1. The audit of Herb’s Hotdogs does pose some engagement risk but not as much risk as a larger, publicly held corporation. The way Herb is required to calculate his rent — and given Herb’s small operations— TLZ Co. may attempt to hold the auditors accountable for missing any material misstatements. Moreover, engagement risk lies, contingently, in the integrity of Herb. Since Herb is required to have an audit, this typically implies a slightly higher level of engagement risk opposed to a firm that is not required to have an audit.
The engagement risk associated with the audit of Herb’s sales is high. Although Herb’s is not a public company and the only outside user of the statements is TLZ Co., the sales audit cannot be classified as having low engagement risk. The fact that this is a first-time audit or review increases the engagement risk. In most firms, a first-time audit or review automatically links an engagement with a high level of risk. 2. The inherent risks associated with Herb’s Hotdogs are: * Errors that could cause over/understated sales and cash: customers paying for the wrong order, employees charging an incorrect price for an order, mis-keyed entries on the cash register, employees ringing up the wrong order, incorrect change is given * Misappropriated assets that could affect sales: employees failing to record sales and pocketing the cash, employees ringing up less than the total sale and pocketing the difference, employees stealing/eating food and not recording the sale or under-recording the sale, employees stealing cash after the sale (multiple employees are using the same till) * Fraud: Herb has the opportunity (no segregation of duties) and incentive (rent increases as sales increase) to underreport sales and pocket the cash 3. The following table provides an analysis of control risks associated with the audit of Herb’s Hotdogs. Controls (C)
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