Auditing Examination and Ethical Issues in Auditing

This article covers topics related to auditing examination, ethical issues in auditing, internal control measures, and practical audit procedures. It includes solved examples and expert guidance.

AUDITING
EXAMINATION

Question 1
1.
Ans. (c)
Explanation: The correct option is “Assurance is not provided as the client determines the
nature, timing, and extent of the evidence that is gathered and will determine their outcome”.
It is because the assurance process is used to check the accuracy of financial reports.
Assurance assures that there is no misrepresentation done in the financial records, and no
fraud, or error. The assurance given on financial reports by independent audit firms indicates
that the financial reports of the company are 100% correct which is not possible in real life.
Hence, the assurance is not provided on client financial records only audit opinion is given by
auditors.
2.
Ans. (b)
Explanation: The correct option is “information is considered material if it has no impact on
the decision-making process of financial report users. It is because materiality means any
information which has a significant impact on the decision-making process of users of
financial statements. It means all the information affecting users’ decision are considered
material information.
3.
Ans. (a)

Explanation: The correct option is that the control environment does not refer to policies, or
procedures that help make sure management directives are carried out. It is because well-
designed internal controls can reduce risk and aid a company in carrying out management's
instructions. The control environment and control activities should be taken into account
when designing internal controls. An organization's control environment establishes its
culture and shapes the morale of its workforce. It serves as the foundation for all other
internal control elements and offers structure and discipline.
4.
Ans. (d)
Explanation: The correct option is all of the above. It is because of the matter of governance
interest that auditors are allowable to discuss the modifications to the audit report, discussing
any practical issues they are while performing the audit, and the potential effect of risk on
financial records to those in charge of governance. It is possible when the management does
not consider the viewpoint of auditors.
QUEDTION 2
Ethical issues involves in the given case
As per the APES 110, there are five fundamental principles of ethics guiding the behaviour of
auditor’s profession which involves integrity, objectivity, professional competence & due
care, professional behaviour and confidentiality. Here as the Daniel’s wife is having
substantial shareholding in a company (Subway) which is going to be taken over by the
Pharmacy ltd whose auditing is being performed by Daniel himself. Therefore, there arise a
conflict of interest among Daniel’s personal interest to protect the shareholding of his wife
and impartial performance of his official duties that is, auditing of Pharmacy limited. At this
point, the fundamental principle of professional ethics that gets hurt involved confidentiality.
According to the confidentiality as a principle of professional ethics for auditors, it is

necessary for member auditors to respect the confidentiality of acquired information as a
result of business or professional relationships. As an auditor, Daniel obviously knowing each
and every financial aspect of the Pharmacy limited which he must not disclosed to his wife
who would be a future shareholder of the company after the completion of the takeover bid.
Further, auditor gets disqualified from the profession if he himself or his partner are having
even a single share in the entity of which the former is the auditor. Therefore, the another
issue arises here is of maintaining the objectivity while giving professional or business
judgement which must not be getting affected as a result of conflict of interest or any other
undue influences.
The options available with Daniel involves the following:
Daniel could resign from the job before the issuance of audit report for the current period to
safeguard his profession.
The matter could be referred to ASIC because Daniel was not aware of the takeover bid and
he is innocent.
Ask his wife to sell all their holding in Subway before the takeover bid begins.
Daniel could refrain from auditing the financial statement of Pharmacy limited for no morein
the future.
Question 3
(a)
Ans. An analytical procedure is a procedure to analyze the relationship between financial and
non-financial information via testing its reasonableness might using selected ratios. In the
present situation, to analyze the financial situation of Strandberg Co., Peter can take
efficiency ratio analysis as well as substantive analytical procedure method. A substantive
analytical test is a test with the help of which the auditor can test balances of the inventory,
debt, and cash flow. To gather substantial evidence on account balances, transaction
categories, and financial statement disclosures for their customers, Peter can carry out

