Question

SIGNIFICANT RISKS In the overall audit strategy for the audit of Keystone Computers & Networks, Inc., Several significant risks were noted as a result of obtaining information about KCN and its environment, including: 1) KCN has engaged in a strategy to sell to customers with higher credit risk. 2) The officers of the company receive significant bonuses based on quarterly results. For each of the two above risks, identify the implications and potential responses. Hoping for a different response from the standard answer below given numerous times. Thank you.

1) The implication of this factor is there may be an increased risk of misstatement of bad debt expense and the allowance for bad debts.

The auditors may decide to assign a more experienced auditor to this audit area. In addition, the auditors will decide to increase the evidence related to the adequacy of the allowance by perhaps examining the credit worthiness of more of the accounts.

2) The implication of this factor is an increased risk that management may misstate quarterly results to maximize bonuses.

The auditors may respond by adjusting the staffing of the engagement, increasing the level of skepticism, adding more unpredictability to the audit procedures, or increasing the evidence collected.

Answer 1

Name of Auditee: Keystone Computers & Networks, Inc.
Nature of Industry: Computers and Network Solutions

Risk I: Enagagement of Customers with HIgh Credit Risk

Credit Risk is also known as Default Risk. It is a fear/risk of customer not turning back for payment on Due Date. There are various other risks associated with Credit Sales having an effect over Operations and Profitability.

Associated Risk:
1. Offering cedit to customers will eventually reduce the Cash Flow capacity of an entity which as a result will affect the Purchasing Power of entity from its suppliers.

2. Often Pricing of Products is different for Cash Sales and Credit Sales , higher price for the latter. This is becuase of the Interest Componenet that an entity will charge from its customer as a reward for offering credit facilities.

If Proper Product pricing strategy is not in Place , then the above mentioned Interest Component will have to be compensated by entity from its profit thereby reducing Profit Margin.

3. Expense associated with Offering Credit like Service Charges/Fees payable to Debt Recovery Agencies which even doesn't guarantees 100% Collection.

4. Legal and Other Expenses to be incurred on defaulting Customer which adds to the cost.

5. Incresed Focus over Accounts Receivable Management which does not only involves Issuing Invoices and Recording Payments Received but also includes:

a. Receivables Due Date Management
b. Regular Follow Ups through Mail, SMS, Call or other mode of Communication.
c. Maintaining Co-ordination between Marketing , Sales Executines and Account Departments regarding Credit Sales, Payment Due Dates. Debt Recovery, Follow Ups and Lodging with Accounts.

6. By offering Credit you are not only bearing your own risk but also sharing risk of some other person (Customer).
This is because epayment from customer depends on financial health of your customer. For suppose in case of econonmic recession or any political or personal instability there might be chances consumer can demand for deferment.

7. There might be chances that a weak Credit Policy is used by Management to effect sales to its Related Parties and resorting to other Techniques lik Teaming and Lading to hide that.

Risk II: Bonuses based on Quarterly Results

Associated Risk:

1. No Doubt the first risk that comes to every auditor is the risk of Inflated Sales Figures (Resulting in High Profits) in order to earn high bonus.
2. This risk is at close proximity with credit risk becuase the mmanagement in order to increase sales figures, will resolve to :

a. Offering Credit Sales
b. Ignoring Curomer Credit Assessment
c. Credit sales on terms which are detrimental to the organisational objective.

3. Risk of Fraud in terms of Fake invoices being issued.
4. Personal Interest is given much Priority over Organisation Interest.
5. There will be risk of fake sales remaining unearthed as this may be perpetrated by management and difficult to get through.

6. The Auditor should not only focus on Sales Figues but also other Incomes which appears to be insignificant individually but as a whole are SIGNIFICANT and hevily affects the Results.
7. The Management might Compromise with Product Quality and Quantity and other Sales or Promotional Expenses to lower the COsts in order to earn high Profits. The Auditor must resort to Analytical Procedured.