Question

Going Concern Facts:

• A Chicago area company (“Company”) has been manufacturing metal gas tanks for passenger automobiles since 1918. The Company has always been a privately held family run business.

• The Company has been profitable for much of its history; retained earnings at the end of 20X1 was $20 million. • Recently mandated EPA mpg requirements have caused automobile manufacturers to move to utilizing plastic gas tanks – which are much lighter than metal. This change in materials helped automobile manufacturers reduce auto weights and meet the increased mpg requirements.

• The Company decided not to convert their operation to plastic gas tanks because their expertise was only in manufacturing metal products. • A few years back, the owners were faced with two options: Liquidate and distribute available assets or move into a different line of business. The Company decided to do the latter. The Company felt it could use its expertise to manufacture metal frames for televisions (like for Toshiba, Panasonic, etc.) • The Company built a new manufacturing plant in Georgia for manufacturing these metal TV frames; the plant was financed with low interest rate IRBs (Industrial Revenue Bonds).

• The IRBs were for $25 million with a 20-year term. The Company has no other debt.

• Unfortunately, in its first two years of operation of the new metal picture frame plant– 20X2 & 20X3 – the Company lost $11 million and $8 million, respectively. The metal TV frame business is extremely competitive; sales prices of metal TV frames are quite low. The Company was simply unable to produce large quantities of metal frames at a cost which would enable the Company to generate adequate gross profit.

• You are finishing your Audit of 20X3 & discussed the Going Concern issue with the Company’s management, including the family owners. The owners / managers feel they have no choice but to continue producing metal TV frames – due to the 20-year IRB term.

• Management prepares financial projections for the next year which shows the Company breaking even; the projections reflect a significant increase in the gross profit – it is unclear how management will improve their gross profit margin so significantly.

Required:

1. State whether you believe there is or is not substantial doubt about the Company’s ability to continue as a Going Concern. Provide your supporting arguments, specifically addressing:

• Conditions and Events

• Management’s Plans

Stating that you believe there is substantial doubt means that your Audit Firm’s Independent Auditor’s Report for the year of 20X3 will include an emphasis of a matter paragraph with the supporting footnote. (There is no need to formally draft the paragraph & supporting footnote.)

Stating that you believe there is no substantial doubt means that your Audit Firm’s Independent Auditor’s Report for the year of 20X3 will not include an emphasis of a matter paragraph but the Audited Financial Statements will include a footnote describing the conditions and events and how management’s plans alleviated the conditions and events. (There is no need to formally draft the footnote.)

Answer 1

As per the relevant standard on Auditing, An Auditor may identify information about some Conditions and Events, which are giving the indication that there is a substantial doubt the entity's ability to work or continue as a going concern. These Conditions and Events may include the Negative Trends of the Company and/or other matters which may affect entity to work as a going concern such as Non Availability of Raw material for indefinite period of time or Non Payment of loans. After Considering Conditions and Events, An auditor must evaluate the Management's Plans of dealing it.

In the Given Case, As an auditor it arises some Conditions and Events which arise a Substantial Doubt that the Chicago Area Company (Company) is not able to Continue as a going concern. The Indicators are: Negative Trends such as two years Consecutive losses in new business line aggregating $19 Mllion. Also Company has shifted to a different line of business because of Recent EPA mpg Requirements and they are certain to make it in future also despite they have incurred a huge loss because of it.

Also, now, after considering Management's Plan, it is seen that Although Management has Prepared next year projection, which is again showing not profits but only a situation of No Profit No Loss. However it is still unclear that how the company will increase its gross profit to that level.

However as per the questions Requirement of first assumption, it will be like as there is a substantial doubt about the going concern assumption , as an auditor we must include an emphasis of matter paragraph to make its users to understand that there is a Question about The going concern of Chicago Area Company, which in the Auditor's judgement is necessary for users to know.

And as per the Second Assumption, after considering the Management Plan of dealing with the Condition and Events that arises question about its survival, auditor is satisfied and thus there is no need to place an emphasis of matter paragraph but the Audited Financial Statements should include a footnote regarding Conditions and events and how the management dealt with it which as per the auditor opinion is not necessary for user understanding but it still requires the footnote at the Audited Financial Statements.