25.1 Completing the Audit, Subsequent Events & Going Concern

Completing the Audit, Subsequent Events & Going Concern

The completion phase of an audit engagement brings together the individual findings, substantive evidence, and risk reassessments accumulated during fieldwork to form an overarching basis for the audit opinion. Governed by PSA 520 (Analytical Procedures), PSA 450 (Evaluation of Misstatements Identified during the Audit), PSA 560 (Subsequent Events), PSA 570 (Revised) (Going Concern), PSA 580 (Written Representations), and PSA 501 (Litigation and Claims), this phase requires rigorous synthesis and partner-level professional judgment.

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1. Final Wrap-Up Procedures in Completing the Audit

                              Audit Wrap-Up Architecture
                                          │
         ┌────────────────────────────────┼────────────────────────────────┐
         ▼                                ▼                                ▼
Final Analytical Review           Working Paper & EQR Review         Evaluation of Misstatements
       (PSA 520)                         (PSA 220)                            (PSA 450)
Mandatory overall check;          Multi-tiered review hierarchy;    Aggregate SUAD schedule;
corroborates financial           clearing all review notes;        evaluate against materiality;
statement conclusions            EQR for public interest firms     request client corrections

Mandatory Final Analytical Procedures (PSA 520)

Under PSA 520, paragraph 6, the auditor must design and perform analytical procedures near the end of the audit that assist the auditor when forming an overall conclusion as to whether the financial statements are consistent with the auditor's understanding of the entity:

• Objective: To determine whether the financial statements, as adjusted for audit entries, make economic sense in light of the entity's business model, industry conditions, and audit evidence gathered.
• Focus: Assessing significant accounting ratios, unusual trends, and unexpected fluctuations that were not previously identified during planning or fieldwork.
• Action on Anomalies: If final analytical procedures identify previously unrecognized risks of material misstatement, the auditor must revise the risk assessment and perform additional substantive procedures before signing the audit report.

Working Paper Review Hierarchy and Quality Reviews

Pursuant to PSA 220 (Revised) and PSQM 1, working papers must undergo structured, multi-tier supervisory review prior to report release:

1. In-Charge / Senior Review: Daily review of audit assistants' working papers, verifying that audit programs were executed, tickmarks cross-referenced, and calculations checked.
2. Manager Review: Focuses on overall audit program completion, technical compliance with PFRS, evaluation of complex transactions, and resolution of audit issues.
3. Engagement Partner Review: The partner with final authority evaluates significant risks, critical accounting estimates, audit adjustments, going concern assumptions, and signs off on the audit opinion.
4. Engagement Quality Review (EQR): Required for audits of listed entities and other public interest entities under PSQM 1. An objective, independent partner not assigned to the engagement team performs an objective evaluation of the significant judgments made by the team and the conclusions reached.

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2. Evaluation of Accumulated Misstatements (PSA 450)

Under PSA 450, the auditor must accumulate all misstatements identified during the audit, other than those that are clearly trivial (trivial threshold is typically set at 3% to 5% of overall materiality).

Categories of Misstatements

1. Factual Misstatements: Misstatements about which there is no doubt (e.g., mathematical errors, direct cutoff errors where goods arrived after year-end, or unrecorded vendor invoices).
2. Judgmental Misstatements: Differences arising from judgments of management concerning accounting estimates that the auditor considers unreasonable, or the selection/application of accounting policies that the auditor considers inappropriate.
3. Projected Misstatements: The auditor's best estimate of misstatements in entire populations, involving the extrapolation of misstatements identified in audit samples to the entire population under PSA 530.

