Question 1 (35 marks) Read the following information about Waste Management Ltd. Case: Waste Management Ltd. You are the partner in charge of the audit of the client Waste Management Ltd. (Waste Management)'s financial statements for the year ended 31 December 2019. Waste Management is a privately held company that contracts with the Hong Kong government to close landfills. Audit risk at the financial statement level is influenced by the risk of material misstatements, which may be related to factors concerning the company, the management or the waste management industry. During the planning of the audit, you have identified the following factors in assessing audit risk: 1 This was the first year Waste Management operated at a profit since 2015 because the Financial Secretary has increased the budget in the area of environmental protection. 2 Waste Management's Board of Directors is controlled by Mr Lee, the majority shareholder, who also acts as the chief executive officer. 3 The internal auditor reports to Mr Wong, the controller and the controller reports to Mr Lee. The accounting department has experienced a high rate of turnover of key personnel. 5 The bank that Waste Management deals with has a loan officer who meets regularly with Mr Lee and Mr Wong to monitor the company's financial performance. 6 Waste Management's employees are paid once every two weeks. 7 This is the fifth year you have been partner in charge of the audit. 8 During 2019, Waste Management changed its method of preparing its financial statement from the cash basis to generally accepted accounting principles. 9 During 2019, Waste Management sold one half of its controlling interest in Sanitation Equipment Ltd. However, Waste Management still retains a significant interest in Sanitation Equipment Ltd. 10 During 2019, a lawsuit that was filed ten years ago by the government against Waste Management alleging that the company discharged pollutants into the Hong Kong harbour was dropped by the government. Disclosures in the notes to the accounts for potential contingent losses were removed from the current year's financial statements. 11 During December 2019, Waste Management signed a contract to lease disposal equipment from a company owned by Mr Lee's parents. This related party transaction is not disclosed in Waste Management's notes to its 2019 financial statements. 12 During December 2019, Waste Management increased its insurance coverage on several pieces of sophisticated machinery from historical cost to replacement cost. 13 Waste Management recorded a substantial increase in revenue in the fourth quarter of 2019. Enquiries indicated that Waste Management initiated a new policy and guaranteed refunds to the government if their work failed site inspection. 14 Waste Management is planning an initial public offering of its shares in 2020. Required: a For each of the factors (1-14) listed above, discuss in detail why you think the item would likely increase risks of material misstatement (RMM), decrease risks of material misstatement or have no impact on risks of material misstatement. (28 marks) b Explain how audit risk and materiality are related and why they need to be considered together in planning the audit. (7 marks) Question 1 (35 marks) Read the following information about Waste Management Ltd. Case: Waste Management Ltd. You are the partner in charge of the audit of the client Waste Management Ltd. (Waste Management)'s financial statements for the year ended 31 December 2019. Waste Management is a privately held company that contracts with the Hong Kong government to close landfills. Audit risk at the financial statement level is influenced by the risk of material misstatements, which may be related to factors concerning the company, the management or the waste management industry. During the planning of the audit, you have identified the following factors in assessing audit risk: 1 This was the first year Waste Management operated at a profit since 2015 because the Financial Secretary has increased the budget in the area of environmental protection. 2 Waste Management's Board of Directors is controlled by Mr Lee, the majority shareholder, who also acts as the chief executive officer. 3 The internal auditor reports to Mr Wong, the controller and the controller reports to Mr Lee. The accounting department has experienced a high rate of turnover of key personnel. 5 The bank that Waste Management deals with has a loan officer who meets regularly with Mr Lee and Mr Wong to monitor the company's financial performance. 6 Waste Management's employees are paid once every two weeks. 7 This is the fifth year you have been partner in charge of the audit. 8 During 2019, Waste Management changed its method of preparing its financial statement from the cash basis to generally accepted accounting principles. 9 During 2019, Waste Management sold one half of its controlling interest in Sanitation Equipment Ltd. However, Waste Management still retains a significant interest in Sanitation Equipment Ltd. 10 During 2019, a lawsuit that was filed ten years ago by the government against Waste Management alleging that the company discharged pollutants into the Hong Kong harbour was dropped by the government. Disclosures in the notes to the accounts for potential contingent losses were removed from the current year's financial statements. 11 During December 2019, Waste Management signed a contract to lease disposal equipment from a company owned by Mr Lee's parents. This related party transaction is not disclosed in Waste Management's notes to its 2019 financial statements. 12 During December 2019, Waste Management increased its insurance coverage on several pieces of sophisticated machinery from historical cost to replacement cost. 13 Waste Management recorded a substantial increase in revenue in the fourth quarter of 2019. Enquiries indicated that Waste Management initiated a new policy and guaranteed refunds to the government if their work failed site inspection. 14 Waste Management is planning an initial public offering of its shares in 2020. Required: a For each of the factors (1-14) listed above, discuss in detail why you think the item would likely increase risks of material misstatement (RMM), decrease risks of material misstatement or have no impact on risks of material misstatement. (28 marks) b Explain how audit risk and materiality are related and why they need to be considered together in planning the audit. (7 marks)