Why is an audit of litigation and claims necessary?

 

Litigation and claims involving the entity may have a material effect on   financial statements therefore the audit of litigation and claims is necessary to obtain reasonable assurance about whether the financial statements as a whole are free from material misstatement.

 To express an opinion on whether the financial statements are prepared, in all material respects, in accordance with an applicable financial reporting framework auditors shall obtain evidence that all liabilities (provisions) related to litigation and claims are completely and accurately included in the statement of financial position and all contingent liabilities related to litigation and claims are properly disclosed in the notes to financial statements.

The auditor designs and performs the following audit procedures to identify litigation and claims involving the entity which may give rise to a risk of material misstatement:

a)      Risk assessment procedures carried out as part of obtaining an understanding of the entity and its environment. Why is an Understanding of the Company and Its Environment, and the Applicable Financial Reporting Framework required in independent audit of financial statements?

b)     Inquiry of management and, where applicable, others within the entity, including in-house legal counsel.  Direct communication with the entity’s external legal counsel assists the auditor in obtaining sufficient appropriate audit evidence as to whether potentially material litigation and claims are known and management’s estimates of the financial implications, including costs, are reasonable. In certain circumstances, the auditor also may meet with the entity’s external legal counsel to discuss the likely outcome of the litigation or claims, for example if the auditor determines that the matter is a significant risk or matter is complex.

c)      Reviewing minutes of meetings of those charged with governance and correspondence between the entity and its external legal counsel; and

d)     Reviewing legal expense accounts, for example the auditor may examine related source documents, such as invoices for legal expenses.

e)     Obtaining the Written Representations from management confirming that all known actual or possible litigation and claims whose effects should be considered when preparing the financial statements have been disclosed to the auditor and accounted for and disclosed in accordance with the applicable financial reporting framework. The role of management`s representations in the audit process

ISA 501 – Audit evidence - specific consideration for selected items