Risk Assessment at Great Gifts, Inc. ✓ Solved

Risk Assessment at Great Gifts, Inc.

Using as reference material your textbook and other written materials posted to the Canvas site, as well as material discussed in lecture and Zoom sessions, please address the following requirements:

  1. Create a bullet point list of risks present at GGI, using a sentence or two to describe the risk factor. After each risk you identify, please briefly note where each risk might be classified according to the components of the engagement risk model.

  2. Based on your identification of risk factors, please assess the overall level of ABR, CBR, and the risk of material misstatement (RMM also known as IR+CR) separately, each on a scale of very low, low, medium, high, and very high. Briefly (as in a couple sentences) explain your assessments.

  3. The facts presented above indicate that management has departed, or plans to depart, from generally accepted accounting principles in a number of situations (each of which is an indicator or evidence of risk). Identify one of those cases (it may also be on your bullet point list of risks above), briefly describe what management is doing wrong, and briefly describe what they should have done instead.

  4. Then identify, for one of the misstated or likely-to-be misstated accounts, one management assertion relating to that account that management is likely misstating.

  5. Briefly, what is the implication of the material weaknesses noted in the purchases and payables process for the integrated audit and the audit report(s)?

  6. Bonus - The previous senior auditor who supervised the interim audit work and testing of controls made an illogical and incorrect decision. Briefly identify that mistake and explain why it was a mistake.

Paper For Above Instructions

1. Risk Factors at Great Gifts, Inc.

  • Management Turnover: The resignation of the CEO and CFO poses a risk as new leadership may not have adequate knowledge of the company's operations. This risk falls under the Category of Engagement Risk (CE) as it might affect overall governance and decision-making processes.

  • New Product Roll-out Delay: The delay in launching the new home décor line can impact revenue. This may be classified under Client Business Risk (CBR) as sales could be adversely affected.

  • Material Control Weaknesses: Identified control weaknesses in the purchasing and payables process can lead to fraudulent activities. This falls under the Audit Risk (AR) as it increases the likelihood of material misstatements.

  • Revenue Recognition Issues: Recognition of $250,000 revenue before product delivery may not conform to GAAP. This is categorized under Engagement Risk (ABR) due to potential legal implications and financial inaccuracies.

  • Bonus Incentives for Executives: Bonuses tied to earnings targets may encourage management to manipulate earnings. This intersects with Client Business Risk (CBR) as it highlights ethical considerations regarding financial reporting.

  • Reduced Allowance for Doubtful Accounts: Lowering the estimate of uncollectible accounts could misstate realizable revenue. This is classified under Audit Risk (AR) as it raises concerns about revenue quality.

  • Inventory Valuation Reversal: Reversing impairment on inventory that may still be obsolete could misstate asset values. This can be analyzed as Engagement Risk (ABR) in terms of financial presentation.

  • Internal Audit Manager Position Vacant: The lack of a dedicated internal audit function can risk financial oversight. This is relevant to both Client Business Risk (CBR) and Audit Risk (AR) since it could lead to unmonitored operations.

  • Labor Relations Issues: Ongoing negotiations with labor may lead to strikes or operational disruptions, affecting financial results. This may be perceived under Client Business Risk (CBR) considering its operational impacts.

  • Implementation of New Software: Problems with the new accounting software might hinder effective financial management. This falls under Audit Risk (AR), as these can lead to inaccuracies in financial reporting.

2. Overall Risk Assessment

The overall level of Audit Business Risk (ABR) for Great Gifts, Inc. is assessed as high due to significant management turnover and control weaknesses, which could lead to serious inaccuracies in the financial statements. Client Business Risk (CBR) is also rated high, stemming from operational delays and aggressive revenue recognition practices that could affect the company’s financial health. The risk of Material Misstatement (RMM) is very high as these issues indicate potential areas where the company may not adhere to GAAP, increasing the likelihood of financial fraud or misrepresentation.

3. Misapplication of GAAP

One significant case of management departing from GAAP is the premature recognition of $250,000 in revenue from future sales to a new customer retail chain. Management recognized revenue based on manufacturing assurances without the products being delivered, violating the revenue recognition principle. Instead, management should have deferred revenue recognition until goods had been delivered, ensuring compliance with GAAP guidelines concerning earned revenue.

4. Misstatement and Management Assertion

The account likely misstatement involves the Accounts Receivable where premature revenue recognition has occurred. The relevant management assertion is "existence," as recognizing revenue before product delivery does not validate that the revenue truly exists at the time of financial reporting.

5. Implications of Material Weaknesses

The material weaknesses in the purchases and payables process imply significant deficiencies in internal controls, affecting the overall integrity of financial reporting. For the integrated audit, these weaknesses necessitate increased scrutiny and a deeper examination of controls, ultimately affecting the reliability of the audit opinion issued. Reports might disclose the need for significant adjustments, which influences stakeholders' perceptions and can result in reputational damage.

6. Mistake in Decision-Making

The previous senior auditor made the mistake of not thoroughly reviewing the implementation and testing of controls within the new accounting software. His decision to proceed without sufficient evaluation of potential control failures was misguided, as it neglected the fundamental auditing principle of assessing risk before concluding on the control environment's effectiveness. This oversight could lead to serious implications regarding the reliability of financial statements.

References

  • Arens, A. A., Elder, R. J., & Beasley, M. S. (2014). Auditing and Assurance Services: An Integrated Approach. Pearson.

  • International Auditing and Assurance Standards Board (IAASB). (2018). International Standards on Auditing. IAASB.

  • American Institute of CPAs (AICPA). (2019). Statements on Auditing Standards. AICPA.

  • Financial Accounting Standards Board (FASB). (2020). Accounting Standards Codification. FASB.

  • Schroeder, R. G., Clark, M. W., & Cathey, J. M. (2019). Financial Accounting Theory and Analysis: Text and Cases. Wiley.

  • Wolk, H. I., & Tearney, M. G. (2015). Accounting Theory: A Conceptual Approach. Cengage Learning.

  • Revsine, L., Collins, D. W., & Johnson, W. B. (2017). Financial Reporting & Analysis. Pearson.

  • Kieso, D. E., Weygandt, J. J., & Warfield, T. D. (2020). Intermediate Accounting. Wiley.

  • Grant Thornton. (2019). Revenue Recognition: Understanding New Standards. Grant Thornton.

  • Deloitte. (2018). Audit Committee Guide: Navigating the Audit Process. Deloitte.