Question

Question 2 (kapter a new audit client recently taken on by the firm. Higher-Heights Limited is,an importer and 204 You are employed by Adoma and Co, a firm of chartered accountants. Higher-Heights Limited is wholesaler of specialist computer hardware During the year the company's chief accountant resigned and in the three months leading up to the appointment of her replacement, no checking had been performed on the monthly reconciliations of the bank account and the receivables and payables ledgers Required a) From the scenario, identify examples of inherent risk and control risk, clearly explaining the nature of any misstatements that might arise in the financial statements From the scenario, identify any potential detection risk, and explain how the firm could 10 Marks b) 10 Marks minimize this risk Total: 20 Marks oy

Answer 1

Case

• Higher heights Limited is a new client recently taken.
• It is an importer and wholesaler of specialist computer hardware.
• Its chief accountant had resigned 3 months before and nobody had been replaced.
• Further, the bank account, receivables and payable ledgers are not updates from the date he resigned.

1. From the scenario, identify examples of inherent risk and control risk clearly explain the nature of any misstatements that might arise in the financial statements.

Inherent risk:

• Inherent risk is misstatement that is expected to occur where there is no control in the system.
• It is clearly stated that the company accountant had left the company 3 months before and every financial traction including bank account, receivables and payable ledgers were not updated.
• Being an importer and wholesaler there will be a high quantity and high amount of financial transaction with complex procedures using INCO terms, letter of Credit or other such financial documents. Hence understanding the business nature itself would take considerable time. Obviously, lack of previous 3 months financial statements for this kind of complicated business operation will ultimately lead to misstatement in financial reporting.
• Hereby replacing past 3 months with predicted value will increase the inherent risk in the report.

Control risk:

• Control risk illustrates the misstatement due to the failure of system control.
• Herein, non-updating of bank account, receivables and payable ledgers clearly indicates the system fails to capture financial data.
• Further with the invoice and bills can help only to a certain level, here the misstatement is unavoidable with the limited data available.
• The company should have either replaced the auditor or should have replaced with supporting system to record the financial transaction.

2. From the scenario, identify any potential detection risk and explain how the firm can minimize this risk.

Detection risk:

Detection risk is the chance that an auditor will fail to find material misstatements that exist in an entity's financial statements.

Steps to minimize the risk:

1. Collect all the bills and invoices happened during the past three months.
2. Collects all the pay slips and operational expanse data especially variable expenses.
3. Check out for any modification in assets level and liability level.
4. Collected the printed copy of bank transaction from the respective bank.
5. Compare the above-collected data and compare it with the previous year data set.
6. Create a rough report and have a concern with the previous auditor.
7. Create the draft document report and while publishing illustrates the scenario and possibility of inherent risk due to previous 3 months data set and its error terms.