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 2019. During your initial planning meeting held with the financial controller, he told you of the following changes in the company’s operations.

1. 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.

2. Sampson has planned to close an inefficient factory in country New South Wales before the end of 2019. 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.

3. 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.

4. 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.

The managing director has returned from the USA, where he signed a contract to import a line of clothing that has become the latest fashion fad in the USA. The company has not previously been engaged in the clothing industry

Required:

For each of the scenarios above, explain how the components of audit risk (inherent, control or detection risk) are affected.

Answer 1

Introduction :- Audit risk can be defined as the risk that the auditor will not discern errors or intentional miscalculations during the process of reviewing the financial statements of a company or an individual .

Components of audit risk:

1) Inherent risk - It is the risk of a material misstatement in the financial statements arising due to error or omission as a result of factors other than the failure of control.

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 .

3) Detection risk - It is the risk that the auditors fail to detect a material misstatement in the financial statements.

In this question the risks involved in the following cases are as follows :-

i) In the first case the component of inherent risk is affected as the workload of finance controller is divided between him and the treasurer so there is less risk of error or omission and even the company is earning profit.

ii) In this case the component of control risk is affected as there is internal control present in the system .

iii) In this case the component of control risk is affected .

iv) In this case the component of detection risk is affected .