Describe the risks associated with the audit of Piper under the headings inherent risk, control risk and detection risk and explain the implications of these risks for overall audit risk
You are the audit manager for Piper Ltd, a limited liability company which sells books, CDs,
DVDs and similar items via two divisions: mail order and on-line ordering on the Internet. Piper
is a new audit client. You are commencing the planning of the audit for the year-ended 31 May
2018. An initial meeting with the directors has provided the information below.
The company’s turnover is in excess of $85 million with net profits of $4 million. All profits are
currently earned in the mail order division, although the Internet division is expected to return a
small net profit next year. Turnover is growing at the rate of 20% p.a. Net profit has remained
almost the same for the last four years.
In the next year, the directors plan to expand the range of goods sold through the Internet division
to include toys, garden furniture and fashion clothes. The directors believe that when one product
has been sold on the Internet, then any other product can be as well.
The accounting system to record sales by the mail order division is relatively old. It relies on
extensive manual input to transfer orders received in the post onto Piper’s computer systems.
Recently errors have been known to occur, in the input of orders, and in the invoicing of goods
following dispatch. The directors maintain that the accounting system produces materially correct
figures and they cannot waste time in identifying relatively minor errors. The company accountant,
who is not qualified and was appointed because he is a personal friend of the directors, agrees with
this view.
The directors estimate that their expansion plans will require a bank loan of approximately $30
million, partly to finance the enhanced web site but also to provide
inventory levels. A meeting with the bank has been scheduled for three months after the year end.
The directors expect an unmodified auditor’s report to be signed prior to this time.
Describe the risks associated with the audit of Piper under the headings inherent risk, control
risk and detection risk and explain the implications of these risks for overall audit risk.
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