Going Concern
Facts:
• A Chicago area company (“Company”) has been manufacturingmetal gas tanks for passenger automobiles since 1918. The Companyhas always been a privately held family run business.
• The Company has been profitable for much of its history;retained earnings at the end of 20X1 was $20 million.
• Recently mandated EPA mpg requirements have caused automobilemanufacturers to move to utilizing plastic gas tanks – which aremuch lighter than metal. This change in materials helped automobilemanufacturers reduce auto weights and meet the increased mpgrequirements.
• The Company decided not to convert their operation to plasticgas tanks because their expertise was only in manufacturing metalproducts.
• A few years back, the owners were faced with two options:Liquidate and distribute available assets or move into a differentline of business. The Company decided to do the latter. The Companyfelt it could use its expertise to manufacture metal frames fortelevisions (like for Toshiba, Panasonic, etc.)
• The Company built a new manufacturing plant in Georgia formanufacturing these metal TV frames; the plant was financed withlow interest rate IRBs (Industrial Revenue Bonds).
• The IRBs were for $25 million with a 20-year term. The Companyhas no other debt.
• Unfortunately, in its first two years of operation of the newmetal picture frame plant– 20X2 & 20X3 – the Company lost $11million and $8 million, respectively. The metal TV frame businessis extremely competitive; sales prices of metal TV frames are quitelow. The Company was simply unable to produce large quantities ofmetal frames at a cost which would enable the Company to generateadequate gross profit.
• You are finishing your Audit of 20X3 & discussed the GoingConcern issue with the Company’s management, including the familyowners. The owners / managers feel they have no choice but tocontinue producing metal TV frames – due to the 20-year IRBterm.
• Management prepares financial projections for the next yearwhich shows the Company breaking even; the projections reflect asignificant increase in the gross profit – it is unclear howmanagement will improve their gross profit margin so significantly.Part 1 (Continued)
Required: State whether you believe there is or isnot substantial doubt about the Company’s ability to continue as aGoing Concern. Provide your supporting arguments, specificallyaddressing: • Conditions and Events • Management’sPlans
Stating that you believe there is substantial doubt means thatyour Audit Firm’s Independent Auditor’s Report for the year of 20X3will include an emphasis of a matter paragraph with the supportingfootnote. (There is no need to formally draft the paragraph &supporting footnote.)
Stating that you believe there is not substantial doubt meansthat your Audit Firm’s Independent Auditor’s Report for the year of20X3 will not include an emphasis of a matter paragraph but theAudited Financial Statements will include a footnote describing theconditions and events and how management’s plans alleviated theconditions and events. (There is no need to formally draft thefootnote.)
