The acceptable audit risk for Pinnacle is low.
External users’ reliance on financial statements:
The information in part one stated that Pinnacle is a medium-sized corporation, meaning the statements are used a moderate amount, as the statements are used more widely the larger a client is. Pinnacle has a large amount of debt, meaning the statements are likely to be used more extensively by creditors compared to if they had less liabilities. They plan to take on more debt too, as finding 4 states that they are going to raise a significant amount of debt to finance the construction of a new manufacturing plant for the Solar-Electro division.
Likelihood of financial difficulties
Liquidity is an issue for Pinnacle. Net income and cash and cash equivalents were highest in 2017, decreased in 2018, and came up slightly in 2019. Pinnacle relies on debt as a means of financing, so this means a greater risk of financial difficulty if the client’s operating success declines. Also, if covenants are not met, loans become immediately due. This is a large risk that could cause extreme financial difficulties in the future. Finding 1 leads us to believe that Pinnacle will have financial difficulties in the solar-powered engine industry due to lack of knowledge to build them and the environmental regulations being postponed. Because the chance of financial loss is high, acceptable audit risk should be reduced.
Lastly, finding 5 states that there is significant turnover of higher-level positions in the internal audit department. This is cause for suspicion of questionable management integrity, which will lower acceptable audit risk. Finding 8 states that there is an ongoing dispute between Pinnacle and the Internal Revenue Service, which will decrease acceptable audit risk as well.
multiple accounts. The significant turnover of high level internal audit employees could increase the risk that there is an issue within the company that spurs the decision of these employees to leave, or necessitates their removal. It is possible that management is removing high level internal audit employees in order to reduce the chance that they identify fraudulent activity. There is also an increased impact on control risk.
For each risk identified in part b., indicate whether you believe the risk represents a significant risk. Explain why it is a significant risk and what test(s) you might perform to address the risk
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