Question

For the following independent situations, assume that you are the audit partner on the engagement: 1. A number of frozen yogurt stores have opened in the last few years and your client, YogurtLand, has experienced a noticeable decline in customer traffic over the past several months that has caused you to have substantial doubt about YogurtLand’s ability to continue as a going concern. 2. Intelligis Electronics is a manufacturer of advanced electrical components. During the year, changes in the market resulted in a significant decrease in the demand for their products, which are now being sold significantly below cost. Management refuses to write off the products or to increase the reserve for obsolescence. 3. In the last 3 months of the current year, Oil Refining Company decided to change direction and go significantly into the oil drilling business. Management recognizes that this business is exceptionally risky and could jeopardize the success of its existing refining business, but there are significant potential rewards. During the short period of operation in drilling, the company has had three dry wells and no successes. The facts are adequately disclosed in footnotes. 4. Your client, Harrison Automotive, has changed from straight-line to sum-of-theyears’ digits depreciation. The effect on this year’s income is immaterial, but the effect in future years may be highly material. The change is not disclosed in the footnotes. 5. Circumstances prevent you from being able to observe the counting of inventory at Brentwood Industries. The inventory amount is material in relation to Brentwood Industries’ financial statements. But, you were able to perform alternative procedures to support the existence and valuation of the inventory at year-end. 6. Approximately 20 percent of the audit of Lumberton Farms, Inc., was performed by a different CPA firm, selected by you. You have reviewed their audit files and believe they did an excellent job on their portion of the audit. Nevertheless, you are unwilling to take complete responsibility for their work.

a. Identify which of the conditions requiring a deviation from a standard unmodified opinion audit report is applicable, if any

Answer 1

One of the major objectives of the auditor is to express an opinion on the financial statements so as to present a true and fair view of the company.

• The question requires the audit partner on the engagament to identify the conditions in the folowing situations. But, as an auditor, it is essential to express an audit opinion in each case.

SOLUTIONS:

1. A number of frozen yogurt stores have opened in the last few years and your client, YogurtLand, has experienced a noticeable decline in customer traffic over the past several months that has caused you to have substantial doubt about YogurtLand’s ability to continue as a going concern.

ANS : The condition here is a substantial doubt regarding the going concern ability of YogurtLand. Being the auditor, I would issue an Unmodified opinion report ( Explanatory Paragraph).

2. Intelligis Electronics is a manufacturer of advanced electrical components. During the year, changes in the market resulted in a significant decrease in the demand for their products, which are now being sold significantly below cost. Management refuses to write off the products or to increase the reserve for obsolescence.

ANS : The condition is management's refusal to write off the products or to increase the reserve for obsolescence. Accordingly, an Adverse report (Qualified opinion) will be issued as, the management did not adhere to the rules of GAAP (Generally Accepted Accounting Principles).

3. In the last 3 months of the current year, Oil Refining Company decided to change direction and go significantly into the oil drilling business. Management recognizes that this business is exceptionally risky and could jeopardize the success of its existing refining business, but there are significant potential rewards. During the short period of operation in drilling, the company has had three dry wells and no successes. The facts are adequately disclosed in footnotes.

ANS : There is no specific condition apart from the presence of significant potential rewards. Nothing is mentioned regarding the decision of the business to continue its operations. Being the auditor, I would issue the report of unmodified opinion (standard wording as it involves potential rewards).

4. Your client, Harrison Automotive, has changed from straight-line to sum-of-the years’ digits depreciation. The effect on this year’s income is immaterial, but the effect in future years may be highly material. The change is not disclosed in the footnotes.

ANS : The condition here is non disclosure of the changed method in the footnotes. Thus, as an auditor, I would issue an unqualified opinion audit report as the change in accounting principle is immaterial for which disclosure is not made.

5. Circumstances prevent you from being able to observe the counting of inventory at Brentwood Industries. The inventory amount is material in relation to Brentwood Industries’ financial statements. But, you were able to perform alternative procedures to support the existence and valuation of the inventory at year-end.

ANS : The condition is the restriction imposed on the scope of audit i.e limited scope of audit. A clear opinion cannot be provided. Thus, I would issue a Disclaimer of opinion report eventhough, I was able to perform alternative procedures with regards to the audit of inventory.

6. Approximately 20 percent of the audit of Lumberton Farms, Inc., was performed by a different CPA firm, selected by you. You have reviewed their audit files and believe they did an excellent job on their portion of the audit. Nevertheless, you are unwilling to take complete responsibility for their work.

ANS : The condition is Report involves other auditors. Since, a portion of work is identified to be done by other auditors, the type of audit report opinion that will be issued is an unmodified one.