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Chapter 14
Case Study
Identify and describe the principal business risks facing Bolington
Where to start! We can categorise the risks by type – this is a useful way of
beginning the risk management strategy process
Classification Risk Implication
Financial risks The company’s turnover
has increased rapidly
over the last three years
Money paid to authors
may not be successful
Daniel wishes to
maintain the share price
The increase in growth
may not be matched by
cash generation leading
to cash flow problems
If the books don’t sell
the advances will not be
recovered resulting in a
loss
There may be a
temptation to adopt
aggressive accounting
policies resulting in a
distortion of the
accounts
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Management risks Daniel is a dominant
personality
There does not appear
to be any system of
corporate governance or
any mention of non –
executive directors
If he is not
counterbalanced by the
opinions of other
directors he may lead to
company to disaster
Daniel may have
freedom to impose his
will on the executive
board who may make
short term decisions
which benefit them
rather more than the
company
Operational risks The IT system is
complex and not
supported
If the IT systems cannot
function the company’s
operations may suffer if
the IT system is used
for book production.
There will be a lack of
management
information if the
financial systems are
not functioning properly
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Currency risk The exchange rate may
become unfavourable This will increase
printing costs putting
pressure on margins
Legal risk The company is being
sued
Combined Code
If the case is lost
damages may have to
be paid and stocks of
books pulped
If the company is listed
it is required to comply
with the Combined
Code- and it probably
doesn’t!
Justify an appropriate audit strategy for the first audit of Bolington
There are three fundamental points which should be developed
a) Systems based auditing may not be appropriate. If the systems are
functioning sufficiently well to record transactions properly – even if the MIS
isn’t working properly – auditing the system will not reveal the full
implications of the problems facing the company
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Suggest some procedures which Bolington could implement
immediately to manage the risks
Risk Actions
Financial risks The company must renegotiate its
borrowings as a matter of urgency to
give it the resources to meet its
obligations
The management information system
must be made functional so that the
management have reliable financial
data, including budgets and forecasts
on which to make decisions
Operational risks The IT system must be made
operational so an IT specialist should
be recruited urgently
The company doesn’t have the
resources for further acquisitions.
The board should be aware that
constant activity in the form of
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The yacht sponsorship should be
capped if the agreement permits
Currency risk Management should work with
bankers to hedge the exchange rate
movement
Legal risk Management should discuss with
lawyers the strength of the case
against the company. If possible
settle the case as cheaply as
possible. Part of this risk may be
insured
What effect might these risks have on the financial statements?
Examination questions
1. FERRY
(a) Top down approach
The term ‘top down’ is therefore used to describe the approach to an audit as
a whole (i.e. as an audit methodology). However, it is also used to describe
the approach to the stages that make up the audit process (e.g. planning,
risk assessment, internal controls, etc).
It means taking a ‘big picture’ approach before tackling the details. For
example:
ŶWhen planning an audit using a top down approach, knowledge of the
business starts at the top with thorough discussions with management and
preliminary analytical procedures on the financial statements (say). From an
in-depth understanding of the client’s business as a whole and then its key
processes, the auditor then focuses on the details of risky transactions and
balances.
Tutorial note: As part (c) is clearly related to the requirement of part (b), it is
appropriate that a ‘tabular’ approach be adopted.
(b) Business risks (c) Processes for managing
Rights to operate
ŶThe rights to operate, which
provide assurance that Ferry is a
ŶAccept at the present level (as one
that has to be borne) but bear in
mind (e.g. when making strategic
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the rights may threaten Ferry’s
operational existence if, for example,
there are any circumstances under
which the rights could be withdrawn.
should be communicated to all staff
so they are clear about the
importance of their areas of
responsibility.
Competition
ŶAlthough at the moment there is
ŶMonitor the progress of plans for
Age of Ro-Ros
ŶThe age of the Ro-Ros (20 years)
ŶAlthough a major refurbishment
Environmental Protection
Regulations
ŶFerry will have to comply with
emissions standards from next year.
Costs must necessarily be incurred to
meet Environmental Protection
Regulations.
ŶTo reduce the risk of disruption to
scheduled crossings and to ensure
that the Ro-Ros are not withdrawn
from use (for non-compliance), Ferry
should:
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Fuel prices
ŶIncreases in fuel prices will reduce
profitability
ŶIncorporation of surcharges into the
price structure so that significant
increases can be passed on to the
customers.
ŶHedging against the effect of
energy price (and exchange rate)
risks through forward contracts.
Weather
ŶWeather conditions may delay or
ŶManage the impact of the
Economy
ŶCurrently 70,000 vehicles a year is
c. 40% capacity (W).
Although capacity has almost doubled
ŶKeep tariffs (i.e. prices) under
review and respond to changes in the
economy and demand patterns. For
ANSWERS TO CASE STUDIES AND EXAMINATION QUESTIONS
Millichamp and Taylor, Auditing, 10th edition
© Cengage Learning 2012
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service levels is likely to result in loss
of customers, revenue and goodwill.
crossings are on time, against a
comparable Ro-Ro ferry service
providers.
