You couldn't be more thrilled about being on your first financial statement audit as you launch into your new professional accounting career. Having recently graduated with a Hons. Bachelor of Commerce Degree in Accounting, you are excited to be employing all the skills acquired in your rigorous accounting program. The client engagement you're now working on is Pristine Corporation, which is a California-based developer and marketer of software used to manage data storage functions for complex computer networks. Pristine Corporation particularly markets its products to other companies who serve as intermediaries for government purchasers. These intermediaries purchase Pristine Corporation products and then "resell" them to government purchasers and other organizations. The company's stock is quoted on the NASDAQ National Market System. The audit manager in charge of the engagement assigned you responsibility for auditing revenues for Pristine Corporation. You are excited to be in charge of this highly significant account and are enjoying the work you've done so far in the audit of some of the significant revenue transactions recorded during the year. The financial statements under audit are for the fiscal period ended September 30, 2019.

You have gathered quite a bit of information about several of the revenue transactions for the year. One of the transactions particularly caught your attention given its size. So, you're in the process of assessing the evidence obtained to determine if the revenues from this transaction are fairly stated. You obtained this information from reviewing documentation related to the transaction and from inquiries you made of the vice president of sales and the accounts controller. You made the following notes about what you've learned and are now preparing for a meeting with the audit manager to discuss issues related to the transaction. Here's what you've noted so far: During July 2019, Pristine's vice president of sales sent a proposal to Pacific Inc, to sell $7 million worth of Pristine's software and services to the U.S. Air Force. Pristine approached Pacific Inc. because Pacific has a relationship with the U.S. Air Force while Pristine does not. Pacific Inc. is a necessary intermediary under the government's procurement regulations. Under terms of the proposal, Pacific would place a $7 million order for Pristine software and services by September 30, 2019, which is the last day of Pristine's fiscal year. In exchange, Pacific would receive a sizeable commission and become an exclusive reseller of Pristine products for the Air Force.

Pristine normally must enter into "reseller agreements" with intermediaries such as Pacific to complete transactions. However, given the short timetable, Pacific was unable to obtain necessary corporate approvals from its legal department to sign a reseller agreement with Pristine before year end on September 30. As a substitute for the reseller agreement, Pacific's buyers agreed to place its order through an "order letter" that would later be followed by a purchase order and the reseller agreement. Before the order letter was submitted, Pacific's legal department requested that Pristine grants Pacific the right to cancel its obligation to pay Pristine the $7 million if Pristine and Pacific were unable to negotiate a mutually acceptable reseller agreement within 30 days. In late September, Pristine's vice president of sales emailed and faxed a letter on Pristine letterhead to Pacific legal specialists. Here is an excerpt from the letter: "Per our discussion, the following is a clarification of the intent of the order letter dated September 30, 2019 between Pristine Corporation and Pacific Inc. The order letter meets GAAP requirement for revenue recognition. The order letter allows Pristine to recognize revenue for our year ended September 30, 2019. The order letter gives us 30 days to reach mutually agreeable terms and conditions. In the unlikely event that we do not reach "mutually agreeable terms and conditions," Pacific will have the right to terminate the order letter and all obligations. This contingency may not be expressly stated in the order letter. However, you have my assurance that in the event that we cannot reach terms we will not hold you to the commitment to pay referenced in the order letter." On September 30, 2019, the Pacific legal department approved the deal and Pacific's purchasers signed and transmitted an order letter from Pacific to Pristine to buy $7 million worth of software and support services. The separate letter from the vice president of sales to Pacific, however, was not attached to the order letter and neither it was referenced in the order letter. The order letter was submitted to Pristine'sfinance department. At that point, Pristine made an accounting entry to record $5.8 million as current revenue for the product Pristine's had shipped. The remaining $1.2 million was to be separately invoiced for updates and technical support services and was therefore recorded as deferred revenue.

REQUIRED:

1. Explain the company's reasoning for recording $5.8 million as current revenue while recording the remaining $1.2 million as deferred revenue. Also, document where on the financial statements the deferred revenue account would be presented and why.

2. Evaluate, as an auditor, the content of the separate letter issued by Pristine's vice president of sales to Pacific. Document your conclusion with justifications about how the content of the letter affects or does not affect revenue recognition for Pristine for the year ended September 30, 2019.

3. Given that the letter from the vice president of sales was not attached to or documented in the order letter submitted by Pacific to Pristine document your conclusion as to the impact, if any, the vice president's letter has on the accounting treatment for the transaction since it was not part of the order letter.

4. In your assessment do you consider there exists fraud or any conditions that might engender fraudulent acts by the auditee's management? Explain with relevant evidences/examples.

5. It is stated in the case that the separate letter from the vice president of sales was emailed and faxed to Pacific representatives. Explain with rationale what would be the impacts ifPristine's vice president had only provided that information orally to Pacific representatives and not forwarded the information in written form?

6. As of September 30, 2019, Pacific Inc. had only submitted the order letter. Document your conclusion with justifications about the impact on the accounting for the transaction ifPristine and Pacific(a) sign the reseller agreement (buy and sale back) within 30 days or (b) do not sign the reseller agreement (buy and sale back) within 30 days.

7. Discuss your final conclusion with rationale and generally accepted accounting principle(s) about the accounting treatment of the transactions held betweenPristine and Pacific.