ole3 GPC's primary objective is to increase revenue 7% and net income 6% in each of the next 4 years prior to a planned initial public offering (in year 5).

The company producess. Hans refuses to purchase from large corporate farms.

The company cannot expand at its present location without purchasing additional acreage. The cost of farm land has been increasing 5% per year.

Their product has earned numerous awards which has provided strong name recognition in Wisconsin. They sell to grocery stores, restaurants, organic food outlets, and online customers. They also sell to a wholesale distributor with access to Illinois, Iowa, Michigan and Ohio. The company is seeking store locations and distributors in other states.

The business is wholly-owned by the Schmidt family, but they are considering doing an initial public offering ("going public") in 5 years. Hans owns 60% and is the CEO. His four children each own 10%. The board is composed of the 5 owners and a family friend who is a lawyer. Hans is chairman of the board. The board does not have a separate audit committee. GPC does not have an internal auditor. An annual audit is required by their bank, The Lake Country Bank.

Han's daughter, Leah Scott, CPA, was recently hired as CFO. She replaced her brother Joe who left abruptly after 10 years. Other family members are employed as department heads. Hans encouraged his family to earn advanced degrees and work for other companies before joining the family business.

The company's sales have been increasing rapidly. The company has reinvested in its operations.

GPC's former auditor is Wilks and Company. When Leah became the new CFO, she suggested a change of firms. She explained that it would be easier working with her former colleagues. She was a Wallace and Brace staff auditor for 4 years, and "knows how they operate."

The Organic Cheese Industry

The organic cheese industry is expected to grow 5-8% per year compared to the non-organic segment which are not expected to grow. New competitors are entering the industry because of the higher profit margins. They may use predatory pricing in order to gain market share. GPC is responding by aggressively marketing new products.

GPC's competitive advantage is that they are the first US cheesemaker to win a world-class award. Since Hans is nearing retirement, they are seeking a highly-skilled cheesemaker from France.

The primary business objective is to increase revenue by 7% and net income by 6% per year for the next 4 years. They will do this through developing new products, aggressive marketing, new stores, and adding new markets. They plan to open a new retail store in each of the next 4 years, assuming they are able locate desirable locations. This year GPC hired a new marketing firm and has increased their advertising.

This year, they implemented 2 new policies in which they offer credit to grocery stores with higher credit risk. They feel that their past policies were too restrictive and limited their sales. They are also offering their sales staff bonuses based on a percentage of sales to grocery stores. They believe that this will lead to higher sales and ultimately to greater profits.

Higher income families consume 70% of organic dairy products, and consumption is highest among adults between ages 25 and 65. Most economists predict modest wage growth in the next 5 years. A few economist predict a recession around year 4.

The industry has seen some merger activity in an attempt to benefit from economies of scale. Large cheese manufacturers are launching organic product lines. This will lead to greater price competition.

In the most recent year, 2.56 billion pounds of organic milk products were sold. That amount represented 5 percent of all milk products. More than 2,500 farms in the United States produced organic milk. Nearly 280,000 dairy cows were certified organic, up from 241,112 dairy cows in the previous year. California produces 20% of the annual organic milk produced. Wisconsin, Texas, and New York produce about 10% each.

Some dairy operations manufacture and sell locally. For national distribution, products tend to move from the farm to a cooperative processor and then to a private distributor before reaching retail outlets.

Organic products sell at a price approximately double the price of non-organic products, but they cost more to produce. Organic feed costs more than standard feed, and organic production uses more labor and capital. Grass-fed cows produce less milk.

USDA standards for organic food were implemented in 2002. Organic dairy is raised in a production system that promotes and enhances biodiversity and biological cycles and uses only organic feedstuffs and health protocol. It is based on minimal use of off-farm inputs. Dairy cattle producing organic milk are not given antibiotics and growth hormone stimulants. In general, organic foods are minimally processed with artificial ingredients or preservatives.

