PA is the auditor of Jayhawk Inc. Jayhawk’s revenues and profitability have decreased in each of the past three years and, as of this year end, 20X3, its retained earnings will fall into a deficit balance. Jayhawk’s long-term debt comes due in 20X4, and its management is currently renegotiating the repayment date and terms with its bondholders. According to PA’s discussions with management, the renegotiation is not going well and there is a significant risk that the bondholders will put Jayhawk into receivership and liquidate its assets. Jawhawk’s CFO has provided draft 20X3 financial statements to PA that are prepared in accordance with GAAP.
a. Discuss the audit reporting implications of the preceding situation.
b. Assume the long-term debt repayment date was not until 20X5. Would your response differ?