Going Concern

Facts:

• A Chicago area company (Company) has been manufacturing metal gas tanks for passenger automobiles since 1918. The Company has always been a privately held family run business.
• The Company has been profitable for much of its history; retained earnings at the end of 20X1 was $20 million.
• Recently mandated EPA mpg requirements have caused automobile manufacturers to move to utilizing plastic gas tanks which are much lighter than metal. This change in materials helped automobile manufacturers reduce auto weights and meet the increased mpg requirements.
• The Company decided not to convert their operation to plastic gas tanks because their expertise was only in manufacturing metal products.
• A few years back, the owners were faced with two options: Liquidate and distribute available assets or move into a different line of business. The Company decided to do the latter. The Company felt it could use its expertise to manufacture metal frames for televisions (like for Toshiba, Panasonic, etc.)
• The Company built a new manufacturing plant in Georgia for manufacturing these metal TV frames; the plant was financed with low interest rate IRBs (Industrial Revenue Bonds).
• The IRBs were for $25 million with a 20-year term. The Company has no other debt.
• Unfortunately, in its first two years of operation of the new metal picture frame plant 20X2 & 20X3 the Company lost $11 million and $8 million, respectively. The metal TV frame business is extremely competitive; sales prices of metal TV frames are quite low. The Company was simply unable to produce large quantities of metal frames at a cost which would enable the Company to generate adequate gross profit.
• You are finishing your Audit of 20X3 & discussed the Going Concern issue with the Companys management, including the family owners. The owners / managers feel they have no choice but to continue producing metal TV frames due to the 20-year IRB term.
• Management prepares financial projections for the next year which shows the Company breaking even; the projections reflect a significant increase in the gross profit it is unclear how management will improve their gross profit margin so significantly.

Part 1 (Continued)

Required: Part 1

1. State whether you believe there is or is not substantial doubt about the Companys ability to continue as a Going Concern. Provide your supporting arguments, specifically addressing:

• Conditions and Events
• Managements Plans

Stating that you believe there is substantial doubt means that your Audit Firms Independent Auditors Report for the year of 20X3 will include an emphasis of a matter paragraph with the supporting footnote. (There is no need to formally draft the paragraph & supporting footnote.)

Stating that you believe there is not substantial doubt means that your Audit Firms Independent Auditors Report for the year of 20X3 will not include an emphasis of a matter paragraph but the Audited Financial Statements will include a footnote describing the conditions and events and how managements plans alleviated the conditions and events. (There is no need to formally draft the footnote.)

Part 2. Subsequent Events

Facts:

You are performing an annual audit of a company with a December 31, 20X1 year-end. Your firm is planning to complete the audit on March 1, 20X2 and release the report on March 31, 20X2. On March 15, 20X2, two material subsequent events occur:

• A fire caused extensive damage to the companys manufacturing plant in New Jersey.
• A large customer went bankrupt. At December 31, 20X1, the Company had a receivable of $2,500,000 from this customer; at December 31, 20X1 the Company had established an allowance for doubtful accounts of $700,000 for this customer.

Required:

1. Explain whether each subsequent event is a Type 1 or Type 2 Subsequent Event.
2. What is the impact of each subsequent event on the companys audited financial statements for the year ended December 31, 20X1? Be specific as to whether (a) there will be an adjustment which will cause the companys balance sheet and / or income statement to change plus footnote disclosure, (b) there will only be footnote disclosure, or (c) there will be no impact to either the financial statements or the footnote disclosures.
3. How should your Audit Firm date its audit report?