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Audit Engagement File
Audit Engagement File
Lisa Sedor, Ph.D. Assistant Professor DePaul University 1 East Jackson Blvd. Chicago, IL 60604 Dear Ms. Sedor: We have prepared a report on our planning activates for the audit engagement of NVIDIA Corporation for their upcoming fiscal year-end date of January 29, 2013. Included in this report is the analysis of NVIDIA s business environment, planning materiality, and the identification and assessment of the risks of material misstatement. Our report integrates information presented in Q2 & Q1 FY2013, Q3 FY2013 CFO Commentary, and 2012 Form 10-K to perform key elements of planning an effective and efficient audit engagement for NVIDIA. Please don t hesitate to contact us should you have any questions or concerns. Sincerely,
Abrar Mirza
Jimmy He
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Table of Contents Copies Auditor s Report Comparative Balance Sheet Income Statement Statement of Cash Flow Documentation of Client s Business and Environment Key Drivers/Industry Performance Managements Strategic Goals and Incentives Important Accounting Policies Company s Industry and Markets Recent Events Planning Materiality Quantitative Materiality Qualitative Materiality Risks of Material Misstatement Financial Statement Account Level Financial Statement Assertion Level Closing References 13 14 14 17 17 18-19 12 13 13 7 78 8 10 10 11 11 12 4 5 6 6
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enabled Nvidia to remain a dominant player in the market is innovation, to be specific, Nvidia added programmability to its graphics chips, this enabled the company to compete with Intel by getting graphics chips to do non-graphics computing tasks, opening doors for Nvidia to get into a wider range of devices. This strategy has basically allowed them to extend the reach of their market from PC s to anything that has visually rich expression.
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percentage of the estimated total direct labor hours required to complete the project. The management regularly evaluates the actual status of each project to ensure that the estimates to complete each contract remain accurate; revenue is recognized over the period the services are performed. The company also maintains a provision for estimated losses on contracts in the period in which loss becomes probable and can be reasonably estimated. Costs incurred in advance of revenue recognized are recorded as deferred costs on uncompleted contracts. If the amount billed exceeds the amount of revenue recognized, the excess amount is recorded as deferred revenue. Royalty revenue is recognized related to the distribution or sale of products that use their technologies under license agreements with third parties, it is recognized upon receipt of a confirmation of earned royalties and when collectability is reasonable assured from applicable licensees. Accounts receivables A standard allowance for doubtful accounts receivable for estimated losses is maintained resulting from inability of the customers to make required payments. The allowance is determined based on specific customer issues as well as on overall exposure. Accounts receivable are highly concentrated and make the firm vulnerable to adverse changes in their customers businesses, and to downturns in the industry and worldwide economy. The overall estimated exposure excludes significant amounts that are covered by credit default swaps. Inventory For inventories, the firm computes the value on an adjusted standard basis, which approximates actual cost on an average or FIFO basis. Inventory is written down to the
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lower of cost or estimated market value. Obsolete or unmarketable inventory is completely written off based upon assumptions about future demand and other estimations. Warranty Liability Another crucial chunk of liabilities that are very common within the technology industry is the warranty liability. Cost of revenue for Nvidia includes the estimated cost of product warranties that are calculated at the point of revenue recognition. Since the products are of complex nature and defects or failures may often arise, the firm invests in additional research and development efforts to find and correct the issue. Such efforts divert the managements and engineers attention from the development of new products and technologies and may lead to an increase in the operating costs and subsequently reduce gross margins. Determination of the amount of warranty charges related to these issues require the management to make estimates and judgments based on historical experience, test data and various other assumptions.
