The following are 5 independent situations involving audit reports. For each cas

Question

The following are 5 independent situations involving audit reports. For each case, describe the type of audit opinion the auditor should issue and explain your reasoning. If more than one type of opinion may be appropriate, describe the conditions under which each type is chosen.

(a) The Big Construction Company is experiencing extreme financial difficulty resulting from a prolonged period of the region’s economic downturn. The company’s liabilities have exceeded the assets by $1om. Further, the company has defaulted in paying the maturing bonds amounting to $5m. The debenture holders are taking actions to freeze the company’s assets and to demand payment. Loan interest of $300,000 due on bank loan also has not been paid. The company only has operating cash flows of $500,000 left in its account and the amount can only cover its operating expenses up to one month. The company is trying hard to negotiate further finance with the banks. (4 marks)

(b) Jay Lo, CPA, holds 25% of the shares in KK Construction Ltd.(KK). The board of directors of KK asks Jay to conduct its annual statutory audit. Jay completes the audit and determines that the financial statements are true and fair in accordance with generally accepted accounting principles. (4 marks)

(c) Due to an argument with the previous auditor, ABC Fashions has employed you as auditor after the company’s financial year end. Therefore, you have not carried out the stock take. The accounting records and other evidence were not reliable enough to enable the auditors to obtain satisfactory evidence regarding the company’s stock balance. (4 marks)

(d) The Tai Shan Manufacturing Co. Ltd. changed its depreciation policy on production machinery from straight line to units-of-production. As a result of the change, the depreciation charge was substantially reduced. In view of the fact that the company is engaged in manufacturing high technology products that have very short product life cycles, the auditors consider it unjustifiable to change the depreciation method. The machinery is basically tailored made for specific product model, so they will become useless if the products are phased out. The company’s chief engineer also agrees with the auditors’ point of view. (4 marks)

(e) After the field work portion of the 2015 financial year end was completed, but before the audit report was issued, the auditors learned that a typhoon destroyed a factory and considerable inventory belonging to its client. The loss was material, and was not covered by any insurance. Management has indicated that the loss will be disclosed in the 2016 financial statements, but no mention will be made in the 2015 financial statements. (4 marks)

Explanation / Answer

The Tai Shan Manufacturing Co. Ltd. changed its depreciation policy on production machinery from straight line to units-of-production. As a result of the change, the depreciation charge was substantially reduced. In view of the fact that the company is engaged in manufacturing high technology products that have very short product life cycles, the auditors consider it unjustifiable to change the depreciation method. The machinery is basically tailored made for specific product model, so they will become useless if the products are phased out. The company’s chief engineer also agrees with the auditors’ point of view.

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