Contingent Liabilities: A Comprehensive Guide for Hong Kong Auditors
As an auditor in Hong Kong, one of the most significant challenges you may face is auditing the financial statement line item “Contingent Liabilities” under the Hong Kong Financial Reporting Standards (HKFRS). Contingent liabilities can be complex and require a deep understanding of the risks, internal controls, and audit procedures surrounding this line item. This blog post will provide valuable insights into the key considerations when auditing contingent liabilities and will highlight the powerful capabilities of our Audit Program 3.0, which can effectively help CPA firms reduce time costs by 99.99% with customized illustrative documentation.
1. Assessing Assertion Level Risks, Inherent Risks, and Control Risks
The first step in auditing contingent liabilities is to assess the assertion level risks, inherent risks, and control risks associated with this financial statement line item. Applying the guidance set forth in HKSA 315 (revised) for identifying and evaluating the risks of material misstatement, auditors should consider factors such as the client’s industry, the complexity of potential contingent liabilities, and the potential for management override.
When documenting the risk assessment, auditors should provide a clear rationale for the risk levels assigned to each type of risk, considering the client’s specific risk factors and the potential impact on contingent liabilities. Staying informed about the economic and regulatory environment is crucial, as changes in these areas could significantly influence the risk assessment.
The following is a sample of illustrative documentation of the risk assessment process extracted directly from our Audit Program 3.0:
“Assertion Level risk assessment for Contingent Liabilities disclosure
Assertion 1: Presentation
The disclosure of contingent liabilities is presented appropriately in accordance with the requirements of accounting standards. The company has consistently applied the relevant disclosure requirements dictating the form and content of the disclosures. The risk for the presentation assertion is assessed as low risk.
Assertion 2: Classification
Contingent liabilities have been appropriately classified between possible and remote based on an evaluation of the likelihood of a liability crystalizing. The company follows established accounting policies for classifying contingent liabilities which comply with accounting standards. The risk for the classification assertion is assessed as low risk.
Assertion 3: Completeness
All required information related to contingent liabilities has been adequately disclosed in accordance with accounting standards. This includes details of the nature of the contingency and an estimate of the financial effect where possible. Relevant data to determine complete disclosures are obtained from underlying records. Historical disclosures indicate that all material information has been captured. The risk for the completeness assertion is assessed as low risk.
In summary, the overall risk for the contingent liabilities disclosure is assessed as low risk. The company has applied consistent accounting policies for classification and disclosure in compliance with accounting standards. Controls over reviewing relevant data and preparing the disclosures should ensure they are complete, appropriately classified and presented. The risk assessment has been documented in compliance with relevant auditing standards and is sufficiently justified to allow another auditor to reach the same conclusion. The overall risk level for this financial statement disclosure is low risk.”
2. Understanding the Design and Implementation of Internal Controls
As part of the requirements set forth in HKSA 315 (revised), auditors must gain a deep understanding of the client’s internal controls surrounding contingent liabilities. This involves evaluating the design and implementation of control activities, as well as the frequency, type of control, and personnel responsible for each activity.
When documenting internal controls, it’s important to provide a clear, step-by-step description of the business process for contingent liabilities. This should include details on the identification, assessment, and reporting of potential contingent liabilities, as well as the periodic review and monitoring of existing contingent liabilities. Additionally, auditors should scrutinize the segregation of duties and consider how the client’s IT systems and applications contribute to an effective control environment.
3. Designing Audit Responses and Procedures
After identifying and assessing the risks and understanding the client’s internal controls, the next step is to design audit responses that address each assertion level risk. To achieve this, auditors must carefully consider the factors influencing contingent liabilities and develop appropriate audit procedures.
When documenting these procedures, it’s crucial to provide a comprehensive explanation of the steps involved, the documents to be checked, and any necessary confirmations or discussions with management or external experts. For example, auditors may need to test the completeness and accuracy of contingent liabilities, verify the appropriateness of management’s assumptions and judgments, and assess the reasonableness of any estimates made by the client.
The following is a sample of illustrative documentation of the design of audit procedures extracted directly from our Audit Program 3.0:
“Assertion 1: Presentation
Audit Procedure 1: Obtain management’s report on contingent liabilities and review presentation for compliance with HKFRS requirements regarding classification, measurement and disclosure.
Audit Procedure 2: Compare presentation of contingent liabilities to prior periods to identify any changes and ensure they are properly disclosed and justified.
Audit Procedure 3: Recalculate contingent liability amounts to determine accuracy of amounts presented.
Assertion 2: Classification
Audit Procedure 1: Review management’s identification and grouping of contingent liabilities based on nature and risk characteristics.
Audit Procedure 2: Assess classification of contingent liabilities for consistency with prior periods.
Audit Procedure 3: Test selected contingent liabilities to ensure proper classification.
Assertion 3: Completeness of Disclosures
Audit Procedure 1: Obtain checklist of required contingent liability disclosures under HKFRS and review management’s disclosures against checklist for completeness.
Audit Procedure 2: Review relevant data such as legal correspondence, claims and guarantees to identify any information that indicates disclosures may be incomplete.
Audit Procedure 3: Verify completeness of disclosures for nature and extent of obligations, uncertainties related to amount or timing, and possible obligations.
Conclusion: The above procedures comply with HKSA 230 and 220 to respond to low risk for the assertions of presentation, classification and completeness of disclosures for the contingent liabilities disclosure, resulting in an overall low risk assessment.”
Revolutionizing the Audit Process with Audit Program 3.0
Navigating the complexities of auditing contingent liabilities under HKFRS can be challenging. However, with our innovative Audit Program 3.0, CPA firms can significantly reduce time costs by 99.99%. Our automated program generates customized, illustrative audit programs, risk assessments, and documentation of internal controls relevant to any client industry and principal activity. By streamlining the audit process, Audit Program 3.0 allows auditors to focus on ensuring the highest level of audit quality and compliance.
In conclusion, auditing contingent liabilities under HKFRS requires a thorough understanding of risks, internal controls, and audit procedures. By following the guidelines set out in this blog post, auditors can navigate the intricacies of this financial statement line item and uphold the rigorous standards set by the AFRC. Moreover, with the unparalleled efficiency of Audit Program 3.0, CPA firms can confidently tackle even the most challenging audits and deliver exceptional results.