Question - TecQuirk is a publicly held manufacturer of medical equipment. Some of the goods are high-tech machines used in hospitals and in laser eye surgery, while other products are consumer-use medical devices sold through drug stores, big box stores, and directly to customers online. The company provides a one year warranty on every product sold. Each year the company gets some returns of the consumer goods for a variety of reasons, and occasionally has warranty claims on the high-tech machines. TecQuirk provides a defined benefit pension plan for employees.
Last year the company learned that several patients had been blinded when their laser eye surgery was used on them. Lawyers for the injured patients just filed a class action lawsuit against the company, requesting at least $500 million in damages. The laser machines are manufactured by a subsidiary of TecQuirk that they acquired three years ago for $1 billion dollars.
Instructions:
Consider the following areas in which estimates are made in the preparation of financial statements:
- Pension obligation
- Warranty liability and related expenses
- Allowance for uncollectible accounts
- Allowance for returned goods
- Litigation and other contingencies
- Goodwill valuation.
For each of the areas where estimates are made in preparation of the financial statements:
- Identify the factors inherent in each account that might significantly affect the dollar estimate of the account balance.
- For each factor identified, briefly discuss the importance of the item to the overall account estimate. For example, how important is the interest rate assumption to the overall estimate of the pension liability?
- For each factor identified, briefly describe audit evidence that should be gathered to determine how the factor should be used in making the accounting estimate. For example, should the auditor determine the proper interest rate assumption in estimating account balances?
- Assuming there are differences between the auditor's estimate and management's estimate, indicate how a professionally skeptical auditor can determine whether management is attempting to manage or smooth earnings or that there is a genuine disagreement on the correct factor to be used in making the estimate.
- Discuss whether an expert is needed by the auditor and, if so, what kind and why?