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 five (5) scenarios (i – v) above, explain how the components of audit risk (inherent risk, control risk or detection risk) are affected.

Answer 1

Case 1

Inherent risk is increased. The treasurer is speculating in foreign currency, which may lead to foreign exchange losses.Also, the complexity of accounting for foreign currency transactions increases the risk of errors. While the appointmentof the treasurer may reduce control risk if he performs additional internal controls, thereby reducing audit risk, there isno evidence of this in the question. If there is a proper delegation of the responsibilities between the financial controllerand treasurer, which takes pressure off the overworked financial controller, this also has the ability to reduce control risk, thereby reducing audit risk

Case 2

Inherent risk is increased. The financial controller will be required to make a subjective estimate of the provision for closure

Case 3

Inherent risk is increased. Tying bonuses to reported sales increases the risk of sales staff processing fictitious sales,making sales to uncreditworthy customers or manipulating sales between periods to increase their bonuses.

Case 4

Control risk is reduced if the new system is able to produce better management accounts, because management use these to monitor the company’s results. Inherent risk is reduced because the package is a popular ‘off the shelf’ software with limited modifications. Therefore, it is likely to have been extensively pre-tested by the manufacturers.

Case 5

Control risk is reduced as the creation of the systems administrator position removes the duties of the administrator from general accounting staff and creates a segregation of duties.