You are a senior auditor on the audit of AC Ltd, a listed company that manufactures heat pumps and refrigeration systems. This is the first time that your audit firm audits the accounts of AC Ltd, and you have received the following information through interviews with managers and employees at AC Ltd.

The heat pump and refrigeration manufacturing market is highly competitive. After experiencing declining overall sales for several years, AC Ltd tried to cut costs but with no success due to the continuous increase in labour cost.

AC Ltd obtained conditional approval for a loan from ABC Bank, subject to meeting profit targets for the financial year currently under audit.

AC Ltd lost a key accounting staff member who they were unable to replace due to the impact of COVID-19. This situation resulted in Deepak Singh, the chief accountant, agreeing to take on more duties and he received a 50 per cent pay rise. Currently, the authorisation of purchase transactions, the recording of those transactions, custody of the assets involving those transactions and lastly, reconciliation of the existing assets for the recorded amount are all performed by Deepak.

Employees and managers disclosed that the CEO had set strict targets for the financial performance and linked these targets to paying the staff bonuses. Interviews suggested that the sales and accounting staff receive about half of their current remuneration from these bonuses.

AC Ltd has an internal audit department that reports directly to the audit committee, which, on behalf of the board of directors, approves the internal audit function’s risk assessment and audit plan and receives reports on the results of internal audit activities.

Based on the information provided:

a) Describe the overall impact on audit risk and the reasons for this.

b) Explain what specific component/s of audit risk would be affected.

c) Identify three possible fraud risk factors and explain why each is a fraud factor.

d) Discuss the extent to which you (the external auditor) can use the work of AC’s internal audit department.

Answer rating: 100% (QA)

a The overall impact of audit risk in the present situation is high because there is a high probability of detection risk due to delegation of all tas... View the full answer