Question 1

Discuss three audit procedures commonly used to search for contingent liabilities.

Accepted Answer

Student answers may vary.
•Inquire of management (orally and in writing)about the possibility of unrecorded contingencies.
•Review current and previous years' Canada Revenue Agency notice of assessment.
•Review the minutes of directors' and shareholders' meetings for indications of lawsuits or other contingencies.
•Analyze legal expense for the period under audit and review invoices and statements from legal counsel for indications of contingent liabilities.
•Obtain a confirmation letter from each major lawyer performing legal services for the client as to the status of pending litigation or other contingent liabilities.
•Review working papers for any information that may indicate a potential contingency.
•Obtain letters of credit in force as of the balance sheet date and obtain a confirmation of the used and unused balance.
•Read contracts,agreements,and related correspondence and documents.

Question 2

If a potential loss on a contingent liability is likely and the amount of the loss can be reasonably estimated,the liability should be
A)accrued and indicated in the body of the financial statements.
B)disclosed in footnotes but not accrued.
C)neither accrued nor disclosed in footnotes.
D)disclosed in the auditor's report but not disclosed on the financial statements.

Accepted Answer

When there is a potential loss on a contingent liability that is likely and the amount of the loss can be reasonably estimated, the liability should be accrued and indicated in the body of the financial statements. This is in accordance with the accrual accounting principle, which states that expenses should be recognized when they are incurred, not when they are paid. Disclosing the liability in footnotes or the auditor's report is not sufficient, as it does not reflect the impact on the financial statements.

Question 3

IFRS uses specific terminology to refer to the likelihood of the occurrence of an organizational event.Which of the following would require note disclosure only?
A)likely to occur and the amount can be estimated
B)possible that an outflow of resources is not required
C)likelihood is remote
D)amount is yet to be confirmed

Accepted Answer

D

Question 4

What situation represents a contingent liability for a company?
A)A candy company's monthly production requires 1000 kg of chocolate.The company entered into a contract with a chocolate producer to purchase 6000 kg of chocolate over the next six months at the market price.
B)A bike company learned that a racer using its bike was seriously injured in an accident on December 30,2018,as the front wheel of the bike was released as the result of a manufacturing defect.The company had not received a claim at December 31,2018,but management expects to receive a claim.
C)A restaurant received a $10 000 claim from a customer for emotional damages as a result of poor service.The legal counsel of the restaurant indicated that the claim was not supported and there was less than a 5% chance that the restaurant would have to pay.
D)A hotel chain was found guilty by a judge for not refunding customers who had online reservations.The hotel chain will have to pay $50 000 to various customers in the following year.

Accepted Answer

A contingent liability is recognized when a company has a potential financial obligation due to a past event, the obligation is probable, and the amount can be reasonably estimated. In choice B, the bike company expects to receive a claim due to a manufacturing defect, which fits the criteria for a contingent liability. Choices A, C, and D do not meet all the criteria for a contingent liability as described.

Question 5

Which level of risk does the auditor normally assign to the presentation and disclosure-related assertion of completeness for contingent liabilities and subsequent events?
A)low risk for inherent risks that required information may not be disclosed in the notes
B)medium for control risk with respect to identifying relevant events
C)medium with respect to providing adequate detail for the notes
D)high risk that all required information may not be disclosed in the notes

Accepted Answer

The auditor would assign a high risk to the presentation and disclosure-related assertion of completeness for contingent liabilities and subsequent events because there is a risk that all required information may not be disclosed in the notes. This is due to the inherent uncertainty and complexity involved in identifying and measuring contingent liabilities and subsequent events, as well as the potential for management bias or fraud. The other options (A, B, and C) may be relevant as well, but the high risk of incomplete disclosure is the most significant consideration.

Question 6

An agreement that commits the firm to a set of fixed conditions in the future regardless of what happens to profits or the economy as a whole is a definition of a
A)contingent liability.
B)potentially hazardous agreement.
C)commitment.
D)conditional contract.

Accepted Answer

A commitment is a promise to do something in the future that binds the firm, regardless of any changes in profits or the economy. It is an obligation that the firm has made to another party to follow through on certain conditions or terms. A contingent liability refers to a potential future obligation that depends on an uncertain event, while a potentially hazardous agreement is a contract that involves a significant risk to the firm. A conditional contract contains terms that only take effect if certain conditions occur.

Question 7

If a potential loss on a contingent liability is unlikely and the event will not likely have a significant adverse financial effect,the liability should be
A)accrued and indicated in the body of the financial statements.
B)disclosed in footnotes but not accrued.
C)neither accrued nor disclosed in footnotes.
D)disclosed in the auditor's report but not disclosed on the financial statements.

