Question

Question 1

One area of law which has been developing is that of the mass tort and/or class action. For example, tobacco companies won every case filed against them, year in and year out, until they finally started losing when the lawyers got together to attack the tobacco companies. There have been large numbers of lawsuits, or class actions, related to asbestos, lead, pollution (think of the movie "Erin Brockovich"), tires which failed on Ford Explorers, etc.

Assume that you are the in-charge auditor for a client company which does engineering design services for buildings, bridges, roads, port facilities, and other such items. During the year, a pedestrian walkway collapsed; the company had designed it for a stock-car racetrack in North Carolina. 20/20, the Sunday night network television program, showed some on-camera interviews in which someone made the claim that the walkway collapsed because the people who designed it had never had to solve problems 30

while they were in college; instead, all the tests they had taken were multiple-choice tests, and the result was that the people who designed the walkway did not know how to do so properly. In fact, the whole world had evidence that the design was improper, because the ten-month-old walkway had spontaneously collapsed on a clear day with little wind, when nobody was on the walkway. Thus, the designers could not credibly claim that the walkway had been subjected to stresses beyond those it was supposed to have been designed to handle.

Required:

Design an audit program for asserted and unasserted claims against this client company. Cite the authoritative professional literature related to the claims, and show how your audit program fulfills your professional responsibilities.

Answer 1

Litigation, Claims, and Assessments:

Audit procedures should be designed and performed to identify litigation, claims, and assessments that may cause a risk of material misstatement. Such procedures include:

• Inquiring of management and persons charged with governance, including any in-house legal counsel.
• Obtaining management's description and evaluation of litigation, claims, and assessments that existed at the financial statements' date and during the period of the subsequent events review.
• Reviewing minutes of meetings of persons charged with governance, documents related to the litigation, claims, and assessments and correspondence with the entity's external legal counsel.
• Reviewing legal and professional expense accounts and related support.

For actual or potential litigation, claims, and assessments, the auditor should obtain audit evidence regarding:

• The period in which the underlying cause for legal action occurred.
• The degree of probability of an unfavorable outcome.
• The amount or range of potential loss.

Communication with the Entity's Legal Counsel:

Unless the audit procedures described above indicate that no material actual or potential litigation, claims, or assessments exist, the auditor should seek direct communication by management's letter of inquiry with the entity's external and internal legal counsel. The response of legal counsel should be made directly to the auditors. When such communication is not made, engagement files should document reasons for not doing so and alternative procedures performed.

Letters of inquiry should include these and other matters:

• The names of the entity and any subsidiaries, and the date of the audit.
• A list prepared by management (or a request by management that the legal counsel prepare a list) that describes and evaluates pending or threatened litigation, claims, and assessments for which the legal counsel has been engaged.
• A list prepared by management that describes and evaluates unasserted claims and assessments that management considers to be probable of assertion and a likely unfavorable outcome for which the legal counsel has been engaged.

Practical Note:

Auditing procedures regarding unasserted and asserted claims and assessments normally begin with an analysis of professional services expense accounts. Coupled with inquiries of management and persons charged with governance, reading minutes of board and/or committee meetings, and information obtained while performing other auditing procedures, an auditor will obtain information as to the existences of legal counsel and potential claims or assessments.

Should no information be discovered in carrying out the procedures above and the client represents there have been no services obtained from legal counsel during the year, the requirements of AU-C Section 501 normally will be satisfied. When facts indicate the services of legal counsel were used and management does not permit the auditor to investigate the issues further, or when management refuses to send a letter of inquiry, the auditor should consider modification of the audit report to either qualify or disclaim an opinion depending on the pervasiveness and financial statement effects of the issues.

Unasserted Claims and Assessments (Considered by Management to be Probable of Assertion and That, if Asserted, Would Have at Least a Reasonable Possibility of an Unfavorable Outcome):

This section ordinarily would include the following: (1) the nature of the matter, (2) how management intends to respond if the claim is asserted, and (3) an evaluation of the likelihood of an unfavorable outcome and an estimate, if one can be made, of the amount or range of potential loss.

Please furnish to our auditors such explanation, if any, that you consider necessary to supplement the foregoing information, including an explanation of those matters for which your views may differ from those stated. We understand that whenever, in the course of performing legal services for us with respect to a matter recognized to involve an unasserted possible claim or assessment that may call for financial statement disclosure, you have formed a professional conclusion that we should disclose or consider disclosure concerning such possible claim or assessment, as a matter of professional responsibility to us, you will so advise us and will consult with us concerning the question of such disclosure and the applicable requirements of Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) 450, Contingencies. Please specifically confirm to our auditors that our understanding is correct.

The auditor may request the client to inquire about additional matters (for example, unpaid or unbilled charges or specified information on certain contractually assumed obligations of the Corporation, such as guarantees of indebtedness of others).

Please specifically identify the nature of and reasons for any limitations on your response. Our auditors expect to have the audit completed about March 1, 2016. They would appreciate receiving your reply by that date with a specified effective date no earlier than February 15, 2016.

Wording that could be used in an audit inquiry letter, instead of the heading and first paragraph, when the client believes that there are no unasserted claims or assessments to be specified to the lawyer for comment that are probable of assertion and that, if asserted, would have a reasonable possibility of an unfavorable outcome as specified by Financial Accounting Standards Board Accounting Standards Codification 450, Contingencies, is as follows:

Unasserted Claims and Assessments:

We have represented to our auditors that there are no unasserted possible claims that you have advised us are probable of assertion and must be disclosed, in accordance with Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) 450, Contingencies. (The second paragraph in the section relating to unasserted claims and assessments would not be altered.)

Don West. President

Always Best Corporation

Segment Information

The auditor should obtain sufficient audit evidence regarding the presentation and disclosure of segment information, following the requirements of the applicable financial reporting framework. Procedures should include:

• Obtaining an understanding of and evaluating the methods used by management in determining and disclosing segment information.