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This situation can arise when the documentation supporting the unit cost is incorrect due to erroneous dating or amounts.

A second example involves a misstatement of market price. For some assets, the determination of market value as well as cost is essential for valuation and disclosure purposes. Two asset classifications that are particularly affected by this rule are inventories, 2 ORIGINAL PRONOUNCEMENTS, Accounting Standards 16 (Fin. Accounting Standards Bd. 1990), and marketable securities, 1 ORIGINAL PRONOUNCEMENTS, FASB Statements of Standards 86 (Fin. Accounting Standards Bd. 1990). According to GAAP, these assets must be reflected in the balance sheet at the lower of cost or market. Problems in determining historical cost have been mentioned, but the assessment of market price can be even more problematic. This has been particularly true in the savings and loan crisis in which repossessed real estate held by financial institutions was based on appraised value (which was lower than cost) that proved to be erroneous for a variety of reasons. Hence, even though GAAP was followed, the market value was too high, thereby inflating the value of the related asset.

Another problem in asset valuation is the determination of net realizable value. Certain asset accounts must be stated in the balance sheet at their net realizable value such as accounts, notes, and loans receivables. For example, gross accounts receivable, net of the allowance for uncollectible accounts, must be reflected in the balance sheet at net realizable value. This value represents the amount that management in good faith believes will ultimately be collected in cash on the receivables outstanding. Therefore, when the collectibility of a receivable amount is questionable, an amount must be included in the allowance to reflect that portion of the receivable balance deemed to be uncollectible. See, e.g., International Mortgage Corp. v. John P. Butler Acct. Corp., 223 Cal. Rptr. 218 (Cal. Ct. App. 1986) overruled by Bily v. Arthur Young & Co., 834 P.2d 745 (Cal. 1992) (accounting firm sued by third party because the assets reflected in client's financial statements were greatly overstated due to inclusion of worthless notes receivable). Without this allowance, net receivables could be inflated.

Another asset valuation-related issue is the lack of disclosure of a "going-concern" problem. Failure to assess this situation properly poses a significant risk of litigation to the auditor. If the auditor does not recognize that a client company is unlikely to survive beyond one year hence, the asset and liability values reflected in the balance sheet at historical cost are not appropriate. As already mentioned, GAAP requires that assets be reflected in the financial statements at historical cost with certain qualifications for specific asset classifications (i.e., lower of cost or market, net realizable value). This GAAP requirement, however, assumes that the client company is a going concern. See, e.g., Rusch Factors, Inc. v. Levin, 284 F. Supp. 85 (D.R.I. 1968) (auditor issued unqualified opinion indicating client was solvent when this was not true). If the company is not a going concern, a liquidation approach would be used in which asset values would be better stated at net realizable value rather than at acquisition cost. See Kieso and Weygandt, supra, at 34.

Other Conditions Not Conforming to GAAP: The third category includes all nonconforming GAAP conditions that are neither revenue recognition problems nor asset valuation problems. For example, using a non-GAAP method of accounting typically has serious consequences for the fair presentation of the financial statements, especially when the effect of the misstatement


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