Question

If the auditor concludes that there are contingent liabilities, he or she must evaluate the significance of the potential liability and the nature of the disclosure needed in the financial statements. Which of the following statements is not true?

A) The potential liability is sufficiently well known in some instances to be included in the financial statements as an actual liability.
B) Disclosure may be unnecessary if the contingency is highly remote or immaterial.
C) A CPA firm often obtains a separate evaluation of the potential liability from its own legal counsel rather than relying on management or management's attorneys.
D) The client's attorneys must remain independent when evaluating the likelihood of losing the lawsuit.

Answer 1

Statement D is not true since the client's attorneys are not required to remain independent; they represent the client. The auditor's independence is the key requirement.

Step-by-step explanation:

When the auditor concludes that there are contingent liabilities, they must assess both the significance of the potential liability and the appropriate form of disclosure in the financial statements. In addressing a student's question about false statements regarding contingent liabilities:

• A) is true because known and estimable contingent liabilities are recorded in financial statements.
• B) is true as immaterial or remote contingencies may not require disclosure.
• C) is partially true. An auditor can seek external advice, but it is not a requirement to consult the auditor's legal counsel instead of management's attorneys. Auditors assess the adequacy of management's evaluation of contingencies, including consultations with management's legal counsel.
• D) is not true. The client's attorneys do not need to remain independent as they represent the interests of the client, not the auditor. The independence requirement applies to the auditor.