The auditor needs to understand the business in order to assess the risk of potential account misstatements. In preparing for a new audit, the auditor arranges to take a tour of the manufacturing plant and the distribution center. The client is a manufacturer of heavy machinery. Its major distribution center is located in a building next to the manufacturing facility.

Required
The auditor made the following list of observations during the tour of the plant and distribution center. For each observation, indicate the following:
a. The potential audit risk associated with the observation.
b. How the audit should be adjusted for the knowledge of the risk.
Tour of Plant Observations
1. The auditor notes three separate lines of production for three distinct product lines. Two seem to be highly automated, but one is seemingly antique.
2. The auditor notes that a large number of production machines are sitting idle outside, and that a second line of one of the company's main products is not in operation.
3. The client utilizes a large amount of chemicals. The waste chemicals are stored in vats and barrels in the yard before being shipped for disposal to an independent disposal firm.
4. The distribution center seems busy and messy. Although there appear to be defined procedures, the supervisor indicates that during peak times when orders must be shipped, the priority is to get them shipped. Employees "catch up" on paperwork during slack time.
5. One area of the distribution center contains some products that seem to have been there for a long time. They are dusty and the packaging looks old.
6. Some products are sitting in a transition room outside the receiving area. The supervisor indicates that the products either have not been inspected yet, or they have failed inspection and he is awaiting orders on what to do with them.
7. The receiving area is fairly automated. Many products come packaged in cartons or boxes. The receiving department uses computer scanners to read the contents on a bar code, and when bar codes are used, the boxes or containers are moved immediately to the production area where they are to be used.
8. One production line uses just-in-time inventory for its major component products. These goods are received in rail cars that sit just outside the production area. When production begins, the rail cars are moved directly into production. There is no receiving function for these goods.
9. The company uses minimum security procedures at the warehouse.
There is a fence around the facilities, but employees and others seem to be able to come and go with ease.