Justin Company, a medium-size manufacturing client located in the Southwest, produces supplies for the automobile industry. The company is publicly traded on the American Stock Exchange. Joann Sielig took over as chief executive officer three years ago after a successful career working with a New York investment-banking firm. The company had been earning minimal returns, and Sielig is intent on turning the company around. She has analyzed the situation and determined that the company's main manufacturing arm could be treated as a cash cow. In other words, although the operations do not generate a lot of profit, they do generate cash flow that could be used for investment purposes. After analyzing the situations, Sielig has decided that the best opportunities for superior returns lie in investments in high-risk marketable securities. When questioned on this strategy during a board meeting, she cited the finance literature that she asserted shows that greater returns are consistent only with greater risk. However, the risk can be minimized by appropriately diversifying the investment portfolio. Given Sielig's knowledge of the subject and quick grasp of the company's situation, the board gave her complete control over all aspects of management. She personally manages the investment portfolio. Moreover, the board was so impressed with her analysis that she was given an incentive pay contract with an annual bonus based on a percentage of profits in excess of the previous year's profits. In addition, she received stock options.

The company has an internal audit department that reports directly to the CEO (Sielig). Although an audit committee exists, it exists more in form than substance and meets with the director of internal audit only occasionally. The audit program for the year is determined by the director of internal audit in conjunction with Sielig and is strongly influenced by two factors: (1) Sielig's perception of areas needing review and (2) areas of potential cost savings.

Sielig has let it be known that all units of the company must justify their existence, and if the internal audit department expected future budget increases, it must generate recommended cost savings in excess of the current internal audit budget. Your CPA firm audits Justin Company. During the preliminary planning for the audit, you note the following:

1. The investment account has grown from approximately 7% of total assets to approximately 30% of total assets.

2. The investment portfolio includes some long-term investments in company stocks; however, many of the stocks held in the portfolio are high risk stocks (with hopes of greater returns).

3. The remainder of the investment portfolio consists of a wide variety of financial instruments including junk bonds, collateralized mortgages, and so forth.

4. Broker fees have increased dramatically. There is also a new line item for investment consulting fees. It appears that most of these fees are to a company that might be somehow related to Sielig.

5. Most of the securities are held by the brokerage firm, but a few are held by the investment consulting company, and a few others are held directly by the company.

6. The company has shown a 25% increase in reported net income over the past year.

7. The company's stock value has appreciated more than 20% during the past year.

Required

a. Identify the elements of inherent risk and control risk in the preceding scenario that should be considered in planning the audit. For the control environment issues identified, briefly indicate the potential audit implication.

b. Outline an audit program that could be utilized for auditing the marketable securities account for the current year.

c. Given only the information presented in the scenario, identify the specific factors the auditor would evaluate in formulating an opinion on the required public reporting of internal control over financial reporting.