TBS and DRS Flashcards
Preliminary List of Risk of Material Misstatements
Jet boats are manufactured at a Mexico facility. This may pose…
…a financial-statement level risk. Foreign operations add another layer of complexity.
Minimal foreign operations typically involve currency transactions.
An entire facility in a foreign country impacts several pervasive financial statement aspects in various ways (for example, valuation, presentation, and disclosure) as well as adding possible confusion in terms of culture and language.
Editors’ Note: While the scenario is similar to another simulation, the items requiring responses are different. The examiners frequently use the same scenarios with different questions.
Finished goods are sold primarily to independent marine stores throughout the United States. This may pose…
…no unforeseen risk. We need not change our audit plan owing to this circumstance.
Sales to independent parties are considered the norm.
Transactions with related parties would merit additional procedures.
Hydrojet, in its ninth year of operations, has experienced two years of declining jet boat sales after a period of rapid growth.
The overall market demand for jet boats also has declined and many competitors have filed for bankruptcy in recent years. This may pose…
…a financial-statement level risk. Significant changes in the operating and economic environment may reveal previously unknown weaknesses.
A significant decline in sales will have a ripple effect to all areas of operations.
As pressure comes from declining sales, management might be tempted to misstate financial position to ensure continued credit and to support managers’ bonuses.
Sales staff working on commission might be tempted to inflate sales just to maintain the same level of compensation.
Operations personnel might feel increasing pressure to contain costs, resulting in lower quality products or raw materials from questionable sources.
Also, any existing fraud or theft may come to light; for instance, the decline in jet boat sales will make it more difficult for any existing lapping of receivables to continue.
That the overall market demand for jet boats has declined and many competitors have filed for bankruptcy in recent years points to a significant change.
Due to several innovations, the demand for personal watercraft has declined only slightly. This may pose…
…a relevant-assertion level risk. New technology may cause obsolescence in existing inventory.
Innovations may cause obsolescence in existing inventory. The dusty inventory sitting in the fenced facility may be a sign of such obsolescence. The valuation of existing inventory must be considered in light of the presumably diminished demand for craft with the old technology. This risk generally would be limited to inventory valuation assertions.
The valuation of existing inventory must be considered in light of the presumably diminished demand for craft with the old technology. The dusty inventory in the fenced facility may be an indication of obsolescence.
assertions.
To help achieve a 25% increase in sales goal, the CEO has changed the sales staff’s compensation from salaried to commission based. This may pose…
…a relevant-assertion level risk. Sales staff on commission might be motivated to commit fraud that they would not consider on salary.
Sales staff on commission might be motivated to commit fraud that they would not consider on salary. This risk generally would be limited to revenue cycle and payroll accounts.
Sales staff newly working on commission might be tempted to inflate sales just to maintain the same level of compensation.
Unhappy with past sales performance, the CEO plans to terminate relationships with several retail outlets and identify new retail outlets for distribution of its product lines. This may pose…
…a relevant-assertion level risk. New sales outlets introduce new potential for a fraudulent entity to take advantage of Hydrojet, under the guise of a legitimate outlet.
This risk generally would be limited to revenue cycle and commission accounts.
Unless the screening process for new outlets is effective, Hydrojet risks, at best, ending up with sales outlets comparable to the ones it sought to replace, and at worst, ending up with monetary losses and damage to its reputation from association with a fraudulent entity.
Hydrojet’s bank has placed strict new covenants on the company’s renewed line of credit. This may pose…
…a financial-statement level risk. Managers with significant bonus opportunities based on profits might be motivated to commit fraud.
Pressure to keep the line of credit might result in management being tempted to misstate the financial statements. These misstatements could occur anywhere in the financial statements where management would think the misstatements would be undetected.
