130247311 audit engagement file

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NVIDIA Corporation Audit Engagement Plan

1 East Jackson Blvd. Chicago, IL 60604



November 13, 2012

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Audit Engagement Plan

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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 NVIDIAs 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

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Table of Contents Copies Auditor s Report Comparative Balance Sheet Income Statement Statement of Cash Flow Documentation of Client s Business and Environment Key Drivers/Industry Performance Managements Strategic Goals and Incentives Important Accounting Policies Company s Industry and Markets Recent Events Planning Materiality Quantitative Materiality Qualitative Materiality Risks of Material Misstatement Financial Statement Account Level Financial Statement Assertion LevelClosing References 13 14 14 17 17 18-19 12 13 13 7 78 8 10 10 11 11 12 4

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Copies Auditor s ReportsTo the Stockholders and Board of Directors of NVIDIA Corporation: In our opinion, the consolidated financial statements listed in the index appearing under Item15(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 smanagement is responsible for these financial statements and financial statemen

t schedule, for maintaining effective internal control over financial reportingand 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 Companys internal control over financial reporting based on our integrated audits. Weconducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan andperform 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 auditsof the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the acco

unting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal controlover financial reporting included obtaining an understanding of internal controlover 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 otherprocedures, as we considered necessary in the circumstances. We believe that ouraudits provide a reasonable basis for our opinions. A company s internal control over financial reporting is a process designed to provide reasonable assuranceregarding 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 includesthose policies and procedures that (i) pertain to the maintenance of records tha

t, 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 reasonableassurance 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, projec



tions of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or thatthe degree of compliance with the policies or procedures may deteriorate. /s/ PricewaterhouseCoopers LLP San Jose, CA March 13, 2012

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Com parative Balance Sheet

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Incom e Statem ent

Statem ent of Cash Flows

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Key Drivers of the NVIDIA/Industry Perform anceNvidia (NVDA) is an American multinational technology company based out of SantaCarla, 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. Thecompany gained prominence when they invented their first GPU in 1999, since thenthe 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 highperformance computing. The company leases design centers, sales and administrati

ve office space in the western U.S. Internationally, the company leases space orowns facilities throughout Europe and Asia. In FY 2009, Nvidia completed its acquisition of Ageia Technologies Inc., Ageia, an industry leader in gaming physics technology.

M anagem ents Strategic Goals and IncentivesIn my opinion Nvidia s primary growth strategy is to capture a larger and largerpart 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

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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.

Im portant Accounting PoliciesRevenue Recognition According to the Management s discussion and analysis thereare several critical accounting policies and estimates; these policies and estimates are in accordance with the U.S. GAAP. For revenue recognition, the companyrecognizes 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 levelof 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. License and development revenue For license anddevelopment revenue, the company uses percentage of completion method. It is based on actual direct labor hours incurred to date as a

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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 maintainsa 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 withthird 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 aswell as on overall exposure. Accounts receivable are highly concentrated and mak

e 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. InventoryFor 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

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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 Liability 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 calculatedat 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.

Com pany s Industry and M arketsNvidia is broadly a part of the technologies industry; more specifically they fa

ll 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 shareof 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 devicethat encompasses a visual unit. They are present in mobile phones, TVs, computers, gaming consoles, simulators etc. The industry has

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positive outlooks as analysts assume that consumers will continue to buy electronic devices like mobile phones, tablet s, laptop s etc., however since Nvidia isa manufacturing company an economic slowdown can have a multiplier effect thatwould 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. TheCompany s 10-Q reveal that Nvidia is subject to litigation arising from allegeddefects 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$466.4Million 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 th

eir foreign earnings could also impact their business.

Recent Events & RisksNvidia s 10-Q filing reveals some risks that they might be exposed to. To beginwith 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

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associated with employee equity compensation, they may decide to increase cash compensation and decrease stock based compensation, Nvidia might be at a risk ofemployees 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.

Quantitative M ateriality 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 ofthe company as of the annual second quarter fiscal year of 2013. Using the 5% m

ethod of the

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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 determinequantitative materiality.

Qualitative M ateriality ConsiderationsBecause of the risk factors discussed above in the light of various reports andcompany 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 ofplanning will have go in for determining materiality associated with differentaccounts. 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 controlrisk factors and also because of ongoing multiple litigations. Also, because the

company ones various intangible assets, mainly patents, tests would have to becarried out to make sure they are not overstated and these accounts are properlyamortized. 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.

Risk of M aterial M isstatem ent

Financial Statem ent Account Level

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Nvidia Corporation seems to have very little financial risk as the company holdsa 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 accountshave a high risk of material misstatement and require additional or significantaudit effort: Accounts Receivable, Inventory, Warranty Liabilities, and Goodwill.

Financial Statem ent Assertion Level

In regards to Accounts Receivable, we are concerned with the performance of theaccount. 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-riskassertion would be valuation. Nvidia maintains an allowance for doubtful accounts receivable for estimated losses resulting from the inability for their custome

rs to make required payments. Management decides this allowance, which consistsof 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

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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, andrevenue 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 mayoften arise, the firm invests in additional research and development efforts tofind and correct the issue. Determination of the amount of warranty charges related to these issues require the management to make estimates and judgments basedon historical experience, test data and various other assumptions. The resultsof these judgments formed the basis for their estimate of total charge to coveranticipated 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 revenueand in turn will materially harm their financial results. We are concerned thatthe 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 modelsfor the

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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 manufacturingyield levels and market conditions. If their estimates are off, they will needto write-down additional future inventory, which will affect their operating result. We are concerned that the inventory estimates will be understated resultingin 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 thestep zero approach that allows them to first assess qualitative factors to dete

rmine 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

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

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 havea significant risk of misstatement, and will require the need for additional audit effort.

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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%7CRN25 01400356/7222878a6da6b320d7cb4cc4bea5d398?u=depaul • Hoover's CompanyRecords - In-depth Records Nvidia Corporation. (November 6, 2012): LexisNexis Academic. Web. Date Accessed: 2012/11/13.

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Nvidia, Corp. (2012). Q1 FY 201310-Q 2012. Retrieved from http://phx.corporateir.net/phoenix.zhtml?c=116466&p=irol-reportsannual Nvidia, Corp. (2011). Q3 FY 201310-Q 2011. Retrieved from http://phx.corporateir.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-ThirdQuarter-Fiscal-Year-2013-8b3.aspx

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<http://venturebeat.com/2011/03/04/qa-nvidia-chief-explains-his-strategy-forwinning-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 StreetJournal. "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-topoor-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-withtsmc-claims-22nm-essentially-worthless>.

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130247311 audit engagement file

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