Robin Yellowbird, CPA looked out his Edmonton office window at the snow that was falling on a grey, January morning. He was thinking about a discussion he had just finished with his audit engagement partner and an earlier phone conversation with the controller of his largest audit client, SmartTech Inc., a software developer that produces software and related technologies used in home automation applications. Robin has been an audit manager with the CPA firm Dolittle and Dunn for seven years, and he has been in charge of the SmartTech audit for the last four years. The audit for the December 31, 2023 fiscal year was just being completed, and the controller had phoned Robin to discuss one of the proposed audit adjustments. The conversation had been difficult, as the controller did not agree with the adjustment being proposed by Robin's audit senior. Robin had subsequently discussed the matter with the SmartTech engagement partner and was now feeling uneasy about the situation. During the 2023 fiscal year, SmartTech introduced a new product, the MicroPet 1000. This product allows for the remote monitoring of pets in the home while the owner is away, including an Internet controlled feeding device. Included in the purchase price of the product was a one-year warranty that provides for repair or replacement of any unit that fails to operate correctly. Sales increased significantly throughout the year, and the product introduction was initially considered a success. However, in October 2023, several warranty claims began to appear, due to the faulty operation of the feeding device. In some instances, the device did not release any food for the pet, and in a few cases, the device actually injured the pet. SmartTech agreed to replace all faulty devices, but some customers just wanted a refund. As well, several customers had threatened legal action as a result of the injuries to their pets. The adjustment proposed by Robin's audit team related to the accrual of expected warranty costs. Based on the incidence of faulty unit claims, the audit team had determined that a reasonable allowance would be $850,000. The SmartTech controller disagreed with this amount, stating that the initial quality problems had been fixed in the production process. As well, the controller stated that because the product was new, there was not enough available information to accurately calculate the warranty accrual. The controller suggested that no more than $50,000 should be accrued for expected warranty claims. The controller also indicated that company was very close to violating its debt-toequity ratio covenant, imposed by the company's bank, and that if this covenant were violated, the bank may enforce its rights to call and withdraw the operating line of credit. If this were to happen, the company would have significant problems managing its working capital. The controller had made this last point very clear to Robin during their phone conversation. The controller also hinted that difficulties with the audit adjustments could result in a change in auditor for the coming year. When Robin discussed this problem with the engagement partner on the file, the partner had indicated that he thought the client's estimate was more reasonable. He stated that the principle of measurement uncertainty required that amounts not be accrued if they could not be proven. The partner echoed the client's comments that because the product was new, there was not enough history to make a reasonable estimate. The partner also indicated that it was important to keep this client happy, because they were going to be requesting proposals for some specialized tax consulting work in the future. This work would be very lucrative for Dolittle and Dunn, and the partner suggested to Robin that his future prospects for partnership in the firm could be directly tied to the acquisition of this special work. Robin continued to watch the falling snow, uncertain how to proceed. He was certain that the $50,000 accrual was too low, but he did not know how to address the concerns of the controller and the partner. Required: Please answer the following questions. 1) The IFRS Conceptual Framework identifies measurement uncertainty as a factor in the application of the principle of faithful representation (sections 2.12 to 2.22 of the conceptual framework). As well, IAS 37 provides some guidance on how to measure uncertain amounts for the purpose of recognizing provisions (sections 36 to 40). Using the principles in these Handbook sections, discuss how Robin can best support his contention that the $50,000 provision is not reasonable. Explain your reasoning and indicate what information might be required to determine a reasonable provision. 2) Assume that the proposed tax consulting services are allowable under the CPA Rules of Professional Conduct and that the proposal is accepted. What safeguards should the firm put in place to mitigate any threats to independence? 3) Apply the GVV methodology and provide advice to Robin on how he should address his engagement partner when discussing this issue. Specifically, provide answers the following questions to assist Robin: a) What are the main arguments he is trying to counter? What are the reasons and rationalizations that will need to be addressed? b) What is at stake for the key parties, including those who may disagree with Robin? c) What levers can Robin use to influence those who disagree with him? d) What is the most powerful and persuasive response to the reasons and rationalizations Robin may face? To whom should the argument be made? When and in what context?

Answer rating: 100% (QA)

1 Discussion on Measurement Uncertainty and Provision for Warranty Claims Robin can best support his contention that the 50000 provision is not reasonable by emphasizing the principles of faithful rep... View the full answer