Question

You are the audit senior responsible for the audit of Sampson Limited. You are currently planning the audit for the year ended 31 December 20X7. During your initial planning meeting held with the financial controller, he told you of the following changes in the company’s operations.

(i) Due to the financial controller’s workload, the company has employed a treasurer. The financial controller is excited about the appointment because in the two months that the treasurer has been with the company he has realised a small profit for the company through foreign-exchange transactions in yen.

(ii) Sampson has planned to close an inefficient factory in country New South Wales before the end of 20X7. It is expected that the redeployment and disposal of the factory’s assets will not be completed until the end of the following year. However, the financial controller is confident that he will be able to determine reasonably accurate closure provisions.

(iii) To help achieve the budgeted sales for the year, Sampson is about to introduce bonuses for its sales staff. The bonuses will be an increasing percentage of the gross sales made, by each salesperson, above certain monthly targets.

(iv) The company is using a new general ledger software package. The financial controller is impressed with the new system, because management accounts are easily produced and allow detailed comparisons with budgets and prior-period figures across product lines and geographical areas. The conversion to the new system occurred with a minimum of fuss. As it is a popular computer package, it required only minor modifications.

(v) As part of the conversion, the position of systems administrator was created. This position is responsible for all systems maintenance, including data backups and modifications. These tasks were the responsibility of the accountant.

Required: For each of the scenarios above, explain how the components of audit risk (inherent, control or detection risk) are affected. (10 marks, maximum 250 words)

Answer 1

Case 1: In this case, the inherent audit risk is greater than before since the treasurer is newly appointed and dealing in complex foreign exchange transactions in Yen. Hence, the inherent risks increased considerably which the auditor needs to report.

Case 2: In the second case where the rearrangement and clearance of factory assets will not be completed till next year, control risk is there since the factory is disorganized and because of which there may be delays in the controls in place and there may not be proper separation of duties as the factory is about to close.

Case 3: There is inherent risk is there since new bonus program is about to announce where in high degree of conclusion and valuation involved about the provisions to be made towards the bonuses payable to the sales staff, further, there no past trend as well since bonuses are yet to be introduced.

Case 4: In this case, inherent risk is there since the general ledger software package is very new and hence, it is not well established and is not stable. Hence, the auditor needs to address the inherent risk here.

Case 5: In the current case, there may be control risk since the position of systems administrator has been newly created and the person who joined the Company is new who needs time to understand the process and controls.

At the end, detection risk is always there in every case since, this is a risk which the auditor fails to detect the material misstatements in the financial statements. The auditor needs to increase the sample in order to lower the detection risk.