Significant areas, litigation and claims

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Significant areas, litigation and claims

MODULE 4 | 4.1.1 | STUDENT COMPANION

Completion is the auditor's last check that nothing important has slipped through. Three significant areas

get a final look: accounting estimates, related parties and fraud. Litigation and claims must be searched

for, and in Australia the rules are in ASA 502. Where the auditor assesses a risk of material misstatement,

it sends the entity's external lawyers a letter of enquiry that management has drafted, and they reply

directly to the auditor. Each legal matter is then tested against the accounting rules: a provision, a

contingent liability disclosure, or nothing at all.

Three significant areas: a final look

Accounting estimates

Review the final figures and their

disclosures

Use evidence from events after year

end, up to the date of the report

Ask whether management's

judgements, taken together, show a

pattern of bias

Related parties

Check that every relationship and

significant transaction identified is

properly disclosed

Get management's written

confirmation that all related parties

have been disclosed

Fraud

Do the analytical procedures near the

end point to a fraud risk not

recognised before?

Could any misstatement found be a

sign of fraud?

Must anything be raised with the

board, the audit committee or others?

At Voltana, that last point is live. The June revenue journals and the undisclosed related party were already being treated as possible fraud;

the completion work confirms that the extended journal testing found no further problems.

Estimates. Events after year end often settle an estimate: a claim paid in July, or stock sold in August below its

carrying amount. Bias is judged across the estimates as a whole. If every judgement leans the same way, say

towards higher profit, each one may look reasonable on its own while the pattern doesn't. Signs of possible bias

aren't misstatements in themselves, but they colour the auditor's view of the statements as a whole and of the

risk of fraud.

Related parties. The auditor checks that the relationships and significant transactions it has found are properly

accounted for and disclosed, and obtains written representations that management has disclosed every related

party, relationship and transaction it knows of (ASA 550).

Fraud. Final analytical procedures can reveal a fraud risk that wasn't recognised before. A misstatement that

may be fraud is never judged on its size alone: the auditor reconsiders the reliability of management's

representations and the evidence generally, tells management at the right level, and those charged with

governance, and considers any duty to report outside the entity (ASA 240).

ADVANCED AUDIT AND ASSURANCE | M4 | 4.1.1 | STUDENT COMPANION

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Searching for litigation and claims

1. Search for legal matters

Ask

Management and, if there

is one, the in-house lawyer

Read the minutes

Board and committee

meetings

Read the

correspondence

Letters and emails with the

external lawyers

Review legal expenses

An invoice is often the first

sign of a dispute nobody

mentioned

Then ask:

A risk of material

misstatement from

litigation or claims

already identified?

Or signs that other

material ones may

exist?

Yes

2. Letter of enquiry (required)

Management prepares it; the auditor sends it

Lists each matter with management's

assessment, for the lawyers to confirm: a

letter of specific enquiry, as in ASA 502's

example

Used when lawyers are unlikely to answer a

general request to name any matters

The lawyers reply directly to the auditor

3. At the end: a written representation

Management confirms that all known actual or possible litigation and claims have been disclosed to the auditor and properly accounted for

The Australian standard. ASA 502 Audit Evidence - Specific Considerations for Litigation and Claims sets

these requirements; ASA 501 now deals only with inventory and segment information. (Internationally, ISA 501

covers all three.) The letter of enquiry isn't optional: when the trigger is met, the auditor must seek direct

communication with the external lawyers through a letter that management prepares and the auditor sends.

