Chapter 24 Audit Report - Exercise

Dana CPA LLP is auditing the financial statements for Tiger Catering Company, a Hong Kong company
that provides food and beverage services for weddings and corporate events. The company’s fiscal year
end is Dec. 31, 2020. For each item described below, determine how it will (independently) affect the
auditor’s opinion in the audit report.

1. Tiger Catering does not use the allowance method for recording bad debt expense as required
under GAAP. The auditor believes that doubtful accounts represent a material portion of the
liabilities of the company, but it does not have a significant impact on the rest of the financial
statements.
Answer: Failure to recognize bad debt expenses represents a misstatement. The effect of the
misstatement is significant but not pervasive so a qualified audit opinion should be issued.

2. Due to COVID 19, the company’s business shrank by 50% in 2020. As a result, the company could
not repay a HK$100,000 loan that was due on Nov. 20, 2020. The company was able to
negotiate for an extension of the loan payment for six months with the bank.

Answer: the client has a severe liquidity problem. Although the loan is extended for another 6
months, the client’s business is unlikely to pick up significantly given the current situation of the
pandemic. Therefore, the auditor may issue a clean audit opinion and discuss the going concern
issue as a kay audit matter.

3. Tiger Catering has an online system that allows customers to place orders through its website.
The company records revenue at the time customers’ orders are placed through the online
system, rather than when the services are provided. The time gap between the order placement
and the event varies from a few days to a few months. The auditor’s cut-off tests indicate that
the dollar amount of orders placed but not fulfilled at the end of the year are material.

Answer: This is a premature recognition of revenue; revenue from services should only be
recognized when the services are provided. The effect of the misstatement is material, so it will
lead to a qualified audit opinion.
(If the misstated amount is highly significant and distorts the overall business operation result it
could lead to an adverse opinion)

4. On 2 January 2021, Tiger Catering received a notice from its primary supplier that effective
immediately, all wholesale price will be increased by 10 percent. On the basis of the notice, the
company revalued its December 31, 2020 inventory to reflect the higher costs. The effect of the
revaluation was not significant to total assets or net income. The increase in valuation is
adequately disclosed in the footnote.

Answer: it is inappropriate to increase the value of inventories in the financial statements simply
because the supplier increased the wholesale price. However, as the effect is not material the
auditor can still issue a clean audit opinion.
5. Tiger Catering has branches in several cities in Guangdong province. Businesses from these
branches contribute to 40% of the company’s total revenue. However, the auditor was not able
to confirm balance due from a wedding company in Guang Zhou, which is a new customer of
Tiger Catering. The balance accounts for 20% of the accounts receivable ending balance, and is
considered significant by the auditor. The auditor performed alternative procedures but was still
concerned about the authenticity and collectivity of the receivables.

Answer: not being able to confirm significant accounts receivable is considered as a scope
limitation. Because the amount involved is significant, it will lead to a qualified audit opinion.
(A 20% of AR balance is significant, but this does not mean the whole 20% is misstated.
Therefore an adverse opinion is not warranted)