Question

In: Accounting

Allentown Credit Union (ACU) is located in a rural community in Canada. Membership is open to...

Allentown Credit Union (ACU) is located in a rural community in Canada. Membership is open to people in the community and the surrounding area. The local economy, which is predominantly agricultural, has been harmed by droughts in recent years and by declines in commodity prices, leading to a decline in ACU’s profitability.

ACU has always had an external audit and has always prepared its financial statements in accordance with International Financial Reporting Standards. Ellino & Co. has audited ACU for the last several years. You, CPA, a senior with Ellino & Co., have been appointed to the audit of ACU for the year ended December 31, 2016. It is now early January 2017, and you are at the client’s premises reviewing the information gathered to date.

ACU was founded in 1942, and it has always maintained a philosophy of serving the community. This has resulted in liberal lending practices and investment in the local community whenever possible. This stance has distinguished it from other financial institutions, which are primarily branches of national banks, and has given ACU a 75% share of the market.

ACU has been headed by the general manager, Ted Richards, for the past ten years. Ted reports directly to the Board of Directors, which is comprised of local people, some of whom have no formal financial training. Ted has always been accessible to members of the credit union and, on occasion, he has intervened in favour of the customer over the staff. He maintains that this flexibility is crucial to generating revenue, which is an important objective of the Board.

The loan manager, Sheila Meigs, joined ACU in the past year. She is responsible for the entire lending function, which includes authorization of loans, appraisal of collateral, and assessment of the collectability of outstanding loans. The loan portfolio is the largest asset on the balance sheet, representing 75% of total assets.

The accountant, Vivian Larson, and the head teller, Joanne Blake, both have 15 years of experience at ACU. Both are married to farmers and work to supplement their income. Both families are members of ACU, and all their personal and business transactions are conducted through the credit union. As you read through your notes, Ted Richards interrupts you to tell you about some of the events that have occurred at ACU during the year.

  • ACU foreclosed on a large loan and sold the land held as collateral. One effect of this sale was to depress the land prices in the surrounding area. ACU still maintains a high inventory of land received from past foreclosures but has decided to hold onto this land for fear of depressing land prices further.
  • As a result of the depressed state of the local economy, provisions have recently been made to allow some customers to repay their loans with grains (i.e., oats and barley) instead of cash. Although such payments are not a common practice, Ted has approved these transactions on an exception basis.
  • Even though the economy is depressed, Ted believes this will turn around and loans will be collected over the long term. Therefore, he has instructed to Sheila Meigs, Loan Manager, not to write off any significant loans as loan balances.

Required:

  1. Define inherent risk and perform an inherent risk assessment for ACU.

Solutions

Expert Solution

Inherent Risk is the risk of a material misstatement in the financial statements arising due to error or omission as a result of factors other than the failure of controls (factors that may cause a misstatement due to absence or lapse of controls are considered separately in the assessment of control risk).

Inherent risk is generally considered to be higher where a high degree of judgment and estimation is involved or where transactions of the entity are highly complex.

For example, the inherent risk in the audit of a newly formed financial institution which has a significant trade and exposure in complex derivative instruments may be considered to be significantly higher as compared to the audit of a well established manufacturing concern operating in a relatively stable competitive environment.

The susceptibility of an assertion about a class of transaction, account balance or disclosure to a misstatement that could be material, either individually or when aggregated with other misstatements, before consideration of any related controls.

Auditor of ACU should perform an inherent risk assessment

Overall Responses

Design and implement overall responses to address the assessed risks of material misstatement at the financial statement level.

Audit Procedures

Nature, timing and the extent of the audit procedures are to be based on and are responsive to the assessed risk of material misstatement at the assertion level. Consider the reason for the assessment given to each class of transaction, account balance and disclosure including:

i. Likelihood of material misstatement due to the particular characteristics of relevant inherent risk

ii. Whether the risk assessment takes into account the relevant controls

Test of Controls

Controls have to be tested to confirm its operating effectiveness and sufficient appropriate audit evidence to be obtained when:

i. There is an expectation that the controls are operating effectively

ii. Substantive procedures alone cannot provide sufficient appropriate audit evidence at the assertion level

More persuasive audit evidence, the greater the auditor relies on the control effectiveness

Timings of Controls Test

Test the controls for the particular time or throughout the period for which the auditor intends to rely on those controls related to risk assessment procedure

Interim Period

When auditor obtains audit evidence about control’s operating effectiveness during an interim period, then:

i. Check for significant changes to those controls subsequent to the interim period

ii. Obtain additional audit evidence for the remaining period

Controls over Significant Risks

Any significant risk in auditor’s opinion should be tested in the current period. During this process, evaluate whether there are any misstatements detected by substantive procedure indicates the control are not operated effectively. If there are deviations, the auditor should understand its potential consequences through specific inquiries and determine:

i. Test of controls performed to provide an appropriate basis for reliance

ii. If an additional test is necessary

iii. If the potential risk of misstatement is to be addressed using substantive procedures

Adequacy of Presentation and Disclosure

Evaluate whether the overall presentation of the financial statements, including related disclosures, is in accordance with the applicable financial reporting framework”

Sufficiency and Appropriateness of Audit Evidence

Before the conclusion of the audit, the auditor should determine whether the audit procedures performed and audit evidence obtained is appropriate for the assessment of the risk of material misstatement at the assertion level.

Documentation

i. Overall response to address the assessed risk of material misstatement and the nature, timing, and extent of further audit procedures

ii. Linkage of those procedures with the assessed risk at the assertion level

iii. The result of the audit procedure including conclusions for unclear ones

If the audit evidence about the operating effectiveness control obtained in previous audits is used by the auditor, such fact should be documented. Auditor’s documentation should demonstrate that the financial statements agree to the accounting records.


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