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Identify the circumstances that affect the inherent/control risks of the specific assertion of the transaction class/account. Consider the following points when writing your answer:
How does a particular risk factor affect the likelihood of mis-statement for this assertion of this particular transaction class/account balance? Does this factor result in an increase or decrease of the risk? What is the nature of the likely mis-statement, for example, error or fraud? Indicate the direction of the likely mis-statement if the fact clearly suggests that an overstatement or an understatement is more likely. Briefly explain how exactly this risk factor can cause a mis-statement, for example, what kind of error or fraud is likely to occur due to this risk factor?
Individual Assignment : Case Study (20 marks)
You are a senior auditor of the accounting firm ABFS. Your audit team is currently planning the 2014 audit of Pinnacle Limited, a medium sized business which manufactures home and office furniture. This is the third year your accounting firm is engaged to perform the audit for this client. The financial year (FY) being audited ends on 30 September 2014 (FY2014). Past audit work and initial audit procedures performed this year revealed the following information:
Due to poor economic conditions and increasing competition in the industry, Pinnacle Ltd's sales have dropped by about 15% over the last three (3) years from FY2011 to FY2013. The audit client's CEO (Chief Executive Officer) told its shareholders at the last Annual General Meeting that the company would at least maintain its FY2013 profit level in FY2014. However, by April 2014, profit for the first seven (7) months was 20% below the profit level for the prior corresponding time period in FY2013. The CEO was concerned that the company may not be able to meet its profit forecast by the end of the year. This would be a big disappointment to the shareholders and would likely have a major impact on the share price. About 30% of the CEO's remuneration is in the form of the company's shares. The CEO asked all employees to make every effort to improve sales and cut costs for the remaining months of the year. Further, the CEO warned the employees that if the company's sales continued to decline, many jobs would be at risk. A special bonus scheme for sales staff was introduced in late July 2014 to boost sales performance. Sales revenue for the last two (2) months of the financial year improved substantially relative to the first ten (10) months of the year.
Accounting staff are paid a fixed salary with no performance-based bonus payments. However, all staff in the company used to receive a bonus when the company achieved a satisfactory profit level for the year.
The Accounting Department is separate from other operating departments. Only the staff in the Accounting Department have access to the accounting system. Even the CEO does not have direct access to the accounting records. The CEO needs to consult with the Chief Accountant about any proposed changes. If the Chief Accountant agrees that an adjustment is appropriate, the Chief Accountant would then make the change in the computer system.
The accounting staff check all related documents before recording journal entries in the computer system, for example, copies of customer order and shipping documents signed by the customer. Senior accounting staff regularly reviews the work of junior staff and report any major issues to the Chief Accountant who reports to the CEO and Board of Directors.
The Chief Accountant has worked for the company for three years. Based on past experience, the auditor finds the Chief Accountant to be co-operative and ethical. The Chief Accountant tends to adopt conservative accounting policies and estimate. From recent conversation, the auditor has discovered that the Chief Accountant is applying for jobs with other companies. The Chief Accountant is unwilling to discuss this matter in detail but just said the pressure at work is substantial. The Chief Accountant keeps the CEO updated about the company's financial progress and discusses major accounting estimates with the CEO.
For the occurrence assertion of sales revenue, answer the following questions. You need to provide sufficient explanations using the facts in the case study.
(7) Explain how the auditor should test the occurrence assertion of sales revenue using substantive procedures in this case. The procedures should be based on your earlier analysis of risk factors. (3 marks)
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The Accounts department updates all sorts of relevant financial progress to the CEO of the company. Having an overview of the whole situation, it could be ascertained that the firm runs a low level of inherent risk supported by a strong accounting team, integrity in the management system and a strong audit background. The issue of weak sales could be managed by the efficient sales team and the economic scenario is a general condition. So leaving aside these issues, Pinnacle Limited needs to be least concerned about the inherent risks to be mattered (Zadek, et al., 2013).
ABFS, the audit firm is well aware of the accounting system followed at the firm. The firm has an excellent system of Authorisation where the CEO needs to consult the Chief Accountant while drafting any sort of strategic change and the work of the junior staff being supervised by the senior staff. So from the mentioned points, it could be held that Pinnacle Limited runs a lower level of control risk keeping in mind of the stringent internal monitoring system supported by trustworthy and co-operative employees.