Last year was a challenging one for Samuel's Snowboards Inc. (SSI),...

Last year was a challenging one for Samuel's Snowboards Inc. (SSI), a large private company that manufactures snowboards and skateboards. Competition has increased in the industry and, in the skateboard segment in particular, SSI lost significant market share. The poor performance of the skateboard segment, which represented a major line of business, led to a recent decision to discontinue this segment and focus on manufacturing snowboards only.

Each year, the audit has gone smoothly. You recently met with Jackson Churchill, the chief financial officer of SSI, to review the draft financial statements for 2019. Jackson noted that sales and earnings were much lower in 2019 than had been budgeted. He expressed concern that this will surely displease the shareholders, who rely on SSI for healthy quarterly dividend payments. He explained to you that management will also be disappointed because year-end bonuses are, in part, calculated based on income from continuing operations.

You decide to start your work by performing some analytical procedures on the year-end financial statements. You notice that fourth-quarter sales are much higher than budgeted and much higher than sales reported in the fourth quarter of the prior year, as shown in the chart below:

This is confusing to you based on your knowledge of the business and the interim work performed in November 2019. As of mid-November 2019, sales for the quarter were expected to fall short of budget.

Because of your concerns, you investigate this anomaly in fourth quarter sales further. It turns out that several large sales were made to SSI customers at the end of December. The sales volumes purchased by these customers were significantly higher than their previous purchases. When reading the fine print of the sales agreement, you realize that these customers have the right to return all unsold snowboards to SSI up to April 30, 2020. This return period is far longer than SSI's typical return policy and industry norms. When you question the sales manager about it, she is very evasive and tells you to speak to the controller of SSI.

You are quite certain that revenue recognition principles are not being applied properly and that management is intentionally misstating results to earn a bonus. You are not sure how to deal with this from an audit perspective. In November, the audit team performed an interim risk assessment, per CAS 240 The Auditor's Responsibilities Relating to Fraud in an Audit of Financial Statements, and concluded that the risk of material misstatement due to fraud was low. However, you are now questioning whether that conclusion was appropriate.

Question 1: What actions should be taken with respect to your suspicions about managements actions? Take taking into consideration your assessment of fraud risk at the relevant assertion level?

Question 2: Suggest any necessary procedures.