CASE STUDY: RISK ASSESSMENT

You are a senior auditor of the accounting firm Roney Partners. Your audit team is currently planning the 2020 audit of Hamilton Limited, a medium sized business which manufactures home and office furniture. This is the third year your accounting firm is engaged to perform the audit for this client, and there were no material misstatements found in the previous audit. The financial year (FY) being audited ends on 30 September 2020 (FY2020). Past audit work and initial audit procedures performed this year revealed the following information:

Due to poor economic conditions and increasing competition in the industry, Hamilton Ltd.'s sales have dropped by about 15% over the last three (3) years from FY2017 to FY2019.The audit client's CEO (Chief Executive Officer) told its shareholders at the last Annual General Meeting that the company would at least maintain its FY2019 profit level in FY2020.However, by April 2020, profit for the first seven (7) months was 20% below the profit level for the prior corresponding time period in FY2019.The CEO was concerned that the company may not be able to meet its profit forecast by the end of the year.This would be a big disappointment to the shareholders and would likely have a major impact on the share price.About 30% of the CEO's remuneration is in the form of the company's shares.The CEO asked all employees to make every effort to improve sales and cut costs for the remaining months of the year. Further, the CEO warned the employees that if the company's sales continued to decline, many jobs would be at risk. A special bonus scheme for sales staff was introduced in late July 2020 to boost sales performance. Sales revenue for the last two (2) months of the financial year improved substantially relative to the first ten (10) months of the year.

Accounting staff are paid a fixed salary with no performance-based bonus payments.However, all staff in the company used to receive a bonus when the company achieved a satisfactory profit level for the year.

The Accounting Department is separate from other operating departments.Only the staff in the Accounting Department have access to the accounting system.Even the CEO does not have direct access to the accounting records.The CEO needs to consult with the Chief Accountant about any proposed changes.If the Chief Accountant agrees that an adjustment is appropriate, the Chief Accountant would then make the change in the computer system.

The computer systems for sales, inventory management and accounting are integrated.However, access to different systems is restricted to authorised staff via individual passwords so that only sales staff have access to the sales computer system, and only accounting staff have access to the accounting system, etc. Authorisation of transactions is also performed via individual passwords.

When customers make an order in store, sales staff enter the details for a sales invoice into the sales computer system. The sales system then sends the details of the sales invoice to the inventory management system. The warehouse staff uses this information to prepare delivery documents. Customers are required to sign a paper copy of the delivery document upon receipt of the furniture. Sales invoices and delivery documents are serially numbered. The original copy of the customer-signed delivery document is then sent to the accounting department while the warehouse staff keeps a duplicate copy of the document. At the end of each day, the warehouse manager gives authorisation in the inventory management system to process sales transactions for which delivery has been made. The system then updates the perpetual inventory records and sends the sales transactions to the accounting system.

The accounting staff check all related documents before recording journal entries in the computer system, for example, copies of customer order and shipping documents signed by the customer.Senior accounting staff regularly review the work of junior staff and report any major issues to the Chief Accountant who reports to the CEO and Board of Directors.

The Chief Accountant has worked for the company for three years.Based on past experience, the auditor finds the Chief Accountant to be co-operative and ethical.The Chief Accountant tends to adopt conservative accounting policies and estimate.From recent conversation, the auditor has discovered that the Chief Accountant is applying for jobs with other companies.The Chief Accountant is unwilling to discuss this matter in detail but just said the pressure at work is substantial. The Chief Accountant keeps the CEO updated about the company's financial progress and discusses major accounting estimates with the CEO.

Required:

(1)Assess inherent risk for the occurrence assertion of sales revenue. In your answer you should indicate which factors, ONLY from the case, would either increase or decrease the inherent risk of misstatements in the occurrence of sales revenue. Conclude with an overall assessment of the qualitative level (high/medium/low) of inherent risk for the sales revenue account.(5 marks)

(2)Assess control risk for the occurrence assertion of sales revenue. In your answer you should indicate which factors, ONLY from the case, would either increase or decrease the control risk of misstatements in the occurrence of sales revenue. Conclude with an overall assessment of the qualitative level (high/medium/low) of control risk for the sales revenue account. (5 marks)

(3)The Audit Partner has advised that the Audit Risk on this client is to be set as "low".

a)Explain what this means and how the Audit Partner may have decided on this.

(2 marks)

b)Based on your analysis in part (1) and part (2) and the audit risk set in part (3), apply the audit risk model using the table below to assess planned detection risk.Explain your logic in coming to this assessment. (2 marks)

Audit risk

Inherent risk

Control risk

Detection risk

Low

(4)Suggest and briefly explain one analytical procedure (excluding re-calculation) that can help identify misstatements related to the occurrence assertion of sales. The procedure should be based on the facts given in the case study. (3 marks)

(5)Select one well-designed control from the case, that should prevent or detect misstatements in relation to the occurrence assertion of sales revenue, and suggest a test of control to evaluate the effectiveness of this control in relation to the occurrence assertion of sales revenue for the audit client. The test should be based on the facts given in the case study. Explain how this test of control specifically relates to the occurrence assertion of sales revenue.(3 marks)