Question

Introduction

It is November 20X6, and you are part of the audit team that is performing various audit planning procedures for the audit of the financial statements of Newport Soup, Inc. (NSI), as of December 31, 20X6.1 NSI makes soups and sells them in the United States (US) and all around the world. After years of losing popularity domestically, the US Department of Agriculture (USDA) reports that soup has made a comeback. Evidence of the comeback is observed by a ten percent increase in soup consumption in 20X6 relative to 20X5. While end consumers of NSI's soup are individuals, the bulk of NSI sales are to grocery, department, and convenience stores. Three of NSI's most significant grocery store customers are Hammis Fleeter, Pubticks, and Alexis Foods.

Table 1 contains six account balances as reported in NSI's September 30, 20X6 un-audited financial statements. Table 2 contains the balances as reported in NSI's 20X5 audited financial statements.

NSI has never had to restate its financial statements and has a reputation for having a fairly ethical management team. Top management (i.e., CEO, CFO) receives base salaries and bonuses that are triggered by NSI's ability to grow sales and meet Wall Street analysts' earnings per share (EPS) expectations. NSI has met or beaten analysts' EPS forecasts in only five of the last 12 quarters.

Table 1

Unaudited balances as of September 30, 20X6, Newport Soup, Inc.

Sales revenue $2,325,000

Cost of goods sold $1,453,125

Accounts receivable $1,200,000

Less: Allowance for doubtful accounts ($50,000)

Net accounts receivable $1,150,000

Inventory $200,000

Less: Reserve for spoilage ($10,000)

Net inventory $190,000

Table 2

Audited balances as of December 31, 20X5, Newport Soup, Inc.

Sales revenue $2,400,000

Cost of goods sold $1,500,000

Accounts receivable $800,000

Less: Allowance for doubtful accounts ($50,000)

Net accounts receivable $750,000

Inventory $100,000

Less: Reserve for spoilage ($5,000)

Net inventory $95,000

1. Identify potential risks to the financial statements overall, if this risk increases or decreases your IR risk assessment, and identify the overall financial statement IR for NSI this year.

2. Identify potential risks to the NSI REVENUE for this year, if this risk increases or decreases you IR risk assessment, what assertion(s) are affected, and identify the overall IR for REVENUE this year.  

Perceived risk factors (Potential to all accounts)   

Risk Description Increase/ Decrease

1.

2.

3.

4.

5.

Overall the Inherent risk for NSI financial statements:

(Options: High/Moderate/Low)

ACCOUNT:   Revenue

Risk Description Increase/Decrease Assertion

1.

2.

3.

4.

5.

Overall the Inherent risk for this account is assessed at:

(Options: High/Moderate/Low)

Answer 1

lets understand the meaning of inherent risk,

* It is a type of risk arises at the time of preparation of financial statements due to wrong totalling, wrong calculations or escaping of any transactions (omissions) but it does not arises due to lack of internal control.

When we analyse the financial statements of NSI (both audited and un-audited) we can understand the following:

1) NSI involved in FMCG (soup).

2) Assuming that ability of going concern is not affected due to loosing of popularities and considering Increase in sales by 10% from previous year.

Note: An Audit is performed to oversee whether the assertions made in the financial statements are "True and Fair" BUT NOT "True and Correct", We can see significant differences in the amounts in the items presented in the Audited and Un-Audited Financial Statements, Considering the fairness and expertise of the management, We can only Assume there might be an Inherent risk involved in the financial statements.

i) Percieved risk factors which are potential to all accounts comparing audited v/s un-audited financial statements.

1) sales-- low.

2) cost of sales.-- low

3) Change in debtors and no-change in provisions.-- medium

4) Change in inventory -- medium

5) Amount of reserve for loss of inventory.-- low

* By considering the above risk factors and since there is no-significant and material Increase or Decrease in sales and cost of goods sold BUT significant decrease in debtors and inventory to consider in the financial statements which are audited when compared with un-aduited, the inherent limitation or inherent risk is Relatively Medium.

ii) Risk description, Increase or Decrease in Revenue Accounts:

a) Sales (increase)-- low risk

b) Debtors (decrease) -- medium risk as it needs reconsider regarding the amount asserted.

c) Provision for debtors (No change but affects revenue account) -- medium risk.

Note: Increase or decrease is derived when audited v/s un-audited financial statements compared.

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