Forestcrest Woolen Mills is a closely held North Carolina company that has existed since 1920. The company manufactures high- quality woolen cloth for men’s and women’s outerwear. Your firm has audited Forestcrest for 15 years.
Five years ago, Forestcrest signed a consent decree with the North Carolina Environmental Protection Agency. The company had been convicted of dumping pollutants (such as bleaching and dyeing chemicals) into the local river. The consent decree provided that Forestcrest construct a water treatment facility within eight years.
You are conducting the current-year audit, and you notice that there has been virtually no activity in the water treatment facility construction account. Your discussion with the controller produces the following comment: “Because of increased competition and lower sales volume, our cash Flow has decreased below normal levels. You had better talk to the president about the treatment facility.”
The president (and majority shareholder) tells you the following: “Given the current cash Flow levels, we had two choices: lay off people or stop work on the facility. This is a poor rural area of North Carolina with few other job opportunities for our people. I decided to stop work on the water treatment facility. I don’t think that the state will fine us or close us down.” When you ask the president if the company will be able to comply with the consent decree, he informs you that he is uncertain.
a. Discuss the implications of this situation for the audit and audit report.
b. Would your answer change if these events occurred in the seventh year after the signing of the consent decree?