$3-10$ Drafting an Audit Report

On March $15,2008,$ you completed the audit of Excelsior Corporation's December $31,2007,$ financial statements, the second year you've supervised the engagement. The following information came to your attention during the engagement.

a$.$ Excelsior is presenting comparative financial statements.

b$.$ Excelsior does not wish to present a statement of cash flows for either year.

c$.$ During $2007,$ Excelsior changed its method of accounting for long$-$term construction contracts, reported the effect of the change in the current year's financial statements, and restated the prior year's statements. You are satisfied with Excelsior's justification for making the change, which is disclosed in Note $12.$

d$.$ Although unable to confirm accounts receivable, you used alternate procedures to satisfy yourself that receivables are presented fairly.

e$.$ Excelsior Corporation is the defendant in a litigation, the outcome of which is highly uncertain. If the case is settled in favor of the plaintiff, Excelsior will be required to pay a substantial amount of cash, which might require the sale of some plant assets. The litigation and the possible effects are disclosed in Note $11.$

f$.$ Excelsior issued debentures on January $31,2007,$ in the amount of $$10,000,000.$ The funds obtained from the issuance were used to finance the expansion of plant facili$-$ties. The debenture agreement restricts the payment of future cash dividends to earnings after December $31,2010.$ Excelsior declined to disclose this data in the notes to the financial statements.

Required: Draft an audit report.

$($AICPA Adapted$)$

$3-11$ The Repercussions of Substantial Doubt

An article entitled, "American Gaming Says Its Chairman Resigns; Audit Raises Ques$-$tions" reported that the board chairman of a public company had resigned, and that the company faced financial difficulties. On the matter of financial difficulties, the article stated, in part, $"...$ the company said an independent audit by Deloitte & Touche found that American Gaming's problems$-$including recurring losses, negative working capital, defaults under debt agreements and uncertainty relating to the liquidation of subsidiaries$$ raise substantial doubt about the ability of the company to continue as a going concern.$\text{'}"$ The article made no link between the chairman's resignation and the auditor's opinion, but did appropriately link American Gaming's financial position to the opinion.

At a meeting between Christine Schutt, an engagement partner assigned to audit a middle$-$market building materials company, and the company's chief executive officer $($CEO$),$ Schutt reveals that she has substantial doubt about the company's ability to continue as a going concern and that she may have to add an explanatory paragraph to the audit report. The CEO says, "I understand your dilemma. You've explained that to me$.$ But what you don't understand is that no supplier will give me credit, even for a week, if you claim you have substantial doubt. What's more, a statement like 'substantial doubt' won't work. If you'll say in your report that you have doubt, I'll buy that, and my creditors may too. But, if you insist on substantial doubt, I'll find another auditor."

Required:

$1.$ Do you think Schutt can overlook the word substantial? Discuss.

$2.$ What is the dilemma the CEO explained to Schutt? Discuss.