Corporate Auditing: Inherent Risks, Control Risks, Internal Control Strength, Planning Materiality and Professional Scepticism

This article discusses inherent risks, control risks, internal control strength, planning materiality and professional scepticism in corporate auditing. It also provides strategies to be adopted for minimizing risks.

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Section 1
Answer 1
Financial statement –
a. The company’s name is Amcor Limited
b. Company’s financial year end is 30th June 2017 (Amcor.com 2018).
c. Name of the company’s external audit firm is PricewaterhouseCoopers
Answer 2
Audit committee –
a. 2 members are there in the audit committee of Amcor Limited. Their names are –
Graeme Liebelt and Paul Brasher. Graeme Liebelt is independent non-executive
chairman and Paul Brasher is independent non-executive director. As both of the
members are independent it makes 100% of the members independent (Amcor.com
2018).
b. Yes, the audit committee of the company discusses about provision of non-audit
service by external auditor. details regarding the discussion was as follows –
During the year under consideration, PwC, the external auditor of the company
provided certain services apart from the regular statutory services. However, the provision of
non-audit services was in compliance with the written advice delivered by the audit and
compliance committee’s resolution. Further, the services were compatible with the
requirement and the auditor’s independence as per the requirement of Corporation Act 2001
was not compromised. All non-audit services were subject to the procedures of corporate
governance applied by the audit and compliance committee of the company (Christensen,
Glover and Wolfe 2014). It further ensures that the services do not have any impact on

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objectivity and impartiality of auditor. Further, the non-audit services those were delivered by
the external auditor did not undermine general principles related to the auditor’s principle
provided in APES 110 regarding code of ethics for the professional accountants.
Answer 3
Auditor’s report –
a. Components of annual report for expressing auditor’s opinion
Opinion of the auditors is the certification that is based on the financial statement and
the opinion is provided on the financial statement of entity irrespective of the the fact that
material misstatement included or not. Auditor’s report starts with the introductory section
that outlines the management’s responsibility as well as the audit firm’s responsibility. 2nd
section states about the financial statement of the company on which the opinion is given by
the auditor. 3rd section states the opinion of the auditor. 4th section states explanation only if
the auditor provides adverse opinion or qualified opinion. Auditors audited the below
mentioned financial reports of the company –
 Declaration of the director
 Income statement
 Statement of the financial position
 Statement of comprehensive income
 Cash flow statement
 Statement of changes in equity
 Notes related to the financial statements that includes summary of significant
accounting policies (Amcor.com 2018).
b. Auditor’s report was signed by the audit partner John Yeoman.

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c. Auditor’s report for the year ended 30th June 2017 was signed by PwC on 22nd August
2017.
d. As per the auditor’s opinion the associated financial report of the company and the
entities controlled by it is in compliance with Corporations Act 2001 and it includes –
 The report is complied with Corporation Act 2001 and Australian Accounting
Standards
 The audit report gives true and fair view of the entity’s financial position and financial
performance as on 30th June 2017 (Amcor.com 2018).
The auditor provided unqualified audit opinion as according to them the audit is
conducted in compliance with the AAS (Australian Accounting Standards). Further, they
believe that audit evidences obtained by then are appropriate and sufficient to provide the
basis for opinion (Blankley, Hurtt and MacGregor 2014).

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Section 2
Question 2.1
a. Inherent risks
Inherent risk is risk of the material misstatement in the financial statement that arises
owing to omission or error. It arises due to factors other than control failure. Generally, the
misstatement arises due to lapse or absence of the controls that are separately considered
while assessing the control risk (Coetzee and Lubbe 2014). Inherent risks are considered
higher if higher degree of estimation and judgements are involved or where the transactions
of the company are of complex nature. Inherent risks found in case of WWW are as follows
–
 Valuation of inventory – WWW is the manufacturer of precious metal studded
wristwatches and pocket watches made of gold. 2 employees are engaged by the
company who are specialized in making watches. However, due to age factors they
are near to their retirement and the new generation are not so interested in this
profession. Moreover, very few watchmakers are there who can match the expertise
level of existing watchmakers. However, it is found that the classic watches of the
company do not match with latest trends. WWW’s experience tells that inventories of
the company do not become obsolete. Inventories are generally recognized at cost or
market value whichever are lower (Makarenko and Yardanova 2015). However, if the
inventories are kept idle it will not be possible for the company to record it in their
book.
 Cash deposit – WWW follows perpetual inventory system and maintains the point of
sale system in computer. However the cash payments received by the company are

