Question

BALEY CORPORATION PLANNING RISK ASSESSMENT

You are in the process of planning for the audit of a newly obtained client Baley Corporation, for the year ended December 31, 2017. Baley is regulated by the state utility commission and because it is a publicly traded company the audited financial statements must be filed with the Securities and Exchange Commission (SEC).

During the risk assessment you have learned the following:

Baley is considerably more profitable than many of its competitors, largely due to its extensive investment in information technologies used in its energy distribution and other key business processes. Recent growth into rural markets, however, has placed some strain on 2017 operations.

Baley expanded its investments into speculative markets and is also making greater use of derivative and hedging transactions to mitigate some of its investment risks. Because of the complexities of the underlying accounting associated with these activities, Baley added several highly experienced accountants within its financial reporting team. Internal audit, which has direct reporting responsibility to the audit committee, is also actively involved in reviewing key accounting assumptions and estimates on a quarterly basis.

Your discussions with the predecessor auditor revealed that the client has experienced some difficulty in correctly tracking existing property, plant, and equipment items. This largely involves equipment located at its multiple energy production facilities. During the recent year, Baley acquired a regional electric company, which expanded the number of energy production facilities.

You plan to staff the audit engagement with several members of the firm who have experience in auditing energy and public companies. The extent of partner review of key accounts will be extensive.

Required:

Based on the above information, discuss the risk factors in the December 31, 2017, financial statements of Baley Corporation. In your discussion, identify the audit risk model component (Audit Risk, Inherent Risk, Control Risk, or Detection Risk) affected by the risk factor and the impact on both the audit risk model component (Increase or Decrease) and the sufficiency and appropriateness of the evidence. Provide examples of evidence when appropriate (your examples can be used more than once). The best way to organize your case is to discuss each risk factor separately. For example:

Baley Corporation is a new audit client for the firm. The engagement team will be unfamiliar with the operations, personnel, and controls of Baley Corporation. When auditors are unfamiliar with the client’s business, this can cause an increase in the risk of material misstatement, specifically inherent risk. In addition, since this is a new client, the firm may wish to lower audit risk. The engagement team will need to increase both the amount of evidence and the quality of evidence. Larger sample sizes may be necessary for key accounts such as Cash, Accounts Receivable, Sales. The engagement team may want to test equipment in multiple locations. An increase in direct evidence will be required; for example, bank statements sent directly from the bank to the auditor, and accounts receivable confirmations.     

Answer 1

In addition to the risk highlighted above there are certain risks that an audit team will have to mitigate by obtaining sufficient and appropriate audit evidence.

1. Physical existence of the existing property plant and equipments are to be tested physically visiting the facilities.

2. The company has in the year has acquired an electric company, which has in turn expanded to various energy production facilities. Audit team will have to ensure that the amount of this facilities are included propery the audit risk related to this facility and its expansion is high so there are inherent risk in the transaction.

3. Baley has also expanded its operations into speculative market by using hedging and derivative transactions. Control risk has to be high since these are automated process also detection risk has to be higher since many of the transactions are manually entered in the system therefore Audit risk is high as this is a major source of income for them.

4. Planning risk Audit team is new and it will be utmost important to plan the audit work appropriately determining the major key risk areas.

5. Company may sought to determine compliance help to ensure that all listing disclosure are correctly made