You are performing the audit for Premium PetCare Pty Ltd (PP), who operate a luxury boarding kennel and daycare facility for dogs and cats. PP bill their customers after their pet’s stay, with 30 day payment terms. The Accounts Receivable turnover has slowed in the past year, with the average collection period going from 31.3 days in the previous period to 50.6 days this financial year. PP’s revenues have remained stable over the past 3 years. In the draft financial statements, PP’s interest-bearing liabilities consist solely of an interest-only 10-year bank loan of $400,000 at a fixed interest rate of with 6.17% per annum. Their interest expense for the past financial year is recorded as $30,850 in the draft statements. Upon assessing the design of internal controls for PP, you conclude that there is a fundamental segregation of duties present and that general IT controls are strong. Complete the following statements with the correct answer from the options provided.
The preliminary assessment of the control risk suggests that control risk is likely to be .low/high
Inherent risk is …..is likely to be set higher as control risk is high/is likely to be set lower as control risk is high/ is likely to be set higher as control risk is low/ is not impacted by control risk/is likely to be set lower as control risk is lower
Detection risk is…… is likely to be set higher as control risk is high/is likely to be set lower as control risk is high/ is likely to be set higher as control risk is low/ is not impacted by control risk/is likely to be set lower as control risk is lower
When assessing control risk, auditors consider the effectiveness of a company’s internal controls in preventing and detecting errors or fraud in financial reporting. In this case, the audit has concluded that Premium PetCare Pty Ltd (PP) has a fundamental segregation of duties in place, and their general IT controls are strong. This indicates that the company has implemented robust internal controls to mitigate the risk of errors or fraud in their financial processes. As a result, the preliminary assessment of control risk is likely to be low because the internal controls are expected to be effective in ensuring the accuracy and integrity of financial information.
Inherent Risk: Inherent risk is the risk associated with a financial statement item or transaction before considering the impact of internal controls. It is influenced by factors such as the nature of the business, industry trends, and economic conditions. In this case, the control risk is assessed as low, indicating that the internal controls are effective. When control risk is low, auditors are more likely to set inherent risk lower because the strong internal controls reduce the likelihood of material misstatements. So, the inherent risk is likely to be set lower as control risk is low.
Detection Risk: Detection risk is the risk that auditors will not detect a material misstatement in the financial statements. It is inversely related to the assessments of inherent risk and control risk. When control risk is low, auditors are more confident in the effectiveness of internal controls, and they can set detection risk lower because they rely on these controls to detect errors or fraud. So, detection risk is likely to be set lower as control risk is low.
In summary, the preliminary assessment of control risk for Premium PetCare Pty Ltd is low due to strong internal controls. This assessment leads to a lower setting of inherent risk and detection risk, as the auditors have confidence in the company’s internal controls to ensure the accuracy of financial reporting. This approach aligns with best auditing practices, reducing the overall audit risk and enhancing the reliability of the audit process
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