Respond to the following in a minimum of 100 words:
A contingency liability is basically a plan “B” that a company creates to accommodate any liability risks when faced with a litigation situation. When it is more probable that the company is not able to win the lawsuit, the company will make a plan that will ensure the company’s survival. So that can entail the company selling some of its assets to pay for the litigation fees. In these types of situations, an auditor’s job is to help the company create that plan. How they would do it is by ensuring there is little misstatements in the financial reports, the company is disclosing its changes in financial statements, and it is accommodating the lawsuit legally and fairly.
Letters from the client’s lawyers are very crucial documents in creating the contingency plan for the litigations because it provides all the necessary facts of whether the company will win the lawsuit, how much the lawsuit will cost so the company can account for it in its financial statements, and is the company able to recover from the lawsuit. Unfortunately, lawyers are very reluctant in providing auditors with the documents because they are afraid it may sway the client in the wrong direction, intentionally or unintentionally.
Post Balance Sheet Review is what it sounds like. Any transactions created after the balance sheet date is reviewed to see whether the transactions are fairly presented and disclosed in the current period statements.
Now how all three terms correlate to Build-A-Bear Workshop is if the company were to get involved in a lawsuit, the company will need create a contingency plan for the liability risk. The auditors involved will then make sure that Build-A-Bear Workshop is correctly stating its financial statements. How auditors can check the company’s work is by using the letters from the company’s lawyers to compare and properly evaluate the type of risk the company is taking. Once everything is compared and confirmed, auditors can analyze the post-transactions and see if any of the transactions is pertinent to the lawsuit in any way, shape, or form.
A contingent liability is a potential future obligation to an outside party for an unknown amount resulting from activities that have already taken place. Accounting standards use two primary approaches in dealing with uncertainty in loss contingencies a fair value and a probability threshold approach.
Auditors are especially concerned about certain contingent liabilities:
• Pending litigation for patent infringement, product liability, or other actions
• Income tax disputes
• Product warranties
• Notes receivable discounted
• Guarantees of obligations of others
• Unused balances of outstanding letters of credit
The auditor’s primary objectives in verifying contingent liabilities are:
· • Evaluate the accounting treatment of known contingent liabilities to determine whether management has properly classified the contingency (classification presentation and disclosure objective).
· • Identify to the extent practical any contingencies not already identified by management (completeness presentation and disclosure
The common audit procedures used to search for contingent liabilities are include : Inquire of management about the possibility of unrecorded contingencies, review current and previous years’ internal revenue agent reports for income tax settlements, review the minutes of directors’ and stockholders’ meetings for indications of lawsuits or other contingencies, analyze legal expense for the period under audit, obtain a letter from each major attorney performing legal services for the client, Rrview audit documentation, and examine letters of credit in force as of the balance sheet date and obtain a confirmation of the used and unused balances.