Question

You are the auditor in charge of the financial statement audit of RoyTech Limited (RTL) for the year ended September 30, 2014. RTL, a private company formed in 1992, manufactures and sells components for computers, including screens and printers. RTL provides components to a variety of big name computer manufacturers all around the world. It is now November 2014. The following are highlights from the team meeting for the RTL engagement:

1) RTL’s main competition consists of foreign manufacturing and a very successful multinational conglomerate that has excellent customer recognition, including a distribution network.

2) RTL’s net income has fallen in recent years because it lost several large sales contracts to provide ink-jet printers. RTL is expecting that its new production methods for laser printers, which are increasing in popularity, will lead to recovery. However, to date, RTL has not secured any new significant sales contracts for laser printers. Revenue and sales information for RTL’s last five years are: Year Revenues Net Income (Loss) Before Income Taxes 2014 (unaudited) $ 12,000,000 $ 200,000 2013 24,000,000 2,200,000 2012 56,000,000 4,900,000 2011 68,000,000 5,400,000 2010 52,000,000 (800,000)

3) During fiscal 2014, the President of RTL authorized a change in credit policies. Previously, customers were granted credit based upon the credit ratings developed by RTL’s credit manager, which took into account the outstanding balance of the customer’s account and an analysis of its financial condition. Due to the recent financial difficulties in the technology sector, the President decided that RTL must use a more lenient credit policy to keep sales flowing. Accordingly, as a cost cutting measure, the credit manager was laid off in December 2013, and the President now evaluates each customer contract or purchase order individually to determine whether credit should be granted. As a result of this new policy, no customer orders were declined for poor credit since December 2013.

4) The collection of accounts receivable has slowed considerably. The summary aging of accounts receivable from RTL’s 600 customers for the current and prior year is shown below: date total Current<30 Days 31-60 days 61-90 Days >90 Days sept 30, 2014 $1,805,509 $ 722,009 $ 270,000 $ 255,000 $ 558,500 Sept 30, 2013 $2,099,080 1,045,080 210,500 222,000 621,500

5) RTL has commenced a lawsuit against a major competitor for patent infringement and industrial espionage. Management has evidence that it believes will result in a successful action, and wishes to record the estimated gain on settlement of $4 million. Although no court date has been set, legal correspondence shows that the competitor intends “to fight this action to the highest court in the land.”

6) Earlier this calendar year, RTL negotiated a $3.5 million term bank loan, which is secured by RTL’s assets. The loan agreement requires RTL to undergo an annual work safety assessment of its production facilities. To date, RTL has not conducted an assessment.

As of September 2014, assets (rounded to the nearest thousand) consisted of: Current Accounts Receivable $ 1,806,000 Inventory 1,650,000 Prepaid Expenses 45,000 ---Total current assets $ 3,501,000 Long-term Capital Assets $ 2,120,000 Patents 835,000-- Total Assets $6,456,000

7) Each year, senior management receives a bonus of five percent of their salary if the actual net income exceeds the budgeted net income by more than 10%. Senior management expects to receive their bonus since the current unaudited numbers exceed the budgeted net income by about 15%.

Required: Assess inherent and control risks for sales and accounts receivable. To facilitate your assessment, do some basic analytical review calculations.

Answer 1

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