PA is the senior in charge of the November 30, 20X1, audit of Baint’s Paints Inc., a manufacturer of various latex and oil-based paints. Baint’s plant is located on the banks of a river and was constructed on this site in the 1930s because the river provided a ready supply of water for manufacturing the paint, for cleaning out the manufacturing tanks, and for dumping surplus liquids produced in the manufacturing process. With the passage of environmental legislation in the 1970s, Baint’s was no longer permitted to use the river water to clean its tanks and was required to have all surplus manufacturing liquid removed for disposal elsewhere because many of these liquids were toxic to the environment. While this environmental regulation severely cut into Baint’s profitability, it was able to reduce costs in other areas of the operation and remain in business, though at a somewhat lower level of profitability. During her tour of the manufacturing operation, PA learns from Baint’s production manager that the plant produces approximately 80,000 litres of paint per month from February to November. December and January are too cold for paint manufacturing, so the two months are used for plant maintenance and cleanup. Baint’s can sell all the paint it produces, so production volumes are quite consistent from year to year. The wastage in the paint manufacturing process ranges from 5–6% of volume. The plant manager estimates that tank cleaning produces about 20,000 litres of waste water a month during production, and about 100,000 litres in December and January because all the pipes and pumping equipment are thoroughly flushed during the plant shutdown. Waste water and paints are stored in 500-litre drums until the disposal company takes them away. The empty drums are returned to Baint’s plant for refilling. 

During her analytical review of the revenue and expense accounts, PA notes that the processing costs are significantly lower in the current year than in the prior years. The main component of processing costs contributing to the decline is the cost of waste disposal. Suspecting a possible error in recording these costs, PA finds out from the accounts payable clerk that the disposal company charges $100 per drum. From this, she estimates that Baint’s has not paid for disposal of approximately 80% of the year’s waste liquid. When she presents her analysis to the general manager for further explanation, he reports that, during the shutdown last year, he found a new disposal company that will take away the waste liquid for only $12 a drum, thus providing this substantial saving in the current year. While she is assessing the plausibility of all this analytical evidence, it occurs to PA that she has been working on the audit at the plant for two weeks now, arriving before light and leaving just at nightfall each day, and has never observed a disposal truck taking away the waste liquid drums.

Required:

a. Use the analytical information provided in the case to assess the approximate disposal costs and volumes. State any assumptions you make.

b. Does the general manager’s explanation make sense? What other possibilities might PA consider, and what additional information might she try to obtain?

c. To what extent is PA responsible for assessing the environmental compliance of Baint’s Paints? Consider the implications of possible financial misstatements, as well as of possible illegal acts by management.