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Apply your Research 1. Write a report identifying the types of risk that are found in an audit.

Describe each of these risks. Discuss the methods by which the various risk levels are assessed by the auditor. Finally, describe the interrelationships among these risks. There are several types of audit risk include inherent risk, control risk, detection risk, and audit risk. An inherent risk (IR) is how likely a material misstatement exists due to the inherent limitations of internal controls. (Messier, 2008, p. 71) IR, because it exists independently, are functions of the entity and its environment (Messier, 2008) and therefore little to no control can be done with the auditor. Control risk (CR) is that material misstatement could occur and not be prevented, by internal controls, on a timely basis. Like IR, CR exists independently and the auditor has little to no control over it. (Messier, 2008) Detection Risk (DR) is that the auditor will not be able to detect if a misstatement exists. The auditor can control DR, unlike IR and CR. The auditor, through audit procedures, determines DR. Audit Risk (AR) is the risk that the auditor may unknowingly fail to appropriately modify the opinion on financial statements that are materially misstated. (Messier, 2008) IR and CR, in combination, are referred to as the risk of material misstatement (RMM). The RMM is derived from the decisions made by the client. The clients controls and audit procedures must be understood by the auditor in order to assess the RMM. Together with RMM and DR the AR can be calculated, though not a real number, rather an assessment as to what the AR is.

2. Write a report discussing the auditors use of analytical procedures in conducting an audit. What are the primary analytical procedures that auditors use? Why are analytical procedures necessary on an audit? How do they help an auditor be more efficient and effective? At what stages of an audit are analytical procedures applied? The primary analytical procedures used by auditors are: industry data, similar prior-period data, client-determined expected results, expected results using non-financial information and auditor-determined expected results. Analytical procedures are necessary because they identify such things as the existence of unusual transactions and events, and amounts, ratios and trends that might indicate matters that have financial statement and audit planning ramifications. (AU 329) By using the analytical procedures an auditor can measure liquidity, profitability, and solvency, within a company. With liquidity the auditor is looking to measure a companys ability to pay short-term debt, a companys inventory worth over number of days, an how long it takes a company, on average, to collect form customers. Profitability is the measurement of a companys return on each dollar invested by owners and by the company as well as a measurement of profit of each sale. Solvency measures a companys assets financed by creditors and whether the company can meet interest payments. The analytical procedures are performed both at the beginning, during the planning stage and at the final stage of the audit.

3. Two of the biggest public companies in Lakesides industry (consumer electronics) are Best Buy and Radio Shack. How does Lakeside compare with these companies in terms of liquidity, profitability, and solvency? Best Buy Annual Report: March 03, 2012 (In Millions) Ratio Computation Current Ratio $10,267 = 8,855 Days to Sell Inventory 365 = (38,132 / 5,731) Average Collection 365 = Period (50,705 / 2,288) Debt-to-Total Assets 12,260 = Ratio 16,005 Times Interest Earned (1,231 + 709 + 134) = 134 Profit Margin 1,231 = 38,132 Return on Assets 1,231 = 16,005 Return on Equity 1,231 = 3,745 RadioShack Annual Report: December 30, 2011 Ratio Computation Current Ratio $1,812,800 = 663,600 Days to Sell Inventory 365 = (2,567,200/ 744,400) Average Collection 365 = Period (4,378,000 / 360,600) Debt-to-Total Assets 1,421,800 = Ratio 2,175,100 Times Interest Earned (72,200+ 40,200 + 46,800) = 46,800 Profit Margin 72,200 = 4,378,000 Return on Assets 72,200 = 2,175,100 Return on Equity 72,200 = 753,300

1.156 54.86 days 16.47 days 76.6% 15.48 times 3.2% 7.7% 55.3%

2.732 105.84 days 30.06 days 65.4% 3.4 times 1.6% 3.3% 9.6%

Lakeside Company Annual Report: December 31, 2011 (In Millions) Ratio Computation Current Ratio Days to Sell Inventory Average Collection Period Debt-to-Total Assets Ratio Times Interest Earned Profit Margin Return on Assets Return on Equity $2,762 2,034 365 (-6,870 / 1,892) 365 (10,754 / 548) 2,372 3,186 (244 + -164 + -228) -228 244 10,754 244 3,186 244 924 = = = = = = = = 1.358 100.52 days 18.6 days 74.5% 64.9 times 2.2% 7.7% 26.4%

Lakeside, compared to Best Buy and RadioShack, as per Liquidity does well in the current ratio, falling between the two other companies. Lakeside has much higher days to sell inventory and their average collection period falls between the two companies. Lakesides profitability compared to the other two companies is also good with net profit margin, return on assets, and return on equity all falling between the mix. Lakesides solvency is much higher in the times interest earned ratio but is comparable in the debt-to-total assets.

Sources Messier, W. F., Glover, S. M., & Prawitt, D. F. Auditing & Assurance Services: A Systematic Approach (6th ed.). New York: McGraw-Hill/Irwin.