Ch24_Solutions students

Ch24_Solutions students - Discussion Questions And Problems...

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Discussion Questions And Problems 24-26 a. A contingent liability is a potential future obligation to an outside party for an unknown amount arising from activities that have already taken place. A commitment is an agreement to commit the entity to a set of fixed conditions in the future, regardless of what happens to profits or the economy as a whole. Knowledge of both contingencies and commitments is extremely important to users of financial statements because they represent the encumbrance of potentially material amounts of resources during future periods, and thus affect the future cash flows available to creditors and investors. Because of this, generally accepted accounting principles require that material contingencies and commitments be disclosed. The auditor has an obligation to discover the existence of such items to determine that they are properly disclosed in order to have complied with auditing standards. b. Johnson’s tests of controls and substantive tests of transactions related to payments of notes payable and related interest expense would provide her information about scheduled debt payments and related interest rate terms, which are required footnote disclosure related items. Similarly, substantive tests of transactions would reveal additions and retirements of notes payable, which both affect notes payable disclosures. Tests of details of balances, such as notes payable confirmations, would provide sufficient appropriate evidence about the existence of ending balances and related notes payable terms, such as interest rates and required collateral. c. Three useful audit procedures for uncovering contingencies that Johnson would likely perform in the normal conduct of the audit, even if she had no responsibility for uncovering contingencies, are: Review internal revenue agent reports of income tax settlements Review minutes of meetings of board of directors and stockholders Confirm used and unused balances of lines of credit d. Three other procedures Johnson is likely to perform specifically for the purpose of identifying undisclosed contingencies are: Make inquiries of management Analyze legal expenses for indication of contingent liabilities Request letters from attorneys regarding the existence and status of litigation and other potential contingent liabilities
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24-27 a. A contingent liability is a potential future obligation to an outside party for an unknown amount resulting from activities that have already taken place. The most important characteristic of a contingent liability is the uncertainty of the amount; if the amount were known it would be included in the financial statements as an actual liability rather than as a contingency. b.
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Ch24_Solutions students - Discussion Questions And Problems...

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