You have been engaged to examine the balance sheet of Hi-Sail Company, which provides services to financial institutions. Its revenue source comes from fees for performing these services. Its primary expenses are related to selling and general and administrative costs. The company has assets and liabilities of approximately $1 million. Operating losses in recent years have resulted in a retained earnings deficit and stockholder's equity close to zero. The assets consist primarily of restricted cash and accounts receivable. Its liabilities consist of accounts payable, accrued expenses, and reserves for potential losses on services previously provided.

Your preliminary audit work indicated that the company generates a high volume of transactions. The internal control system surrounding these transactions is weak. It is also apparent that management is involved only moderately in day-to-day activities and spends most of its time dealing with non-routine transactions and events.

You expended a significant amount of time and cost to complete your examination of the balance sheet. The client understood the extended efforts and stated a willingness to pay whatever cost to complete this engagement. However, monthly progress billings have not been paid.

On completion of the audit fieldwork, you reviewed a draft of the balance sheet and related notes with the company's president and chief financial officer/controller. With minor wording modification, they agreed with the draft. They requested that you issue this report as soon as possible. You committed to the issuance of your opinion, subject to a review of the draft with the company's chairperson of the board.

After the chairperson reviewed the draft, she requested a special meeting outside the company's office. At the subsequent meeting, she stated that the drafted balance sheet and notes are severely in error. Included in her comments are the following:

1. The previous year's tax returns have not been filed, and the company has extensive potential tax liabilities.

2. The company has guaranteed significant amounts of debt related to joint ventures. These ventures have failed, and the company's partners are insolvent.

3. Significant notes payable to the chairperson have not been recorded.

4. Amounts payable to the chairperson and other officers related to reimbursement of monies expended by these individuals personally for travel, entertainment, and related expenses on the company's behalf have also not been recorded.

The chairperson surmised that the president and the chief financial officer/controller did not disclose these items because of their detrimental impact on the company. She believed that those officers were trying to stage a shareholder dispute to unseat her. You continued to have separate meetings with these individuals.

It became clear that the parties were in dispute, and you found it increasingly difficult to understand what was factual and what was not. The two officers, in particular, requested urgent conclusion of the audit and delivery of your opinion. They claimed the chairperson's position was self-serving and not representative of the company's financial position.

You discovered that the reason the two officers were anxious for the opinion and balance sheet was that they were attempting to sell the company. You also learned from the company and from another of your clients that the second client was interested in purchasing the company. This second client has asked you why you have not yet issued your report on Hi-Sail.

Discussion Issues

a. Refer to the ethical framework in the chapter, and write a report describing what course of action you would take concerning the audit and how you decided on that course of action.

b. Indicate what you would do in response to the second client's inquiry and why.