In Part 1 of the case, you performed preliminary analytical procedures for Pinnacle (pp. 257-259).
The purpose of Part II is to identify factors influencing risks and the relationship of risks to
audit evidence.
During the planning phase of the audit, you meet with Pinnacle's management team and perform
other planning activities. You encounter the following situations that you believe may be relevant
to the audit.
1. Your firm has an employee who reads and saves articles about issues that may affect key clients.
You read an article titled, "EPA Regulations Encouraging Solar-Powered Engines Postponed?".
After reading this article, you realize that the regulations management is relying upon to increase
sales of the Solar-Electro division might not go into effect for at least ten yers. A second article
is titled "Stick to Diesel, Pinnacle!". The article claims that although Pinnacle has proven itself
within the diesel engine industry, they lack the knowledge and people necessary to perform well
in the solar powered engine industry.
2. You ask management for a tour of the Solar-Electro facilities. While touring the warehouse, you
notice a section of solar-powered engines that do not look like the ones advertised on Pinnacle's
Web site. You ask the warehouse manager when those items were first manufactured. He
responds by telling you, "I'm not sure. I've been here a year and they were here when I first
arrived."
3. You also observe that new computerized manufacturing equipment has been installed at Solar-
Electro. The machines have been stamped with the words, "Product of Welburn Manufacturing,
Detroit, Michigan."
4. During discussions with the Pinnacle controller, you learn that Pinnacle employees did a
significant amount of the consturction work for a building addition because of employee idle
time and to save costs. The controller stated that the work was carefully coordinated with the
construction company responsible for the addition.
5. While reading the footnotes of the previous year's financial statements, you note that one
customer, Auto-Electro, accounts for nearly 15% of the company's accounts receiveable balance.
You investigate this recieveable and learn the customer has not made any payments for several
months.
6. During a meeting with the facilities director, you learn that the board of directors has decided
to raise a significant amount of debt to finance the construction of a new manufacturing plant for
the Solar-Electro division. The company also plans to make a considerable investment in
modifications to the property on which the plant will be built.
7. While standing in line at a vending machine, you see a Pinnacle vice president wearing a golf
shirt with the words "Todd-Machinery." You are familiar with the company and noticed some of
its repairmen working in the plant earlier. You tell the man that you like his shirt and he responds
by saying "Thank you. My wife and I own the company, but we hire people to manage it."
8. After inquiry of the internal audit team, you realize that there is significant turnover in the
internal audit department. You conclude the turnover is only present at the higher-level positions.
9. While reviewing Pinnacle's long-term debt agreements, you identify several restrictive
covenants. Two requirements are to keep the current ratio about 2.0 and debt-to-equity ratio
below 1.0 at all times.
10. The engagement partner from your CPA firm called today notifying you that Brian Sioux, an
industry specialist and senior tax manager from the firm's Ontario office, will be coming on-site
to Pinnacle's facilities to investigate an ongoing dispute between the Internal Revenue Service
and Pinnacle.
11. A member of your CPA firm, who is currently on-site in Detroit at the Welburn division, calls
you to see how everything is going while you are visiting Solar-Electro in Texas. During your
conversation, he asks you if you know anything about the recent inter-company loan from
Welburn to Solar-Electro.
C. Identify inherent risks for the audit of Pinnacle using the information from Parts I and II. For each inherent risk, identify the accounts and the relevant audit objectives that may be affected. Inherent Risk Account or Accounts Affected Relevant Audit Objectives