Question

3) The following are two unrelated situations. For each situation, outline possible deviations (if any) from an unmodified auditor's report that may be necessary and give reasons. State your assumptions.

B) Maple Manufacturing Limited constructs furniture out of maple wood. The furniture is prized for its durability and craftsmanship. Last year, the company received a letter from a government agency advising that it had been found that Maple's factory was located on contaminated land that leached hazardous chemicals into the air. This was a preliminary letter stating that a full investigation into the health effects was underway. Management has stated that everything is okay and the investigation was terminated. However, the lawyer refused to sign the legal letter with respect to several lawsuits regarding employee claims for long-term disability due to a nervous disorder that affected employees' ability to work. Neither the investigation nor the lawsuits are disclosed in the notes to the financial statements.

Answer 1

A

The letter received by the company from the government agency advising that it had been found that Maple's factory was located on contaminated land that leached hazardous chemicals into the air indicates the going concern may get affected. Hence the fact that a communication confirming the initial notice is awaited should have been part of the financial statements.

Hence there is a material misstatement of the financial statements that relate to narrative disclosures.

The auditor shall include in the Basis for Opinion section an explanation of how the disclosure is misstated.

Ref: ISA 705

B

Also, the lawsuits do involve substantial money to be paid out as settlements. A disclosure should have been made in the financial statements regarding the lawsuits against the company. In such a case the quantification of the contingency should also have been disclosed if the management were not certain about the outcome of the verdict.

Hence there is a material misstatement of the financial statements that relate to specific amounts in the financial statements even though it is a quantitative disclosure required in the notes to the financial statements. If management is able to quantify the expected expense due to such lawsuit, a provision in the period to this extent is also mandatory.

The auditor shall include in the Basis for Opinion section description and quantification of the financial effects of the misstatement, unless impracticable. If it is not practicable to quantify the financial effects, the auditor shall so state in this section.

Ref: ISA 705