CHAPTER

14 Completing a Quality Audit

1
Johnstone, Auditing: A Risk-Based Approach, 11th Edition. ©2019 Cengage. All Rights Reserved. May
not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part
Learning Objectives
LO 1 Review, summarize, and resolve detected misstatements
and identified control deficiencies.
LO 2 Review and assess the appropriateness of the client’s
significant accounting estimates.
LO 3 Review the adequacy of disclosures.
LO 4 Review the appropriateness of the going-concern
assumption using relevant professional guidance.
LO 5 Describe the contents of a management representation
letter.
LO 6 Determine how to address situations in which omitted
audit procedures come to the auditor’s attention after the
audit report has been issued.

2
Johnstone, Auditing: A Risk-Based Approach, 11th Edition. ©2019 Cengage. All Rights Reserved. May
not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part
LO 7 Assess the adequacy of supervision and perform
an engagement quality review.
LO 8 Identify issues to communicate to the audit
committee.
LO 9 Identify issues to communicate to management
via a management letter.
LO 10 Describe the process by which audit firms make
client acceptance and continuance decisions.
LO 11 Identify the requirements concerning mandatory
partner rotation and mandatory audit firm
rotation for publicly traded audit clients.
3
Johnstone, Auditing: A Risk-Based Approach, 11th Edition. ©2019 Cengage. All Rights Reserved. May
not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part
Categories of misstatements

Known or factual misstatements

• Specifically identified

Projected misstatements

• Best estimate of misstatement in a given population

Judgmental misstatements

• Differences in auditor and management judgment concerning:

• Accounting estimates
• Selection or application of accounting policies
Resolving Detected Misstatements
● Audit firms use a schedule to:
● Accumulate known and projected misstatements
● Carryover effects of prior-year uncorrected misstatements
● Immaterial misstatements are waived (left uncorrected)
Resolving Detected Misstatements
● Materiality of a misstatement is based on:
● Quantitative amount of the misstatement
● Nature of misstatement to determine the qualitative features
that would make it material
judgmental estimates included in Financial
statement balances
● Examples:
● Fair value of many assets
● Net realizable values of inventory and receivables
● Warranty expenses and associated liabilities
● Depreciation and amortization methods
Reviewing Significant Estimates
● Auditors should be alert to period-end adjusting journal
entries
● They are responsible for providing assurance that:
● Estimates are reasonable
● Estimates are presented in conformity with GAAP
● Disclosure about estimates is adequate
Reviewing Significant Estimates
● Management estimates are based on:
● Subjective factors
● Objective factors
● Events or transactions useful in identifying and evaluating
reasonableness of estimates occur:
● After balance sheet date
● Before audit report date
Reviewing Significant Estimates
● Auditor should focus on factors and assumptions that are:
● Significant to accounting estimate
● Sensitive to variations
● Deviations from historical patterns
● Subjective and susceptible to misstatement and bias
● Inconsistent with current economic trends
Reviewing the Adequacy of Disclosures
● Auditor’s report must indicate if disclosures are not
reasonably adequate
● Disclosures can be made:
● On face of financial statements
● In form of classifications or parenthetical notations
● In notes to statements
Reasonable assurance that auditors should have
When assessing adequacy of disclosures
● Disclosed events and transactions have occurred and
pertain to the entity
● All disclosures that should have been included
● Disclosures are understandable to users
● Information is disclosed accurately and at appropriate
amounts
Evaluating the Going-Concern Assumption
● Responsibility of management - Assessing company’s
going concern status for a reasonable period of time
● Reasonable period of time: A period of time not to exceed one
year beyond the date of the financial statements being audited
● Responsibility of auditor - Evaluating appropriateness of
that assessment
● Use of bankruptcy prediction models to analyze whether
a particular client might have a going-concern problem
EXHIBIT 14.3 - Going-Concern Process

14.3.png
 Evaluating the Going-Concern Assumption

If substantial doubt about entity’s

If substantial doubt about entity’s
ability to continue as a going concern
ability to continue as a going concern
for a reasonable period of time
is alleviated
remains

Consider disclosure of conditions

that initially caused auditor to Include an emphasis-of-matter
believe there was substantial paragraph in auditor’s report to
doubt reflect that conclusion

