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Case:

You are a senior auditor of the accounting firm AMC Partners. Your audit team is currently planning the 2019 audit of Mung Limited, a listed company that buys and sells home and office furniture. This is the third year your accounting firm is engaged to perform the audit for this client. The financial year being audited ends on 30th June 2019. Past audit work and initial audit inquiries this year have revealed the following information:

Mung Limited hired a new Chief Executive Officer (CEO) in 2016, and the companys sales and profit grew at an average rate of about 6% between 2016 and 2018. The board of directors was satisfied with the companys profit and share price performance, and rewarded the CEO with an annual cash bonus each year when profit growth exceeded 5%. The CEO is keen to maintain the good performance and started a plan to open 15 new stores around the country between 2019 and 2020. To raise the money required for the expansion plan, the company borrowed $7 million in September 2018 from a local bank. The debt contract requires the audit clients interest coverage ratio to be above 10, and the debt to assets ratio is required to be below 60%.

The bank loan is not sufficient to cover all costs for the expansion plan, so the company is also planning to make a major public share issue in January 2020. To obtain the best share price possible, it is important for the company to show a strong and healthy financial report. The CEO e-mailed all employees in April 2019 to encourage all staff to focus on increasing revenues and cutting costs. A special bonus would be paid to all staff if the companys profit growth reached 5% for the 2019 financial year.

The auditor noted last year that inventory turnover slowed down in 2018. One of the reasons is because the companys main competitors also opened new stores close to the audit clients stores. In addition, the companys sales staff said some of the furniture that was trendy during 2016 and 2017 have become less popular with customers. The companys competitors have started to mark down the selling prices of such furniture since the end of 2018. The audit client has not held a clearance sale for older inventories yet.

The audit client uses a perpetual inventory system. The accounting department is separate from other operating departments. Only the accounting staff has access to the accounting system. The CEO does not have direct access to the accounting records. The CEO needs to consult with the chief accountant about any proposed changes to the accounting records. If the chief accountant agrees that an adjustment is appropriate, the chief accountant would then make the change in the computer system.

The computer systems for sales, inventory management and accounting are integrated. However, access to different systems is restricted to authorised staff via individual passwords so that only sales staff has access to the sales computer system, and only accounting staff has access to the accounting system, etc. Authorisation of transactions is also performed via individual passwords.

When customers make an order in store, sales staff enters the details for a sales invoice into the sales computer system. The sales system then sends the details of the sales invoice to the inventory management system. The warehouse staff uses this information to prepare delivery documents. Customers are required to sign a paper copy of the delivery document upon receipt of the furniture. Sales invoices and delivery documents are serially numbered. The original copy of the customer-signed delivery document is then sent to the accounting department while the warehouse staff keeps a duplicate copy of the document. At the end of each day, the warehouse manager gives authorisation in the inventory management system to process sales transactions for which delivery has been made. The system then updates the perpetual inventory records and sends the sales transactions to the accounting system. The accounting staff checks the online sales invoices, but do not verify these against the signed delivery documents, before giving authorisation for the accounting system to record the sales in the accounting records. A junior accounting staff member is required to regularly check recent sales transactions to see whether there are duplicate or missing sales invoice numbers, and whether each sales transaction has both a sales invoice number and a delivery document number. This staff member admitted that she only checks occasionally however because the system is so reliable and has been used by the firm for numerous years.

The chief accountant was hired by the CEO three years ago and they are close friends. The chief accountant keeps the CEO updated about the companys financial progress and discusses major accounting issues with the CEO. However, they both say that the CEO does not attempt to override the chief accountants professional judgment. Both the CEO and chief accountant are very friendly to the auditors and the directors. These managers have a good relationship with the board of directors.

Required :

Assess the inherent risk of the audit client by discussing the factors that will increase or decrease inherent risk. In your answer you should conclude with an assessment of the level of inherent risk (High/medium/low)