Problem - Opinions and Finishing the Audit
Assume you are a partner supervising the audit of Mean Green Jeans (MGJ), a publicly-traded clothing distributor that operates in the North Texas region. This is your firm's first year auditing MGJ. It is now late February 2015, and you are attempting to decide which type of opinion to issue to the client. All audit issues have been resolved to your satisfaction except two, which you must decide how to address. Both of these issues are material.
- MGJ is losing market share to national companies that offer products at lower prices. Sales have been trending downward for several years, and operating cash flows have been negative during this time. MGJ is in the process of implementing a plan that the CEO and CFO believe will provide time to turn the company around. For example, the company is considering issuing new stock. A report from an independent broker indicates that if MGJ issues new stock, it will provide the company sufficient capital to cover 11 months of operations. Furthermore, MGJ is considering laying off workers to maintain its long-term viability. You also know that in 2014, MGJ restructured existing debt and took out a new loan to address its cash needs. However, the new loan carries a higher than normal interest rate because of the company's struggles.
- Part of MGJ's financial troubles is the result of the loss of the company's third largest customer. This customer went out of business during the first half of February, 2015. MGJ's CFO believes this is a Type II subsequent event because the customer's failure occurred after year end and was not the result of deterioration over time. The customer was privately-held, and you cannot access any data to corroborate or refute the CFO's claim. Accordingly, the 12/31/14financial statements include a footnote to disclose the loss of this receivable.
Questions:
1. According to auditing standards, what specific responsibilities does the auditor have in evaluating the client as a going concern? Be sure to cite the appropriate standard(s). Do not quote the standard(s); use your own words.
2. Would you issue a going concern opinion to Mean Green Jeans? Why or why not?
3. Assume you decided to issue a going concern opinion and Mean Green Jeans was able to thrive in 2015, erasing any concern about its financial health. Does this mean that the going concern modification was the wrong opinion? Why or why not?
4. According to auditing standards: (a) Describe the difference between Type I and Type II subsequent events. (b) What procedures should an auditor perform to identify and evaluate subsequent events? Cite the appropriate standard(s) and describe the audit procedures in your own words.
5. Will you accept Mean Green Jeans' accounting for the loss of the account receivable? Why or why not?