[Anonymous]

Which of the following characteristics most likely would heighten an auditor’s concern about the risk of material misstatements in an entity’s financial statements?

A. The entity’s industry is experiencing declining customer demand.

B. Employees who handle cash receipts are not bonded.

C. Bank reconciliations usually include in-transit deposits.

D. Equipment is often sold at a loss before being fully depreciated.

A. Inherent risk includes the environmental risk in which a client operates. The higher the level of inherent risk, the more likely that a client’s overall financial statements are materially misstated. If a client operates in an industry experiencing a decline in customer demand, the results are probably more pervasive and more likely to affect the overall financial statement presentation than the other items.

---

How does being in an industry that is experiencing declining customer demand make it “more pervasive and more likely to affect the overall financial statement presentation”?

[Anonymous]

If the company is experiencing declining customer demand, the officers have more pressure to act unethically to make their financials look better. The more pressure on the officers, the more risk that they will cook the books.

[J.kms]

The components of the Risk of Material Misstatement (RMM) are Inherent risk and Control risk. When the industry in which the entity operates is experiencing a decline in customer demand, this increases the inherent risk and thus RMM.

FROM BECKER:

“Inherent Risk- susceptibility of a relevant assertion to a material misstatement, assuming there are no related controls.

-Assertions involving high volume trans, complex calculations, amounts derived from estimates and cash have relatively higher inherent risk.

-Other factors specific to the entity and its environment may also tend to increase inherent risk, such as technological developments that render a product obsolete, a lack of working capital, or a decline in the overall industry or economy”

AUD: 99 (11/26/2014)
BEC: 1/5/2015
REG: 2/27/2015
FAR: 5/18/2015

Using Becker Review, but will add Ninja MCQ for FAR&REG.

[Author]

Replies