Two kinds of letter

General enquiry Specific enquiry

What it asks The lawyers list any litigation and claims they

know of, with their view of the outcome and

an estimate of the financial effect, including

costs

The letter lists each matter with

management's assessment and estimate; the

lawyers confirm whether those are

reasonable and say if the list is incomplete or

wrong

When it's used Where the lawyers can be expected to

answer an open request

When lawyers are unlikely to answer a

general request, for example because their

professional body discourages it. ASA 502's

example letter takes this form

Further ASA 502 requirements. If an in-house lawyer has primary responsibility for litigation and is best placed

to corroborate management, the auditor tries to obtain a similar letter from them. If a lawyer's reply materially

disagrees with management's evaluation, the auditor discusses it with management and the lawyers. For a

matter that is a significant risk, complex or disputed, the auditor may also meet the lawyers, normally with

management's permission and a representative of management present.

ADVANCED AUDIT AND ASSURANCE | M4 | 4.1.1 | STUDENT COMPANION

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Accounting Ahead | Original study resource | accountingahead.com.au

Provision, contingent liability or nothing?

Present obligation

from a past event?

Yes

No

Outflow of resources

probable?

Yes

No

Amount can be

reliably estimated?

Yes

No

Recognise a provision

All three tests met

Is the chance of an outflow

remote?

Disclose a contingent liability

Not recognised in the statements

Nothing required

Neither recognised nor disclosed

No Yes

Contingent liability VOLTANA

Class action (Federal Court, May 2026)

Customers say batteries lost capacity faster than the marketing

promised. Lawyers: early stage; liability possible, not probable; no

reliable estimate yet. Disclose its nature and, where practicable, an

estimate of its financial effect and the uncertainties.

Provision VOLTANA

Overseas cell supplier's claim

About $2.4m claimed after Voltana cancelled orders. Lawyers expect a

settlement between $1.2m and $1.6m. Management's $1.4m provision

sits inside that range, so it's supported.

The accounting rules (AASB 137). Recognise a provision when there's a present obligation from a past event,

an outflow of resources is probable, and the amount can be reliably estimated. A contingent liability is disclosed

but not recognised: an obligation that is only possible, or a present obligation where an outflow isn't probable or

the amount can't be measured reliably. If the chance of an outflow is remote, nothing is required.

Voltana's two legal matters

The board minutes and large legal payments in May and June pointed to two matters. Linden Ridge received the

lawyers' replies directly.

Matter Management The lawyers' replies Conclusion

Overseas cell supplier's claim

for about $2.4m after cancelled

orders

Provision of $1.4m Likely to settle for $1.2m to

$1.6m

All three tests met; $1.4m sits

inside the range: provision

supported

Class action filed in the

Federal Court in May 2026:

batteries lost capacity faster

than the marketing promised

Nothing recorded Early stage; liability possible

but not probable; no reliable

estimate yet

Contingent liability: disclose its

nature and, where practicable,

an estimate of its financial

effect and the uncertainties.

The team checks the draft note

When the lawyer won't answer

Lawyers may limit a reply to protect legal professional privilege, and that's accepted. A refusal is different:

management won't allow contact, or the lawyers won't respond appropriately. The auditor then tries alternative

procedures, such as:

asking management and those charged with governance more about each matter;

arranging a discussion with management and the lawyers together, if possible;

reading the board minutes and other documents management holds, and examining the lawyers' invoices;

the auditor's right (section 310) to information and explanations from the company's officers.

ADVANCED AUDIT AND ASSURANCE | M4 | 4.1.1 | STUDENT COMPANION

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If they can't provide sufficient appropriate evidence, the scope of the audit is limited and the opinion must be

modified: qualified if the possible effects are material, a disclaimer if they could be both material and pervasive

(Exam Reference Pack, page 8). Management's word is no substitute: it has the most interest in the answer.

Practice questions

MODULE 4 | 4.1.1 | TRY THESE BEFORE THE WORKED ANSWERS

Question 1 - Searching for legal matters

Steerwell Driving Schools Ltd (imagined) runs 38 driving schools in New South Wales and the ACT, with about

150 instructors, some employed and some on contracts. It has no in-house lawyer and uses two external law

firms. This year a learner was hurt when a Steerwell car was hit at an intersection, four schools closed before

their leases ended, and the state transport regulator reviewed its instructors' accreditation records. List the

procedures you would use to identify litigation and claims, and what each could reveal.

