Discussion Overview You are auditing the financial statements for your new clien


Discussion Overview
You are auditing the financial statements for your new client, Paper Packaging Corporation, a manufacturer of paper containers, for the year ended March 31, 2022. Paper Packaging is a public company. Paper Packaging’s previous auditors had issued a going concern opinion on the March 31, 2021, financial statements for the following reasons:
Paper Packaging had defaulted on $10 million of unregistered debentures sold to three insurance companies, which were due in 2021, and the default constituted a possible violation of other debt agreements.
The interest and principal payments due on the remainder of a 10-year credit agreement, which began in 2017, would exceed the cash flows generated from operations in recent years.
The company had disposed of certain operating units. The proceeds from the sale were subject to possible adjustment through arbitration proceedings, the outcome of which was uncertain at year-end.
Various lawsuits were pending against the company.
The company was in the midst of tax proceedings as a result of an examination of the company’s federal income tax returns for a period of 12 years.
You find that the status of the above matters is as follows at year-end, March 31, 2022:
The company is still in default on $4.6 million of the debentures due in 2021 but is trying to negotiate a settlement with remaining bondholders. A large number of bondholders have settled their claims at significantly less than par.
The company has renegotiated the 2017 credit agreement, which provides for a two-year moratorium on principal payments and interest at 8 percent. It also limits net losses ($2.25 million for 2022) and requires a certain level of defined cumulative quarterly operating income to be maintained.
The arbitration proceedings were resolved in 2022.
The legal actions were settled in 2021.
Most of the tax issues have been resolved, and, according to the company’s outside legal counsel, those remaining will result in a net cash inflow to the company. At year-end, Paper Packaging had a cash balance of $5.5 million and expects to generate a net cash flow of $3.2 million in the upcoming fiscal year. The following information about Paper Packaging’s plans for its operations for the fiscal year ending in 2023 may also be useful in arriving at a decision.
Paper Packaging’s Plans Operations for the Fiscal Year Ending in 2023
Fiscal Year 2023
Budget
Fiscal Year 2022
Actual
Fiscal Year 2022
Budget
Net revenues
$ 66.2
$ 60.9
$ 79.8
Gross margin
34.7
33.6
45.6
Operating expenses
27.9
34.7
31.4
Interest—net
5.1
6.0
5.7
Other income (expenses)—net
(0.8)
2.1

Earnings before income taxes and extraordinary items
1.5
(5.1)
(0.2)
Cash flows:
Receipts
69.9
79.7
Disbursements
66.7
96.9
Excess or deficit
3.2
(22.8)


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