Jade Jewellery Ltd. is a company incorporated in Hong Kong and is engaged in the manufacturing and trading of a wide range of jade and gem jewellery. Its products are mainly sold to local customers and tourists in Hong Kong. Recently, Lee & Chung CPA, a partnership of two partners with most clients in Hong Kong, was approached by the company to be its auditor for the year ended 31 December 2019. As the manager-in-charge of the engagement, you noted the following during the planning stage of the audit: 1. Jade Jewellery Ltd. was founded 25 years ago by Mr. C.K. Chow who is highly respected in the jade industry. Mr. Chow holds 80% of its issued shares and is the Chief Executive Officer of the company and Chairman of the board. Mr. Chow’s two sons, Jason and Jeffery each holds 10% of the shares and are also executive directors on the board. 2. Jade Jewellery Ltd.’s previous auditor was a sole practitioner who retired last year due to health problem. Your firm was introduced to Mr. Chow through his daughter-in-law, who is currently the administration manager of your CPA firm. Prior to this engagement, your CPA firm had never been involved with companies in the jewellery industry. 3. Jade Jewellery Ltd. had unmodified audit reports issued by its previous auditors in the past twenty-five years. 4. There has been a sharp increase in the company’s sales in the past two years. To cope with such an increase, the company has opened two new shops in early 2019, one located in Tsim Sha Tsui and another in Macau, in addition to its main shop in Central. 5. Mr. Chow keeps all the high value jades and gems in his private safe in the main shop. Required:

(a) Auditors are required to obtain an understanding of the client and its environment. This understanding is particularly important for a new client. Discuss five potential sources (internal or external) of information you can obtain about Jade Jewellery and its environment.  

(b) Auditors use the audit risk model to plan for the audit. Briefly explain the nature of each of the components of the audit risk model and how these components are interrelated.  

(c) Specifically related to Jade Jewellery, discuss circumstances that would affect your judgement of risk of material misstatements (inherent risk and control risk) and indicate your assessment of the level of risk (i.e., high, medium or low) with justifications.  

(d) Discuss the potential independence and competency issues that affect Lee & Chung’s acceptance of Jade Jewellery as a new audit client. Be sure to identify any potential threats to the 5 fundamental principles and your reasoning, if applicable.