Task 2) – Inherent Risk and Materiality
Part a – Perform the following tasks and document them in the ABC Risk and Material Memo Template Word document.
· Preliminary Inherent Risk Assessment – Review the description of ABC Appliances, Inc. and identify four entity-level inherent risks based on the information provided. I have listed one potential inherent risk area as an example and you need to add four more to the list. Inherent risks can flow from client’s business risks, the nature of its governance structure, and its strategic plans. However, you need to be clear about how your risks create an increased risk of material misstatement in the financial statements and not just how they might create risks of lower operating or business performance for the firm.
Thus, for each inherent risk, describe the feature of the firm you believe affects inherent risk and explain how and why. By “how,” I mean whether it increases or decreases inherent risk. Make sure your “how” addresses a specific risk to the accuracy of the financial statements and whether audit effort should be increased or decreased for specific accounts or related groups of accounts if possible.
Limit your inherent risk analysis to the following sections of the case:
· Description of Firm and Market Conditions
· The Control Environment (only identify issues related to inherent risk)
Part b. covers risks identified using analytical procedures based on the financial data. You will be asked to identify transaction process risks associated with sales and purchases in another task.
· 1. Preliminary Analytical Procedures – Review ABC Appliance’s financial statements, ratios, and industrial data presented at the end of this document. Identify four accounts that you believe need additional audit scrutiny and explain why. I have included one example – and you will need to add four more to the list. Copies of ABC’s audited 2014 and unaudited 2015 financial statements are included after these requirements. Some common ratios for ABC and their industry are also included.
· 2. Preliminary Materiality Judgments– Set two preliminary materiality dollar amounts for the ABC audit – one for the balance sheet and one for the income statement. Document how you calculated your materiality amounts and explain why you chose the approach you did. There are many sources of materiality level judgments for audits in websites on the internet. You can select the approach that you like – remember that you need to explain the approach that would be best for ABC. Remember that the materiality level sets the level for transactions that an auditor will look at; below that level the auditor may not look at the transaction unless there is a high risk for that particular type of transaction.
Completed ABC Inherent Risk and Materiality Memo Template file containing the results of your inherent risk assessments, preliminary analytical review, and materiality level determination.