ADG Partners: Audit Risk Assessment of WOW Electrical Limited Audit

This report, prepared by Mark Walker, assesses the audit risks associated with WOW Electrical Limited. It addresses the importance of considering external user reliance on financial statements and the potential for material misstatements, especially given the company's reliance on bank debt and imports. The report highlights the likelihood of financial failure due to management control issues, complex transactions, and risky financial estimates, including the improper use of pre-numbered purchase orders and rapid retail expansion. The assessment also examines the integrity of management, noting concerns arising from frequent disagreements with prior auditors and personnel changes. The report includes an analysis of the completeness assertion of purchase, industry factors, and control risks and suggests follow-up audit procedures for inventory turnover, accounts receivable, and profit margin. The author emphasizes the need for strict control measures and careful consideration of the management's actions to mitigate potential risks.

ADG Partners
Assessment of Audit Risk
Client: WOW Electrical Limited
From the Desk of Mark Walker To: Mr. Kate Jones
In continuation to the Memo of 17th May instant received from you, I am
forwarding you my assessment of audit risk which we can encounter in the case of our
client M/s WOW Electrical Limited. In the following pages I have given a broader view
of the difficulties and the precautions which we need to adopt while taking up the audit.
Since you have entrusted the task to my team, as its leader I assure you of a fair and
impartial assessment and I shall take leads from your experience of the last year’s audit
which was conducted by you.
1. Assessing Acceptable Audit Risk
(A) Reliance by External Users
Any external user, such as the lender, supplier and a regulator will try to gauge
the risks contained in the financial statements if these are materially incorrect or have
any material misstatements. I need to focus on these two components and insert caution
while identifying the risks associated with material misstatements. WOW needs to be
cautious with its bank which has put the condition of a minimum 15% profit ratio after
the $100m loan.
Taking note of last year’s misstatements by the management, I will be more
cautious with the management’s reports, so that external users have no reason of
mistrust. The management also needs to take note of the fact that its supplies are highly
reliant on imports. Any changes in the administrative structure will have long term
effects on its supply chain and this may disturb the relations with the external parties.
(B) Likelihood of Financial Failure
Inherent risk is often caused by an error or omission in financial statements. In the
case of WOW I find these happening because of management’s failure of control. The
other factor occurs because of complexity created in transactions by the management. In
WOW’s case, a financial failure can also occur if the management demonstrates a high
degree of judgment when making financial estimates.
I also want to issue a note of caution to the management on the following –
(a) Its improper and highly risky system of using numbered purchase orders.
Even if the management continues with the practice of using them, it should
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ADG Partners
Assessment of Audit Risk
Client: WOW Electrical Limited
From the Desk of Mark Walker To: Mr. Kate Jones
immediately put in place a system of checking and following their
authenticity and implementation. I am going to discuss this issue in detail in
my notes on “Completeness Assertion of Purchase” given below.
(b) The company is heavily reliant on bank debt and the management has to
tread cautiously with regard to its profitability. It cannot afford laxity in
controls.
(c) Fast and unchecked expansion of the retail network will not only create
bottlenecks in the administrative system, it will also choke the entire
financial system if not handled with strict and adequate control measures.
The above factors will also contribute to the chances of a financial failure, if the
management does not follow the advice of this audit team. I shall be elaborating on
these factors in my notes on “Completeness Assertion of Purchase” given below.
(C) Integrity of Management
Client’s questionable integrity is the most disturbing factor for an auditor and this is
likely to force the auditor in lowering the level of the acceptable audit risk. In the case
of WOW I can mention the following two as important indicators of the management’s
integrity:
(a) Its frequent disagreement with prior auditors.
(b) Inadvertent change of the key financial and HR personnel.
In my opinion, the management should not have changed the CFO at this critical
juncture as the new incumbent will take time to understand the organisation’s working
and may not be able to provide adequate information to the external audit team.
Moreover, this change will also create difficulties for the Internal Audit team of the
company as they will not be able to adjust to changes at such a crucial juncture.
2. Completeness Assertion of Purchase
(A) Assessing Inherent Risks
(a) Industry Factors
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ADG Partners
Assessment of Audit Risk
Client: WOW Electrical Limited
From the Desk of Mark Walker To: Mr. Kate Jones
(b) Nature of Client’s Business
(c) Integrity of Management
(d) Motivation to Staff
(e) Results of Previous Audits
(B) Assessing Control Risk
(a) Pre-numbered Purchase Orders
(b) Maintaining Sequence
(c) Reconciling General Ledger
(d) Inadequate HR Functioning
(e) Review of Staff
3. Assessment of Ratios
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ADG Partners
Assessment of Audit Risk
Client: WOW Electrical Limited
From the Desk of Mark Walker To: Mr. Kate Jones
(A) Current Ratio
(a) Trend of the Ratio
(b) Follow-up Audit Procedures
(c) Test of Controls
(B) Inventory Turnover Ratio
(a) Trend of the Ratio
(b) Follow-up Audit Procedures
(c) Test of Controls
(C) Accounts Receivable
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ADG Partners
Assessment of Audit Risk
Client: WOW Electrical Limited
From the Desk of Mark Walker To: Mr. Kate Jones
(a) Trend of the Ratio
(b) Follow-up Audit Procedures
(c) Test of Controls
(D) Profit Margin
(a) Trend of the Ratio
(b) Follow-up Audit Procedures
(c) Test of Controls
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ADG Partners
Assessment of Audit Risk
Client: WOW Electrical Limited
From the Desk of Mark Walker To: Mr. Kate Jones
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