Revolution Com (RC) operates in the telecommunications industry. It sells long-distance, local telephone access, mobile, internet and data services to end users (both corporate and private customers). RCs draft 2023 financial statements are in Appendix I.

The telecommunications industry in Canada is highly regulated and competitive. Each year RCs has its operating licence renewed by the Canadian Radio-television and Telecommunications Commission (CRTC). Currently RC serves approximately 25,000 customers. Revenue from the largest customers is approximately $300,000 each annually. Smaller customers provide annual revenue of $1,000 each.

You, Fred Taylor, CPA, are employed by Ipp and Winter, CPAs, LLP. The engagement partner, Harry Simpson, CPA is the engagement partner on the audit of RCs financial statements for the year ended August 31, 2023. Ipp and Winter have developed a good relationship with RCs management over the years and have not identified any reasons why their relationship with RC should be discontinued.

Ipp and Winter completed the audit plan in June 2023 and the results were presented to the RCs board of directors.

RCs board of directors believe a potential share offering is a possibility in the next year and the company in the early stages of considering an initial share offering to generate additional funds.

The audit work related to RCs Ltd.s August 31, 2023 year-end is underway. However, the audit senior working on RCs financials has been unable to work for the last three weeks due to illness. Harry is anxious to complete the work required for the audit since the audit client has imposed a deadline, and he wants you to take over the audit work for RC. You have indicated to Harry that you have never audited a company in the telecommunications industry before. Since there are no other accounting firm employees who are more experienced than you, Harry insisted that you review RCs excerpts from the draft financial statements and the executive reporting documents and complete the audit of RCs financial statements. He requests you to provide the draft audited financial statements for his review in two weeks time. Before starting your work, Harry asks that you first read the information below.

Meeting with Tom Brady, President of RCs

You have a preliminary meeting with Tom Brady where he says the following Since your firm has done the audit for a number of years and not much has changed, I am going to suggest the audit staff not ask many questions of my staff this year-end. We recently lost two key finance staff and are scrambling just to get the bills paid. In addition, the company is in the process of implementing a new billing system.

Tom asked you to complete the audit by the end of September 2023, because RC has to send the audited financial statements to CRTC for their consideration of renewal of the license. If the renewal is not granted, RC may have to suspense its operations in a few months time.

Tom offers to give you an Apple I-phone 14 Pro in return for your cooperation and completion of the audit on time.

In addition, he would like to treat the audit staff as their companys staff. He offers to give the staff discount to the audit staff on the RCs audit to purchase an Apple I-phone 14 Pro each. Normally, the staff discount price is 30% less than the ordinary customers price.

Notes prepared by the previous audit senior before he went on sick leave

Letter from Canadian Radio-television and Telecommunications Commission (CRTC)

In early September 2023, RC received a letter from the CRTC regarding its CRTC fee calculations. CRTC has informed RCs management their intentions to revoke its operating license based on RCs continuing failure to comply with CRTC regulations. The license could possibly be revoked on November 30, 2023. RC has asked its lawyers to look into the matter.

Control Environment (noted by the previous audit senior)

During the interim audit, we did an evaluation of the internal control environment at RC. We observed the following:

• Tone at the Top Tom is a business person and seems not to care about internal controls. He thinks implementing controls would add unnecessary costs and inefficiency to the operations.
• Board of Directors meets only once a quarter. In their board meetings, they discussed sales and operations issues more than financials and controls.
• Tom believes counting inventory on a periodical basis would slow down the sales operation. He ordered that inventory counting is only carried out once a year on the New Year Day. The RC employees have informed us that there were several inventory counting errors over the year. These inventory shortages were not accounted for in the financial statements.
• The accounts receivable is not regularly reviewed to provide for doubtful accounts on a timely basis.

Inventory

Inventory at RC consists of routers and modems that RC sells to its customers. Total inventory on August 31, 2023 had a book value of $3,219,000. The inventory level at year end would appear to be extremely high and may require write-down. The main reason for the substantial increase in inventory relates to the $2,500,000 of inventory which was purchased in September 2022. Given that the inventory tends to have a short life (typically 12 months), it is not clear why RC would purchase such a large quantity of inventory as its annual sales do not justify such a large purchase.

Deferred Research and Development Costs

Research and development (R&D) expenditures include projects in process that may or may not become commercially viable. All research and development costs are expensed as incurred in Administration Expense on the statement of comprehensive income unless they have been capitalized as noted below.

