Case: New Territories Light and Power Ltd

You are the manager in charge of the audit of a newly obtained client, New Territories Light and Power Ltd (NT), for the year ended 31 December 2016. NT has entered into a Scheme of Control Agreement (SCA) with the Hong Kong Government. SCAs provide the framework for the Government to regulate the power companies and monitor their corporate affairs to protect the interests of consumers. Pursuant to the SCAs, the power companies are required to seek the approval of the Executive Council for certain aspects of their development plans, including projected basic tariff levels, and the agreement of the Government to their annual tariff adjustments. Meanwhile, the technical, environmental and financial performance of the power companies are subject to annual auditing reviews conducted jointly by the Government and the companies. As NT is a publicly traded company, the audited financial statements must be lodged with the HK Exchange and Clearing Ltd.

NT is considerably more profitable than many of its competitors, l argely 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 the 2016 operations.

Additionally, NT 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, NT hired 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.

Your discussion with the previous auditor revealed that the client has experienced some difficulties in correctly tracking the existing property, plant and equipment items. This largely involves equipment located at its multiple energy production facilities.

You plan to staff the audit engagement with several members of your CPA firm who have experience in auditing energy and public companies.

Partner review of the key accounts will be extensive.

Required

a) Based on the above information, identify seven factors that affect the risk of material misstatements for the audit of 31 December 2016 financial statements of New Territories Light and Power Ltd. Indicate whether the factor increases or decreases the risk of material misstatements. Also, identify which audit risk component is affected by the factor. Use the format below.

Factor Effect on the risk of Audit risk material misstatement component

b) Based on the above information, identify two factors that may affect the planned detection risk.

c) In general, discuss the reasons for an increased or decreased planned detection risk.