accounts receivable balance. You investigate this recerivable and learn th 6. Du
ID: 2451450 • Letter: A
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accounts receivable balance. You investigate this recerivable and learn th 6. During a mectirg wa signitica a mecting with the facilities director, you learn that the board nt amount of debt to finance the ew manufacturing plant for the Solar-Electro division. The co e make a considerable investment in modifications to the propty has decided to raise a to the property on whi e plant will be built Vhile standing in line at a vending machine, you see a Pinnacle vice You are fam Company and noticed some of its repairmen working in the plantl the man you like the shirt and he responds by saying, "Thank youMe,Yo own the company, but we hire people to manage it. 8. After inquiry of the internal audit team, you realize there is internal audit department. You conclude the turnover is 9. While reviewing Pinnacle's long-term debt agreements, you identify severa 10. The engagement partner from your CPA firm called today notifying you th will be coming on-site to Pinnacle's facilities to investigate an ongoing II. A member of your CPA firm, who is currently on-site in Detroit at the W higher-level positions Causin The size Jérôme had gan tive covenants. Two requirements are to keep the current ratio above 20andels e20Rogue 2.0 and de and de to-equity below 1.0 at all times Sioux, an industry specialist and senior tax manager from the firm's Ontari l between the Internal Revenue Service and Pinnacle dispe division, calls you to see how everything is going while you are vsting Sa Kervie in Texas. During your conversation, he asks if you know anything about the compuny losn foo weba yhabout the oppo intercompany Joan from Welburn to Solar-Electro, a. Review Part I of the case and the situations in Part II and identify inform Required of nd identify information th uat affects your assessment of acceptable audit risk. Note that only some of the si in Part I will relate to acceptable audit risk. Classify the information based mor dire bet se in three factors that affect acceptable audit risk. External users' reliance on financial statements Likelihood of financial difficulties Management integrity b. Assess acceptable audit risk as high, medium, or low considering the items yoo identified in requirement a. (A risky client will be assessed as a low acceptable aude risk.) Justify your response c. Identify inherent risks for the audit of Pinnacle using the information from Parts and II. For each inherent risk, identify the account or accounts and the relevant aud objectives that may be affected. Inherent Risk Account or Accounts Affected Relevant Audit Objectives RESEARCH PROBLEM 9-1 MATERIALITY AND PERFORMANCE MATERIALITYExplanation / Answer
a External users’ reliance on financial statements:
Likelihood of financial difficulties:
1. The solar power engine business revolves around constantly changing technology, thus making it inherently more risky than other businesses, with a better chance of subsequent bankruptcy. Item 1 in the planning issues raises a concern about the viability of the Solar-Electro division, but not necessarily the entire company.
2. The conclusion in Part I of the case was that the likelihood of financial failure is low, even considering the issue with Solar-Electro.
3. Item 9 in the planning phase indicates there is a debt covenant requiring a current ratio above 2.0 and a debt-to-equity ratio below 1.0. The current ratio has fallen below 2.0. This could result in the loan being called unless a waiver of the loan covenant is granted.
Management integrity:
No major issue exists that would cause the auditor to question management integrity, but the auditor should have done extensive client acceptance procedures before accepting the client. It is possible that Item 8 in the planning phase, turnover of internal audit personnel, could be intentional and increases the risk of fraudulent financial reporting.
b. Acceptable audit risk is likely to be medium to low because of the factors listed previously, especially the planned increase in financing and the potential violation of the debt covenant agreement. Some might prefer an even lower acceptable risk because it is a first year audit.
C Inherent risks are addressed by examining each of the 11 items in the planning phase.
1. Inherent Risk: No effect on inherent risk
2. Inherent Risk: The primary concern is the possibility of obsolete inventory, which affects the valuation of inventory at the lower of cost or market. Accounts Affected: Inventory, cost of good sold
3. Inherent Risk: There is a potential related party transaction, which could affect the valuation of the transaction and may require disclosure as a related party transaction. Accounts Affected: Manufacturing equipment, footnote
4. Inherent Risk: This situation involves a nonroutine transaction where there is a risk that materials, labor and/or overhead are incorrectly applied to the property accounts. Accounts Affected: Property accounts, inventory and cost of sales.
5. Inherent Risk: A receivable outstanding for several months from a customer making up 15% of the company’s outstanding accounts receivable balance may indicate a major collection problem, which could result in an understatement of the allowance for uncollectible accounts. Accounts Affected: Accounts receivable, bad debt expense, allowance for uncollectible accounts.
6. Inherent risk: No affect on inherent risk
7. Inherent Risk: There is a potential related party transaction, which could affect the valuation of the transaction and may require disclosure as a related party transaction. Accounts Affected: Repairs and maintenance expense and accounts payable
8. Inherent Risk: Although this does not directly affect inherent risk, it is possible that turnover of internal audit personnel could be intentional and increases the risk of fraudulent financial reporting. The turnover may also affect the auditor’s assessment of control risk. Accounts Affected: All accounts
9. Inherent Risk: In addition to affecting acceptable audit risk, the auditor should be concerned about the risk of fraudulent financial reporting due to the incentive to make certain that all debt covenants have been met. Accounts Affected: All accounts , allowance for uncollectible accounts.
10. Inherent Risk: An ongoing dispute with the Internal Revenue Service may require an adjustment to income tax liability or a disclosure in footnotes for a contingency, depending on the status of the dispute. Accounts Affected: Income tax expense and income taxes payable
11. Inherent Risk: This situation involves a related party transaction (Solar-Electro borrowed money from the Welburn division). Because this transaction was not conducted with an outside party, it is possible that the related receivable and payable might not have been properly eliminated on Pinnacle’s consolidated financial statements. Accounts Affected: Notes payable, notes receivable, interest expense and interest income.
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