Auditor’s Business Risk Case Studies Examples
Business risk means the possibility that an auditor incurs damage to his professional training. It may also be defined as the danger that may arise from activities or in activities that could unfavourably affect an entity’s capabilities to attain its purposes and implement its policies. Risks are a usual part of business, however, if not well managed they can endanger the operations of companies. There are countless reasons that may cause a client‘s business risk. They include progressive scientific change, competitors’ activities such as discounting values of goods and services and including new product lines in their existing industry. The success of a firm’s internal controls may also affect client’s business risk by identifying inaccuracies or deliberate misstatements. Examples include: major variations in a firm such as acquisition or disposal of high value equipment.
ALI Inc. is a fully owned firm by BMG and shows a business risk. BMG’s goal is to maximize financial gain. As a result ALI Inc. was directed to enter into agreement with Boeing, Lockheed Martin, and Raytheon in order to boost revenue. However, ALI Inc. did not notify BMG because he was afraid that BMG may cancel its affiliation with ALI Inc. or straightaway lower the price and demand refund of extra prices charged in the former years. The destruction of the manufacturing plant of ALI Inc. represents a danger to the surviving trade especially if the lost value is not recovered. ALI Inc. was compensated 3 million by the insurance company. If the remaining value is not paid, it will be a client business risk in the future. The insurance company proposed to pay 5.1 million dollars in clearance of the unsettled value.
The auditor business risk is the danger that the auditor could be harmed by a lawsuit, hostile publicity or other proceedings arising in connection with audited financial statements. Some of the fundamentals of auditor’s business risk are lawsuits and lack of professional standards. Lawsuits could include expenses such as attorneys’ fees and court settlements. The auditor can influence auditor’s business risk, hence engagement risk, by the choice of clients. Irrespective of the quality of work done, auditor business risk is inevitable when an auditor engages a client.
The case of ALI Inc. shows a situation where the auditor did not show in the books of accounts 47% share interest on investment in acquired from GlueCo. of 5 million. The auditor did not also qualify the audit report. This means that the financial statements did not reflect the real picture of ALI Inc. because of the omission of the share interest on the investment. ALI Inc. can sue the auditor for to disclose vital information. The incoming auditor should ask the previous auditor to inform the management that he did not disclose the equity interest investment acquired. The previous year audit report was not qualified and it should have been qualified since a major investment was not recorded. ALI Inc.’s auditors were denied the privilege of accessing accounting information by the firms that had custody of their accounting books. The auditors of ALI Inc. were denied the chance to access accounting system by Exostar. An auditor can only perform his duty effectively and efficiently if he has full access to books of accounts.
Audit risk is the danger that the auditor provides an incorrect audit judgment when financial statements are substantially misstated. When an auditor chooses a lower level of tolerable risk, it means that the auditor wants to be more convinced that the financial statements are not significantly misstated. The auditor must know that once a client is acknowledged, audit risk cannot be disregarded. However, the auditor can manage and determine audit risk by doing targeting particular areas where financial reporting risk is high.
Inherent risk is defined as the danger that other accounting factors apart from in-house controls will significantly impact on financial statements. Hence, inherent risk will be significant where the subjectivity is high or where the entity’s business is complex. Control risk is the danger that the misstatements will occur due to poor in-house controls. An example is where an entity does not advocate for segregation of duties and allows one person to do almost all crucial duties of a company. ALI Inc. inherent risk may be considerably large because ALI Inc. was acquired by a host company whose goals are to make more sales which is in conflict with the goals of ALI Inc. of creating better relations with its clients.
Management of Risks before client Acceptance
An audit firm should carry out numerous actions before accepting a client, in order to decide whether to accept the audit engagement or not. This aids the audit firm in decreasing its engagement risks. Once a client is considered, the audit firm is exposed to engagement risk. Nonetheless, low engagement risk is satisfactory. In appraising the engagement risk, the auditor estimates the client’s and the auditor risks and hence adopts the level of audit risk. The level of audit risk is determined by regulating the techniques the auditor uses while auditor’s business risk is measured through the client’s approval decision process. If an auditor foresees high audit business risk, he should decline the client in order to reduce a high level of engagement risk. In the event of low audit business risk, it is the auditor’s responsibility to ensure that all procedures of evaluating a risk are followed so as to decide about the engagement with the client.
In ALI Inc.’s case, the major concern should be the 47% share interest investment that was purchased and not reflected in the books of accounts. Another aspect is the failure by the auditor to issue a qualified report concerning the true picture of financial statements. The incoming auditor must evaluate the auditor’s business risk and decide whether to accept the engagement or not.
The Financial Reporting Framework requires that financial statements should give a perception that financial information is fairly presented. The size of an item determines how material that item is. A small omission of 1000 dollars omitted in a firm’s financial statement whose worth is 100 million dollars is immaterial. This is because that amount is insignificantly small compared to the worth of the firm. Such omission cannot affect the decisions of investors. However, an omission of 3 million dollars is material if it is omitted in the financial statements. This is because that amount is large enough to affect the decisions made by investors. An item is considered material if its omission affect the decision made by users of financial statements. The materiality level for total assets is 0.3%. By taking 0.3% and multiply with total assets should not give a different figure from the level set. Different figure is an indication of irregularities.
There is a large deviation between the actual materiality level and the one set by the auditor. Taking 0.3% of 100 million gives a figure which is by far smaller than the one set by the previous auditor. This is an indication of irregularities in the previous years audited accounts. However, the liquidity level is not threatened since current assets are higher than current liabilities.
Specific Accounting and Other Audit Issues
Acquisitions, mergers, reorganizations form part of specific accounting. The accounting procedures of such entities are different from the normal businesses. This is because if a certain percentage is acquired by the holding company, only that part is used when accounting for that organization. Firms have rights and privileges over other firms depending on the ownership of the holding company. ALI Inc. is a subsidiary of BMG and it is 100% owned. This means that BMG has every right to control the affairs of ALI Inc. At the end of the year, all the accounting transactions of ALI Inc. and BMG are consolidated and reported as one amount. BMG is also responsible for all the liabilities of ALI Inc. ALI Inc.is obligated to disclose the information about the clients it obtained. The 45% share interest investment which is not recorded in ALI Inc. must be recorded in the books of BMG. The recording should be done according to Equity method.
Executive Summary of Aerospace Inc.
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