audit engagement file

ACC 372 - 403

1 East Jackson Blvd. Chicago, IL 60604

NVIDIA Corporation

Audit Engagement Plan

November 13, 2012 ACC 372 - 403 Audit Engagement Plan 2

CONFIDENTIAL

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


CONFIDENTIAL

Table of Contents Copies Auditor’s Report 4 Comparative Balance Sheet 5 Income Statement 6 Statement of Cash Flow 6 Documentation of Client’s Business and Environment Key Drivers/Industry Performance 7

Managements’ Strategic Goals and Incentives 7 ‒ 8 Important Accounting Policies 8 ‒ 10 Company’s Industry and Markets 10 ‒ 11

Recent Events 11 ‒ 12 Planning Materiality Quantitative Materiality 12 ‒ 13 Qualitative Materiality 13 Risks of Material Misstatement Financial Statement Account Level 13 ‒ 14 Financial Statement Assertion Level 14 ‒ 17 Closing 17 References 18-19


CONFIDENTIAL

Copies Auditor ’s Reports

To the Stockholders and Board of Directors of NVIDIA Corporation: In our opinion, the consolidated financial statements listed in the index appearing under Item 15(a)(1) present fairly, in all material respects, the financial position of NVIDIA Corporation and its subsidiaries at January 29, 2012 and January 30, 2011, and the results of their operations and their cash flows for each of the three years in the period ended January 29, 2012, in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in the index appearing under Item 15(a)(2) presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of January 29, 2012, based on criteria established in Internal Control ‒ Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for these financial statements and financial statement schedule, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in Management’s Report on Internal Control over Financial Reporting appearing under Item 9A. Our responsibility is to express opinions on these financial statements, on the financial statement schedule, and on the Company’s internal control over financial reporting based on our integrated audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures, as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions. A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. /s/ PricewaterhouseCoopers LLP San Jose, CA March 13, 2012


CONFIDENTIAL

Comparative Balance Sheet


CONFIDENTIAL

Income Statement

Statement of Cash Flows


CONFIDENTIAL

Key Drivers of the NVIDIA/Industry Performance

Nvidia (NVDA) is an American multinational technology company based out of

Santa Carla, California. They have operations overseas as well and they are best known for

developing and selling graphics processing units (GPUs). Jen-Hsun Huang, Chris

Malachosky, and Curtis Priem founded Nvidia in 1993. All three founders formerly worked

in the IT industry for companies that are now rivals of Nvidia. Nvidia currently employs

more than 6000 people and has revenues of US$ 3.997 billion for the fiscal year 2012. They

are a public company listed on the NASDAQ. The company gained prominence when

they invented their first GPU in 1999, since then the company has expanded within the

visual computing market and has also established itself as a key player in super, mobile and

cloud computing. The mobile processors are used in smartphones, tablets and auto

infotainment systems. PC gamers rely on Nvidia’s GPUs to enjoy extraordinary new heights

of video gaming; furthermore, in the film industry Nvidia’s devices are used to create visual

effects and researchers utilize GPU’s to further their research with the help of high

performance computing. The company leases design centers, sales and administrative

office space in the western U.S. Internationally, the company leases space or owns facilities

throughout Europe and Asia. In FY 2009, Nvidia completed its acquisition of Ageia

Technologies Inc., Ageia, an industry leader in gaming physics technology.

Managements’ Strategic Goals and Incentives

In my opinion Nvidia’s primary growth strategy is to capture a larger and larger

part of the market share, they do this by investing heavily in research and development

and also by acquisitions of smaller companies. Another prominent key strategy that the


CONFIDENTIAL

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.

Important Accounting Polic ies

Revenue Recognit ion

According to the Management’s discussion and analysis there are several critical

accounting policies and estimates; these policies and estimates are in accordance with the

U.S. GAAP. For revenue recognition, the company recognizes revenue from product sales

when the product has been delivered, the price is fixed or determinable and collection is

reasonable assured. Purchase orders and contractual agreements are used as evidence of

an arrangement. The company considers delivery to occur upon shipment provided title

and risk of loss have passed to the customer based on the shipping terms. Policy on sales

to certain distributors, with rights of returns, is to defer recognition of revenue and related

costs of revenue until the distributors resell the products, as the level of returns cannot be

reasonably estimated. For rebates, which are offered to customers as an incentive to

promote sales, liability is recognized for these rebates at the later of the date at which they

record the related revenue, or the date, which the rebate is offered.

