Question

LLL Avionics Ltd. has contacted your accounting firm to inquire about the cost of an external audit. The company’s president explained that he feels that “the previous auditor charged too much and only issued a qualified opinion.” Your firm was recommended to LLL by your bank manager. LLL has a large loan request at the bank, and the interest rate of the new loan will depend on the audit opinion. As the partner in charge of this file, you interviewed the president and controller of the company as part of your decision to accept or reject LLL as a client. You have found that the company has a new design for an aircraft and plans to borrow funds from the bank and to issue common shares to finance a prototype plane to test the design. The new funds will also greatly improve the company’s balance sheet by providing the funds to bring the company’s existing bank loan up to date. If the design is successful, more common shares will be issued for more capital.

The controller was very helpful in your discussions, and you note his high level of enthusiasm for the project as this is his first job at this level. However, the president was not so helpful and seemed annoyed with your questions.

Indicate five factors in the above situation that impact the risk of material misstatement. Explain your answer.

Answer 1

Five factors that impact the risk of material misstatement

(1) Information Hidden in the internal system of the Company.

'Internal auditing is an independent, objective assurance and consulting activity designed to add value and improve an organization's operations. It helps an organization accomplish its objectives by bringing a systematic, disciplined approach to evaluate and improve the effectiveness of risk management, control and governance processes.^[1] Internal auditing is a catalyst for improving an organization's governance, risk management and management controls by providing insight and recommendations based on analyses and assessments of data and business processes.

(2) Defection in Authenticity and validity of transactions.

   Accounting Transactions is event that occurs that has an impact on your business’ financial statements. This event is recorded in your business’ accounting records, and keeping track of the totality of these transactions allows you to analyze and predict your business’ financial health.

(3) Defection in arithmetical accuracy of books of accounts, casting, balancing etc.

A Trial Balance is a statement that shows the total of debit and credit balances of accounts. The total of debit amounts shall be equal to the credit amounts for the trial balance to tally. Hence, it verifies the arithmetical accuracy of the postings in the ledger accounts.

(4) Forgery in the current value of assets and liabilities

  Current value accounting is the concept that assets and liabilities be measured at the current value at which they could be sold or settled as of the current date.

(5) Variance between capital and revenue type of transactions is based on wrong information.

  Capital expenditures are for fixed assets, which are expected to be productive assets for a long period of time.

Revenue expenditures are for costs that are related to specific revenue transactions or operating periods, such as the cost of goods sold or repairs and maintenance expense. Thus, the differences between these two types of expenditures are as follows:

• Timing. Capital expenditures are charged to expense gradually via depreciation, and over a long period of time. Revenue expenditures are charged to expense in the current period, or shortly thereafter.
• Consumption. A capital expenditure is assumed to be consumed over the useful life of the related fixed asset. A revenue expenditure is assumed to be consumed within a very short period of time.
• Size. A more questionable difference is that capital expenditures tend to involve larger monetary amounts than revenue expenditures. This is because an expenditure is only classified as a capital expenditure if it exceeds a certain threshold value; if not, it is automatically designated as a revenue expenditure. However, certain quite large expenditures can still be classified as revenue expenditures, as long they are directly associated with sale transactions or are period costs.