Problem:
ABC Tech Company has been growing rapidly and has recently engaged a firm as its auditor. it is actively traded over the counter (OTC) and believes it has outgrown the service capabilities of its previous auditor. However, on contacting the previous auditor it was learned that a dispute led to the firms dismissal. The client wanted to recognize income on contracts for its produced but not shipped. The client believed the contract were firm, and that all the principal revenue-producing activities had been performed. The change in accounting principle would have increased net income 35 per cent during the last year.
ABC Tech Company is 30 per cent owned by John Q, who has a reputation as a turn around artist. John Q brought out the previous owner of ABC Tech (formerly XYZ Industries) three years ago. The company's primary products are in the materials handling business, such as automated conveyors for warehouses and production lines. John Q has increased profits by slashing operating expenses most notably personnel and research and development. In addition, he has outsourced a significant potion of component part production. Approximately 12% of the company product is now obtained from MY Ltd, a privately held company 50% owned by John Q and his brother.
A brief analysis of previous financial statement shows that the sales have been increasing by 20% per year since John Q assumed control. Profitability has increased even more. However, a tour of the plan gives the impression that it is somewhat old and not kept up-to-date. Additionally, a large amount of inventory is sitting near the receiving dock awaiting final disposition.
1. Identify the elements of inherent risk associated with the revenue cycle that the auditor should consider.
2. For each element of inherent risk identified, briefly indicate the audit concern and suggest audit procedures to address the risk.