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positive outlooks as analysts assume that consumers will continue to buy electronic devices like mobile phones, tablet s, laptop s etc., however since Nvidia is a manufacturing company an economic slowdown can have a multiplier effect that would affect sales of PC s used in businesses (which is a big market for Nvidia) and ultimately effect the sales for Nvidia. In August 2011, Nvidia predicted the growth of its revenues to be between 4-6%, instead of just 4% as analysts predicted, they indeed ended up surpassing analysts expectations. Moreover, the company has consistently satisfied or surpassed analysts expectations of sales. The Company s 10-Q reveal that Nvidia is subject to litigation arising from alleged defects in their previous generation MCP and GPU products which if determined could do subsequent damage to the business. Out of the US$ 475.9 Million, US$466.4 Million has been charged against the cost of revenue to cover anticipated customer warranty, repair, return, replacement and other costs arising from product defects. Nvidia is also a party to other litigation, including patent litigation, which could affect their cash flow and financial results; they are party both as a defendant and as a plaintiff. Changes in the US tax legislation regarding their foreign earnings could also impact their business.
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associated with employee equity compensation, they may decide to increase cash compensation and decrease stock based compensation, Nvidia might be at a risk of employees not putting in their 100% and ultimately affecting their operating results as well as their competitive position. Moreover, the risk of fines, suspension of production, excess inventory, sales limitation and criminal and civil liabilities exist if Nvidia fails to comply with applicable environmental regulations. Also, as mentioned by Nvidia s auditors in form 10-K of 2011 and 2012, the risk that internal control over financial reporting may not prevent or detect misstatements. This is a crucial element and shifts the control risk of the engagement to high and lowers the acceptable detection risk rate.
Planning Materiality = Amount From Table + (Percentage From Table x Base Amount)
The method that we chose to use is a method that is based on the total assets of the company as of the annual second quarter fiscal year of 2013. Using the 5% method of the
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percentage of net income to calculate quantitative materiality wouldn t be appropriate. Also it should be noted that total annualized revenue is less than the total assets of the year, which is also why we chose to use that base amount to be the total assets. We used the second quarter financial statements to determine quantitative materiality.
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Nvidia Corporation seems to have very little financial risk as the company holds a substantial amount of cash on its books with very little to no debt. However, due to the nature of the business, we have assessed that the following accounts have a high risk of material misstatement and require additional or significant audit effort: Accounts Receivable, Inventory, Warranty Liabilities, and Goodwill.
In regards to Accounts Receivable, we are concerned with the performance of the account. The Accounts Receivable account is among the industry s worst with 33.64 days of inventory outstanding. This can only imply that the revenues are not being collected in an efficient manner leading to a high risk of material misstatement. We are concerned that this amount would be understated and the high-risk assertion would be valuation. Nvidia maintains an allowance for doubtful accounts receivable for estimated losses resulting from the inability for their customers to make required payments. Management decides this allowance, which consists of the amount preidentified for specific customer issues, and a general amount based on general estimated exposure. Their overall estimated exposure excludes significant amounts that are covered by credit insurance and letters of credit. Should financial health of their customers, the financial institutions providing credit, or their credit insurance carriers were to deteriorate, additional allowances will be made that could affect their operating result. As a percentage of their gross accounts receivable, their allowance for doubtful accounts range between 0.2% and 0.3%. We need to obtain adequate and sufficient evidence that the estimates for the doubtful accounts are
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adequate at 0.2% - 0.3%. If the estimate is too low of an estimate then the amount of revenue being recognized will be understated and the high-risk assertion will also be calculation. In addition, we have to make sure their collection, and revenue recognition models are adequate.
Warranty liabilities are another concern of ours. Due to the nature of any company within the tech industry, warranty liability is huge. As mentioned before, the estimated cost of product warranties are calculated at the point of revenue recognition. Since the products are of complex nature and defects or failures may often arise, the firm invests in additional research and development efforts to find and correct the issue. Determination of the amount of warranty charges related to these issues require the management to make estimates and judgments based on historical experience, test data and various other assumptions. The results of these judgments formed the basis for their estimate of total charge to cover anticipated customer warranty, repair, return, and replacement, and other associated costs. If and when actual repair, return, replacement, and other associated costs and/or actual field failure rates exceeds their estimates, they will record additional reserves, which will result in an increase in the cost of revenue and in turn will materially harm their financial results. We are concerned that the warranty liability estimates could possibly be understated, which would result in the high-risk assertion of completeness. Due to the very nature of their products, due to the complexity, there will be defects and experiences of failures due to a number of issues in design, fabrication, packaging, and materials used within a system. We need to find reasonable assurance that the estimate models for the
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estimate of the cost of warranties is accurate and adequate in predicating the number of products being sent back to be serviced.
