QUESTION

Surfer Dude Duds, Inc.: Considering the Going-Concern Assumption

CONTENT REQUIREMENTS

Requirement 1

What is a going concern opinion and what does it mean?  How is it different than an unqualified audit opinion? (4 pts)

Requirement 2

What are the types of information that the auditor should consider when determining whether a going concern opinion is appropriate?  What audit procedures might an auditor perform to determine the appropriateness of the going concern opinion? (6 pts)

Requirement 3

How might a going concern opinion become a “self-fulfilling” prophecy for Surfer Dude? (4 pts)

Requirement 4

What are the potential implications to the audit firm if they issue an unqualified opinion without the going concern explanatory paragraph? (6 pts)

Requirement 5

How might Mark convince George that a going concern opinion is in the best interests of all parties involved?  Give some arguments that Mark might make. (6 pts)

Requirement 6

Obtain “Audit Committee Characteristics and Auditor Dismissals following ‘New’ Going-Concern Reports” by Joseph Carcello and Terry Neal published in Accounting Review, January 2003.  This can be located through the University’s library database EBSCO.  You can skim the “Research Design and Sample” and “Results” sections since these may seem very confusing, and the gist of the paper can be obtained from the other sections – be sure to at least skim them, however.  Based on your reading, answer the following questions:

1. What would these authors argue is a main reason why auditors are hesitant to issue a going concern opinion for their clients? And have previous studies found that these auditors’ fears are warranted? (3 pts)
2. What is the main research question of this study? And what is their theoretical basis for making the hypothesis they make? (3 pts)
3. Give a brief (no more than 3 sentences) summary of the findings of the study. (4 pts)
4. What do you believe the reactions of Senator Sarbanes and Senator Oxley would be regarding the results of this study? (4 pts)

Writing Restrictions for this assignment:

• Any spelling/punctuation requirement included on a prior assignment will also be reviewed for accuracy if included in this paper.  For example, since “than” and “then” were included on the first assignment, if you use either in this assignment, they must be spelled correctly.
• 12-point font
• Double-spaced
• 3 pages

• ANSWER

Surfer Dude Duds, Inc.: Considering the Going-Concern Assumption

Requirement 1: Going Concern Opinion vs. Unqualified Audit Opinion

A going concern opinion is a statement made by an auditor in their audit report indicating doubts about the entity’s ability to continue its operations for a specified period. It suggests that there is a significant uncertainty about the entity’s ability to meet its financial obligations and sustain its business activities. On the other hand, an unqualified audit opinion is issued when the auditor concludes that the financial statements are free from material misstatements and fairly present the entity’s financial position, results of operations, and cash flows in accordance with the applicable financial reporting framework. Unlike a going concern opinion, an unqualified opinion does not raise doubts about the entity’s ability to continue as a going concern.

Requirement 2: Determining the Appropriateness of a Going Concern Opinion

To determine whether a going concern opinion is appropriate, the auditor considers various types of information. These include:

Financial Information: The auditor assesses the entity’s financial statements, including its liquidity position, cash flow projections, debt repayment obligations, and the availability of credit facilities.

Management’s Plans and Representations: The auditor evaluates the entity’s management plans to mitigate financial difficulties, raise additional capital, or restructure debt. They also consider the accuracy and reliability of management’s representations.

 External Factors: The auditor considers the industry and economic conditions, market competition, regulatory changes, and any potential litigation or claims that could affect the entity’s financial viability.

To evaluate the appropriateness of the going concern opinion, the auditor performs audit procedures such as:

Analyzing Financial Statements: The auditor examines the entity’s financial statements, including balance sheets, income statements, and cash flow statements, to identify any indications of financial distress or inability to meet obligations (SAE INTERNATIONAL 2017 PROFESSIONAL DEVELOPMENT RESOURCE GUIDE GROUND VEHICLE – PDF Free Download, n.d.).

Reviewing Cash Flow Projections: The auditor assesses the reasonableness and accuracy of the entity’s cash flow projections, evaluating the assumptions and sources of information used.

Assessing Debt Agreements: The auditor examines the terms and conditions of debt agreements to determine whether any breaches or defaults have occurred or are likely to occur.

Inquiring Management and Third Parties: The auditor obtains information from management, lenders, and other relevant third parties to gather insights into the entity’s financial condition, ability to obtain financing, and potential risks.

