Auditing Case Research

Should XYZ’s 2016 income statement include the $10 million loss related to its investment in DBL commercial paper? Discuss all the reasons for your answer.

XYZ should not recognize a loss of $10 million on its 2016 income statement. This loss should be recognized in the 2017 income statement. This is for the following reasons:

This loss actually occurred in 2017 when Drexel Burnham Lambert, Inc. (DBL) filed for bankruptcy. The bank filed for bankruptcy on February 10, 2017, according to the case. Legal if the company seeks protection under bankruptcy law, it is freed from any debt that it had before (Branch and Hugh 207). This means that it is not obliged to pay for any debts or obligations such as unsecured paper. Therefore, XYZ lost its money on the day DBL bank filed for bankruptcy. As at December of the year 2016, it was still in position to claim the ten million. By the time the debt matured on January 7, 2017, the company also had the opportunity to claim. Although its debt ratings had gone down in the year 2016 and its financial difficulties were evident by December of the same year, DBL was able to pay all its commercial papers in the month of January 2017. Further, the commercial paper of XYZ had not matured by the end of 2016 and hence it did not have a right to claim payment.

Most business organizations use the accrual method of accounting in preparing the financial statements. This means that expenses and revenues are recognized when incurred or earned respectively (Heintz and Robert 146). In this case, the loss was incurred on February 10, the year 2017 when the bank filed for bankruptcy. As such, it could only record it in the financial statements of the year 2017.

Audit Report

Board of Directors, Owners and Shareholders

XYZ Company, Inc.

Date:

Dear

This is to satisfy that we have conducted a thorough audit of XYZ Company financial statements of the year ended December 2016. The statements that have been audited include the income statement, statement of financial position, retained earnings and the cash flow. Preparation of these statements was the responsibility of the management and the company’s accountants/financial department. According to the Generally Accepted Accounting Principles (GAAP) the management is required to prepare and present fair financial statements. My responsibility as the auditor was to assess them and give an independent opinion on the statements. The report is in accordance with the GAAP standards.

The GAAP standards require that as an auditor, I plan and carry out an audit in order to a good assurance and develop an opinion in regard to whether the financial statements of the company have adhered to the right standards and whether they contain any material misstatements. In conducting this audit, I have examined on test basis any evidence that would support the figures and disclosures that have been recorded in the financial statements. I have also assessed the accounting principles that were used in preparing the statements, determining whether there were any estimates provided by the management as well as conducting an evaluation on to whether the statements were correctly presented as per the guidance given by the general accepted accounting principles. In conducting this audit, I followed all the rules and regulations that an auditor is required to follow in order to make the audit valid and ensure that the opinion given is free and fair.

In my opinion, there was a material misstatement that occurred in the financial statement of the year 2016. A loss amounting to $10 million was not recorded in the statement. However, there was a footnote indicating that that the amount was related an unsecured commercial paper that the company had acquired from DBL bank. The note also indicated that the bank filed for bankruptcy in the year 2017 and indicated that the loss would be recorded in the income statement of that year. However, the loss did not occur in the year 2016. Despite the fact that there were signs of bad financial health for the bank by the end of the year 2016, there was still no indication that it would file for bankruptcy. As a matter of fact, it was active in the high yield bond market but too a large write- down on its portfolio as at December 31, 2016. Early in the year 2017, DBL showed good signs of recovering. It actually paid all its commercial papers for the period between January 7 and February 9. Therefore, putting a footnote for a loss that was to occur in the year 2017 yet it had not occurred at the time was a misleading statement and did not adhere to the standards of GAAP which requires that a loss should only be recognized when it has actually been incurred. At the time of preparation of the 2016 financial statement, the loss had not occurred and hence it ought not to have been recognized in any way. All the other statements presents a fair financial position of the company as at December 31, 2016 and are prepared in accordance with GAAP.

Signature

Auditors name:

Reasons as to why I believe that my audit report is appropriate

First, the audit report has focused on all the aspects of the financial statements including the recording of figures and adherence to the GAAP standards. Second, it has recognized that although the figures are well recorded, the financial statement fails to adhere to the requirements of GAAP and foes on to recognize a loss that does not relate to the year in question through a footnote. This would probably affect or other influence the opinion of the statements users as it is a material statement. Third, the audit report has followed the standard format that is required by the AICPA and the GAAP. It has explained in brief the purpose of the audit, the areas to be audited and the procedure to be followed during the audit. In addition, the audit report has also stated in brief the responsibility of the auditor and distinguished it from the responsibilities of a manager.

Works Cited

Branch, Ben, and Hugh Ray. Bankruptcy Investing: How to Profit from Distressed Companies. Washington, D.C: Beard Books, 2007. Print.

Heintz, James A, and Robert W. Parry. College Accounting: Chapters 1-27. Mason, OH: Thomson/South-Western, 2008. Print.