Case:

Peterson Medical Products (PMP) is a medical supplies manufacturer owned by three individuals. PMP is a C-Corporation that began operations in 1994 when a group of doctors in San Diego, California discovered a medical device which greatly improved survival rates of patients following organ transplant surgeries. The device is made up of two components, which the company assembles in its warehouse. Due to patented technology, PMP is required to purchase one of the components exclusively from Bronson Industries, Inc. The other component is not protected by patents and can be purchased from several suppliers.

Given the company’s innovation and success of its products, PMP has been profitable for most of its existence. However, during the year ended December 31, 2010, the company generated a loss from operations and experienced its third lowest net income in its history. In the three years since that period, PMP’s sales have been steadily decreasing due to increased competition and new developments in the medical device industry. In an effort to obtain funding for the research and development of new products, the owners of PMP invited seven additional wealthy investors to purchase an equity interest in PMP.

In order to provide additional working capital, PMP established a line of credit (LOC) with Charter Bank during May 2011. The LOC allows the Company to borrow up to $475,000. No other lines of credit or unused notes payable existed at year end. At December 31, 2011, PMP had not drawn on its LOC, and the company had a cash balance of $873,650. Given its declining sales trend and its efforts to research and develop new products, PMP is currently spending $138,500 more cash than it brings in each month.

Assume that you are an audit manager for KPR & Associates, the public accounting firm that has been engaged to complete the PMP audit for the period ending on December 31, 2011. As your engagement team is completing its audit of PMP on March 17, 2012, the expectation is that an unqualified opinion will be issued with respect to the financial statements.

Questions:

1. Assume that one of PMP’s wealthy shareholders extended a line of credit to PMP on March 16, 2012. Should that type of subsequent event be considered when an auditor is assessing whether going concern verbiage should be included in the audit report? Explain.

2. Assume that the line of credit mentioned above was extended and that KPR included it in its going concern assessment. What would the minimum amount of the line of credit need to be in order to provide a sufficient comfort level such that the auditor would not need to include going concern verbiage in its audit report?