a. Analysis and evaluation: Does KCI have a justified change in accounting principle? If so, how should the change be presented in the financial statements?

b. Conclusions: Assuming KCI has a justified change in accounting principle and has accounted for the change properly, draft the audit report that Thornson & Danforth will issue.

King Companies, Inc. (KCI) is a private company which owns five auto parts stores in urban Los Angeles, California. KCI has gone from two auto parts stores to five stores in the last three years, and it plans continued growth. Eric and Patricia King own the majority of the shares in KCI. Eric is the chairman of the board of directors of KCI and CEO, and Patricia is a director as well as the CFO. Shares not owned by Eric and Patricia are owned by friends and family who helped the Kings get started. Eric started the company with one store after working in an auto parts store. To date, he has funded growth from an inheritance and investments from a few friends. Eric and Patricia are thinking about expanding by opening three to five additional stores in the next few years.

KCI employs 20 full-time staff. These workers are employed in store management, sales, parts delivery, and accounting. About 40% of KCI’s business is retail walk-in business, and the other 60% is regular customers where KCI delivers parts to their locations and bills these customers on account. During peak periods, KCI also uses part-time workers.

Your accounting firm, Thornson & Danforth, LLP, is conducting the annual audit of KCI for the year ended December 31, 2022. Your audit team discovers numerous misstatements, mostly caused by human error and weak internal controls. In aggregate, the misstatements are material, but management agrees to make your recommended adjustments to correct the misstatements. Also, during 2022, KCI changed its method of valuing inventory from a weighted-average method to FIFO. When Eric and Patricia opened their first store, they thought the easiest way to value inventory was to use an average cost for each category of inventory items. As the company grew, they never revisited this practice. Now that the company is significantly larger with multiple stores, Eric and Patricia realize they need to be more focused on tracking inventory costs because that impacts their profit margins. The change was made to FIFO because it is more commonly used in the industry.

Your team concludes fieldwork on March 1, 2023, and Eric and Patricia are planning to provide the audited financial statements and audit report to its lenders on March 6, 2023.