Reference no: EM132839930

Question - Using all the information provided, explain auditor's response to each risk, in planning the audit of Prancer Construction Co.

1) Prancer Construction Company is a new client to the audit firm.

The audit team may have insufficient knowledge related to the construction field so they will be hard to detect the possible risk of material misstatements from certain transactions.

The possibility that the auditors who do not have related knowledge and expertise in this field may not know how the management recognised the sales transaction which caused them unable to detect the hidden material misstatement include cut-off issues.

2) Prior year financial statements recognise work in progress of $1.8 million, which comprises property construction in progress as well as ongoing maintenance services for finished properties.

There is a risk that the work in progress will be overstated due to the possibility of error in the calculation of percentage of completion for the project.

3) August 20X7 management account recognised $2.1 million inventory of completed properties compared to a balance of $1.4 million in September 20X6.

4) A full year-end inventory count will be undertaken on 30 September at all of eleven building sites where construction is in progress.

It is unlikely that the auditor will be able to attend inventory counts at all locations. This is the risk that inventory is misstated if not all the inventory counts are accurate

5) Five-year building warranty given to the customers to claim for any construction defects. However, the finance director anticipates lower provision than last year since the company has improved its building practices so the quality of the finished properties increased as well.

The risk of a lower amount of provision will be recognised. There is a risk that the provision will be understated.

6) Customers who wish to purchase a property are required to place an order and pay a 5% non refundable deposit prior to the completion of the building.

The deposits or prepayments should not be recognised as revenue unless the performance obligation as per the contracts is satisfied under IFRS 15. The revenue is only recognised when the building is completed or not the revenue will be overstated.

7) The management accounts show the payables payment period was 56 days for August 20X7, compared to 87 days for September 20X6. The finance director anticipates it will get even lower in September 20X7.

There is a risk that the trade payable ledger is misstated. This is because the forecast profit before tax is higher than last year but the finance director has confirmed minimum profit and net assets covenants attached to the overdraft.

This scenario has indicated there is deteriorating in cash so it will be unusual that the trade payable keeps decreasing. Therefore, there is a risk that the trade payables are understated.