Trusted Technologies Ltd. (TTL) provides technology solutions to manufacturing companies. TTL is a wholly owned subsidiary of

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Trusted Technologies Ltd. (TTL) provides “technology solutions” to manufacturing companies. TTL is a wholly owned subsidiary of Global World International Inc. (GWI), a publicly owned conglomerate. In 20X5, TTL was performing poorly and GWI considered selling the company for the best offer. As a last resort, GWI hired turnaround specialist, Jane Bowen, to more effectively manage and salvage TTL. Ms. Bowen’s employment contract specifies that in addition to an annual salary she would receive a $10 million cash bonus after the end of the 20X8 fiscal year if TTL meets a number of performance objectives over the 20X6 to 20X8 period. For 20X6 and 20X7, Ms. Bowen achieved the objectives. To meet the performance objectives for 20X8, TTL must report net income in excess of $30 million.

It is now January 25, 20X9. TTL’s financial statements for the year ended December 31, 20X8 have been received at GWI’s corporate offices. TTL’s net income for 20X8 is reported to be $30,550,000. GWI’s CFO has examined the financial statements and is satisfied with most aspects of them but is concerned with the reporting of some transactions and economic events. The issues of concern are described in the following Exhibit A.

Ms. Bowen has already called the CFO to arrange a meeting to discuss the financial statements and the payment of the bonus.

You are the staff member with Friedlan & Jones LLP, CPAs, GWI’s external auditor. The CFO met with the engagement manager and asked her to examine the issues of concern as a special engagement between your firm and GWI. The CFO wants a report that explains the problem in each issue, identifies reasonable alternatives, and provides full support for any conclusions. The engagement manager asked you to prepare a report to her that she will use in her next meeting the CFO on this issue.

Required:

Prepare the report requested by the audit manager.

Exhibit A Issues Identified on Your Review of TTL’s 20X8 Financial Statements

1) In the last week of December 20X8, TTL shipped a $1,250,000 control system to a new customer. The system is a standard product that had some minor modifications to meet needs of the customer. For the first time TTL bundled the control system with a number of other services. Jane indicated that she thought this would generate more business. The customer has been having financial difficulties, so TTL provided special financing terms that gave the customer four months to pay instead of the usual 30 days. Payment is guaranteed by the company that owns the customer. Included in the selling price is:

Control system—standalone value $1,100,000. Cost of system $710,000;

Standard two-year warranty against defects and failure to meet specification. This warranty is not sold separately. Average cost of fulfilling warranty claims per contract is $28,000;

Training—TTL will provide onsite training for staff on how to use the control system and maximize the benefit from it. Training will be provided in late January over a one-week period. Standalone value $85,000. Cost of providing training is $60,000;

Technical support—TTL will provide comprehensive technical support to address technical and operation problems with the system. This service can be purchased separately but was included in the overall purchase price following negotiations. Standalone value is $105,000;

Parts service—TTL will provide ship all needed replacement parts to the customer as needed for three years. The customer is responsible for installing the parts. Standalone value is $180,000. Average cost of providing parts in contracts like this over the term of the arrangement is $82,000

The order was scheduled to be shipped in early January, but because of an opening in the production schedule TTL was able to complete the order several weeks early. Once the order was completed, it was shipped to the customer. The customer agreed to accept early delivery before TTL shipped the order. The goods were received in good order by the customer on December 31, 20X8. TTL recognized revenue when the goods were delivered, as it normally does.

2) In September 20X6 TTL introduced a new type of system for auto parts manufacturers, based on a new technology. Because it was a new product using a new technology it came with a four-year rather than the standard two-year warranty. Once the product is established TTL plans to reduce the warranty coverage to two years. Since this product was introduced TTL has sold 385 systems.

Until August 20X7 warranty claims were small. However, beginning in September 20X8 warranty claims, particularly on older systems—ones sold in 20X6—became more frequent. To date, warranty claims that have cost TTL between $1,000 and $2,000 to fulfil have been made on seven of the 28 units sold in the fourth quarter of 20X6 (the first quarter the product was sold).

Jane Bowen thinks that most of the problems have arisen because of poor installation by third-party installers. She contends that since mid-20X7 all installers have been trained by TTL on how to do the job. Jane doesn’t think there will be more than 15 or 20 systems needing extensive service.

Information obtained from the chief engineer indicated that she examined the system and is satisfied there is no design flaw. However, she is concerned that there may be a problem with units that operate in humid conditions. She said that all seven of the systems that had the large warranty claims operated in humid conditions. Of the 385 systems sold about 170 are operated in humid conditions.

3) Early in 20X8, TTL entered into a contract to with a digital marketing company called “Digital Consultants” (DC). DC will provide TTL one year of service around the latest trends in digital technology, and will provide recommendations on how to reach a broader audience through their online platforms. In return, TTL will help to update DC’s internal reporting systems. TTL would normally charge $80,000 for this type of work. DC recently quoted a similar project for digital marketing consultations for around $65,000.