Munich IT Solutions (MITS) is a fast-growing, medium-sized business that primarily provides integrated server solutions that manage the storage, organization, and retrieval of information. MITS provides IT solutions by offering both server hardware and database management soft ware.

MITS’s CEO, CFO, and COO are compensated based on a 10% bonus of pre-tax net income if revenues exceed $4 million. The net income and revenue measures are based on the financial statements prepared in accordance with IFRS. The board of directors implemented such a bonus structure in order to help align the goals of top management and shareholders, and also ensure that executives do not cut discretionary spending in order to reach a net income bonus threshold.

MITS’s top management team is excited about the current year’s results because the draft fi nancial statements reveal revenues in excess of the $4-million threshold and a bonus of $156,390 will be payable. Th e draft financial statements are to be reviewed by the internal audit department, in anticipation of the external auditor’s field work next week.

You have just been hired as an internal auditor, reporting directly to the internal audit manager. Th e manager has called you into her office to discuss your fi rst engagement:

Manager: “Welcome to the team. We are very happy that you decided to accept our offer of employment.”

You: “Thank you. I am very excited to be here, and look forward to being a part of the team.”

Manager: “Excellent. Well, your first engagement is a very important task. I would like you to review our draft income statement prior to the external audit next week. Specifically, I would like to you focus on the revenue line item. Please prepare a report that outlines any concerns that you have, and addresses any accounting issues.”

You: “Okay, sounds interesting. How can I start?”

Manager: “Well, here is a copy of the draft income statement (Exhibit I). In addition, I have prepared the following notes of the current year’s operations for your review (Exhibit II). This should be enough to get you started on your report. We can meet again once you have prepared your report.”

You: “Sounds good. I’ll get started right away.”

Required Prepare the report.

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EXHIBIT I - DRAFT INCOME STATEMENT For the year ended December 31 (unaudited) Sales Mainframe server sales Small business solution sales $2,200,000 2,625,000 $4,825,000 Cost of sales Mainframe server 1,200,000 Small business solutions 1,350,000 Gross profit 2,550,000 $2,275,000 Expenses Advertising and promotion Amortization $ 187,950 98,000 Insurance 16,540 Interest 19,560 Legal and accounting 8,900 Lease expense 44,500 Office and general expenses 25,000 Repairs and maintenance 17,000 Utilities Wages and benefits 34,000 272,000 723,450