Question

This is the second year that your firm is auditing JJ Company, which is developing a new drug for a rare form of cancer. The company is controlled by Jack, who purchased the shares from the previous owner this year. You have been informed that the company's bank requires an audit to increase the company's operating line of credit. Jack has also informed you that he would like to convert the company into a public company next year, and sell shares on the stock exchange, as he does not expect that the company will have significant revenues for at least four years. At present, the company has two other drugs under patent, and these products produce sufficient revenues to service the debt load of the company, including anticipated new borrowing this year. However, these patents will expire in five years, so Jack is trying to plan ahead.
Required
Indicate whether you feel the overall audit assurance should be high or low in the audit of JJ. State two reasons to support your answer.

 

Answer 1

The level of overall audit assurance should be high because of the following factors:

 

•   Heavy reliance will be placed on the financial statements (the bank and potential investors will be relying on the audited financial statements).

 

•   The nature of the business is considered to be risky (the company’s only revenue source is expiring in 5 years and the new drug is not yet ready for market).

The nature of the business is considered to be risky (the company’s only revenue source is expiring in 5 years and the new drug is not yet ready for market).