Question

Consider the following independent situations, all of which apply to audits of entities for the year ending 31 December 20X7:
(i) Slipway Limited, a listed company, has been experiencing declining sales over the last 2 years. Cost cutting has proved difficult due to the high level of imported machinery used in Slipway’s operations and consequently margins have been falling. While the bankers are presently happy to continue providing Slipway with loan facilities, they do expect to see improved results in the next financial report. Articles about Slipway’s expected financial results appearing in recent press reports all had quite a pessimistic tone.
For each of the above independent situations describe the overall impact on audit risk and identify the specific component(s) of audit risk affected.

Answer 1

Overall impact on audit risk

The overall effect is an increase in audit risk. Slipway Limited's current circumstances are ikely to place increasing pressure on the company’s management to produce favourable financial results. This affect inherent risk at the financial report level.

Specific component(s) of audit risk affected.

Audit risk is the function of inherent risk, control risk and detection risk. Detection risk is the risk of failing to detect material misstatement with substantive procedures.  Auditor can therefore set lower materiality level when audit risk is high.