Requirement 3: Self-Fulfilling Prophecy of a Going Concern Opinion

A going concern opinion can become a “self-fulfilling” prophecy for Surfer Dude if stakeholders, such as suppliers, customers, and creditors, lose confidence in the company’s financial viability. If they perceive the going concern opinion as an indication of imminent failure, they may reduce their support or terminate their relationships with Surfer Dude. This could lead to a decrease in sales, loss of credit lines, and difficulty in sourcing materials, exacerbating the financial challenges faced by the company. Thus, the negative perception created by the going concern opinion could potentially become a reality for Surfer Dude.

Requirement 4: Implications of Issuing an Unqualified Opinion without the Going Concern Explanatory Paragraph

If the audit firm issues an unqualified opinion without including the going concern explanatory paragraph when it is necessary, there can be significant implications. These include:

Misleading Financial Statements: Omitting the going concern opinion when it is appropriate can mislead financial statement users, as it fails to disclose the entity’s financial difficulties and risks.

Legal and Professional Consequences: The audit firm may face legal repercussions if stakeholders incur losses due to reliance on financial statements that did not include a necessary going concern opinion. The audit firm’s professional reputation and credibility could also be adversely affected.

Regulatory Compliance: Failing to issue a going concern opinion when required may result in non-compliance with auditing standards and regulatory requirements, leading to disciplinary actions or sanctions imposed by regulatory bodies.

Requirement 5: Convincing George of the Importance of a Going Concern Opinion

To convince George that a going concern opinion is in the best interests of all parties involved, Mark could present the following arguments:

Transparency and Accountability: Including a going concern opinion ensures transparency and accountability to stakeholders by disclosing the entity’s financial challenges and risks. This allows them to make informed decisions based on accurate and complete information.

Stakeholder Protection: A going concern opinion protects the interests of stakeholders, such as lenders, suppliers, and investors, by providing them with early warning signs of potential financial distress (Team, 2023). It enables them to take necessary precautions or actions to mitigate risks.

 Long-Term Viability: Addressing financial difficulties in a timely manner increases the likelihood of overcoming them and ensuring the long-term viability of Surfer Dude. It provides an opportunity for management to develop and implement effective strategies to address the underlying issues.

Maintaining Trust and Credibility: By including a going concern opinion when appropriate, Surfer Dude demonstrates its commitment to transparent financial reporting. This helps build trust and credibility with stakeholders, fostering stronger relationships and enhancing the company’s reputation.

Requirement 6: Reactions of Senator Sarbanes and Senator Oxley

Based on the study “Audit Committee Characteristics and Auditor Dismissals following ‘New’ Going-Concern Reports” by Joseph Carcello and Terry Neal, it can be inferred that Senator Sarbanes and Senator Oxley would have contrasting reactions to the results of the study.

Senator Sarbanes, who co-authored the Sarbanes-Oxley Act (SOX), which strengthened corporate governance and auditing standards, would likely view the study’s results as concerning (Romano et al., 2004). The study suggests that auditors are hesitant to issue going concern opinions due to the potential negative consequences, including client dismissals. This reluctance undermines the objective of providing transparent and reliable financial reporting to protect investors.

On the other hand, Senator Oxley might view the study as confirming the need for regulatory reforms such as SOX. The findings suggest that auditors’ fears are justified, indicating the importance of strengthening corporate governance and the role of audit committees in overseeing auditors’ independence and objectivity.

Overall, the study’s results would likely reinforce the need for continuous evaluation and improvement of auditing practices and regulations to address the challenges and incentives that auditors face when issuing going concern opinions.

References

Romano, R., Arlen, J., Core, J., & Mccubbins, M. (2004). The Sarbanes-Oxley Act and the making of quack corporate governance. ResearchGate. https://www.researchgate.net/publication/229023260_The_Sarbanes-Oxley_Act_and_the_making_of_quack_corporate_governance 

SAE INTERNATIONAL 2017 PROFESSIONAL DEVELOPMENT RESOURCE GUIDE GROUND VEHICLE – PDF Free Download. (n.d.). https://docplayer.net/60239776-Sae-international-2017-professional-development-resource-guide-ground-vehicle.html 

Team, C. (2023). Stakeholder. Corporate Finance Institute. https://corporatefinanceinstitute.com/resources/accounting/stakeholder/