Chapter 6

Assessing inherent risk and other specific business risks

Learning objectives
6.1 Explain the factors that influence the assessment of inherent risk.
6.2 Explain the auditor’s consideration of the risk of fraud.
6.3 Explain the auditor’s consideration of related parties.
6.4 Explain the auditor’s consideration of the appropriateness of the going concern basis.

Major chapter sections

Inherent risk
Fraud
Related parties
Appropriateness of the going concern basis

Lecture plan
In the last lecture students were exposed to a process by which auditors gain knowledge of the business
and industry of their client and evaluate business risk. The knowledge gained at this stage will provide
the auditor with the information to assess inherent risk at an overall level, with the assessment continuing
at the assertion level and at the account balance, class of transactions and related disclosure levels. The
chapter also covers the special risk areas of fraud, related parties and the appropriateness of the going
concern basis.

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You should outline the learning objectives for this chapter, and also walk them through how this chapter
fits into the flowchart of the planning and risk assessment stage of a financial report audit.

[Use slides 6-1 to 6-3]

LO 6.1: Inherent risk

A lot of this knowledge comes through gaining an understanding of the business and industry and
assessing business risk. It is important to talk about assessing the risk of material misstatement and then
introduce the concept of inherent risk and its relationship to business risk. It is necessary to explain the
different levels at which inherent risk is assessed. An example is included of how an identified inherent
risk can flow through to an account balance assertion, and the type of audit procedures the auditor would
later undertake.

[Use slides 6-4 to 6-11]

LO 6.2: Fraud
This section covers the issues of assessing the risk of fraud. It covers the auditor’s requirements regarding
fraud at the planning stage of the audit. Students should be exposed to the different types of frauds—
fraudulent financial reporting and misappropriation of assets. Fraud should be distinguished from errors.
It includes a discussion of red flags which indicate fraud, and the different types of earnings management
that the auditor should be aware of. Students are introduced to the fraud triangle that needs to exist for
fraud to occur.

We discuss the auditor’s responsibilities in fraud detection, which can be referred back to our earlier
discussion of the expectation gap. We also discuss the auditor’s responsibilities for reporting fraud and
discuss the concept of whistleblowing.

[Use slides 6-12 to 6-29]

LO 6.3: Related parties

ASA 550/ISA 550 requires auditors to specifically assess the risk that related parties and related-party
transactions will not be identified or appropriately disclosed and/or measured. The reasons that the
auditor must identify all related parties when planning the audit include the existence of related parties or
related-party transactions that can affect the financial information, the reliability of audit evidence as a
function of the source of that evidence and that the initiation of a related-party transaction might be
motivated by fraud rather than ordinary business conditions. Examples of related party frauds and
procedures for identifying related parties are considered.

[Use slides 6-30 to 6-34]

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LO 6.4: Appropriateness of the going concern basis
ASA 570/ISA 570 requires auditors to assess going concern at planning stage, as imminent business
failure might have an effect on the appropriateness of presentation of financial report or might motivate
management misrepresentations. Examples of going concern indicators and mitigating factors are
considered.

[Use slides 6-35 to 6-40]

Summary
We provide a summary slide of the main learning takeaways in this chapter.

[Use slide 6-41]

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 SOLUTIONS
REVIEW QUESTIONS

6.1 Inherent risk is the susceptibility of an account balance, class of transactions or disclosure to material
misstatement given inherent and environmental characteristics, but without regard to internal control.

Inherent risk at the financial report level is an important consideration in general planning because it
specifically affects other decisions made at this time, such as staffing requirements, and other aspects of the
audit plan. For example, some of the possible responses to high inherent risk are to assign more
experienced audit personnel, to increase the extent of supervision and to conduct the audit with a
heightened degree of professional scepticism.

Consideration of the inherent risk of material misstatement at the assertion level for classes of transactions,
account balances and disclosures is important, as it directly assists the auditor in determining the nature,
timing and extent of specific further audit procedures at the account and assertion level necessary to obtain
sufficient appropriate audit evidence.

6.2 Inherent risk at the financial report level refers to risks that are pervasive to the financial report as a
whole and therefore may affect many assertions. These risks are not necessarily identifiable with
specific assertions at the class of transactions, account balance or disclosure level. Rather, they
represent circumstances that may increase the risks of material misstatement at the assertion level
through factors that could potentially affect several accounts and several assertions.

