Chapter 17 - Solution Manual

B if lancaster does not capitalize the installment

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b. If Lancaster does not capitalize the installment purchase as recommended, Mr. Olds should explain the circumstances in his report and qualify his opinion as to conformity with generally accepted accounting principles (or express an adverse opinion, if the amounts involved are so material that in his judgment a qualified opinion is not justified). Item 4 a. A competitive development of this nature normally is considered to be the second type of subsequent event, one that provides evidence with respect to a condition that did not exist at the date of the balance sheet, but in some circumstances the auditor might conclude that Lancaster's poor competitive situation was evident at year-end. In any event, this development should be disclosed to users of the financial statements because the economic recoverability of the new plant is in doubt and Lancaster may incur substantial expenditures to modify its facilities. Because the economic effects probably cannot be determined, the usual disclosure will be in a footnote to the financial statements. If the present recoverable value of the plant can be determined, Lancaster should consider disclosure of the Company's revised financial position in a pro forma balance sheet, assuming that this event is concluded to be evidence of a condition that did not exist at year-end. (Only if circumstances were such that it was concluded that this condition did exist at year-end should financial statements for the year ended December 31, 2011 be adjusted for the ascertainable economic effects of this development.) b. If Lancaster does not disclose this event as the auditor recommends, the financial statements are misleading. Mr. Olds should take exception to the adequacy of disclosure and depending upon the degree of materiality, he may express an adverse opinion. A Subject to" opinion or disclaimer of opinion (neither of which is proper under the given assumption) might be justified if the development were adequately disclosed and the economic effects could not be determined. The occurrence of this event after the completion of field work does not affect the need for disclosure. The auditor generally is responsible for inquiry as to subsequent events
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363 only to the end of field work and dates his report accordingly, but he has the responsibility to evaluate subsequent information if it comes to his attention. Case 17-4 a& b.l. The auditor might recommend the following footnote be appended to the financial statements in regard to item 1. Note A. The federal income tax return filed by the Corporation for the year 2008 is being examined by the Internal Revenue Service. The Internal Revenue Service has questioned the amount of a deduction claimed by the Company's domestic subsidiary for a loss sustained in 2008. The examination by the Internal Revenue Service has not progressed to the point that would indicate the extent of the Company's liability. The Company's tax counsel believes that the Company will not be subject to any substantial income tax liability with respect to this matter.
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