Chan and Lam (CL) is a small CPA practice in Hong Kong. CL currently employs 20

Question

Chan and Lam (CL) is a small CPA practice in Hong Kong. CL currently employs 20 audit staff and many of them are junior auditors. You are reviewing the work of three audit field staff with details as follows:

Simon Lee, who has recently promoted to assistant manager, has worked on the audit of Cole Foods Limited for six years. Since the client never had audit adjustments in the prior audits, Simon concludes that the inherent risk of Cole Foods must be zero for the coming engagement.

Amy Chan is responsible for the audit of AOP Electronics (AOP). The client’s fiscal year ends on December. Amy had performed an exhaustive study and evaluation of internal control of this client on November 30. She concludes that the client has no control risks as she observed the presence of multiple layers of error checking process in AOP, and she considered that it’s not possible for the firm to have material errors given such detailed error checking process.

Sam Wong is responsible for the audit of Plastim Manufacturing. Sam enjoys doing substantive audit work and has decided to use a substantive approach to this audit. Consequently, Sam has performed test of details on substantially all financial statement items and concludes that the risk of failing to detect material errors and irregularities is less than two percent. Sam has very little understanding about the client and the industry. To satisfy the requirement of the necessity to understand internal control as required by the auditing standards, a limited review of Plastim’s internal control was conducted.

Required:

(a) Based on the information given, comment on the conclusion and workdone for the three audit field staff.

(b) Certain audit risks are significant in that they require special audit consideration. Give two examples of these significant risks that auditors should be aware of.

Explanation / Answer

Answer –

A)

Simon Lee – Cole Foods Limited

The conclusion that there are no inherent risks for the coming engagement since the client has never done any audit adjustment in prior audits is not valid. The auditor needs to assess the business environment in which Cole Foods is operating, there is a possibility that due to any change in business environment, some inherent risks may have emerge for the firm.

Also the auditor needs to understand the current business process of the Cole Foods. Although the auditor is auditing this firm for last six years, so he must be well aware with the business process. But, still the auditor needs to understand them for the coming engagement, as there may be some change in the process for current year or new processes may have been added to due to growth. These changes in business environment and business process and practices of Cole Foods limited may result in emergence of inherent risks.

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Amy Chan – AOP Electronics

The conclusion is not valid since the auditor has performed the audit procedures till 30 november only, hence the auditor cannot give assurance on existence of no material errors for the complete fiscal year ending on December. The auditor should perform the exhaustive study and evaluation of internal controls for the complete audit period in scope i.e. till end of fiscal year of the client.

Also the auditor should not provide the conclusion based on the observation of internal controls. The auditor should perform additional audit procedures like substantive testing of individual transactions to determined and concluded on the existence of internal controls.

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Sam Wong – Plastim Manufacturing

The auditor’s conclusion is not valid, since the auditor has no understanding about the client Plastim Manufacturing and the industry in which the client is operating.

It is very important for the auditor to gain an understanding of the client and the industry before proceeding with audit procedures. To gain understanding the auditor should review previous year annual reports and financial statements of the client. The auditor should read report and articles about the industry in which client is operating.

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B)

Significant audit risk

Control risk – risk that a material misstatement may remain undetected from a system of internal control existing in a client.

Example – A client may have an internal financial control where a transaction posted by an accountant is reviewed by his manager before posting. It may be possible that a financial transaction with a material misstatement related to account or amount posted by an accountant may remain undetected from the manager of that accountant during the review.

Detection Risk – risk that a material misstatement may remain undetected from the auditor or the audit.

Example – A material misstatement in the financial statements of a client like incorrect amount of Currents Assets in Statement of Financial position may remain undetected from the audit procedures used by auditor during his audit.

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