. Although the fault posed no safety risks to consumers, Queenscorp
decided to launch a full product recall on the following day.
4. On 30 July 2017, the Bureau of Meteorology issued a cyclone warning for parts
of Far North Queensland. Queenscorp has a large sugar cane plantation in this
area. On 2 August, the cyclone hit, wiping out about 90% of the crop.
5. Queenscorp has invested significant funds in developing a new type of
cholesterol-reducing margarine. On 7 July, Queenscorp applied for a patent for
the margarine, only to discover that a competitor had lodged a similar
application on 28 June. The granting of Queenscorp’s application is now in
doubt.
6. Queenscorp’s bank loan is conditional upon certain ratios being maintained at
all times. On 20 August, you discovered that one of the ratios was breached for
a 24-hour period on 18 August.
7. Queenscorp has large landholdings on the outskirts of Sydney. On 20 July,
Queenscorp received preliminary notice from the federal government informing
the company that, should the new Sydney airport proceed, about 30% of this
land will be forcibly acquired. Queenscorp has no legal right to challenge the
acquisition.
8. In early June, one of Queenscorp’s largest debtors informed Queenscorp that it
was experiencing serious financial difficulties. On 5 July, Queenscorp was
informed that the debtor had gone into receivership.
Preliminary reports suggest Queenscorp will recover only 10 cents in the dollar
of the outstanding debt.

Required
(a) Outline the key additional procedures you should have performed in relation to each
of the above events.
(b) What actions should you have recommended to management in relation to each of the
above events?
1.
(a) The auditor will need to discuss with management regarding the settlement of the
legal dispute and review the evidence of what amounts have been agreed upon to be
paid etc. The auditor should also contact the audit client’s solicitor about through a
solicitor’s representation letter regarding this before the audit report is due to be
signed so as to establish any loss that should be recorded in the accounts.
(b) This is a post balance date event relating to conditions existing at balance date i.e. it is
an adjusting event. Any loss or costs payable that can be verified should be recorded
as litigation costs or liability in the accounts. As the dispute has been there for a
number of years, the company would have a contingent liability account for this
dispute. This would have been transferred to liability account which is incorporated
within the financial statements as the legal dispute has been resolved.

2.
The auditor should also contact the audit client’s solicitor about through a solicitor’s
representation letter regarding this and confirm with management the dates on which
the legal dispute is settled.
This is an event occurred after the date of audit report but it relates to conditions
existing at the balance date. The auditor would have to discuss with management the
need to amend the accounts for this change and the audit report would also need to be
reissued on the amended accounts.

3.
(a) The auditor should discuss with management about the faulty product lines and the
launch of a full product recall. The further evidence to be obtained would be
documentation to ensure that the dates given by the management were correct.
(b) This event occurred after the balance date but before the audit report date. The
appropriate action for the auditor is to request that management disclose the facts of
the fire in the financial report.

4.
(a) The auditor should confirm the dates on which the cyclone hit and discuss with
management how it will affect the company.
(b) It is a post balance date event not relating to conditions existing at balance date i.e. a
non-adjusting event. The cyclone hit on 2 August, after the audit report was signed.
No action recommended for this year’s accounts.

5.
(a) The auditor should confirm the dates on which Queenscorp has applied for a patent
for a new type of margarine. The auditor should also confirm with the patent
registration office or discuss with a patent expert on the probability of the granting of
Queenscorp’s application as well as discuss with management the implications of
this event.
(b) The auditor should recommend the management to disclose the event and its
implications within the notes of the financial statements as Queenscorp has invested
significant funds in developing the new type of margarine. The application has just
been lodged and there is uncertainty about the results so there isn’t a need for adjust
in the financial report.
6.
(a) This event occurred after the financial reports have been mailed did not exist at the
date of the mailing of the financial reports; therefore, it is of no concern to you for
this year’s accounts. The further evidence the auditor would seek would be
documentation and contracts to ensure that the dates given to you by the general
manager were correct.
(b) No action recommended for this year’s accounts.

7.
(a) The auditor should confirm with management that this event did occur and examine
the notice letter received to check the date on which the notice letter was received.
(b) This is a post balance event that is not connected to conditions existing at balance
date i.e. non-adjusting event. The auditor should request the management to disclose
the fact that 30% of the land owned will be forcibly acquired by the federal
government should the new Sydney airport proceed and how it will affect the
company.

8.
(a) The auditor should obtain an external confirmation from that particular debtor to
ensure that it had gone into receivership and the amount that would be recoverable.
The auditor should also confirm the date of receivership was in fact before the date
of the audit report.
(b) This is a post balance date event relating to conditions existing at balance date. In
early June, the debtor has informed Queenscorp that it has been experiencing serious
financial difficulties and it had gone into receivership on 5 July. The auditor should
request management to adjust the provision for bad debts account or the trade
receivables account based on the preliminary reports that only 10% of the receivables
are recoverable.