Question

Audit Planning and Analytical Procedures (A)Audit Planning Two independent material situations are given below with regards to Manukau Super Timber Limited (S.T.) a large retail company. () Michelle White was the long-term CEO of S.T. until she died unexpectedly during the current financial year. Following her death, her son Ronald White became the new CEO of S.T. and embarked on a rigorous cost-cutting exercise, which included a reduction in key staff in the credit department. (ii) During the planning stage of the audit of s.т., the audit senior assessed the sales control systems to be effective. However, when testing sales, the audit assistant traced two sales to supporting documentation (invoices) that had dates that were in the prior financial year. Required For each of the two situations described above: (1) Outline briefly why the situation constitutes an audit risk. (2) Explain the component of the audit risk model affected (4 marks) (3 marks)

Answer 1

Audit Risk is the risk that an auditor issues an incorrect opinion on the financial statements. Audit Risk has three components i.e. Inherent Risk, Control Risk and Detection Risk.

1. In situation 1 given in the question, the key staff of the credit department has been removed which can lead to the risk that the remaining staff will not be as experienced as the key staff and it will lead to failures in the system of controls used by the credit department. There will be lack of proper accounting controls in the department which will lead to misstatements.
   
   In situation 2, two sales invoices were found that had dates that were in the prior financial year which leads to the risk that the prior period sales are being booked in the current year. There is a risk that other invoices may also have been booked which relate to the prior period which will increase the sales of current year although they do not belong to the current year.
   
2. The component of audit risk model that is effected in the first situation is the Control Risk i.e. because of the inexperienced staff, there will be inefficient controls and misstatement would not be detected.
   The component of audit risk model that is effected in the second situation is the Inherent Risk as the system itself is not effective. There is error in the financial system due to failure of control.