TechSol Group

TechSol Group $($TSG$)$ is a fast$-$growing, medium$-$sized business that primarily provides integrated server

solutions that manage the storage, organization, and retrieval of information. TSG provides IT solutions

by offering both server hardware and database management software.

TSG$\text{'}$s CEO, CFO, and COO are compensated based on a $10\%$ bonus of pre$-$tax net income if

revenues exceed $$4$ million. The net income and revenue measures are based on the financial

statements prepared in accordance with IFRS. The board of directors implemented such a bonus

structure in order to help align the goals of top management and shareholders, and also ensure that

executives do not cut discretionary spending in order to reach a net income bonus threshold.

TSG$\text{'}$s top management team is excited about the current year's results because the draft financial

statements reveal revenues in excess of the $$4-$million threshold and a bonus of $$156,390$ will be

payable. The draft financial statements are to be reviewed by the internal audit department, in

anticipation of the external auditor's field work next week.

You have just been hired as an internal auditor, reporting directly to the internal audit manager. The

manager has called you into her office to discuss your first engagement:

Manager: "Welcome to the team. We are very happy that you decided to accept our offer of

employment."

You: "Thank you. I am very excited to be here and look forward to being a part of the team."

Manager: "Excellent. Well, your first engagement is a very important task. I would like you to

review our draft income statement prior to the external audit next week. Specifically, I would like

you to focus on the revenue line item. Please prepare a report that outlines any concerns that

you have and addresses any accounting issues."

You: "Okay, sounds interesting. How can I start?"

Manager: "Well, here is a copy of the draft income statement $($Exhibit I$).$ In addition, I have

prepared the following notes of the current year's operations for your review $($Exhibit II$).$ This

should be enough to get you started on your report. We can meet again once you have prepared

your report."

You: "Sounds good. I'll get started right away."

Required

Prepare the report. EXHIBIT I $-$ DRAFT INCOME STATEMENT

For the year ended December $31($unaudited$)$ OPERATIONS

Mainframe Servers: TSG sells large mainframe servers for $$550,000.$ The cost of the server is $$300,000.$

TSG delivers and installs the server at the customer's site. The customer signs off on an acceptance form

once the server is installed and tested. TSG has never had a customer reject the installation of a

mainframe server.

In order to help promote sales, TSG began to offer a two$-$year warranty with all mainframe servers. The

warranty is expected to cost an average of $$45,000$ per server to service the warranty over the two$-$year

period. Industry competitors that offer similar warranties set the warranty price as two times expected

cost$.$

TSG has received orders for four mainframe servers during the current year, of which all four have been

delivered and installed and three have been accepted by the customer. During the current year, the

periods of the warranties for the servers covered by TSG totalled $13$ months.

Small Business Solutions: TSG$\text{'}$s typical small business solution customer is a growing business without a

designated information technology department that purchases server hardware. TSG sells a small

business solution of $$175,000,$ with payment in advance to allow TSG to order the servers. The small

business servers cost $$90,000.$

Included with the purchase of a server is one year of database management services. If a customer does

not want the database management services, TSG provides a discount of $$25,000$ from the mainframe

purchase price. All customers wanted the services in the current fiscal year and TSG provided a total of

$47$ months of DMS services as a result of these sales.

Database Management Services $($DMS$)$: TSG recently began marketing its DMS on a stand$-$alone basis for

$$3,500$ per month, which is consistent with competitor prices. As of year end, the company has not

received any orders for only DMS; however, management expects orders to begin to pick up shortly.

The gross margin percentage on the small business server and mainframe server is expected to be the

same.

Small business solutions server revenue is recorded when the cash is received.