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Background

Helio, Inc. (the Company) is a medical device company founded in2013 in Provo, Utah that specializes in the development andmanufacturing of cutting-edge medical devices designed for alltypes of joint replacement surgeries. In January 2015, the FDAapproved Helio’s premier product, a hinged titanium axle designedto provide physicians with more precise placement of joints duringjoint replacement surgery.

In early 2016, approximately one year after the new product’sapproval, the Company hired a new senior vice president (SVP) ofsales to oversee sales, physician training, product delivery, andcustomer service. The broad set of responsibilities allowed thecharismatic SVP to significantly influence the Company’s revenuegeneration. The hiring of the new SVP was also done in large partto help guide the company’s development of an important new saleschannel: third-party distributors that are each strategicallylocated in close proximity to key hospitals in regions around thecountry.

The move to hire the SVP was in direct response to overwhelmingdisappointment about the first year’s sales volume for the newsurgical implant, which was lagging significantly behindexpectations. Reports from the field led management to recommendthe new sales channel to the board of directors that overwhelminglyapproved the new strategy, the execution of which was being led bythe new SVP.

Execution of strategy

To help execute the new strategy, the SVP hired five regionalsales managers who would become his trusted cohorts. Together, theyset aggressive sales targets for the Company’s surgical implants.The sales targets focused on achieving a growth pattern that wascharacterized by a record high sales volume for each successivequarter in each region. In fact, it is fair to say that the salestargets were intentionally created at almost unreachable levels toremove any question about possible weakness in demand for theCompany’s new product.

The strategy focused on the development of a new sales channelwith third-party distributors. Each of the distributors had alreadyestablished close relationships with the physicians that wereactually using the product during surgical procedures. To help payfor the launch of their new product, along with the execution ofthe new strategy, the Company was also working hard to raise asignificant amount of new investment capital to fund the resultingincreased operating costs. In order to be successful in attractingthe new investment capital, top management made it clear to the SVPhow important it was to report strong sales for its premierproduct, the surgical implant for titanium joints. The SVP, inturn, passed along the same message to the regional salesmanagers.

© 2018 KPMG LLP, a Delaware limited liability partnership andthe U.S. member firm of the KPMG network of independent memberfirms affiliated with KPMG International Cooperative (“KPMGInternational”), a Swiss entity. All rights reserved. NDPPS741662

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Management control philosophy

The upper management team of Helio can be described as beingaggressive in business practices and often emphasizes speed andefficiency when implementing their decisions. Management rarelyhires external consultants because they are of the opinion thatconsultants are too expensive and often follow a conservativeapproach. The upper management team meets regularly with its keymanagers. In general, the upper management team has cooperated withthe audit team in order to provide fair and adequate financialreporting, but there have been disagreements in the past. TheCompany has a strict policy for following all established internalcontrol procedures.

Incentive compensation

Top management focuses significant attention on achievingshort-term performance measures based on the audited financialstatements when determining compensation and making promotiondecisions. Revenue earned is the most important criterion inperformance assessment throughout the organization. As part of thelaunch of its new surgical implant, a new bonus plan wasestablished to provide additional incentives for the entireorganization to focus on this new opportunity, with revenue earnedas the key criterion used to determine incentive compensation.

Preliminary results

Despite the SVP’s optimism about sales in 2017, internal reportshave indicated that the actual sales volume of the surgical implantwas well below budget each quarter. The SVP responded to thesereports by repeatedly communicating his disappointment to theregional sales managers. Furthermore, he consistently warned thatif the team could not boost sales, the Company would likely not beable to raise additional investment capital and would then beforced to significantly downsize its headcount.

Unfortunately, boosting revenue of the new surgical implants wasnot as simple as merely shipping the product to distributors. Thedistributors were hesitant to purchase product until the sale tothe final customer was finalized as the distributors did not wantto be stuck with the inventory on their own balance sheets.Further, the terms of the sales do not include any refund or rebateconditions. In addition, the Company has no intention of changingthose terms and accepting any return. Therefore, any sale todistributors are final.

By the end of 2017, the Company had signed on a total of 73distributors to sell its surgical implants in more than 20different states throughout the United States. Each distributor wasindependently owned and operated but the company routinely sharedbest practices among its network. The SVP monitored sales closelyfrom the distributor network through his regional sales managers.In fact, he even maintained a monthly sales report from each of the73 distributors.