Recent mergers in the organic milk industry could result in lower organic milk prices which reduce the price paid to milk producers. There is also concern that the industry is being dominated by mega-farms. The small producers accuse these large operations of not complying with all the organic regulations. The mega-farms have also created excess supply which suppresses milk prices. The imbalance of power could put small family farms out of the industry. The number of family-farms is expected to decrease. This would allow the larger producers to control the market (and price) of milk.

The company subscribes to industry research in order to monitor economic and industry conditions which may affect future sales. They also monitor competitors' prices and products.

Information from Predecessor Auditor, Wilks and Company

The previous auditor replied that they were comfortable working with the staff and management of GPC. The people have integrity, and are open to recommendations.

They expressed admiration for Hans's business instincts and GPC's distribution channels. Hans is nearing retirement, and though the children are equally dedicated to the business, they do not have his skills.

Wilks and Company will allow Wallace and Brace, CPA to review their audit working papers.

Audit Practice Set Part 1: Audit Planning and Risk Assessment

Instructions:

After reading the document entitled "Green Pastures Cheese, LLC: Background" and completing ratios in the preliminary analytical procedures Excel workbook, respond to each question with complete sentences and reasoning to support your answer. Cite sources.

Wallace and Brace CPA assign a partner to screen and recommend (or decline) potential clients prior to acceptance. Discuss at least 4 specific issues which should have been considered prior to accepting GPC as a client and how they impacted the decision. (Consider both positive and negative factors.)

How does the ownership structure of Green Pastures Cheese affect the type of audit and the auditing standards to be applied?

Discuss the extent to which Wallace and Brace CPA may be liable to 3rd parties. Do the 1933 and 1934 Acts apply to this audit? Why or why not?

GPC has adopted 2 new policies which should be considered in planning the audit. Describe the 2 polices and explain how they might lead to material errors. (What accounts could be misstated?)

Identify 3-5 factors which affect GPC's business risk. For each factor indicate a business objective which could be affected by the particular risk.

1 (i) There are n 1 people working on a project. If the ith person contributes xi 0 hours (1 i n), the resulting utility for each individual j is given by uj(x1; : : : ; xn) = 100 n i=1 xi 1 + n i=1 xi xj All individuals choose their efforts simultaneously aiming to maximize their utility. (a) Find all pure-strategy Nash equilibria, and find the unique symmet- ric pure-strategy Nash equilibrium, i.e., an equilibrium in which all people contribute the same number of hours x. Find the value of x, and the utility for each player in that Nash equilibrium. (8 marks) (b) Suppose that the individuals can sign a contract agreeing on their (equal) contribution to the project. If what utility would each person obtain? (5 marks) (ii) Alice and Bob play a game given in strategic form as follows: I II III A 2, 1 3, 4 5, 3 B 4, 3 1, 2 2, 1 C 3, 8 0, 6 1, 6 (a) Find all weakly dominated strategies and all strictly dominated strategies. (2 marks) (b) Eliminate iteratively all strictly dominated strategies. (2 marks) (c) Find all pure-strategy and all mixed-strategy Nash equilibria of this game.

2 (i) Consider a finite, two-player, zero-sum game G = (S; T; u). (a) Describe the sets R and C of mixed strategies of both players. (2 marks) (b) Define the value of the game G. (2 marks) (c) Define what optimal strategies of G are. (2 marks) (d) Let p and q be optimal mixed strategies for the row and column players, respectively. Show that (p; q) is a Nash equilibrium. (7 marks) (ii) A magic square is an nn array where each integer from 1 to n2 occurs and with the property that all row and column sums are equal. For example, 2 664 16 3 2 13 5 10 11 8 9 6 7 12 4 15 14 1 3 775 is a 4 4 magic square. Consider a two-player zero-sum game G whose payoff matrix for the row player is a n n magic square. Find the value of G and find optimal strategies for both players. Explain your answer in detail. (12 marks) MAS348

