Assume that you are auditing Paradox, Inc., a manufacturer of hand-held personal digital assistants (PDAs). The following is information that you have extracted from the audit working papers. The market for PDAs is very competitive with several companies battling for market share, which in turn has put downward pressure on profit margins. Rapid advances in technology have further reduced the product life cycle. In the race to remain competitive a number of companies, including Paradox, have significantly increased their research and development efforts. Funding the increased R&D has been a growing concern for Paradox. The company currently is actively seeking capital. Paradox is a public company listed on the NASDAQ exchange. Top managements compensation is heavily tied to the companys profitability. The company does not have an internal audit function and the audit committee has not been very diligent in the past.

1. What are your responsibilities to make sure the financial statements are free from material misstatement?

2. How will SAS No. 99 affect the procedures you will perform for this audit?

3. SAS No. 99 requires you to conduct a discussion among engagement team personnel. Based on the background information provided, what insights would you share with the other audit team members? Describe your insights in terms of the three characteristics of fraud, incentive, and rationalization.

4. When performing field work, you find that in responding to an accounts receivable confirmation, a customer notes that the receivable relates to a purchase that was made under the companys new extended return policy and the customer is still deciding whether to keep the items purchased. How does this new information affect your fraud risk assessments? How should you respond to this situation?