Brandybuck, Brandywine and Brandy, Chartered Accountants (hereafter Brandy), is planning the audit of a newly obtained client, Frodo Ring Corporation (hereafter Frodo/Frodo Ring), for the year ended December 31, 2019. Frodo Ring is regulated by the Office of Weapons Manufacturers as an entity that manufactures swords, spears and other weapons of edged destruction. As a publicly traded company, Frodo’s audited financial statements must be filed with the Two Towers Stock Exchange on time every year or face financial penalties.

There are significant inter-company transactions with Frodo Ring’s parent company in the United States, Shire Conglomerate. From the accounting records, it is clear that without the parent company’s financial support, Frodo’s ability to continue to operate would be in jeopardy. The directors of Shire Conglomerate have been explicit in stating that the parent company will be providing long-term financial support for at least the next five years.

Frodo Ring enjoys a significant share of the weapons market, partly due to its extensive investment in information technologies used in its weapons manufacturing and other key business processes. Its ability to charge lower prices than its key competitors is partly reliant on the support of its parent company which allows Frodo to carry loss making product lines and under-cut competitors. The demand for weapons is dependent on the likelihood of war among the races.

Recent growth into rural markets has led to financial strain on the company’s resources. In the rural areas, the demand for Frodo’s line of premium blades is at best lukewarm with the inability of rural folk to afford the cost of the blades.

Additionally, Frodo Ring expanded its financial investments into speculative markets, seeking to take advantage of the record rises in the capital market of TrumpUSA. It has engaged in the purchase of exotic financial instruments involving the use of hedges and derivatives. In order to properly manage its expanding and dynamic financial portfolio, Frodo Ring has added a mix of several highly experienced accountants and graduates from the University of Technicalities to its financial reporting team. The valuation of these instruments involves the use of estimates by management.

Internal audit, which has direct reporting responsibility to the audit committee, is also actively involved in reviewing key accounting assumptions and estimates on a quarterly basis.

Brandy’s discussions with the predecessor auditor revealed that Frodo Ring has experienced some difficulty in correctly inventory items. This mainly occurs because of the multiple warehouse sites, some of which are owned by other parties. During the year under review, Frodo acquired two more warehouses by outright purchase in Rivendell, a distant rural town.

Brandy plans to use staff experienced in the auditing of weapons makers. The partner review of key accounts will be very extensive.

Required: 

Based on the above, identify eight (8) factors that affect the risk of material mis­statements in the December 31, 2019 financial statements of Frodo Ring Corporation. You are required to clearly indicate whether the factor increases or decreases the risk of material misstatements. Also, identify which audit risk model component is affected by the factor identified. Use a tabular format as outlined below. 

Answer rating: 100% (QA)

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