In Class #4.1 – Assessing Inherent Risk & Assessing ...

In Class #4.1 – Assessing Inherent Risk & Assessing Preliminary Materiality Securimax Limited (Securimax) has been an audit client for KFP Partners (KFP) for the past 15 years. Securimax is based in Waterloo, where it manufactures high-tech armour-plated personnel carriers. Securimax often has to go through a competitive market tender process to win large government contracts. Its main product, the small but powerful Terrain Master, is highly specialized and Securimax only does business with nations that have a recognized, democratically elected government. Securimax maintains a highly secure environment, given the sensitive and confidential nature of its vehicle designs and its clients. In September 2011, Securimax installed an off-the-shelf costing system to support the hghly sophisticated and cost-sensitive nature of its product designs. The new system replaced a system that had been developed in-house, as the old system could no longer keep up with the complex and detailed manufacturing costing process that provides tender costings. The old system also had difficulty with the company’s broader reporting requirements. The manufacturing costing system uses all of the manufacturing unit inputs to calculate and produce a database of all product costs and recommended sales prices. It also integrates with the general ledger each time there are product inventory movements such as purchases, sales wastage, and damaged stock losses. Securimax’s end of financial year is December 31. Required #1: Based on the background information, what are the major inherent risks in the Securimax audit? Consider both industry and entity risks in your answer. Industry level: - defence - high sensitivity of product information, customer information - Risk of selling to allies which later become enemies, or on-sale of products to others - competitive market tendering to win government contracts Entity level: - high reliance on one product, specialized nature of product and reliance on export customers creates risk to revenue stream - pricing of sophisticated product designed to meet customer specifications - adequate security over designs, customer details – effect on personnel (e.g. security clearances required?), inventory management (secrecy over product components?), etc - new inventory costing system, replacing in-house system – does new system provide comparable information, has it been tested, integration with other client systems - sophisticated nature of product design and costing information, questions about standard costing, inventory movements - adequate documentation for tendering

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sufficient accountability of waste – is any waste controlled substances e.g., dangerous chemicals used? How are damaged items and wastes disposed of?

Required 2: As preliminary materiality is based on user needs, discuss the factors to consider when determining preliminary materiality for Securimax. 1. Management – Management uses the financial statements to determine if the business is profitable. They also assess business performance and identify areas where there is room for improvement. 2. Government- The government will want to see the financial statements to ensure the entity is a going concern and has the financial strength to support the project Securimax is bidding on. As this is a for-profit entity and both financial statement users are interested in assessing profitability, the most appropriate base for materiality is net income before tax.