(Solved Homework): For each of the following independent situations, indicate the reason for and the type of financial statement audit rep…

For each of the following independent situations, indicate the reason for and the type of financial statement audit report that you would issue. Assume that all companies mentioned are private companies and that each item is at least material.

a. Thibodeau Mines, Inc., uses LIFO for valuing inventories held in the United States and FIFO for inventories produced and held in its foreign operations.

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b. Walker Computers is suing your client, Super Software, for royalties over patent infringement. Super Software’s outside legal counsel assures you that Walker’s case is completely without merit.

c. In previous years, your client, Merc International, has consolidated its Panamanian subsidiary. Because of restrictions on repatriation of earnings placed on all foreign-owned corporations in Panama, Merc International has decided to account for the subsidiary on the equity basis in the current year. You concur with the change.

d. In prior years, Worcester Wool Mills has used current market prices to value its inventory of raw wool. During the current year, Worcester changed to FIFO for valuing raw wool.

e. Upon review of the recent history of the lives of its specialized automobiles, Gas Leak Technology justifiably changed the service lives for depreciation purposes on its autos from five years to three years. This change resulted in a material amount of additional depreciation expense.

f. During the audit of Brannon Bakery Equipment, you found that a material amount of inventory 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.

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

h. Ramamoorthi Savings and Loan’s financial condition has been deteriorating for the last five years. Most of its problems result from loans made to real estate developers in Saint Johns County. Your review of the loan portfolio indicates that there should be a major increase in the loan-loss reserve. Based on your calculations, the proposed writedown of the loans will put Ramamoorthi into violation of the state’s capital requirements. The client refuses to make the adjustment or to disclose the possible going concern issue in the notes to the financial statements.

Expert Answer


a. Valuation of inventories is a matter of the company’s custom and all that the audit firm can do is to inquire & understand the reason/s behind the practice and ensure consistency in accounting the same.An unqualified audit report can be issued.
b. Relying on Super Software’s outside legal counsel’s opinion that” Walker’s case is completely without merit” an unqualified audit report can very well be issued.There is absolutely no necessity to mention the fact anywhere in the auditor’s report
c. The auditor has concurred with the change . But the change from consoidation to equity basis(ie. Ownership of the client Co.) of accounting need to be made known to the users of the financial statements of the company being audited & reported.
That being the case, the auditor has to add an explanatory paragraph to his otherwise-unqualified audit report. He has to modify his standard unqualified audit report,ie. Modified unqualified audit report
d. Change in inventory valuation from LIFO to FIFO affects the financial statements and the equity valuation.Consistency has been affected. So the fact should be brought out in the audit reports.
The auditor has to modify his standard unqualified audit report & issue modified unqualified audit report
e. As the change resulted in a material amount of additional depreciation expense,even if justified,the users of the financial statements need to take an informed decision about the cash flow within the company.
The auditor has to modify his standard unqualified audit report & issue modified unqualified audit report
f.As the omission was an unintentional oversight and the management has promptly corrected the error prior to the finalization of the financial statements,the auditors have ensured true & fair reporting.
The auditor can very well issue unqualified & clean audit report .
g. Jay Rich, CPA, holding 10 percent of the stock in Rothenburg Construction Company cannot audit the company nor issue any audit opinion,as he is not independent of the Company.
So the situation entails a disclaimer report as the possible effects on the financial statements may be both material & pervasive
h. After having obtained sufficient & appropriate audit evidence,to increase the reserves ,and write-down of loans –that is bound to clash with the State’s capital requirements — the client refuses to make the adjustment or to disclose the possible going concern issueas notes to the financial statements—-
due to the pervasive nature of the case, the auditor can only issue an adverse report

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