Case 35

Surfer Dude Duds, Inc.:

Considering the Going-Concern Assumption
Mark S. Beasley, Frank A. Buckless, Steven M. Glover, Douglas F. Prawit
Learning Objectives
After completing and discussing this case, you should be able to
- Understand the difficulty of assessing the clients goinc concern assumption
- Describe the self-fulfilling prophecy aspect of a going-concern modified
auditors report
- Identify factors that encourage objective auditor judgments despite the
presence of friendly client-auditor relationships
BACKGROUND
Mark glanced up at the clock on his office wall. It read 2:30 P.M. he had
scheduled a 3:00 P.M meeting with George Hang-ten Baldwin, chief executive
officer of Surfer Dude Duds, Inc. Surfer dude specialized in selling clothing and
accesories popularized by the California surfer culture. Mark had served as
audit partner on the Surfer Dude Duds audit for the past six years and was about
ready to wrap up this years engagement.
He enjoyed a strong client relationship with George Baldwin, who was ordinarily a
relaxed and easygoing man, now going on 50 years of age. For several years,
Mark had received a personal invitation from George to attend a special
Christmas party held only for Georges employees and close associates. Mark
considered George a good friend.
In his six years on the audit, Mark never had any reason to give anything but a
clean audit opinion for Surfer Dude Duds, Inc. But this year was different. The
economy was in a mild recession, and given the faddishness of clothing trends,
Surfer Dudes retail chain was hurting. As sales decreased, Surfer Dude was
struggling to meet all its financial obligations. Retail analysts foresaw continuing
hard times for clothing retailers in general, and current fashion trends did not
seem to be moving in Surfer Dudes direction. As a result, Mark was beginning to
doubt Surfer Dudes ability to stay in business through the next year. In fact,
after conferring with the concurring partner on the audit, Mark was reluctantly
considering the addition of a going-concern explanatory paragraph to the audit
report. When Mark broached this possibility with George several weeks ago,
George brushed him off.

The purpose of the scheduled 3:00 meeting was to inform George of the decision
to issue a going-concern report and to discuss the footnote disclosure of the
issue. Mark rehearsed what he was going to say several times, but he remained
uneasy about the task before him.
When Mark arrived at George Baldwins office, a secretary greeted him and told
Mr. Baldwin of Marks arrival. When Mark heard George say, send him in, he
took a deep breath and headed into Georges office with a smile on his face.
George was sprawled out in a large executive chair, with his ever-present smile.
Mark always marveled at how a person could invariably seem so relaxed and
happy. Hey Mark, whats up? You know I dont like meetings onf Friday
afternoons, George yawned.
Well George, Ill get right to the point. As you well know, the retail clothing
marke has really gone south the past few months. I know I dont need to tell yout
that Surfer Dude is struglling right now.
I know, but well put out of it. George insisted. When you fall off, youve got to
climb right back on to ride the monster, right? We always manage to come out
on top. We just need to ride this one out, just like the other times weve
struggled.
George, I know youve high hopes that things will get better soon, but this time
things are a little different, Mark sighed. I know that you might just be able to
pull the company out of this. But given the circumtances, I think were going to
have to lokk at including a going-concern explanatory paragraph in the audit
report. I substantially doubt that Surfer Dude will be able to continue as a going
concern for the next year. I also recommended that you include a footnote in
your financial statements to the same effect.
What? Mark, you cant go slapping a going-concern report on me! Surfer Dude
will go belly-up for sure. No one will be williing to loan us any money. Shoot,
nobody will even be willing to sell us anything on accountall our inventory
purchases and everything else will be C.O.D. Itll be cash-and-carry only. And
what about our customers? Will they buy if theyre not sure well be there to
stand behind our return policy? Itll be your report that puts us under, not the
ripples were hitting now. Ive got a feeling things are going to better soon. We
just need a little more time.
George, youve got to consider the consequences if...
Mark, if you slap me with a going-concern report, there is no way well be able
to pull out of this. Think of all the people who will lose their jobs if Surfer Dude

shuts down. Please, Im asking you to at least think about it. Georges everpresent smile was gone.
Mark was silent for what seemed like an eternity. Okay George, lets both think
about it over the weekend. Ill drop by on Monday morning so we can work this
out. Thanks for your time.
Mark walked slowly out of the building and to his car. This was not going to be a
relaxing weekend.
REQUIREMENTS
1. What are Marks options?
2. How might a going-concern explanatory paragraph become a self
fulfilling prophecy for Surfer Dude?
3. What potential implications arise for the accounting firm if they issue an
unqualified report without the going-concern explanatory paragraph?
4. Discuss the importance of full and accurate auditor reporting to the public,
and describe possible consequences for both parties if the going-concern
explanatory paragraph and footnote are excluded. How might Mark
convince George that a going-concern report is in the best interests of all
parties involved?
5. How appropriate is it for an auditor partner to have a friendly personal
relationship with a client?
6. What factors should motivate Mark to be objective in his decision, despite
his personal concern for his friend?
7. In your opinion, what should Mark do?