Reference no: EM131082250

Question 1:

Whirlwind Inc. is a refrigerator retailer headquartered in Oklahoma. In January 2016, the Company's Board of Directors (Board) met to project annual sales volume and set the sales performance benchmark for store managers. Store managers beating the benchmark in 2016 earn a bonus. Because all 20 of its stores are the same size and are located in similar demographic areas, the Board sets the same performance benchmark for each store manager.

The Board predicted aggregate target-area demand of 100,000 refrigerators sold, and multiplied it by Whirlwind's projected market share of 10 percent, yielding a prediction of 10,000 Whirlwind refrigerators sold for the year. The sales performance benchmark is 105% of each store's share of projected sales: 10,000 refrigerators / 20 stores x 105% = 525 refrigerators per store. Store managers selling at least 525 refrigerators in 2016 would earn the bonus.

It is now mid-January of 2017. The Board is examining disappointing sales volume figures and reconsidering its original benchmark. Board members worry about manager morale and believe that all managers worked hard in 2016. The Board decides to retroactively change the policy so that managers arenot penalized for probable sources of biasin their original prediction, but the prediction would not be adjusted for sources of noise.An internal audit has identified several reasons for the shortfall in refrigerators sold in 2016, as shown in the comparison to the Board's prediction below.

Reconciliation between Predicted and Actual Unit Sales

For the Fiscal Year Ending December 31, 2016

Reconciling item explanation    No. units

Predicted refrigerator sales as of January 2016 (100,000 units x 10% share)	10,000
Actual aggregate demand was 95% of the predicted demand (i.e., 95,000 refrigerators were actually sold in the target area).  In the past 5 years, the Board has consistently overestimated aggregate demand to a similar degree.
A new competitor started selling similar refrigerator models via the Web. The competitor was unknown prior to the start of the year, but ended up penetrating 4% of the target area.
A series of summer tornadoes destroyed six stores, resulting in a loss of 1,500 planned unit sales.  Although the Board did not build the impact of seasonal tornadoes into its prediction, a rational probability assessment that such activity would destroy 6 retail stores is about 5%.
One store manager held a special half-price, Christmas-to-New Year's Eve sale in 2016, resulting in 150 additional unit sales.  Another store manager shifted 30 sold refrigerators from the first 2 weeks of 2017 to 2016.
The rest of the difference appears attributable to the impacts of other, non-systematic variables.
Actual company-wide unit sales of refrigerators	7,390

Please answer questions (1) through (3) below.

(1) Fill in the missing unit numbers in the right-hand column of the reconciliation above, showing the impact of each listed reconciling item on 2016 unit sales. In the space below, show any computations you need to make, and briefly explain how you determined each unit sales number you filled into the reconciliation.

(2) Using the completed reconciliation and the other information on the previous page, develop a new sales performance benchmark for 2016 consistent with the Board's desire not to penalize store managers for bias in the original prediction. Clearly document your assumptions, calculations, and rationale supporting your benchmark.

(3) Why would the Board choose to adjust the benchmark for potential sources of bias in its prediction of sales, but not for potential sources of noise? Explain your answer fully.

Question 2:

Founded in 1939, DePint is a thriving manufacturer of chemicals used in a variety of markets ranging from housing and construction to aerospace and national defense. In 2016, audited revenues from three divisions - Piezoelectric, Aromatic Chemicals, and Defense Chemicals totaled over $7 billion.

It is November 2017, and you've just begun conducting a planning analytical review of DePint's third quarter financial information. Oddly, the gross margin is on pace to increase from last year's 35% margin to about 37.5%. The current gross margin would fall outside of the previous five- year range of 34.1% to 36.8%. While DePint's gross margin has always exceeded industry averages, this year's mark is well above the industry average of 34%. The table below highlights this increase.

3rd Quarter Data ($ in millions)	2016 3rd Quarter Totals	2017 3rd Quarter Totals	2017 3rdQtr Aromatic Chemicals Division	2017 3rdQtr Piezoelectric Division	2017 3rdQtr Defense Chemicals Division
Sales revenue	$1,774	$2,238	$1,120	$489	$629
COGS	-1,153	-1,399	-707	-342	-350
Gross profit	$621	$839	$413	$147	$279
Gross margin	35.01%	37.49%	36.88%	30.06%	44.36%
% of 3rdQtr2017 sales revenue			52%	21%	27%
% of 3rdQtr2016 sales revenue			55%	32%	13%

When you ask DePint's CFO about the increase, he explains. "Our gross margin is higher because our sales mix changed. We recently won a big contract with the U.S. Defense Department (USDD). So, our Defense Chemical division accounts for 27 percent of our 2017 sales, instead of just 13 percent as was the case in 2016. Naturally, our margins improve when we sell relatively more Defense Chemicals products. Fortunately, we are the most qualified firm to meet the USDD's needs, and the USDD appreciates the value we add to its products. We also cut back slightly on our lower-margin Piezoelectric Division. All told, the sales mix drives the increase."

(1) Focus on the increase in gross margin and the CFO's explanation for it. Based solely on the information provided, is the sales mix explanation, alone, quantitatively capable of explaining substantially all (> 90%) of the increase in gross margin? Explain fully your reasoning, and show any supporting calculations you make.

(2) Develop two alternative explanations for the increase in gross margin. Make one a fraud-related explanation and the other an error-related explanation. Explain each in detail, and show through example calculations how each would increase DePint's total gross margin.
(NOTE: Make sure that your examples result in amounts that are consistent with those shown above in the table!)

(3) Consider now the audit evidence you would need to gather in order to substantiate the CFO's explanation (assertion) and your alternative explanations. DePint is a very large company with many thousands of sales transactions. Describe 2 audit procedures you would need to perform to gather evidence substantiating the CFO's assertion. Be as specific as you can, and explain how the evidence from the procedures would support the CFO's assertion and not support your alternative explanations.