Western Trading Company is a sole proprietorship engaged in the grain brokerage business. On December 31, 2006, the entire grain inventory of the company was stored in outside bonded warehouses. The company's procedure of pricing inventories in these warehouses includes comparing the actual cost of each commodity in inventory with the market price, as reported for transactions on the commodity exchanges on December 31. A write-down is made on commodities in which cost is in excess of market. During the course of the 2006 audit, the auditors verified the company's computations, and they compared the book value of the inventory with market prices on February 15, 2006, the last day of fieldwork. The auditors noted that the market prices of several of the commodities had declined sharply subsequent to year-end until their market price was significantly below the commodities' book values.
The auditors re-priced the inventory based on the new market prices and found that the book value of the inventory was higher than the market value on February 15 by approximately $21,000. The auditors proposed that the inventories be written down by $17,000 to this new market value, net of gains on the subsequent sales. The management protested this suggestion, stating that in their opinion the market decline was only temporary and that prices would recover in the near future. They refused to allow the write-down to be made. Accordingly, the auditors qualified their audit opinion for a departure from generally accepted accounting principles.
Were the auditors justified in issuing a qualified opinion in this situation? Discuss fully, including alternative courses of action.
State your opinion as to whether or not the course of action was appropriate in this situation.
Discuss what one might identify as essential, regarding the context of the case presented, the content fact established, the process within the organization and the accounting control system. How do these factors influence or alter the answers that you have proved for Questions 1 and 2?
Following are the significant factors to be discussed in this problem:
1. The LCM (lower of cost or market) approach to pricing inventory
2. Subsequent events with regard to inventory pricing
3. Options for presentation of subsequent facts in the audit report
4. Materiality of the adjustment
5. Internal control procedures within the company
6. Industry information about the type of business
Following are some short paragraphs about the issues for your use in preparing a fuller response. The order of the factors above for presentation in a paper may be more appropriate if listed as 6, 5, 1, 2, 4, 3, but the following paragraphs match the listing above.
1. The LCM method of pricing inventory is in accordance with GAAP and should be applied consistently. Current and prior year records would identity consistent application of the principle in pricing inventory at the lower of cost or market. If similar adjustments have been made in the past, there ...
The solution presents six significant factors to be discussed in resolving an audit issue between a client and the auditors. There is a paragraph of explanation for each of the six factors as part of the total solution of 617 words. Other relevant facts can lead to more than one conclusion in this case.