9-39 (OBJECTIVES 9-5, 9-6, 9-7) Whitehead, CPA, is planning the audit of a newly obtained
client, Henderson Energy Corporation, for the year ended December 31, 2019. Henderson
Energy is regulated by the state utility commission, and because it is a publicly traded
company the audited financial statements must be filed with the Securities and Exchange
Henderson Energy is considerably more profitable than many of its competitors,
largely due to its extensive investment in information technologies used in its energy
distribution and other key business processes. Recent growth into rural markets, however,
has placed some strain on 2019 operations. Additionally, Henderson Energy
expanded its investments into speculative markets and is also making greater use of
derivative and hedging transactions to mitigate some of its investment risks. Because
of the complexities of the underlying accounting associated with these activities,
Henderson Energy added several highly experienced accountants within its financial
reporting team. Internal audit, which has direct reporting responsibility to the audit
committee, is also actively involved in reviewing key accounting assumptions and
estimates on a quarterly basis.
Whitehead’s discussions with the predecessor auditor revealed that the client has experienced
some difficulty in correctly tracking existing property, plant, and equipment
items. This largely involves equipment located at its multiple energy production facilities.
During the recent year, Henderson acquired a regional electric company, which expanded
the number of energy production facilities.
Whitehead plans to staff the audit engagement with several members of the firm who
have experience in auditing energy and public companies. The extent of partner review of
key accounts will be extensive.
Based on the above information, identify factors that affect the risk of material misstatements
in the December 31, 2019, financial statements of Henderson Energy. Indicate
whether the factor increases or decreases the risk of material misstatements. Also, identify
which audit risk model component is affected by the factor. Use the format below:
INTEGRATED CASE APPLICATION—PINNACLE
MANUFACTURING: PART II
9-40 (OBJECTIVES 9-6, 9-7) In Part I of the case, you performed preliminary analytical procedures
for Pinnacle (pp. 267–269). The purpose of Part II is to identify factors influencing
risks and the relationship of risks to audit evidence.
During the planning phase of the audit, you meet with Pinnacle’s management team
and perform other planning activities. You encounter the following situations that you
believe may be relevant to the audit:
key clients. You read an article in the file titled, “EPA Regulations Encouraging
Solar-Powered Engines Postponed?” After reading the article, you realize that the
regulations management is relying upon to increase sales of the Solar-Electro division
might not go into effect for at least 10 years. A second article is titled, “Stick to Diesel,
Pinnacle!” The article claims that although Pinnacle has proven itself within the diesel
engine industry, they lack the knowledge and people necessary to perform well in the
solar-powered engine industry.
that one supplier, Auto-Electro, provides over 20 percent of the raw materials used
by Pinnacle. You investigate Auto-Electro and discovered that the company is considering
entering Chapter 11 bankruptcy proceedings due to continuing cash flow
covenants. Two requirements are to keep the current ratio above 2.0 and debt-to-equity
below 1.0 at all times. The loans become immediately due if the covenants are not met.
decided to raise a significant amount of debt to finance the construction of a new manufacturing
plant for the Solar-Electro division. The company also plans to make a considerable
investment in modifications to the property on which the plant will be built.
in the internal audit department. You conclude the turnover is only present at the
you notice a section of solar-powered engines that do not look like the ones
advertised on Pinnacle’s Web site. You ask the warehouse manager when those items
were first manufactured. He responds, “I’m not sure. I’ve been here a year and they
were here when I first arrived.”
a golf shirt with the words “Todd-Machinery.” You are familiar with the company
and noticed some of its repairmen working in the plant earlier. You tell the man you
like the shirt and he responds by saying, “Thank you. My wife and I own the company,
but we hire people to manage it.”
Sioux, an industry specialist and senior tax manager from the firm’s Ontario office, will
be coming onsite to Pinnacle’s facilities to investigate an ongoing dispute between the
Internal Revenue Service and Pinnacle.
in this assignment and information provided in Part I in Chapter 8 (pp. 267–269).
Justify your response. In making your assessment, include your evaluation of the
company on the three factors that make up acceptable audit risk.
Pinnacle. Indicate whether the situation indicates the following:
sheet account affected
significant risk. Explain why it is a significant risk and what test(s) you might perform
to address the risk.
the risks that you identified as affecting accounts payable, identify the relevant audit
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