Devon, Inc., a private company, engaged Rao to examine its financial statements for the year ended December 31, 2013. The financial statements of Devon, Inc., for the year ended December 31, 2012, were examined by Jones, whose March 30, 2013, auditor’s report expressed an unqualified opinion. The report of Jones is not presented with the 2013– 2012 comparative financial statements.

Rao’s working papers contain the following information that does not appear in footnotes to the 2013 financial statements as prepared by Devon, Inc.:

• One director, appointed in 2013, was formerly a partner in Jones’ accounting firm. Jones’ firm provided financial consulting services to Devon during 2011 and 2010, for which Devon paid approximately $ 1,600 and $ 9,000, respectively.

• The company refused to capitalize certain lease obligations for equipment acquired in 2013. Capitalization of the leases in conformity with generally

accepted accounting principles would have increased assets and liabilities by $ 312,000 and $ 387,000, respectively; decreased retained earnings as of December 31, 2013, by $ 75,000; and decreased net income and earnings per share by $ 75,000 and $. 75, respectively, for the year then ended. Rao has concluded that the leases should have been capitalized.

• During the year, Devon changed its method of valuing inventory from the first- in, first- out method to the last- in, first- out method. This change was made because management believes LIFO more clearly reflects net income by providing a closer matching of current costs and current revenues. The change had the effect of reducing inventory at December 31, 2013, by $ 65,000 and net income and earnings per share by $ 38,000 and $. 38, respectively, for the year then ended. The effect of the change on prior years was immaterial; accordingly, the change had no cumulative effect. Rao supports the company’s position.

After completing the fieldwork on February 28, 2014, Rao concludes that the expression of an adverse opinion is not warranted.

Required:

Prepare the body of Rao’s report, addressed to the board of directors, dated February 28, 2014, to accompany the 2013– 2012 comparative financial statements. Rao has conducted an audit of Devon’s internal controls over financial reporting based on the COSO framework. No material weaknesses were identified.