Assume that you are the new audit senior on the LV Drug Corporation (LVD) engagement. LVD is a pharmaceutical company that has three successful drugs and a number of drugs in progress in its research and development pipeline. You are considering your audit plan and it is important to identify the inherent risks that LVD has and how they relate to the planning process.
Required:
For each of the following factors, indicate whether it will tend to increase, decrease, or have no effect on inherent risk, and the reasoning for your answer.
a. Dr. Jones is the major shareholder of LVD and its CEO.
b. Your firm has audited LVD for the last four years.
c. There has been high turnover of key accounting personnel during the last two years.
d. The internal audit function reports to the audit committee.
e. LVD has been the subject of lawsuits by users of Framadon who claim that the drug affects their liver functions. LVD is confident that there are no such side effects from the use of Framadon
a. Increase: The CEO, as the major shareholder, has additional incentive to "manage" earnings.
b. No effect: The history that the auditor has with the entity has no effect on the inherent risks of the business. However, the auditor will be able to use his past experience in designing tests that are efficient and effective.
c. Increase: The turnover in personnel may indicate issues in the management of the company. At a minimum, the fact that many key personnel are new and do not know the company well will increase risk.
d. No effect: The reporting structure of the internal audit group is a control system issue, not an inherent risk factor.
e. Increase: The mere presence of an ongoing lawsuit presents increased business/inherent risk, even if the company is confident that it will prevail.
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