Risk Assessment – Knowsia

AAA – L3 – SA – Q4.6 – Audit evidence

Which factors contribute to inherent risk in an audit?

Question

Which of the following may be factors contributing to inherent risk?

1 Number of customers

2 Strength of internal controls

3 Number of products

4 Rate of staff turnover

A 1,2 and 3 only

B 1,3 and 4 only

C 2,3 and 4 only

D 1,2 and 4 only

Answer

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Tags: Customers, Inherent Risk, Internal controls, Products, Risk Assessment, Staff turnover
Level: Level 3

Topic: Audit Evidence

AA – L2 – SA – Q4.4 – Inherent Risk Factors

Identifying non-inherent risk factor.

Question

Which of the following is NOT an inherent risk factor?

A Control environment

B Subjectivity

C Uncertainty

D Change

Answer

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Tags: Audit Planning, ICAG, Inherent Risk, Risk Assessment
Level: Level 2

Topic: Audit and Assurance Risk Environment

FM – L2 – Q71 – Discounted Cash Flow

Calculate NPV for a project with GH₵3M equipment cost, 5-year cash flows, and 8% cost of capital, ignoring inflation and taxation.

Question

A company, Zenith Innovations Ltd, is considering an investment in a new project to manufacture and sell a new product with a five-year lifespan. The project requires an investment of GH₵3 million in equipment. The residual value of this equipment after five years will be 30% of its original cost.

The estimates of net cash flows from operations in each year of the project are as follows:

Year	Net Cash Flow (GH₵)
1	400,000
2	800,000
3	800,000
4	700,000
5	400,000

These cash flows are based on estimates that the annual increase in cash spending on fixed costs will be GH₵200,000, and the contribution/sales ratio from transactions will be 40%. The company’s cost of capital is 8%.

The management of Zenith Innovations Ltd is aware that actual cash flows could be higher or lower than expected, and sensitivity analysis should be carried out to establish the extent to which costs or revenues could differ from the estimate before the project ceases to have a positive NPV.

The investment in working capital will be minimal. Inflation and taxation should be ignored.

Required
(a) Calculate the net present value of the project.

(b) Carry out sensitivity analysis on the following items:

(i) The cost of the equipment, assuming that the residual value will be 30% of cost.

(ii) The residual value of the equipment.

(iii) Sales revenue.

(iv) Variable costs.

(v) Annual fixed costs.

Answer

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Tags: investment appraisal, NPV, Project Risk, Risk Assessment, Sensitivity Analysis
Level: Level 2

Topic: DCF: Risk and uncertainty

FM – L2 – Q70 – DCF: Risk and uncertainty

Calculate the expected NPV of a project with uncertain cash inflows affected by multiple probabilistic factors, using a 10% cost of capital.

Question

A company is considering whether or not to invest in a project where the investment would be GH¢5,250,000. The project would have a five-year life, and estimated annual cash flows are as follows:

Year	Cash inflows	Cash outflows
	GH¢	GH¢
1	3,000,000	1,500,000
2	4,000,000	1,800,000
3	5,000,000	2,400,000
4	4,000,000	1,700,000
5	3,000,000	1,000,000

The cost of capital is 10%.
The estimates of cash outflows are considered fairly reliable. However, the estimates of cash inflows are much more uncertain. Several factors could make the annual cash flows higher or lower than expected.
Factor 1: There is a 20% probability that government measures to control the industry will reduce annual cash inflows by 20%.
Factor 2: There is a 30% probability that another competitor will also enter the market: this would reduce the estimated cash inflows by 10%.
Factor 3: There is a 40% probability that demand will be stronger than expected. The company would not be able to supply more products to the market, but it would be able to sell at higher prices and cash inflows would be 5% higher than estimated.
Required
Calculate the expected net present value of the project.

Answer

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Tags: Cash Flows, Discounted cash flow, Expected value, investment appraisal, Net Present Value, Probability Analysis, Risk Assessment
Level: Level 2

Topic: DCF: Risk and uncertainty

AA – L2 – Q69 – Audit Reports

Draft a management report addressing inventory and credit limit deficiencies at TechTrend Solutions, including implications and recommendations.

Question

TechTrend Solutions sells personal computers (PCs) to independent shops. You are the external auditor of TechTrend Solutions. Your interim audit revealed the following issues:

(1) The half-year physical inventory count revealed that some PCs supposed to be in inventory were missing and that other machines which had been returned by customers were in inventory but had not been recorded as having been returned. A few of the missing PCs have been traced to directors who borrowed them for use at home.

(2) Two customers had been allowed to exceed their credit limits and new customers in the last year had not been allocated credit limits.

Required:

Draft the section of your report to management dealing with the above deficiencies. Set out the deficiencies, their implications, and your recommendations for improvement.