L icense and development revenue

For license and development revenue, the company uses percentage of

completion method. It is based on actual direct labor hours incurred to date as a


CONFIDENTIAL

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


CONFIDENTIAL

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 Liabil ity

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.

Company’s Industry and Markets

Nvidia is broadly a part of the technologies industry; more specifically they fall

under the “Semiconductor and Related Device Manufacturing Industry”. This industry has

roughly about 881 companies and revenues exceeding US$ 500 Billion. Nvidia holds the

second largest market share in the graphic card manufactures’ industry; according to “Top

Graphics Chip Makers Worldwide, 2009”. Nvidia has a share of 24.30% just behind Intel’s

share of 55.20%. The industry is very vast and articulated. Graphic cards can be found in

almost every consumer electronic device that encompasses a visual unit. They are present

in mobile phones, TVs, computers, gaming consoles, simulators etc. The industry has


CONFIDENTIAL

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.

Recent Events & Risks

Nvidia’s 10-Q filing reveals some risks that they might be exposed to. To begin

with they are subject to risks of owing property in the U.S, as well as China and India. The

risks include the possibility of environmental contamination and the costs associated with

the mitigation of the problems, adverse changes in the value of these properties, increased

cash commitments, increased operating expenses etc. Also, because of an increased cost


CONFIDENTIAL

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.

Quantitat ive Material ity Considerations

Calculation: Total Assets, 7/29/2012 = $55,529,280,000

Planning Materiality = Amount From Table + (Percentage From Table x Base Amount)

Planning Materiality = $1,600,000 + (0.00058 * $55,529,280,000

Planning Materiality = $4,820,600

Tolerate Misstatement Calculation = Planning Materiality x Factor

Tolerable Misstatement = $4,820,600 x 0.75

Tolerable Misstatement = $3,615,450

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


CONFIDENTIAL

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.

Qualitat ive Material ity Considerations

Because of the risk factors discussed above in the light of various reports and

company’s 10-Q and 10-K filings, and because of a high control risk and predecessor

auditor determining weak internal controls over financial reporting a lot of planning will

have go in for determining materiality associated with different accounts. Firstly, I think

revenue recognition is an important element and because of prior sales returns and

defective inventory in my opinion that account would a high risk one. Warranty and

litigation liability would also have to be assessed and tested for material misstatements

because of inherent risk and control risk factors and also because of ongoing multiple

litigations. Also, because the company ones various intangible assets, mainly patents, tests

would have to be carried out to make sure they are not overstated and these accounts are

properly amortized. Company’s goodwill should also be tested for impairments and

subsequent overstatements. Because of weak internal controls, various liability and

expense accounts such as accounts payable and other liabilities should be tested for

understatements and fraudulent financial reporting.

R isk of Material Misstatement

Financial Statement Account Level


CONFIDENTIAL

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.

F inancial Statement Assert ion Level

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


CONFIDENTIAL

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


CONFIDENTIAL

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


CONFIDENTIAL

concerned that the account is overstated, resulting in a high-risk assertion of

completeness.

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.


CONFIDENTIAL

References

• "Semiconductors." Encyclopedia of Emerging 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%7CRN2501500089/fc342fcf405f6fdaa41df670e9414e38?u=depaul

• "Computer Peripheral Equipment, Not Elsewhere Classified." Encyclopedia of 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%7CRN2501400356/7222878a6da6b320d7cb4cc4bea5d398?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). Q2 FY 201310-Q 2012. Retrieved from http://phx.corporate-ir.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-Third-Quarter-Fiscal-Year-2013-8b3.aspx

• • Takahashi, Dean. "VentureBeat | News About Tech, Money and

Innovation."VentureBeat. VentureBeat, 4 Mar. 2011. Web. 12 Nov. 2012.


CONFIDENTIAL

<http://venturebeat.com/2011/03/04/qa-nvidia-chief-explains-his-strategy-for-

winning-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." â�“ Computer Chips & Hardware Technology. N.p., 8 June 2012. Web. 13 Nov. 2012. <http://www.geek.com/articles/chips/nvidia-loses-order-due-to-poor-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-with-tsmc-claims-22nm-essentially-worthless>.

audit engagement file

Documents