As the external audit, Identify and explain the inherent audit risks for the following financial statements.

You are an auditor with Buoy & Alex (B&A). B&A has just been appointed as the external auditor of Hope Anchor Ltd. (H.A.). The audit partner, Wendy Tse, has called you to a meeting. Wendy explains that you will be the lead auditor on the external audit work. The initial audit planning must be done in the next week or two. She briefs you on H.A. and gives you her file of notes from her recent meetings with H.A.s managing director. Extracts from the file are documented below.

Wendy would like you to prepare a memo in order to inform the audit team. The memo will include your analysis of the inherent risks relating to the audit of H.As financial statements.

There are two new audit trainees with B&A who will be on the H.A. audit team. Because of this, Wendy has asked for two more areas of information to be included in the memo to help develop the new trainees knowledge of auditing. Firstly, Wendy wants you to provide a note of the general areas an auditor must gain an understanding of in order to assess inherent risk in the context of an external audit, and; secondly, Wendy wishes you to outline the actions an external auditor must undertake before accepting a new audit client.

H.A. makes boats for sport and leisure and sells these to rich individuals who like to sail, or be on board their own boat to entertain rich friends and celebrities. The business began ten years ago when its founder, James Lam, the managing director and majority shareholder, established the company to manufacture boats using his long list of rich friends as contacts and customers. The company was initially very successful with several lucrative orders in each of the first five years. James had to work very hard in terms of sourcing the right skills, suppliers and materials for making the boats. After this initial success the last few years have been harder. Revenue is falling and several complaints have been received from previous customers saying their boats are leaking and parts are falling off important safety equipment during sailing trips. James recently received a lawyers letter from a former friend and customer threatening to sue him if he did not return the full amount of the sales price of a boat to the customer due to it now being unusable.

Orders have been falling in the last three years and so James has launched an ambitious marketing campaign to get more customers. This has involved him flying first class round the world, showing potential rich buyers his colourful and high-quality brochure of boats and trying to get new orders. So far, no new orders have been achieved, but James remains hopeful. He approached the bank manager in the last month to ask for a loan, but the bank manager refused.