The legal opinion will normally only provide advice

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Unformatted text preview: ning whether the isolation criterion has been met to support a conclusion regarding surrender of control is largely a matter of law. An auditor is trained in accounting and auditing and acquires a general knowledge of business matters but is not expected to possess the expertise of spets trained in other fields. The legal opinion will normally only provide advice for the 'isolation' criteria and not for existence, completeness or valuation. CICA 5360.05 (now 5049.75) identifies the following factors that will influence the auditor's decision as to the extent of his or her procedures: (a) the materiality of, and the risk of significant misstatement in, the item being examined in relation to the financial statements as a whole; (b) the complexity of the item; and (c) the absence or nature of other sources of audit evidence available with respect to the item. The auditor must assess the lawyer's reputation and competence. The lawyers report must be reviewed in detail. It must also be determined if the assumptions and findings are reasonable. 50 QUESTION 8 (6 marks) Revenue (CICA 3400, EIC-123 Reporting Revenue Gross as Principal versus net as an Agent) The decision on whether Service Limited (SL) should recognize revenue on a gross or net amount is a matter of professional judgement. The relative strength of the following factors should be assessed and professional judgment used. The factors include: • The enterprise is the primary obligator in the arrangement -No. • The enterprise has latitude in establishing price -No. • The enterprise changes the product or performs part of the service - No. • The enterprise is involved in the determination of product or service specifications - No. • The SL has credit risk - Yes. • The amount the SL earns is fixed - Yes. Factors supporting net reporting are the college, and not the enterprise, is the primary obligator to the applicant, because the college is responsible for reviewing and accepting or denying applications, and the college sets the admission fee and SL receives a fixed percentage of that amount. A weaker factor supporting gross reporting is present only for credit risk in the form of collecting credit card charges. The credit risk factor for gross reporting is not sufficiently strong to overcome the factors supporting net reporting. It is not required but the gross value may be disclosed if it is useful to the users of SL’s financial statements. The disclosure should be parenthetically on the Income Statement or in the notes. The disclosure should not be referred to as “revenue”. A description like “gross billings” would be appropriate. The disclosure should not be in a column that sums to net income. 51 QUESTION 9 (8 marks) AuG-31 Applying Materiality and Audit Risk Concepts in Conducting an Audit In evaluating the effect of misstatements, qualitative considerations may result in misstatements of relatively small amounts having a material effect on the financial statements. Qualitative factors the auditor may consider relevant include the following: • The potential effect of the misstatement on trends, especially in profitability. • A misstatement that changes a loss into income or vice versa. • The effect of the misstatement on segment information. For example, the significance of the matter to a particular segment important to the future profitability of the entity, the pervasiveness of the matter on the segment information, and the impact of the matter on trends in segment information, all in relation to the financial statements taken as a whole. • The potential effect of the misstatement on the entity's compliance with loan covenants, other contractual agreements, and regulatory provisions. • The existence of statutory or regulatory reporting requirements that affect materiality thresholds. • A misstatement that has the effect of increasing management's compensation. For example, by satisfying the requirements for the award of bonuses or other forms of incentive compensation. • The sensitivity of the circumstances surrounding the misstatement. For example, the implications of misstatements involving fraud and possible illegal acts, violations of contractual provisions, and conflicts of interest. • The significance of the financial statement item affected by the misstatements. For example, a misstatement affecting recurring earnings as contrasted to one involving a non-recurring charge or credit, such as an extraordinary item. • The effects of misclassification. For example, misclassification between operating and nonoperating income or recurring and non-recurring income items, or a misclassification between restricted and unrestricted resources in a not-for-profit organization. • The significance of the misstatement or disclosures relative to the auditor's perception of users' needs. For example: o the significance of earnings per share to public company investors and the significance of shareholders' equity to the creditors of private profit oriented entities; o the magnifying effects of a misstatement on the calculation of purchase price in a transfe...
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