Question

Neptune is a European company that manufactures high quality computer components and assembles computer parts. It has existed for some years and is part of a vertical supply chain for a well-known brand of computer hardware. Profts are coming under increasing pressure from manufacturers in the Far East and Asia with lower  labour costs, and from rising raw material costs. Neptune is listed on a stock exchange. There is pressure from institutional investors for better returns in the form of dividends and the main institutional investors are considering selling a proportion of their shares in the company. The directors of Neptune are considering whether to move into new market areas. Neptune has good accounting and internal control systems. Inventory is material to the accounts, and there is a good set of permanent inventory records. No year-end inventory count is conducted.
Operational compliance issues are important to Neptune as many countries have in?exible quality standards and some projects are being held up because of diffculties in obtaining approval from regulators for new components. All staff and directors of Neptune are remunerated (at least in part) on a performance-related basis, some with share options. Staff are generally highly qualifed and well paid.

This is your frst year as auditors. Your frm has very little experience in this industry. External audit costs are tightly controlled and your frm has agreed to a budget that will allow very little ?exibility. Based on the above scenario, you are required to:
(a) Describe the risks relating to Neptune under the headings of inherent risk, control risk and detection risk.
(b) Based on the risks identifed in part ‘a’ above, list the matters to which you will pay particular attention during the audit of Neptune and explain the work you will perform in relation to each.

Answer 1

Solution :

a) 1. Inherent Risk : It is a risk of material misstatement in the financial statement arising due to errors or omissions as a result of factors other than failure of controls.

Here, in this case, profits coming under increasing pressure from manufacturers with lower labour costs; pressure from institutional investors for better returns; moving to new market areas etc are some inherent risks

2.Control Risk : It is the risk of a material misstatement in the financial statements arising due to absence or failure in the operation of relevant controls of the entity.

Here, inspite of good permanent inventory records, no year end inventory count is conducted; etc are some control risks.

3. Detection Risk : It is the risk that the auditors fail to detect a material misstatement in the financial statements.This is particularly when, misstatements are individually immaterial, but which are material when aggregated.

Here, all staffs are paid based on performance and also through stock option, this case needs to be exercised further in order to avoid risk ahead. Also operational compliance issues to be considered,External audit costs are tightly controlled this might restrict the independence on scope of audit work; etc are some detection risks.

b) Matters that will be paid particular attention during audit of Neptune :

1. All material and labour costs are allocated to products in a proper way. Policies followed by the company in valuing of raw material will be analysed.

2. It is prerogative of the management to consider physical inventory count atleast once a year, this shall be made.

3. Scope on the work of audit shall be analysed properly. Wherever, sufficient appropriate audit evidence is in doubt, atleast a written representation shall be obtained from management. If due to restriction on scope or work of audit , it is not possible for an auditor to express an opinion thereon, he should find appropriate remedies as whether withdrawal is permissible ? Or a qualified or adverse opinion can be expressed.

4.Management has got many new planshence it is very important to analyse the effect of these plans on the going concern of the entity.

5. To obtain an assurance as to the fact that there has been a compliance with all applicable laws & regulations relating to an entity.