External Matters (e.g., legal proceedings, loss of a key patent)
Auditor's Playbook
Consider plans to borrow money, sell assets, reduce spending, or increase equity. These plans must be both feasible and likely to be implemented effectively.
Perform additional procedures to gather evidence about the conditions, events, and management's plans. This includes obtaining written representations from management.
Decision Point
Scenario: The auditor concludes substantial doubt about the entity's ability to continue as a going concern remains, even after considering management's plans. The financial statement disclosures are adequate. What is the impact on a nonissuer's audit report?
Risk Area: Accounting Estimates
Risk Indicators
High degree of estimation uncertainty (subjectivity, complexity).
Changes in methods or assumptions that appear favorable to management.
Selection of a point estimate that indicates a pattern of optimism or pessimism.
Auditor's Playbook
Evaluate the reasonableness of the methods, significant assumptions, and data used by management. Check for mathematical accuracy and potential management bias.
Develop an auditor's point estimate or range to compare against management's estimate. This provides a benchmark for reasonableness.
Decision Point
Scenario: The auditor concludes that management's estimate for the warranty liability is unreasonably low. The difference between the recorded estimate and the auditor's best estimate is material. What should the auditor do?
Risk Area: Related Parties
Risk Indicators
Unusual, non-recurring transactions near year-end.
Transactions with terms that differ significantly from market terms.
Loan guarantees or large non-monetary exchanges.
Previously unidentified related parties discovered during the audit.
Auditor's Playbook
Inquire of management, review SEC filings, review prior year workpapers, and read minutes to identify all related parties.
Read underlying contracts, evaluate the business purpose, and obtain evidence that the transactions were properly authorized, approved, accounted for, and disclosed.
Decision Point
Scenario: The client's financial statements include a note stating a significant related party transaction was conducted on "terms equivalent to those that prevail in an arm's-length transaction." The auditor cannot find sufficient evidence to substantiate this claim. What is the most likely impact on the report?
Risk Area: Litigation, Claims & Assessments
Risk Indicators
Correspondence from regulatory agencies or attorneys indicating disputes.
Large, unexplained legal expense payments.
Discussion of lawsuits or potential claims in board minutes.
Auditor's Playbook
Management is the primary source of information. Ask about policies for identifying, evaluating, and accounting for litigation and claims.
Prepare a letter of inquiry, to be sent by the auditor, to the client's external legal counsel to corroborate management's information.
Decision Point
Scenario: Management refuses to allow the auditor to send a letter of inquiry to its external legal counsel regarding a potentially material lawsuit. What is the auditor's most likely course of action?
