Assignment #4 Inventory and Purchases Part A − Assessing Audit Risk (Optional Exercises) 1. Memorandum Regarding Assessment of Inherent Risk [Note to instructor. Answers will vary because of the subjective nature of this assessment.] Peach Blossom Cologne Company MEMORANDUM December 31, 2005 Date: January 20, 2010 From: James W. Pritchard, Audit Senior To: Peach Blossom Cologne Company Audit Engagement File Subject: Assessment of Inherent Risk for Inventory Assertions Inherent risk is an assessment of the probability of material misstatement regarding the assertion before consideration of the effectiveness of internal controls. Audit research has indicated that inventory is an account that is susceptible to errors. Misstatements occur frequently because (1) inventory is pilferable, (2) numerous transactions affect the inventory account, and (3) it is often necessary to record transactions that are unusual in nature and require judgment, such as the recognition of obsolete inventory. Due to the susceptibility of inventory to errors, our firm has established a policy that inherent risk for inventory assertions should not be assessed at less than a level designated as “moderate.” Based on my examination of the client’s records and the error we detected in the prior year’s inventory, I would assess inherent risk as “high.” 40
Peach Blossom Cologne Company E-2 Search for Unrecorded Liabilities 1-27-10 12-31-09 AH ============================================================================ Invoice Un-Vo. Date/ recorded No. Vendor Terms Comments Amount ============================================================================ 1-1 1-4-10 December services 1400 X 1-6 A to Z Janitorial 1-6-10 December services 365 X 1765 X Vouched to vendor's invoice and other supporting documents. Represents December service or merchandise. Propose (AJE #4): 830 Utilities expense 1400 832 Miscellaneous expense 365 301 Accounts payable 1765 NOTE: Reviewed all cash vouchers and supporting documents for period January 1, 2010 to January 11, 2010, as well as unmatched invoice and receiver files for period January 1, 2010 to January 11, 2010 No January vouchers represented merchandise or services on or prior to December 31, 2009, except as noted.