The audit risk model has become the commonly used basis for audit planning. The following are independent situations that could have an effect on various components of the audit risk model.
For each situation, identify the element(s) of the audit risk model (that is, audit risk, inherent risk, control risk, and detection risk) that is (are) most likely to be directly affected and the nature of the change in risk levels (increase or decrease) relative to a typical audit. Explain your reasoning in detail.
a. A company provides all customers with the option to return unused goods within two weeks of the purchase.
b. In the current year, the company began performing credit checks for all new customers. The customers' credit ratings were used to determine credit limits for the customers.
c. A client's sales team is primarily compensated on a commission basis. Commissions are determined on a percentage-of-sales basis.
d. All cheques greater than a pre-determined limit require the signature of the controller and the chief financial officer.
e. In order to raise capital, in the current year the owner-manager of a business sold 20% of the common shares to a private-equity investor. The owner will remain actively involved in the business. The private-equity investor will not actively partake in the daily management of the business.
f. An auditor tests a control and observes several compliance deviations.
g. In the past two prior-year audits, the auditor has identified several material overstatements in inventory.