                      Evaluating Misstatements Schedule (SUAD)
                                         │
                  Accumulate All Non-Trivial Misstatements
                  ├─ Factual Misstatements
                  ├─ Judgmental Misstatements
                  └─ Projected Misstatements
                                         │
                   Communicate to Management and Request Correction
                                         │
                     ┌───────────────────┴───────────────────┐
                     ▼                                       ▼
          Management Corrects All                  Management Refuses to Correct
                     │                                       │
         Unadjusted Misstatements = 0              Auditor evaluates aggregate SUAD
         Issue Unmodified Opinion                  against Overall Materiality
                                                             │
                                                 ┌───────────┴───────────┐
                                                 ▼                       ▼
                                        Aggregate < Materiality     Aggregate > Materiality
                                                 │                       │
                                            Unmodified              Modified Opinion
                                              Opinion              (Qualified / Adverse)

The Summary of Unadjusted Audit Differences (SUAD)

The auditor aggregates all uncorrected misstatements on a working paper schedule called the Summary of Unadjusted Audit Differences (SUAD) or Schedule of Uncorrected Misstatements.

• Management Correction Request: The auditor must communicate all accumulated misstatements to management on a timely basis and request that management correct them. Professional standards state that management has the primary responsibility to correct all known misstatements.
• Evaluating Uncorrected Misstatements: If management refuses to correct some or all misstatements, the auditor considers management's reasons and evaluates whether uncorrected misstatements, individually or in aggregate, are material.
• Rollover vs Iron Curtain Approaches:
  • Rollover Approach: Quantifies misstatements based on the amount of error originating in the current year income statement, ignoring the cumulative balance sheet effect.
  • Iron Curtain Approach: Quantifies misstatements based on the cumulative effect of correcting the balance sheet at year-end, regardless of the year the misstatement originated.
  • Under Philippine SEC guidelines, if a misstatement is material under either approach, an audit adjustment is required.

Practical SUAD Schedule Illustration

Consider the following audit summary for a trading firm (Overall Materiality = PHP 1,000,000; Performance Materiality = PHP 750,000; Clearly Trivial Threshold = PHP 50,000):

Audit Analysis: The net pre-tax income overstatement is PHP 750,000. While this does not exceed overall materiality (PHP 1,000,000), it equals performance materiality (PHP 750,000). The auditor must consider qualitative factors (e.g., does this turn an operating loss into a profit, or mask a loan covenant breach?). If management refuses to adjust, the auditor assesses whether remaining undetected misstatements could push total errors past PHP 1,000,000.

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3. PSA 560 & PAS 10: Subsequent Events

Subsequent events are events occurring between the date of the financial statements and the date of the auditor's report, and facts that become known to the auditor after the date of the auditor's report. PAS 10 (Events After the Reporting Period) and PSA 560 (Subsequent Events) govern their accounting and auditing treatment.

                                Subsequent Events Classification
                                                │
                       ┌────────────────────────┴────────────────────────┐
                       ▼                                                 ▼
           Type I: Adjusting Events                          Type II: Non-Adjusting Events
    (Conditions existed ON or BEFORE year-end)            (Conditions arose AFTER year-end date)
                       │                                                 │
         ADJUST FINANCIAL STATEMENTS                       DISCLOSE IN FINANCIAL STATEMENT NOTES
• Bankruptcy of customer with balance at Dec 31     • Fire or natural disaster destroying warehouse in Jan
• Settlement of lawsuit confirming Dec 31 liability • Material business combination or sale of subsidiary
• Subsequent sale of inventory proving NRV < Cost   • Issuance of substantial shares, bonds, or debt
• Discovery of fraud showing Dec 31 numbers false   • Sharp decline in quoted market value of investments

The Three Chronological Periods of Auditor Responsibility

                             Subsequent Events Timeline & Auditor Duties

  Balance Sheet Date           Auditor's Report Date          Financial Statements Issued
     (December 31)                (March 15)                       (March 31)
           │ ◄──────────────────────────► │ ◄──────────────────────────────► │ ◄─────────────────────►
           ▼                              ▼                                  ▼
       Period 1                       Period 2                           Period 3
     ACTIVE DUTY                    PASSIVE DUTY                       PASSIVE DUTY
  Auditor must perform           No obligation to perform           No obligation to inquire;
  proactive procedures           procedures; if facts become        if facts discovered that existed
  to detect all subsequent       known, discuss with management;    at report date, take steps to
  events.                        Dual Date or extend report.        prevent reliance if client refuses.

