Question

Niagara Dairy is a boutique cheese maker based in the Niagara region of Ontario. Over the years, the business has grown by supplying local retailers and, eventually, by exporting cheese products. In addition, there is a "farm-gate" shop and café located next to the main processing plant in Niagara-on-the-Lake, which serves tourists who also visit other specialist food and wine businesses in the region. Quality control over the cheese manufacturing process and storage of raw materials and finished products at Niagara Dairy is extremely high. The company is committed to high quality control because poor food-handling practices could cause a drop in cheese quality or contamination of cheese products, which would ruin the business very quickly.

The export arm has been built up to become the largest revenue earner for the business by the younger of the two brothers who have run Niagara Dairy since it was established. Jim Bannock has a natural flair for sales and marketing but is not as good at completing the associated detailed paperwork. Some of the export deals have been poorly documented, and Jim often agrees to different prices for different clients without consulting his older brother, Bob, or informing the sales department. Consequently, there are often disputes about invoices, and Jim makes frequent adjustments to accounts receivable using credit notes when clients complain about their statements. Jim sometimes falls behind in responding to customer complaints because he is very busy juggling the demands of making export sales and running his other business, Café Consulting, which provides contract staff for the café business at Niagara Dairy.
Required Identify the factors that would affect the preliminary assessment of inherent risk and control risk at Niagara Dairy. Explain how these factors would influence your choice between a substantive strategy and the combined audit strategy for sales, inventory, and accounts receivable.

Answer 1

Inherent and control risks at Niagara Dairy are affected by poor documentation, variable pricing, and oversight issues, leading auditors to potentially prefer a substantive audit strategy. This approach focuses on verifying transaction and account details due to low control reliability.

Step-by-step explanation:

The factors that would affect the preliminary assessment of inherent risk and control risk at Niagara Dairy include the complexity of transactions, Jim's informal approach to documentation and pricing, and high dependence on the export business. For instance, poor documentation and informal pricing strategies elevate the inherent risk of inaccuracies in financial statements. Moreover, the lack of oversight from Jim's brother, Bob, and the sales department increase control risks as there may be inadequate controls over the agreement of transaction terms and subsequent invoicing.

Given the high inherent and control risks, an auditor might lean towards a substantive audit approach, focusing on detailed tests of transactions and account balances. This is because a substantive strategy would allow the auditor to independently verify the existence, accuracy, and completeness of the sales, inventory, and accounts receivable records due to the low reliability in the company's internal controls.