AU 561: Subsequent Discovery of Facts Existing at the Date of the Auditor’s Report1

AU-C 560: Subsequent Events and Subsequently Discovered Facts

AU EFFECTIVE DATE AND APPLICABILITY

Original Pronouncement Statement on Auditing Procedure (SAP) 41 (codified in Statement on Auditing Standards [SAS] 1) and SAS 98.
Effective Date These statements currently are effective.
Applicability The auditor’s discovery of facts, after he or she has issued the report on the financial statements, that:
  • Existed at the date of the report
  • Were not known by the auditor at the date of the report
  • Would have required the auditor to change the report had he or she been aware of them
NOTE: The section does not apply to matters identified in a subsequent events review that covers the period after the financial statements but before the original issuance date of the auditor’s report (see Section 560, Subsequent Events).
The section applies only to audits; however, Statements on Standards for Accounting and Review Services (SSARSs) refer to it in situations in which the accountant becomes aware of facts existing at the date of the report after he or she issued a compilation or review report. The accountant might wish to consider the section in an analogous situation in a compilation or review engagement.

AU-C EFFECTIVE DATE AND SUMMARY OF CHANGES

SAS No. 122, Codification of Auditing Standards and Procedures, is effective for audits of financial statements with periods ending on or after December 15, 2012.

AU-C 560 supersedes AU 530; AU 560, Subsequent Events; AU 561, Subsequent Discovery of Facts Existing at the Date of the Auditor’s Report; and paragraphs .51–.73 of AU 508.

AU-C 560 does not change extant requirements in any significant respect.

AU DEFINITIONS OF TERMS

This section contains no authoritative definitions.

AU-C DEFINITIONS OF TERMS

Source: AU-C 560.07

Accounting estimate. An approximation of a monetary amount in the absence of a precise means of measurement. This term is used for an amount measured at fair value when there is estimation uncertainty, as well as for other amounts that require estimation. When this section addresses only accounting estimates involving measurement at fair value, the term fair value accounting estimates is used.

Auditor’s point estimate or auditor’s range. The amount or range of amounts, respectively, derived from audit evidence for use in evaluating the recorded or disclosed amount(s).

Estimation uncertainty. The susceptibility of an accounting estimate and related disclosures to an inherent lack of precision in its measurement.

Management bias. A lack of neutrality by management in the preparation and fair presentation of information.

Management’s point estimate. The amount selected by management for recognition or disclosure in the financial statements as an accounting estimate.

Outcome of an accounting estimate. The actual monetary amount that results from the resolution of the underlying transaction(s), event(s), or condition(s) addressed by the accounting estimate.

OBJECTIVES OF AU SECTION 561

Before the issuance of SAP 41, there was no authoritative guidance for the auditor if, after issuing the report on the financial statements, he or she became aware of facts that existed at the date of the report that would have required the auditor to change the report had he or she been aware of them. SAP 41 was a direct result of Fischer v. Kletz, commonly known as the Yale Express case.

In the case of Yale Express, a large CPA firm did not promptly disclose material errors in financial statements covered by its issued report that were subsequently discovered during a consulting services engagement. The court rejected the contention in the defendant’s motion to dismiss the case that an auditor has no duty to those still relying on the report to disclose subsequently discovered errors in that report. The case was settled out of court, however, and the precise nature and extent of an auditor’s duty to those relying on a previous report was unclear. SAP 41 was issued to delineate the nature and extent of the auditor’s responsibility.

This section established the auditor’s continuing responsibility for the validity of the report. It provides guidance on procedures the auditor should follow after the date of the report if he or she becomes aware of certain facts that may have existed when the report was issued.

This section is distinguishable from Section 560 on subsequent events. Under Section 560, the auditor has no responsibility to search for events subsequent to the date of the financial statements after the audit report has been issued. Under Section 561, an event subsequently comes to the auditor’s attention that existed at the audit report date, and the auditor is required to apply procedures to investigate whether the event would have affected the audit report if known at that earlier date.

OBJECTIVE OF AU-C SECTION 560

AU-C Section 560.05 states that:

. . . the objective of the auditor is to obtain sufficient appropriate audit evidence about whether, in the context of the applicable financial reporting framework

a. accounting estimates, including fair value accounting estimates, in the financial statements, whether recognized or disclosed, are reasonable and
b. related disclosures in the financial statements are adequate.

FUNDAMENTAL REQUIREMENTS

Consultation with Attorney

The section states that the auditor is well-advised to consult with his or her attorney upon encountering circumstances to which this section applies.

NOTE: The auditing standard setters have always avoided making the failure to consult legal counsel a departure from professional standards because consultation is undertaken to protect the auditor.

Determination of Reliability of Information

Whenever he or she becomes aware of information covered by this section, the auditor should determine its reliability and whether it existed at the date of the report. The auditor should discuss the matter with whatever level of management is appropriate, including the board of directors, and request cooperation to whatever extent necessary.