Answer

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Topic: AUDIT REPORT

AAA – L3 – Q65 – Reporting

Prepare a management report on payroll internal control deficiencies at Bibini Co. Ltd., including implications and recommendations.

Question

Kofi & Co. have audited the annual financial statements of Akoma Co. Ltd., a public limited liability company, for the year ended 31st December 2014. The accounting system of the company is partially computerised.
During the audit, it was detected that just two members of staff, out of one hundred and fifty workers, were entirely and equally responsible for the maintenance of personnel records and preparation of the payroll. The chief accountant only confirms that the amount of the wages and salaries cheque agrees with the total of the net wages column in the payroll, then he signs without any reasonableness check of the amount of the total wages cheque. This situation is a serious deficiency in the system of internal control which can have serious implications. As audit senior, you are considering communicating this situation to the management, showing the deficiency, implications, and recommendations.

Required:
Prepare an appropriate report to management on the deficiency noted in the system of internal control for payroll.

Answer

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Tags: Audit Deficiency, Audit Procedures, Corporate Governance, Financial Statements, Fraud Risk, Internal Control, Management Report, Payroll, Recommendations, Risk Assessment
Level: Level 3

Topic: Reporting

AAA – L3 – Q48 – Assurance services

Discuss the statement that assurance work offers audit firms less work, lower risk, and lower assurance compared to standard audits.

Question

The growth in assurance-type work provides a great money spinning opportunity for audit firms to provide a lower level of assurance, involving less work and reduced engagement risks, compared to the standard audit.

Required:

Discuss this statement.

Answer

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Tags: Assurance engagements, Assurance levels, Audit comparison, Fee income, Risk Assessment
Level: Level 3

Topic: Assurance Services

AAA – L3 – Q47 – Financial instruments

Discuss challenges in auditing financial instruments and matters for planning the audit of Tap Co’s forward exchange contracts.

Question

You are the manager in Dee Kay Company, a firm of Chartered Accountants. You have just attended a monthly meeting of audit partners and managers at which client-related matters were discussed. Information relating to one client which were discussed at the meeting is given below.
Tap Co
Tap Co is a clothing manufacturer, which has recently expanded its operations overseas. To manage exposure to cash flows denominated in foreign currencies, the company has set up a treasury management function, which is responsible for entering into hedge transactions such as forward exchange contracts. These transactions are likely to be material to the financial statements. The audit partner is about to commence planning the audit for the year ending 31 July 2014.
Required:
Discuss why the audit of financial instruments is particularly challenging, and explain the matters to be considered in planning the audit of Tap Co’s forward exchange contracts.

Answer

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Tags: Audit Planning, Financial instruments, Forward exchange contracts, Risk Assessment, Treasury management
Level: Level 3

Topic: Audit Evidence

AA – L2 – Q49 – Analytical Procedures

Explain reasons for changes in current ratio, gross profit margin, and inventory holding period at audit planning. Explain automated tools and techniques and their use at the audit planning stage.

Question

Analytical procedures are an important and powerful tool for auditors explaining the performance of a business. ISAs 315 and 320 require the auditors to apply analytical procedures at the planning and overall review stages of the audit.

Required
(a) Explain the possible reasons for the following changes in accounting ratios found at the planning stage of the audit:
(i) an increase in the current ratio;
(ii) a decrease in the gross profit margin; and
(iii) an increase in the inventory holding period.

(b) Explain what automated tools and techniques are and describe how they can be used at the planning stage of the audit.

Answer

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Tags: Accounting Ratios, Analytical Procedures, Audit Planning, Risk Assessment
Level: Level 2

Topic: Audit Evidence

AA – L2 – Q42 – Audit Evidence

List and explain factors influencing the auditor's judgment on sufficiency of audit evidence. List substantive audit procedures for trade payables, accruals, and provision for legal action at Regent Co.

Question

ISA 500 Audit Evidence states that the objective of the auditor is to ‘design and perform audit procedures in such a way as to enable the auditor to obtain sufficient appropriate audit evidence to be able to draw reasonable conclusions on which to base the auditor’s opinion’.

Required:

(a) List and explain the factors which will influence the auditor’s judgment concerning the sufficiency of audit evidence obtained.

You are the audit senior in charge of the audit of Regent Co, a company that has been trading for over 50 years. Regent Co manufactures and sells tables and chairs directly to the public. The company’s year-end is 31 March.
Current liabilities are shown on Regent Co’s statement of financial position as follows:

	20X8	20X7
	C	C
Trade payables	884,824	816,817
Accruals	56,903	51,551
Provision for legal action	60,000	–
	1,001,727	868,368

The provision for legal action relates to a claim from a customer who suffered an injury while assembling a chair supplied by Regent Co. The directors of Regent Co dispute the claim, although they are recommending an out of court settlement to avoid damaging publicity against Regent Co.

