It is October 21, 2018, and you, an audit manager at E&N LLP, are in charge of reviewing the audit engagement file of Eye in the Sky Inc., which has a yearend of July 31, 2018. Today you will be reviewing audit work performed by your colleague Peter on Eye’s revenue section. Peter has been with E&N LLP for almost two years. He recently passed the CFE and this was his first time working on such a large and complex audit section.

Company Background Eye is a privately controlled Canadian company that uses specialized drone technology to offer aerial imagery services for surveying and monitoring mining sites. The company also sells high-end specialized drones that customers can buy and use themselves. Most of Eye’s customers are located in Africa and South America, where many new mines are currently under development.

Revenue – Significant Risks Per the draft financial statements, total revenue for the year was $4 500 000. During planning, occurrence and cutoff of revenue and valuation of accounts receivable were identified as significant risks.

Completed Audit Work
1. On July 1, 2018, Big Dig, a mining company operating in Tajikistan, placed an order for 15 specialized drones equipped with infrared monitoring cameras. Each drone sells for about $75 000. The company was planning to use the drones to monitor its mines at night. Eye shipped the drones to Tajikistan on July 14, and they arrived in Dushanbe (capital city of Tajikistan) on July 25. The plan was to deliver the drones the next day to Big Dig’s location in the Pamir Mountains. However, due to heavy rains, the road through the mountains flooded and the drones couldn’t be delivered until August 4, 2018. Eye recognized revenue related to this sale when the drones landed in Dushanbe.

As part of verifying cutoff of revenue, Peter wrote an email to Eye’s sales manager asking him to confirm the date the drones were delivered to Big Dig. The manager replied that the drones were delivered on August 4. In his reply, the manager also wrote that he is currently away on a three-week vacation in Europe, but that from what he remembers the delivery term in the contract was FOB shipping point.

2. On July 29, Eye transferred an encrypted video file, containing surveillance images of potential mining sites, to one of its customers in Zimbabwe. For this work, Eye billed the customer $150 000. The customer wasn’t able to open or use the file because Eye used an encryption key not compatible with the customer’s computer system. After the customer reported the problem, Eye reformatted the file and sent it back on August 2, 2018. As part of verifying the occurrence and cutoff of revenue, Peter obtained the contract related to this transaction and matched contract details such as price and customer information to the invoice. Peter also matched the invoice total of $150 000 to a deposit in Eye’s September bank statement, as the customer had already paid for these services.

3. On June 25, Eye completed a mine surveying contract for a client operating in the El Caura region in Venezuela. Eye invoiced the customer $20 000 for the work. Due to strict Venezuelan banking rules enforced by President Maduro’s government, payment to foreign companies that conduct work in Venezuela can only be made in local currency, the Venezuelan bolivar. Money transfers in Venezuelan bolivar and conversion of the bolivar into other currencies fall under international anti-money laundering rules governed by the International Monetary Fund (IMF). In the course of their investigations, the IMF places a 90-day freeze on all international currency conversions and transfers of the bolivar, only releasing the funds to the recipient after the 90-day freeze elapses.

Due to an unstable political situation, Venezuela’s inflation rate in 2018 is estimated to have reached 1640%. This has had a significant effect on the exchange rate between the Venezuelan bolivar and the Canadian dollar. As part of verifying the existence and valuation of accounts receivable, Peter sent a confirmation letter to the IMF to confirm the amount of funds subject to the 90-day freeze. The IMF responded back saying that it had 1 500 000 bolivars and that it will approve the conversion and transfer of the funds to Eye on September 23, 2018.

4. In March 2018, a company operating mines in Peru ordered 11 drones from Eye with an upgraded long-lasting battery. The battery can extend flight times between recharges by up to 50%. Eye shipped the drones in April 2018, but unfortunately five of the shipped drones were not equipped with the upgraded battery. In June 2018, the mining company sent the drones on a long-distance flight and the five deficient drones ran out of power and crashed in a remote mountainous region of Peru. The customer immediately informed Eye about the crash. In July 2018, Eye uncovered the shipping mistake through an internal investigation and issued a $95 000 refund to the customer the next month.

As part of verifying the occurrence and cutoff of revenue, Peter obtained Eye’s August 2018 bank statement and searched for the refunded amount. He then vouched the amount to the credit note and the original contract.

5. In February 2018, Eye was hired by the King of Swaziland, Mswati III, to conduct drone surveillance of opposition group members. The King feared these members were trying to destabilize the country and overthrow him. A dispute arose when, having shipped too few drones to Swaziland, Eye was not able to carry out the surveillance to the extent that it promised to the King. The King now refuses to pay $300 000 for the work that Eye performed.

Despite the dispute, the King really liked Eye’s drones and bought five of them for $375 000. Eye delivered the drones to the King in June 2018 and he paid for them in September 2018. As part of verifying the existence and valuation of accounts receivable, Peter sent a confirmation letter to the King of Swaziland in early October. After waiting over two weeks for a response, Peter contacted the King’s representative. The representative told him that the confirmation has been received; however, everyone is on a one-month holiday celebrating King Mswati III’s birthday, and the confirmation won’t be processed until late November. Peter couldn’t wait that long, so he tested the existence and valuation of accounts receivable through an alternative procedure, looking at payments made by the King subsequent to year end. 

After finding the $375 000 payment on the September 2018 bank statement, Peter concluded that the entire $675 000 accounts receivable balance was stated correctly at year end.

REQUIRED

a. Review the audit work performed by Peter. For each of the five audit issues, discuss if the evidence he obtained is reliable and if his work related to the stated assertion.

b. Where applicable, suggest more reliable evidence that Peter should obtain and, if his work did not relate to the stated assertion, propose additional audit procedures.