James Johnson has just completed a detailed analysis of a potential new audit client, Rural Railroad and Pipeline, Inc. (RRP). James reports that the name is deceiving. The company is no longer in the railroad business but owns a significant amount of land rights along former railway lines. The land rights have been leased to pipeline companies for transporting natural gas. It has also leased some land rights to communications companies for laying fiber-optic cable. The company is traded over the counter. James interviewed the current auditors and members of management in preparing the following outline report:
The company is dominated by Keelyn Kravits. Ms. Kravits has recently acquired the company through a leveraged buyout (LBO). The LBO was achieved through a substantial borrowing that is now recorded on the books of RRP. The debt is at 3% over prime and requires the maintenance of minimum profitability and current ratios. If those ratios are not attained, the debt will either be immediately due-or, at the option of the lender, the interest rate can be raised anywhere from 2 to 4%.
Ms. Kravits has a reputation for coming into a company, slashing expenses, and making the company profitable. At the end of three to five years, she often takes the company back to being publicly traded. Although most of this is commendable, it should also be noted that Ms. Kravits has been very aggressive in using the flexibility in accounting principles to achieve profitability objectives.
The LBO has generated a large amount of recorded goodwill. In fact, the recorded goodwill represents 43% of total assets. The company recently acquired a small communications company that is providing local phone service in one part of the region covered by RRP. The company has older technology and appears to have lagged behind the industry in developing computerized billing procedures. Its billing is all computerized, but it appears to be more error prone than that of some of its competitors, judging by the number of phone calls to the customer service department.
The company has been subject to governmental investigations and has constantly pushed the limit in acquiring and marketing additional rights of way. The governmental complaints have often focused on environmental issues and noncompliance with land-use approvals for new developments.
The previous auditor had no significant problems with the company under its old management. Ms. Kravits believes the previous audit firm was not large enough to render services needed; she wants an auditor who acts like a "business partner" and will not be reluctant to offer constructive suggestions.
Ms. Kravits states that she will look to the new audit firm to do a substantial amount of consulting work.
One recent acquisition is a small casino that will operate on the company's property in Las Vegas. Although the company is not experienced in this area, it plans to retain existing management to run this operation. Ms. Kravits believes this acquisition is an ideal fit, because she would like to use communications technology to bring the excitement of Las Vegas to the Internet.

Required
a. The audit partner wants a report summarizing the potential benefits and disadvantages of becoming the auditor for RRP. In your memo, identify all the pertinent risks the audit partner should consider in determining whether to make a proposal to become the auditor for RRP.
b. What factors should the audit partner consider in determining how much to bid to become the auditor for RRP? For each factor identified, indicate its effect on the cost and conduct of the potential audit.
c. What other information would you want to gather before developing a proposal for the audit of RRP?