Inventory cost is another concern of ours. Inventory costs are computed on an adjusted standard basis, which approximates actual cost on average or FIFO basis. Nvidia s inventory consists of primarily the cost to semiconductors purchased from subcontractors. They write down their inventory based on the assumptions of future demands, future, product purchase commitments, and estimated manufacturing yield levels and market conditions. If their estimates are off, they will need to write-down additional future inventory, which will affect their operating result. We are concerned that the inventory estimates will be understated resulting in the high-risk assertion of completeness. We need to find reasonable assurance that their inventory write-off estimation model is accurate.
Adopted during the fourth quarter of the fiscal year of 2012, Nvidia adopted the step zero approach that allows them to first assess qualitative factors to determine if it is necessary to perform the two-step quantitative good will impairment test. Nvidia s review process compares the fair value of the reporting unit where the goodwill resides to its carrying value. They determined that their reporting units are equivalent to their operating segments, or components of an operating segment, for the purposes of completing their goodwill impairment test. When determining the number of reporting units and the fair value, it requires using judgment and is heavily based on estimates and assumptions. It should be noted that even Nvidia states that their fair value estimates on assumptions are believed to be reasonable but are unpredictable and inherently uncertain. We are
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Closing Note
In planning for the Nvidia Corporation s 2013 audit engagement, we have established sufficient and clear understanding of the company s operations, industry, and recent events. We have also calculated and established quantitative and qualitative materiality for the engagement. We have identified key accounts that have a significant risk of misstatement, and will require the need for additional audit effort.
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References
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American Industries. Ed. Lynn M. Pearce. Detroit: Gale, 2012. Business Insights: Essentials. Web. 13 Nov. 2012.
Document URL http://bi.galegroup.com.ezproxy2.lib.depaul.edu/essentials/article/GALE%7CRN25 01400356/7222878a6da6b320d7cb4cc4bea5d398?u=depaul Hoover's Company Records - In-depth Records Nvidia Corporation. (November 6, 2012): LexisNexis Academic. Web. Date Accessed: 2012/11/13.
Nvidia, Corp. (2012). Q1 FY 201310-Q 2012. Retrieved from http://phx.corporateir.net/phoenix.zhtml?c=116466&p=irol-reportsannual Nvidia, Corp. (2011). Q3 FY 201310-Q 2011. Retrieved from http://phx.corporateir.net/phoenix.zhtml?c=116466&p=irol-reportsannual Nvidia, Corp. (2012). Q3 FY 2013 CFO Commentary. Retrieved from http://nvidianews.nvidia.com/Releases/NVIDIA-Reports-Financial-Results-for-ThirdQuarter-Fiscal-Year-2013-8b3.aspx
Takahashi, Dean. "VentureBeat News About Tech, Money and Innovation."VentureBeat. VentureBeat, 4 Mar. 2011. Web. 12 Nov. 2012.
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<http://venturebeat.com/2011/03/04/qa-nvidia-chief-explains-his-strategy-forwinning-in-mobile-computing/>. "Top Graphics Chip Makers Worldwide, 2009." Market Share Reporter. Robert S. Lazich and Virgil L. Burton, III. 2011 ed. Detroit: Gale, 2011.Business Insights: Essentials. Web. 12 Nov. 2012. DON CLARK, Wall Street Journal. "Nvidia's Profit, Share Price Rise." Aug 12, 2011. Matthews, Lee. "Nvidia Loses 10 Million GPU Order Due to Poor Linux Support." Computer Chips & Hardware Technology. N.p., 8 June 2012. Web. 13 Nov. 2012. <http://www.geek.com/articles/chips/nvidia-loses-order-due-topoor-linux-support-20120628/>. Hruska, Joe. "ExtremeTech." ExtremeTech. N.p., 23 Mar. 2012. Web. 13 Nov. 2012. <http://www.extremetech.com/computing/123529-nvidia-deeply-unhappy-withtsmc-claims-22nm-essentially-worthless>.
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