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Clarified Auditing Standards: Opening Balances (AU-C Section 510) – Part 2

Jul 23rd 2015
CPA Firm Support Services, LLC
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As required by AU-C Section 510, an auditor must either review the documentation of a predecessor's prior-period audit or perform appropriate auditing procedures for opening balances. The objective of both alternatives is to determine that appropriate audit procedures have been performed to determine that relevant financial statement assertions for the opening balances are appropriate and reasonable, and that accounting policies and procedures are consistent with those applied in the current period.

General Procedures for a Successor Auditor
AU-C Section 510 requires either the performance of appropriate risk assessment procedures for opening balances and/or evaluating the sufficiency of the predecessor auditor's risk assessment procedures and determining that accounting policies and procedures are consistent with the current period's financial reporting framework policies and procedures.

Illustrative Test of Balances Audit Procedures for Opening Balances
For this illustration, assume the user of the current-period financial statement requires US Generally Accepted Accounting Principles as the applicable financial reporting framework. This is performed either by the predecessor and/or the current period's audit engagement team.

1. Examine bank-statement reconciliations for the last month of the prior period and the first month of the current period for unusual entries. Consider tracing balances and reconciling items to supporting sources. Determine if individually significant items are recorded in the periods to which they are applicable.

2. Reconcile the aged trial balance to the general ledger at the end of the prior period. Review the aged categories, calculate appropriate analytical procedures, and inquire about subsequent collection of older accounts.

3. Review the computation of the allowance for doubtful accounts at the end of the prior period for consistency and reasonableness.

4. Perform a limited sales cutoff test by examining shipping reports and sales invoices for X days (depending on assessed level of risk for account classification) before and after the end of the prior period.

5. Perform a limited purchases cutoff test by examining vendors' invoices and/or receiving reports for X days (depending on assessed level of risk for account classification) before and after the end of the prior period.

6. Examine the summary of inventories and count sheets for checks of clerical accuracy and pricing, and the inventory observation procedures documentation and evidence of controls over the count at the end of the prior period. Consider limited clerical and pricing tests, compare inventories' composition with the current year-end, and prepare and analyze gross margin and inventory turnover by product line for the prior period. Follow up on exceptions and determine – in the absence of our or predecessors' observations of the prior year's inventory taking – if we can obtain sufficient evidence to issue an unqualified opinion on the current statement of comprehensive income by performing alternative procedures for the opening balances (such as a combination of reconciliations using accounting records and analytical procedures).

7. Compare prior-period prepaid expense or deferred charge balances to the current year. Explain unusual fluctuations.

8. Review property and equipment and related accumulated depreciation accounts for the X previous years (based on assessed levels of misstatement). Inspect support for X percent of the major additions. Physically inspect another X percent of the recorded assets. Determine the company's capitalization and depreciation policies. Compare repair accounts for several prior periods and investigate significant variations. Review beginning accumulated depreciation balances for reasonableness.

9. Analyze intangibles and other assets for the X previous years (concentrating on acquisition costs). Consider their nature and valuation. Review their amortization methods and lives for consistency and reasonableness.

10. Compare accounts payable at the end of the prior period with this year's balance at the reporting date. Investigate and explain significant variations. Perform a search for unrecorded liabilities as of the end of the prior period based on the assessed level of risk of misstatement for accounts payable.

11. Compare accrued expenses at the end of the prior period with the amounts at the end of the current period. Investigate any significant variations.

12. Review the calculations of income tax liabilities for open years. Obtain information concerning deferred taxes from the date of inception of each temporary difference. Review the appropriateness and the consistency of computation methods and calculations.

13. Obtain copies of outstanding debt agreements, determine compliance with debt covenants, and evaluate the presentation and disclosure of opening balances.

14. Obtain an analysis of capital stock and additional paid-in capital accounts for the X previous years (sufficient to establish reliability of opening balances). Supporting data for opening entries and other large or unusual entries should be traced to supporting documents. Account for stock certificates issued, retired, and unused.

15. Obtain an analysis of retained earnings for the X previous years (sufficient to establish reliability of opening balances). Investigate large or unusual entries.

16. Review and excerpt minutes for the X previous years (at least for the prior period).

17. Determine that major contractual obligations, such as those relating to sales, purchases, wages, vacation pay, deferred compensation, pension obligations, and product guarantees, have been properly recorded in the financial statements. Obtain copies of agreements.

18. Obtain and read the prior year's audit report, financial statements, and internal-control communication letter.

19. If the auditor becomes aware of information that leads him or her to believe that financial statements reported on by the predecessor auditor may require revision, request that the client inform the predecessor auditor of the situation and arrange for the client, the predecessor, and successor to discuss the information and attempt to resolve the matter. In these situations, the auditor should communicate to the predecessor auditor any information that the predecessor auditor may need to consider in accordance with AU-C Section 560, Subsequent Events and Subsequently Discovered Facts, which presents the procedures to be followed when the auditor discovers events and facts that may have affected the prior period's audited financial statements.

20. Other necessary procedures.

Part 3 of this article will contain illustrative correspondence with the predecessor and successor auditor.

More Information
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Related article:

Clarified Auditing Standards: Opening Balances (AU-C Section 510) – Part 1


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