Case Study 10

Disclosing All Relevant Information to the Auditor

Intended audience: Professional Accountants in Business


You are the Financial Director of a large private construction company, X Pte Ltd. The company undertakes major construction projects such as building new commercial offices and private residential developments, etc. Until last year, the company had been very profitable but the economic downturn has started to hit the company hard. The company’s year-end is 31 August and the auditors were in during October to do their fieldwork. It is now December and the auditors are coming in tomorrow for their closing meeting to discuss their main findings and any adjustments that will be required to the draft accounts.

You are aware of at least one significant issue which requires to be discussed at the meeting. This relates to the fact that a significant debtor as at 31 August, Y Pte Ltd, has just recently run into financial difficulties and could possibly end up in bankruptcy. Additionally, Y Pte Ltd has been disputing the quality of the work and hence the actual amount due. No payments have been received from that customer post year-end. You are unaware as to whether the auditors are aware of this fact or not. If none of the debt is recovered then the balance sheet position as at the year-end will reduce from a net assets position of S$2,500,000 to S$700,000.

What makes it worse is that the company has carried out further work for this client post year-end to the sum of S$650,000. You have not yet had time to update your projections to take account of the likely impact of this potential bad debt and of the worsening economic environment which has seen many potential development projects postponed. The projections which the auditors had reviewed in October in your opinion now appear to be very optimistic. You believe that they will need to be updated and a copy given to the auditors.

Just as you are thinking this over, Mr Z, the Chief Executive Officer (CEO), comes into your office. He asks whether you have updated the accounts and projections to take account of the new information. You advise that you are just about to do so and that the figures will be available later in the day. He advises you that there is no need and that what the auditors already have is sufficient for their purposes and that projections are a “guesstimate” at the best of times. He also informs you that no adjustments should be made for the debtor which has just recently run into financial difficulties and could possibly end up in bankruptcy. You inform him that the auditors will demand that the year-end debt is provided for. He advises you to leave the discussions on the recoverability of the debt to him. Additionally, you inform him that the projections will require to be updated as they now look overly optimistic given what has happened in the past few days with your largest debtor now possibly going into bankruptcy and development projects which you had budgeted on winning being postponed.

Mr Z replies that, “The past year has been very challenging and the bank is putting pressure on me to send them a copy of the audited financial statements at the earliest possible opportunity. If the financial statements do not show the company to be in reasonable health then negotiating our new funding facilities is going to be at best very difficult. Remember, it is not only your job that is on the line – think of all the other 60 or so employees and their families. We will be able to trade through this downturn if we are only given a chance. It is not our fault that we find ourselves in this position – don’t let them pull the rug from our feet.”

What do you do now?

Analysis of Scenario: What are the readily-identifiable ethical issues for your decision?

I.     For you personally

Can you follow Mr Z’s orders and not update the accounts and projections? Undoubtedly, he is correct in that projections are a best guess of the future, however, they need to be based on the most up to date and best information available. To not take into account current events could be construed as misleading the auditors.

II.    Who are the key parties who can influence, or will be affected by, your decision?

‘You’, the CEO, your other fellow directors, the shareholders (if different from the directors), the employees, the auditors, the bank, and any other creditors.

III.   What fundamental ethical principles for accountants are most applicable and is there an apparent conflict between them?

  • Integrity:  Can you preserve your integrity if the information presented to the auditors is not up to date and does not reflect recent events?
  • Objectivity:  The need to set aside the potential consequences of recent events (in a worst case scenario, the bank might withdraw/not renew their funding) to prepare financial information which takes account of their implications.
  • Professional behaviour: The need to prepare realistic projections based on the most up to date information available. The need also to comply with legal requirements in relation to the provision of information to auditors.

IV.  Is there any further information (including legal obligations) or discussion that might be relevant?

What is the likelihood of getting repayment of any of the amount due from Y Pte Ltd?

V.  Is there a conflict between the ‘Guardian’ and ‘Commercial’ strands of an accountant’s responsibilities?

The ‘Guardian’ role would place emphasis on producing the best information possible for decision-making purposes for all parties concerned. In this scenario, the ‘Commercial’ pressure is likely to conflict with this need for transparency.

Acknowledgement: This case study was published by the Technical Policy Board of The Institute of Chartered Accountants of Scotland (ICAS), and adapted by the Institute of Singapore Chartered Accountants (ISCA) with the permission of ICAS