During your audit work as of December 31, 19X7, you discovered a lawsuit against your client, Alpha Corporation, asserting a material claim for negligence in producing defective toys. The management of Alpha has refused to disclose the lawsuit on the grounds that the probability of an unfavorable outcome is remote. Legal counsel has opined that there is at least a reasonable possibility of an unfavorable outcome and that the effect of the suit could be material to the financial statements.

a. Discuss the reporting problem involved in the case.

b. Draft the audit report you would issue.