Module I: Assessment of Inherent Risk In this module, you will assess inherent risk after you have done the following: 1. Analyzed Brony's Bikes' organizational structure and prepared an organization chart; 2. Applied preliminary analytical procedures to Brony's Bikes' financial data; and 3. Studied Brony's Bikes' business operations and the bicycle manufacturing industry generally.

In completing this assignment, you may assume that Derick has decided on the following initial risk assessments: Inherent risk: 100% Control risk: 100% Audit risk: 5%

Overview of Brony's Bikes' Business and Industry As part of his continuing study of Brony's Bikes' operations, Derick has extracted the following additional data from the computerized permanent file entitled "Business and Industry."

1. In 20X9, in the face of increasing liquidity problems, payment of trade accounts payable within the specified credit terms became increasingly difficult. After much discussion with Harvey Bombenmyr, the president of Bank Two, and Bank Two's lending officers, Lawton was able to negotiate a ten-year 12% note payable for $45 million. The note is unsecured and is payable in equal annual installments, together with interest, beginning March 1, 20X9, and contains restrictive covenants. Those relevant to the Brony's Bikes audit are the following: a. A minimum balance of $10 million must be maintained in Brony's Bikes' demand deposit account with Bank Two; b. Further borrowing is prohibited until the Bank Two note has been amortized below $10 million; and c. Dividends may be declared only from retained earnings in excess of $45 million. d. In April 2008, Lawton borrowed $3 million from the company in exchange for an unsecured note. The transaction resulted in a debit to Account 1203 - Notes Receivable, Officers. According to Groth, Lawton planned to repay this note prior to December 31, 20X9.

2. Legal action against the company was initiated by Rollfast, a competitor, in late 20X8. The suit alleges that Brony's Bikes infringed on a process already patented by Rollfast. The process, according to Rollfast's attorneys, enables a bicycle manufacturer to produce a frame in one piece, thereby adding strength to the bicycle by eliminating welding. Brony's Bikes has responded to the action by demonstrating the unique characteristics of its bicycle frame which is also patented. By July 20X9, the suit had neither been heard by the court nor settled outside the courts by the litigants. Rollfast is suing Brony's Bikes for $50 million.

3. Although Lawton and Groth have intensified efforts in recent years to establish and implement a sound internal control system, the independent auditors have not seen fit to reduce the assessed level of control risk below the maximum level. If it is determined that the auditors' 20X8 recommendations have been implemented, however, Derick anticipates a reduction in the assessed level of control risk in one or more of the significant transaction cycles.

4. In the past, the audit team has used the internal audit staff only when necessary to assist in various phases of the Brony's Bikes audit.

Note: that all requirements for Modules I XV ignore the income tax effects of audit adjustments. We recommend only printing the results of these requirements if your instructor requires you to submit your work in paper form. Your instructor may require you to submit your completed workpapers in paper or electronic form for all 15 modules. Follow your instructor's directions on this.

1. a). Prepare a complete organization chart for Brony's Bikes based on the narrative contained in Brony's Bikes Intro and Module 1, the section titled "Brony's Bikes Personnel" and identify the major strengths and weaknesses in Brony's Bikes' organizational structure.

b). Refer to your self-prepared organization chart and the Partially Completed Figure BB.A: Brony's Bikes Organization Chart. Compare your organization chart to the Partially Completed Figure BB.A: Brony's Bikes Organization Chart. Certain boxes in Figure BB.A are blank except for a question reference number 1-8. Each box should contain either the last name of a person or the one, two, or three word function that should appear in the blank box.

1.1. From the dropdown menu select the correct last name or the function for blank box #1 on the organization chart. Selectproduct manageraccounts payabletransaction processingchief accountantfactory supervisorssales staffvice president marketingItem 1

1.2. From the dropdown menu select the correct last name or the function for blank box #2 on the organization chart. SelectRustMcAfeeFenningJohnstoneLawtonGrothGramblingItem 2

1.3. From the dropdown menu select the correct last name or the function for blank box #3 on the organization chart. Selectproduct manageraccounts payabledata entrytransaction processingchief accountantgeneral ledgerfactory supervisorssales staffItem 3

1.4. From the dropdown menu select the correct last name or the function for blank box #4 on the organization chart. Selectaccounts payabledata entrytransaction processingchief accountantgeneral ledgerfactory supervisorssales staffItem 4

1.5. From the dropdown menu select the correct last name or the function for blank box #5 on the organization chart. SelectRustMcAfeeFenningJohnstoneLawtonGrothGramblingItem 5

1.6. From the dropdown menu select the correct last name or the function for blank box #6 on the organization chart. Selectproduct manageraccounts payabletransaction processingchief accountantgeneral ledgerfactory supervisorssales staffItem 6

1.7. From the dropdown menu select the correct last name or the function for blank box #7 on the organization chart. Selectproduct manageraccounts payabledata entrytransaction processingchief accountantgeneral ledgerItem 7

1.8. From the dropdown menu select the correct last name or the function for blank box #8 on the organization chart. Selectproduct manageraccounts payabledata entrytransaction processingchief accountantgeneral ledgerfactory supervisorssales staffvice president marketingItem 8

1.9. Based on the organization chart you prepared, the internal audit function is independent of Brony's Bike's management. SelectTrueFalseItem 9

1.10. With respect to the Controller, Gerald Groth, is Groth's previous employment with Vaughn & Co. a strength or weakness in the control environment over financial reporting of Brony's Bikes? Selectstrengthstrength and weaknessweaknessneither strength nor weaknessItem 10

1.11. AU 315 Understanding the Entity and Its Environment and Assessing the Risks of Material Misstatement specifies that the auditor should, as part of understanding the entity, understand the organizational structure of the entity. State the specific citation within AU 315 that imposes this requirement on the auditor. Use the following form to enter your answer AU 315.paragraph number and any sub number.

2. Download the Excel file "20X9 Analytic Procedures WP A.1-7". The 20X9 Analytic Procedures file contains seven worksheets. Each workpaper (WP) is on a separate worksheet tab in the Excel file. WP A.1- Comparative income statements WP A.2 - Sales and cost of goods soldby product line WP A.3 - Comparative schedule of manufacturing overhead and operating expenses WP A.4 - Inventories WP A.5 - Budget vs Actual Income Statements (prepared by client - no calculations required) WP A.6 - Comparative Common Sized Balance Sheets WP A.7 - Wheels 4U Financial Statements 20X8 and 29X9 (These financial statements were obtained from Wheels' website - no calculations required).