Like most high school graduates, Michael Dell had a sense of anticipation, if not exhilaration, when he left home to begin his college career. Because Dell planned to become a doctor, like his father, he declared premed as his major when he enrolled in the University of Texas (UT) in the fall of 1983. Over the next few months, Dell's interest in college waned as he began spending most of his time and energy on a hobby that he had pursued in high school, namely, tinkering with computers. By the end of his first semester at UT, Dell's dorm room had become a workshop in which he and a few friends tore apart, reconfigured, and then reassembled personal computers (PCs).
In the spring of 1984, Dell decided to go into business for himself. By the end of the spring semester, Dell's small business was producing more than $10,000 in revenues each month from the sale of PCs and PC-related products. The success of his business convinced him to drop out of college and create Dell Computer Corporation.
Less than a decade later, Michael Dell, at age 27, became the youngest chief executive officer (CEO) of a Fortune 500 company. Dell's company, which had been renamed Dell Inc., surpassed Compaq in 2001 as the world's largest manufacturer of PCs. By 2012, Dell's personal worth was estimated at nearly $15 billion, which placed him 22nd on the Forbes 400 list of the wealthiest Americans.
The critical feature of Dell Inc.'s business model that allowed it to grow so rapidly was the "Dell Direct" strategy of selling custom-designed PCs. The company's sales force took purchase orders over the phone or the Internet and then transmitted those orders to a production facility that assembled the PCs and shipped them in a matter of days. Unlike competitors, Dell spent only modest amounts on research and development.
Instead, Dell focused its operations on delivering state-of-the-art computer technology developed by other companies at the lowest cost possible by emphasizing operating efficiencies throughout its supply chain.
Increasing competition that caused profit margins to narrow dramatically on PC sales began undermining Dell's business model during the late 1990s. In 2002, Dell faced the unhappy prospect of reporting disappointing earnings to its investors. At that point, Intel Corporation, which provided the microprocessors for Dell's PCs, stepped into the breach and offered Dell "exclusivity payments" that would wipe out its earnings shortfall. Intel made these payments in exchange for a commitment from Dell that it would not purchase microprocessors from other suppliers, including Intel's principal competitor, Advanced Micro Devices, Inc. (AMD). Because AMD was developing microprocessors that were reportedly superior to those of Intel, Intel's management had become increasingly concerned that Dell would choose AMD as its primary supplier of microprocessors.

Questions
1. Define the phrase "earnings management." Under what conditions, if any, is earnings management acceptable? Do auditors' responsibilities include actively searching for instances of earnings management by clients? Defend your answers.
2. Dell recorded the exclusivity payments as an offset or reduction to its operating expenses. What "management assertion" did that accounting treatment violate? What audit procedure or procedures might have resulted in the discovery of that accounting treatment?
3. During the time frame that Intel was making exclusivity payments to Dell, Dell's business model was being adversely affected by the increasingly competitive nature of the PC industry. What responsibility, if any, do auditors have to analyze a client's business model? Do auditors have a responsibility to track and analyze key developments in a client's industry? Defend your answers.
4. What ethical issues do exclusivity agreements such as that between Dell and Intel raise? Are there analogous ethical issues faced by audit firms and their clients? Explain.