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deposited in bank once in week as there is no bank in nearby location (Louwers et al.
2015). However, chances are there for the misstatement of cash. Cash being highly
volatile item it is always susceptible to embezzlement, misstatement or theft. As cash
are not deposited on daily basis it will create inherent risk for the cash account and its
records.
 Stock taking – Stock take for jewellery used to be carried out by the retail manager on
monthly basis. However, owing to his bad health stock take became less frequent.
Inventories shall be physically counted and matched with inventory register on
regular basis (Contessotto and Moroney 2014). Therefore, it will create inherent risk
to inventories as inventories are subject to misstatement, theft and wrong valuation.
b. Control risk
It is the risk related to material misstatement involved in financial statement generated
owing to failure or absence in operation of the relevant controls of company. Each company
shall have sufficient internal control measures for detecting and preventing errors or frauds. It
is considered as high where the client company does not have proper internal control
measures for detecting and preventing errors or frauds (Ruhnke and Schmidt 2014). Control
risks found in case of WWW are as follows –
 Segregation of duties – as WWW deals with high value watches its inventories
involve higher amount. Therefore, responsibilities of stock taking shall have been
segregated between 2-3 people. The manager being only responsible person for stock
taking his ill health significantly hampered the stock taking procedure (Melikhova and
Nikolayenko 2017). It will lead to control risks over the company’s inventories.
 Reporting loss – As the company reported its first ever loss during the year 2018
chance is there that financial reports of the company is being misstated. The

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possibility is also there that the financial statement includes error or fraud that is not
detected by the company or the auditor.
 Cash deposit – As the cash receipts of the company are deposited in bank once in a
week chances are there that the amount of cash is misstated. Cash being highly
volatile item it is always susceptible to embezzlement, misstatement or theft. As cash
are not deposited on daily basis it will create control risk for the cash account and its
records.
c. Internal control strength
Internal control is the organizational plan in which all the measures and method of the
company are co-ordinated and adopted within the business for safeguarding the assets,
checking the reliability and accuracy of the accounting data for improving operational
efficiency and encouraging adherence to required managerial policies (Johnstone, Gramling
and Rittenberg 2013). Internal control strengths found in case of WWW are as follows –
 To prevent the store against theft the company keep it locked. Therefore, the
customers are required knock on the door to enter in the store. It will protect the store
from theft.
 Watches of the company are kept in the locked display case and one spare copy is
kept in back storeroom. Therefore, it will be convenient for the customers to search
for their required items as it will not depend on availability of particular staff.
 At night all the watches are removed by the company from display cases and it is
locked in safe. Further, the store has the facility of security alarm that is directed to
police station. The alarm switch is kept on while last employee leaved from the store.
It will provide additional security to the products kept in the store safe.

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d. Component of audit risk
Audit risk states the risk that the auditor will provide incorrect opinion regarding
financial statement. Audit risk is equal to inherent risk * detection risk * control risk. The
audit risk is measured as product of assorted risks that can be encountered for the audit
performance. For keeping the audit engagement risk lower than the acceptable limit, auditor
shall assess the risk level associated with each audit risk component. Control risk arises due
to failure of the existing control or absence of the control that leads to misstatement in
financial statement. Detection risk arises due to failure on the part of auditor regarding
discover of the material misstatement include in financial statement. Inherent risk arises
through omission or error arises from the factors except the control failures. Therefore, the
risks identified above as inherent risk and control risk can be justified properly for detecting
valuation of inventory, Cash deposit and Stock taking risks as inherent risks and Segregation
of duties, Reporting loss and Cash deposit risks as control risk.
e. Strategies to be adopted
 Stock taking responsibilities shall be segregated between 2-3 people. It will enable
maintaining appropriate stock for the inventories so that any error or fraud will be
detected in early stages (Hamova and Mel'nik 2016).
 Cash shall be deposited in bank on daily basis so that chances of misstatement or
misappropriation cash will be minimized
 Inventories shall be removed from the stock and stock register when it becomes
obsolete and valuation shall be made on the basis of cost or market value whichever is
lower (Tarasenko 2015).
 As the company reported loss for the 1st time in 2018, all the items those led to loss or
the amount of the items those significantly varied with last year shall be checked
thoroughly.

