Pinnacle Case 4

A. Review Part II and identify information that affects your assessment of acceptable audit risk. Note that only some of the situations in Part II will relate to acceptable audit risk. Classify the information based on the three factors that affect acceptable audit risk.
• External users’ reliance on financial statements o There is a large amount of debt for a publically held company, and the financial statements will be used rather extensively. o Situation 6: the board of directors has decided to raise significant amount of debt to finance the construction of the new manufacturing plant for the Solar-Electro division. This would draw more attention in regards to the financial statements.

• Likelihood of financial difficulties o The solar
o Situation 9: several restrictive covenants were identified. Two requirements were to keep the current ratio above the 2.0 and debt to equity below 1.0 at all times. If the current ratio falls that could cause the loans to be called.

• Management integrity o Situation 8: there is a high turnover most notably at the higher level position in the internal audit departments. This turnover may be intentional therefore an increase the risk of fraudulent financial reporting is a must. o Situation 7: the vice president of Pinnacle owns a company that was hired to work at the plant doing repairs. This could result in a conflict of interest against the shareholders. o Situation 10: a conflict with the IRS may point towards a problem with management
Obsolete inventory will have an effect on the valuation of inventory. Account affected would be cost of goods sold and inventory.
3. Related party transaction that could be material to the transaction valuation and needs to be disclosed as a related party transaction. Accounts affected would be equipment.
4. Employees performing work during idle time to save costs is a non-routine transaction that may end in materials, labor and overhead being incorrectly used on accounts. Account affected would be inventory, cost of goods sold.
5. Outstanding receivable, past due for several months that makes up 15% of the outstanding account receivable indicating that there is a collection issue and potential understatement of allowance for doubtful accounts. Account receivables, bad debt expense, allowance for doubtful accounts.
6. No inherent risk
7. The Vice President stating that he and his wife owns the company but hires others to manage it brings up worries of potential related party transaction that may sway the assessment of the transaction and require admission as such. Account affected would be accounts payable
8. Turnover of high level audit personnel may be deliberate and raises the probability of fraudulent financial reporting. The turnover could affect the auditor’s assessment of control risk. Accounts affected are all