Page 1 of 6Question 1 Suggested Solution The factors that most likely would increase the risk of material misstatements are: Interest rates have been volatile recently (inherent risk). The principal shareholder is also the chief executive officer and controls the board of directors (weakness in control environment –control risk). Branch management iscompensated based on branch profitability (unusual pressure on management providing incentives for management to misstate financial reports –inherent risk). Management fails to establish proper procedures to provide reasonable assurance of reliable accounting estimates (Accounting estimates are more likely to be misstated than routine factual data and require a greater degree of judgement –inherent risk; constant underestimation of the allowance for loan losses questions control consciousness of management (control environment) –control risk). HS recently opened a new branch office that is not yet profitable (unusual pressure on management providing incentives for management to misstate financial reports –inherent risk). HS recently installed a new sophisticated computer system (increases risk during break-in or debugging period) (significant changes in IT may increase inherent risk since errors may occur through incorrect conversion of a new system or because information in the system may be unacceptable to the new system; there may also be greater chances of material misstatement since staff may not be adequately trained in the new system and/or controls built in the system may not be working adequately increasing control risk).The factors that most likely would decrease the risk of material misstatements are: Government regulation over the finance sector is extensive. HS operates profitably in a growing prosperous area. Overall demand for the industry’s product is high.The availability of funds for additional mortgages is promising. The internal auditor reports directly to the chairman of the board’s audit committee, a minority shareholder. The accounting department has experienced little turnover inpersonnel recently. HS is a continuing audit client. Management has been receptive to Audrey’s suggestions relating to accounting adjustments.
Page 2 of 6Question 2 Suggested Solution (a) Business risks are threats that the organization faces in attempting to achieve its goals. In this case, there are a couple of main business risks to HealthyGlow, both are in relation to the purchase of the new full-body scanning machines. - Studies that have shown the potential side-effects of the new machines is a concern, which is a risk in the longer term. In the short term, the bad publicity is a risk although it appears to have had little effect on the level of bookings.