Question

Milligan Companies, Inc (MCI)is a private company which owns five auto parts stores Houghton. MCI has gone from two auto parts stores to five stores in the last three years, and it plans on continued growth. Sheila and Walter own the majority of the stock. Sheila is the chairman of the board and the CEO. Walter is the COO as well as the CFO. Shares not owned by Sheila and Walter are owned by friends and family who helped get MCI started. Sheila started the company with one store after working in an auto parts store. To date, she has funded growth from an inheritance and investments from a few friends. They are thinking about expanding by several more stores in the near future.
MCI employs 20 full time staff. These workers are employed in store management, parts delivery and accounting. About 40% of MCI is retail walk-in business and the other 60% is regular customers where MCI delivers parts and bills these customers on account. During peak periods, MCI also uses part-time employees.
Your accounting firm ACC4100, is conducting the annual audit for the year ended December 31, 2020. Your audit team discovers numerous misstatements, mostly caused by human error and weak internal control. In aggregate, the misstatements are material, but management agrees to make your recommendation adjustments. Also, during 2020, MCI changed its method of valuing inventory from a weighted-average method to FIFO. When Sheila opened the first store, she thought the easiest way to value inventory was to use an average cost for each category of items. As the company grew, they never revised this practice. Now that the company is significantly larger with multiple stores, Sheila realize they need to be more focused on tracking inventory costs because of the impact of their profit margin.   The change was made to FIFO because it is more commonly used in the industry.
Your team concludes fieldwork on March 1, 2021 and Sheila is planning to provide the auditing financial statements and audit report to its lenders on March 6, 2023
A.      Does KCI have a justified change in accounting principle? If so, how should the change be presented in the financial statements?
B.      Assuming KCI has a justified change in accounting principle and has accounted for the change properly, draft the report that the CPA will issue.
C.      If management does not make agree to make the adjustments to correct the financial statements, and does not properly present the change in accounting principle in the financial statements. What reporting options does the CPA firm have?

Answer 1

Answers to the given questions

A.  Yes KCI have justified change in accounting priciple. Because when change in accounting principle is the term used   when the company selects between two different generally accepted accounting principles or changes the  method  wtith which a principle is applied.

In the given situation MCI has changed the method of valuing inventory from Weighted average method to FIFO so this shows clearly this is a change in accounting principle.

Presentation of change in accounting principle in financial statements:

  Whneever there is a change in accounting principle made by a company, the company must retrospectively apply

the change to all the prior periods as if the new principle had been in place, unless its impracticable to do so.

keeping in mind these requirements only impact direct effects not indirect effects.

If the adoption of new accounting principle results in a material change in an asset or liability, the adjustment must be reported to the reetained earnings opening balance. Aditionally the nature of change in accounting principle must be disclosed in the footnotes of financial statements.

B. Drafting of report in compliance with change in accounting principle

The auditor considers all audit evidence obtained and evaluates whether that evidence provides reasonable assurance that the financials statements taken as a whole are free from material mis statements. The auditor considers the sufficiency and appropriatenes of audit evidence uptained & evaluates the effects of misstatements identified.

The auditor considers whether, in the auditor’s judgment:

(a) the accounting policies selected and applied are consistent with the applicable financial reporting framework and are appropriate in the circumstances.

(b) the information presented in the financial statements, including accounting policies, is relevant, reliable comparable and understandable.

(c) the financial statements reflect the underlying transactions and events in a manner that fairly presents, in the case of financial statements prepared in accordance with applicable accounting policies.

(d) the financial statements provide sufficient disclosures to enable users to understand the impact of particular transactions or events that have a material effect on, in the case of financial statements prepared in accordance with IFRS.

C. If management does not make agree to make adjustments to correct the financial statements, does not properly present change in accounting policy in financial statements, then the auditor should express either a qualified or adverse opinion depending upon the materiality of the item in relation to the financial statements.