Question 1

Inherent risks can be classified according to their nature, such as unusual pressure on management or account likely to require adjustments; and also their level as either a financial report level inherent risk or an assertion level inherent risk.

Required: Below are listed six situations that can give rise to inherent risks. Classify each situation by its nature and level.

Note: In answering this question please write the letter that denotes the situation followed by its nature and level. For example, if you believe that the situation A is an example of Nature of the Entity, write: A: Nature of the entity; FR level

SITUATIONS A. Senior management of your client, Black Pty Ltd, can earn substantial bonuses if they meet certain revenue targets.

B. This the fourth year that you are auditing Brown Pty Ltd. In the past two years you have had to ask Brown to adjust its provision for warranty.

C. You are auditing Blue Pty Ltd (Blue). During the year, Blues CFO entered into a number of hedging contracts in an attempt to smooth fluctuations in the costs of imported inventory.

D. Your client, Red Pty Ltd, a leading home builder, hired a new Credit Controller during the year. While this person is highly credentialed, she has not worked in the building industry before.

E. Your client, Green Pty Ltd (Green) sells mobile telephones. Recently, Greens CFO undertook a comprehensive review of inventory.