You are an Audit Senior currently planning the 30 June 2017 audit of Pearl Technology Limited (Pearl), an Australian-owned company that is a manufacturer of computer hardware. You note the following situations relating to Pearl.

1. The old costing system that was developed in-house, could no longer keep up with the complex and detailed manufacturing costing process that provides tender/bid submission costings and the companys comprehensive reporting requirements. As a result, Pearl purchased and installed a popular off the shelf (not customized) costing system to support the highly sophisticated and cost sensitive nature of its product designs. Since this system had been utilised by many other firms in the industry, Pearl have not thoroughly tested the adequacy of the features and controls inherent within the system. At the same time, the staffs are not feeling confident with the new system due to lack of training and supervision.

2. Pearl has been experiencing declining sales over the last 2 years. Cost cutting has proved difficult due to the high level of imported machinery used in Pearls operations and consequently margins have been falling. Over the last 2 months, warranty claims on Pearls best-selling product line, M4 has increased from 1.5% to 4.5% of sales. The average cost of repair has risen by 20% to $200 per claim. While the bankers are presently happy to continue providing Pearl with loan facilities, they do expect to see improved results in the next financial report.

3. A team of internal auditors has been hired 10 months ago by Pearl to improve on its existing internal control, which has been relied on for the past 10 years. Based on your experience, the revamping process should only take about 8 months. It came to your attention that only a short while after the employment of the internal auditors, the CEO of Pearl experienced severe personal financial difficulty. You also find that the process of revamping the internal control has been dragging because the CEO kept on declining the internal auditors suggestions for improvement. The accountant of Pearl has been notorious for finding gaps in the legislations in order to make its clients financial statements look presentable as desired by the clients themselves. In the past few years, Pearl has always been required by the Australian Tax Office to provide additional supporting information after the lodgement of its tax returns.

Required:

1. For each of the above situations relating to Pearl Technology Limited, answer the following:

(a) Identify and discuss why the above situation represents a risk.

(b) By applying auditing knowledge, identify the main account or group of accounts affected by this risk in the audit plan.

(c) Identify how the audit plan will be affected by the risks and recommend specific procedures to address these risks. (12 Marks)

2. Prepare a memorandum to the Audit Manager, outlining your risk assessment relating to Pearl Technology Limited based on the above situations and your recommendations on the audit approach to be used. (8 Marks)