[Anonymous]

Bestwood Furniture, a nonissuer that procedures wood furniture, is undergoing a year 2 audit. The situations int he table below describe changes Bestwood made during year 2 that may or may not contribute to audit risk. For each situation, double-click in the aossicate dhsaded cell and select from the list provided the impact, if any, that situation has on a specific component of audit risk for the year 2 audit.

1. In year 2, the auditor noted that the company’s newly hired purchasing agent was not obtaining competitive bids for all major purchase requisitions.

impact on component of audit risk: increases control risk

---

How does a purchasing agent not doing well in any way affect control risk?

[pfitz092]

Here is my reasoning for why it increases CR:

The act of “obtaining competitive bids” is a preventative internal control activity that serves to mitigate the risk that vendors are given preferential treatment or that purchasing agents are in some other way not acting in the best interest of the company (e.g., price fixing, collusion, etc). The fact that the current purchasing agent is not obtaining competitive bids (despite the fact that doing so is most likely a required procedure) limits the operating effectiveness of the control. This increases the risk that the control (obtaining competitive bids) will fail to prevent, detect, correct a material misstatement in a timely fashion (i.e., the purchasing agent's actions increase CR).

[Anonymous]

Audit risk is a function of inherent risk, control risk, and detection risk (IR x CR x DR).

DR is under the control of the auditor, whereas IR and CR are not and therefore represent the risk that the financial statements are materially misstated.

Since the failure of a purchasing agent to obtain competitive bids for major purchase requisitions is beyond the control of the auditor, you can easily eliminate DR, leaving IR and CR.

IR addresses the risk that the financial statements are misstated by the characteristics and behaviors of the accounts on the financial statements – for example cash is more inherently risky than a building because it prone to misappropriation or theft whereas no one is going to leave work in the afternoon with a bag full of building tucked away in their jacket. Recording goodwill is going to be riskier than valuation of marketable securities because it is a complex transaction open to subjectivity whereas marketable securities will be less risky because securities that are highly liquid and traded on an active market will have an objective and easily determinable value as of the date of the financial statements.

CR addresses the risk that the financial statements are misstated due to a failure of controls or a weakness in the design of internal controls. A purchasing agent obtaining competitive bids for major purchase requisitions would be a key control over purchasing as it would prevent misappropriation of assets caused by a kickback scheme, so the fact that a newly-hired purchasing agent is not securing competitive bids before making large purchases indicates that there is a failure or weakness in controls. Therefore, RMM is increased specifically due to an increase in CR.

[Author]

Replies