Auditing and assurance revision question and answer

Auditing and Assurance Revision Questions and Answers

Write short notes on:
a) Fundamental Errors (5 Marks December 2008)
b) Contingent Liabilities (5 Marks December 2008)
c) Accounting Estimates
a. Answer
Errors in the preparation of the financial statements of one or more prior periods may be discovered in the current period. Errors may occur as a result of mathematical mistake, mistakes in applying accounting policies, misinterpretation of facts, fraud or oversights. The correction of these errors is normally included in the determination of net profit or loss for the current period. In some cases, an error may have a significant effect on the financial statements of one or more prior periods that those financial statements can no longer be considered to have been reliable at the date of their issue. These errors are referred to as fundamental errors. Fundamental errors need to be rectified restatement of the financial statements of the relevant previous year else adjusted in the retained earnings.

b. Answer
A contingent liability is a liability arising out of uncertain event that is not recognized in the accounts. Contingent liabilities are not recognized as liabilities because they are possible obligations which are yet to be confirmed. Hence contingent liabilities are the probable liabilities that may arise at a future date or the happening or non-happening of a probable event giving rise to financial obligation.

Examples of contingent liabilities are unexpired contract commitments, compensation amount in respect of a law suit pending court‟s verdict etc.

Unless the possibility of any outflow in settlement is remote, an enterprise should disclose a brief description of the nature of the contingent liability with certain details as at the balance sheet date in its financial statement.

c. Answer
When a positive (revenue or profit) or negative (expenses or loss) outcome of an event or transaction cannot be measured with the given means and such amount is estimated and accounted for in the books of accounts they are known as accounting estimates.

Management is responsible for making accounting estimates.
Some estimates are based on past experience and data such as accrued revenue or depreciation based on useful life of an asset. In those cases, risk of material misstatement would be generally lower compared to the audit of accounting estimates based on uncertain events.
It is very important for the auditor to obtain appropriate audit evidence before drawing conclusion regarding the reasonableness of accounting estimates.

General approaches to the audit of accounting estimates are:
 Obtain and review the basis of accounting estimate made the management
 Use an independent estimate to assess the amount estimated the management and assess its uniformity
 Review subsequent events that confirm the estimate

Based on the above the auditor should make final assessment as to whether the estimate is reasonable and whether there is the possibility of any material misstatement.

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