Factors that may increase inherent risk at the financial report level include the following:

 Integrity of management

If management lacks integrity, it is more likely to be prepared to produce materially misleading

financial reports.

 Management experience, knowledge and changes during the period

Inexperience of management and its lack of knowledge may affect the preparation of the financial
report. In addition, if poor business decisions are made, this may introduce pressure to bias the
results.

 Unusual pressure on management

This may provide incentives for management to misstate the financial report. For example, if the
entity is facing cash flow problems, poor liquidity, poor operating results or insufficient capital to
continue operations, there may be an incentive to make the financial position look better than the true

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 situation. If management compensation schemes are tied to earnings or share prices, there is an
incentive for management to misstate the result in order to obtain a bonus.

 Nature of the entity’s business

Some types of businesses are inherently risky. For example, companies will be inherently risky if their
products are subject to a high inherent risk of obsolescence. Products such as high technology and
fashion items may become obsolete due to changes in technology or consumer tastes.

 Factors affecting the industry in which the entity operates

Changes in economic and competitive conditions would be expected to have a major impact on the
inherent risk of an entity. For example, the possibility of breaches of restrictive covenants in loan
agreements increases during economic downturns.

6.3 Inherent risk is greater for some assertions and related classes of transactions, account balances and
disclosures than for others. Inherent risk at the assertion level refers to the likelihood of a material
misstatement existing in a particular account balance, class of transactions or disclosures.

Factors that may increase inherent risk at the assertion level include the following:

 Accounts likely to require adjustment

Accounts that were found to be misstated in previous audits are likely to contain similar
misstatements in the current year’s accounts.

 Complexity of underlying transactions

Transactions characterised by difficult calculations or a complex accounting standard are more

prone to error than simple repetitive transactions.

 Judgment involved in determining account balances

The greater the degree of judgment involved in determining account balances, the greater the
chance of error. Accounting estimates, such as provision for doubtful debts, obsolescence and
warranty, are more likely to be misstated than routine factual data.

 Susceptibility of assets to loss or misappropriation

If an entity processes large amounts of cash, such as a supermarket, susceptibility to

misappropriation is increased.

 Occurrence of unusual and complex transactions, particularly at or near year-end

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 Material and/or unusual transactions occurring near the end of the year have a higher inherent
risk, as they may have been undertaken with the objective of manipulating profits or covering up
a poor liquidity position.

 Transactions not subject to ordinary processing

Transactions that are not subject to ordinary processing are more susceptible to errors or
misappropriation.

6.4 Fraudulent financial reporting may be achieved by:

 manipulation, falsification or alteration of records or documents

 suppression or omission of the effects of transactions from records or documents

 recording of transactions without substance

 intentional misapplication of accounting policies.

6.5 Types of enquiry that the auditor will make of management in regard to fraud include:

 management’s assessment of the risk that the financial report may be materially misstated due to
fraud

 management’s process for identifying and responding to the risks of fraud in the entity, including
any specific risks of fraud that management has identified or account balances, classes of
transactions or disclosures for which a risk of fraud is likely to exist

 management’s communication, if any, to those charged with governance regarding its processes for
identifying and responding to the risks of fraud in the entity

 management’s communication, if any, to employees regarding its views on business practices and
ethical behaviour.

6.6 The auditor needs to have a thorough knowledge of the client’s business to be able to identify opportunities
for the perpetration of fraud. Advanced data analytics can assist in this area, as patterns or connections that
might not have been discovered with traditional methods are much more easily identified, analysed and
visualised with advanced data analytics.

6.7 Related parties exist where one entity is able to significantly influence or control the operating, financing
or investing decisions of another; or if several entities are subject to control from the same entity; or if the
party is a joint venture in which the entity is a venturer. Key management personnel (including directors),
their close family members and entities controlled by them are also related parties, as are superannuation
funds for the benefit of employees or related parties of the entity.

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6.8 Examples of transactions that may indicate the existence of unidentified related parties include transactions
that:

 are overly complex (for example, transactions involving multiple parties within a consolidated
group)

 have abnormal terms of trade, such as unusual prices, interest rates, repayment terms or guarantees

 lack an apparent logical business reason to justify their occurrence

 have been processed in an unusual matter.

6.9 As per ASA 550.A29 (ISA 550.A29), indicators of dominant influence being exerted by a related party
include the following.

