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Incorrect Assumptions in Mill’s Audit Case

Certified accountant Baker, despite his prestigious status and professional skills, made several inaccuracies and mistakes during the audit of the financial statements of Mill Company. In assessing the risk of controls, the auditor can use audit data from previous years. However, this time Baker changed his approach to a statistical one, which made it impossible for him to compare the assessments of the magnitude of the risk of controls. Baker wanted to assess the risk of control as low, increasing the deviation from the prescribed control procedure to 20%. It is believed that this should reduce the sample size, but Baker increased the size from 80 to 100. The determinant of his decision was the discovery of the actual population of up to 10,000 shipping documents. However, this increase in the number of items has a negligible impact on the size of the required audit sample (Etemadi & Abdoli, 2018). Thus, an inaccuracy in determining the number of samples in the assessment of controls has been proven. This incorrect assumption increases the risk of controls, predetermined by Baker as low.

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An increase in the risk of controls implies their ineffectiveness or impracticability of their assessment. Baker took a haphazard, non-statistical approach, collecting 25 invoices for the first month of each quarter. He compared the general sample of invoices with shipping documents and found eight deviations. In one of these pairs, the bill differed from the actual one by $ 9, which the auditor considered an insignificant deviation. In this case, there is no information about the auditor’s assessment of materiality and its relative level in other cases of deviations.

The decision to postpone consideration of the risk assessment of control is also an erroneous action. The size of the test sample is essentially directly dependent on this estimate. However, audit activities allow for a low assessment of control risk if the auditor plans to conduct tests of controls to confirm the assessment (Popovici, 2019). However, such tests were not subsequently carried out due to the adoption of low-risk control support by the results obtained.

The auditor set the permissible deviation rate at a sufficiently high level, and the expected deviation rate, on the contrary, was low, which determines the sample size. In this case, it had to be minor, which was correctly chosen by the auditor. However, the estimate of the achieved upper level of variance of 14 percent according to the statistical table is overestimated since, by international standards, it is just below 13% (Sultana et al., 2019). Therefore, when adjusted for the sampling risk, the actual sampling rate is precisely 13%, which is insignificant, but more than the upper rate of variance. This fact does not allow us to make an unambiguous conclusion that the sample maintained a low level of control risk.

In this situation, Baker needed to do more detailed work to find evidence of the effectiveness of control systems to justify the consideration of the risk of control assessment. The auditor should be guided by the complete set of facts affecting the sample size he considered during the audit. The lack of an assessment of materiality casts doubt on the number of deviations that determine further conclusions. Qualitative sample research allows the auditor to make an objective conclusion regarding the effectiveness of the internal control system of the client firm and then apply monetary sampling or conduct quantitative sample research with minimal risk of the auditor’s opinion on the reliability of financial statements. Consequently, Baker’s conclusions look inconsistent and require new checks and evaluations.

References

Etemadi, H., & Abdoli, L. (2018). Audit quality and financial statement fraud. Journal of Financial Accounting Knowledge, 4(4), 23-43.

Popovici, M. (2019). Reflections on risks in fixed assets audit. Ecoforum Journal, 8(1).

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Sultana, N., Singh, H., & Rahman, A. (2019). Experience of audit committee members and audit quality. European Accounting Review, 28(5), 947-975.

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