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Risk assessment:

You are the in-charge auditor of the audit of the municipality of Sackville, New
Brunswick. The municipality has a budget of about $65 million and has had a balanced
budget of the last three years. There are about ten people in the accounting office and the
rest of the employees are operational, dealing with supervision of roadwork, garbage
collection, and similar matters. Many services are outsourced, minimizing the need for
employees. The municipality has a chief executive officer and a controller, and reports to
the council of elected representatives.
Required
For each of the following situations, state a preliminary conclusion for risk of material
misstatement and assessment of the control risk for the company. Justify your
conclusions. Outline the general audit approach and why it is appropriate. State any
assumptions that are necessary for you to reach your conclusion.
(1) This is the first year that you have been auditing Sackville. There has been
extensive turnover after the recent election. Costs are out of control and it looks
like it may be necessary to raise realty taxes by as much as 15 percent.
This is the first year that I am auditing Sackville, and as such, I will need to gain a
thorough understanding of the client, their internal controls, information technology
environment, and corporate governance environment. Sackville is a small, rural town
sitting close to the border between Nova Scotia and New Brunswick, competing with a
bigger nearby city, Moncton. I assess the inherent risk to be high due to the fact that it is
in a rural location and there is a chance that the municipality might want to overstate
revenues to improve or expand infrastructure and services within the town.
Fraud risk is an important factor to consider during the risk identification process.
Extensive turnover is a red flag that signifies a possibility that fraud may have occurred.
A high turnover of staff could signify a bad management system and that employees are
unsatisfied with their job or compensation or corporate governance individuals. This can
be detrimental to Sackvilles revenues and profit values if educated employees are
constantly joining and leaving the company, as training could take some time. In addition
it states that costs are out of control and as a result, the municipality might need to raise
realty taxes by 15%. I will need to further investigate the reason of why costs are out of
control, and determine whether this is a due to a lack of efficient internal controls system.
Control risk is therefore assessed as high.
Because inherent and control risk are assessed as high, the detection risk is set as
low. There is a better chance of detecting material misstatement through substantive
testing than testing internal controls. The general audit approach I will use is a
predominantly substantive approach to testing. I will not rely too heavily on analytical
procedures and conduct many tests of controls. Instead, I conduct more time consuming
and costly substantive testing of transactions and balances to test managements
assertions.

(2) For four years now, you have been auditing Sackville. The employees are
experienced and any control recommendations that you have suggested have been
discussed, and where feasible, implemented. There is a tiny budget surplus this
year, and it looks as if a balanced budget is in sight again for next year.
However, Sackville is being hit by bad press. It seems that one of the purchasing
agents set up a fictitious company and was billing the municipality for goods that
had not been received. To make it worse, the purchasing agents wife was the
assistant accountant. The chief executive officer and the controller uncovered the
fraud, reported it to the council and investigated the matter fully. The office of
the provincial Auditor General has sent a letter to the controller of Sackville
stating that the municipality has been selected for audit by the provincial Auditor
Generals Office based on a random sample, and the provincial auditors will be
arriving within two weeks of the completion of your audit.
Sackville is not seen by the public in a good light, and this gives an opportunity for the
municipality to take a bath. They will have an incentive to understate revenues to
provide a lower revenue base to increase from in the following years. In addition,
A material misstatement has been detected within the financial statements. This implies
that there is no internal controls system that could detect fictitious sales set up by the
purchasing agents. If there one material misstatement has occurred, there is a higher
possibility that other material misstatements have occurred as well. For that reason, I
cannot rely on the internal controls for detecting material misstatements, and I assess
control risk as high.
Because inherent risk and control risk are set as low, detection risk is set as high. I will
implement a predominantly substantive approach to testing. Since there is a known
material misstatement, it is beneficial to perform close substantive tests of balances and
transactions for billings by the municipality. In addition, because this company has a
related party risk due to the fact that the purchasing agents wife is responsible for
accounting tasks, there is an opportunity to fraud. Other incentives include tied bonuses
to earnings and personal issues (e.g. If they have personal debt obligations). Its
important to identify such related parties to determine whether more controls or securities
need to be implemented in order to eliminate the opportunity of fraud risk. The general
audit approach is to conduct more time consuming and costly substantive testing of
transactions and balances to test management assertions, and to conduct less test of
controls, since there has been a known material misstatement.

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