Review Questions There are four presentation and disclosure-related audit objectives:
PRESENTATION AND DISCLOSURE-RELATED AUDIT OBJECTIVES Occurrence and rights and obligations Completeness Accuracy and valuation Classification and understandability
DESCRIPTION Account-related information as described in the footnotes exists and represents the rights and obligations of the company. All required disclosures are included in the financial statement footnotes. Footnote disclosures are accurate and valued correctly. Account balances are appropriately classified and related financial statement disclosures are understandable.
24-2 A financial statement disclosure checklist is an audit tool that summarizes all disclosure requirements contained in generally accepted accounting principles. Auditors use the disclosure checklist to determine that all required disclosures are completely presented and disclosed in the financial statements and accompanying footnotes. This helps the auditor obtain sufficient appropriate evidence about the completeness objective for the presentation and disclosure-related audit objective. 24-3 A contingent liability is a potential future obligation to an outside party for an unknown amount resulting from activities that have already taken place. Some examples would be:
Pending litigation Income tax disputes Product warranties Notes receivable discounted Guarantees of obligations of others Unused balances of outstanding letters of credit
24-3 (continued) An actual liability is a real future obligation to an outside party for a known amount from activities that have already taken place. Some examples would be:
Notes payable Accounts payable Accrued interest payable Income taxes payable Payroll withholding liabilities Accrued salaries and wages
24-4 If you are concerned about the possibility of contingent liabilities for income tax disputes, there are various procedures you could use for an intensive investigation in that area. One good approach would be an analysis of income tax expense. Unusual or nonrecurring amounts should be investigated further to determine if they represent situations of potential tax liability. Another helpful procedure for uncovering potential tax liabilities is to review the general correspondence file for communication with attorneys or internal revenue agents. This might give an indication that the potential for a liability exists even though no actual litigation has begun. Finally, an examination of internal revenue agent reports from prior years may provide the most obvious indication of disputed tax matters. 24-5 The auditor would be interested in a client's future commitments to purchase raw materials at a fixed price so that this information could be disclosed in the financial statements. The commitment may be of interest to an investor as it is compared to the future price movements of the material. A future commitment to purchase raw materials at a fixed price may result in the client paying more or less than the market price at a future time. 24-6 The analysis of legal expense is an essential part of every audit engagement because it may give an indication of contingent liabilities which may become actual liabilities in the future and require disclosure in the current financial statements. Since any single contingency could be material, it is important to verify all legal transactions, even if the amounts are small. After the analysis of legal expense is completed, the attorneys to whom payment was made should be considered for letters of confirmation for contingencies (attorney letters). 24-7 Pyson should determine the materiality of the lawsuits by requesting from Merrill's attorneys an assessment of the legal situations and the probable liabilities involved. In addition, Pyson may have his own attorney assess the situations. Proper disclosure in the financial statements...