Indigo Osho Manufacturing Limited (IOML)

Indigo Osho Manufacturing Limited (IOML)You have been assigned as the auditor in charge of one of your firm’s high-technology public company audits. Indigo Osho Manufacturing Limited (IOML), located in Ottawa, Ontario, designs and sells computer monitors, televisions, and viewing monitors for a variety of devices in the computing and technology sectors, including the health care industry. For example, it sells monitors that are used in telephones, personal digital assistants, X-ray machines, and other health-scanning and computing systems.The company is working on new flat screen systems that are low cost leaders by a substantial margin over other such systems currently on the market. The new technology supports screens so large that they can be hung on a wall, providing the ability to have wall-sized television, or large monitors that can easily display video feeds of large areas such as call centres or shopping mall food courts for security purposes. In addition to hardware, the company is developing software to provide high-resolution viewing software for these large screens.Company management is excited. Although production bugs have not yet been fully worked out, they have promised wall-sized televisions to several dealers around the world, to be shipped within the next production quarter. Accordingly, the company has started taking deposits on orders for wall-screen systems.Projected net income for the year is up fourfold from the prior year because of the smaller versions of the new technology — light, flat computer screens that have already started shipping this month. They are 50% lighter than other competing flat screens.Only two years ago, the company was barely breaking even on revenue of about $130 million, but this year it expects to have $72 million in net income on over $500 million in revenue. Share prices are climbing rapidly, from $4 earlier in the year to a current price of over $30. With the new flat-screen technology, management is expecting a share price of close to $100 by the end of the year and is looking forward to large profits on its stock options. The year end will also be a great time to float a new share issue and retire the company’s huge $250 million bank loan.IOML has five senior managers, all of whom own at least 4% of the stock of the company and have stock options as part of their remuneration. These managers also receive a bonus based on income before taxes. A key to IOML’s success has been a solid integration of design and production manufacturing information technology, custom-developed by three information systems staff members who also own shares in the company. These three individuals worked closely with design engineers to research, design, and produce the new screens.As it is now gearing up to take orders from hundreds of dealers, IOML decided to purchase a new enterprise resource planning (ERP) system with packaged software modules for general ledger, sales, accounts payable, inventory management, and payroll. The software was recommended by the CEO’s brother-in-law, who is a salesperson for the software company. Unfortunately, the software is difficult to use, and is more suited to national retail sales than to manufacturing and wholesale international distribution. After some initial problems, the sales, general ledger, and accounts payable modules are now up and running. However, the company is still using spreadsheet software to record the more complex sales that involve foreign exchange, freight, and customs. IOML is still using its old inventory management software, and will likely implement the remaining software modules in the coming six months, after the year end. The accounting manager, Karl, is a bit harried, having trained three new staff members in the past month to use the ERP software, as well as managing the conversion of the data.Karl is having a bit of a problem with the general ledger system: there is about a $7,000 out-of-balance situation and he is not sure of the source. Karl thinks it may be from the sales sub-system, since there were numerous costing issues that arose as he was untangling the existing data to move it into the new system. The company has 43 different models of screens available in several different sizes. Costs are assigned using raw materials, production time, and machine time, as well as foreign exchange and import duties and taxes.Karl has carefully checked the costs associated with each machine and labour group. He has found that his cost figures for the new, light-weight smaller screens and about 12 of the other screens used in the healthcare industry, went up considerably when he moved the costs to the new system. After checking and re-checking, it seems that the old software costing program actually had a calculation error in it, not a data entry error. This would mean that sales prices of these screens need to be increased somewhere between 15 and 30% to provide the appropriate target gross margins for the company.Karl has discussed these costing errors with executive management several times over the past three weeks, preparing spreadsheet after spreadsheet, and he still comes up with the same conclusions. It seems that the costing programs previously developed by in-house computing staff were incorrect. Karl has a meeting with computing staff next week to find out a bit more about how those old programs were put together. He plans to also take a look at the costs for the new-technology mid-size screens that are expected to start shipping next month. The wall-screen sizes are targeted for shipment in two months.Karl’s assistant, Jinyeung, has been doing the security set-up for the new accounting systems and has allocated basic passwords corresponding to each person’s last name as his or her password and first name as the user identification code. Jinyeung used the same protocol for user code assignment for the custom software that is used throughout the organization. All accounting personnel have access to all accounting software.Joe, the senior in-house programmer, is responsible for continuity planning for the company’s 40-station local area network systems. Joe recently sat down with Karl and told him what he must do to help update the disaster recovery plan for the new accounting software. Together, they expect to update the planning process over the next two months or so.Joe also told Karl to take a copy of the new software and keep it at his home. This is in addition to the main server backup that Joe does and takes to his own home every Friday night. Karl also has his assistant take a backup of the accounting data every evening. Five sets of accounting data backup are cycled, one for each day of the week. Four are kept at Karl’s house, and the most recent is kept in Karl’s desk at work, in the event that a recovery is needed.You have reviewed the information systems strategy document that was provided to you by the information systems manager, Jeneve. Jeneve told you that the company will likely need additional computing resources, since manufacturing computing is strained, often causing