1. Period 1: Balance Sheet Date to Auditor's Report Date (Active Duty):
   • The auditor has an active professional responsibility to perform audit procedures designed to identify all material subsequent events up to the report date.
   • Mandated Procedures: Inquiring of management, reading minutes of shareholder and board meetings held after year-end, reading the entity's latest interim financial statements, inquiring of external legal counsel regarding litigation, and obtaining specific written representations in the Management Representation Letter.
2. Period 2: Auditor's Report Date to Date Financial Statements are Issued (Passive Duty):
   • The auditor has no obligation to perform any audit procedures regarding the financial statements after the report date.
   • Action on Known Facts: If, however, a fact becomes known to the auditor that, had it been known at the report date, might have caused the auditor to amend the report, the auditor must discuss the matter with management and TCWG.
   • Dual Dating: If management amends the financial statements for a specific event (e.g., Note 28 on a major fire on March 20) and the auditor does not want to extend overall subsequent event testing to March 20, the auditor dual dates the report: $\text{"March 15, 2027, except as to Note 28, which is as of March 20, 2027."}$ Dual dating restricts the auditor's responsibility for subsequent events occurring after March 15 strictly to the specific event described in Note 28.
3. Period 3: After the Financial Statements Have Been Issued (Passive Duty):
   • The auditor has no active duty to inspect subsequent records.
   • If a critical fact is discovered that existed at the report date and would have caused the report to be modified, the auditor discusses revision with management. If management agrees, management reissues the financial statements with a new audit report. If management refuses, the auditor notifies TCWG and takes legal/regulatory steps (e.g., notifying the SEC and PRC) to prevent further reliance on the auditor's report.

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4. PSA 570 (Revised): Going Concern Evaluation

Under the going concern assumption, an entity is viewed as continuing in business for the foreseeable future. Assets and liabilities are recorded on the basis that the entity will be able to realize its assets and discharge its liabilities in the normal course of business. Governed by PSA 570 (Revised), the auditor's responsibility is to obtain sufficient appropriate evidence regarding the appropriateness of management's use of the going concern basis of accounting.

Management Assessment Horizon

Management must assess the entity's ability to continue as a going concern covering a period of at least twelve (12) months from the end of the reporting period (e.g., from December 31, 2026, through at least December 31, 2027). If management's assessment covers less than 12 months, the auditor must request management to extend its assessment period.

Going Concern Warning Indicators

                               Going Concern Red Flag Indicators
                                               │
         ┌─────────────────────────────────────┼─────────────────────────────────────┐
         ▼                                     ▼                                     ▼
  Financial Indicators                  Operating Indicators                   Other Indicators
• Net liability / current liability   • Management intentions to liquidate   • Non-compliance with statutory
  deficits; negative working cap.       or cease operations.                   capital rules (e.g., SEC/BSP).
• Adverse key financial ratios.       • Loss of key management without       • Pending catastrophic lawsuits
• Substantial recurring operating       replacement.                           threatening insolvency.
  losses & negative operating cash.   • Loss of major customer, market,      • Changes in legislation or
• Default on loan covenants.            franchise, or key supplier.            government regulations.

Mitigating Factors & Management Plans

When adverse indicators exist, the auditor evaluates management's plans for future actions, assessing whether they are realistic and feasible:

• Plans to liquidate non-core assets.
• Plans to borrow money or restructure existing debt obligations.
• Plans to reduce or delay discretionary expenditures.
• Plans to increase equity capital through private placement or new share offerings.

The Definitive Going Concern Reporting Matrix (PSA 570 Revised)

                       Going Concern Audit Opinion Decision Logic
                                           │
                   Is Going Concern Assumption Appropriate?
                                           │
                     ┌─────────────────────┴─────────────────────┐
                     ▼                                           ▼
                    YES                                         NO
                     │                                           │
     Does a Material Uncertainty Exist?                  Financial Statements
                     │                                   Prepared on Going Concern?
         ┌───────────┴───────────┐                               │
         ▼                       ▼                     ┌─────────┴─────────┐
        NO                      YES                    ▼                   ▼
         │                       │                    YES                  NO
     UNMODIFIED        Is it Adequately Disclosed?     │                   │
      OPINION                    │               ADVERSE OPINION     Alternative Basis
                       ┌─────────┴─────────┐     (Inappropriate      (e.g., Liquidation)
                       ▼                   ▼      framework)         Adequately Disclosed:
                      YES                  NO                        Unmodified with EOM
                       │                   │
                  UNMODIFIED         MODIFIED OPINION
                   OPINION          (Qualified or Adverse
              with dedicated section: due to GAAP disclosure
              "Material Uncertainty      deficiency)
             Related to Going Concern"

