Case Study 1 (20 marks): DEF Ltd is a global leader in the manufacture, integration and support of networking and
telecommunications systems. The company sells broadband wireless products and a line of handset
equipment to operators in emerging and established telecommunications markets worldwide. The
auditor reported material weaknesses in the company’s internal controls to the audit committee.

Significant deficiencies related to revenue and deferred revenue accounts and the associated cost
of sales were noted. These material weaknesses were evidenced by the identification of six separate
transactions aggregating approximately $5 million in which revenue was initially included in the
Company’s financial statements before all criteria for revenue recognition were met. In addition,
there were other transactions for which there was insufficient initial documentation for revenue
recognition purposes, but which did not result in any adjustments to the Company’s financial
statements. If unremediated, these significant deficiencies have the potential of misstating revenue
in future financial periods.

The Company’s planned remediation measures reported to the audit committee include the
following:

a. The Company plans to design a contract review process in China requiring financial and
legal staff to provide input during the contract negotiation process to ensure timely
identification and accurate accounting treatment of nonstandard contracts.
b. The Company conducted a training seminar regarding revenue recognition, including
identification of nonstandard contracts, in Australia and a similar seminar in China. The
Company plans to conduct additional training seminars in various international locations
regarding revenue recognition and the identification of nonstandard contracts.
c. The Company will begin requiring centralized retention of documentation evidencing
proof of delivery and final acceptance for revenue recognition purposes.

Required:

1. Using the disclosures above as a starting point, brainstorm about the challenges regarding
internal controls and that a company may face in doing business internationally? (5 marks)
2. The company has disclosed its planned remediation efforts. How might the auditor use that
information during the next year’s audit in terms of audit planning? (5 marks)
3. Considering potential analytical procedures relevant to the revenue cycle, identify what
types of analytics might be applied in the next year’s audit to provide evidence that the
problems detected have been remedied. (5 marks)
4. Considering potential substantive tests of revenue, identify procedures that might be
applied in the next year’s audit to provide evidence that the problems detected have been
remedied. (5 marks)