Case 5: Questions

(a) Among the risk factors that can be identified are:

• The company had expanded its operations by opening new sites in a few strategic locations
across the country. Such expansion may result in material misstatements since decision
making may become decentralised without adequate internal control. The increase in the risk
of material misstatement due to this factor will result in a lower determination of detection
risk and an increase in the scope of the auditor’s work.
• The management appointed an experienced charted certified accountant to set up an
internal audit department. With the existence of an internal audit department may lower the
risk of material misstatement, resulting in a higher assessment of detection risk and lesser
substantive testing.
• April 2016, the company has been reporting a negative cash flow for the year with sales going
down in one of its sites due to the fierce competition in the automobile industry and with the
slow economic development in the country. These industry factors will lead to an increased
assessment for the risk of material misstatement, resulting in a lower assessment of detection
risk and more substantive testing.
• Among the factors that relates to the control risks are first, an extensive range of spare parts is
held for which perpetual inventory records are kept but no continuous checking is conducted
by the storekeeper and second, the car servicing and body repairs are carried out in workshops
by employed and sub-contracted service engineers where most jobs are started and finished in a
day, but the invoice are not immediately prepared upon completion. All these factors represent
poor internal controls exist within the company. Hence, leads to an increased assessment of
the control risk, resulting in a lower assessment of detection risk and more substantive testing.
• In the last financial year end, the company also faced a change in management with the
resignation of the company’s CEO, Mr Tamatsu Honsi. Such a change in management increases
the risk of material misstatement, hence resulting in a lower determination of detection risk
and increasing the auditor’s work.
Overall, based on risk factors identified and the assessment made pertaining to the audit risk
model, the auditor needs to set the audit risk at a lower level.

(b) Among the sources of information commonly used by auditors for performing analytical
procedures during the planning of the audit are:
• Financial information for prior periods
• Expected or planned results from budgets and forecasts
• Comparison of linked accounts relationships (such as interest expense and debt)
• Ratios of financial information (such as common-size financial statements)
• Company and industry trends
• Relevant non-financial information