Assessing Risk and Key Audit Matters in Auditing Theory and Practice: Case Study Analysis

The executive summary provides an overview of the report on auditing theory and practice, focusing on assessing the risk of material misstatement in two case studies. The report discusses key audit matters, practical audit procedures, and the necessity of communicating audit findings. It addresses significant assertions at risk related to inventory and PPE, highlighting the importance of accuracy and valuation. The report emphasizes adherence to ASA 701 guidelines for effective communication and documentation.

Running head: AUDITING THEORY AND PRACTICE
Auditing Theory and Practice
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Executive Summary:
The current report is based on assessing the risk involved in the material misstatement of the
two case study given namely the Advance Computer Solutions and Green Machines Ltd. The
report would take into the account key audit matters that the auditors must consider while
forming an opinion on the financial statements. Throughout audit declarations, the auditors is
ought to keep an eye on detailed procedures and standards so that they can prearrange rules to
establish the presence of risks in the monetary misstatement and collaborating the same to the
administration. The report would be addressing the risks that are involved in the audit
assertions and implement necessary approach for audit disclosure.

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Table of Contents
Introduction:...............................................................................................................................3
Answer to Question 1: Advanced Computer Solutions.............................................................3
1.1 Significant declarations at risk associated to inventory:.............................................3
1.2 Practical audit procedures for each identified risk:..........................................................4
1.3 Necessity of ASA 701 Communicating Key Audit Matters:...........................................5
1.4 Rationale for selection of key audit matters:....................................................................6
1.5 Documentations relevant with ASA 701:........................................................................6
Answer to Question 2: Green Machine Limited........................................................................7
2.1 Significant declarations at risk associated to PPE:..........................................................7
2.2 Practical audit procedures for each identified risk:..........................................................8
2.3 Necessity of ASA 701 Communicating Key Audit Matters:...........................................9
2.4 Rationale for selection of key audit matters:....................................................................9
2.5 Documentations relevant with ASA 701:......................................................................10
References:...............................................................................................................................12

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Introduction:
As a general rule, audit is referred as the customary procedure based on which the
auditors accountability is dependent for implementing the analytical methods on the financial
statements to identify the material misstatements. The auditors are responsible for keeping
record of time taken to perform the work of audit and special focus should be placed on
assertions made by organizations in the financial reports (Sirois, Bédard and Bera 2018).
These audit assertions is further viewed as explicit or implicit claims for an organization’s
management while preparing financial statements.
There are occasions where auditors have responded to the assertions risks based on
material misstatement. The responsibility of the auditors include assessing the assertions to
determine the existence of any substantial risks (Cordoş and Fülöp 2015). During audit
assertions, the auditors should follow specific guidelines and standards so that they can
organised rules to ascertain the existence of risks in the financial misstatement and
communicating the same to the management. The report would be addressing the risks that
are involved in the audit assertions and implement necessary approach for audit disclosure.
Answer to Question 1: Advanced Computer Solutions
1.1 Significant declarations at risk associated to inventory:
The current scenario obtained from the case study states that the auditor can recognize the
two main assertions under risks namely the completeness and accuracy. The justification for
such risks is given below;
Completeness:
Every business is required to perform an appropriate valuation of inventory.
According to the audit assertion, the management is accountable for recognizing the material

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misstatement in the inventory valuation (Christensen, Glover and Wolfe 2014). While an
inadequate information may lead to understatement of the inventory amount. In the present
situation of Advance Computer Solution Ltd it is evident that assessment of management
may be under risks as the staff has failed to make link while recording inventory following
the purchase. This is related to risk of internal control as well. The scenario obtained from
Advance Computer Solution Ltd suggest that the business recorded 18% sales while an
inventory of 26% in 2018. As evident there is a clear incorrect inventory valuation that
contributed to sales in 2017. Therefore, the company is exposed to significant risks on the
basis of this assertion.
Accuracy:
For any management in business the procedure of inventory valuation forms critical in
maintaining accuracy in financial statements. Because of this reason, the companies are better
able to recognize the event of unsustainable techniques or mistake that is made while
performing inventory valuation (Kachelmeier, Schmidt and Valentine 2017). On the basis of
specific assertion, the management for any business is dedicated towards correctly valuing
the physical count of inventory and incorporating the same into the financial statements. This
enables audit procedure easy for the auditor in obtaining the needed knowledge because of
transferring the warehouse to six different regions during March 2018.
Assertions relating to accuracy is helpful in recognizing the accountable person that is
assigned with the responsibilities of performing the audit in the procedure of physical count
of inventory as the turnover rate for the business declined to 3.18 in 2018 from the figures
posted in 2017. As understood the combination of above stated justification would enable the
auditor in performing specific risk assertion that is at risks for the business (Brasel et al.
2016).

