Case 4-5Han, Kang& Lee, LLC

Joe Kang is an owner and audit partner for Han, Kang & Lee, LLC. As the audit on Frost Systems was reaching its concluding stages on January 31, 2016, Kang met with Kate Boller, the CFO, to discuss the inventory measurement of one its highly valued products as of December 31, 2015. Kang told Boller that a write-down of 20 percent had to be made because the net realizable value of the inventory 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 with Boller, Kang was told to use the January 31, 2016, value, which reflected a full recovery of the market amount. Boller suggested that subsequent values were acceptable under GAAP. Besides, she said, that was the method the previous auditors had used. She went on to explain that the market value for this product was known to be volatile and a smoothing effect was justified in the accounting procedures.

Kang was under a great deal of pressure from the other partners of the firm to keep Boller happy. It seems Frost Systems was about to embark on a variety of projects, on which it was considering having the firm provide consulting assistance, advice, and recommendations. The revenue from these arrangements could turn out to be twice the audit fees. Kang called a meeting of the other partners. While the three of them had different points of view on the issue, the final vote was 2-1 to accept the client's accounting.

Questions

1.Do you think the client's accounting approach to the market valuation of the inventory was acceptable under GAAP? Include in your discussion a brief explanation of why fair value measurements are difficult.

2.Evaluate the professional judgment used by Kang and the firm in assessing the client's accounting and reaching its own decision to accept it.

3.Would independence be impaired if the firm were offered, and accepted, the consulting arrangements? Consider whether any threats to independence would exist and, if so, how they might be reduced to an acceptable level.

4.What would you do at this point if you were Joe Kang and why?