Question

Which of the six risks should be considered a significant​ risk? Explain why they represent a significant risk. For each risk that you identified as a significant​ risk, describe how you might address the risk to give it special audit consideration. For​ example, a valuation risk might be addressed by engaging a valuation specialist.

Begin by determining which of the six risks should be considered a significant risk.​ Then, for each risk that has been identified as a significant​ risk, 1) select the reason why the risk represents a significant risk using the corresponding letter from the first list provided​ below; and​ 2) select an action which might address the risk to give it special audit consideration using the corresponding letter from the second list provided below.

A The significant​ build-up of inventory and potential for a​ write-down for obsolescence appears to be a significant risk. B The industry competition is a business​ risk, which suggests it should be considered a significant risk. C The increase in the age of accounts receivable increases inherent risk for accounts receivable which suggests it should be considered a significant risk. D The transaction is significant and the organization is not familiar with this type of accounting which suggests it should be considered a significant risk. E The​ entity's ability to operate as a going concern in a market filled with competitors creates a significant risk. F Regardless of the expertise of the​ firm, percentage of completion contract accounting is always considered a significant risk due to the complex nature of the accounting. G The increase in the bad debt expense increases control risk for operating income which suggests it should be considered a significant risk. H This appears to be a fraud risk related to revenue recognition. All fraud risks should be considered significant risks. I The potential impairment of significant amounts of goodwill appears to be a significant risk.

J	To address the significant risk related to contract​ accounting, the audit firm should make sure that staff with experience auditing contracts​ in-progress are assigned to the area and review the results of testing more closely.
K	The company should increase emphasis on collections and offer additional incentives to encourage prompt payments.
L	The auditor could address the significant risk for potential inventory obsolescence by examining subsequent sales and selling prices of inventory sold after year end.
M	The significant risk due to potential revenue recognition fraud will likely result in several changes in testing. The auditor will likely want to expand revenue cutoff​ testing, and also increase tests for sales returns after​ year-end. The auditor may increase the use of accounts receivable​ confirmations, including confirmation of the terms of sale.
N	To address the risks related to significant​ competition, the company should invest in new and different technology for their industry.
O	The use of a valuation specialist will help address potential goodwill impairment.

Risks identified during audit planning	Significant risk or Not a significant risk	If a Significant risk, reason why (A-I)	How you might address the risk to give it special audit consideration (J-O)
1. Fernandez Wholesalers sells energy drinks to various distributors. As they have expanded sales to additional customers, there has been some increase in the age of accounts receivable, which could require an increase in the allowance for doubtful accounts.
2. Sansone Construction builds light commercial real estate properties. This year they started a new project that is three times larger than previous projects completed by the company, and is the first one that will take more than one year to complete. The company has limited experience with percentage of completion contract accounting, and the project is running significantly behind schedule.
3. Horton Sports produces high-end sporting gear. Sales and receivables have increased significantly in the fourth quarter over the previous year, and the company has pressured customers in the past to purchase more product than they need, resulting in significant returns.
4. Alset Motors is a start-up focused on self-driving vehicles. Their technology has shown significant promise in selected test markets, but there are several competitors also in the market, including major auto manufacturers and technology firms.
5. Orion Computer has a significant amount of goodwill on its balance sheet resulting from its acquisition of another enterprise software company in the prior year. The company has seen a significant decline in sales and its stock price due to increased cloud computing.
6. Lumony manufactures yoga pants and other activewear. Due to changes in consumer tastes, it has experienced a significant build-up in inventory of two of its products that may require a write-down.

Fill out the table according to the headings.

Answer 1

Risks identified during audit planning	Significant risk or Not a significant risk	If a Significant risk, reason why (A-I)	How you might address the risk to give it special audit consideration (J-O)
1. Fernandez Wholesalers sells energy drinks to various distributors. As they have expanded sales to additional customers, there has been some increase in the age of accounts receivable, which could require an increase in the allowance for doubtful accounts.	Significant	(1) The increase in the age of accounts receivable increases inherent risk for accounts receivable which suggests it should be considered a significant risk. (2) The increase in the bad debt expense increases control risk for operating income which suggests it should be considered a significant risk.	The company should increase emphasis on collections and offer additional incentives to encourage prompt payments.
2. Sansone Construction builds light commercial real estate properties. This year they started a new project that is three times larger than previous projects completed by the company, and is the first one that will take more than one year to complete. The company has limited experience with percentage of completion contract accounting, and the project is running significantly behind schedule.	Significant	(1) The transaction is significant and the organization is not familiar with this type of accounting which suggests it should be considered a significant risk. (2) Regardless of the expertise of the​ firm, percentage of completion contract accounting is always considered a significant risk due to the complex nature of the accounting.	To address the significant risk related to contract​ accounting, the audit firm should make sure that staff with experience auditing contracts​ in-progress are assigned to the area and review the results of testing more closely.
3. Horton Sports produces high-end sporting gear. Sales and receivables have increased significantly in the fourth quarter over the previous year, and the company has pressured customers in the past to purchase more product than they need, resulting in significant returns.	Significant	This appears to be a fraud risk related to revenue recognition. All fraud risks should be considered significant risks.	The significant risk due to potential revenue recognition fraud will likely result in several changes in testing. The auditor will likely want to expand revenue cutoff​ testing, and also increase tests for sales returns after​ year-end. The auditor may increase the use of accounts receivable​ confirmations, including confirmation of the terms of sale.
4. Alset Motors is a start-up focused on self-driving vehicles. Their technology has shown significant promise in selected test markets, but there are several competitors also in the market, including major auto manufacturers and technology firms.	Significant	The industry competition is a business​ risk, which suggests it should be considered a significant risk.	To address the risks related to significant​ competition, the company should invest in new and different technology for their industry.
5. Orion Computer has a significant amount of goodwill on its balance sheet resulting from its acquisition of another enterprise software company in the prior year. The company has seen a significant decline in sales and its stock price due to increased cloud computing.	Significant	The potential impairment of significant amounts of goodwill appears to be a significant risk.	The use of a valuation specialist will help address potential goodwill impairment.
6. Lumony manufactures yoga pants and other activewear. Due to changes in consumer tastes, it has experienced a significant build-up in inventory of two of its products that may require a write-down.	Significant	The significant​ build-up of inventory and potential for a​write-down for obsolescence appears to be a significant risk.	The auditor could address the significant risk for potential inventory obsolescence by examining subsequent sales and selling prices of inventory sold after year end.

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