Question 3 -- Audit Risk Model (Adapted from Moroney 3rd Edition)

Avionics Ltd. ("Avionics") contacted your accounting firm to inquire about having your firm conduct an external audit of its financial

statements. Avionics is currently a private company which sells specialized jet planes. The company's president explained that he

feels that "the previous auditor charged too much and only issued a qualified opinion." Your firm was recommended to Avionics by

your banker who is also the banker for Avionics. Avionics has a large loan application at the bank, and the interest rate of the new

loan will depend on the audit opinion.

A few days have passed and you, as the partner in charge of this file, have satisfied yourself that it is okay for you to accept Avionics

as a new client. During the Planning phase, you learned that the company has developed a new design for an aircraft and plans to

borrow funds from the bank to finance a prototype plane to test the design. The new funds will also improve the company's liquidity

and overall balance sheet by providing the funds to reduce the company's large balance on the line-of-credit, and to avoid a default

of any existing loan covenants. If the new plane design is successful, new common shares will be issued for more capital with an

eventual goal of becoming a public company on the TSX.

The recently-hired controller, who is working towards obtaining his CPA, was very helpful in your discussions, and you note his high

level of enthusiasm for the project. However, the president was not so helpful and seemed annoyed with your questions. He was

generally evasive and unwilling to cooperate. As an example of the president's mentality, when you asked him about who are the

directors of the company and his view about internal controls, he said, "We are a family-run business. I am the sole director and

CEO. I don't have time or money to spend on internal controls."

REQUIRED (Use point form in your answers. Be clear and concise.)

(a) In the given information, it says, "...you have satisfied yourself that it is okay for you to accept Avionics as a new client..." List

and briefly explain three (3) important steps/issues that the partner should take/consider before accepting any new client, such as

Avionics.

(b) What do you think should be the acceptable level of audit risk for this engagement? Explain.

(c) Make an assessment of inherent risk for the audit of Avionics. In you assessment, identify and briefly describe three (3) factors

that impact on inherent risk for Avionics.

(d) Make an assessment of control risk for the audit of Avionics. Explain your assessment.

(e) Which of the two types of audit strategies should you use? Why?