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5. Management Representation Letter (PSA 580)

Pursuant to PSA 580, the auditor shall request written representations from management with appropriate responsibilities for the financial statements and knowledge of financial matters (typically the Chief Executive Officer and Chief Financial Officer).

Fundamental Rules Governing the Representation Letter

1. Nature of Evidence: Written representations constitute audit evidence. However, they do not provide sufficient appropriate audit evidence on their own, nor do they affect the nature or extent of other audit procedures. The auditor cannot rely on management representations as a substitute for substantive testing.
2. Signatories: Must be signed by executive officers with primary operational and financial responsibility (CEO/President and CFO/Controller).
3. Dating of the Letter: The representation letter must be dated as near as practicable to, but not after, the date of the auditor's report on the financial statements. In standard Philippine practice, the representation letter is dated the exact same date as the auditor's report.
4. Mandatory Core Representations:
   • Acknowledging management's responsibility for preparing financial statements in accordance with PFRS.
   • Acknowledging responsibility for designing, implementing, and maintaining internal control.
   • Confirming that all transactions have been recorded and are reflected in the financial statements.
   • Stating that management has provided the auditor with unrestricted access to all records and personnel.
   • Confirming disclosure of all known fraud or suspected fraud.
   • Attaching the Summary of Unadjusted Audit Differences (SUAD) and affirming that uncorrected misstatements are immaterial.
5. Refusal to Provide Written Representations: If management refuses to provide one or more requested written representations, the auditor shall discuss the matter with management, re-evaluate management integrity, and evaluate the effect on the audit opinion. Under PSA 580, paragraph 20, refusal to provide written representations regarding basic responsibilities constitutes a severe scope limitation that requires the auditor to DISCLAIM AN OPINION on the financial statements (or withdraw where permitted).

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6. Communication with Those Charged with Governance (PSA 260) and Omitted Procedures

PSA 260 (Revised) requires two-way communication with those charged with governance (TCWG), usually the board of directors or its audit committee:

Significant findings are communicated in writing when oral communication would not be adequate. Communication with TCWG supports their oversight of financial reporting and helps the auditor obtain information relevant to the audit.

Omitted procedures discovered after the report date. The PSAs have no standard dedicated to this situation, and it is commonly analyzed using the approach in US auditing standards (AU-C 585) and PSQM 1 monitoring. When a post-issuance review shows that a necessary procedure was omitted, the auditor assesses whether the omission impairs the ability to support the opinion. If it does, and users may still rely on the report, the auditor promptly performs the omitted procedure or alternative procedures. If those procedures reveal that the financial statements were materially misstated at the report date, the auditor follows the PSA 560 steps for facts discovered after the financial statements were issued.

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7. Inquiry of External Legal Counsel (PSA 501)

Under PSA 501, the auditor must design and perform audit procedures to identify litigation, claims, and assessments involving the entity that may give rise to a risk of material misstatement.

• The Letter of Audit Inquiry: The primary procedure is sending a formal letter of audit inquiry to the client's external legal counsel.
• Protocol:
  • The letter is prepared on the client's letterhead and signed by management (to authorize counsel to release confidential legal information).
  • The letter is mailed directly by the auditor to the external legal counsel.
  • The external legal counsel sends their written response directly to the auditor's office.
• Lawyer's Refusal to Respond: If external legal counsel refuses to respond or is prohibited from responding by management, and the auditor cannot obtain sufficient appropriate evidence through alternative procedures, the auditor is faced with a scope limitation, requiring a Qualified Opinion or Disclaimer of Opinion under PSA 705.