Due to a variety of reasons, such as current economic conditions and individual operating results, companies may not have the ability to continue as a going concern. This assumption is of great interest to users of financial statements, as GAAP financial statements make the assumption the company will continue. Assets, for example, may be carried at a cost that is higher than liquidation value. Audit standards require that auditors consider whether the company under audit will be able to continue as a going concern. Auditors do not need to perform specific procedures, but they do need to use judgment in making an assessment. Items like the ability to pay debt, negative cash flow issues, legal situations, etc. all come into play.
Dillon, CPA, is the auditor for Sunshine Industries, a manufacturer of widgets. Sunshine's cash flow has cash used in operations of an amount twice that from last year, a net loss and current liabilities exceed current assets by about 25 percent. Company management insists they are spending lots of money investing in new product development and expect to see profits from these new products in the next year. Additionally, according to the CEO of Sunshine Industries, a lawsuit from a former supplier is expected to be settled in the next year.
1. What procedures should the Dillon, CPA, audit team consider based on these facts?
2. What should the audit team include in its report if the auditors cannot get comfortable with Sunshine management's optimistic attitude?
3. What specific items could Dillon, CPA, include in an emphasis-of-matter paragraph?