Risk Assessment for Australian Heart Rhythms Limited (AHRL)

Background

You are an Audit Senior on the audit engagement of Australian Heart Rhythms Limited (AHRL) for the financial year ending 30 June 2021. AHRL specialises in the design and manufacture of cardiac pacemakers and invests more than two and a half times the industry average in research and development. While undertaking audit planning procedures you become aware of the following:

AHRL has been developing its latest cardiac pacemaker, the W4D, for a number of years. AHRL has invested heavily in research and development of the W4D and has capitalised a significant amount in relation to the development phase of the product. Market studies and prototypes of the W4D have proved successful for bringing it to the market. In July 2020, AHRL acquired two technologically advanced machines specifically designed for manufacturing the W4D, at a cost of $25 million each. Production and sales of the W4D cardiac pacemakers commenced in October 2020, and demand for the product has been extremely high since its launch. AHRL has sold large volumes of the product and further manufactured a large stockpile of the W4D in anticipation of on-going high demand, and a substantial number have already been implanted in patients.

AHRL purchases Titanium for its pacemakers from two suppliers in the United States. AHRL upgraded its accounts payable system to a fully integrated package that automatically updates the general ledger when creditor entries are made. Some problems have been experienced with the creditors ledger, which is split into US dollar ($US) and Australian dollar ($AUD) amounts. 60% of the Titanium purchased must be paid for in $US by AHRL. In some cases, $US amounts have been recorded as $AUD, resulting in inaccurate creditor balances. Month-end rollovers have also proved problematic, with creditor balances being incorrectly re-set to zero at the first of every month. This has required each creditor’s history to be re-entered manually each month, a time-consuming process that is taking accounting staff away from their normal duties. There has recently been a sharp increase in incidences of the pacemaker malfunctioning, resulting in consistently slow heartbeats (sinus bradycardia) of patients commencing legal action against AHRL for damages and prompting the company to initiate a recall. Initial investigations reveal that the defect is attributable to a design flaw. It is likely that the product in its current form cannot be sold. Management of AHRL is confident that it will be possible to re-engineer the two machines acquired for the manufacturing of the W4D to enable production of its four other product lines and potentially for other products currently under development.

Prepare a memorandum to the audit manager, outlining your risk assessment relating to AHRL. When making your risk assessment:

(a) Identify four (4) key account balances from the information provided that are subjected to an increase in audit risk. Briefly explain what factors increase the audit risk associated with the four (4) accounts identified. In your explanation, please mention the key assertion(s) at risk of material misstatement.

(b) Identify how the audit plan will be affected and recommend specific audit procedures to address the risks associated with each account identified.