 The related party has vetoed significant business decisions that have been taken by management or
those charged with governance.

 Significant transactions are referred to the related party for final approval.

 There is little or no debate among management and those charged with governance concerning
business proposals initiated by the related party.

 Transactions involving the related party (or a close family member of the related party) are only
rarely independently reviewed and approved.

6.10 The going concern assumption means that the entity is viewed as continuing in business for the
foreseeable future without any intention or necessity to liquidate or otherwise cease its operations. When
the going concern assumption is appropriate, assets and liabilities are recorded on the basis that the assets
will be realised and the liabilities discharged in the normal course of business. This means either cost or
fair value is used. However, an imminent business failure will have an effect on the appropriateness of
the presentation of the financial report. If the company is not a going concern, the financial report should
be prepared on a liquidation basis, which is likely to be vastly different to the going concern basis.
Further, going concern problems may motivate management misrepresentation. Therefore, the
appropriateness of the going concern assumption is very important in determining the audit procedures
and the degree of professional scepticism to be applied and whether the fina1ncial report gives a true and
fair view. As a result, ASA 570.10 (ISA 570.10) requires that when planning and performing audit
procedures and evaluating the results, the auditor must consider the appropriateness of the going concern
assumption that underlies the financial report.

6.11 As per ASA 570.5 (ISA 570.5), factors that affect management’s assessment of the appropriateness of the
going concern basis include the following.

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  The uncertainty associated with the outcome of an event or condition increases significantly the
further into the future the event or condition or its outcome occurs.

 The size and complexity of the entity, the nature and condition of its business and the degree to
which it is affected by external factors all affect the judgment regarding the outcome of events or
conditions.

 Any judgment about the future is based on information available at the time at which the judgment
is made. Subsequent events may result in outcomes that are inconsistent with judgments that were
reasonable at the time they were made.

6.12 As per ASA 570.16 (ISA 570.16), additional audit procedures that the auditor shall perform when events or
conditions are identified that call into question the ability of an entity to continue as a going concern
include the following:

 Where management has not yet performed an assessment of the entity’s ability to continue as a
going concern, request that management make such an assessment.

 Evaluate management’s plans for future actions in relation to its going concern assessment, whether
the outcome of these plans is likely to improve the situation and whether management’s plans are
feasible under the circumstances.

 Where the entity has prepared a cash flow forecast, and analysis of the forecast is a significant factor
in considering the future outcome of events or conditions in the evaluation of management’s plans
for future action:

o evaluate the reliability of the underlying data generated to prepare the forecast

o determine whether there is adequate support for the assumptions underlying the forecast.

 Consider whether any additional facts or information have become available since the date on which
management made its assessment.

 Request written representations from management and, where appropriate, those charged with
governance, regarding their plans for future action and the feasibility of these plans.

DISCUSSION PROBLEMS AND CASE STUDIES

6.13 (Easy)

The following factors should be considered by Megan Martin when making her assessment.

 Accuracy, valuation and allocation: The exclusive wines may be subject to obsolescence if not
sold relatively quickly, as new vintages are always coming onto the market and some vintages

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 become less drinkable over time. Obsolescence of the cabinetry is unlikely to be a problem, as it is
made to order.

 Existence: Expensive bottles of wine are susceptible to theft due to their relatively small size and
ease of resale or consumption by the thief. The made-to-order cabinetry is bulkier and not as
saleable on the illegal market, as it has been made to the customer’s specific requirements.

Based on the above, Megan is likely to assess the inherent risk of the exclusive wine lines of Exclusive
Boutique Pty Ltd as being higher than the cabinetry of Ready Made Pty Ltd.

6.14 (Medium)

(a) The company might experience going concern problems in the future, given declining sales and
falling margins. This is especially so given the bank’s desire to see improved results in the next
reporting period and the related potential threat to loan funding. The pessimism displayed in the
financial press is also likely to deter future investors and lenders for CBL’s operations. The overall
effect is an increase in audit risk.

(b) The current circumstances are likely to place increasing pressure on the company’s management to
produce favourable financial results. This affects inherent risk at the financial report level. It is also
likely to increase inherent risk at the assertion level for accounts where judgment or estimates are
involved, such as provisions.

6.15 (Medium)

(a) Inherent risk is increased. Tying bonuses to reported sales increases the risk that sales staff will
process fictitious sales, make sales to uncreditworthy customers or manipulate sales between periods
to increase sales and thereby their bonuses.

