CASE STUDY

Identifying and Assessing Audit Risk

Blue & Green Chartered Accountants has just been appointed the external auditor for Orange Ltd.

Tom Brown is the Audit Senior for the new client and is in the process of planning the audit for the year ended December 31, 2016. He is currently performing risk assessment procedures to identify and assess the risk of material misstatement for further development of the audit procedures to ensure that the requisite audit evidence is obtained.

Background Data

Orange Ltd is a public limited company which was incorporated on June 1, 2000 as a motor insurance business. Its primary activity is the provision of motor insurance in return for a premium and its main expenses are Operating Expenses, Claims Expenses and Payroll Costs. The companys major assets are Fixed Assets and Investments and its major liability is Outstanding Claim Settlement.

The Managing Director is connected to the Chairman of the Board of Directors by marriage and is paid a 40% share of profits in addition to a fixed salary. The criteria for profit pay is that the company must achieve a 25% Return on Investment; the other companies in the industry make an average ROI of 10%.

The following issues were extracted from the respective sources noted:

Required:

1. Explain the previous year financial statements and discussion with previous auditors including informtion below

a)There is a concern that the fair value of a commercial building owned by the company is materially overstated as the building which is currently unoccupied is in an area which has become rundown

b)The Provision for Outstanding Claims is deemed to be understated as based on the tests done the level of provision on a case to case basis is understated

2. Review of the Management Letters from the previous auditors and explain the below

a)The procedure to review balances due from a customer on a periodic basis to assess collectivity has not been effective as it was discovered that the supervisor was not doing the review as required

b)The procedure to review Claims and make a provision based on an assessment of liability was not applied consistently, especially in the case of bodily injury which were the higher cost claims. The Managing Director had given directives to ensure that provisions were kept as low as possible.

c)The Managing Director authorized the write off of a material amount from Deferred Tax Liability which was unsupported.