ACC 492 Week 4 Completing the Audit and Issuing the Report Example

The Last Three Weeks Before Signing: Subsequent Events, a Going Concern Question, Legal Letters, Representations, Uncorrected Misstatements and the Report for a Composite Specialty Food Manufacturer

[Student Name]

University of Phoenix

ACC/492: Contemporary Auditing II

Week 4 Assignment

[Instructor Name]

[Date]

The manufacturer, its lender and all figures are composites written for a model paper; standards and research findings come from the sources listed.

A composite manufacturer produces frozen dumplings, sauces and prepared meals sold under private labels to grocery chains. Its December 31 statements show revenue of $73 million and a small profit. On February 3, as the audit team was finishing its work, the company's largest customer, a grocery chain responsible for 31% of sales, announced it would move its private-label business to another supplier when the current contract ends in May. The company's bank loan contains a covenant based on earnings. The last three weeks of an audit are when the auditor must decide what the statements and the report say about events that happened after the year being audited. This paper describes how the team completed the audit.

Subsequent Events

The team reviewed board minutes, interim financial information for January, legal matters and inquiries of management through the report date. Two events needed evaluation.

First, in late January the company settled a customer claim arising from a product recall in November for $640,000; it had accrued $400,000 at year end. Because the settlement provides evidence about a condition that existed at December 31, the recall liability, it is a recognized event. The company increased the accrual by $240,000.

Second, the loss of the grocery chain arose from a decision made in February. It did not exist as a condition at year end, so it is a nonrecognized event. It does not change the year-end figures but requires disclosure because of its significance.

Going Concern

The customer loss raises the question of whether substantial doubt exists that the manufacturer can keep operating as a going concern for one year after the statements are issued (American Institute of Certified Public Accountants, 2017). The team first identified conditions: after May, revenue would fall by nearly a third, the company would likely breach its earnings covenant by the third quarter and its line of credit matures in September.

The team then considered management's plans. Management had signed a letter of intent with a regional chain for about half of the lost volume, planned to eliminate one production shift and had obtained a term sheet from its bank to extend the line of credit to the following March, conditional on the new contract. The team examined the letter of intent and term sheet, evaluated the cost reductions against payroll records and reviewed cash flow forecasts. It concluded that management's plans, while reasonable, depend on contracts not yet signed, so substantial doubt is not alleviated. Management expanded its going concern disclosure to describe the conditions and plans.

Legal Letters

Management's list of claims included the recall claim, a wage and hour complaint and a trademark dispute. The team sent a letter of inquiry, signed by management, to the company's outside counsel, asking counsel to confirm the list and evaluate each matter. Counsel confirmed the recall settlement, described the wage complaint as reasonably possible with a range of $50,000 to $150,000 and considered the trademark dispute remote. The company disclosed the wage matter.

Management Representations

The team obtained a representation letter, dated the same day as the report, in which management confirmed its responsibility for the statements, that all records and minutes had been provided, that all known claims and subsequent events had been disclosed and that its going concern plans were accurately described.

Uncorrected Misstatements

After the recall adjustment, three misstatements remained uncorrected: a $60,000 cutoff error, a $45,000 understatement of accrued vacation and a $30,000 overstatement of prepaid expenses, a net overstatement of income of $135,000. Overall materiality was $520,000. The team evaluated each item and the total, including their qualitative effects. Because the earnings covenant is sensitive, the team considered whether the misstatements affected compliance at year end; they did not. The total was below materiality, and the team documented its conclusion.

Final Review

The team performed final analytical procedures, comparing the adjusted statements with its expectations and finding them consistent with what it had learned. An engagement quality reviewer, a partner not on the engagement, reviewed the going concern evaluation and the draft report.

The Report

The report includes an unmodified opinion, because the statements, as adjusted and with the expanded disclosure, are presented fairly in all material respects. Under current reporting standards, the opinion appears first, followed by a basis for opinion section stating the auditor's independence (American Institute of Certified Public Accountants, 2019). A separate going concern section, under the heading the standard prescribes, points readers to the note that describes the conditions and management's plans. The report then describes management's and the auditor's responsibilities. It is dated when the team obtained sufficient appropriate evidence, the same date as the representation letter.

Carson et al. (2013) reviewed research showing that going concern reports are often followed by consequences for companies, such as higher costs of capital, and that auditors face both the risk of issuing unnecessary reports and the risk of missing failures. Those consequences are why the team based its conclusion on documents rather than management's optimism.

Why the Report Date Matters

The report date tells readers how far the auditor's responsibility for subsequent events extends. The team dated its report February 21, after the bank's term sheet and the letter of intent had been examined and the representation letter signed. If a significant event occurs after that date but before the statements are issued, such as the regional chain withdrawing its letter of intent, management must tell the auditor, who may need to revise the disclosure and dual-date the report for that note. The team reminded management of that obligation in its closing meeting.

Communication With Governance

The team communicated in writing to the board its going concern conclusion, the recall adjustment, the uncorrected misstatements, the wage claim and two control deficiencies found during the audit.

Conclusion

Completing the audit required sorting subsequent events, evaluating going concern with management's plans, obtaining legal and management letters, evaluating uncorrected misstatements and performing a final review. The result is an unmodified opinion with a going concern section, which tells the bank and owners that the statements are fairly presented while drawing attention to the uncertainty the lost customer created.

References

American Institute of Certified Public Accountants. (2017). The auditor's consideration of an entity's ability to continue as a going concern (Statement on Auditing Standards No. 132).

American Institute of Certified Public Accountants. (2019). Auditor reporting and amendments, including amendments addressing disclosures in the audit of financial statements (Statement on Auditing Standards No. 134).

Carson, E., Fargher, N. L., Geiger, M. A., Lennox, C. S., Raghunandan, K., & Willekens, M. (2013). Audit reporting for going-concern uncertainty: A research synthesis. Auditing: A Journal of Practice & Theory, 32(Suppl. 1), 353-384. https://doi.org/10.2308/ajpt-50324