Question

You are an assurance services senior at Reeves & Associates and have noted the following independent issues in relation to the audit of Fancy Pty Ltd:

1. The accounting system at Fancy Pty Ltd did not operate effectively during the first year of operations. Consequently, some general ledger accounts had to be based on estimates, as the actual data relating to these balances had been lost.
2. As a result of cost constraints, the directors of Fancy Pty Ltd did not implement effective internal controls for debt collection. The debtors’ turnover is 3.2 times.
3. Due to increased competitive pressures, Fancy Pty Ltd has recently moved the manufacture of some of its clothing lines out of Melbourne into regional areas. While Fancy Pty Ltd saves around 20% in costs, the manufacturing process takes longer and on several occasions late delivery has resulted in lost sales.

Explain the impact of each of these separate issues on your assessment of audit risk, the materiality level and the audit strategy that would be adopted. (12 marks)

Answer 1

Answer:

The matters connected with operational inefficiencies will come under the detection risk, it is because the auditor sees that there is material misstatement and make available view based on the approximations only and not built on actual data. The cost difficulties have arises due to the absence of internal control measures, so any material misstatement related with this condition will come under control risk. The company F's sales has been abridged due to the situation of the business like rivalry and place of production, so the risks linked with this kind of condition will come under inherent risk. Materiality level will be determined by the auditor based on the material misstatements. Audit strategy is arranged by the auditors to direct the audit actions, the timing and the duration of the audit. Based on the risks, the audit policies are articulated by the auditors.

Explanation:

When the auditor knows that there is material misstatement, the risks linked with those misstatements will be deliberated as detection risk. It is because the auditor knows that there will be material misstatement as the actual records are absent. The company F lacks in internal control measures, thus cost problems have been arised. So, the risks related with this situation will be considered as control risk. The company has faced problems in sales due to the intricacy in the business environment and the competitors, so the risks related with this condition will come under inherent risk. Based on the risk and material misstatements, the materiality level will be determined. The auditor typically defines the materiality level. Materiality level shows the level of misstatements in the financial reports. Audit strategies help the auditors to do their work in a strategic manner. Audit plans will show all the works to be done to complete the auditing work, the span of audit work and scope of the auditing work. So, based on the level of materiality and the misstatements the auditor creates the audit strategies for the company F.