25D - AGMT - FINANCIAL AUDIT SRVS

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SECTION 4: SPECIFIC AUDIT APPROACHAND METHODOLOGY, Laws and Regi<itlations Approach When planning and performing audit procedures and in evaluating and reporting the results thereof, we need to recognize that an illegal act may materially affect the financial statements. Laws and regulations vary considerably in their relation to the financial statements: Direct and material effect on financial statements • We consider laws and regulations that generally have a direct and material effect on the determination of financial statement amounts. For example, escheat or unclaimed property laws, may affect recorded liabilities and revenues and applicable laws and regulations may affect the amount of revenue accrued under government contracts. However, we consider such laws or regulations from the perspective of their known relation to audit objectives derived from financial statement assertions rather than from a legal perspective. Indirect effect on financial statements • The City may be affected by many other laws or regulations, including those related to occupational safety and health, equal employment, and other violations. Generally, these laws and regulations relate more to an organization's operating aspects than to its financial and accounting aspects, and their financial statement effect is indirect. We ordinarily do not have sufficient basis for recognizing possible violations of such laws and regulations. Their indirect effect is normally the result of the need to disclose a contingent liability because of the allegation or determination of illegality. Normally, our audit does not include procedures specifically designed to detect illegal acts that indirectly affect the financial statements. However, the procedures listed below, which may be performed for the purpose of forming an opinion on the financial statements, may bring possible illegal acts to our attention: • Familiarization with the particular legal operational framework applicable to the client and its operations. • Inquiring of management and the client's attorneys regarding the accounting for and disclosure of loss contingencies. • Inquiring of management as to the laws and regulations that may be expected to have a fundamental impact on the operations of the City. • Discussing with management policies and procedures adopted for identifying, evaluating, and accounting for litigation claims and assessments. • inspecting relevant documentation and correspondence with relevant licensing or regulatory authorities. • Obtaining written confirmation from management that they have disclosed all events of which they are aware which involve possible illegal acts, together with any actual or contingent consequences which may arise. We also remain cognizant for any instances of non-compliance with laws or regulations at all times during the course of our audit that may come to our attention through: • The performance of other substantive procedures; • Review of the minutes of the governing bodies of the City; and • Inquiry of the City and its lawyers regarding litigation, claims, and assessments, and others. Sampling I%- roach Audit sampling is the application of an audit procedure to less than 100% of the items within an account balance or class of transactions for the purpose of evaluating the value of the balance or class. Substantive test ("variables") sampling provides a technique for estimating the extent of monetary misstatement in a class of transactions or balances. It can also be used for estimating the amount of a population. It answers the question, "How much?" rather than "How many?" as In sampling for attributes (such as the operation of a control), and is normally used to help decide if a balance is materially misstated. Sampling can be very useful in performing substantive tests on, for example, inventory or accounts receivable. Sampling is sometimes also used for determining sample sizes for substantive tests of recorded transactions (e.g., vouching of sales, purchases). There are situations when the more formal approach to sample size determination is often not practical. These situations include: • Test counting during inventory observations. • Examining canceled checks when reviewing a bank reconciliation. • Checking depreciation calculations. • Requesting vendor statements. • Testing accruals. • Interviewing client personnel in conjunction with observation and inquiry procedures. • Applying analytical procedures. This does not mean that we would never use sampling for the above types of procedures. For example, sampling might be used when determining the extent of testing for: • Examining canceled checks when the client's outstanding check list consists of an unusually large number of items which are similar in amount, such as a payroll account for a very large client. + Selecting invoices for verifying an accounts payable listing consisting of an unusually large number of items similar in amount. • Testing an accrual comprised of a large number of small items. The application of sampling requires significant auditor judgment in areas such as: 34 25D-20 =d??