Case 12.4: Surfer Dude Duds, Inc.

: Considering the GoingConcern 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 clients goingconcern assumption
Describe the self-fulfilling prophecy aspect of a goingconcern modified auditors 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 years 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 Georges 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 Dudes 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 Dudes

direction. As a result, Mark was beginning to doubt Surfer
Dudes 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.
When Mark arrived at George Baldwins office, a secretary
greeted him and told Mr. Baldwin of Marks arrival. When
Mark heard George say, Send him in, he took a deep breath
and headed into Georges office with a smile on his face.
George was sprawled out in a large executive chair, with his
ever-present smile. Mark always marveled at how a person
could invariably seem so relaxed and happy. Hey Mark,
whats up? You know I dont like meetings on Friday
afternoons, George yawned.
Well George, Ill get right to the point. As you well know,
the retail clothing market has really gone south the past
few months. I know I dont need to tell you that Surfer Dude
is struggling right now.
I know, but well pull out of it, George insisted. When
you fall off, youve got to climb right back on to ride the
next monster, right? We always manage to come out on top. We
just need to ride this one out, just like the other times
weve struggled.
George, I know you have high hopes that things will get
better soon, but this time things are a little different,
Mark sighed. I know that you might just be able to pull the
company out of this. But given the circumstances, I think
were going to have to look at including a going-concern
explanatory paragraph in the audit report. I substantially
doubt that Surfer Dude will be able to continue as a going
concern for the next year. I also recommend that you include
a footnote in your financial statements to the same effect.
What? Mark, you cant go slapping a going-concern report on
me! Surfer Dude will go belly-up for sure. No one will be
willing to loan us any money. Shoot, nobody will even be
willing to sell us anything on accountall our inventory
purchases and everything else will be C.O.D. Itll be cashand-carry only. And what about our customers? Will they buy

if theyre not sure well be there to stand behind our

return policy? Itll be your report that puts us under, not
the ripples were hitting now. Ive got a feeling things are
going to get better soon. We just need a little more time.
George, youve got to consider the consequences if....
Mark, if you slap me with a going-concern report, there is
no way well be able to pull out of this. Think of all the
people who will lose their jobs if Surfer Dude shuts down.
Please, Im asking you to at least think about it. Georges
ever-present smile was gone.
Mark was silent for what seemed like an eternity. Okay
George, lets both think about it over the weekend. Ill
drop by on Monday morning so we can work this out. Thanks
for your time.
Mark walked slowly out of the building and to his car. This
was not going to be a relaxing weekend.
Requirements
1. What are Marks options?
The option available to Mark was only to convince George
about the financial position of the concern. Although George
knows the lacunae involved in his retail business he is not
willing to accept the fact that the business is so much at a
loss that it needs no going concern explanatory paragraph.
Therefore it is the duty of Mark to explain to George the
consequences of not including the explanatory paragraph in
the report. He should also probably predict the future
position of Surfer Dude given the present economic
conditions and try to explain George the reasons why the
company may not be able to recover in the consequent year
for which the going concern explanatory report becomes
necessary.
2. How might a going-concern explanatory paragraph become a
self-fulfilling prophecy for Surfer Dude?
By giving the going concern explanatory paragraph in the
audit report it becomes a self fulfilling prophecy to Surfer
dude as the various classes of people involved with the
company that is the creditors, customers, investors etc.,
all their hopes and plans will be shattered and the company
will lose its business for eternity. There will be no one
willing to lend money, no one willing to sell stock to the
company and just about no one will be willing to trust the
company.

3. What potential implications arise for the accounting firm

if they issue an unqualified report without the goingconcern explanatory paragraph?
It would be unethical to issue an unqualified report without
the going concern report. This is because every audit report
must consist of the reasons for the unqualified report. An
unqualified report is a clean bill of health of the
organization and an auditor must not exclude any information
or insert any irrelevant information in this report. Every
unqualified report has a structure which consists of three
parts that is introductory paragraph, scope paragraph and
opinion paragraph therefore it is necessary that the auditor
fills in all the necessary information.
4. Discuss the importance of full and accurate auditor
reporting to the public, and describe possible consequences
for both parties if the going-concern explanatory paragraph
and footnote are excluded. How might Mark convince George
that a going-concern report is in the best interests of all
parties involved?
It is necessary that the auditor and the company reports
full and perfect information in the audit report. This is
because the audit report acts as an ideal way of getting to
know the health of the business. It is the responsibility of
the organization to provide full and correct information to
the auditor which in turn helps the auditor to prepare
correct report. If the company does not provide the correct
accounts, it will be held liable. If the auditor despite
knowing the fact that the financial information is not
correct and he prepared a report in favor of the company he
will be held liable by the court of law. Therefore it is
essential that the parties involved in auditing provide a
true report. Mark might convince George by telling him the
consequences of not including the going concern report. He
may also encourage him by telling him that the well wishers
of the organization who would not like the company to
liquidate may come forward to help the company or he may
suggest the company to merge with its competitors to avoid
the current financial position.
5. How appropriate is it for an audit partner to have a
friendly personal relationship with a client?
It is appropriate for the audit partner to have a friendly
personal relationship with the client so long as it does not
disturb their professional values and standards. Just as in
this case, Mark was so hesitant to tell George about his
wanting to include the going concern explanatory paragraph

in the audit report. Mark was actually in a awkward position

to reveal this to George but then he did it. This condition
arouse because Mark and George were friends. So long as the
friendship of audit partner and client does not affect their
professional motives it is good to maintain a healthy
relationship.
6. What factors should motivate Mark to be objective in his
decision, despite his personal concern for his friend?
The factors that should motivate Mark to be objective are
The legal consequences
The values and standards of auditor
The ethical considerations
7. In your opinion, what should Mark do?
In my opinion it is essential that Mark should include the
going concern explanatory paragraph in his report. This is
because he will be doing justice to his profession. This
will in a great way be of help to both the company and the
various parties involved with the company. This will help
the company to take this as a challenge to recover from its
loss position provided it has the required finances and this
report will provide a clear picture of the company to the
parties and help them to secure their capital.