Chapter 16: Completing the Engagement

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Chapter 16 Completing the Engagement

• Problem 16-32
• By Gillian Andrews, Andrea Barbour, and Jamie
  Hollett

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Overview

• In 2002, Medical Products Inc. (MPI) emerged
  itself into the optical equipment industry.
• MPI aimed to report a profit of at least 1.25
  million for 2004.
• Achieved a profit of 1.35 before tax and post
  adjustments for vacation pay for 2004.
• MPIs auditor Hammer Bammer (HB) suggested
  reevaluating its inventory amount because
  inventory bought was for a special order that in
  the end was cancelled and despite managements
  promise, was not sold reducing profit by 450,000.

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Overview continued

• HB had previously proposed in 2003 that
  cumulative executive vacation pay of 300,000
  must be accrued for in 2004.
• MPIS president is refusing the auditors
  submission to account for both the inventory
  write-off and vacation pay accrual.

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Question A

• Should the inventory adjustment be taken in 2004?

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• The 450,000 amount for inventory should be
  adjusted for in the 2004 books as it is a
  material amount when compared to MPIs expected
  profit of 1.35 million. HB brought up concerns
  of inventory valuation in 2002 but was assured by
  MPI that it would be sold by 2004 without being
  subjected to a loss.
• Technology obsolescence concerns.
• Misstatements should be aggregated.

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• HB has 2 choices available
• It could adjust the accounts to reduce the
  misstatement since the inventory amount is
  believed to be material and will affect the
  decisions of the financial statement users.
• It could give an adverse opinion.

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Question B

• Irrespective of your decision regarding inventory
  adjustment, should the auditor insist on accrual
  of the executives vacation pay?

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• Contingent liabilities must be accounted for in
  the books due to the matching principle.
• Materiality AuG-41 suggests quantitative
  guideline for profit-oriented entity at 5 of
  after tax income from continuing operations. In
  2004, the 300,000 of accrued vacation pay for
  the executives is gt than the 5.
• Substantial enough to affect the decisions of
  investors and other related parties.
• No mention of 2002s audit with the regards to
  the accrual.

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Question C

• Consider the conflict between Adams (MPI
  president) and Schmidt (HB Auditor). Assuming
  that Schmidt believes the inventory adjustment
  and vacation accrual must be made and that she
  does not want to lose MPI as a client, what
  should Schmidt do?

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• HB should complete the audit including the
  markdown for inventory and adjustment for
  vacation pay accrual.
• HB should include issues with MPIs going-concern
  in the audit report.
• HB should inform the appropriate level of
  management along with the auditing committee of
  the misstatements identified during the audit.

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• There needs to be formal communication between HB
  and MPI, this is not intended for third party use
  (CICA HB section 5750).
• HB should relay concerns of the disagreement they
  had with MPI regarding significant matters that
  arose during the audit ( CICA HB section 5751).
• Again, HB has a responsibility to the users of
  the financial statements.

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Thank You