During the planning phase of the audit, you meet with Pinnacles management team and perform other planning activities. You encounter the following situations that you believe may be relevant to the audit:

Required:

a. Assess acceptable audit risk as low, moderate, or high. Justify your response. In making your assessment, include your evaluation of the company on the three factors that make up acceptable audit risk. External users reliance on financial statements Likelihood of financial difficulties Management integrity

b. Assess acceptable audit risk as high, medium, or low considering the items you identified in requirement (a). Justify your response.

c. Identify inherent risks for the audit of Pinnacle. For each inherent risk, identify the account or accounts that may be affected.

(1) Your firm has an employee who reads and saves articles about issues that may affect key clients. You read an article in the file titled, EPA Regulations Encouraging Solar- Powered Engines Postponed?" After reading the article, you realize that the regulations management is relying upon to increase sales of the Solar-Electro division might not go into effect for at least 10 years. A second article is titled, Stick to Diesel, Pinnacle!" The article claims that although Pinnacle has proven itself within the diesel engine industry, they lack the knowledge and people necessary to perform well in the solar-powered engine industry. (2) While reading the footnotes of the previous year's financial statements, you note that one supplier, Auto-Electro, provides over 20 percent of the raw materials used by Pinnacle. You investigate Auto-Electro and discovered that the company is considering entering Chapter 10 bankruptcy proceedings due to continuing cash flow difficulties. (3) While reviewing Pinnacle's long-term debt agreements, you identify several restrictive covenants. Two requirements are to keep the current ratio above 2.0 and debt-to-equity below 1.0 at all times. The loans become immediately due if the covenants are not met. (4) During a meeting with the facilities director, you learn that the board of directors has decided to raise a significant amount of debt to finance the construction of a new manufacturing plant for the Solar-Electro division. The company also plans to make a considerable investment in modifications to the property on which the plant will be built. (5) After inquiry of the internal audit team, you realize there is significant turnover in the internal audit department. You conclude the turnover is only present at the higher-level positions. (6) You ask management for a tour of the Solar-Electro facilities. While touring the warehouse, you notice a section of solar-powered engines that do not look like the ones advertised on Pinnacle's Web site. You ask the warehouse manager when those items were first manufactured. He responds, I'm not sure. I've been here a year and they were here when I first arrived." (7) While standing in line at a vending machine, you see a Pinnacle vice president wearing a golf shirt with the words Todd-Machinery." You are familiar with the company and noticed some of its repairmen working in the plant earlier. You tell the man you like the shirt and he responds by saying, Thank you. My wife and I own the company, but we hire people to manage it." (8) The engagement partner from your CPA firm called today notifying you that Brian Sioux, an industry specialist and senior tax manager from the firm's Ontario office, will an ongoing dispute between the be coming onsite to Pinnacle's facilities to investigate Internal Revenue Service and Pinnacle. (1) Your firm has an employee who reads and saves articles about issues that may affect key clients. You read an article in the file titled, EPA Regulations Encouraging Solar- Powered Engines Postponed?" After reading the article, you realize that the regulations management is relying upon to increase sales of the Solar-Electro division might not go into effect for at least 10 years. A second article is titled, Stick to Diesel, Pinnacle!" The article claims that although Pinnacle has proven itself within the diesel engine industry, they lack the knowledge and people necessary to perform well in the solar-powered engine industry. (2) While reading the footnotes of the previous year's financial statements, you note that one supplier, Auto-Electro, provides over 20 percent of the raw materials used by Pinnacle. You investigate Auto-Electro and discovered that the company is considering entering Chapter 10 bankruptcy proceedings due to continuing cash flow difficulties. (3) While reviewing Pinnacle's long-term debt agreements, you identify several restrictive covenants. Two requirements are to keep the current ratio above 2.0 and debt-to-equity below 1.0 at all times. The loans become immediately due if the covenants are not met. (4) During a meeting with the facilities director, you learn that the board of directors has decided to raise a significant amount of debt to finance the construction of a new manufacturing plant for the Solar-Electro division. The company also plans to make a considerable investment in modifications to the property on which the plant will be built. (5) After inquiry of the internal audit team, you realize there is significant turnover in the internal audit department. You conclude the turnover is only present at the higher-level positions. (6) You ask management for a tour of the Solar-Electro facilities. While touring the warehouse, you notice a section of solar-powered engines that do not look like the ones advertised on Pinnacle's Web site. You ask the warehouse manager when those items were first manufactured. He responds, I'm not sure. I've been here a year and they were here when I first arrived." (7) While standing in line at a vending machine, you see a Pinnacle vice president wearing a golf shirt with the words Todd-Machinery." You are familiar with the company and noticed some of its repairmen working in the plant earlier. You tell the man you like the shirt and he responds by saying, Thank you. My wife and I own the company, but we hire people to manage it." (8) The engagement partner from your CPA firm called today notifying you that Brian Sioux, an industry specialist and senior tax manager from the firm's Ontario office, will an ongoing dispute between the be coming onsite to Pinnacle's facilities to investigate Internal Revenue Service and Pinnacle