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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.