substantive audit procedures. To properly address the assessed risk of material misstatement
during an audit, Peter is responsible for developing and implementing meaningful audit
procedures. While with the help of the efficiency ratio analysis method of analytical
procedure, the auditor of Strandbag Co. (Peter) can analyze the liquidity, profitability, and
efficiency performance of the company. Here, Peter is required to compute ratios and plot
them over a long period. Maintain a stable financial state, aids in trend identification, and
allow them to monitor the organization's financial status over several years or fiscal periods.
Peter can conduct an additional study to find and fix the problem if they observe that the
financial reports for a certain period fall above or below the trend.
(b)
Although the audit opinion declares that the financial reports are devoid of any substantial
misstatements, there is still a chance that the financial statements are materially inaccurate.
After analysis of the case study of Strangbag Co., the following audit risk has been identified
which need to be understood by auditors:
Control risk (Risk of auditing the store inventory): This is a control risk that arises because
any transaction is not verified. There is a risk that whether the pre-order of inventory has
been placed by a company or not. They also need to check whether they have incorporated
the pre-order in the current year’s financial report or not.
Inherent risk: The inherent risk is a risk of material misstatement which arises in the audit
because of fraud and incompetence. For example, in the case of Strangbag Co., Peter has the
risk that why the client is facing issues in renewing their bank debt two years more. This
arises the risk of fraud.
(c)

The auditor (Peter) could take the above risk into account in the audit plan via the risk
assessment procedure.
Risk Assessment Procedure: The systematic process of discovering, evaluating, and
controlling risks and hazards is known as a risk assessment. A competent individual
determines the steps that need to be taken to reduce or eliminate risk in the workplace in
every given circumstance.
To incorporate this in their audit plan, Peter is required to follow the five steps of risk
assessment:
 Determine the danger.
 Analyze the danger.
 Set up safeguards and controls
 Reevaluate the risk after implementing the control.
 Verification of lower risk.
QUESTION 4
Key assertion at risk are as follows:
 The payment at overtime rates made to the casual and full time worker gives rise to
the risk of assertion pertaining to its presentation and disclosure. The assertion could
be associated with the accuracy, valuation and occurrence of the events or transaction
within the entity. Therefore, the assertion of overtime payment to full & part time
worker is at risk that they have really occurred within the Mine ltd and QLD Mine
Pty.
 Payment to supplier for twice is another assertion at risk because of the event being
occurred just for once while its recording in the books of accounts have been done for
twice.
 Prior payment to supplier that is, Mine Limited’s staff are having the procedure for
processing the transactions with their suppliers where they attempt to prepare cheque

for their suppliers prior to the receiving of goods. Therefore, the assertion a risk here
is that whether the transaction have really occurred or is recognised in the relevant &
current accounting time periods.
Practical prevent internal control to directly address the risk are as follows:
For the prevention of the risk of incorrect or unnecessarily high payments to the staff shown
in the financial records on the ground of overtime working at night shifts and weekend,
auditor could establish the internal control as follows.
They could go for inspecting the payroll records to ensure that everything is accurate along
with ensuring that there is no fake ids created for setting aside higher payment. Further, the
time cards could be inspected and audited periodically to ensure that the valid amount has
been set aside for payroll processing.
For preventing the risk associated with the problem of twice payment to supplier for one time
transfer of goods could be overcome through bank reconciliation statements and other audit
evidences such as supplier invoices. This way, auditor could assure that the twice payment
made has been adjusted through future purchases or the reverse entry has been made in
respect of the dual payment.
For the prevention of risk associated with the prior payment made to the supplier in respect of
receiving goods in future, the auditor could ensure that all the previous cheques have a
subsequent receiving of supplier invoice as well as the goods. This could ensure no existence
of fake entries and undue record of payment to suppliers.
Practical detect internal control that could be implemented in respect to the above risks are as
follows:
For the detection of risk through internal control, auditors could go for adopting substantive
audit procedure which is considered as an audit test to be undertaken by an auditor for the
evaluation of financial statements of the company. Here, the auditor is required to create
conclusive evidence for the verification of transactions in terms of completeness, accuracy,
occurrence, existence and measurement of the financial records of the entity.
For instance, the verification of payments to the suppliers could be done through the audit
evidence that is, purchase invoice. Also, for the verification of the payroll amount, the
corresponding audit evidence could be verified is the payroll records, the wage rates and the

