Question

Respond to the following in a minimum of 175 words:

The final phase of an audit is addressing contingent liabilities and their relation to the audit.

Discuss a review for contingent liabilities, letters from the client’s lawyers and post-balance-sheet review for subsequent events.

Please do not do a copy paste from another site that has been marked incorrect...I have seen this in a prior question answered.

Thanks for your assistance!

Answer 1

Contingent Liabilities is one of the most important areas of the financial statements and for the auditor as well because this is one area which has a lot of potential for fraud and manipulation. Contingent liabilities is something investors also like to have a look at to estimate the legal/litigation exposure of the company. This is also one area which management would like to manipulate in order to show a better position by hiding a lot of cases against the company which could even question the going concern assumption of the company.

For the auditor as well, it is really hard to audit this area especially because there's no place from where auditor could get a complete list of all the cases pending against the company and also since the cases are "pending" it is really hard to judge the outcome of the case and hence the outcome of the case on the company as well. Generally audit procedures performed in order to audit Contingent liabilities involve :

1. Obtaining management representation letters that the list of cases pending against the client as provided by management is true and best to their knowledge.

2. Obtain confirmation from lawyers regarding the cases handled by them for the client, their opinion on the status of a pending case and the potential loss / potential gain in the future from such cases.

3. Perform post balance-sheet subsequent event checks to check if any demand order has been received from indirect taxes or direct tax department.

Even though the above mentioned procedures do sound extensive and reliable, they are really not.

One procedure which is really hard to perform is getting letter from the client's lawyers. Since lawyers are not obligated legally to provide any such confirmation to the auditors, it becomes really hard to convince them to provide an appropriate and correct response to the auditor's queries. Sometimes the lawyers are also biased and provide a favourable opinion of the case in order to please their clients. It is advised that while sending lawyer confirmation letters, a summary of the cases pending against the client should be mentioned so that the lawyers are motivated to provide accurate information and the letter should always ask for whether any other pending cases which have not been mentioned in the letter are in the knowledge of such lawyer. This is very important because this way we will be able to identify if the client is hiding any case from us.

Lastly, subsequent event checks are also very important and the auditor should make sure these are performed. This is particularly important because generally the demand orders from taxation authorities come a little late for the period we are auditing. For example : If we are auditing for FY ending 31st December, 2020 and we are completing the audit by 31st March, 2020 itself, then demand orders for this FY would not have come within 3 months from the year end. They usually come towards the later part of the next year which becomes an issue as we might be passing a clean opinion on the financial statements whereas there might be a huge potential litigation order received post our balance sheet date. And if any such event is actually investigated and identified by the auditor, he should make sure that if such event is material to the financial statements or if such event would have caused the auditor to change his opinion, he should ensure that the information regarding such event should reach the stakeholders and all the parties who would have seen the audited financial statements.