Ditka Engineering Company & First Federal Finance Company (situational analysis)
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But what is our liability?
Ditka engineering company has signed a third party loan guarantee for liberty company . The loan is fro the national bank of illinois for $500,000. Liberty has recnetly filed for bankruptcy , and it is estimated by the companys auditors that creditors can expect to receive no more than 40% of their claims fro mliberty. Ditka's treasurer believes that because of the high uncertainty of final settlement , a liability should be recorded for the entire $500,000. The chief accountant , on the other hand , believes the 40% collection figure is reasonable and proposes that a $300,000 liability be recorded. Ditka's president does not thin a reasonable estimate can be made at this time an dproposes that nothing be accrued for the contingent liability but that a note be added to the financial statements explaining the situation. As a independent outside auditor, what position would you take? Why?
2) ARE current values necessary for valuing investment assets?
First federal finance company has a large investment securities portfoilio . In the "old days" first federal was allowed to value these securities at the lower of cost or market. Statement of financial accounting standards number 115 now requires current market valuation on the balance sheet for most securities. As a banker you do not consider current value reporting to be necessary . Indeed , you feel it unfairly harms your reported performance. As a banker , why would current value accounting be threatening to you? How owuld you respond to these concerns if you were a member of the FASB?
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In my opinion, I would go for the combined one - to report the liability at 40% (provision), plus a disclosure (notes) in the financial statement.
I will also see how much $500,000 means to Ditka - is it material or not - as that may affect the going concern problem if material. However I would assume $500,000 here is not material, and that as long as the auditor explain in the notes it should be fine. The auditor should issue an "except for" auditor opinion however, as there's high uncertainty involved.
The auditor should state that the financial statement is true and fair (if, it is, of course), except for the provision of the third party loan guarantee, as there is uncertainty. Auditor should state that they are unable to obtain sufficient audit evidence to satisfy themselves as to the amount of provision of the third party loan guarantee, and in particular whether the basis for determining the estimated amount is appropriate.
However since its not ...
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