7-25 09 The audit staff have recently completed risk assessment procedures to gain an under- standing of Chocolate from Heaven Inc.'s (CFHI) business and to identify risk factors relevant to the risk of material misstatement. (For further background on the company, refer to Question 6-42 on page 205.) a. For each risk factor below, decide whether each piece of information would fit into your assessment of inherent risk (IR) or control risk (CR), and whether it would increase or decrease the specified risk area. 1 2 3 4 5 6 7 Due to the size of the CFHI's business, only one accounting clerk does most of the IRIRCR CR accounting. In recent years there has been increased competition in the artisanal small batch IR TIR I CR CR chocolate business. The management bonuses at CFHI are based on net income IR 1 IR! CR CR! All cheques require the signature of both owners. IR IR I CR CR Access to the warehouse at CFHI is restricted to warehouse employees only, who carry IRTIR I CR CR! their own security cards. The chocolate inventory has a one-year shelf life. IR IRCR CR! David Chan has developed a personal trusted relationship with each of the cocoa IRIR. CR CR bean farmers in Tanzania, Ecuador, Philippines, and Honduras. He visits each farmer annually. He believes these strong relationships help to ensure farmers send CFHI high-quality beans. High-quality beans are critical to the production of high-quality chocolate. CFHI just switched to an inventory tracking system that was developed by the owner's IR TIRI CR CR! son as part of a computer programming course. The project received an A grade. CFHI customers include major retailers such as Target, Marshalls, and high-end IR IRCR CR grocery stores. One month before Christmas, a major selling time-representing approximately 30 percent of sales-CFHI's custom-made cocoa butter press broke down. It took two weeks to obtain the necessary part to repair the machine. Orders were shipped to major retailers more than two weeks late and several are refusing to pay for the order, claiming that the delayed delivery resulted in a significant quantity of unsold chocolate. 8 9 b. Assuming acceptable audit risk is low, for each situation specific to CFHI listed below, assess Inherent Risk and Control Risk. Determine an appropriate level for Detection Risk and the resulting level of evidence. Use High, Low, and Moderate for your assessments. Situation 1: Accuracy of recorded sales and valuation of receivables. CFHI sells goods to the United States and often transacts in US currency. The accounting clerk is inexperienced and not accustomed to recording foreign currency transactions. Audit risk (AR) - Inherent risk (IR) Control risk (CR) Detection risk (DR) Level of Evidence LOW RISK Situation 2: Existence of equipment. All equipment is highly specialized and extremely large. For safety reasons, the equipment is also bolted to the floor in the warehouse. CFHI purchases new equipment once every three to four years. All purchases are authorized by David (the owner). Cheques are signed by both owners after complet- ing a review of the supporting documents. Audit risk (AR) - LOW RISK Inherent risk (IR) Control risk (CR) Detection risk Level of Evidence (DR) Situation 3: Existence of finished goods chocolate inventory. Finished goods (chocolates) are kept in a locked area of the warehouse. Access to finished goods is restricted to warehouse employees only, who carry their own security cards. A video surveillance sys- tem monitors the finished goods area. The audit team has verified that the security system is working and has been operational throughout the year. (Refer to Risk Factors 6 and 9 in Part (a) to assist in the assessment of inherent risk.) Audit risk (AR) = LOW RISK Inherent risk (IR) Control risk (CR) Detection risk (DR) Level of Evidence 7-25 09 The audit staff have recently completed risk assessment procedures to gain an under- standing of Chocolate from Heaven Inc.'s (CFHI) business and to identify risk factors relevant to the risk of material misstatement. (For further background on the company, refer to Question 6-42 on page 205.) a. For each risk factor below, decide whether each piece of information would fit into your assessment of inherent risk (IR) or control risk (CR), and whether it would increase or decrease the specified risk area. 1 2 3 4 5 6 7 Due to the size of the CFHI's business, only one accounting clerk does most of the IRIRCR CR accounting. In recent years there has been increased competition in the artisanal small batch IR TIR I CR CR chocolate business. The management bonuses at CFHI are based on net income IR 1 IR! CR CR! All cheques require the signature of both owners. IR IR I CR CR Access to the warehouse at CFHI is restricted to warehouse employees only, who carry IRTIR I CR CR! their own security cards. The chocolate inventory has a one-year shelf life. IR IRCR CR! David Chan has developed a personal trusted relationship with each of the cocoa IRIR. CR CR bean farmers in Tanzania, Ecuador, Philippines, and Honduras. He visits each farmer annually. He believes these strong relationships help to ensure farmers send CFHI high-quality beans. High-quality beans are critical to the production of high-quality chocolate. CFHI just switched to an inventory tracking system that was developed by the owner's IR TIRI CR CR! son as part of a computer programming course. The project received an A grade. CFHI customers include major retailers such as Target, Marshalls, and high-end IR IRCR CR grocery stores. One month before Christmas, a major selling time-representing approximately 30 percent of sales-CFHI's custom-made cocoa butter press broke down. It took two weeks to obtain the necessary part to repair the machine. Orders were shipped to major retailers more than two weeks late and several are refusing to pay for the order, claiming that the delayed delivery resulted in a significant quantity of unsold chocolate. 8 9 b. Assuming acceptable audit risk is low, for each situation specific to CFHI listed below, assess Inherent Risk and Control Risk. Determine an appropriate level for Detection Risk and the resulting level of evidence. Use High, Low, and Moderate for your assessments. Situation 1: Accuracy of recorded sales and valuation of receivables. CFHI sells goods to the United States and often transacts in US currency. The accounting clerk is inexperienced and not accustomed to recording foreign currency transactions. Audit risk (AR) - Inherent risk (IR) Control risk (CR) Detection risk (DR) Level of Evidence LOW RISK Situation 2: Existence of equipment. All equipment is highly specialized and extremely large. For safety reasons, the equipment is also bolted to the floor in the warehouse. CFHI purchases new equipment once every three to four years. All purchases are authorized by David (the owner). Cheques are signed by both owners after complet- ing a review of the supporting documents. Audit risk (AR) - LOW RISK Inherent risk (IR) Control risk (CR) Detection risk Level of Evidence (DR) Situation 3: Existence of finished goods chocolate inventory. Finished goods (chocolates) are kept in a locked area of the warehouse. Access to finished goods is restricted to warehouse employees only, who carry their own security cards. A video surveillance sys- tem monitors the finished goods area. The audit team has verified that the security system is working and has been operational throughout the year. (Refer to Risk Factors 6 and 9 in Part (a) to assist in the assessment of inherent risk.) Audit risk (AR) = LOW RISK Inherent risk (IR) Control risk (CR) Detection risk (DR) Level of Evidence