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Toxic Waste Disposal Audit Risk Assessment

3.46 Risk Assessment. This question consists of 15 items pertaining to an auditor's risk analysis for a company. Your task is to tell how each item affects overall audit risk?the probability of giving an unqualified audit report on materially misleading financial statements.

Bond, CPA, is considering audit risk at the financial statement level in planning the audit of Toxic Waste Disposal (TWD) Company's financial statements for the year ended December 31, 2004. TWD is a privately owned company that contracts with municipal governments to remove environmental wastes. Audit risk at the overall financial statement level is influenced by the risk of material misstatements, which may be indicated by a combination of factors related to management, the industry, and the company.

Required:
Based only on the information below, indicate whether each of the following factors (Items 1 through 15) would most likely increase overall audit risk, decrease overall audit risk, or have no effect on overall audit risk. Discuss your reasoning.

Company Profile
1. This was the first year TWD operated at a profit since 2000 because the municipalities received increased federal and state funding for environmental purposes.
2. TWD's board of directors is controlled by Mead, the majority stockholder, who also acts as the chief executive officer.
3. The internal auditor reports to the controller and the controller reports to Mead.
4. The accounting department has experienced a high rate of turnover of key personnel.
5. TWD's bank has a loan officer who meets regularly with TWD's CEO and controller to monitor TWD's financial performance.
6. TWD's employees are paid biweekly.
7. Bond has audited TWD for five years.

Recent Developments
8. During 2004, TWD changed its method of preparing its financial statements from the cash basis to generally accepted accounting principles.
9. During 2004, TWD sold one-half of its controlling interest in United Equipment Leasing
(UEL) Co. TWD retained significant interest in UEL.
10. During 2004, litigation filed against TWD in 1996 alleging that TWD discharged pollutants into state waterways was dropped by the state. Loss contingency disclosures that TWD included in prior years' financial statements are being removed for the 2004 financial statements.
11. During December 2004, TWD signed a contract to lease disposal equipment from an entity owned by Mead's parents. This related-party transaction is not disclosed in TWD's notes to its 2004 financial statements.
12. During December 2004, TWD completed a barter transaction with a municipality. TWD removed waste from a municipally owned site and acquired title to another contaminated site at below-market price. TWD intends to service this new site in 2005.
13. During December 2004, TWD increased its casualty insurance coverage on several pieces of sophisticated machinery from historical cost to replacement cost.
14. Inquiries about the substantial increase in revenue TWD recorded in the fourth quarter of 2004 disclosed a new policy. TWD guaranteed several municipalities that it would refund the federal and state funding paid to TWD if any municipality fails federal or state site clean-up inspection in 2005.
15. An initial public offering of TWD's stock is planned for late 2005.

Using the above information assume that your firm is considering taking on Toxic Waste Disposal Company (TWD) as a client. Considering the 15 items listed, discuss the risks associated with taking on TWD as a client. Be sure to take into account the provisions of SAS 99 and to identify potential fraud areas. Recommend ways to mitigate the risk associated with taking on TWD as a client.

Solution Preview

Company Profile
1. This was the first year TWD operated at a profit since 2000 because the municipalities received increased federal and state funding for environmental purposes.
Increases the audit risk; the terms and conditions of the increased funding have the potential for increasing audit risk.
2. TWD's board of directors is controlled by Mead, the majority stockholder, who also acts as the chief executive officer.
Increases the audit risk; there is a higher level of inherent risk. Mead can use his authority to perpetrate frauds in the company.
3. The internal auditor reports to the controller and the controller reports to Mead.
Increases the audit risk; there is an increase in control risk. Mead can override internal controls in the company.
4. The accounting department has experienced a high rate of turnover of key personnel.
Increases the audit risk; new personnel may not be aware of the transactions that have taken place prior to their appointment. The change in personnel may be the moment when frauds take place. Increases the level of control risk and inherent risk.
5. TWD's bank has a loan officer who meets regularly with TWD's CEO and controller to monitor TWD's financial performance.
Decreases the audit risk; the loan officer will typically evaluate the loan repayment capacity of TWD and this will reduce the inherent risk of the company.
6. TWD's employees are paid biweekly. Increases the audit risk; the repeated payments and the larger number of payments increases the possibility of making misstatements, errors and frauds.
7. Bond has audited TWD for five years. Decrease the audit risk; Bond knows the weak points of TWD financial system and so with his experience he will easily be able to detect material misstatements, errors and frauds.

Recent Developments
8. During 2004, TWD changed its method of preparing its financial statements from the cash basis to generally accepted accounting principles. Decrease audit risks; The GAAP if followed correctly reduce the chances of making material misstatements and errors. The GAAP will ensure that sound principles of accounting are followed and if these principles are followed then material misstatements can be detected with greater ease that what is possible in case of cash accounting.

9. During 2004, TWD sold one-half of its controlling interest in United Equipment Leasing (UEL) Co. TWD retained significant interest in UEL.
Does not effect the audit risk; the size of the holding in a subsidiary does not affect the audit risk in TWD. In case Bond does not audit the accounts of UEL then he can give a disclaimer to that effect in his final audit report.

10. During 2004, litigation filed against TWD in 1996 alleging that TWD discharged pollutants into state waterways was dropped by the state. Loss contingency disclosures that ...

Solution Summary

This solution talks about audit risk assessment in Toxic Waste Disposal Company. It then discusses the company profile and recent developments in the company that increase audit risk. 1800 words.

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