Inherent Risks and Factors to Consider in Auditing Theory and Practice

AUDITING THEORY & PRACTICE

Audit
Answer- 1
Part-a
The inherent risks are those risks that can cause a material misstatement in the
financial statements irrespective of the internal controls. The inherent risks are
present in the e-business and there is no method that can completely remove the
existence of it. When it comes to the concept of inherent risk, it is essential that
the organization should have a sound risk management approach ( Merchant, 2012).
In the case of Max Security Limited, the inherent risks are the following:
i. The top-level employees or the employees that are directly related to the
operations may have committed fraud- the main inherent risk that is expected in
this case is that fraud. The company deals in manufacturing of high tech armour
plated vehicles. Such kinds of vehicles are used for safety and security of top
class people such as bureaucrats, army officers and other top-level security
officers. Hence, the company has to maintain a very highly secure environment
where the designs of the vehicles can be kept safe and confidential. If there is
any leakage in the designs of the company vehicles, it might bear a threat to the
high-level officials using the same (Neimi & Sundgren, 2012). The inherent risk
here is that any top-level management employee of the company may leak the
design of the vehicle just in order to earn some good money as they have major
control over the internal controls of the entity. This will lead to the leakage of
design and create an adverse situation for the company. In addition, they have
the ability to manipulate the accounts and stop the auditors from detection of
such manipulations in accounts thus leading to misstatements in financial
statements.
ii. Risk in successful implementation of the new costing system- another
inherent risk that is there while conducting audit is that there has been change in
the costing system. A new costing system has been introduced in the company
over the old one. The old costing system was unable to capture the complex
manufacturing process. In addition, there were problems in reporting of the total
costing of the manufacturing process. Hence, a new costing system was put in
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Audit
place. Inherent risk here is that while replacing the systems, there might be some
major costs that were not recorded by mistake or that were overlooking in the
time gap between discarding old system and implementation of new one as
implementation of any new system takes time. These overlooked or non-booked
costs can lead to financial misstatements.
iii. Leakage of information- another risk considering the industry as a whole is
that the patent information of the security vehicles may be leaked and may cause
huge losses to the company. The auditor must go through each aspect to check
financial and nonfinancial leakages, which may lead to any kind of misstatement
or may affect the company as a whole.
iv. Clerical errors – it might be possible that while compiling the database of
the products cost and their inventories each time a transaction is moved such as
purchase, sales, returns etc., there might be clerical errors on the part of the
employee who is feeding the database (Matthew, 2015). Hence, where such error
exists, there are major changes that there may be material misstatement in the
financial statements, as the wrong inputs will obviously result in wrong output in
the form of reports.
v. Other risks may include failure of the completely costing system, theft of
patent information, theft of data, loss of data by fire, etc.
Hence the costing system should provide more security and a backup plan may be
formed by the company so that in case there is a loss of data by theft etc the
company should have a backup plan ready in hand.
Part- b
Factors to consider while determining preliminary materiality for Max Security:
Materiality is the amount that makes a difference in the analysis of financial
statements. For example, if a company has booked the total revenues of the
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