5-34
(Risk of material misstatement) Your client, a manufacturer of computer components, has experienced slowing demand for its product. Recently, it cut back from three shifts a day to two shifts a day, and the company has eliminated the backlog of orders that existed in prior years by providing financing to customers. Newspaper reports indicate that competition has taken significant business away from the client because a large investment in R&D has not resulted in improved products. Furthermore, a small handful of your client’s customers are experiencing financial difficulties because of slowing demand for your client’s products.
Required
a. Consider the implications of the above information for revenues. What assertions, if any, are likely to be misstated? As a result, what accounts are likely to be overstated or understated? Explain your reasoning.
b. Consider the implications of the above information for inventory. What assertions, if any, are likely to be misstated? As a result, what accounts are likely to be overstated or understated? Explain your reasoning.
5-35
(Developing responses to assessed risks) Your client, General Television, Inc. manufactures televisions and during the current year acquired Micro Engineering, Inc., which manufactured flat panel plasma screens for computers so that it could compete in the market for flat panel televisions. Following is a list of several risks that have been identified in the audit of this television manufacturer.
1. General Television has strong internal controls over the existence of inventory. It has a good perpetual inventory system and regularly compares inventory on hand with the perpetual records.
2. Prices have been changing rapidly in General Television’s marketplace. Although the marketplace is relatively stable for traditional televisions, the prices on flat panel televisions have become much more competitive.
3. General Television had to pay a premium to acquire Micro Engineering. General Television had independent appraisals of the fair value of assets and has determined that about 35 percent of the purchase price should be allocated to goodwill.
Required
Answer the following questions for the risks described in 1, 2, and 3 above.
a. Identify the relevant assertion.
b. Does this assertion represent a significant inherent risk? Explain.
c. How might you respond to this risk in terms of staffing decisions?
d. How might you respond to this risk in terms of the nature of audit tests?
e. How might you respond to this risk in terms of the timing of audit tests?
f. How might you respond to this risk in terms of the extent of audit tests?