Problem - You are auditing the financial statements for your new client, PPC, a manufacturer of paper containers, for the year ended March 31, 2013. PPC's previous auditors had issued a going concern opinion on the March 31, 2012 financial statements for the following reasons:
- PPC had defaulted on $10 million of private bonds sold to three insurance companies, which were due in 2012, and the default constituted a possible violation of other debt agreements.
- The interest and principal payments due on the remainder of a 10-year credit agreement, which began in 2007, would exceed the cash flows generated from operations in recent years.
- There were various lawsuits pending against the company.
- The company was in the middle of IRS tax proceedings resulting from a tax audit covering 8 years.
You find that the status of the above matters at year-end, March 31, 2013:
- The company is still in default on $4.6 million of the private bonds but is trying to negotiate a settlement with remaining bondholders. A large number of the claims have been settled for significantly less than par.
- The company has renegotiated the 2007 credit agreement, which provides for a two-year moratorium on principal and interest payments. It also limits net losses to $2.25 million for 2013 and requires a certain level of defined quarterly operating income.
- The legal actions were settled in 2013.
- Most of the tax issues have been resolved, and those remaining will result in a net cash inflow to the company, according to outside legal counsel.
At year-end, PPC had a cash balance of $5.5 million and expects to generate new cash flows of $3.2 million in the next year. Net revenues were budgeted at $79.8 million for 2013 but only came to $60.9 million. Operating expenses were budgeted at $31.4 million but came in at $34.7 million. Earnings before taxes was budgeted at ($0.2 million) but came in at ($5.7 million).
Required:
1. What should you consider in deciding whether to discuss a going concern uncertainty in your audit report?
2. How much influence should the report from the prior year have on your decision?
3. Should your report for the year ended March 31, 2013 include a discussion of a going concern uncertainty? Why or why not?