QUESTIONS AND ANSWERS Auditing Help

Your client is engaged in developing software for sale and for own use which take substantial time for development. Enumerate some significant risks and how the company may minimize the impact and likelihood of such risks

Possible risks are:

1. Judgments are involved in identifying whether and when there is an identifiable asset that will generate expected future benefits.
2. The software may not be technically feasible.
3. Technical, financial and other resources may be inadequate.
4. Estimates and judgments involved in cost allocation.
5. The product cannot be guaranteed to be bugs free.
6. Technological obsolescence.

Certain measures to minimize the risk are:

1. Written agreement with the customer specifying when and how much funds will be provided in advance
2. Monthly review and monitoring the development
3. Monthly comparison of actual with budgeted cost
4. Recruitment of competent staff
5. Continues feed back from customers

Explain the difference between business risk approach and audit risk approach

1. Business risk includes inherent risk. Inherent risk is the susceptibility of misstatement in the financial statements. Inherent risk directly relates to those risks which affect financial risk. Business risk includes both financial and non financial risk. Accordingly, in case of audit risk approach, the auditor makes an assessment of inherent and control risk and then determines acceptable detection risk. In business risk approach, in addition to inherent financial risk,· the auditor also makes assessment of other business risk.
2. In business risk approach, the auditor first obtains IN DEPTH understanding of the entity’s objectives, strategies, threats that the objectives may not be achieved, and then focuses attention on relatively more risky areas (top down approach)

Audit risk approach (bottom up approach) involves:

• Preliminary assessment of inherent and controls risks
• Performance of test of controls
• Final assessment of control risk
• Substantive procedures.
3. In audit risk approach, the focus is on key controls in purchases and payables, sales and receivables, cash receipts and cash payments, salaries and wages, inventories and cost of sales, non current assets and other significant areas.
In business risk approach the focus is on high risks which may affect the business of the client.
4. In business risks approach, the involvement of partners and senior managers in planning is much greater than in audit risks approach.

Give examples of some business risk and the measures the company can take to minimize impact and likelihood of risk

1. Business risks

Risk of adverse trends in foreign exchange

Managing the risk
Forward contract

2. Business risks
Increase in the prices of raw materials

Managing the risk
Hedging

3. Business risk
Going concern

Managing the risk
Monitor cash flow and profitability

4. Business risk
Excessive customer complaints

Managing the risk
More strict quality controls

5. Business risk
Safety

Managing the risk
Staff training

6. Business risk
Litigation

Managing the risk
In house counseling or regular legal advice.

7. .Business risk
Excessive reliance on certain key employees

Managing the risk
Backup arrangements for key functions

8. Business risk
Excessive reliance on a few products or customers

Managing the risk
Diversify

9. Business risk
Excessive reliance on a few suppliers

Managing the risk
Explore alternative supply sources

10. Business risk
Over trading

Managing the risk
Close monitoring of working capital management

Enumerate risks associated with over trading in those cases where the management is unable to attract more equity capitals.

If owners’ capital is not available, reliance will have to be placed on
borrowings.

Potential risks are:
• Deterioration in credit rating.
• Increase in debt – service cost resulting in further increase of borrowings.
• Restrictions imposed by banks.
• Further finance may not be available, and if available, it will be at exorbitant rates.
• Unable to take early settlement discounts from suppliers.
• Loss of business opportunities.
• Highly geared company
• Penal interest on outstanding loans
• Off balance sheet financing.

Posted on November 4, 2015 in Audit of Specialized Industries

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