Question

Joe Kang is an owner and audit partner for Han, Kang & Lee, LLC. As the audit on Frost Systems was reaching its concluding stages on January 31, 2016, Kang met with Kate Boller, the CFO, to discuss the inventory measurement of one its highly valued products as of December 31, 2015. Kang told Boller that a write-down of 20 percent had to be made because the net realizable value of the inventory was 20 percent less than the original cost recorded on its books. That meant the earnings for the year would be reduced by $2 million and the client would show a loss for the year. In a heated exchange with Boller, Kang was told to use the January 31, 2016, value, which reflected a full recovery of the market amount. Boller suggested that subsequent values were acceptable under GAAP. Besides, she said, that was the method the previous auditors had used. She went on to explain that the market value for this product was known to be volatile and a smoothing effect was justified in the accounting procedures. Kang was under a great deal of pressure from the other partners of the firm to keep Boller happy. It seems Frost Systems was about to embark on a variety of projects, on which it was considering having the firm provide consulting assistance, advice, and recommendations. The revenue from these arrangements could turn out to be twice the audit fees. Kang called a meeting of the other partners. While the three of them had different points of view on the issue, the final vote was 2-1 to accept the client’s accounting.

What would you do at this point if you were Joe Kang and why?

Answer 1

The duty of the auditor is to make an unbiased report which gives a true and fair view of financials of a company. In this case Joe Kang suggestions were correct as inventories should be shown at net realisable value or book value whichever is less. Book value of inventories are relating to old business cycle which might not be the same in current scenario hence it is necessary to revalue such high valued products. The stand of Boller is not justified for showing inventories at old cost which will lead to misrepresentation of value of stock. The matter relating to inventory valuation has a significant value hence it is not at an acceptable value.

Joe King raised this issue of pressurising by Boller to change the report in her favor but partners majorly voted to go in favor of client. As an auditor I will not support the wrong practise of accounting and I would have withdrawn my engagement from such report where i am not able to give an independent and un biased report on a cleints financials.