Question 1

Inherent risks can be classified according to their nature, suchas “unusual pressure on management” or “account likely to requireadjustments”; and also their level as either a “financial reportlevel inherent risk” or an “assertion level inherent risk”.

Required: Below are listed six situations thatcan give rise to inherent risks. Classify each situation by itsnature and level.

Note: In answering this question please writethe letter that denotes the situation followed by its nature andlevel. For example, if you believe that thesituation A is an example of “Nature of the Entity”, write: A:Nature of the entity; FR level

SITUATIONS
A. Senior management of your client, Black Pty Ltd, can earnsubstantial bonuses if they meet certain revenue targets.

B. This the fourth year that you are auditing Brown Pty Ltd. Inthe past two years you have had to ask Brown to adjust itsprovision for warranty.

C. You are auditing Blue Pty Ltd (Blue). During the year, Blue’sCFO entered into a number of hedging contracts in an attempt tosmooth fluctuations in the costs of imported inventory.

D. Your client, Red Pty Ltd, a leading home builder, hired a newCredit Controller during the year. While this person is highlycredentialed, she has not worked in the building industrybefore.

E. Your client, Green Pty Ltd (Green) sells mobile telephones.Recently, Green’s CFO undertook a comprehensive review ofinventory.