Question

Caring for Kids Ltd (CFK) is listed on the Australian Securities Exchange. The company provides childcare services for pre-school children. CFK has undertaken significant expansion of its operations over the past two years. This strategy has resulted in the acquisition of a total of 200 new centres with childcare licences in Australia, New Zealand and the Page 259 United Kingdom. The expansion strategy has been funded mainly from borrowings that have been sourced in both local and foreign currency. CFK’s board consists of five directors: three non-executive directors, the CEO and CFO. None of the three non-executive directors have any formal qualifications or background in business. The board has expressed concern about the pace of expansion, due to CFK’s accounting system failing to effectively integrate the acquired companies’ complex information systems.

Based on the background information, identify four inherent risk factors for CFK and explain their impact on the financial report.

Answer 1

Inherent risk is the risk that financial statement might be misstated prior to audit of financial statement. It is the suspectibility of a transaction being misstated in the absence of internal contols. It is the risk which is derived from the charecteristics of the entreprise and its environment

The four inherent risk factors and their impact on financial statements are as below -

1. Significant expansion in operations in last two years - It is an inherent risk arising from non-routine transactions. Due to the nature of these transactions, it may be possible that the transactions have not been reflected properly or in a manner which depicts true and fair view.

2. Borrowings in foreign currency - The transactions may not have been translated using correct rate. There is also risk that foreign exchange losses may arise.

3. Absence of formal qualifications or background in business - A board consisiting of qualified non-executive directors with relevant exposure is required to oversee the functioning of the company by its executive directors. Lack of such overseeing may result in ineffective controls resulting in misstatements

4. Failure to effectively integrate the acquired companies’ complex information systems - It may result in misstatements resulting from errors in transferring data from one system to another.

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