Question

Small Finance Ltd (SF) provides small and medium-sized personal, car and business loans to clients. It has been operating for more than 10 years and run throughout its life by Ben Stanley. Ben has been the public face of the finance company, appearing in most of its television and radio advertisements, and developing a reputation as a friend of the ‘little person’ who has been mistreated by the large finance companies and banks.

SF’s major revenue stream is generated by obtaining large amounts on the wholesale money market and lending in small amounts to retail customers. Margins are tight, and the business is run as a ‘no frills’ service. As a result of COVID-19, the demand for finance for cars has dropped off dramatically. Ben is also very concerned about the impact of COVID-19 on the recoverability of loans. Offices are modestly furnished and the mobile lenders drive small, basic cars when visiting clients. SF prides itself on full disclosure to its clients and all fees and services are explained in writing to clients before loans are finalised. However, although full-disclosure is made, clients who do not read the documents closely can be surprised by the high exit charges when they wish to make early repayments or transfer their business elsewhere.

SF’s mobile lenders are paid on a commission basis; they earn more when they write more loans. For example, they are encouraged to sell credit cards to any person seeking a personal loan. SF receives a commission payment from the credit card companies when it sells a new card and SF also receives a small percentage of the interest charges paid by clients on the credit card.

Identify the factors that would affect the preliminary assessment of inherent risk and control risk for SF’s revenue?

Explain which management assertions (refer ASA315, paragraphs A128 and A129) are at most risk

Answer 1

Inherent risk is the inbuilt level of risk that’s inherent in a business before the company employs any processes to reduce the risk. This is the amount of risk before a company applies any internal controls and systems.

Factors affecting inherent risks are:

Nature of clients business - Since SF Ltd is anyway a small and medium size loan lending company, also its model warrants tight margins between borrowing in the wholesale market and lending in small portions to retail customers. That could affect the business going concern in a pandemic situation.

Results of previous audits - Misstatement found in previous year’s audit is more likely to occur again, if in this Covid situation SF ltd doesn't pivot itself quickly to survive in the market it could perish.

Other factors like transactions with relared parties, non-routine transactions incorrectly recorded, complexity of transactions etc are also factors affecting the inherent risk in an audit.

Control Risk is the measure of auditor’s assessment of likelihood that misstatements exceeding tolerable amount in a segment won’t be prevented or detected by internal controls.

Factors affecting control risks are:

Deficiencies in Internal Control - In the case of SF Ltd. they get commission from Credit card companies and also a small % of interest paid by customers. In this case if the accountant is also one of the mobile lenders of SF Ltd then there will be no maker checker function present and hence a loophole to manipulate accounts would be possible.

Improper Recording of transactions - Errors made while inputting financial transactions, errors of omission and commission could lead to material mis-statements in the books of accounts.

Management assertions that are at most risk are:

(i) Occurrence—Loan and card Transactions and events that have been recorded or disclosed, have occurred and such transactions and events pertain to the entity.

(ii) Completeness—All transactions and events that should have been recorded have been recorded, and all related disclosures that should have been included in the financial report have been included. Cut off procedures have been performed.

(iii) Accuracy—Amounts and other data relating to Card and loan transactions and events have been recorded appropriately, and related disclosures have been appropriately measured and described.