Additional Revision Questions

Additional Revision Question 1
Consider the following independent situations, all of which apply to audits of entities for the
year ending 31 December 20X7:
(i) Slipway Limited, a listed company, has been experiencing declining sales over the
last 2 years. Cost cutting has proved difficult due to the high level of imported
machinery used in Slipway’s operations and consequently margins have been falling.
While the bankers are presently happy to continue providing Slipway with loan
facilities, they do expect to see improved results in the next financial report. Articles
about Slipway’s expected financial results appearing in recent press reports all had
quite a pessimistic tone.
(ii) Discount Foods Limited is a large supermarket chain with offices in all capital cities
around Australia. Until 30 June 20X7 data processing relating to payroll transactions
will be carried out in each capital city by an independent computer service bureau.
(iii) Getaway Pty. Limited is a long established firm which has been operating a boutique
hotel in the Blue Mountains for over 20 years. During this time, it has adopted a
conservative business strategy that has seen it produce adequate, though slightly
unimpressive, results. A new CEO has been appointed to run the firm from 1
September 20X7. He has already released his plans for renovating the hotel, despite
not officially serving as CEO yet. You have also heard him discuss the
implementation of a new marketing strategy to boost occupancy rates.
(iv) Angora Pty. Limited is a small primary producer specializing in the production of
angora wool. Angora’s recent display at a trade show has seen orders flood in from
overseas buyers. The accountant, Michael, has done his best to satisfy the orders as
quickly as possible while maintaining the appropriate (foreign currency) accounting
records. However, from some of the questions he has been asking you, you suspect he
is out of his depth.
(v) Kings Pty. Limited has been manufacturing uniforms for the Australian market for the
last 40 years. The government’s recent tariff reduction policy has placed Kings in
direct competition with cheaper uniforms manufactured overseas. In a bid to retain
market share, Kings has been selling part of its school uniform range at less than cost.
However, overall profit figures remain buoyant.
(vi) Micro Pty. Limited’s best selling product line is the M4 - a `no frills’ microwave oven
designed for domestic use. Over the last 2 months, warranty claims on the M4 have
trebled from 1.5% to 4.5% of sales. The problem appears to relate to the glass
turntable, which shatters if the oven is constantly used. The average cost of repair has
risen by 20% to $200 per claim.
Required:
For each of the above independent situations describe the overall impact on audit risk and
identify the specific component(s) of audit risk affected.
Answer
Specific components of audit risk affected:

Overall impact on audit risk:
i) Slipway Limited’s declining sales and Slipway Limited's current circumstances are
falling margins may be heading likely to place increasing pressure on the
towards future going concern company’s management to produce
problems. This is important given the favourable financial results.
banker’s desire to see improved results This affects inherent risk at the financial
in the next reporting period and the report level.
related potential threat to loan funding.
The pessimistic articles in the financial
press are also likely to have a negative
impact on Slipway’s results. The
overall effect is an increase in audit
risk.
ii) The change in Discount Food The change in payroll processing and the
Limited’s payroll processing from an related change in the internal control affects
internal one generating many errors to control risk, in particular those controls
an unknown external bureau may have surrounding the information system.
a variety of effects on audit risk. On the
one hand, overall audit risk may fall
because of the abandonment of the
error-prone processing function.
However, on the other hand, overall
audit risk is likely to rise due to the
changeover in processing functions, the
risk associated with new procedures,
and the increased number of locations
processing the payroll function, (i.e. a
computer service in each capital city).
iii) The future change in CEO appears The change in management and loss of the
likely to result in a change in the experience of the existing CEO affects
business philosophy of the firm, from a inherent risk at the financial level.
conservative to a more risk-taking
approach. While there may be benefits
for the firm, there is a risk that it may
lose its existing customer base and fail
to achieve adequate financial results.
The overall effect is an increase in
audit risk.
Specific components of audit risk affected:
Overall impact on audit risk:
iv) Angora’s move into overseas markets Angora’s move into overseas markets has
is a positive one as far as increased changed the nature of its business. In
sales are concerned. However, there is addition, accounting staff and management
an apparent lack of expertise in the may lack the experience to correctly account
company in relation to accounting for for foreign currency transactions.
foreign currency transactions. This leads to an increase in inherent risk at
The overall effect is an increase in the financial report level.
audit risk. The increasing complexity of Angora’s
transactions are also likely to affect the
following specific account balances/specific
classes of transactions:
 sales revenue;
 trade debtors; and
 cash at bank.
This leads to an increase in inherent risk at
the account balance, class of transaction and
disclosure level.
Given the increased pressure on the
accountant, specific control procedures may
be overlooked, increasing control risk.
v) The effect of the recent tariff policy The increasing competitiveness of the
must be quite severe, as they have industry in which Kings operates has an
already forced Kings to reduce prices overall effect on inherent risk. There is
on some goods. This is likely to worsen likely to be an increase in inherent risk at
over the next 6 months. the financial report level, as management
tries to maintain profits at the current level.
The steps management have taken to
mitigate the effects of the tariff cut At the account balance, class of transaction
have not affected profit levels. and disclosure level, there is likely to be an
However, continuing to sell below cost increase in the level of judgment required to
is likely to have negative long-term accurately value inventory at the lower of
implications. cost or net realisable value.
Overall audit risk is increased.
vi) The increasing warranty claims on The change in the level and nature of
Micro's best selling product line are a warranty claims is likely to increase the
concern. There may also be public degree of judgement required to arrive at
liability claims arising from the materially correct figures for balances such
problems with the glass turntables. as trade receivables, inventories and
There is also likely to be an adverse provision for warranty. This leads to an
effect on sales and Micro's reputation increase in inherent risk at the account
in the market balance/class of transaction level.

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Additional Revision Question 1

Specific components of audit risk affected:

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