Case 1: Determining Type of Opinion in Varying Circumstances

ACC 8033 Business Asssurance Audit Report Cases

John T. Rigsby

An independent CPA firm, Deaf, Dumb and Blind (DDB), LLC, recently encountered the following situations on four assignments.

1. Buehler Hotel had decided to value fixed assets using replacement costs and to record inventory at the selling price rather than the original cost (both practices produce a higher cost and were significant in nature). Mr. Buehler assumed that this would better suit the information needs of the shareholders. After DDB informed Buehler that these practices were departures from generally accepted accounting principles, Buehler insisted that if the information is allowed in supplemental reporting, it should also be permitted in the body of the statements.

2. Martin Industries has been an audit client for three years. Martin’s operations are profitable, and business is accelerating. Because it is 85 days after the end of Martin’s fiscal year, management is urging DDB to prepare the auditor’s report. Martin’s net inventory balance is 20% of total assets, but Martin’s management has not authorized the taking of a physical inventory because it would disrupt company activities to the extent where sales would be lost. DDB has been unable to verify the inventory balance using alternative methods and believes there is not sufficient evidence to form an opinion.

3. Duke Corporation has recently sold common stock to the public market and has hired DDB as the auditor. After completion of the field work, DDB was told that the company does not wish to issue a Statement of Cash Flows, as Duke’s management believes it is misleading and not necessary to evaluate company activities. No other problems were noted during the audit.

4. Harvey Corporation has been a client for several years and has received “a clean opinion” on every engagement. During the current year, Harvey changed the estimates used in the depreciation of its major assets because of new engineering information. This change increased Harvey’s net income and is disclosed in a footnote to the financial statements.

Required: Identify the type of opinion Deaf, Dumb, and Blind (DDB), the independent audit firm, would render for each engagement. Be sure to explain the rationale for the type of opinion rendered! Case 2: Rewrite an Insufficient Audit Report

The independent CPA firm, Deaf, Dumb, and Blind (DDB) has completed the audit of the consolidated financial statements of Marcus Corporation as of and for the year ended December 31, 2016. DDB also audited and reported on the Marcus financial statements for the prior year. Mr. Deaf, the managing partner, delegated to a senior the drafting of the audit. The following draft was submitted:

Auditor’s Responsibility We have audited the consolidated balance sheet and statements of income, retained earnings, and cash flows of Marcus Corporation as of December 31, 2016. Our audit was made in accordance with generally accepted accounting standards and accordingly included such tests of the accounting records as we considered necessary in the circumstances.

Opinion In our opinion, the above-mentioned financial statements are accurately and fairly presented in accordance with generally accepted accounting principles in effect at December 31, 2016.

Deaf, Dumb, and Blind, CPA March 15, 2017

Other Information:

1. Marcus is presenting comparative financial statements for 2015 and 2016. 2. During 2016, Marcus changed its method of accounting for long term construction contracts and properly reflected the effects of the change in the current year’s financial statements and restated the prior year’s statements. Deaf is satisfied with Marcus’s justification for making the change, which is discussed in footnote number 12. 3. Deaf was unable to perform normal accounts receivable confirmation procedures, but alternative procedures were used to satisfy Deaf as to the validity of the receivables. 4. Marcus Corporation is the defendant in a litigation, the outcome of which is highly uncertain. If the case is settled in favor of the plaintiff, Marcus will be required to pay a substantial amount of cash that might require the sale of certain fixed assets. The litigation and the possible effects have been properly disclosed in footnote number 11. 5. Marcus issued debentures on January 31, 2016, in the amount of $10 million. The funds obtained from the issuance were used to finance the expansion of plant facilities. The debenture agreement restricts the payment of future cash dividends to earnings after December 31, 2023. Marcus declined to disclose this essential data in the footnotes to the financial statements.

Required: Consider all the facts given and rewrite the auditor’s report in acceptable and complete format incorporating any necessary departures from the standard report. Also, identify and explain any items included in Other Information that need not be part of the auditor’s report. Case 3: Modification of Audit Report for Consistency

Mr. Blind, of DDB, has asked you as the Manager of several audits to review a number of situations the firm has to make a decision on. Assume the following lists describes changes that have a material effect on a client’s financial statements for the current year.

1. A change from the completed-contract method to the percentage-of-completion method of accounting for long-term construction–type contracts.

2. A change in the estimated useful life of previously recorded fixed assets based on newly acquired information.

3. Correction of a material mathematical error in inventory pricing made in a prior period.

4. A change from prime costing (labor and material) to full absorption costing (labor, materials, and overhead) for inventory valuation.

5. A change from presentation of statements of individual companies to presentation of consolidated statements.

6. A change from deferring and amortizing pre-production costs to recording such costs as an expense when incurred because future benefits of the costs have become doubtful. The new accounting method was adopted in recognition of the change in estimated future benefits.

7. A change to classify the employer share of FICA taxes as “Retirement Benefits” on the income statements instead of as “Other Taxes.”

8. A change from the FIFO method of inventory pricing to the LIFO method of inventory pricing.

Required: Mr. Blind wants you to identify: (1) the type of change described in each item above, (2) state whether an explanatory paragraph is required in the auditor’s report as it relates to the second standard of reporting, and (3) state whether the prior-year financial statements should be restated when presented in comparative form with the current year statements. Organize your answer as follows:

Add Qualified or Adverse, Emphasis or Should prior-year No. Type of Change Other paragraph? statements be restated? Case 4: Listing of Deficiencies and Omissions in an Audit Report

Upon the completion of field work, DDB issued the following report to the directors of Green Farms, Inc.:

To the Directors of Green Farm Inc.

Report on the Financial Statements

We have audited the balance sheet of Green Farm Inc. as of December 31, 2016, and the related statements of income and retained earnings. In accordance with your instructions, a complete audit was conducted.

Auditor’s Responsibility

We conducted our audit in accordance with generally accepted auditing standards. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. We believe that our audit was appropriate in the circumstances.

In many respects, this was an unusual year for Green Farm, Inc. The weakening of the economy in the early part of the year and the strike of plant employees in the summer of 2016 led to a decline in sales and net income. After making several tests of sales records, nothing came to our attention that would indicate that sales have not been properly recorded.

Opinion

In our opinion, with the explanation given above and the exception of some minor errors that are considered immaterial, the aforementioned financial statements present fairly, in all material respects, the financial position of Green Farm, Inc., at December 31, 2016, and the results of its operations for the year then ended, in conformity with pronouncements of the Financial Accounting Standards Board.

Required: List and explain deficiencies and omissions in this audit report. Organize your answer by paragraph: report on the Financial Statements, Management’s Responsibility, Auditor’s Responsibility, and Opinion, as well as any explanatory paragraph, e.g., Qualified or Adverse or Emphasis or Other.