Posted: April 17th, 2016

Describe the “self-fulfilling prophecy” aspect of a going-concern modified auditor’s report?

Case 12.4: Surfer Dude Duds, Inc.: Considering the Going-Concern Assumption*

*This case was prepared by Mark S. Beasley, Ph.D. and Frank A. Buckless, Ph.D. of North Carolina State University and Steven M. Glover, Ph.D. and Douglas F. Prawitt, Ph.D. of Brigham Young University, as a basis for class discussion. The case was inspired by discussions with Craig Isom, a former audit partner, and we gratefully acknowledge his contribution to its development. Surfer Dude Duds is a fictitious company. All characters and names represented are fictitious; any similarity to existing companies or persons is purely coincidental.

Mark S. Beasley, Frank A. Buckless, Steven M. Glover, Douglas F. Prawitt

Learning Objectives
After completing and discussing this case, you should be able to
• Understand the difficulty of assessing the client’s going-concern assumption
• Describe the “self-fulfilling prophecy” aspect of a going-concern modified auditor’s 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 accessories 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 year’s 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 George’s employees and close associates. Mark considered George a good friend.

In his six years on the audit, Mark had 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 Dude’s 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 Dude’s direction. As a result, Mark was beginning to doubt Surfer Dude’s 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.