P9-37

a. Based on the information from Part I and Part II of the Pinnacle Manufacturing case one can conclude that engagement risk and acceptable audit risk will be affected.

External users’ reliance on financial statements – In correlation with this factor acceptable audit risk and engagement risk are affected. Regulations management is relying upon the solar-powered division to get an increase in sales. However, this increase in sales may not take effect for at least ten years. External users and shareholders cannot make accurate predictions based on this fact.

Likelihood of financial difficulties – The above example could be used to describe this factor as well; however there are several other examples that could lead to pinnacle financial difficulties. Auto-Electro accounts for 15% of pinnacle’s accounts receivable balance but the balance has been outstanding for several months. This is a concern because the likelihood of bad debts increasing from this account could increase. 15% of accounts receivable balance is material and very well could lead to a financial difficulty.

Management integrity – The pinnacle vice president mentioning that he and his wife own “Todd-Machinery” (which has repairmen working at pinnacle) and they hire people that work for it. Management integrity issues can arise from this fact as well as the issue of related parties.

b. Acceptable audit risk for pinnacle after analyzing facts from parts I and II should be assessed as medium to low. There are a variety of reasons why acceptable audit risk should be at the medium to low level. Pinnacle has shown that it is a risky client. From the examples listed above and the issues with the bad debt expense from part I this can be proven.

c.

Inherent Risk Account(s) Affected1. Uncertainly on solar-powered market Accounts Receivables, Equities 2. Inadequate knowledge from warehouse manager.

Inventory

3. N/A N/A4. Raising debt to finance new manufacturing plant.

Long term Liabilities

5. Related Party Payroll6. Internal audit department turnover at high-level positions.

Affect a variety of accounts as a result of inconsistencies in internal auditing.

7. N/A N/A8. 15% of accounts receivable balance belongs to Auto-Electro

Accounts Receivable

9. Dispute between IRS and Pinnacle Tax accounts10. Intercompany loan from Welburn to Solar-Electro

Accounts Receivable/Payable