In: Accounting
1. the audit firm of PWC evaluates the risk of material misstatement by disaggregating the total risk into its main components and sub components as indicated below
(a) inherent risk, (b) Control risk, (c) Detection risk (d) Operational risks, (e) finance risk and (f) compliance risk
required:
for each of the scenarios below, select the component of risk that is most directly illustrated. the component may be used once, more than once, or not at all. also suggest the effect on the financial statement and hoe the auditor might mitigate the risk (you may present your answer in the format below)
SCENARIO COMPONENT RISK EFFECT ON THE FINANCIAL STATEMENT HOW TO REDUCE THE RISK
A
B
C
D
E
F
A) A client fails to discover employee fraud on a timely bases because bank accounts are not reconciled monthly
B) The client's business manly deals with cash sales which is more susceptible to theft than credit sales
C) Confirmation of receivables by a new audit staff fails to detect a material misstatement
D) Disbursements (payouts) have occurred without proper approval
E) There is inadequate segregation of duties in the payroll section
F) The client is very close to violating debt covenants
G) XYZ Company, a client, lacks sufficient working capital to continue operations
SCENARIO |
COMPONENT RISK |
EFFECT ON THE FINANCIAL STATEMENT |
HOW TO REDUCE THE RISK |
A) A client fails to discover employee fraud on a timely bases because bank accounts are not reconciled monthly |
Control risk |
There will be misappropriations in the financial statement. There is will be mismatch between cash balance as per bank statement and cash as per books |
Bank reconciliation process should be undertaken at regular interval, that is monthly or fortnightly. |
B) The client's business mainly deals with cash sales which is more susceptible to theft than credit sales |
Finance risks |
There is possibility of getting inappropriate cash balance |
Proper trade credit policy should be prepared |
C) Confirmation of receivables by a new audit staff fails to detect a material misstatement |
Detection Risk |
Financial statements will be misstated to the substantial level |
Auditors need to detect all possible misstatements |
D) Disbursements (payouts) have occurred without proper approval |
control risk |
There will be imbalance between current assets and current liabilities |
Proper chain of invoice payments should be developed to avoid such awful conditions |
E) There is inadequate segregation of duties in the payroll section |
Operational risks |
There is a possible misuse of positions to create personal benefits by employees in payroll section. This can harm the business income, business relation with other vendors and reputation. |
Proper segregation of duties should be undertaken |
F) The client is very close to violating debt covenants |
inherent risk |
Client can disappear which can hamper companies balance sheet and business. |
After auditing the client accounts, if client is found to be in a risky situation then immediately stop the supplies to that client and start actions to recover the money. |
G) XYZ Company, a client, lacks sufficient working capital to continue operations |
inherent risk |
Client is not capable to handle the current debt situation so it can hamper the company’s business with that client. |
Company needs to focus on cash management, receivable management and inventory management. |