Question

You are currently involved in planning for the audit of Curtains & Blinds Ltd (CBL), a national company producing curtains and blinds. The curtain and blind market is highly competitive, and CBL has been experiencing declining sales over the past three years. Cost cutting has proven very difficult, as the cost of materials used in the company’s production lines has increased each year. CBL’s bank has continued to provide CBL with loan facilities; however, it has indicated that it expects to see improved results in the next financial report and has placed a number of quite restrictive covenants in CBL’s lending agreements. Recent articles appearing in the financial press concerning CBL’s expected financial results have been very pessimistic about its likely performance.

Based on the information provided:

(a) What specific component(s) of audit risk would be affected?

(b) Discuss the overall impact on audit risk.

Answer 1

The main risk involved in the particular audit would be, the client will try to improve the profit by hook or crook. Because it is the lending agreement of bank which makes mandatory to earn profits and also it will become difficult to get support from the external sources if the company ceases to earn profit.

By this we can conclude that there will be some behaviour by the Management to overstate the net income so that the company would be surviving. And this would be the main risk for the engagement.