1 (i) Alice and Bob participate in a first-price sealed-bid auction, by bidding a and b respectively, where a and b are integers satisfying 0 a 3 and 0 b 3. When the bids are revealed, if there was a highest bid, the person who made that bid pays the amount of the bid and receives the object. If a = b, a winner is chosen randomly by tossing a fair coin, and the person chosen as winner pays their bid and receives the object. The object on sale is worth 3 for Alice and 2 for Bob. (a) Describe this auction as a game in normal form in which players' utilities are the expected values of their profits. (6 marks) (b) Find all weakly dominated strategies and all strictly dominated strategies. (6 marks) (c) Find all pure-strategy Nash equilibria of this game. (5 marks) (ii) Alice Inc. and Bob Plc. form a duopoly in the market for kryptonite. The cost of producing 1 gram of kryptonite is 10 for Alice and 20 for Bob. The price p(q) of one gram of kryptonite as a function of its supply q in grams is given by p(q) = 1000 q/10. Alice and Bob will decide their production levels independently and simultaneously. Find a production profile which results in a Nash equilibrium. (8 marks) 2 (i) Alice and Bob face the following game in normal form l m r U 1, 2 3, 0 1, 3 M -1, 3 2, 5 0, 4 D 0, 5 7, 0 3, 2 (a) Eliminate iteratively all dominated strategies. (2 marks) (b) Find all Nash equilibria of this game. (11 marks) (ii) Alice and Bob face the following game l r U 0, 0 4, 4 D 2, 7 9, 3 and choose to negotiate an outcome, with the knowledge that, if they fail to strike a deal, utilities of 3 will be imposed on both. (a) Sketch the cooperative payoff region of the game. (4 marks) (b) Describe parametrically the payoffs that satisfy the Individual Rationality and Pareto Optimality conditions. (3 marks) (c) Find the Nash Bargain of this setup. (5 marks) MAS348 3 Turn Over MAS348 3 (i) Country A learns that country B is boosting its military in preparation for a possible invasion. A has a choice between preparing for an invasion, at a cost if 100 units of wealth, and not preparing, in full view of B's spies. In case of invasion, a prepared A can choose to destroy its entire infrastructure at an additional cost of 900 units of wealth, or not to do so. If an invasion occurs and A's infrastructure is not destroyed country B gains 100 units of wealth and A loses 100 units of wealth (in addition to the preparation cost of 100 units, if A has prepared). If an invasion occurs and A's infrastructure has been destroyed, B loses 5 units of wealth. If no invasion occurs, country B gets nothing. (a) Describe this game using a tree, carefully labelling all its components. (5 marks) (b) Solve this game using backward induction. (3 marks) (c) Describe the game in strategic form, find all its pure-strategy Nash equilibria and indicate which of these is subgame perfect. (7 marks) (ii) (a) State Zermello's Theorem for finite, two-player sequential games. (3 marks) (b) Consider a game played with 10 dots drawn on a sheet of paper. Two players, Red and Blue, alternate in choosing a pair of dots which has not been chosen before by either player, and connecting the two dots with a line of their colour. Red moves first. The game ends if either there are four dots pairwise connected with lines of same colour, in which case that colour is declared the winner, or if all pairs of points have been connected with a line, but there is no winner, in which case the game ends with a draw. Use a strategy stealing argument to prove that there is a strategy that guarantees a win or a draw to the first player to move. (7 marks) MAS348

1 Short Answer Questions 1. The price elasticity of demand for gasoline is -2%. If the government wants to reduce gasoline consumption by 20% how much should it increase the price of gasoline? 2. The cross-price elasticity of good x as a consequence of an increase in the price of good y is -0:5. Are goods x and y substitutes or complements? 3. Suppose that 2 identical rms produce the same good at marginal cost c and they compete a la Bertrand. Draw the best response of Firm 1. 4. When do we say that a rm has market power? Can you name two sources of market power? 5. Suppose that the elasticity of demand for cars in Germany is -2 and -3 in the U.K., while the marginal cost of these cars is $20,000. How will prices dier in Germany and the U.K.. 2 Monopoly, Cournot and Stackelberg KEY - The market demand function for gelato in Summersville is Qd = 70 P 2 Its cost function for producing gelato is TC = 5 + 20Q. 1. What is xed cost, the variable costs, average costs and marginal costs of producing gelato? Does the cost function of gelato have economies or diseconomies of scale? 2. Suppose that there is only ONE producer of bathing suits. Find the prot-maximizing quantity and price for bathing suits. 1 3. Suppose that rm can perfectly price discriminate (rst degree price discrimination). How much will is produce? How much will its prots be? 4. What will be the equilibrium prices and quantities, if there are TWO rms that choose quantities simultaneously? (Cournot Competition). 5. Now assume that the rst rm gets to choose quantity before the entrant. What are the quan- tities that these rms will produce and the price in the market (Stackelberg Competition). Why are these quantities dierent? 2