Consider possible effects of such Audit report will include phrase -

conditions or events, and any Substantial doubt about entity’s
mitigating factors, including ability to continue as a going
management’s plans concern
Reasons auditors might resist issuing a going-
concern audit opinion
● It can be a self-fulfilling prophecy that the company will
go bankrupt
● It is difficult to know beforehand whether a financially
distressed client will:
● Cease operations
● Pull itself away from that outcome
Indicators of Potential Going-Concern Problems
● Negative trends
● Internal matters
● External matters
● Significant changes in:
● Competitive market
● Competitiveness of client’s products
Mitigating Factors for a going-concern problem
● Identify and assess management’s plans to overcome this
problem
● Identify factors most likely to resolve the problem and
gather independent evidence to determine success of
such plans
● Consider, and independently test, adequacy of support
for major assumptions
management representation letter
● Purpose is to help promote audit quality by:
● Reminding management of its responsibility for financial
statements
● Confirming oral responses obtained by auditor
● Reducing the possibility of misunderstanding
● Management’s refusal to sign the letter:
● Implies their untruthfulness in verbal representations
● Considered a scope limitation
EXHIBIT 14.8 - Subsequent Periods
Review of Subsequent Events
● Subsequent events: Occur between the date of the
financial statements and date of the auditor’s report
● Subsequent events review: Review of events in the period
between the balance sheet date and the audit report date to
determine their effect on the financial statements
● Type I subsequent events: Existed at the balance sheet
date (adjustment to financial statements)
● Type II subsequent events: Did not exist at balance sheet
date (disclosure)
Audit Procedures Concerning the Review of
Subsequent Events
● Cutoff tests
● Reviewing subsequent collections of receivables
● Searching for unrecorded liabilities
● Reading minutes of meetings
● Reading and comparing interim financial statements to
audited financial statements
● Inquire of management concerning:
● Significant changes noted in the interim statements
Dual Dating
● Awareness of an event occurring after audit report date
but before report release date
● Report release date: Grant of permission to the entity to use
the auditor’s report in connection with financial statements
● Options for dating the audit report:
● Using date of this event as date of audit report
● Dual-date the report
Consideration of Omitted Procedures Discovered
after the Report Date
● Omitted procedure: After the audit report has been
issued, auditor may discover that an important audit
procedure was not performed
● If previously issued audit report cannot be supported in
light of omitted procedures
● Alternative procedures should be promptly performed and
documented
Performing an Engagement Quality Review
● Engagement quality review (Concurring partner review):
Review at the end of each audit conducted by an
experienced auditor having appropriate competence,
independence, integrity, and objectivity
● To help make sure that audit and audit documentation are
complete and support audit opinion
Performing an Engagement Quality Review
● Procedures that reviewer should perform as part of the
review process
● Discussing with audit team significant matters related to
financial statements and internal controls
● Evaluating judgments about materiality and disposition of
corrected and uncorrected identified misstatements
● Reviewing evaluation of firm’s independence in relation to
engagement
Reasons for External Auditors to Communicate
with the Audit Committee
● Audit committee serves as an independent subcommittee
of board of directors
● Audit committee can assist auditor during a disagreement
between the auditor and management
● Audit committee must be assured that auditor:
● Is free of any restrictions
● Has not been inappropriately influenced by the management
typical communications between the auditor and
the audit committee
● Auditor’s responsibility under generally accepted auditing
standards
● Overview and planned scope of audit
● Independence
● Significant accounting policies
● Management judgments and accounting estimates
● Significant audit adjustments
Communicating with Management via the
Management Letter
● Management letter: From the auditor to the client
identifying any problems and suggested solutions to
improve management’s efficiency or effectiveness
● Used to make significant operational or control
recommendations to client
Issues Relating to Audit Firm Portfolio Management, Audit
Partner Rotation, and Audit Firm Rotation
● Audit firm portfolio management - Deciding whether to:
● Continue providing audit services to client
● Begin providing services to a new client
● Consider mandatory partner rotation and mandatory
audit firm rotation requirements for publicly traded audit
clients
Client Acceptance and Continuance Decisions
● Decisions taken by audit firms and individual engagement
partners immediately before agreeing to conduct an audit
or after completing audit
● Called client acceptance and continuance decisions
● Client acceptance decision: When a new client is
evaluated by the audit firm and individual engagement
partner prior to being accepted into the audit firm’s
portfolio of clients
Client Acceptance and Continuance Decisions
● Client continuance decision: When existing clients are
evaluated by the audit firm and individual engagement
partner at the completion of the audit to determine
whether the audit firm should continue to provide
services again in the next period
Client Acceptance and Continuance-Related Risks
● Client entity characteristics
● Independence risk factors
● Third party /due diligence risk factors
● Quantitative risk factors
● Qualitative risk factors
● Entity organizational or governance risks
● Financial reporting risks
Reasons for not providing audit services to a
client
● Client does not fit the profile that the firm requires to
achieve its growth strategy
● Client not in an industry that the firm wants to emphasize
● Client’s growth not feasible for firm anymore
● Client being potentially problematic
Partner Rotation and Audit Firm Rotation
● Familiarity threat occurs when auditor has a longstanding
relationship with an important person associated with
the client
● Having a longstanding relationship with client could:
● Aid audit quality
● Knowledge that partner and members of engagement team gain
through time
● Impair auditor’s willingness or ability to perform an unbiased
assessment of audit evidence
Partner Rotation and Audit Firm Rotation
● Differences exist internationally in terms of:
● Requirement of rotation
● Length of time:
● Auditor or audit firm may serve before rotation
● Of a cooling off period
● Cooling off period: Number of years after which individual auditor or audit
firm may resume its prior role with audit client
EXHIBIT 14.10 - U.S. and International Guidance on Mandatory
Audit Partner Rotation and Mandatory Audit Firm Rotation