Subject: Auditing I

 

Question: (a) What are some of the auditing and accounting implications for the situation described below?

(b) What are the implications to the Cash and Accounts Receivable accounts as it relates to auditing?

 

White, CPA audits LJM Supply. There is an issue as to the proper treatment of $60 million in capitalized costs related to the construction of a partially complete processing plant. This issue impacts the company's financial statements.

 

Six years ago, LJM started construction of the processing plant, with the original estimated cost of $37 million and completion expected within four years. Cost overruns have been huge with construction delayed by associated litigation. At this time, the project is only 59% complete, and construction is at a standstill, as LJM seeks more funding. If the processing plant gets finished, some of the costs may be recouped through state granted surcharges. Since it is the state, there is no assurance that the surcharges will be allowed or that they will cover all the costs associated with the construction of the plant. If the project was abandoned now, $0 of the construction costs would be recovered. The write-off would amount to 68% of LJM's shareholder's equity. It is likely, though, that the company would survive, even with the write-off.

 

The management at LJM is committed to completing the processing plant. Management has received authorization from the shareholders to issue $40 million in bonds and additional shares of common stock to provide funds for the project's completion. If LJM takes on this additional debt without making the processing plant operational, it is likely that company would have to file bankruptcy. LJM's management and shareholders are willing to roll-the-dice and take the risk with the new plant.

 

Thank you.