Case 9-56: Judging the quality of a client’s internal audit function and determining the effects of internal audit’s work Case study for advance auditing discussion CPAs is performing the audit of REDTOP Sports. You are on the external audit team for that engagement. Following is some information about the client and its internal audit function. After reviewing this information, you will be asked to assess the quality of the internal audit function and whether the external auditor should rely on work performed by the internal auditors. General Background Information about REDTOP Sports REDTOP Sports Company is a publicly held manufacturing company. The primary activities of REDTOP Sports Company include the design and manufacture of sporting and athletic goods. The major product lines are bicycle helmets for infants, youths, and adults and other bicycle accessories, including child bicycle seats, car bicycle carriers, and water-bottle cages. In the United States, a number of jurisdictions have passed mandatory helmet regulations and REDTOP Sports is currently a market leader in this growing market. Sales are made primarily on credit to independent bicycle dealers and sporting goods stores. The sales terms require that balances be paid within sixty days. This practice is consistent with the industry. Company Objectives and Related Risks For this company, there is a specific risk associated with potential errors in the valuation of receivables, the existence of receivables, and the cutoff of sales. This risk results from REDTOP Sports’ interest in expanding to a global market. Helmet sales in Europe are expected to increase significantly in the near future and REDTOP would like to be in a position to obtain a significant market share in Europe. REDTOP Sports would like to finance this growth through an additional stock offering during the next year. To assure that the stock offering is successful, some pressure has been exerted on management to meet slightly optimistic growth levels over the past two years. Bonuses for top management have been partially based on the achievement of these growth goals. Summary Financial Information Sales of REDTOP Sports continue to grow. Over the last five years, sales have climbed at an average annual rate of 27%. When compared to other companies in this industry, the growth in earnings per share (EPS) over the past two years has been at the same level as the growth for the industry: 39%. In comparing this company to the S&P 500, the company’s EPS has increased at 39% while the EPS of the S&P 500 has increased at 14% (about 2.8 times more). The growth in accounts receivable has been primarily due to the increased sales demand. Current-year recorded sales total $99,133,000. The accounts receivable balance for the current year consists of approximately 500 accounts, primarily from retail and sporting goods stores. The individual accounts range from approximately $300 to $65,000. The year-end balance in the ac ...