Computer Commodity, Inc. (CCI) was founded five years ago by a group of engineers who were focused on entertainment applications of computer technology. These engineers left former employers with significant wealth and wanted to start their own business. Four founders plus the CFO hold various ownership interests in the company. CCI’s initial years have been difficult as the company spent most of the initial investment on research and development, but the company has produced a series of successful products that have received market acceptance in the last three years. While the company has reached the point of generating positive cash flow from operations, it has yet to report a profit. The company’s loss has been decreasing and it expects to report its first profit in the fiscal year ended June 30, 2016.
Summary financial information for the last three fiscal years is presented below.
Selected Financial Data: Computer Commodity, Inc. ($000)Fiscal Year End201520142013Revenues97,169$ 100%69,802$ 100%53,923$ 100%Cost of Revenues64,225$ 66%41,172$ 59%25,411$ 47%Research and Development23,973$ 25,926$ 29,143$ 26%Selling General and Administrative Expe20,690$ 21,475$ 21%48,187$ 89%Operating Loss(11,719)$ -12%(5,771)$ -8%(33,818)$ -63%Income Tax Expense (Benefit)8$ 0%1,530$ 2%(194)$ 0%Net Loss(11,727)$ -12%(7,301)$ -10%(33,624)$ -62%Current Assets29,647$ 13,005$ 9,153$ Long Term Assets20,131$ 13,546$ 16,152$ Total Assets49,778$ 26,551$ 25,305$ Current Liabilities48,505$ 22,728$ 10,139$ Long Term Liabilities8,505$ 639$ -$ Contributed Capital128,516$ 127,205$ 127,004$ Accumulated Deficit(135,748)$ (124,021)$ (116,720)$ Total Liabilities and Shareholder’s Equity49,778$ 26,551$ 20,423$ (135,748)$ (124,021)$ Cash Flow from Operations17,422$ 7,434$ 1,030$ Cash Flow from Investing Activities(7,486)$ (8,537)$ (829)$ Cash Flow form Financing Activities(3,658)$ 401$ (971)$ Change in Cash6,278$ (702)$ (770)$
CCI produces hard drives (similar to computer hard drives) primarily for the audio and video industry. The company has nurtured relationships with manufacturers of MP3 players, personal video recorders, and digital video recording equipment, and smart phones. CCI’s industry is very competitive, and the cost of product has consistently fallen while offering more capacity to customers. The company has earned a market niche because of product quality, effective research and development, and pricing terms offered to assemblers who use CCI’s product in their equipment. Sales growth had been driven by consumer demand for these new products, but sales have also been dependent upon pricing and sales terms. Competition in the industry is intense. Consumer demand is growing, but the company also faces increasing competition from larger public companies. Almost 70 percent of CCI’s business is with audio, video, and cell phone equipment assemblers who enjoy substantial allowances depending on market conditions. Assemblers usually submit blanket purchase orders on a quarterly basis, and customers may hold as much as .5 – 1.5 months worth of inventory at any one time.
CCI currently has only one research and manufacturing facility in North America. Research and development expenditures are essential to continue presence in the market. The company currently allocates about 25 percent of sales to research and development of new products, and the company holds several patents that have allowed it to compete effectively for market share. CCI focuses its engineering on coordinating its product design and manufacturing processes in order to bring its products to market in a cost-effective and timely manner. CCI manufactures or purchases certain magnetic heads, media controllers, spindle motors, and other mechanical parts used in the head disk assembly. The assembly process occurs in a clean room environment, which demands skill in process engineering and efficient utilization of the clean room layout in order to reduce the high operation cost of this manufacturing equipment. CCI warrants its new manufactured disk drives against defects in materials and workmanship for a period of one to five years for the date of sale.
CCI is primarily equity financed, but it also uses accounts payable and advances from customers as financing sources. In 2005 the company financed the equipment out of operating cash flow. The company has recently started to explore plans to finance growth with an initial public offering.
Part I: Materiality
Required: Using information from your auditing textbook, estimate overall materiality for the fiscal year ended June 30, 20