Question

3-26 (Objectives 3-4, 3-5, 3-6, 3-7, 3-8) 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-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.

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.

Required For each situation, do the following:

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

b. State the level of materiality as immaterial, material, or highly material. If you cannot decide the level of materiality, state the additional information needed to make a decision.

c. Given your answers in parts a. and b., state the appropriate audit report from the following alternatives (if you have not decided on one level of materiality in part b., state the appropriate report for each alternative materiality level):

1.Unmodified opinion—standard wording
2. Unmodified opinion—explanatory paragraph
3. Unmodified opinion—nonstandard report wording
4. Qualified opinion only—GAAP departure
5. Qualified opinion—scope limitation
6. Disclaimer
7.  Adverse*

*Based on AICPA question paper, American Institute of Certified Public Accountants.

please help me answer A, B, & C

Answer 1

Solution

No.	Part A	Part B	Part C
1	Substantial doubt about going concern	Material	Unmodified opinion—explanatory paragraph
2	Failure to follow GAAP	Material	Qualified opinion only—GAAP departure
		Highly material	Adverse
3	Existence of significant potential rewards	None	Unmodified opinion—standard wording
4	Change in accounting principle	Immaterial	Unmodified opinion—standard wording
5	Scope of the audit has been restricted	Material	Unmodified—standard wording
		Highly material
6	Report involving other auditors	Material	Unmodified— nonstandard report wording

Part 1

An explanatory paragraph to the unmodified opinion is added due to substantial doubt about the business continuation

Part 2

If reduce the value of the inventory is not reduced for a decline in value then it is a departure from GAAP

Part 3

No indication that questions the ability of the business to continue operations exists.

Part 4

The change in accounting principle is immaterial and therefore there is no need for disclosure .

Part 5

Initially the scope of audit being restricted, it as possible to auditor to satisfy himself using different methods.

Part 6

It is shared audit report hereby auditor comes to know about the duty performed by other auditors stated in the auditor’s responsibility paragraph. It can issue an unmodified opinion. Assets and revenues should be stated either in absolute dollar amounts or percentages.