Loss of subsidy
ŶFerry may be financially dependent
on the subsidy which it receives. If
information in the quarterly returns is
not submitted on a timely basis, cash
ŶFerry’s information system must
have internal controls necessary to
provide accurate and timely
information on the number of
vehicles carried.
Passenger safety
ŶAlthough passenger safety is of
paramount importance, associated
costs are likely to be onerous.
ŶCosts of providing a safe service
should be reflected in the prices
charged (e.g. including an insurance
premium).
ŶFerry should disclaim liability where
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Crew safety
ŶFerry will have difficulty recruiting
and maintaining the services of
ŶWork rosters should ensure, for
example, that:
Disaster
ŶA serious accident (e.g. fire),
collision or breakdown may threaten
ŶExternal consultants could be
engaged to develop a model to
simulate unwanted outcomes (e.g.
Safety management
ŶThe application for a safety
management certificate will be turned
down if there is insufficient
information to support Ferry’s
conformity to documented
ŶFerry must have documented
procedures. Adherence to them must
be monitored (e.g. through captain’s
logs) and their effectiveness reported
to management.
WORKING
2 boats x 40 vehicles x 6 crossings per day x 365 days = c. 175,000 vehicles.
Therefore 70,000 represents 40% capacity.
(ACCA)
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2(a) Internal controls
Tutorial note: Remember that not all controls are preventive. Some should
detect (so as to correct) things that have ‘gone wrong’.
(i) Lack of investment
ŶMonthly review and monitoring of:
– admission fees;
ŶApproval of annual budgets which plan for adequate investment to attract
visitors.
ŶMonthly comparison of actual expenditure on new exhibits and breeding
programs against budget – to see the extent to which the expected level of
investment in development is being made.
(ii) Incomplete data transfer
identified, reason for occurrence, amounts involved, how rectified.
(iii) Non-charges
ŶMonitoring of sponsorship income generated (i.e. actual) to that available
(e.g. projected), by class of animal, and investigation of shortfalls.
ŶComparison of BZG’s advertising expenditure against budget (to identify
potential for unrecorded costs).
(iv) Misappropriated cash
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ŶAll cash received from visitors should be counted and recorded and a
receipt given.
ŶCash and a copy of the receipts should be transferred, securely, to
cashiers.
ŶThe existence of CCTV at the kiosks should be made evident, to act as a
deterrent.
(v) Systems not available
ŶBack up/recovery/contingency plans must be in place to ensure that BZG
can take bookings and issue tickets even when the electronic system is not
available.
(vi) Unrecorded donations
ŶPeriodic inspection of animals and comparison with book records (e.g. fixed
asset register for larger species and inventory records for smaller species).
ŶComparing new animals identified by veterinary records to additions to
inventory records (or asset register).
(b) Financial statement risks
Tutorial note: The numbering in this answer corresponds to the applicable
risks in the question.
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(i) A going concern (‘failure’) risk arises from lack of investment. Any
significant doubts about going concern must be suitably disclosed in the
notes to the financial statements. Disclosure risk arises if the requirements of
IAS 1 ‘Presentation of Financial Statements’ are not met.
(i) A reduction in admission income may result in asset impairment. BZG’s
management should perform impairment tests on the carrying amount of the
larger exhibits, in accordance with IAS 36 ‘Impairment of Assets’.
ŶIncome may be materially understated due to:
(ii) incomplete data transfer resulting in invoices not being raised;
(iii) unrecorded sponsorships arising from advertising arrangements.
(v) There may be no financial statement risk. For example, if BZG were to
admit people for free there would be no admission fees to be recorded for
that day. Alternatively, in the absence of an adequate back up system, the
risk of unrecorded cash/income identified in (iv) may be exacerbated.
(vi) Assets (and reserves) will be understated if donated animals are not
initially recognised at fair value (IAS 16 ‘Property, Plant and Equipment’).
(c) Substantive analytical procedures – factors to be considered
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ŶNature of entity – BZG’s income will be seasonal, with more visitors in fine
weather, at weekends, during school holidays and on national holidays. The
relationship between income and weather/dates will provide a basis for
making comparisons year-on-year.
ŶThe greater the degree of disaggregation of information, the greater the
extent and reliance on substantive analytical procedures. For example,
sponsorship income will be clearly distinguished from ticket income. Also,
income from sales of food and retail will be separately identifiable from
admissions.
admittance.
ŶRelevance of information – budgets will be more reliable if based on
realistic rather than ideal targets (e.g. achieving 70% rather than 100%
sponsorship).
ŶSource of information available – for verification of completeness of
recorded sponsorship income there will be non financial records of the
animals. External sources of information might include weather reports and
local newspaper reports of major donations, sponsorships, etc.
ŶComparability of information – as the nature of the BZG is quite specialised
there may be no broad industry data available. Therefore most of the
comparisons will be with prior period information.
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ŶAccuracy of predictions – food and retail sales are likely to have established
margins – therefore the completeness of recorded income from these sources
may be predicted more accurately than sponsorships (say) where there are
no directly attributable costs to be verified.
ŶInherent and control risk assessments – as much of the income is cash,
inherent risk is assessed as high. However, if controls over the issue of
tickets are strong, more reliance may be placed on analytical procedures
than if control risk in this area was assessed as high.