Question

A company has changed its method of inventory valuation from an unacceptable one to one in conformity with generally accepted accounting principles. The auditor's report on the financial statements of the year of the change should include?

1) no reference to consistency.
2) a reference to a prior period adjustment in the opinion paragraph.
3) an explanatory paragraph that justifies the change and explains the impact of the change on reported net income.
4) an explanatory paragraph explaining the change.

Answer 1

The auditor's report should include an explanatory paragraph justifying the change in inventory valuation to GAAP and explaining its impact on reported net income, providing clarity and ensuring users understand its effects.

Step-by-step explanation:

When a company changes its method of inventory valuation from one that is not accepted to one that is in conformity with generally accepted accounting principles (GAAP), the auditor's report should reflect this change. The appropriate action, in this case, would be for the auditor to include an explanatory paragraph in the financial statements. This explanatory paragraph should justify the change and explain the impact of the change on reported net income, ensuring that financial statement users are fully informed of the nature and effect of the change.

The reference to the change in inventory valuation methods should provide clarity on the change's conformity with GAAP, and, if material, should explain the ramifications of the change for a proper understanding of the company's financial position and performance. If the change has a material effect on the comparability of current and prior period financial statements, it may also warrant a mention in the statement about consistency, typically included in the note disclosures rather than the auditor's opinion itself.