Business Case Study: Plastim Manufacturing

Question 1

(a) Simon Lee As the client didn’t do any adjustment before, the conclusion of there is inherent risk is not valid. Inherent risk is the susceptibility of an assertion to material misstatement, assuming no related internal control.

For Simon Lee, the auditor of Cole Foods Limited, he should appraise the business environment of his client. Since there will be change of business environment, inherent risk may appear. Besides, he should figure out the business process which the client is applying now. He needs to know the engagement in the future because there will be some change in the business process.

Amy Chan

According to Amy, she make a conclusion that the AOP Electronics has no control risks.
Since internal control
The auditor, Sam Wong, is not totally understanding the operation of Plastim Manufacturing. Before applying the audit procedure, it is essential for an auditor to have a well understanding of the client and the industry. Auditors should make a review on the annual reports and financial statements in the past year in order to make an understanding of the entity.

(b) There are two significant risks that auditors should be aware of, control risk and detection risk.

Control risk is the risk that material misstatements will not be prevented or detected by internal controls.

Detection risk is the risk that the auditor will not detect a material misstatement that exists in the financial statements even after performing the necessary audit procedures.
Question 2

(a) This view is correct. According to COSO framework, internal control is broadly defined as a process, effected by a company’s Board of Directors, management and other personnel, designed to provide reasonable assurance regarding the achievement of objectives in the following categories. Therefore, according to S123(6) of the Companies Ordinance, they are also responsible for establishing internal controls to ensure the financial statements are prepared in accordance with selected generally accepted accounting
An auditor is required to understand the major types of activities that the entity uses to monitor internal control over financial reporting, and correct the problems when the entity is applying the internal control. Therefore, the auditor should understand the five components of internal control in order to plan the audit. This knowledge is used to identify types of potential misstatements, consider factors that affect the risk of material misstatement, design tests of control and design substantive procedures.

(c) This view is correct. An auditor should conduct substantive test procedures if the auditor has give a statement that the internal controls exists. this substantive test procedure can help to check if material misstatement is existing because of fraud or error.

(d) This statement is incorrect. The bank statement or suppliers’ statements are provided by external party while bank reconciliations or depreciation schedules are prepared by the client. This shows that the evidence are provided separately by external and internal party. Since evidence of internal party are less reliable than those from external party, the statement that “both evidence have equally reliable” are wrong.

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