Question

Financial Auditing

Please list and discuss the following concerning contingencies:

1. How are contingencies handled by GAAP?

2. How do auditors obtain sufficient appropriate audit evidence concerning contingencies?

3. What should the auditor do if the client doesn't follow GAAP concerning contingencies?

4. What should the auditor do if the auditor can't obtain sufficient appropriate audit evidence?

5. What should the auditor do if the auditor can not estimate a contingency and the probability of it occurring is probable?

Answer 1

1.Under GAAP, a contingent liability is defined as any potential future loss that depends on a "triggering event" to turn into an actual expense. ... There are three GAAP-specified categories of contingent liabilities: probable, possible, and remote. Probable contingencies are likely to occur and can be reasonably estimated.

2.

Auditors usually ask management to write a statement acknowledging they disclosed all known contingent liabilities.

1. Search for Undisclosed Contingencies. In a perfect world, management would disclose all contingent liabilities to their auditors. ...
2. Evaluate Materiality. ...
3. Evaluate Event Likelihood. ...
4. Look at Probable Events.

3.Errors or omissions in applying GAAP can be costly in a business transaction; impacting credibility with lenders and leading to incorrect decisions. These violations can cause inaccurate reporting for internal and budgeting purposes, as well as a reduced reliance on prepared financial statements for 3rd party readers.

4.The inability of the auditor to gather sufficient appropriate audit evidence is technically termed as limitation on scope of auditor’s work or limitation on the scope of audit i.e. auditor has been restricted to perform his effectively and in the absence of evidence auditor is not able to reach conclusions and without relevant conclusions auditor cannot form audit opinion.

However, limitation on scope of audit does not equate inability to perform certain audit procedure where auditor can obtain sufficient appropriate audit evidence by applying alternative audit procedure. Auditor most of the time able to substitute one procedure with the other if one is not working.

5.If a contingent liability is a material amount or the amount can't be estimated, auditors should estimate the likelihood that the event will occur. ... The company must disclose material contingent liabilities that are possible or probable by adding a footnote to the financial statement