9.30Audit risk, components of audit risk

Audrey Pearce is an audit partner of Pearce Green, a firm of accountants. She is considering audit risk at the overall financial statement level in planning the audit for the finance company Homes South Ltd (HS) for the year ending 30 June 2015. This risk is influenced by a combination of factors related to management, the industry and the entity. Audrey has gathered the following information concerning HS's environment.

1.HS has been consistently more profitable than the industry average by marketing mortgages on properties in a prosperous rural area, which has experienced considerable growth in recent years. HS packages and sells mortgages to large investment trusts. Despite recent volatility of interest rates, HS has been able to continue selling its mortgages as a source of new lendable funds.

2.HS's board of directors is controlled by George Watson, the majority shareholder, who also acts as the chief executive officer. Management at the company's branch offices has authority for directing and controlling HS's operations, and is compensated according to branch profitability. The internal auditor reports directly to Henry Stevenson, a minority shareholder, who is chairman of the audit committee.

3.The accounting department has experienced little turnover in personnel during the 5 years for which Audrey has audited HS. HS's formula constantly underestimates the allowance for loan losses, but its financial controller has always been receptive to Audrey's suggestions to increase the allowance.

4.During 2014, HS opened a branch office in a metropolitan area 30 kilometres from its principal place of business. Although this branch is not yet profitable (as a result of competition from several well-established banks), management believes it will be profitable by 2016.

5.During 2014, the company increased the efficiency of its operations by installing a new computer system.

Required

Based only on the information provided, indicate the factors that would affect the risk of material misstatement and explain why.