MVT is a midsize publicly traded industrial company that has been in operation for over ten years. This is the first year that North Central CPAs has been engaged to audit MVT.

Communication with the predecessor auditor revealed that the MVT audit engagement was discontinued by the predecessor firm as part of its effort to reorganize its client portfolio to meet an objective of more concentrated specialization in other industries. MVT manufactures commercial vacuum systems capable of absorbing large quantities of both loose materials and liquids, providing containment of hazardous substances during the vacuuming process. MVT also purchases new tank trucks and modifies them with large vacuum systems to create mobile vacuum units. These trucks can be moved to various locations as needed for industrial cleanup such as the collection and containment of excess waste materials and liquid spills, as well as for remediation of accidents and natural disasters like floods and hurricanes.

The preliminary planning documentation that North Central CPAs has compiled for the new MVT engagement includes historical financial statements prepared for both internal and external reporting, public information including company filings, and a series of questionnaires prepared by the audit managers during the client acceptance process to collect information about the company and its environment. This information indicates that the company has experienced remarkable sales growth in recent years, which is attributable to first time sales of vacuum trucks to new industrial and emergency services clients. While the industrial customer base continues to grow, the emergency services sector is somewhat dependent upon the much less predictable occurrence of natural disasters and accidental chemical spills. Due to anticipated supplier backlogs, MVT has purchased a large inventory of tank trucks that it expects will be sufficient to meet customer demand for the next 12 to 18 months, based on the prior year’s sales levels. This inventory of tank trucks can be fitted with standard or custom-designed vacuum units to meet customer specifications.

Sasha and Dak’s research shows that MVT operates in a profitable and dynamic industry, with new companies entering the market each year. In addition to sales of commercial vacuum units and tank trucks, the industry offers opportunities for servicing and aftermarket sales to buyers of vacuum units. MVT currently subcontracts its warranty repair and support services through an affiliated company. Estimates of warranty and support service costs are recorded based on information provided by the subcontractor. Despite the potential in the industry, MVT’s stock price has fallen 12 percent since its initial public offering five years ago, with the largest annual decline occurring during the current fiscal year. Management attributes the decline to an overall drop in stock market prices during recent months, coupled with the company’s inability to grow sales at the tremendous pace it had experienced in the past. Profitability ratios such as gross profit percentage and net profit percentage have declined over the last two years. MVT is feeling pressure to cap the growth in selling, general, and administrative expenses, despite the need to maintain or increase marketing and promotion efforts. Among the expenses that have grown recently is warranty expense, as the company offers an enhanced warranty to attract new customers without lowering the unit prices of its products.

While reviewing the MVT documentation, Sasha and Dak also learn that MVT recently started offering extended credit terms to customers and relaxed its credit evaluation standards. As a result, the collectability of amounts due from customers appears to be declining, as evidenced by an increasing collection period. In addition, MVT has excess capacity in its production capabilities based on current-year sales projections and has committed to investment in research and development to upgrade its products. The company has recently acquired a similar size industry competitor to leverage cost savings and economies of scale, and to expand its customer base. The acquisition was financed with cash and long-term debt. The long-term debt agreement includes restrictive covenants related to liquidity ratios and limitations on the assumption of additional debt. MVT is eager to convince stakeholders that the acquisition was a smart business move.

MVT Case Requirements

Address the following requirements to identify inherent risk factors and account for those risks as part of the substantive audit testing plan. Your instructor may provide an Excel worksheet to record your answers; the worksheet presents some of the options for use in parts (b), (c), and (d) of the assignment.

1. Based on the facts of the case, identify at least ten inherent risk factors that should be considered during the planning phase of the MVT audit. You may wish to analyze and organize your responses according to the five categories of inherent risk factors suggested by the PCAOB and listed on page 10.
2. For each inherent risk factor identified in part (a), indicate if it is an entity-level risk that potentially affects the financial statement as a whole, or risk at the assertion level that could lead to misstatement of a specific account on the financial statements.
3. For each inherent risk factor identified in part (b) as presenting risk at the assertion level, identify a significant financial statement account at risk of material misstatement, and a relevant management assertion for the risk and account identified. As a source of assertions to consider, refer to the PCAOB list of assertions in Exhibit 1, plus the cutoff assertion as used by North Central CPAs.
4. For each of the accounts and assertions identified in part (c), describe a specific substantive task employing an audit procedure that could be performed by the North Central CPAs audit team. You may wish to first select a type of audit procedure from those provided in the PCAOB guidance in Exhibit 2, Panel A, then elaborate on the nature of an audit task that would be appropriate.