Inherent Risk and Materiality
Tasks
• Preliminary Inherent Risk Assessment - Review the description of Southwest Appliances, Inc. and identify four inherent risks based on the information provided. Inherent risks can flow from client's business risks, the nature of its governance structure, and its strategic plans. However, you need to be clear about how your risks create an increased risk of material misstatement in the financial statements and not just how they might create risks of lower performance for the firm.
Thus, for each inherent risk, describe the feature of the firm you believe affects inherent risk and explain how and why. By "how," I mean whether in increases or decreases inherent risk. Make sure your "why" addresses a specific risk to the accuracy of the financial statements and whether audit effort should be increased or decreased for specific accounts or related groups of accounts if possible.
Limit your inherent risk analysis to the verbal information in the case and not the financial statement data.
• Preliminary Analytical Procedures - Review Southwest Appliance's financial statements, ratios, and industrial data presented at the end of the case. Identify four accounts that you believe need additional audit scrutiny and explain why.
• Preliminary Materiality Judgment- Set a preliminary materiality level for the Southwest audit. Document your materiality level and explain why you chose it.
Evaluating Controls
Tasks
•Review the Southwest case to evaluate transaction control weaknesses
1. Describe the control weakness (just a short statement of weakness);
2. Describe how the weakness could create a material error in the financial statements
3. Make a recommendation on how their controls could be improved to mitigate this weakness; and
4. Discuss some potential weaknesses in the control you suggest (e.g., how it might be overridden).
5. Limit your answers to the four most serious weaknesses you find in each process.
•Document your findings in the SW Controls Template.
•Write up an analysis of Southwest's sales and purchasing processes vulnerability to fraud based on your analysis of their control systems.