1 (i) Alice and Bob participate in a first-price sealed-bid auction, by bidding a and b respectively, where a and b are integers satisfying 0 a 3 and 0 b 3. When the bids are revealed, if there was a highest bid, the person who made that bid pays the amount of the bid and receives the object. If a = b, a winner is chosen randomly by tossing a fair coin, and the person chosen as winner pays their bid and receives the object. The object on sale is worth 3 for Alice and 2 for Bob. (a) Describe this auction as a game in normal form in which players' utilities are the expected values of their profits. (6 marks) (b) Find all weakly dominated strategies and all strictly dominated strategies. (6 marks) (c) Find all pure-strategy Nash equilibria of this game. (5 marks) (ii) Alice Inc. and Bob Plc. form a duopoly in the market for kryptonite. The cost of producing 1 gram of kryptonite is 10 for Alice and 20 for Bob. The price p(q) of one gram of kryptonite as a function of its supply q in grams is given by p(q) = 1000 q/10. Alice and Bob will decide their production levels independently and simultaneously. Find a production profile which results in a Nash equilibrium. (8 marks) 2 (i) Alice and Bob face the following game in normal form l m r U 1, 2 3, 0 1, 3 M -1, 3 2, 5 0, 4 D 0, 5 7, 0 3, 2 (a) Eliminate iteratively all dominated strategies. (2 marks) (b) Find all Nash equilibria of this game. (11 marks) (ii) Alice and Bob face the following game l r U 0, 0 4, 4 D 2, 7 9, 3 and choose to negotiate an outcome, with the knowledge that, if they fail to strike a deal, utilities of 3 will be imposed on both. (a) Sketch the cooperative payoff region of the game. (4 marks) (b) Describe parametrically the payoffs that satisfy the Individual Rationality and Pareto Optimality conditions. (3 marks) (c) Find the Nash Bargain of this setup. (5 marks) MAS348 3 Turn Over MAS348 3 (i) Country A learns that country B is boosting its military in preparation for a possible invasion. A has a choice between preparing for an invasion, at a cost if 100 units of wealth, and not preparing, in full view of B's spies. In case of invasion, a prepared A can choose to destroy its entire infrastructure at an additional cost of 900 units of wealth, or not to do so. If an invasion occurs and A's infrastructure is not destroyed country B gains 100 units of wealth and A loses 100 units of wealth (in addition to the preparation cost of 100 units, if A has prepared). If an invasion occurs and A's infrastructure has been destroyed, B loses 5 units of wealth. If no invasion occurs, country B gets nothing. (a) Describe this game using a tree, carefully labelling all its components. (5 marks) (b) Solve this game using backward induction. (3 marks) (c) Describe the game in strategic form, find all its pure-strategy Nash equilibria and indicate which of these is subgame perfect. (7 marks) (ii) (a) State Zermello's Theorem for finite, two-player sequential games. (3 marks) (b) Consider a game played with 10 dots drawn on a sheet of paper. Two players, Red and Blue, alternate in choosing a pair of dots which has not been chosen before by either player, and connecting the two dots with a line of their colour. Red moves first. The game ends if either there are four dots pairwise connected with lines of same colour, in which case that colour is declared the winner, or if all pairs of points have been connected with a line, but there is no winner, in which case the game ends with a draw. Use a strategy stealing argument to prove that there is a strategy that guarantees a win or a draw to the first player to move.