Question

Question  

ABC Enterprises Ltd. deals in currency transactions. Most of the company’s business involves buying and selling foreign currency to small businesses. ABC’s strength in the past has been providing higher levels of service than its competitors. The company is owned by three brothers who are equal shareholders, each of whom has provided the company’s long-term financing. To increase sales this year, ABC has reduced its profit margins. This strategy is not popular with the managers at the company’s several locations because their bonuses are based on net income for their own location. However, the controlling shareholders have made it clear that they are committed to this strategy for the short term at least, but that margins are expected to improve in the future. Many of the company’s capital assets are leased.

Required

   a. Identify three factors that affect inherent risk regarding ABC Enterprises Ltd.

   b. Each purchase of foreign currency is approved by the branch location’s manager, who initials the purchase order, indicating his approval and that he has recalculated the amount. The auditor concluded that control risk was high for the authorization objective. Answer the following questions regarding the auditor’s test of controls:

i) What attribute was the auditor testing for in the test of controls?

ii) Define the conditions for deviation.

iii) Define the population.

iv) Explain the acceptable risk of assessing control risk too low (ARACR) in the auditor’s test.

Post your responses to the discussion forum and critically respond to at least one post from one of your peers.

Answer 1

Answer to Question a:

Inherent risks are posed by factors other than the failure of controls.

3 factors affecting the inherent risk of ABC Enterprises Limited

1. Regulatory changes that may not be complied with pose inherent risk as the regulator can bring actions in terms of fines and ultimately revocation of licence for not following the guidelines around the purchase and sale of foreign currency.

2. Money laundering activities by the buyer or seller of the foreign currency can be a factor of inherent risk. If a customer engages in such activities through the currency conversion exercise done by ABC, the company may be questioned by the foreign jurisdictions to explain its involvement in the transaction. The transaction may have appropriate maker-checker controls in place but these activities generally go beyond the authorisation. Fraud by the customer using complex organisational structures also adds to the inherent risk.

3. Due to the nature of the business and volatile nature of currency prices, even going concern risk can be an inherent risk as a result of ABC not being able to manage its currency positions. This may closely be linked to the market risk or liquidity risk in the currency markets which is beyond ABC's control.

Answer to Question b:

i. The attributes that the auditor was testing for would be the following:

- whether the purchase of foreign currency authorised by the Branch manager

- whether the purchase had Branch Manager's initials indicating his approval

- whether the branch manager recalculated the amount before approving

ii. The conditions for deviations would be the purchase of currency not having the Branch Manager's approval or branch manager's lapse to put his initials to indicate his approval or the branch manager not recalculating the amount to be paid for purchase.

iii. The population would be all the foreign currency purchase transations that happened during the accounting period under review.

iv. The acceptable risk of assessing control risk too low (ARACR) in the auditor’s test in this case would be the auditor signing off this control as effective when the deviations are beyond tolerable limit in the population.