4.59 Risk Assessment – Suggested Solution – Answers will vary!! 1. Decrease. Ordinarily, the fact that this is the first profitable year after a string of losses would cause concern. The auditor might suspect an overstatement of revenues or understatement of expenses. However, in this situation, the increase in revenues (and net income) appears to be the result of additional federal and state funding for environmental purposes to TWD’s customers, which are municipalities. Given that TWD has a limited number of customers, the year-end receivables (and even revenue) can be confirmed with those municipalities. As such, there would be no increase in audit risk. The decrease in audit risk would result from lessening the company’s need to get through a “difficult period,” that is, the years of losses. 2. Increase. TWD’s board of directors is controlled by its major stockholder who also acts as the company’s CEO. That person may act in his or her best interests rather than in accordance with those of the minority shareholders and other financial statements. The potential for financial statement fraud would increase as a result. As a sidenote, closely held / family ownership in general is considered a big fraud risk. 3. Increase. The internal auditor reports to the Controller, who has responsibility for the company’s accounting system and the preparation of its financial statements. The internal auditor should report to the audit committee so that objectivity is maintained. Because the controller could steer the internal auditor away from problem areas, audit risk would be increased.