Question

Material loss contingencies should be recorded in the financial statements if available information indicates it is probable that a loss had been sustained prior to the balance sheet date and the amount of such loss can be reasonably estimated. These considerations will affect the audit report as follows:

A. If a loss has been recorded in accordance with these criteria, the auditor may issue an unqualified opinion but is required to point out the contingency in an explanatory paragraph of the report.
B. If a loss meets these criteria but is disclosed in the financial statement notes rather than being recorded therein, the auditor may issue an unqualified opinion, but is required to point out the contingency in an explanatory paragraph of the report.
C. If a loss meets these criteria but is disclosed in the financial statement notes rather than being recorded therein, the auditor may issue an unqualified opinion, but should consider adding an explanatory paragraph as a means of emphasizing the disclosure.
D. If a loss is probable but the amount cannot be reasonably estimated and is disclosed in the notes to the financial statements rather than being recorded therein, the auditor may issue an unqualified opinion.

Answer 1

Material loss contingencies that are probable and can be reasonably estimated should be recorded in the financial statements. If properly disclosed in the notes, the auditor may issue an unqualified opinion. The auditor may add an explanatory paragraph to emphasize the matter, or issue an unqualified opinion without further comment if the loss is not estimable.

Step-by-step explanation:

The question you are asking relates to the accounting treatment and audit reporting of material loss contingencies. When a loss is both probable and can be reasonably estimated, and it occurred before the balance sheet date, accounting standards require this loss to be recorded within the financial statements. If the loss is properly recorded, the auditor may issue an unqualified opinion without the need for further emphasis on the loss. However, if the loss is only disclosed in the notes to the financial statements and not recorded, the following rules apply:

• Option B suggests that an explanatory paragraph must be added. This is incorrect because an explanatory paragraph is not required for contingencies that are properly disclosed.
• Option C states that the auditor might consider adding an explanatory paragraph to emphasize the disclosed contingency. This option is more in line with auditing standards.
• Option D states that when a loss cannot be estimated but is probable and disclosed in the notes, the auditor may still issue an unqualified opinion. This is correct and consistent with auditing standards.

Therefore, the most appropriate response would be Options C and D, with option C involving auditor judgment on emphasizing the disclosure and option D applicable when loss amounts cannot be estimated.