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% of the outstanding voting common shares of Hardy Products Corporation.
Upon further investigation, you learn that Hardy Products Corporation manufactures a line of hardware goods, 90% of which are sold to Hardy Hardware. Mr. James L. Hardy, president of Hardy Hardware, has supplied you with objective evidence that he personally owns 30% of the Hardy Products voting shares and that the remaining 70% is owned by Mr. John L. Hardy, his brother and president of Hardy Products. James L. Hardy also owns 20% of the voting common shares of Hardy Hardware Distributors. Another 20% is held by an estate of which James and John are beneficiaries, and the remaining 60% is publicly held.
Hardy Hardware consistently has reported operating profits greater than the industry average. Hardy Products Corporation, however, has a net return on sales of only 1%. 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 brothers, you learn that you were appointed as auditor because the brothers had a heated disagreement with the former auditor over the issues of accounting for the Hardy Products investment and the prices at which goods have been sold to Hardy Hardware.

Required:
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 on 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 adequate disclosure in the financial statements of Hardy Hardware Distributors? Audit trail, and the amount. Your assignment is to write the audit approach analysis portion of the case, organized around these sections:
Audit objectives: Express the objective in terms of the facts supposedly asserted in financial records, accounts, and statements.
Control procedures relevant to the process:
Write a brief explanation of control considerations, especially the kinds of manipulations that may arise from the situation described in the case.
Tests of controls: Write some procedures for getting evidence about existing controls, especially procedures that could discover management manipulations. If there are no controls to test, then there are no procedures to perform; go then to the next section. A “procedure” should instruct someone about the source(s) of evidence to tap and the work to do.
Tests of details of balance: Write some procedures for getting evidence about the existence, completeness, valuation, ownership, or disclosure assertions identified in your objective section above.
Audit results: Write a short statement about the discovery you expect to accomplish with your procedures.