(b) Inherent risk is increased. The CFO will be required to make a subjective estimate of the provision
for closure.

(c) Inherent risk is increased. The company is entering into a market in which it has no experience. The
product is susceptible to fashion changes, and it is not yet known whether it will be accepted in the
Australian market. The fact that the product is imported also exposes the company to foreign
exchange fluctuations.

(d) Inherent risk is increased. The treasurer appears to be speculating in foreign currency, which might
lead to foreign exchange losses. Also, the complexity of accounting for foreign currency
transactions would increase the risk of errors.

6.16 (Medium)

Inherent risk Impact on financial report

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 Strategy of expansion by acquisition Complexity and judgment associated with valuation of
intangible assets such as child care licences and goodwill
on acquisition may give rise to a risk of material
misstatement
Significant expansion overseas funded by Translation of foreign currency loans may give rise to a
borrowings in local and foreign currency risk of a material misstatement
Inability of CFK’s accounting system to integrate Overall integrity of financial information may be
the acquired companies’ complex information impacted
systems
Lack of financial skills of the board Board’s inability to review financial information may
impact on the overall integrity of the financial report
6.17 (Easy)

(a) ASA 240.5 (ISA 240.5) indicates the auditor should plan and conduct the audit so as to have a
reasonable expectation of detecting misstatements that have a material impact on the financial
report as a result of fraud or error. Effectively this means the auditor should maintain an attitude of
professional scepticism and consider the possibility of fraud when planning the audit by taking into
account factors that increase the risk of fraud (and error). The existence of an extensive IT
environment is an example of such a factor.

(b) The following factors are considered to be some of the most common indicators of IT vulnerability
to fraud:

 poor controls over manual input/output handling

 weak or absent physical access controls

 weaknesses in computer and terminal operations

 poor control over computer programs

 lack of operating system access controls and integrity

 weak library controls.

6.18 (Medium)

Fraud risk factor Explanation

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 Modern Electricals Ltd is Risk of fraudulent financial reporting, as getting close to breaching
close to breaching its debt debt covenants creates an incentive to manipulate assets and liabilities
covenants to ensure that the required ratio is met
William Walters receives a Risk of fraudulent financial reporting, as there is an incentive to
large proportion of his overstate profits and increases in receivables, as this has a direct
remuneration from bonuses impact on his remuneration
Sales staff are paid bonuses Risk of misappropriation of assets, as there is inadequate oversight by
based on unverified emailed management as to whether claims submitted by email for payment of
information provided by staff bonuses are legitimate
6.19 (Medium)

Fraud risk factor Explanation

Management’s remuneration is Management has an incentive to overstate sales to achieve optimistic
heavily weighted by incentives performance targets and receive their bonus
based on ambitious sales levels
Small, high-value inventory Titanium bolts are small but very valuable and so could be stolen by
staff for resale
6.20 (Hard)

Account Key assertion Explanation

Trade and other receivables Existence There is a risk that there may be fictitious debtors.
Trade and other receivables increased by 14%, while
revenue increased by less than 1%. It is unusual for
the debtors’ balance to increase without a similar
corresponding increase in revenue.
Deferred revenue Completeness There is a risk of overstatement for revenue and
understatement for deferred revenue. Deferred
revenue decreased by 30%, while revenue increased
slightly. It is unusual for deferred revenue to decrease
while revenue increases for a services business.
6.21 (Easy)

Related-party transactions are of interest to the auditor for three reasons. Firstly, they require detailed
disclosures and might result in adjustments to some balances where the accounting standards require that
they be considered separately. Secondly, evidence concerning these transactions is more likely to be
internally generated, thus the auditor will need to consider the nature, timing and extent of procedures
necessary to support these transactions. Finally, related-party transactions are usually non-routine and can

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 be quite complex. Some transactions might also be motivated by reasons other than benefits to the
company subject to audit.

Each of these factors increases the inherent risk of the audit and, given that there are unlikely to be controls
in this area, similarly increases the amount of substantive testing required. In order to ensure that this
testing is completed in an efficient and effective manner and that the evidence is obtained in time to
support the auditor’s opinion, the auditor will need to specifically consider the extent and nature of related-
party transactions as part of the planning process. ASA 315.28 (ISA 315.28) requires the auditor to
specifically consider whether there is a risk of misstatement involving related parties when deciding which
risks are significant.