Required:
(b) List the substantive audit procedures that you should undertake in the audit of current liabilities of Regent Co for the year ended 31 March 20X8. For each procedure, explain the purpose of that procedure.
marks are allocated as follows:
(i) Trade payables (9 marks)
(ii) Accruals (3 marks)
(iii) The provision for legal action (4 marks)

Answer

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Tags: Audit Evidence, Auditor Judgment, Risk Assessment, Sufficiency of Evidence
Level: Level 2

Topic: Audit Evidence

Tag (SQ): Risk Assessment

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AAA – L3 – SA – Q4.6 – Audit evidence

Which factors contribute to inherent risk in an audit?

AA – L2 – SA – Q4.4 – Inherent Risk Factors

Identifying non-inherent risk factor.

FM – L2 – Q71 – Discounted Cash Flow

Calculate NPV for a project with GH₵3M equipment cost, 5-year cash flows, and 8% cost of capital, ignoring inflation and taxation.

FM – L2 – Q70 – DCF: Risk and uncertainty

Calculate the expected NPV of a project with uncertain cash inflows affected by multiple probabilistic factors, using a 10% cost of capital.

AA – L2 – Q69 – Audit Reports

Draft a management report addressing inventory and credit limit deficiencies at TechTrend Solutions, including implications and recommendations.

AAA – L3 – Q65 – Reporting

Prepare a management report on payroll internal control deficiencies at Bibini Co. Ltd., including implications and recommendations.

AAA – L3 – Q48 – Assurance services

Discuss the statement that assurance work offers audit firms less work, lower risk, and lower assurance compared to standard audits.

AAA – L3 – Q47 – Financial instruments

Discuss challenges in auditing financial instruments and matters for planning the audit of Tap Co’s forward exchange contracts.

AA – L2 – Q49 – Analytical Procedures

Explain reasons for changes in current ratio, gross profit margin, and inventory holding period at audit planning. Explain automated tools and techniques and their use at the audit planning stage.

AA – L2 – Q42 – Audit Evidence

List and explain factors influencing the auditor's judgment on sufficiency of audit evidence. List substantive audit procedures for trade payables, accruals, and provision for legal action at Regent Co.

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AAA – L3 – SA – Q4.6 – Audit evidence

Which factors contribute to inherent risk in an audit?

You're reporting an error for "AAA – L3 – SA – Q4.6 – Audit evidence"

AA – L2 – SA – Q4.4 – Inherent Risk Factors

Identifying non-inherent risk factor.

You're reporting an error for "AA – L2 – SA – Q4.4 – Inherent Risk Factors"

FM – L2 – Q71 – Discounted Cash Flow

Calculate NPV for a project with GH₵3M equipment cost, 5-year cash flows, and 8% cost of capital, ignoring inflation and taxation.

You're reporting an error for "FM – L2 – Q71 – Discounted Cash Flow"

FM – L2 – Q70 – DCF: Risk and uncertainty

Calculate the expected NPV of a project with uncertain cash inflows affected by multiple probabilistic factors, using a 10% cost of capital.

You're reporting an error for "FM – L2 – Q70 – DCF: Risk and uncertainty"

AA – L2 – Q69 – Audit Reports

Draft a management report addressing inventory and credit limit deficiencies at TechTrend Solutions, including implications and recommendations.

You're reporting an error for "AA – L2 – Q69 – Audit Reports"

AAA – L3 – Q65 – Reporting

Prepare a management report on payroll internal control deficiencies at Bibini Co. Ltd., including implications and recommendations.

You're reporting an error for "AAA – L3 – Q65 – Reporting"

AAA – L3 – Q48 – Assurance services

Discuss the statement that assurance work offers audit firms less work, lower risk, and lower assurance compared to standard audits.

You're reporting an error for "AAA – L3 – Q48 – Assurance services"

AAA – L3 – Q47 – Financial instruments

Discuss challenges in auditing financial instruments and matters for planning the audit of Tap Co’s forward exchange contracts.

You're reporting an error for "AAA – L3 – Q47 – Financial instruments"

AA – L2 – Q49 – Analytical Procedures

Explain reasons for changes in current ratio, gross profit margin, and inventory holding period at audit planning. Explain automated tools and techniques and their use at the audit planning stage.

You're reporting an error for "AA – L2 – Q49 – Analytical Procedures"

AA – L2 – Q42 – Audit Evidence

List and explain factors influencing the auditor's judgment on sufficiency of audit evidence. List substantive audit procedures for trade payables, accruals, and provision for legal action at Regent Co.

You're reporting an error for "AA – L2 – Q42 – Audit Evidence"

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