Question

Problem VIII ;

please answer all both question please

Facts:

• A Chicago area defense subcontractor (“ABC”) manufactures metal gear boxes for tanks and fighter aircraft. It has been in business since the 1960’s -- & has a December 31st year- end.

• In 2016, a Canadian Company (“Parent”) purchased 100% of ABC.

• In 2017 the Company had a slight loss.

• In 2018, the Company had a much larger loss, significant decline in sales & terminated about 25% of its workers. The sales decline was directly caused by a steep decline in orders for tanks & planes by the Department of Defense.

• In 2019, preliminary numbers reviewed by your audit firm during October, 2019 (as part of the planning phase of the 12/31/2019 year end audit), reflected a very large loss, a continued decline in sales & additional staff reductions.

• In 2017, 2018, and 2019 ABC has suffered recurring losses from operations, and has had a net capital deficiency.

• ABC expects continued weak demand for its defense products in 2020 & beyond.

• ABC hopes to use its manufacturing expertise to enter into other non-defense oriented markets starting in 2020.

• Since the acquisition, the ABC Company has maintained large bank loans pursuant to bank lines with a local bank. There is no additional borrowing capacity on these bank lines.

• The audited financial statements are due 90 days after the 12/31/2019 year end – i.e. 3/31/2020. Your audit firm intends to release the audited financial statements on or prior to this due date.

• The ABC Company bank debt is due on demand, is secured by its equipment and is guaranteed by Parent.

• Pursuant to Canadian / U.S. banking procedures, the Parent obtains a Letter of Credit from its Canadian bank to serve as collateral for its guarantee of ABC’s U.S. bank debt. (The letter of credit will be converted to cash to payoff ABC’s local bank debt if ABC defaults on this bank debt). The Canadian Bank which issues the Letter of Credit is Canada’s 2nd strongest Bank.

• The letter of credit is for a 1 year term (i.e. from each April 10th to the following April 10th) & automatically renews each April 10th unless any of the parties to the arrangement wants to terminate the letter of credit.

• Substantially all of the work for the calendar 2019 audit is completed by March 15, 2020.

Two Questions:

a. For the December 31, 2019 year-end, do you believe there is substantial doubt about ABC Company’s ability to continue as a Going Concern? Provide your supporting arguments, specifically addressing: (8 Points)

• Conditions and Events

• Management’s Plans

b. If ABC could get a 30 day extension on the due date of the audited financial statements from the local bank – i.e. from 3/31/2020 to 4/30/2020, how, if any, would your answer change? Why or why not? (4 Points).

Answer 1

a. I do believe that there is substantial doubt about ABC’s ability to continue as a going concern.

This assessment is mainly due to adverse market conditions with weak demand for defense equipment. Also the company has continuously incurred losses for the past three years and management expects sales to remain lacklustre in the coming years, thus it can be gained that losses will continue to occur for the forseeable future. The company has a net capital deficiency at present, since there will most likely be losses in the future, there will be a need for more funds which seems improbable as the bank loan obtained by ABC has reached it's maximum limit.

Management’s plans to enter non-defense markets in 2020 does not allay the doubt regarding going concern ability. This is due to the fact that the firm has not diversified since the 1960's and the chances that ABC will find customers for new products are low since there are already established competitors in other sectors, in addition ABC does not have excess funds to invest into machinery, tooling, training etc... which could hamper it's plans to expand into other sectors.

b. My answer would not change because substantially all the conditions existing as on 3/31/2020 will continue to exist on 4/30/2020 and the doubt about ABC's ability to continue as a going concern will remain the same.