Auditing and Assurance: Identifying Inherent and Control Risks

This document discusses the elements of inherent risk and control risk in auditing and assurance. It also explores the factors that influence the auditor's opinion on internal control over financial reporting. The document provides insights into the case of Ms Abbas, the CEO of Tobias Ltd, and the risks associated with the company's investment portfolio.

AUDITING AND ASSURANCE

TABLE OF CONTENTS
QUESTION......................................................................................................................................1
ANSWERS......................................................................................................................................1
A) Identifying elements of inherent risk and control risk............................................................1
B) Audit program being utilised for auditing the marketable securities account for the current
year...............................................................................................................................................2
C ) Factors that influence the auditor's opinion analysing the strengths of internal control over
financial reporting. ......................................................................................................................3
CONCLUSION................................................................................................................................3

QUESTION
The question is related to the understanding of situation related to the inherent control risks, audit
planning and evidence gathering. In the present case Ms Abbas has been appointed as CEO for
directly dealing with all the internal audit department. Ms Abbas has restructured the investment
portfolio of business. As an independent auditor of Tobias ltd various risks associated with
company and respective audit implications are to be identified.
ANSWERS
A) Identifying elements of inherent risk and control risk
Audit risks refers to risk when an inappropriate opinion is expressed on financial
statement of company. It is divided into inherent risk and control risks. Inherent risks of material
misstatements in financial statements that arises because of errors and omission due to factors
other than control failures. Inherent risks are considered where degree of judgements are high,
estimations are involved or when transactions of company are complex.
Control risks relate to material misstatement that arises due to failure or absence of
operations of relevant control systems of the entity. Internal controls are required for preventing
and detecting the frauds and errors instances. This risks is high where internal controls are not
adequate for preventing and detecting fraud and error in financial statements.
In the present case inherent risks can be associated with the transactions. As company is
having high investments transactions of securities that involves high estimations risks. While
planning the audit, auditor has to consider the investment portfolios, the amounts invested by the
company. It has to analyse the level of speculations made by CEO in the investments. The long
term investments are to be analysed by the company as risky shares can lead the company to
suffer losses.
Auditor has to inspect the portfolio of investments identifying the securities, mortgages
and instruments that are not active and are nor deriving any profits for company. Broker charges
are part of controls risks, auditor has to inspect the invoices that are issued by the broker for the
investment and also ensure that it does not include the personal investment consultancy shares of
Ms Abbas. All the fees paid by the company is to checked that they are related to the
investments of company only. Investment documents of company related to investments are
required to be audited. Increase in net income of the company may involve elements of inherent
and control risks.
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Control environment of the company does not seems to be strong. Though the company
is showing an increase but there are no controls over the governance of Ms Abbas. Investments
in much high risk shares is not having high controls. Control over the increasing brokerage fees
should be laid by company as the auditor is required to control the risks factors. The brokerage
documents are to be audited so that it can be ensured that all investments are in the name of
company. The costs of acquisitions are correctly recorded by company and the brokerage charges
are not above the limits specified. The control environment is also flexible and effective as
assignment of authority and responsibility by company to Ms Abbas has helped company in
increasing its profitability by increasing the investments in securities markets. Auditor has to
ensure that there is no errors and omissions in recording the investments. The returns generated
on investments is recorded in appropriate sections as inadequate recording can lead to
misstatement of statements. Auditor have to make in depth inspection of all the transactions
related to investments.
B) Audit program being utilised for auditing the marketable securities account for the current
year
Source of Cash
Cash include the general cash, petty cash fund, cash equivalents such as certificate
deposits etc., these receipts and payment are all important in the financial audit. So the auditor
will require from what source the cash is generated as the cash may be generated from some
illegal source and then that cash is laundered into the business. The liquid nature of cash
increases the risk undetected fraud. The auditor will see the internal control over the cash
transactions, existence of the cash recorded, completeness of the cash recorded etc., these are
some of the auditor strategies which they use to check that the source of cash is valid or not, so
that any fraud can be identified and reported.
Electronic Fund Transfer
This is a system through funds are being transferred into the company electronically.
These transfers may be done either by a customer or by other business. The auditor will again
have to check that these fund comes from a valid source for this the auditor will perform
substantive tests to reconcile that the fund is received from a valid source, obtain a reconciliation
statement from the bank, investigate any large amount being credited and then ask the board of
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director to give explanation about these unusual transfer, and if a valid explanation is not
generated then further investigation should be done.
Brokerage Fees
In the case given a large amount of broker fees is being given and this fees is appearing to
be paid to a company that is related to Mr. Abbas, so the auditor need to investigate that if these
funds are invested in the market securities or Mr. Abbas is doing a fraud by transferring this
money into his company.
C ) Factors that influence the auditor's opinion analysing the strengths of internal control over
financial reporting.
Auditing the specific factors of company related to investments opinion on the internal control
systems are to be evaluated.
The internal controls requirement are given under ASA 315. In the present case internal
controls are required to be placed over many procedures. Controls regarding the investment have
been given to Ms Abbas, all the transactions related to investments should be recorded correctly
with supporting of the number and amount of investments made in different securities. As an
auditor it is to inspected that investments made by company are authentic. Investment in Junk
bonds and mortgages are made on proper authority of CEO and higher authorities. Controls
regarding the payment of brokerage fees should be strong but they are not reviewed and payment
are made by company.
The internal controls are not strong regarding investment documents of company. There
is not any set procedure for making the investments in securities this can lead to irregular or
unwanted investments. Increase in profits of company due to investments requires in depth audit.
There is no control for assessing where the payments are made by company. The opinion of the
auditor can be negative if the brokerage fees are paid to company in which Abbas is interested or
belongs to Abbas. This factor could have instances of fraud and errors if broker company is of
CEO she might have increased the portfolio for benefiting herself.
CONCLUSION
In the given question auditor has to analyse each and every aspect related to investments.
The investments n risky shares may be made for increasing the benefits arising to brokerage
company of Abbas. Internal controls regarding the authorisations are very weak. There is no
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control procedure for auditing the invoices being raised against company these may involve fake
invoices. Increase in profits may have been done by misstatement of financial statements as she
has been given higher authority. Therefore the auditor has to audit in detail about the brokerage
company and that investments are made in name of company. Documents related to the
securities also rests with brokers that shows company is having very weak internal controls.
Auditor has to frame proper audit programme for auditing the company and its investments. This
factor can have significant impact over the opinion of auditor therefore it should be adopted very
accurately by auditor.
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