Consider each of the following situations, which are independent of each other.
ID: 2566210 • Letter: C
Question
Consider each of the following situations, which are independent of each other.
a) Your audit plan for sales places substantial reliance on the system of internal control and the use of analytical review. Your testing of the internal control system for sales has found a significant number of instances where customer credit ratings have not been checked and abnormally large discounts have been given. The sales manager states that these changes have been the result of difficulties in maintaining past sales levels.
b) You are carrying out the annual audit of a tractor retailer. You are aware of significant problems in the rural industry over the past six months and little improvement is in sight.
c) Since the last audit your client has introduced a new management compensation scheme with the result that top managers’ salaries are closely tied to the company’s profitability.
d) A new competitor of your client entered the market two months before year end and, since that time, selling prices have fallen significantly. Your inquiries have revealed that the industry expects heavy discounting to continue for the whole of next year.
In each case
1. Identify how the situation impacts on audit risk
2. How does the situation effect audit planning?
3. How does the situation affect audit sampling?
Consider each of the following situations, which are independent of each other.
a) Your audit plan for sales places substantial reliance on the system of internal control and the use of analytical review. Your testing of the internal control system for sales has found a significant number of instances where customer credit ratings have not been checked and abnormally large discounts have been given. The sales manager states that these changes have been the result of difficulties in maintaining past sales levels.
b) You are carrying out the annual audit of a tractor retailer. You are aware of significant problems in the rural industry over the past six months and little improvement is in sight.
c) Since the last audit your client has introduced a new management compensation scheme with the result that top managers’ salaries are closely tied to the company’s profitability.
d) A new competitor of your client entered the market two months before year end and, since that time, selling prices have fallen significantly. Your inquiries have revealed that the industry expects heavy discounting to continue for the whole of next year.
In each case
1. Identify how the situation impacts on audit risk
2. How does the situation effect audit planning?
3. How does the situation affect audit sampling?
Explanation / Answer
a. In this case, the control system itself has allowed the deviations to meet the sales target. Giving larger discounts is an internal policy decision taken by the company ,which is certain to affect company's profitability& inflate receivables
As auditors can only control detection risk, because the above being a control risk is the responsibility of the company's management. As the auditor would like to keep the audit risk low, the auditor will increase the audit procedures like checking individual accounts and the discounts offered.
So, audit sampling increases in no. of receivables account taken for scrutiny.
b. This is an inherent risk, inherently present in this type of audit
The auditor has to keep this in mind while applying various audit procedures
The auditor can adopt the haphazard collection of samples, to gather audit evidence to form an opinion.
c. This is a control risk ----again a policy decision to achieve profit targets.
Audit should be planned to see if all items of incomes & expenses properly belong to that period only & procedures should verify that no income is over-stated & no expense is under-stated.
This entails collection of appropriate samples either as strata or groups like different heads of incomes & expenses
d. This is an inherent risk, present by nature, in this type of audit, over which the auditor has no control.
During planning the audit, he can only strategies as to check the individual clients & the discounts offered, are in tandem.
Stratified, i.e. Taking samples from different stratum or interval sampling, i.e. Taking one sample at fixed intervals --can be gathered as audit evidence.
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