6.22 (Medium)

Related party transaction How it increases risk or prevents fair presentation

Purchases between Golden Touch and No one outside the purchasing department is aware of
Elite Fabrics are now on cash terms the change in terms, which increases the risk, including
instead of the usual agreed-upon 30-day the risk of non-commercial transactions (given cash is
terms involved).
Use of Chinese factory by Amos The risk of material misstatement in the financial report
Campbell’s wife, including exchange is increased because of the practice of writing off
for free clothes to the Campbell family manufacturing costs as bad debts. The offer of free
goods may lead to unethical behaviour.
6.23 (Hard)

Factor 1

The controls over related party transactions are weak. This is evidenced by a lack of understanding of
AASB 124 (IAS 24) by Kirsten, low importance placed by management on identifying and disclosing
related-party transactions, and lack of appropriate oversight by those charged with governance. Given the
ineffective controls, the auditor may be unable to obtain sufficient appropriate audit evidence about
related-party relationships and transactions. The auditor would need to consider the implications of this for
the audit, including the impact on the auditor’s report.

Factor 2

There have been a number of transactions that are considered to be outside the normal course of business
and are fraud risk factors:

 dealings with an offshore entity in a jurisdiction with weaker corporate laws (Sunshine in Fiji)

 rendering of services with no consideration exchanged (management services provided to Sunshine)

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  lack of business rationale for a transaction (sale of property to Clayton, but still including property
management fees).

Factor 3

ASA 550.A19 (ISA 550.A19) gives examples of possible fraud risk factors arising from related-party
transactions. One of these factors is engaging in complex transactions with related parties, such as special-
purpose entities that have been structured to misrepresent the financial position of the entity. Clayton may
be a special-purpose entity as it was set up specifically to buy the property. The auditor would need to
determine whether Clayton was controlled by Highland and also investigate the apparent sale of the
property and why Highland still has a continuing involvement with the property.

Diamond appears to be a related party of Highland in accordance with AASB 124 (IAS 24), due to the
substantial interest of a director, so the claim that transactions are on an arm’s-length basis would need to
be evaluated.

Sunshine, Clayton and Diamond all appear likely to be related parties of Highland. As such, under ASA
550.A19 (ISA 550.A19) there is a very significant risk of material misstatement due to fraud that could
result from the entities’ related-party relationships and transactions. Also, there is a risk of lack of
disclosure in the financial report as Kirsten is claiming that they are not related parties.

6.24 (Easy)

Going concern risks always need to be considered due to the impact on the audit if they exist. Going
concern issues are important for three key reasons. Firstly, they can have a significant effect on the
appropriateness of the presentation of the financial report, as an entity that is not considered to be a going
concern is required to adopt an alternative basis of presentation of financial information. This would have a
number of implications for the audit procedures used to determine the appropriateness of the valuation
assertion for assets and liabilities.

Secondly, the possibility of business failure increases the motivation for intentional misstatement of the
financial report in order to fend off creditors and attract additional sources of funding. The auditor will
therefore need to play closer attention to matters such as the existence and valuation of assets, and
completeness and valuation of liabilities, and exercise a greater degree of scepticism, if there are going
concern risks.

Finally, the possibility of liquidation due to going concern issues increases the likelihood that the auditor
will be required to defend the quality of the current and previous audits in court.

6.25 (Medium)

(a) Events or conditions that may indicate material going concern uncertainties include:

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  Bob’s Boats, a major customer of Blue Water, has indicated that it intends manufacturing its
own engines. This is likely to result in a significant loss of sales, as it is unlikely that Bob’s Boats
will continue to purchase Blue Water’s engines once they start producing their own engines.

 As a result of being able to import engines at a lower cost, some of Blue Water’s customers have
indicated that they may purchase their engines from overseas rather than from Blue Water,
potentially resulting in a significant loss of sales.

 The intense competition in the local market will make it harder for Blue Water to secure
contracts with alternative customers to sell its engines.

(b) Mitigating factors to support the going concern assumption include:

 Blue Water had a positive working capital position as at 30 June 2018

 Blue Water has been profitable for several years

 Blue Water has successfully expanded by developing a new type of engine for export to New
Zealand.

