EP 2-11
Qualified reports are audit reports that contain an opinion statement informing users that the auditors did not give a positive assurance for everything that is in the financial statements. It protects auditors from any liability that may arise due to complete reliance on the financial statements by third parties. DQ decided to issue a qualified report for the Bunting financial statements is due to the following reasons:
1. Before the statements were audited, a competitor firm of Bunting released new technology that rivals Bunting’s inventoried machinery in both price and superior speed. Due to this event, the auditors concluded that Bunting’s inventory should be written down to reflect the changes in the product market. They deemed this necessary because:
a. The write-down is material. Since the company had 11 months of stored inventory, the change in the technology massively affected the financial position of the company. If reported adequately, it would reduce Bunting’s retained earnings (by the amount of write-down) and current assets (loss in inventory value).
b. The write-down is highly probable. As the market now has technology that is better (faster) and cheaper than Bunting’s technology, it would be rational to assume that all customers would prefer the newer version. Bunting’s argument that the write-down cannot be sufficiently predicted is skewed.
2. Auditors are bound by the GAAS reporting standards to insure that their report and financial statements contain all-important accounting details that users may want to know. Given the high materiality and probability of the inventory write-down, it is the auditors’ fiduciary duty to inform Bunting’s users of the issue. If they failed to do so, they would be personally liable for any losses occurred due to the reliance on their statements by users. The professional board can take their CPA certification away as well.
3. Auditors are expected to review issues with professional skepticism and the onus of proof falls on the client. Bunting couldn’t reasonably convince the auditors, with relevant information, that the inventory value was intact and therefore the auditors were bound to report the value they determined to be more appropriate.
On the other hand, Bunting has argued that the news of new technology occurred after the year-end date and since its complete (or any) affect to Bunting’s inventory is unknown, the qualified report will unjustly destroy the company’s reputation as well as customer relationship. This is a difficult matter to decide, although it must be noted that the company completely refused to even disclose the information related to the inventory – driving the auditors to a defensive stance to publish the report.
Impact of DQ’s audit report qualification
A. Bunting Technology Corporation:
i. The qualified report directly decreased the value of the net income and the current asset value reported by the company in their financial statements, reducing the company’s net worth. ii. The ethical and moral standing of Bunting has been challenged; the industry and users would assume the company to be misrepresenting its value and their trust in it would decrease, affecting future relations with the company. Consumers would be angry at Bunting for continued negotiations in light of the new circumstances. iii. Within Bunting, the management and the research specialist will be criticized and possible fired for not foreseeing the changing market dynamics before deciding to invest in a large inventory production.
B. Users of the audited financial statements:
i. Investors would become mistrustful of the corporation and demand a change in the managing team. The share price would possibly fall, as shareholders will try to sell off their shares given the poor corporate governance, further deteriorating the company’s value. ii. Consumers would also become wary of the company and switch suppliers on the basis of being vexed to
