Standby Letter of Credit Attorney

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					          The Impact of Legal
          Matters on Financial
           Statement Audits

                              January 21, 2009

Presented by Jim Hasle, CPA
Mikunda, Cottrell & Co.
    Navigating Today’s Presentation
•    Contingencies
       Accounting Estimates
       What is a Contingency?
       Loss Contingencies
       Accrual, Disclosure or Nothing?
       And The Probability Is…
       Disclosure Decision Tree

•    Attorney Letters
       What Is an Attorney Letter?
       The Importance of Dates
             Accounting Estimates
•   Companies preparing their financial statements in conformity with
    generally accepted accounting principles are required to make
    estimates and assumptions
•   Those estimates and assumptions can affect the reported amounts of
    assets, liabilities, revenues and expenses
•   Estimates are necessary due to the inherent uncertainties in business
•   Examples include:
      Allowance for doubtful accounts
      Depreciation
      Inventory obsolescence
      Goodwill
      Contingencies
               What is a Contingency?
•   Financial Accounting Standard (FAS) 5 defines a contingency as:
      An existing condition, situation, or set of circumstances involving
       uncertainty as to possible gain or loss that will ultimately be resolved
       when one or more future events occur or fail to occur
      Resolution of the uncertainty may confirm the acquisition of an asset
       or the reduction of a liability (gain) or the loss or impairment of an
       asset or the incurrence of a liability (loss)
•   Not all uncertainties inherent in the accounting process give rise to
    contingencies. For example:
      Depreciation – the eventual expiration of the utility of the asset is not
       uncertain. Thus, depreciation of assets is not a contingency
      Accruals – there is nothing uncertain about the fact that accrued
       obligations have been incurred
                   Loss Contingencies
•   FAS 5 lists examples of loss contingencies as follows:
      Collectibility of receivables
      Obligations related to product warranties and product defects
      Risk of loss or damage of enterprise property by fire, explosion, or
       other hazards
      Threat of expropriation of assets
      Pending or threatened litigation
      Actual or possible claims and assessments
      Risk of loss from catastrophes assumed by property and casualty
       insurance companies including reinsurance companies
      Guarantees of indebtedness of others
      Obligations of commercial banks under “standby letters of credit”
      Agreements to repurchase receivables (or to repurchase the related
       property) that have been sold
         Accrual, Disclosure or Nothing?
•   Accrual:
        Information available prior to issuance of the financial statements indicates that it is
         PROBABLE that an asset had been impaired or a liability had been incurred at the date of
         the financial statements. It is implicit in this condition that it must be probable that one or
         more future events will occur confirming the fact of the loss
        The amount of loss can be REASONABLY ESTIMATED

•   Disclosure:
        Footnote disclosure for all accruals
        Information available prior to issuance of the financial statements indicates that it is at least
         a REASONABLE POSSIBILITY that a loss or an additional loss may have been incurred
        The amount of loss can be REASONABLY ESTIMATED
        Disclosure is not required for an unasserted claim or assessment unless it is considered
         probable that a claim will be asserted and there is a reasonable possibility that the outcome
         will be unfavorable
        Disclosures must indicate the nature of the contingency and give an estimate of the
         possible loss or range of loss or state that such an estimate cannot be made

•   Nothing:
        Loss contingencies that are not at least REASONABLY POSSIBLE and REASONABLY
         ESTIMABLE do not need to be accrued or disclosed
              And The Probability Is…
•   FAS 5 defines the three ranges of probability as follows:
      Probable: the future event or events are likely to occur
      Reasonably possible: the chance of the future event or events
       occurring is more than remote but less than likely
      Remote: the chance of the future event or events occurring is slight
 Disclosure Decision Tree
                                      Does the
                                  Condition Exist
                                  as of the Date of
                                   the Financial

                            No                        Yes

                                                       Is It PROBABLE
                No Disclosure                          that the Results
                  Required                                   Will Be

                                       No                                  Yes

                 Is It
                                                                                     Is the Amount of
            POSSIBLE that
           the Results Will
           Be Unfavorable?

          No                Yes                                                     No             Yes

                           Is the Amount of                                                        Accrue on the
No Disclosure                     Loss                                    No Disclosure             Face of the
  Required                  REASONABLY                                      Required                 Financial
                             ESTIMABLE?                                                             Statements

                          No                Yes

                                             Disclose in the
                No Disclosure               Footnotes to the
                  Required                      Financial
            What Is an Attorney Letter?
•   An attorney letter is a letter sent by the auditors to the client's lawyer(s) to
    verify litigation information provided by management
•   The attorney letter is a standard audit procedure
•   It is the auditors’ primary means of obtaining corroboration of information
    furnished by management concerning litigation, claims and assessments
•   It is also used to assess the impact contingencies may have on the client's
    financial position
              The Importance of Dates
•   Because auditors need to receive the attorney’s response prior to the date
    of the auditor’s report and need time to evaluate it, the effective date of the
    attorney’s response should be as close to the completion of audit fieldwork
    as practicable
•   Auditors will generally also ask for an updated response about 10 days
    before the expected date of the auditor’s report

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