ADVANCED AUDIT AND ASSURANCE | M4 | 4.1.1 | STUDENT COMPANION

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Question 2 - Provision, disclosure or nothing?

For each matter, decide whether Steerwell needs a provision, a contingent liability disclosure, or nothing, and

explain why.

Legal matter at 30 June Your decision Why

(a) A former instructor's unfair dismissal claim. The

lawyers expect it to succeed and to settle for about

$45,000.

(b) Thirty contract instructors have started a Federal

Court claim that they were really employees,

seeking superannuation and leave. The lawyers say

it's at an early stage, could go either way, and can't

yet be estimated.

(c) In 2025 a rival school complained that a

Steerwell advertisement copied its slogan. Nothing

has happened since, and the lawyers think any

claim would be very unlikely to succeed.

(d) The landlord of a closed school claims $90,000

to restore the premises under the lease. The

lawyers say Steerwell will probably have to pay,

most likely about $70,000.

Question 3 - No contact with the lawyers

Steerwell's managing director refuses to let you write to its lawyers about the instructors' claim, saying a letter

could damage the company's position in court. How would you respond?

ADVANCED AUDIT AND ASSURANCE | M4 | 4.1.1 | STUDENT COMPANION

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Accounting Ahead | Original study resource | accountingahead.com.au

Worked answers

MODULE 4 | 4.1.1 | WORKED ANSWERS - ATTEMPT THE QUESTIONS FIRST

Question 1 - Steerwell Driving Schools (sample answer)

Enquiries of management: the managing director, finance manager and operations manager, about current,

threatened and possible claims: the injured learner, the closed schools, instructor disputes, the regulator.

Minutes: board and committee minutes for the year and up to the report date, for legal matters, settlements, the

closures and the regulator's findings.

Correspondence with both law firms: it can reveal matters management hasn't mentioned, and their status.

Legal expense accounts: match every invoice to a matter; a firm or matter not on management's list needs

following up.

Related records: the insurance claim for the crash, the regulator's letters, the leases and landlords' letters for the

closed schools, and instructors' contracts.

Letter of enquiry and representations: given the risks, management prepares a letter of specific enquiry to both

firms, which you send and they answer directly to you; at the end, management confirms in writing that all known

actual or possible litigation and claims are disclosed and accounted for.

Question 2 - The four matters

Decision Why

(a) Provision, about $45,000 Present obligation from a past event (the dismissal); outflow probable; reliable

estimate

(b) Contingent liability:

disclose

Whether anything is owed depends on the court, so the obligation is only possible,

and there's no reliable estimate. Disclose its nature and the uncertainties; consider

whether other contractors could claim too

(c) Nothing An outflow is remote: no provision and no disclosure

(d) Provision, about $70,000 The lease created the obligation before year end; payment is probable; the most

likely outcome is a reliable estimate (the $90,000 is the landlord's opening claim)

Question 3 - The managing director refuses (sample answer)

Understand and explain: ask what worries the managing director; explain that ASA 502 requires you to seek direct

communication with the lawyers when there's a risk of material misstatement, and that the lawyers can limit their

reply to protect privilege. Offer a meeting with management present.

Go to those charged with governance: ask the board or audit committee to permit the letter.

Reassess: blocking a check on a significant claim raises questions about management's integrity and its other

representations.

Try alternative procedures: further enquiries of management and the board, the minutes and documents about the

claim (including court filings), the lawyers' invoices, and your section 310 right to information and explanations from

officers.

Decide the opinion: if evidence is still insufficient, management has limited the scope of the audit: qualify if the

possible effects are material but not pervasive; disclaim if they could be both. Document it all.

ADVANCED AUDIT AND ASSURANCE | M4 | 4.1.1 | WORKED ANSWERS

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