Question 1: Risk Assessment. Your task is to tell how each item affects overall audit risk?the probability of giving an unqualified audit report on materially misleading financial statements. Bond, CPA, is considering audit risk at the financial statement level in planning the audit of Toxic Waste Disposal (TWD) Company's financial statements for the year ended December 31, 2004. TWD is a privately owned company that contracts with municipal governments to remove environmental wastes. Audit risk at the overall financial statement level is influenced by the risk of material misstatements, which may be indicated by a combination of factors related to management, the industry, and the company.
Required:
Based only on the information below, indicate whether each of the following factors would most likely increase overall audit risk, decrease overall audit risk, or have no effect on overall audit risk. Discuss your reasoning.
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1. During December 2004, TWD signed a contract to lease disposal equipment from an entity owned by Mead's parents. This related-party transaction is not disclosed in TWD's notes to its 2004 financial statements.
2. During December 2004, TWD completed a barter transaction with a municipality. TWD removed waste from a municipally owned site and acquired title to another contaminated site at below-market price. TWD intends to service this new site in 2005.
3. During December 2004, TWD increased its casualty insurance coverage on several pieces of sophisticated machinery from historical cost to replacement cost.
4. Inquiries about the substantial increase in revenue TWD recorded in the fourth quarter of 2004 disclosed a new policy. TWD guaranteed several municipalities that it would refund the federal and state funding paid to TWD if any municipality fails federal or state site clean-up inspection in 2005.
5. An initial public offering of TWD's stock is planned for late 2005.