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    Toxic Waste Disposal: Audit Risk

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    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.

    Based only on the information below, indicate whether each of the following factors (Items 11 through 15) would most likely increase overall audit risk, decrease overall audit risk, or have no effect on overall audit risk. Discuss your reasoning.


    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.

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    Solution Preview

    Increases the overall audit risk;
    The lease for disposal of equipment from an entity owned by Mead's parent's means that there are possibilities of material misstatements. These may be in relation to the lease value or the actual work done and this will be difficult to verify. This increases the control risk. There is a greater possibility of material misstatement because the related party transaction has not been mentioned in the notes. This raises suspicions about the purpose of the transaction and increases the overall audit risk.


    Solution Summary

    This solution talks about risk assessment in the context of auditing. It also explores how the different actions of Toxic Waste Disposal increases the audit risk.