A legal invoice can reveal a threatened lawsuit absent from management's litigation listing. The auditor must perform audit procedures that identify omitted matters before evaluating whether recorded liabilities and disclosures are adequate.
A loss contingency is an existing uncertain circumstance whose resolution may produce a loss. Litigation involves legal proceedings, claims involve demands for remedies, and assessments include amounts sought by governmental authorities.
The auditor investigates four connected questions:
- What litigation, claims, or assessments exist, including matters absent from the accounting records?
- When did the underlying events occur, and which financial statement period do they affect?
- How likely is an unfavorable outcome?
- What amount or range is supportable, and what information belongs in the notes?
Management identifies and evaluates claims and assessments and prepares the related accounting. Counsel supplies legal information and judgments within the engagement's scope; the auditor evaluates the evidence and resulting financial statement treatment.
Inquiries of management address how the entity identifies litigation, claims, and assessments, including who receives complaints and how those matters reach accounting personnel.
Common mistakes
- Fees treated as damages. Invoice E83's $18,000 identifies legal work; it does not measure Hale's potential liability.
- Initial schedule treated as complete. The December 18 minutes contradict Marlon's one-matter listing and require investigation of the omission.
- A range treated as unknowable. Vale's $300,000 to $500,000 range supports recognition despite the absence of a better point estimate.
Bottom line
- Litigation procedures address completeness through inquiries, minutes, legal expense records, correspondence, and appropriate direct legal communication.
- Management supplies descriptions, evaluations, and consent; counsel responds directly, and the auditor evaluates the evidence.
- Legal inquiry requests distinguish pending or threatened matters from qualifying unasserted claims and assessments.
- Genuine estimation uncertainty, appropriate response boundaries, refusal, and nonresponse require different follow-up.
Exam shortcut
Start with the missing link: an omitted matter, unclear legal evaluation, unsupported amount, or inadequate disclosure. Select the procedure that addresses that specific gap. Circle the reason for a missing estimate. “Evidence has not developed” calls for corroborating uncertainty; “existing analysis withheld” calls for resolving access and evidence. Match the source to the question. Minutes identify discussion, invoices identify work, and counsel evaluates legal matters within the engagement's scope.
The full lesson (about 4,227 words, 28 min read) adds 2 worked examples, all 6 common mistakes, a self-check, free in the app.
Learning objectives
- III.E4
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