Simulation

You are working with Willi am Bond, CPA, and you are considering the risk of material misstatement in planning the audit of Toxic Waste Disposal (TWO) Company's financial statements for the year ended December 31, 20XO. TWO is a privately owned entity that contracts with municipal governments to remove environmental waste.

Based only on the information below, indicate whether each of the following factors would most likely increase (I), decrease (D), or have no effect (NE) on the risk of material misstatement.

Information Effect on Risk of

Material Misstatement

1. Because municipalities have received increased federal and state funding for environmental purposes,

1. a) TWD returned to profitability for the first year following three years with losses.

2. TWD's Board of Directors is controlled by Mead, the majority stockholder, who also acts as the chief executive off ice.

3. The internal auditor reports to the controller and the controller reports to Mead.

4. The accounting department has experienced a high rate of turnover of key personnel.

5. TWD's bank has a loan officer who meets regularly with TWD's CEO and controller to monitor TWD's financial performance.

6. TWD's employees are paid biweekly.

7. TWD has such a strong financial presence in its industry to allow it often to dictate the terms or conditions of transactions with its suppliers.

8. During 20X1, TWD changed its method of preparing its financial statements from the cash basis to generally accepted accounting principles.

9. During 20X1, TWD sold one-half of its controlling interest in United Equipment Leasing (UEL) Co. TWD retained significant influence over UEL.

10.During 20X1, litigation filed against TWD from an action 10 years ago that alleged that TWD discharged pollutants into state waterways was dropped by the state. Loss contingency disclosures that TWD included in prior years' financial statements are being removed from the 20X1 financial statements.

11. During December 20X1, TWD signed a contract to lease disposal equipment from an entity owned by Mead's parents. This related-party transaction is not disclosed in TWD's notes to the 20X1 financial statements.

12. During December 20X1, TWD completed a barter transaction with a municipality.

13. TWD removed waste from the municipally owned site and acquired title to another contaminated site at below market price. TWD intends to service this new site in 20X2 .

14. During December 20X1, TWD increased its casualty insurance coverage on several pieces of sophisticated machinery from historical cost to replacement cost.

15. Inquiries about the substantial increase in revenue TWD recorded in the fourth quarter of 20X1 disclosed a new operating policy.

15. a) TWD guaranteed to several municipalities that it would ref und the federal and state funding paid to TWD if any municipality fails a federal or state site clean-up inspection in 20X2.

16. An initial public offering of TWD's stock is planned for late 20X2.

Required:

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