ANALYSIS OF POTENTIAL LEGAL LIABILITY
Potential Client: Type of Engagement:
Form Completed By: Date:
(1) Is the potential client privately held or publicly held?
(2) Evaluate the possible liability to the client that Abernethy and Chapman might incur, if the engagement is accepted.
(3)
(4) Discuss the possibility that other third parties will be brought into a position where they would be expected to see the financial statements of the potential client. These parties are also called foreseeable beneficiaries.
(5)
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Exhibit 2-2
Abernethy and Chapman INFORMATION FROM PREDECESSOR AUDITOR
Potential Client: Form Completed By: Predecessor Auditor: Date of Interview:
(1) Discuss the predecessor auditor’s evaluation of the integrity of the management of the potential client.
(2) Did the predecessor auditor reveal any disagreements with management as to accounting principles, auditing procedures, or other similarly significant matters? If so, fully describe these disagreements.
(3) What was the predecessor auditor’s understanding as to the reasons for the change in auditors?
(4) Did the predecessor auditor give any indication of other significant audit problems associated with the potential client?
(5) Did the predecessor auditor indicate any problem in allowing Abernethy and Chapman to review prior years’ audit documentation for the potential client? If “yes,” explain.
(6) Was the predecessor auditor’s response limited in any way?
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Exhibit 2-3
Abernethy and Chapman Preliminary Judgment about Materiality
Client: _____________________________ Balance Sheet Date: __________________ Prepared by: ________________________
Determine the preliminary judgment about materiality for the client as a whole. Express your answer as a dollar amount. Determine the appropriate level of materiality based on all analyses completed for the client thus far. Fully support and discuss the materiality level that you determine.
Quantitative Considerations: Because materiality is relative, it is necessary to have bases for establishing whether misstatements are material. A base is a critical item of which users tend to focus while making decisions. The base will vary depending on the nature of the client’s business. Typical bases may include net income before taxes, net sales, total assets and stockholders’ equity. Percentages typically range from 1% to 10% depending on the base.
| Base (from previous year) | Dollar Amount of Base | Percentage Range | Base x Percentage |
Qualitative Considerations: Certain types of misstatements are likely to be more important to users than others, even if the dollar amounts are the same. For example, misstatements that involve fraud may be more important to users than misstatements due to unintentional errors. Fraud reflects on the integrity of management and other employees of the client.
| Item to be Considered | Impact on Materiality (Increase or Decrease) |
Preliminary Judgment about Materiality: Combine the quantitative and qualitative considerations into one overall materiality level.
| Materiality level: | $ |
Discussion: Discuss how you arrived at this dollar amount for the preliminary judgment about materiality. That is, how did you combine the qualitative and quantitative considerations to arrive at this dollar amount?
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