Accepted Answer

If a potential loss on a contingent liability is unlikely and the event will not likely have a significant adverse financial effect, it should neither be accrued nor disclosed in footnotes. This is because accounting standards typically require accrual or disclosure only when a loss is probable or reasonably possible and could have a material effect on the financial statements.

Question 8

Which of the following procedures might be useful in discovering a contingent liability for a lawsuit that management is intentionally neglecting to disclose?
A)inquiries (orally and in writing)of management
B)analyzing legal expense and reviewing invoices and statements from outside legal counsel
C)reviewing current and previous years' Canada Revenue Agency correspondence
D)obtaining a letter of representation from management that it is not aware of any undisclosed contingent liabilities

Accepted Answer

Analyzing legal expenses and reviewing invoices and statements from outside legal counsel can provide clues about any pending or potential lawsuits that management may not be disclosing. This can be a useful way to uncover any undisclosed contingent liabilities. Option A may not be effective if management is intentionally neglecting to disclose the liability. Option C may not be relevant to discovering a contingent liability related to a lawsuit. Option D is not a reliable method since management may not disclose intentionally or may not be aware of the undisclosed contingent liability.

Question 9

When the proper disclosure in the financial statements of material contingencies is through footnotes,the footnote should describe the nature of the contingency to the extent it is known and
A)the auditor's opinion as to the expected outcome.
B)the opinion of legal counsel or management as to the expected outcome.
C)an estimate of the amount or a statement that the amount cannot be estimated.
D)the steps the client has taken to ensure that it doesn't recur.

Accepted Answer

When the proper disclosure in the financial statements of material contingencies is through footnotes, the footnote should describe the nature of the contingency to the extent it is known and provide an estimate of the amount or a statement that the amount cannot be estimated. The auditor's opinion, legal counsel or management's opinion, and steps taken by the client to ensure it doesn't recur are not required in such disclosures.

Question 10

State the three conditions required for a contingent liability to exist.

Accepted Answer

The answer of State the three conditions required for a...

Question 11

The auditor's responsibility with regards to contingent liabilities is to
A)identify the appropriate accounting treatment.
B)decide on the appropriate accounting treatment.
C)prepare note disclosure.
D)evaluate the accounting treatment of known contingent liabilities.

Accepted Answer

The auditor's responsibility is to evaluate the accounting treatment of known contingent liabilities to ensure they are properly disclosed and accounted for in accordance with applicable accounting standards.

Question 12

Which of the following scenarios regarding a lawsuit filed against a client by a third party would qualify as a "contingent liability"?
A)A lawsuit has been filed but not yet resolved.
B)A lawsuit was filed and concluded with the client winning.
C)A lawsuit was filed and concluded with a third party winning an award of $100 000,but the client hasn't paid yet.
D)A lawsuit was filed and concluded with a third party winning an award of $100 000,which the client paid after the balance sheet date but before the statements were issued.

Accepted Answer

A contingent liability is a potential obligation that may arise depending on the outcome of a future event, such as a lawsuit that has been filed but not yet resolved.

Question 13

Which of the following substantive tests would the auditor conduct as a search for contingent liabilities?
A)select an attribute sample of legal expenses for matching to invoices
B)select a dollar unit sample of legal expenses for matching to invoices
C)inspect legal expense invoices and perform a census test of legal expenses
D)review a sample of legal invoices,looking for appropriate authorization for payment

Accepted Answer

Inspecting legal expense invoices and performing a census test of legal expenses would be the most appropriate substantive test to search for contingent liabilities. This test would allow the auditor to identify any potential contingent liabilities from legal expenses incurred by the company. Selecting an attribute or dollar unit sample would not be sufficient as it may not capture all the relevant expenses. Reviewing a sample of legal invoices for appropriate authorization would not necessarily identify contingent liabilities.

Question 14

If the amount of a probable loss on a contingent liability is not determinable,the liability should be
A)accrued and indicated in the body of the financial statements.
B)disclosed in footnotes but not accrued.
C)neither accrued nor disclosed in footnotes.
D)disclosed in the auditor's report but not disclosed on the financial statements.

Accepted Answer

If the amount of a probable loss on a contingent liability is not determinable, the liability should be disclosed in footnotes but not accrued. This is because the liability is not yet certain and estimable. However, it is important to provide information to users of financial statements about the potential impact of the contingency on the entity's financial position and performance. Therefore, disclosure in footnotes is the most appropriate option. The disclosure should include details about the nature of the contingency and the possible range of outcomes.

Question 15

List the assertions and audit objectives the auditor considers while testing for presentation and disclosures.

Accepted Answer

The answer of List the assertions and audit objectives the...

