CASE 12

a. What action should you take in this situation?

b. If the client should decline to take any action in the matter, would you insist that the unpaid amount of P54,000 be included in the liabilities shown on the statement of financial position as a condition necessary to your issuance of an unqualified audit report.

ANSWER:a. The auditor should inform the management of Rojo Company of the underpayment for store fixtures and existing liability of P54,000. An adjusting entry should be proposed to increase the cost of the store fixtures and to increase accounts payable to the correct amount.

b. The portion of the liability amounting which is unpaid that amounts to P54,00 is definitely a liability. The auditor has the responsibility to see that all liabilities are included on the balance sheet. On the part of the auditor, failure to reflect the correct data would make the financial statements misleading and would represent dishonesty and willful misrepresentation.

However, it is not the responsibility of the auditor to try to force the management to pay the liability.

The Rojo Company may include the P54,000 amount as part of the total of accounts payable on the balance sheet without identifying the creditor or taking any steps toward paying the debt. Such action would meet the requirement of adequate disclosure in the financial statements and would permit the auditor to issue a report indicating that the statements present fairly the financial position, operating results, and cash flows.

Whether the auditor would be justified in using the information gained in the audit of Rojo Company to reopen an account receivable on the accounting records of Western Showcase, Inc. constitutes a puzzling question in professional ethics. To do so might be considered a violation of the professional and confidential relationship between the auditor and the client, Rojo Company. Failure to take action, on the other hand, might be regarded as a breach of faith with the second client. It could be argued that the auditor has a duty to speak so that an obvious injustice may be corrected.

If the auditor had not been retained by Western Showcase, Inc., he would not have been justified in going to that concern on his own initiative and disclosing the existence of the uncollected account. However, since he has been retained to make an audit of Western Showcase, Inc.'s financial statements, he should, in the opinion of the authors, utilize all information at his command to develop an accurate determination of the company's financial position. Professional conduct would seem to call for him to review accounts receivable of Western Showcase, Inc. very carefully. In the course of doing so, he will "discover" the underbilling of Rojo Company, and propose an adjustment to reinstate this receivable.

Also, during this investigation of receivables, the auditor may find accounts from other customers incorrectly handled; the fact that the error in the receivable from Rojo Company went undetected suggests that internal control over receivables may be weak in the Western Showcase, Inc. system. Note that this is the opinion of the authors and that the Code of Ethics does not directly address the issue.