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f. Computation of planning materiality
Planning materiality refers to misstatement amount that are set by the auditors at the
stage of audit planning on the basis of materiality with regard to the financial statement.
Below mentioned are the quantitative factors used for computing materiality planning –
 1% to 5% of the sales = $ (33,00,000*1%) = $ 33,000 to $ (33,00,000*5%) = $
165,000
 1% to 2% of total assets = $ (44,00,000*1%) = $ 44,000 to $ (44,00,000*5%) = $
220,000
 2% to 5% of the shareholders equity = $ (23,00,000*1%) = $ 23,000 to $
(23,00,000*5%) = $ 115,000
While calculating planning materiality the auditor may consider the highest amount
from above. However, based on the case scenario the auditor can set the materiality level. In
the given case, if the lower limit is considered then $ 44,000 that is 1% of total asset can be
set as the level for planning materiality (Audsabumrungrat, Pornupatham and Tan 2015).
Question 2.2
Answer a
From the given case study it is found that Nick Leeson made $ 10 million of profit for
the 1st week of February 1995. This significant amount of profit caught attention of various
other members in bank. Head of the Global Futures and Options Sales, Mike Killian was in
view that if Nick makes same profit level through entire year it will be half billion dollar
profit for the year. This professional attitude is known as professional scepticism. Mike was
cynical about the fact that if one person is making more money as compared to rest of staff’s
entire earning it may raise questions regarding the reliability of information. Professional
scepticism shall be applied properly throughout the auditing procedure. It is the component of

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auditor’s general duty with regard to care that is applicable through the procedure of audit.
This attitude includes questions in mind and critical assessment for sufficiency and
appropriateness of the audit evidence. It includes 3 elements – auditor’s mindset, actions and
attributes (Kim and Trotman 2015). It plays an important role in audit as it forms integral part
of skill set for the auditor. It helps in appropriate exercise of the professional judgement
especially in decision making regrading –
 Timing, extent and nature of the audit procedure that is to be performed for reducing
risk to the appropriate level
 Drawing conclusions on the basis of audit evidence available.
 Whether required audit evidences are gathered and whether more evidences required
for achieving the audit objectives as per the relevant standards on assurance.
 Evaluating the judgement of management (Chiang 2016)
It further improves the effectiveness of the audit procedure and its application.
Further, it reduces the chances of selecting inappropriate audit methodologies, misapplication
of audit procedure and misinterpretation of audit results.
Answer b
Nick Leeson was the floor manager and at the same time he was the head of the
settlement operations. Thus, he was in a position to settle his trades without considering the
internal control of bank. Hence, his action will create self interest threat and self review threat
as per APES 110 on the Code of Ethics for Professional Accountants. Self interest threat is
created when financial or any other interest inappropriately influences the behaviour or
judgement (Tepalagul and Lin 2015). On the other hand, self review threat is the threat that
the member will inappropriately analyse the results of previous judgement or any service
performed by any other person. For reducing the threat, Baring Bank shall segregate the

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duties properly. For instance, the settlement and trades related to Nick Leeson shall be
reviewed by any other competent person. It will reduce the chances of misstatement and
fraud (Fiolleau et al. 2013).
Answer c
Unqualified audit report determines that the entity’s financial statements are presented
appropriately and fairly without any in compliance and exceptions to accounting standards. It
is most common type of the audit report and it does not raise any question regarding the
company’s financial statement. Unqualified audit report states that the financial statement of
the company is financially sound and there is no gap between the audit expectation and
performance (Czerney, Schmidt and Thompson 2014). This kind of report suggests that the
identification of responsibilities with respect to expectation of the auditor reflects proper
knowledge of the company regarding the audit procedure.
Unqualified audit report, the most common type of the audit report is the clean report
that does not demand any modifications in the auditor’s opinion. Though the audit report
received by the bank was of unqualified nature that indicated all the internal control and
financial statement requirements were in place. However, there were some inherent risks that
led to bankruptcy of the bank (Guiral Ruiz and Choi 2014). Therefore, before issuing the
unqualified audit report the auditor should have applied in depth knowledge associated with
mindset, actions and attributes.

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