slowdowns in the network. The recently acquired midrange processor does not seem to have sufficient memory capacity. Development for IOML’s website is done in-house. The site is hosted by a local Internet service provider.IOML’s website allows suppliers to place orders and view the status of their orders online. The general public can view products and be directed to the dealer closest to them for purchase. Jeneve is excited about the new Facebook application developed by one of her staff. It is a game that is really a contest for consumers, and the game is spreading like wildfire. There are currently close to a million friends signed up to IOML’s Facebook profile. The game requires individuals to search for clues and fight their way through many dangerous virtual situations to win a television sequence code. Each week, if the user completes the sequence code, a new sequence code can be started. There is a target date of next September 30, when all of the completed sequence codes will be placed in an electronic bin and three individuals will be selected to win a five-foot-wide by four-foot-high wall-screen television set valued at over $25,000. When you told your family about this contest, you were surprised to learn that both of your children were already playing the game and have been successfully obtaining sequence codes for the contest for the past month.Your firm is a successful user of audit automation products, including ACL. As part of the audit, your firm has decided that you will be using ACL to test the sales transactions. To assist with the planning for this computer-assisted audit test, you have obtained a data file called COMMQ2.dbf, which shows the sales transactions for salesman 15, comprising sales of $4,081,767.21 and commission of $269,962.02. IOML provides sales commissions based on the customer category of the sale. Category A pays a commission of 10%, Category B pays 5%, while Category C pays 3%.Requireda. Set preliminary audit risk for the IOML financial statement audit engagement and explain your reasoning using four factors.(5 marks)b. Evaluate inherent risk and explain your reasoning using four factors.(5 marks)c.Evaluate control risk at IOML and explain your reasoning. As part of your assessment, evaluate weaknesses and risks of material misstatement. For each weakness or risk identified, state the impact on the organization, and provide a recommendation for improvement or control that would mitigate the risk. Also state the impact of the weakness on the financial statement audit, noting applicable affected audit assertions. (35 marks) A table format may be used for proper presentation. Provide an overall conclusion for control risk and the impact on the audit strategy. (5 marks)(40 marks)d. What are five impacts of the accounting system conversion on the financial statement audit?(5 marks)e. Provide five points that assess the suitability of using test data and ACL during the audit of IOML.(5 marks)f. Conduct audit tests f1 through f5 (described below) using the sales data that you received about salesman #15. Note that menu items you can choose in ACL to conduct the tests are set in bold type and square brackets following each test, although some tests could be completed using alternative ACL commands. For each audit test, prepare audit working paper documentation as follows:(25 marks)Identify and briefly explain the audit objective of the test in the context of your risk assessment.State your expectations prior to conducting the audit test.Include the ACL commands that you used (cut and paste from the log file or output to screen) and the results of your audit test (cut and paste or output to file).Discuss your audit findings in the context of your expectations. If your findings were not met (that is, there were unexpected results), what is the impact of these findings and what audit steps would you conduct next? What are the likely causes of the exceptions?It is important that the audit working papers are clear, stating the purpose of the audit work, your expectations, the actual audit tests that you performed, and your results, with further impact on the financial statement audit noted.f1. Summarize sales and commission dollar totals by category [Analyze,summarize. Tip: leave “other fields” section blank] and overall.f2. Recalculate HST and compare to client-calculated HST by adding another column that contains your calculation subtracted from client-calculated HST. Include in your working paper file a copy of the formula that you used and a listing of any exceptions [Edit,Table Layout,Add a new expression— third icon from the top on the left side;add a columnby right-clicking on the blank column]. Note that the HST rate is 13%. Use theDISPLAYcommand in the Command Line (Window menu tab) above the data table to show the commands that you used in the data file.f3. For each invoice, recalculate commission for each sales category. List only those invoice details for which there is an exception. Hint: When calculating, sorting, or extracting records based on a category, the letter A, B, or C will need to be put in quotation marks and the correct case, as ACL is case-sensitive (for example, CATEGORY = “A”). [First, add a new expression with conditions:Edit,Table Layout,Add a new expression— third icon from the top on the left side. Set the default value as equal to the calculation for Sales Category A, then place all three conditions in the table using the first condition icon in the Condition/Value table. Add a column by right-clicking on the blank column.Second, create a new expression and add a column that contains the difference between the commission column and your new column. Third, select those records that have a non-zero commission difference. Tip: Use > 0 and < 0.Data,Extract Data. To format your output result better and to be able to add information beside the differences, useData,Export to Other Applicationto export the data to an Excel file.]f4. Run a gap test and a duplicates test on invoice number [Analyze,Look for gaps;Analyze,Look for duplicates].f5. Select a dollar unit sample for further testing [Sampling,Sample Records,Size]. You will need to calculate the sample size first using a 95% confidence interval, a materiality of $2,750,000, and expected total errors of 5. Use a random start of 123. Summarize the results [Sampling, Calculate Sample Size]. Identify the invoice numbers for sampling.g. IOML is thinking of hiring your firm to conduct a WebTrust engagement prior to expanding the scope of its supplier portal. What are the advantages to IOML of WebTrust, and explain what actions the client must take before you would be able to conduct such an engagement.(7 marks)h. IOML has been approached by an organization that specializes in providing internal audit support for public companies. The organization is suggesting that IOML implement continuous auditing for its inventory systems and accounts payable systems, with a view to improving quality control and eliminating duplicate payments to suppliers. Provide an assessment to IOML of the advantages and disadvantages of these techniques.(8 marks)