PART TWO: AUDIT PREPARATION Case Study Solution
Identification of significant Financial Statement Risks
| Description of Potential Financial Statement Risk | Financial Statement Account(s) Affected | Explanation / Justifications | Level of Risk |
| Liquidation risk | Cash, LTD, Other LT Liabilities, PPE, Other LT Assets and Inventory. | Company’s debt to equity ratio is almost 2:1, which indicates that debt is two times more than equity. Debt to equity ratio indicates greater risk of liquidation if debt holder demands their money back. In short, company lacks enough cash to pay off its liabilities fairly quick. | High |
| Presentation and Discloser Risk | Accounts Receivable, Expenses, Inventory | Subsequent event includes liquidation details of a company’s client that will increase expenses for the company by decreasing accounts receivable. Avoiding it can lead to exploitation of potential investors of the company. Another potential risk could be proper valuation of an Inventory account by measuring the lower cost and net realizable value. | Moderate |
| Completeness Risk | Accrued Liabilities, Account Receivables, Expenses | For the purpose of increasing the profits, there is a possibility that company could undervalue its expenses that will lead to not complying of completeness assertion. | Low |
| Classification Risk | Expense, Assets | For the purpose of ignoring taxation, there is a possibility that company ignores the compliance of classification assertion by transferring current year revenues to the next year and by showing expense related to this transaction in current year statement. | Moderate |
| Exchange Rate Risk | Expense, Retained Earnings, Revenues | Due to the variation in exchange rate on daily basis, there is a possibility of manipulation in unrealized gains and losses. | Low |
| Overall Recommended Inherent Risk (IR) Assessment: | Moderate |
Calculation of Recommended Materiality
| Materiality Formula | Lower Threshold (,000 Canadian Dollars) | Higher Threshold (,000 Canadian Dollars) | |
| Net Income | 5% to 10% of Net Income | 4,191 | 8,382 |
| Total Assets | 0.5% to 1% of Total Assets | 7,212 | 14,424 |
| Equity | 0.5% to 5% of Equity | 2,659 | 26,592 |
| Recommended Materiality Threshold: | 6,287 |
After analyzing all the errors we can consider that liquidation risk can fall in general error category whereas presentation and disclosure risk, classification and completeness risk fall in the category of errors and exchange change risk falls in a fraudulent risk category. Recommended materiality threshold level has been calculated by taking the average of net income’s lower threshold level and higher threshold level. As company doesn’t have a manufacturing concern and provides transportation services from one country to other therefore by analyzing its nature of operations, total assets and equity threshold level will be unjustifiable for it. Since it is a Service Providing Company and does not hold much assets and equity over its balance sheet hence, net income’s threshold level has been recommended for materiality threshold by taking the average of low and high level as company’s overall risk level is moderate.
Conclusion
The five major risk which are identified through the financial statements and transaction of the company includes liquidation risk, presentation and disclosure risk, completeness risk, classification risk, and exchange rate risk. Hence, the risk which are identified affecting the cash account, inventory account, liabilities, accounts receivable and retained earnings accounts. Although, the overall level of risk associated with the identified risks is moderate and does not impact the materiality of the company to a greater extent...........
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