e-Vision: Business Models, Business Risks and Audit Risk Assessment J. Efrim Boritz and Theophanis Stratopoulos University of Waterloo

e-Vision Company Background e-Vision is a medical imaging software developer facing several challenges to its business model arising from environmental changes

First Challenge HIPAA of ‘96 in the US created stringent privacy requirements for all health care industry participants... HIPAA fully in place as of January ’05 and many US competitors are already in compliance. Early ‘05, a major OEM who advanced half the funds for a $5 million contract for the delivery of a toolkit for its MRI scanners has requested that all company personnel be trained in HIPAA requirements as well as procedures and documentation to ensure the training was tracked and will be maintained. The customer has the right to audit the company’s development practices under ISO 9000:2000. Company’s goals are to increase market share in the US, retain OEM customers. The company has added HIPAA requirements to the specifications for all new systems so that new products will be HIPAA compliant in ‘06. The company has been encouraging all its employees to complete an internally developed course on HIPAA.

Second Challenge Mergers have given some U.S. competitors more access to funding and better distribution channels and have led to lost sales. The company’s goal is to have high-quality distinctive products and increase their U.S. market share while facing increasingly fierce competition. In order to deal with the competition they need to have the best-in-class product (product leadership strategy). From an internal processes and resources standpoint, they want to get some competitive intelligence on what the competitors are doing in the same space and see if they do have this best-in-class product. Then they can say how their features and functionalities are superior to their competition.

Third Challenge A significant customer segment is the application end-users such as small hospitals, clinics, and imaging centers. End-users find the company’s applications more affordable or more feature rich than those supplied by its major competitors. In order to reinforce this trend the Marketing/sales and post sales support in 2005 began to focus on the end-user application market. The company’s longstanding practice has been to extend credit or accept shares in lieu of cash. Many customers who pay with shares are not public companies. Meanwhile, large custom development projects are increasingly complex in terms of number of employees involved, milestones, and inter-dependencies. Development teams use various project management systems to track customer project activities and costs. Some groups use spreadsheets, while others use MS Project. These systems are not integrated and do not roll up into an overall cost management system.

Fourth Challenge Two recent technological developments (open source development tools and 64 bit operating systems) potentially could affect the company’s strategic goals. Open source development tools provide new insight into software development and e-Vision is working on an automated testing system to replace human testers and thus reduce development times. In addition to this the company has reallocated some of its personnel from customer projects to R&D work to incorporate open source concepts and has provided them with additional training. New personnel with the skills required to develop the testing infrastructure have been hired. In 2005, Microsoft and other software and hardware companies released 64 bit operating systems and computers. Responding to this technological change e-Vision has redeployed some of its existing personnel from customer projects to support development of applications for 64-bit systems.

Learning objectives Tracing from … environmental changes, to business strategy changes, to internal process changes, and ultimately to financial statement impacts … is a complex and challenging task.

Graphic Teaching Aid Help students see the linkages between … environmental changes, strategic responses, internal processes and financial statement accounts Help them perform task more effectively

Graphic Teaching Aid

Implementation Guidance 1.Pre: Outline the principles of Strategic Auditing and ask students to review the case (Approximately minutes) 2.During - General Information: Audit risk assessment and business models. Business risk implications associated with industry structure and company’s strategy. Review financial statements. (Approximately 30 minutes) 3.During - Case Discussion: Select simplest possible combination for first challenge and make it more complicated as you move to the subsequent challenges. (Approximately 40 to 50 minutes or 20 to 25 minutes per challenge) 4.Post: Assign one of the other challenges – with desired degree of difficulty - as a homework assignment.

Classroom Testing Objective: Evaluate the effectiveness of the case. Tool/Method: A pre and post questionnaire. Matched pairs. Target Audience: Arts/Public accounting and Math/Public accounting students in a co-op program (with 8 months prior co-op work experience) taking an audit class prior to an 8- month co-op term Condition: Instructor was not involved in the development of the case and had access only to teaching notes

Classroom Testing (Pre & Post) Question - Five point Likert scale (1 = strongly disagree, … 5 = strongly agree). - Questions were asked before and after the completion of the case Arts/Public Accounting Math/Public Accounting Average (Pre-Post) t-score (p-value) Average (Pre-Post) t-score (p-value) Understanding a audit client’s business strategy is essential for performing effective audit (.62) (.01) External auditors should focus more on the risk of errors in judgment and application of GAAP than on the risk of poor strategic business decisions made by client (.34) (.00) Risks arising from a change in a client’s business strategy are important in the long- run but unlikely to create audit risk of the current period (.48) (.61)

Classroom Testing (Post) Question - Five point Likert scale (1 = strongly disagree, … 5 = strongly agree). - Questions were asked after the completion of the case Arts/Public Accounting Math/Public Accounting Average t-score (p-value) Average t-score (p-value) The e-vision case enhanced my understanding of how strategic business risks affect the risk of material misstatement (.00) (.00) The diagram enhanced my understanding of how strategic business risks affect the risk of material misstatement (.00) (.83)

Teaching Notes The degree of difficulty of the case, can be modified to the experience of your students. For example provide the relationships linking the external factors to relevant strategic goals to internal processes and provide a list of relevant as well as irrelevant accounts. (See next slide)

Graphic Teaching Aid

Teaching Notes Teaching notes, based on personal interviews with audit partners and senior audit managers from the Big-4 firms, cover the following areas: 1. General Evaluation –Company Background –Strategy –Financial Statement Analysis –Stock Market 2. Detailed Evaluation of Each of the 4 Challenges

References Martin, R. and F. Phillips “Aerospace Lighting, Inc. (ALI): Linking Business Strategy to Audit Planning.” Issues in Accounting Education, 21(3), pp Ballou, B. and W Robert Knechel Ceskoslovenska Obchodni Banka, a.s.: Applying business risk audit techniques. Issues in Accounting Education; Aug 2002; 17, 3, Bell, T., F. Marrs, I.Solomon and H. Thomas Auditing Organizations Through a Strategic-Systems Lens. Montvale, NJ: KPMG Peat Marwick LLP. Bell, T.B., M. E. Peecher, and I.Solomon The strategic- systems approach to auditing. In Cases in Strategic-Systems Auditing eds. T.B. Bell and I.Solomon,1-34.