A client, a multinational technology company, has recently acquired several smaller startups in various countries. During the risk assessment phase, the auditor identifies a significant risk related to the integration of financial reporting systems and consolidation of financial results. Which of the following audit responses would be most appropriate in addressing this significant risk?
- AIncrease reliance on internal controls over revenue recognition at the parent company.
- BPerform extensive testing of consolidation adjustments and intercompany eliminations.
- CEngage a forensic accountant to investigate potential fraud in the acquired entities.
- DIncrease the sample size for substantive testing of cash balances.
Show answer & explanationAnswer & explanation
Correct answer: B. Perform extensive testing of consolidation adjustments and intercompany eliminations.
The significant risk identified relates to the integration of financial reporting systems and consolidation. Therefore, the audit response should directly address these areas, specifically focusing on the accuracy and completeness of consolidation adjustments and intercompany eliminations. This ensures the consolidated financial statements are free from material misstatement.
Why the other options are wrong
- A. Increasing reliance on internal controls over revenue at the parent company does not address the risks arising from the integration of acquired entities' financial systems and consolidation.
- C. While fraud is always a concern, the identified risk is about system integration and consolidation, not specifically fraud in acquired entities.
- D. Increasing sample size for cash balances does not directly address the risk of consolidation and integration issues.
Auditor's Response to Significant Risks
Auditors must design and implement overall responses to address assessed risks of material misstatement at the financial statement level, and design and perform specific audit procedures responsive to assessed risks at the assertion level.
- Responses should be proportionate to the risk.
- Responses can involve changes to the nature, timing, and extent of audit procedures.
- High risks often require more persuasive audit evidence.
Memory trick: Risk Calls for Direct Action and Evidence.