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1.2 Practical audit procedures for each identified risk:
The auditors have the authority for carrying out the audit procedure following the risk
assessment. An identical state of affairs is noticed for Advanced Computer Solutions Limited.
The auditors has identified the risk assertion relating to the accuracy. In the current case the
accurate substantive audit procedure would enable the business in administering their risk
while performing the count of inventory. The physical count of inventory would act as the
methodological process in performing the inspection of entire process (Ferguson, Francis and
Stokes 2016). The auditors can undertake different audit process for discussing the same with
the responsible staff that are accountable for performing the physical count of inventory and
also identify the weakness involved in process following a detailed assessment of the stock
samples for detection of errors. Based on the information from data of March 2018, the
company has moved its central warehouse to six different regions. Therefore, performing the
physical count of inventory for the six warehouse is necessary to match the inventory of main
warehouse.
Furthermore, the case highlights that there is a risk of completeness. The auditor must
engage in substantive audit process to reconcile with the items of inventory against the book
value as this only forms the appropriate process of controlling risks (Köhler, Ratzinger-Sakel
and Theis 2016). The responsibility of the auditor’s remains vested in recognizing the values
of stock obtained following the physical count of inventory and examining the existence of
any probable errors. On implementing this process, the auditor would be able to get the
necessary information that would help in providing correct valuation of inventory.
1.3 Necessity of ASA 701 Communicating Key Audit Matters:
The auditors must essentially locate the noteworthy audit matters and communicating
the same to the stakeholders of the business on the basis of guidelines stated under ASA 701.
These standards are helpful for the auditors in numerous manners (McMullen and

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Raghunandan 2016). Adhering with the guidelines of ASA 701 would help the auditors in
maintaining an effective channel of communication that must be formed between the
governance group and main stakeholders in the statement of key audit matters. This
disclosure would help in promoting transparency and quality of financial information. The
ASA 701 guidelines would help the auditors in placing their special focus relating to the
overall improvement in the preparation and presentation of the financial statement as well as
maintaining the quality of audit (Gimbar, Hansen and Ozlanski 2015). Finally, it is necessary
for the auditors to obtain the motivational morale from the guidelines of ASA 701. This will
help the auditors in revising the financial reports and similarly taking into the account the key
audit matters. The guidelines of ASA 701 will not only help the auditors in contributing
towards the overall improvement of the financial reports but would also help in better
understanding of the financial statements.
1.4 Rationale for selection of key audit matters:
In accordance with the guidelines of ASA 701, the noteworthy assertions associated
to the risk of Advance Computer Solutions Ltd is related to the understanding of key audit
matters for varied reasons. At first, any kind of material misstatement may create an impact
on the financial position of the business as well as the efficiency of the business (Reid et al.
2016). This would create a damaging effect on the stakeholders of the business. Furthermore,
there might some uncertainties related to the transparency based on the judgements that is
made by the management while valuing the inventory that may result in material
misstatement. As a result the key audit matters might support the financial reports after
understanding the above stated declarations.
1.5 Documentations relevant with ASA 701:
According to the guidelines of ASA 701, the audit might recognize the key audit
matters and the same should disclosed in the statement based on the appropriate way

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(Adelopo 2016). As evident in the current situation of Advanced Computer Solutions proper
explanation must be provided to select the key audit matters that will enable the business in
moving forward with the material of auditing and issuing the conclusions in the audit report.
Answer to Question 2: Green Machine Limited
2.1 Significant declarations at risk associated to PPE:
In the current case study of Green Machine Limited, the auditor can place his
assertion based on the two areas of risks namely accuracy and valuation. The rationale for
explanation is given below;
Accuracy:
The business firms must carry out the appropriate valuation of fixed assets namely the
PPE. The management is required to correctly record the figures along with the transactions
that are considered with the PPE in the company’s books of accounts (Gustavson 2015).
Furthermore, it is necessary to maintain a different record of capital expenses as well as
revenue expenses. The information gained from the case study shows that Green Machine
Limited has maintained a separate books of records for its property, plant and equipment. As
a result of this the management of Green Machine Limited is found to be at fault as it has
incorrectly capitalized the revenue expenses and recorded the same as repairs and
maintenance in the income statement. Below listed are some of the main risk assertion which
are as follows;
Valuation:
Every business firms is under the obligation of performing the correct valuation of its
property, plant and equipment (Jones 2017). In accordance with the guidelines of ASA 701,
an assertion can be stated for the management of Green Machine Limited where it should
record the value of PPE following the subtraction of depreciation, disclosure of sales and