NOTE: Information about facts existing at the date of the auditor’s report may come from many sources, such as:
1. Tax engagements
2. Consulting engagements
3. Client executive or any other current or former employee of the client
4. Audit staff performing interim work
5. Unattributable rumors or an anonymous informant

Auditor Action

The auditor should advise the client to disclose the newly discovered facts and their effect on the financial statements to persons known to be currently relying, or who are likely to rely, on the financial statements and the related auditor’s report if:

1. The subsequently discovered information is reliable.
2. It existed at the date of the auditor’s report.
3. The auditor’s report would have been affected if all the information had been known to him or her at the date of the report and had not been reflected in the financial statements.
4. The auditor believes there are persons currently relying, or likely to rely, on the financial statements who would attach importance to the information.

The auditor should take whatever steps he or she believes necessary to satisfy himself or herself that the client has made the requested disclosures (see the section “Techniques for Application” for methods of disclosure).

Client Refusal to Make Disclosures

If the client refuses to make the disclosures requested, the auditor should notify each member of the board of directors of the refusal and of the auditor’s intention to take steps to prevent future reliance on the report.

NOTE: In this situation, if the auditor has not already done so, it is prudent to consult his or her attorney.

Auditor Steps When Client Refuses to Make Disclosures

Unless his or her attorney recommends otherwise, the auditor should take the following steps when the client fails to make the requested disclosures:

1. Notify client that the audit report must no longer be associated with the financial statements.
2. Notify regulatory agencies with jurisdiction over the client that the report should no longer be relied on.
3. Notify each person known specifically by the auditor to be relying on the financial statements that the report should no longer be relied on (see section on “Techniques for Application”).

Content of Auditor Disclosure

If the auditor determines that the information is reliable and the client refuses to make appropriate disclosures, the auditor should disclose:

1. The nature of the subsequently acquired information and its effect on the financial statements
2. What effect the subsequently acquired information would have had on the auditor’s report had it been known at the date of the report and not reflected in the financial statements
NOTE: The disclosure should be precise and factual and should avoid comments concerning the conduct or motives of any person.

If the auditor takes the steps described in the prior section, “Auditor Steps When Client Refuses to Make Disclosures,” and has not been able to determine the reliability of the information because the client refused to cooperate, he or she should disclose that:

1. Information has come to his or her attention that the client has not cooperated in trying to substantiate.
2. If the information is true, the auditor believes the report must no longer be relied on or associated with the client’s financial statements.
NOTE: These disclosures should be made only if the auditor believes that the financial statements may be misleading and that the report should not be relied on.

INTERPRETATIONS

Auditor Association with Subsequently Discovered Information When the Auditor Has Resigned or Been Discharged (February 1989)

The investigation of whether subsequently discovered information is reliable and whether facts existed at the date of the original audit report should be performed even when the auditor has resigned or been discharged prior to undertaking or completing the investigation. In other words, Section 561 is equally applicable to a predecessor auditor and a continuing auditor.

TECHNIQUES FOR APPLICATION

Parties to Be Notified

When the auditor has concluded that subsequently discovered information should be disclosed, some or all of the following might be notified:

1. Stockholders
2. Banks
3. Bond trustees
4. Major note holders, such as insurance companies
5. Major suppliers
6. Credit agencies
7. Securities and Exchange Commission (SEC)
8. Stock exchanges
9. Regulatory agencies
10. Other persons known to be currently relying or likely to rely on the financial statements and related auditor’s report

Notification of parties other than the client is a serious step and should be undertaken only under the guidance of legal counsel. The requirement to notify applies only for persons actually known by the auditor to be relying and not to persons that the auditor might infer could be relying. However, whether to notify and whom to notify should be considered with the advice of legal counsel.

Methods of Disclosure

The method of disclosing new information depends on the circumstances.

Revised Financial Statements and Auditor’s Report

If the effect of the new information can be determined promptly, disclosure should consist of issuing, as soon as practicable, revised financial statements and auditor’s report.

1. The reasons for the revision should be described in a note to financial statements and referred to in the auditor’s report.
2. The opinion paragraph of the auditor’s report accompanying revised financial statements would start as follows:
In our opinion, the aforementioned financial statements, revised as described in Note X, present fairly . . .
3. The auditor’s report accompanying the revised financial statements should contain two dates: the date of the original report and the date of the revision described in a separate note to the financial statements (see Section 530, Dating of the Independent Auditor’s Report).

Current Financial Statements and Auditor’s Report

When audited comparative financial statements and the related auditor’s report for a subsequent period are about to be issued, disclosure of the revisions can be made in these reissued statements.

1. In these circumstances, the prior financial statements will be revised and the revision disclosed, but the auditor’s report need not refer to the revision.
2. This method may be used only if disclosure of the new information is not seriously delayed.

Effect Not Promptly Determinable

Occasionally, the effect of subsequently discovered facts cannot be determined without prolonged investigation. In these circumstances, the issuance of revised financial statements and auditor’s report would be delayed. If it appears that the new information will require revision of the financial statements and the report, the auditor should request that the client do the following:

1. Notify persons known to be relying, or who are likely to rely on, the financial statements and the related auditor’s report that they should not be relied on.
2. Inform these persons that revised financial statements and auditor’s report will be issued when the current investigation is completed.
3. Communicate with SEC, stock exchanges, and regulatory agencies.

1 This section is affected by the Public Company Accounting Oversight Board’s (PCAOB’s) Standard, Conforming Amendments to PCAOB Interim Standards Resulting from the Adoption of PCAOB Auditing Standard No. 5, An Audit of Internal Control over Financial Reporting That Is Integrated with an Audit of Financial Statements.

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