This question consists of a number of items pertaining to an auditor’s risk analysis for a company. Your task is to tell how each item affects overall audit risk—that is, the probability of issuing an unmodified audit report on materially misleading financial statements.
Bond, CPA, is considering audit risk at the financial statement level in planning the audit of Toxic Waste Disposal (TWD) Company’s financial statements for the year ended December 31, 2014. TWD is a privately owned company that contracts with municipal governments to remove environmental wastes. Audit risk at the overall financial statement level is influenced by the risk of material misstatements, which may be indicated by a combination of factors related to management, the industry, and the company.
Required:
Based only on the following information, indicate whether each of the following factors (Items 1 through 15) would most likely increase overall audit risk, decrease overall audit risk, or have no effect on overall audit risk. Discuss your reasoning.
Company Profile
1. This was the first year TWD operated at a profit since 2009 because the municipalities received increased federal and state funding for environmental purposes.
2. TWD’s board of directors is controlled by Mead, the majority stockholder, who also acts as the chief executive officer.
3. The internal auditor reports to the controller, and the controller reports to Mead.
4. The accounting department has experienced a high rate of turnover of key personnel.
5. TWD’s bank has a loan officer who meets regularly with TWD’s CEO and controller to monitor TWD’s financial performance.
6. TWD’s employees are paid biweekly.
7. Bond has audited TWD for five years.
Recent Developments
8. During 2014, TWD changed the method of preparing its financial statements from the cash basis to the accrual basis under generally accepted accounting principles.
9. During 2014, TWD sold one-half of its controlling interest in United Equipment Leasing (UEL) Co. TWD retained significant interest in UEL.
10. During 2014, the state dropped litigation led against TWD in 2010 alleging that the company discharged pollutants into state waterways. Loss contingency disclosures that TWD included in prior-years’ financial statements are being removed for the 2013 financial statements.
11. During December 2014, TWD signed a contract to lease disposal equipment from an entity owned by Mead’s parents.
This related-party transaction is not disclosed in TWD’s notes to its 2014 financial statements.
12. During December 2014, TWD completed a barter transaction with a municipality. TWD removed waste from a municipally owned site and acquired title to another contaminated site at below-market price. TWD intends to service this new site in 2015.
13. During December 2014, TWD increased its casualty insurance coverage on several pieces of sophisticated machinery from historical cost to replacement cost.
14. Inquiries about the substantial increase in revenue that TWD recorded in the fourth quarter of 2014 disclosed a new policy. TWD guaranteed several municipalities that it would refund the federal and state funding paid to it if any municipality fails federal or state site cleanup inspection in 2015.
15. An initial public offering of TWD’s stock is planned for late 2015.