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impairment of property, plant and equipment. The gathering of these issues has made it
necessary for the management to disclose their values of property, plant and equipment in the
fair and precise way. The rate of depreciation that is charged is very low and as result of this
the operating expenditure of Green Machine Limited would significantly reduce related to the
material effect on the financial report of the company. The auditor can consider this assertion
at risk.
2.2 Practical audit procedures for each identified risk:
The auditors are under the obligation of performing a substantive and audit process
for every areas of risks identified in the case of Green Machine Limited. Earlier assessment
has contributed to the knowledge that the business has not be successful in maintaining the
separate record for both the capital and revenue expenditure (Barndt, Fuller and Flynn 2016).
The auditor should play an active role in proceeding with the performance of organizational
review for capitalizing the expenses. The auditor should also review the different types of
expenses that are related to the company namely the operating costs and labour cost amid
numerous forms of other expenses. As a result, the auditors will be able to gain better
knowledge of the expenditure that were earlier capitalized in correct manner. Finally, a
detailed review should be performed to determine whether Green Machine Limited has
substantially complied with the standards of revenue and capital expenses reporting.
The case study vividly provides that Green Machine Limited has not followed a
correct depreciation rate for property plant and equipment. Based on the auditor’s
perspective, substantial audit procedure would enable the company to assess the rate of
depreciation in different aspects of residual values relating to PPE. This also includes the
profit and loss relating to PPE together with the organizations policy of replacing the assets
and assessing the economic life (Dennis 2015). The auditor should understand whether the
PPE has complied with the right accounting standard relating to depreciation. Based on the

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above stated explanation, the auditor should necessarily compare the rate of depreciation by
finally assessing correct rate of depreciation. It is also necessary to calculate the rate of
depreciation to determine the correct depreciation expenditure.
2.3 Necessity of ASA 701 Communicating Key Audit Matters:
According to the guidelines given under ASA 701 the auditors are required to
evaluate the different forms of key audit matters that would be conclusive in creating an
opinion on financial statements to make sure that the effective communication of the matters
is stated in the financial statements (Griffiths 2016). According to the guidelines of ASA 701,
it also defines the issues that should be taken into the account while preparing the financial
statements and the same forms an important element of auditor’s judgement. Therefore, it is
necessary to communicate the key audit matters that must be taken into account by the
governance team.
According to ASA 701 guidelines, certain aspects of audit key audit matters should be
considered. The auditors should necessarily assess the areas that have greater possibilities of
material misstatement based on the ASA 315 (Stefaniak, Houston and Brandon 2016). The
auditor should review the critical judgements that are be made by the management in
preparing the financial statements and hence expecting contingencies. Impact created by such
judgements should be assessed by the auditors as the central outcome of remaining dependent
on the auditing activities. The auditors must ensure that the specific issues and events that
might have the material effect on the financial statements should be considered.
2.4 Rationale for selection of key audit matters:
In the current situation of Green Machine Limited, the risk matters that are detected
are in accordance with the ASA 701 because of several reasons. At first, the operating
expenditure for Green Machine Limited has declined significantly because of the lower rate

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of depreciation (Hines et al. 2015). This inaccuracy might overstate the profits for Green
Machine Limited and may further increase the scope of material misstatement in the financial
reports. The situation has declined further because of incorrect recording of capital and
revenue expenses that may create a negative impact on the profit margin for the company.
The risk assertion relating to the material misstatement in the company can result in the
necessity for the auditor to prepare the key audit matter reports.
2.5 Documentations relevant with ASA 701:
According to the statement of ASA 701, it states that the auditors have the
accountability of recognizing the key audit matters that would help in making sure that the
sufficient disclosure is made in the financial statements (Chan and Vasarhelyi 2018). The
adoption of such procedure would help in making sure that the auditor is responsible for
providing the necessary information on significant incidents and simultaneously forming an
opinion relating to KAM. Therefore, this becomes necessary for the auditors to make sure
that the necessary information is disclosed in the substantive audit procedure to implement
control on the risks assertions.
Conclusion:
On arriving at the conclusion, the above stated explanation represents that while
performing the work of audit, opinions of organizations management can be obtained in
preparing the financial statements. Additionally, the analysis of such situation helps in the
case of Advanced Computer Solution has enabled the auditor in recognizing the assertions
that are under risks particularly the accuracy and completeness. The auditors are also
responsible for performing the crystal clear and organized audit procedure following the
recognition of key assertions that are under risk. This can be applied in the current situation

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of Advanced Computer Solution. The information obtained from this case enables the auditor
to recognize the two main assertions at risks namely the valuation and accuracy.
In accordance with the guidelines issued under ASA 701, the auditors are responsible
for determining the key audit matters with the help of audit opinion in the financial
statements of the client company and simultaneously making sure that effective
communication is followed to describe the opinions formed. With reference to ASA 701 the
auditors of Green Machine Limited should consider the two main guidelines. The audit must
play an active role in disclosing information that relates to significant event and contributing
to the KAM. Conclusively, the auditors must make sure that disclosure of information
relating to substantive audit process should be made in accordance with the appropriate risk
assertion at the time of preparing financial reports.

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Confidence. Routledge.
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Misstatement in Auditing: A Modified Delphi Method as a Teaching Tool. In Advances in
Accounting Education: Teaching and Curriculum Innovations(pp. 125-140). Emerald Group
Publishing Limited.
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negative outcomes: The effects of reporting critical audit matters on judgments of auditor
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audit matters on auditor liability. Current Issues in Auditing, 10(1), pp.A24-A33.

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Griffiths, P., 2016. Risk-based auditing. Routledge.
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