Joe Kang is an owner and audit partner of Han, Kang & Lee, LLC. As the audit of Frost Systems was reaching its concluding stages on January 15, 2022, Kang met with Kate Boller, the CFO, to discuss the inventory valuation of one of its highly valued inventory products as of the balance sheet date, December 31, 2021. She was concerned because the January 31, 2022, financial statement issuance date was coming soon. Kang told Boller that a write-down of 20 percent had to be made because the net realizable value of the inventory on December 31 was 20 percent less than the original cost recorded on its books. That meant the earnings for the year would be reduced by $2 million and the client would show a loss for the year. In a heated exchange, Boller demanded Kang use the value now estimated on January 15, 2022, which reflects a full recovery of the “proposed” 20 percent write-down. Boller reminded Kang that the financial statements could be adjusted for “subsequent events” under accounting standards and the inventory valuation matter was one such occasion. Besides, Boller said, the previous auditors had allowed her to do a similar thing.

Exhibit 1 provides an overview of the standards for recording subsequent events.

Kang was under a great deal of pressure from the other two partners of the firm to keep Boller happy. It seems the firm was about to find out if its bid to provide consulting services for Frost Systems was accepted. Kang knew that the revenue from these arrangements could turn out to be twice the audit fees. Kang called a meeting of the other partners. He was concerned that the final vote would be 2-1 to accept the client’s interpretation of the accounting rules and record the inventory value estimated on January 15, 2022.

Questions

1. Did Boller apply the correct interpretation of PCAOB rules for subsequent events? Explain.
2. Assume the consulting services are permissible under SOX and the AICPA rules of conduct, explain what safeguards should exist to mitigate any threats to independence.
3. Put yourself in Kang’s position. You are preparing for the meeting with the other two partners. Consider the following in crafting an outline of points you may have to respond to.

What are the main arguments you are trying to counter? That is, what are the reasons and rationalizations you need to address?
What is at stake for the key parties, including those who disagree with you?
What levers can you use to influence those who disagree with you?
What is your most powerful and persuasive response to the reasons and rationalizations you may need to address? To whom should the argument be made? When and in what context?

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EXHIBIT 1 PCAOB Rule for Subsequent Events The following are the rules for recognizing Subsequent Event values in accounting under the auditing standards, PCAOB AU 560.25 An independent auditor's report ordinarily is issued in connection with historical financial statements that purport to present financial position at a stated date and results of operations and cash flows for a period ended on that date. However, events or transactions sometimes occur subsequent to the balance-sheet date, but prior to the issuance of the financial statements, which have a material effect on the financial statements and therefore require adjustment or disclosure in the statements. These occurrences hereinafter are referred to as "subsequent events." Two types of subsequent events require consideration by management and evaluation by the independent auditor. The first type consists of those events that provide additional evidence with respect to conditions that existed at the date of the balance sheet and affect the estimates inherent in the process of preparing financial statements. All infor- mation that becomes available prior to the issuance of the financial statements should be used by management in its evaluation of the conditions on which the estimates were based. The financial statements should be adjusted for any changes in estimates resulting from the use of such evidence. Identifying events that require adjustment of the financial statements under the criteria stated above calls for the exercise of judgment and knowledge of the facts and circumstances. For example, a loss on an uncollectible trade account receivable as a result of a customer's deteriorating financial condition leading to bankruptcy subsequent to the balance-sheet date would be indicative of conditions existing at the balance-sheet date, thereby calling for adjust- ment of the financial statements before their issuance. On the other hand, a similar loss resulting from a customer's major casualty such as a fire or flood subsequent to the balance-sheet date would not be indicative of conditions