Question

For each of the following situations, indicate the type of financial statement audit report that you would issue and briefly explain your reasoning. Assume that all companies mentioned are public companies.

1. In prior years, Daffy Co. used first-in-first-out (FIFO) to value its inventory. During the current year, Daffy Co. changed to last-in-first-out (LIFO) to value its inventory. The changed produced a material effect on net income for the current year. The change was adequately disclosed in the notes to the financial statements.

2. You are auditing Diverse Carbon, a manufacturer of nerve gas for the military, for the year ended September 30. On September 1, one of its manufacturing plants caught fire, releasing nerve gas causing damages to the surrounding community. The company’s legal counsel indicates that the company is likely liable but the amount of the liability cannot be reasonably estimated. The company fully discloses this information in the notes to the financial statements.

3. On January 31, Asare Toy Manufacturing hired your firm to audit the company’s financial statements for the prior year. You were unable to observe a material portion of the client’s inventory on December 31. However, you were able to satisfy yourself about the inventory balance using other auditing procedures.

4. Green Co, leases its manufacturing facility from a partnership controlled by the chief executive officer and major shareholder of Gelato. Your review of the lease indicates that the rental terms are in excess of rental terms for similar buildings in the area. The company refuses to disclose this related-party transaction in the footnotes.

5. During the audit of Star Co, you found that a material account payable had been excluded from the company’s financial statements. After discussing this problem with management, you become convinced that it was an unintentional oversight. Management appropriately corrected the error prior to your finalization of field work.

6. Jay Rich, CPA, holds 10 percent of the stock in Rothenburg Construction Company. The board of directors of Rothenburg ask Rich to conduct its audit. Rich completes the audit in accordance with PCAOB auditing standards and determines that the financial statements present fairly in accordance with generally accepted accounting principles.

Answer 1

Ans 1)

Unqualified Audit Report including an eplanatory paragraph for change in accounting principal.

Ans 2)

Adverse Audit Report as management is not in the position to disclose the quantum of liability on the financial statements.

Ans 3)

Unqualified Audit Report as the deficiencies were satisfied using other auditing procedures.

Ans 4)

Qualified Audit Report as company refuses to disclose the related party transactions in its foot notes.

Ans 5)

Unqualified Audit Report as error was unintentional and management appropriately corrected the error before the finalization of field work.

Ans 6)

Qualified Audit Report including a disclaimer of opinion as auditor owns 10 percent of the stock of company therefore, he will not be considered as Independent.