10.59 Intercompany and Interpersonal Investment Relations. You have been engaged to audit the financial statements of Hardy Hardware Distributors Inc., as of December 31. In your review of the corporate nonfinancial records, you have found that Hardy Hardware owns 15 percent of the outstanding voting common stock of Hardy Products Corporation. Upon further investigation, you learn that Hardy Products Corporation manufactures a line of hardware goods, 90 percent of which is sold to Hardy Hardware. James L. Hardy, president of Hardy Hardware, has supplied you objective evidence that he personally owns 30 percent of the Hardy Products voting stock and the remaining 70 percent is owned by Juana Hardy Lewis, his sister and president of Hardy Products. Hardy also owns 20 percent of the voting common stock of Hardy Hardware Distributors, another 20 percent is held by an estate of which Hardy and Lewis are beneficiaries, and the remaining 60 percent is publicly held. The stock is listed on the American Stock Exchange. Hardy Hardware consistently has reported operating profits higher than the industry average. Hardy Products Corporation, however, has a net return on sales of only 1 percent. The Hardy Products investment always has been reported at cost, and no dividends have been paid by the company. During the course of your conversations with the Hardy siblings, you learn that you were appointed as auditor because they had a heated disagreement with the former auditors over the issues of accounting for the Hardy Products investment and the prices at which goods have been sold to Hardy Hardware.

Questions:

a. Identify the issues in this situation as they relate to (1) conflicts of interest and (2) controlling influences among individuals and corporations.

b. Should the investment in Hardy Products Corporation be accounted for using the equity method?

c. What evidence should the auditor seek with regard to the prices paid by Hardy Hardware for products purchased from Hardy Products Corporation? d. What information would you consider necessary for