Question 16

What audit approach is used to search for unknown commitments?
A)include as part of the search for subsequent events
B)conduct with substantive tests associated with the cutoff assertion
C)perform as part of the audit of each cycle or audit area
D)include with the legal letter sent to lawyers

Accepted Answer

Performing the search for unknown commitments as part of the audit of each cycle or audit area ensures that all potential commitments are identified and evaluated in the context of the specific financial statement areas they may impact.

Question 17

Which of the following is a required condition for a contingent liability to exist?
A)There is a potential liability to an employee of the client.
B)The amount of the future payment is known.
C)The liability resulted from known events.
D)The outcome has been resolved by a current event.

Accepted Answer

A contingent liability must be the result of a possible obligation stemming from past events. It is not yet a present obligation because the outcome is uncertain. The amount of future payment and any potential liabilities to employees are not required conditions for a contingent liability. The outcome must be uncertain, and not yet resolved by a current event.

Question 18

If the amount of a probable loss on a contingent liability cannot be estimated but the event is likely,the liability should be
A)accrued and indicated in the body of the financial statements.
B)disclosed in footnotes but not accrued.
C)neither accrued nor disclosed in footnotes.
D)disclosed in the auditor's report but not disclosed on the financial statements.

Accepted Answer

If the amount of a probable loss on a contingent liability cannot be estimated, it should not be accrued in the financial statements. However, it should be disclosed in the footnotes to the financial statements to inform users of the potential liability. This is in accordance with the accounting principle of Full Disclosure.

Question 19

IFRS uses specific terminology to refer to the likelihood of the occurrence of an organizational event.Which of the following would need to provide for the recognition of the obligation (i.e.the financial statements adjusted)?
A)outflow of resources is required,but cannot be reliably estimated
B)probable that an outflow of resources is required
C)likelihood is remote
D)amount is yet to be confirmed

Accepted Answer

According to IFRS, when it is probable that an outflow of resources is required, an obligation must be recognized in the financial statements. The other options do not meet the recognition criteria. Option A states that an outflow of resources is required but cannot be reliably estimated, and therefore no recognition can be made. Option C specifies that the likelihood is remote, which means that no recognition is needed. Option D implies that the amount is uncertain, and therefore recognition cannot be made until it is confirmed.

Question 20

When auditing contingent liabilities,the primary objective at the initial stage of the tests is to determine
A)the materiality of any liability.
B)what constitutes adequate disclosure of the liability.
C)the likelihood of the liability.
D)the existence of the liability.

Accepted Answer

The primary objective at the initial stage of auditing contingent liabilities is to determine whether there is evidence of the existence of the liability. Only after it is established that the liability exists can further procedures be carried out to determine its likelihood and materiality. Adequate disclosure of the liability is not the primary focus at the initial stage of testing.

Quiz 18: Completing the Audit

Discuss three audit procedures commonly used to search for contingent liabilities.

If a potential loss on a contingent liability is likely and the amount of the loss can be reasonably estimated,the liability should be

IFRS uses specific terminology to refer to the likelihood of the occurrence of an organizational event.Which of the following would require note disclosure only?

What situation represents a contingent liability for a company?

Which level of risk does the auditor normally assign to the presentation and disclosure-related assertion of completeness for contingent liabilities and subsequent events?

An agreement that commits the firm to a set of fixed conditions in the future regardless of what happens to profits or the economy as a whole is a definition of a

If a potential loss on a contingent liability is unlikely and the event will not likely have a significant adverse financial effect,the liability should be

Which of the following procedures might be useful in discovering a contingent liability for a lawsuit that management is intentionally neglecting to disclose?

When the proper disclosure in the financial statements of material contingencies is through footnotes,the footnote should describe the nature of the contingency to the extent it is known and

State the three conditions required for a contingent liability to exist.

The auditor's responsibility with regards to contingent liabilities is to

Which of the following scenarios regarding a lawsuit filed against a client by a third party would qualify as a "contingent liability"?

Which of the following substantive tests would the auditor conduct as a search for contingent liabilities?

If the amount of a probable loss on a contingent liability is not determinable,the liability should be

List the assertions and audit objectives the auditor considers while testing for presentation and disclosures.

What audit approach is used to search for unknown commitments?

Which of the following is a required condition for a contingent liability to exist?

If the amount of a probable loss on a contingent liability cannot be estimated but the event is likely,the liability should be

IFRS uses specific terminology to refer to the likelihood of the occurrence of an organizational event.Which of the following would need to provide for the recognition of the obligation (i.e.the financial statements adjusted) ?

When auditing contingent liabilities,the primary objective at the initial stage of the tests is to determine