Principles of Auditing 330-01
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).