time cards record maintained by the entity. This involves test of details associated with the
transactions that took place within the entity and helps in collecting evidences for the
evaluation of disclosures, balances as well as other accounting transactions associated with
the business and their financial records.
 Verification of lower risk.
Question 5
The principal audit objectives for purchase are as follows:
 Appropriate means of communication between the departments before placing a
purchase order.
 The audit objective for purchase is that the order should be placed by an authorized
person.
 All the terms and conditions related to the purchasing order should be satisfied by the
vendor.
 The purchases are free from material misstatement that is fraud and error.
 The invoice should be gathered from the vendor.
Audit assertions for purchase:
 All purchase events and transactions have been recorded only if they occurred and
pertain to the entity.
 All purchases transaction and events have been recorded in financial reports on an
accrual basis that is following Australian accounting standards.
 All purchases are properly authorized.
 Amounts regarding purchase have been recorded appropriately.

 It should be recorded in the correct accounting period.
 Lastly, it should be recorded in proper accounts.
(b)
The substantive procedure for purchase is as follows:
Occurrence
 Follow the invoices and any other relevant documentation, such as GRNs (goods
received note), for a sample of the spending shown in the purchase ledger.
 Identify the purchase orders from a sample of GRNs.
Completeness
 Examine the file for unmatched GRNs and look for any explanations, then follow any
unmatched items to the year-end accruals.
 Conducting analytical procedures by comparing the level of expenses from month to
month in the prior year.
Cut-off
 agree that the amounts on a sample of GRNs dated just before and after year-end are
posted in the appropriate financial year.
 Obtain an accruals schedule and check the dates on the GRNs to ensure that the
accruals have been made appropriately and that any products received after the year's
end have not been included.
(c)

Principle audit objective for the cost of sales:
 The audit objective for the cost of sales is that the auditor is required to follow the
rule of inventory. The rule is recording inventory at a lower cost and net realizable
value. It is because the cost of sales is linked with an inventory.
Audit assertion for the cost of sales:
 The transaction regarding the cost of sales should be accurately recorded in the
financial statements (income statement)
 All transactions regarding closing inventory and purchases should be maintained in
full in the financial statement.
 The amount and cost of sales transaction should be related to the current period only
following accrual basis accounting.
 The material information regarding the cost of sales should be properly disclosed in
notes to accounts of financial statements.
(d)
The testing of closing inventory balance is an appropriate substantive audit test that helps the
auditor to gather evidence regarding whether the closing stock is recorded at a lower cost or
net realizable value or not. Further, the auditors are also required to conduct physical
verification of inventory at the client warehouse. The telephonic conversation and
observation with the vendor are also required to be done by the auditor to gather purchase-
related evidence.
(e)

The substantive test of cost of sales and purchase are linked as both require the physical
verification of inventory. Both require testing the closing stock balance at the year-end from
the balance sheet of the company. Also, under both testing, the auditors need to communicate
with the vendor to verify the goods received notes. It is because the cost of sales and
purchases are interlinked with each other.
QUESTION 6
The internal auditor’s work could be used by the auditor in the following manner:
 The auditor could obtain the audit evidences associated with each and every financial
records maintained by the entity.
 Using the assistance of internal auditors in carrying out of the financial statements of
the business which involves the following:
o Examination of operating as well as the financial information.
o Management of risk pertaining to the going concern of the business.
o Review of regulations and laws that are complied by the business.
 Before using the work of internal auditors, it is must for the external auditor to ensure
that the work exhibits the required level of proficiency.
 Also, the external auditor must ensure that there is a consistency between the reports
and working papers generated by the internal auditors.
Yes, there are going concern issues associated with the Pacific Limited because they are no
more able to negotiate borrowing facility with their bankers which could result in the
financial constraints for the business in terms of not able to raise funds for financing their
future requirements or prospects through borrowings. Furthermore, the business has lost
significant customers which is another issue associated with the going concern of the
business.
The issues associated with the going concern of the business could be presented within the
audit report by including a new or separate section headed as “Material uncertainty related to

going concern” if the auditor identified that there is material uncertainties involved with the
entity’s future prospects.
On identifying inadequate disclosure of material uncertainties within the financial statements
of the business, auditor could recommend the management to make changes in the financial
statements by making additions to the notes to accounts. If the management do not undertake
the action as suggested by the auditors, then the auditor could include the qualified or adverse
opinion within their reports.