Surfer Dude Duds, Inc.

Mark glanced up at the clock on his office wall. It read 2:30 P.M. He had scheduled a 3:00 P.M. meeting with George "Hang-ten" Baldwin, chief executive officer of Surfer Dude Duds, Inc. Surfer Dude specialized in selling clothing and accessories popularized by the California "surfer" culture. Mark had served as audit partner on the Surfer Dude Duds audit partner on the Surfer Dude Duds audit for the past six years and was about ready to wrap up this year's engagement.

He enjoyed a strong client relationship with George Baldwin, who was ordinarily a relaxed and easygoing man, now going on 50 years of age. For several years running, Mark had received a personal invitation from George to attend a special Christmas party held only for George's employees and close associates. Mark considered George a good friend.

In his six years on the audit, Mark had never had any reason to give everything but a clean audit opinion for Surfer Dude Duds, Inc. But this year was different. The economy was in a mild recession, and given the faddishness of clothing trends, Surfer Dude's retail chain was hurting. As sales decreased, Surfer Dude was struggling to meet all its financial obligations. Retail analysts foresaw continuing hard times for clothing retailers in general, and current fashion trends did not seem to be moving in Surfer Dude's reaction. As a result, Mark was beginning to doubt Surfer Dude's ability to stay in business through the next year. In fact, after conferring with the concurring partner on the audit, Mark was reluctantly considering the addition of a going-concern explanatory paragraph to the audit report. When Mark broached this possibility with George several weeks ago, George brushed him off.

The purpose of the scheduled 3:00 P.M. meeting was to inform George of the decision to issue a going-concern report and to discuss the footnote disclosure of the issue. Mark went over in his mind several times what he was going to say, but remained uneasy about the task before him.

When Mark arrived at George Baldwin's office, a secretary greeted him and told Mr. Baldwin of Mark's arrival. When Mark heard George say, "Send him in," he took a deep breath and headed into George's office with a smile on his face. George was sprawled out in a large executive chair, with his ever-present smile. Mark always marveled at how a person could invariably seem so relaxed and happy. "Hey Mark, what's up? You know I don't like meetings on Friday afternoons, "George yawned.

"Well George, I'' get right to the point. As you well know, the retail clothing market has really gone south the past few months. I know I don't need to tell you that Surfer Dude is struggling right now."

"I know, but we'll pull out of it," George said. "When you wipe out, you've got to climb right back on to ride the next bomb, right? We always, manage4 to come out on top. We just need to ride this one out, just like the other tough times we've been through."

"George, I know you're optimistic that things will get better soon, but his time things are a little different," Mark sighed. "I know you well enough to know that you might just be able to pull the company out of this. But given the circumstances, I think we're going to have to look at including a going-concern explanatory paragraph in the audit report. There is a non-trivial possibility that Surfer Dude will not be able to continue as a going concern for the next year. I also recommend that you include a footnote in your financial statements to the same effect."

"What? Mark, you can't go slapping a going-concern report on me! Surfer Dude will go belly-up for sure. No one will be willing to loan us any money. Shoot, nobody will even be willing to sell us anything on account - all out inventory purchases and everything else will be C.O.D. It'll be cash-and-carry only. And what about your customers? It'll be your report that puts us under, not the ripples we're hitting now. I've got a feeling thins are going to be better soon. We just need a little more time."

"George, you've got to consider the consequence if...."

"Mark, if you slap me with a going-concern report, there is no way we'll be able to pull out of this. Think of all the people who will lose their jobs if Surfer dude shuts down. Please, I'm asking you to think hard about this." George's ever-present smile was gone.

Mark was silent for what seemed even to him like an eternity. "Okay George, let's both think about it over the weekend. I'll drop by on Monday morning so we can figure out where to go from here. Thanks for your time."

Mark walked slowly out of the building and to his car. This was not going to be a relaxing weekend.

Question:

a. What are Mark's option? b. How might a going-concern explanatory paragraph becomes a "self-fulfilling prophecy" for Surfer Dude? c. What potential implications arise for the accounting firm if they issue an unqualified report without the going-concern explanatory paragraph? d. Discuss the importance of full and accurate auditor reporting to the public, and describe possible consequences for both parties if the going-concern explanatory paragraph and footnote are excluded. How might Mark convince George that a going-concern report is in the best interests of all parties involved. e. Is it appropriate for an audit partner to have a friendly personal relationship with a client? At what point could be a personal relationship become an independence issue? f. What factors might motivate Mark to be objective in his decision, despite his personal concern for his friend? e. In your opinion, what should Mark do? Briefly justify your position and explain how you would approach George on Monday.