Question

The financial year of your audit client Pickles Ltd ended on 31 December 2019. Your audit report was signed on 20 February 2020 and the financial statements were issued on 5 March 2020.

Each of the following independent events, which the auditors have discovered after the end of the financial year, have a material effect on the financial statements:

1. 14 February 2020

   You found that the audit client had lost a court case for breaching a contract with a supplier. The litigation started on 2 February 2019. The company is required to pay $45,000 damages to the supplier.

2. 27 February 2020
   Pickles Ltd announced that it is making a takeover offer for another company.

Required:

For each of the two events above, explain the auditor’s responsibilities and the auditor’s appropriate course of action.

Answer 1

The events have occured after the balance but before the signature of the audit report and issue of the same. The auditing standard on Subsequent events deals with the situations.

For the first event, the condition existed at the time of the balance sheet since the litigation started on 2 February 2019. The auditor's responsibility in this case is to ensure that the financial statements are reflected to have an adjutsment of $45,000. The amount should be reported as a liability and a disclosure of the adjustment done. The auditor must take up this matter with the management and suggest that they make an adjustment in the financials as the settlement of the litigation is a culmination of events that took over a period of time. If the management does not agree to the course of action suggested by the auditor, then he may choose to qualify the report or add in the emphasis of matter paragraph based on the severity of the litigation.

The second event of takeover of another company is condition that did not exist prior to the balance sheet and hence requries no adjustment. Only a disclousre of the same is required in the financial statements prior to the issue. The auditor is only responsible to ensure that an appropriate disclosure of the takeover bid is made in the financial statements. The potential bid amount must be included in the disclosure paragraph.