QUESTION 2 (14 MARKS)

You are an assurance services senior at Reeves & Associates and have noted the following independent issues in relation to the audit of Fancy Pty Ltd:

A. The accounting system at Fancy Pty Ltd did not operate effectively during the first year of operations. Consequently, some general ledger accounts had to be based on estimates, as the actual data relating to these balances had been lost.

B. As a result of cost constraints, the directors of Fancy Pty Ltd did not implement effective internal controls for debt collection. The debtors' turnover is 3.2 times.

C. Due to increased competitive pressures, Fancy Pty Ltd has recently moved the manufacture of some of its clothing lines out of Melbourne into regional areas. While Fancy Pty Ltd saves around 20% in costs, the manufacturing process takes longer and on several occasions late delivery has resulted in lost sales.

Required:

(a) Describe the components of the Audit Risk Model. (2 marks)

(b) Explain the impact of each of these separate issues on your assessment of audit risk, the materiality level and the audit strategy that would be adopted. (12 marks)