Question

PART A Blue Cow is a long-established soft drink organisation, manufacturing a popular product for major supermarket chains. The audit of the company has been straightforward in the past, and the company has reliable suppliers and loyal customers. In addition, the directors and senior management are highly respected for their abilities and the strong ethical culture they inspire, as well as the excellent internal controls they demand. The company only sells one product – a 300ml can, which has historically been priced at a 331/3 % markup on cost, yielding a gross profit percentage (GP%) of 25%. In the past any variations on the GP% have never been outside the range of 24% to 26%.

Required: a) Identify the three components of audit risk and explain what your assessment of risk is for each component, based on the above information (use only ‘high’, ‘medium’ or ‘low’).

b) Explain how your risk assessments in (a) above would impact on planned substantive procedures.

Answer 1

a. Audit risk is the risk that financials statments are not providing true and fair view which can be relied upon. This may be encountered during or after performance of audit.

The three components of audit risks are:-

1. Inherent risk- This is the risk which evolves from the error or ommission which leads to material mistatement. It is to be considered when higher level of judgement or estimation is required or where transactions are of high value and complex.

In this scenario, this risk is low, as the entity does not have any complex transaction and deals in one product only.

2. Control rislk- This is the risk which arise due to the failure of internal controls of the organisation that leads to material mistatements in financial statements. This is high when entity does not have adequate internal controls to prevent or detect frade and error in financial statements or controls of entity are not suffcient enough to prevent and detect the same.

In this scenario, company is having low control risk , as there is no process lapses or failure of controls from the infomration available.

3.Detection risk :- Due to inherent limitations of audit, this risk is always present in the organsation. It is evolved from the misapplication or omission of critical audit procedures that leads the auditors failed to detect material mistatement in financials statements.

In this scenario, company is having low risk , as there are no omission of critical audit procedures ascertained from the given information.

b. Substantive procedures are perfomed to detect material mistatement or fraud at assertion level.

As per above assesment risk , which is low in each component, it will not impact or influence the decisions of users of the financial statements.All the elements of transaction such as occurance, accruacy, classification. completeness, authorization and cut-off will be at helpful in ascertaining the actuals mistatement if any.