Based on the following descriptions of events (1-10) at different audit clients, determine the most likely

effect (I = increase, D = decrease, N = no effect, and C = cannot determine from information provided) on

each of the audit risk model components:

I. Control risk I D N C

II. Inherent risk I D N C

III. Acceptable audit risk I D N C

IV. Planned evidence I D N C

1. The clients management materially increased long-term contractual debt. The company engaged in several new complex derivative transactions during the year.

Inherent Risk = I

2. The company changed from a publicly held company to a privately held company. The company hired a new CFO who performs several key accounting controls and estimates.

3. The auditor decided to set assessed control risk at the maximum (it was previously assessed below the maximum). This is the second year of the audit and there were no misstatements found in last years audit. For the audit team there is a new partner and manager on the engagement.

4. An account balance increased materially from the preceding year without apparent reason. The company closed all foreign operations and operates exclusively in the domestic market.

Inherent Risk = I

5. You determined through the planning phase that working capital, debt-to-equity ratio, and other indicators of financial condition all worsened during the past year. The auditor decided to set assessed control risk at the minimum (it was previously assessed below the maximum). This the second year of the audit.

6. The company is the largest firm in an industry that is characterized by fierce competition. This is the first year of the engagement, and a review of the predecessor auditors working papers shows there were few misstatements found in the previous years audit. The auditor also decided to increase reliance on internal control.

Inherent Risk = I

7. A continuing client has been selling products online to customers through its Web page during the year under audit. Calculations and remittance of tax amounts is complex, but the online customer ordering process is well integrated with the companys accounting system. Client sales staff are experienced and dedicated to accuracy in the performance of their job duties when they are required to print customer order information and enter that data manually into the sales accounting system.

8. This is the first year of an engagement with a new client. There has been no change in key management personnel. Also, you believe that management sets an appropriate tone with regard to the accuracy financial reporting. The audit firm is being investigated by the PCAOB and the Department of Justice with regard to issues over inappropriate relationships with several other audit clients.

9. The company recently a defendant in a civil lawsuit, the company was not expected to successfully defend the lawsuit. The company fully expected to suffer a material loss as a result, instead the company has actually been able to recover a substantial portion of attorneys fees devoted to defending the suit. In auditing inventory, you obtain an understanding of internal control and perform tests of controls and find them to be ineffec tive. You also note that the clients inventory is homogenous and the market value is readily determinable.

10. In discussion with management, you conclude that management is planning to sell the business in the next few months. Because of the planned changes, several key accounting personnel quit several months ago for alternative employment. The new accounting personnel seem to lack integrity in comparison. You still believe that it is appropriate to do the audit. You also observe that total debt has significantly decreased with that of the preceding year and profitability and liquidity have increased.

Section Learning objectives addressed by this exercise: 2 2. Based on the following descriptions of events (1-10) at different audit clients, determine the most likely effect I increase, D-decrease, N - no effect, and cannot determine from information provided) on cach of the audit risk model components I. Control risk IDNC II. Inherent risk IDNC III. Acceptable audit risk IDNC IV. Planned evidence IDNC 1. The client's management materially increased long-term contractual debt. The company engaged in several new complex derivative transactions during the year. 2. The company changed from a publicly held company to a privately held company. The company hired a new CFO who performs several key accounting controls and estimates. 3. The auditor decided to set assessed control risk at the maximum (it was previously assessed below the maximum). This is the second year of the audit and there were no misstatements found in last year's audit. For the audit team there is a new partner and manager on the engagement 4. An account balance increased materially from the preceding year without apparent reason. The company closed all foreign operations and operates exclusively in the domestic market. 5. You determined through the planning phase that working capital, debt-to-equity ratio, and other indicators of financial condition all worsened during the past year. The auditor decided to set assessed control risk at the minimum (it was previously assessed below the maximum). This the second year of the audit. 6. The company is the largest firm in an industry that is characterized by fierce competition. This is the first year of the engagement, and a review of the predecessor auditor's working papers shows there were few misstatements found in the previous year's audit. The auditor also decided to increase reliance on internal control. 7. A continuing client has been selling products online to customers through its Web page during the year under audit. Calculations and remittance of tax amounts is complex, but the online customer ordering process is well integrated with the company's accounting system. Client sales staff are experienced and dedicated to accuracy in the performance of their job duties when they are required to print customer order information and enter that data manually into the sales accounting system & This is the first year of an engagement with a new client. There has been no change in key management personnel. Also, you believe that management sets an appropriate tone with regard to the accuracy financial reporting. The audit fimm is being investigated by the PCAOB and the Department of Justice with regard to issues over inappropriate relationships with several other audit clients 9. The company recently a defendant in a civil lawsuit, the company was not expected to successfully defend the lawsuit. The company fully expected to suffer a material loss as a result, instead the company has actually been able to recover a substantial portion of attomey's fees devoted to defending the suit. In auditing inventory, you obtain an understanding of internal control and perform tests of controls and find them to be ineffective. You also note that the client's inventory is homogenous and the market value is readily determinable. 10. In discussion with management, you conclude that management is planning to sell the business in the next few months. Because of the planned changes, several key accounting personnel quit several months ago for alternative employment. The new accounting personnel seem to lack integrity in comparison. You still believe that it is appropriate to do the audit. You also observe that total debt has significantly decreased with that of the preceding year and profitability and liquidity have increased