The Company invoices customers when the goods are shipped, andinvoicing triggers the recording of revenue. The Company does notinclude freight costs in sales revenue but does offset shippingcosts with any freight charged to customers.

The following relevant financial data is taken from theCompany’s unaudited trial balance, which was used to produce theunaudited financial statements:

© 2018 KPMG LLP, a Delaware limited liability partnership andthe U.S. member firm of the KPMG network of independent memberfirms affiliated with KPMG International Cooperative (“KPMGInternational”), a Swiss entity. All rights reserved. NDPPS741662

Sales revenue, year ended 12/31/2017	$84,867,855
Gross accounts receivable, 12/31/2017	$11,988,886

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Audit approach

Your audit team is currently in the midst of year-end testing inthe revenue and accounts receivable cycle for the audit of thecalendar year 2017 financial statements. Your testing will focus onthe existence/occurrence, cutoff, and accuracy assertions for salesrevenue, as well as the existence and valuation assertions foraccounts receivable. The audit team has assessed the risk ofmaterial misstatement (RMM) for each relevant assertion in order todetermine the nature, timing, and extent of the procedures to beperformed at Helio.

Other members of the audit team have already completed awalk-through of the revenue and accounts receivable processes,identified “what could go wrongs” within the process, andidentified the controls that have been placed in operation tomitigate the risks. Based on the work performed, the team decidedto test the operating effectiveness of certain key controls duringinterim testing. The results are found below.

Tests of controls – Revenue and accounts receivable cycle –Interim

Four key application controls were tested at interim. Theinformation technology (IT) auditors tested the general controls(GITCs) over program changes, access to programs, and computeroperations that are relevant to the revenue and accounts receivablecycle. The GITCs were found to be effective. In addition, the ITauditors tested the system to make sure that proper segregation ofduties occurred throughout the period and were operatingeffectively.

The first control is an automated three-way sales match. Thecontrol matches the details from 1) an approved sales order; 2)relevant shipping documents; and 3) the sales invoice beforerevenue is recorded. A test of the control’s operatingeffectiveness was conducted at the interim. No exceptions

new customers, including the new distributors. A test of thecontrol’s operating effectiveness was conducted at interim. Noexceptions were noted.

The third control is an automated sales authorization control.When a sales order is entered into the system, the amount of thesale is added to the existing accounts receivable balance for thatcustomer. The sum is then compared to the customer’s credit limit.A test of the control’s operating effectiveness was conducted atinterim. No exceptions were noted.

The fourth control is a monthly review of the adequacy of theallowance for doubtful accounts, completed by the controller. Atest of the control’s operating effectiveness was conducted atinterim. No exceptions were noted.

© 2018 KPMG LLP, a Delaware limited liability partnership andthe U.S. member firm of the KPMG network of independent memberfirms affiliated with KPMG International Cooperative (“KPMGInternational”), a Swiss entity. All rights reserved. NDPPS741662

were noted.

The second control requires the credit department at Helio toconduct a detailed credit check for all

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Roll-forward period

By the end of the third quarter of 2017, sales revenue for thecompany’s premier surgical implant was still lagging far behindexpectations. To help ensure that Helio delivered impressive fourthquarter revenue numbers, the entire sales team, led by the SVP andthe regional sales managers, began to exert pressure on a number ofdistributors in an attempt to improve sales in 2017. This effortseemed to be paying off as the sales team successfully persuadedmore than a dozen distributors to purchase product in advance offinal customer demand.

These circumstances presented a problem for the Company, becausethe distributors began to ask for concessions from Helio. Forexample, in order to persuade the distributors, the Company agreedto hold the inventory in their own warehouse.

The SVP’s actions led to a dramatic increase in revenue for thefourth quarter of 2017. In fact, sales increased year-over-year by214 percent for the fourth quarter alone. The upward trajectory ofsales revenue helped the Company raise the much-needed investmentcapital as Helio issued more than 10 million shares of common stockfor $40 million in early 2018.

1. [5 points] Based on yourunderstanding of fraud risk assessment and material:
   • Identify at least three (3) specific fraud riskfactors related to Helio.