CPA Exam — AUDAssessing Risk and Developing a Planned ResponseHard
A client, a rapidly growing software company, frequently acquires smaller tech start-ups. The auditor notes that the client's accounting department has a high turnover rate and is often understaffed. This situation would most likely lead the auditor to assess control risk as high for which of the following areas?
- ARevenue recognition.
- BCash and cash equivalents.
- CAccounts payable.
- DBusiness combinations and intangible asset valuation.
Show answer & explanationAnswer & explanation
Correct answer: D. Business combinations and intangible asset valuation.
High turnover and understaffing in the accounting department, coupled with frequent and complex business combinations, significantly impair the client's ability to properly account for these transactions, including the valuation of acquired intangible assets. This directly increases control risk in these complex areas.
Why the other options are wrong
- A. Revenue recognition can be complex for software, but the scenario emphasizes 'frequently acquires smaller tech start-ups' and staffing issues, making business combinations a more direct and high-risk area.
- B. While understaffing can affect all areas, the specific context of 'frequent acquisitions' points to a higher risk in business combinations, which are more complex than routine cash transactions.
- C. Accounts payable is generally less complex than business combinations, and while staffing issues can affect it, the scenario's focus on acquisitions makes business combinations a more specific and high-risk area.
Control Risk (Complex Transactions)
Control risk is the risk that a material misstatement will not be prevented or detected by the entity's internal controls on a timely basis.
- High turnover or understaffing weakens controls.
- Complex, non-routine transactions are harder to control.
- Business combinations involve significant judgment and specialized accounting.
Memory trick: Turnover makes 'B'usiness 'C'ombinations a 'CONTROL' mess.