Question

Part 1: Using the company profile below, identify TWO material misstatement risks- either at the entity-level (i.e. risk of material misstatement at the overall financial statement level) or account assertion level. For each account or entity-level risk identified, briefly describe why it qualifies as risky.

Part 2: Using the comparative financial information given in the next tab, identify THREE specific account-related misstatement risks. For each risk, briefly describe why it qualifies as a risk and the related accounts and assertions that potentially may be violated.

Company Profile: Your audit firm has been engaged to issue an opinion on the financial statements of CNX Corporation which sells and leases office equipment. Initially, CNX focused on selling and leasing copiers but CNX is finding that its customers, as is the general trend, are becoming increasingly paperless and adopting cloud computing as opposed to maintaining their own servers. This change in the business environment has hurt CNX’s sales of copiers, printers, and computer servers, and CNX is feeling the need to shift to selling cloud computing solutions on a subscription basis to better serve its customers. CNX's revenue has been declining over the past 3 years, but this was the first year that CNX experienced a net loss. In response, the CEO Darren Paul, issued a press release stating, “Our repositioning will necessarily require some additional expenses in the initial years, but we are confident that it will set the stage for CNX to exploit the explosive growth in cloud computing solutions." CNX benefits from its long established relationships with its exisiting customers, giving it an advantage over other companies in the same industry; however, cloud-based software companies are increasingly establishing their own sales forces to sell directly to customers. CNX has a reputation for being a good corporate citizen, and the CEO and CFO serve on the boards of major charities. CNX has had the same accounting team in place for the past ten years and has lower than average employee turnover throughout its ranks. This is your firm's eighth audit of CNX. There have been no disagreements over accounting issues in any of the previous audits.

Answer 1

Solution:-

Part 1 Based upon the company's profile the two risks of material misstatement are as listed below:-

1. Risk of material misstatement pertaining to expenses Assertion- Occurence(Transaction), Cutoff :- As the company incurred a net loss this year, there is risk assosciated with overstatement of expenses, and identifying expenses pertaining to subsequent year into current period resulting in net loss instead of net profit. Further, the entity is expecting an increase in expense in subsequent years as well thereby making expenses a significant area for audit purposes.

Further, as the company is in leasing business, there is a risk assosciated with classifying the additions to Property, Plant and Equipment as expenses resulting in net loss.

2. Entity level risk (Risk of management override of controls):-

The risk assosciated with financial statements is management override of controls. Management is in a significant position to perpetuate fraud. The management can direct the accounting personnels and alter the financial records. There should be mitigating controls such as management should not have access to put accounting entries in the system. The management may enter into related party transaction at prices above arms length price. Therefore, management override of control happens to be a significant risk at the financial statement level.