Sam Johnson is a new partner in Wilkerson, James, and Flores, an accounting firm. He is in charge of an audit for Zappo Electronics, which manufactures circuit board parts for major international electronics companies.

Zappo’s main asset is its inventory, which is listed on the books at $742,000. After doing a complete audit of the inventory, however, Sam discovered that nearly half of it is obsolete and worthless. He reported to the partner in charge that the inventory needs to be written down by $350,000 before the firm could sign off on a clean opinion.

The partner in charge meets with Zappo’s CEO, who argues strongly against any write-down of inventories.

“We’ll find a market for every last item in the inventory,” said the CEO. “It might take some time, but we’ll sell everything.”

 

 

The partner in charge tried to disagree, but the CEO was adamant. “If you make us write down the inventory that much, we won’t be able to get any more bank loans and that will put us out of business.”

The senior partner and the CEO haggled back and forth until they finally agreed to a $125,000 write-down.

“That will keep our credit intact,” said the CEO.

The next day, Sam met with the senior partner.

“We’ve agreed to a $125,000 write-down,” said the senior partner to Sam. “The company has already made the adjustment, and now I want you to sign the audit report without any qualifications or modifications. This is a good client, and I’m not going to let us lose it over something stupid like this.”

Sam objected. His analysis of the inventory was solid, and he did not understand how an honest auditor could simply negotiate a write-off.

“Forget about it,” said the partner in charge. “The company is financially sound, so what does it matter? Where’s our liability? We don’t have to worry about getting sued unless the company fails, and you know it isn’t going to fail. It’s overflowing with military contracts. I wish I owned part of the company myself.”

“But that’s not how we’re supposed to do auditing,” said Sam.

“Look,” said the senior partner, “Who’s to say for sure what that inventory is worth? Just forget about it. Besides, we can get it to do more write-offs next year. If I listened to you, there would be no next year; the company would be cut off from its creditors and out of business.”

a. Do you agree with Sam or the senior partner?

b. Defend your position.

c. Should auditors consider the impact of their opinions on clients? A negative opinion can sometimes destroy a company.