The largest project is the Wireless Technology Project which is expected to improve margins by 5% for all products and services due to more efficient distribution methods. RC is seeking $20 million from Loyal Bank of Canada to fund the additional expenditures in its Wireless Technology Project. Loyal Bank of Canada requires audited financial statements to accompany the loan application for their review and evaluation.

We have reviewed the Accounting Guidance for research and development costs and consulted the firms Accounting Standards Department. RC clearly does not meet all of the criteria for recognition as an intangible asset. We need to discuss this with Tom Brady as soon as possible.

Wireless Network Outage

On May 21, 2023, RC experienced a service outage across the wireless networks. The cause to a network system failure following a maintenance update in RCs core network, which caused some of their routers to malfunction. RC disconnected the specific equipment and redirected traffic, which allowed their network and services to come back online over time (several days after the incident) as they managed traffic volumes returning to normal levels.

The outage had caused many corporate business clients business interruptions (e.g., Interac transactions could not be processed through the network) and private clients could not use their smart phones. Some customers could not reach emergency services, that is 911, which is mandatorily required by CRTC.

Due to many customers complaints, RCs management had to compensate their customers. It would proactively credit the customers account for the 5-day outage. This credit will be automatically applied to all the customers bills and no action is required from the customers.

Many corporate and private customers were still not happy with this arrangement. They threatened to launch a class action lawsuit against RC.

In addition, CRTC had announced to form a commission to investigate the incident. CRTC had indicated that penalty and or suspension of license could be possible.

Management Bonus

To ensure retention of top talent, RCs management has implemented a management bonus plan in 2023. The plan will cover senior employees. The total bonus payout is based on profitability and is $1,000,000. It has been charged to Administration Expense in 2023.

Sales Commissions

To meet targets, sales staff will be given higher quotas. The salespeople are paid a base salary of $45,000 per year. If they meet their quota, they can earn up to $85,000 per year including commissions. Comparable positions in the industry are paid a base salary of $65,000 plus commissions. RCs management believe that keeping their sales force motivated to earn commissions through a lower base salary encourages them to make sales.

APPENDIX I

EXCERPTS FROM 2023 REVOLUTION COM

DRAFT FINANCIAL STATEMENTS

DRAFT STATEMENT OF FINANCIAL POSITION

As at August 31

(unaudited) in $000

	2023	2022	2021
Assets
Current Assets
Cash	351	8,321	8,546
Accounts receivable	15,865	6,788	5,034
Inventory	3,219	883	881
Non-current Assets
Property, plant and equipment	62,533	65,643	66,343
Intangible assets	10,754	1,655	1,667
Total Assets	92,758	83,327	82507
Liabilities
Current liabilities
Trade and other payables	13,066	8,719	8,713
Current portion of long-term debt	9,200	7,800	7,800
Non-current liabilities
Long-term debt	44,153	41,647	39,546

APPENDIX I (continued)

EXCERPTS FROM 2023 REVOLUTION COM

DRAFT FINANCIAL STATEMENTS

DRAFT STATEMENT OF COMPREHENSIVE INCOME

For the years ended August 31

(unaudited) in $000

	2023	2022	2021
Revenue	65,072	65,177	65,813
Cost of sales	30,715	30,592	30,427
Gross profit	34,357	34,585	33,386
Expenses
Selling and marketing	16,875	16,584	15,095
Administration	13,336	16,411	15,417
	30,211	32,995	30,512
Operating profit	4,146	1,590	2,874
Interest expense	2,968	2,878	2,776
Profit (loss) before income taxes	1,178	(1,288)	98
Income taxes	-	-	-
Profit (loss) and comprehensive income	1,178	(1,288)	98

Required:

1. Identify two potential breaches of the Professional Rules of Conduct for Ipp and Winter. For each breach, identify the type of breach that may exist including a rationale and a safeguard to eliminate or reduce the threat or breach.

Use the following table format for your answer:

Situation (case facts) that causes a breach of the Professional Rules of Conduct	Type of breach including a rationale (List one only type)	Safeguard to eliminate or reduce the threat/breach

B. Identify four case facts that impact the risk of material misstatement at the overall financial statement level. For each factor identified, indicate if the factor increases or decreases risk, the type of risk (inherent risk or control risk) and provide your rationale for why the factor increases or decreases risk.

Use the following table format for your answer:

Case fact which impacts RMM at OFSL level	Does this factor increase or decrease risk	Type of risk (inherent risk or control risk)	Rationale for why this factor increases or decreases risk
1.
2.
3.
4.