6.26 (Hard)

Factors that suggest that the area of going concern at CAL should be assessed as high risk are as follows.

 the likelihood of obtaining new contracts has decreased because of increased competition

 the bank might withdraw its financing facilities if cash-flow forecasts are not adequate

 the future viability of the company is at risk because there are no new contracts

 the provision for warranty might deplete CAL’s existing cash resources.

Mitigating factors in this decision are as follows.

 the current working capital position is positive

 there are potential orders currently being negotiated and it is not abnormal in this industry for sales
to be inconsistent from year to year. By the time the audit is completed, new contracts might have
been negotiated and agreed

 there might be alternative sources of financing, such as funds from majority shareholders, sale and
lease-back of assets, sale of redundant assets and factoring of receivables

 it might be possible to restructure the debt.

Overall, given the extent of the problems, going concern is likely to be assessed as high risk.

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6.27 (Hard)

(a) Factors that suggest possible going-concern problems include the following:

 There are poor liquidity ratios below the industry averages and the normal benchmarks of 2
for current ratio and 1 for quick asset ratio.

 There is an increasing debt-equity ratio, indicating more dependence on high-risk debt, when
a decrease was budgeted.

 Management has failed to reach its targeted profitability in the current year, and has not even
produced results equivalent to the previous year. It is performing well below industry
benchmarks. There may be pressure to perform exerted by the directors and there is a risk
that account balances might have been manipulated to produce better results. Consequently,
the auditor would be watchful for any such manipulation.

 The increase in the current ratio as compared to the prior year and to the budget, together
with the quick asset ratio being almost the same, supports the possibility that inventory could
be overstated. This is consistent with the increase in days in inventory. It should be noted that
there would be a further decrease in the gross profit ratio should it be found that inventory
was overstated.

Given these ratios and the fact that Apple Pie operates in a low-margin environment, going
concern is an issue for the auditor to consider.

(b) As per ASA 570.A16 (ISA 570.A16), audit procedures that may be relevant include the following:

 Analyse and discuss the basis for budgeting for a drop in gearing levels with management, as
well as their analysis of cash flow under various scenarios.

 Read the minutes of the meetings with shareholders, those charged with governance and the
relevant committees, for references to gearing levels and financing.

 Review the terms of loan agreements (regarding financial gearing) and determine whether
any such terms have been breached.

 Ascertain whether there are any arrangements to provide or maintain financial support with
related and third parties.

 Review events after period end to identify those that either mitigate or otherwise affect the
entity’s ability to continue as a going concern.

CONTINUOUS CASE STUDY

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 6.28

Inherent risk factors that arise from the nature of RPL’s business operations include:

 RPL purchases 50% of its inventory requirements of paper, ink and binding materials from Asia and
pays for the inventory in the relevant currency of the country from which it is purchased. As
transactions have to be recorded in Australian dollars, there is an increased risk of errors in
translation at transaction date, which affects purchases and inventory and translation at payment or
balance date, which affects accounts payable.

 RPL changed its business structure through the acquisition of the business operations of MBL during
the year. Acquisition of a new business generally increases inherent risk. Specifically, RPL
recognised an intangible asset for the copyright attaching to the medical textbooks that MBL
produces. However, an article published in a medical journal could cause the medical textbooks that
RPL acquired the rights for to become obsolete. As a result, the copyright is at risk of being
impaired.

6.29

(a) Fraudulent financial reporting is a key fraud risk for the following reasons:

 The remuneration package of the CEO, William Jackson, includes a performance bonus based on
RPL achieving two key performance indicators (KPIs): annual growth of 10% in total revenue and
annual growth of 10% in net profit after tax. These key performance indicators create an incentive
for fraudulent financial reporting in relation to sales and net profit, so that William can achieve his
bonus.

 RPL’s debt covenants require RPL to maintain a current ratio of at least 1.5 and a debt to equity ratio
of less than 1. Failure to maintain these key financial ratios would result in Trim Finance having the
right to recall the loan. This creates an incentive to manipulate figures affecting these two ratios to
ensure that the loan covenants are not breached.

(b) The audit would need to concentrate on accounts susceptible to manipulation, particularly those
involving management estimates and accounts that directly affect either the performance KPIs or the
debt covenant ratios, such as sales, inventory and allowance for doubtful debts.

As the CEO has an incentive to manipulate the results, the risk of management override of controls is
increased and so a more substantive audit approach may be required for the accounts subject to high
fraud risk.

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