Suggested Answer Activity 1: Audit risks and auditor's response
Audit risk Auditor's response
Audit The audit is a new audit for the
risk 1 firm; the firm may not have as
good an understanding of the
client as it would have for an
established client and so there is
likely to be an increased level of
detection risk.
Audit Dress You Like Co is a clothing
risk 2 manufacturer whose inventory
will be subject to changing
seasons and trends. It is possible
that some inventory items may
be difficult to sell and may be
overvalued at the year-end if
they are recorded at cost rather
than at the lower of cost and
net realisable value as required
by IAS 2.
Audit Dress You Like Co has two sites
risk 3 Review the inventory counting
where inventory is
held/despatched and errors
have previously occurred
concerning the transfer of
inventory between sites. There
is the possibility that some
items are counted twice (once
at each location), and that some
are not counted at all leading to
a risk that inventory may be
under or overstated.
Audit Dress You Like Co is reliant on
risk 4 one supplier for its purchases.
Should it encounter a problem
The auditors should spend time ensuring they
fully understand the nature of the business, its
products or services, its locations, revenue
sources, key customers and suppliers, internal
controls and any external pressures or laws and
regulations it is subject to in order to best assess
the risk of material misstatement in the financial
statements.
This information must be communicated to all
members of the audit team.
Consideration should also be given to using a
more experienced audit team and the testing
that will be required on the opening balances.
An aged inventory report should be obtained to
identify items of slow moving or non-saleable
inventory.
The salability of these items should then be
discussed with management and their valuation
in the financial statements reviewed to ensure
they are valued at the lower of cost and net
realisable value.
Review the inventory instructions of Dress You
Like Co to determine whether controls exist to
ensure that all inventory items are counted only
once.
Where inventory count instructions are not
sufficient, discuss this with management before
the count so that changes can be made to
counting procedures.
Discuss with management whether Dress You
Like Co has any alternative suppliers in the
event that the supply chain is interrupted.
 or delay with its supply chain, it Review Dress You Like Co's contract with the
may not be able to fulfil its supermarket chain and any other customers to
orders (especially to the determine whether there are any penalties
supermarket chain). This could payable should deliveries be delayed and
lead to dissatisfaction from its whether they could cancel their contract with
customers and ultimately the Dress You Like Co.
loss of the customer. This in
turn could lead to going concern
problems.
Audit Dress You Like Co allows its Request that management produce cash flow
risk 5 supermarket customer 60-day forecasts for the year ahead to identify any
credit terms. This may place deficits in cash flow. Consider the
additional strain on cash flow reasonableness of the assumptions on which
and lead to potential going these are based (especially relating to the timing
concern problems given the of cash flows from the supermarket).
deterioration during the year of Consider whether there are any known
cash flow and working capital. concerns about the supermarket's ability to
settle its debts
Determine from management whether they
have access to any short-term finance should
any cash flow problems arise
Audit The finance director is suing the Review correspondence from both the director
risk 6 company for constructive and the entity's legal advisers relating to the
dismissal but no mention of this legal claim in order to establish the likely
has been made in the year-end outcome of the claim. Discuss the appropriate
financial statements (ie no accounting treatment for the claim with the
provision or contingent liability). directors.
The case has been going on for Review minutes of board meetings and events
some time which suggests that after the reporting period to determine whether
at least disclosure of a the claim was settled.
contingent liability is required
and so there is a risk that
provision/contingent liability
disclosures may not be
complete.
Audit There has not been a finance Determine from management whether there
risk 7 director in place for the last six will be appropriate personnel available to
months of the year (since March answer the audit team's queries and provide the
20X6). The lack of finance information they require for the audit. Particular
director increases control risk attention should be paid to judgemental areas
and furthermore there is a lack to ensure any judgernents made are reasonable.
of experience at this high level
and the assistant is also
overloaded. The assistant may
 not have the time or ability to
answer queries from the audit
team which could lead to
difficulty in obtaining sufficient
information and explanations
required by the auditor.
Audit The internal audit function used A detailed review of the year-end bank
risk 8 to perform reviews on the bank reconciliation and supplier statement
reconciliation and supplier reconciliations should be performed in order to
statement reconciliations which determine the accuracy and completeness of
would increase the reliability of bank and payables.
the bank and payables balances. A larger sample size may be necessary if it is
The fact that there is now no anticipated that there will be a high level of
longer any internal audit errors. A detailed review of reconciling items
function means that there is an and payments made in the post year-end period
increased likelihood that should be conducted.
material errors in the
completeness, accuracy and
validity of the bank balance and
the completeness of payables
may not have been detected by
the client staff.