Biomed Products Incorporated (BPI) is a public company, listed on the Toronto Stock Exchange (TSX), that manufactures and markets various types of medical equipment that monitors patients’ vital signs (i.e., heart rate, breathing, blood pressure). BPI has been audited by Cooper & Zhang, a large public accounting firm, since its inception 10 years ago.
You are the audit senior responsible for the March 2019 yearend audit. Within the next day or two, you will be meeting with the audit manager to go over significant accounting and audit issues regarding the revenue cycle. Excerpts from the income statement for the first nine months of the current fiscal year and the previous two years are below:
Over the past week, you have been updating the preliminary planning related to the revenue cycle, visiting BPI’s premises, and interviewing the client staff. Your notes are summarized below.
1. The preliminary materiality is based upon revenue and overall materiality is set at $250 000. Performance materiality is $200 000. Due to each hospital contract being unique, inherent risk for revenue recognition is high; however, controls have been effective; therefore, risk of material misstatement is set at moderate.
2. Cooper & Zhang have relied upon internal controls in past audits. The internal control environment is strong. The staff members in the accounting area are competent and there is adequate segregation of duties. Based upon your update and testing of the systems, no changes have occurred in the accounting area.
However, your documentation of the processing of revenue reveals that BPI has begun to expand into foreign countries through distributor agreements. This is different from its usual customer base of Canadian hospitals. Your preliminary discussions with the VP sales reveal that initial contacts with the distributors are made through foreign trade shows. He notes that before signing a deal, BPI does background and credit checks on the companies. However, the quality of information received varies by country.
3. Your review of foreign revenue reveals that BPI has entered into a agreement with a Russian distributor for a five-year period commencing June 2019.
BPI is quite excited about the agreement since the opportunities in Russia are vast—a significant portion of hospital medical equipment is worn and needs replacement.
BPI believes this agreement has phenomenal prospects since the distributor is established and knows which hospitals are refurbishing and have money.
As part of the agreement, the distributor has paid BPI an up-front and nonrefundable fee of $250 000. BPI has recorded the fee as part of its current revenue. As part of normal Russian business practice, the distributor pays the individual hospital administrator a commission for agreeing to purchase BPI products. Each month, the distributor will submit a list of individuals who have received the commission and BPI will reimburse the distributor the amount. Although no hospital sales have been finalized, the distributor has the promise of three separate administrators and has paid them each a commission of $5000.
The distributor has requested that BPI reimburse it the $15 000.
4. In late August, BPI shipped 500 units (at a sale price of $650 per unit and a cost of $400 per unit) to the distributor so that the distributor may have stock on hand.
BPI has recorded this shipment as a sale since part of the agreement is that the distributor pays for all goods received. You note that the Russian distributor balance is still outstanding as of December 31, 2018. The VP sales is not concerned since it is normal for BPI customers to pay anywhere between 30 and 60 days after receiving the invoice.
a. Explain how the expansion of BPI to foreign markets impacts the audit strategy for Biomed Products.
b. The two key accounting issues are the upfront fee and the shipment of the 500 units in November. For each accounting issue perform the following:
i Analyze the accounting issue.
ii Identify the accounts and assertions most at risk related to this transaction. Provide your rationale.
iii Provide one substantive audit procedure that would address the assertions at risk.
c. Explain the audit implications of the upfront commission payable to the Russian hospital administrators.
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