Principles of Auditing

This article discusses the principles of auditing with a focus on a case study of Unique Furniture Manufacturing Pty ltd. It identifies the assets accounts that are under the risk of being materially misstated and the potential material misstatement in the prior period figures of sales and inventory. The subject of the audit is Unique Furniture Manufacturing Pty ltd and the course code is AUDIT101.

Running head: PRINCIPLES OF AUDITING
Principles of Auditing
Name of the Student:
Name of the University:
Author’s Note:

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PRINCIPLES OF AUDITING
Table of Contents
Part A...............................................................................................................................................2
Part A-1........................................................................................................................................2
Part A-2........................................................................................................................................2
Part A-3........................................................................................................................................3
Part A-4........................................................................................................................................3
Part B...............................................................................................................................................5
Part C.............................................................................................................................................10
Part C-1......................................................................................................................................10
Part C-2......................................................................................................................................12
Part D.............................................................................................................................................13
Reference.......................................................................................................................................16

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PRINCIPLES OF AUDITING
Part A
Part A-1
As per the case study provided in the question, Pharmaceutical ltd is engaged in business
of chemical manufacturing. The ethical issues which the business is facing is regarding the
disposal of toxic wastes of the company. The company is under investigation for a spill of toxic
waste in a nearby river. The senior level employees of the business are trying to conceal the
matter.
As per Environmental Protection Agency (EPA), no organization is allowed to dispose
toxic wastes or chemical wastes in water sources as per the regulation of Water Management Act
(Powell 2014). The ethical consideration is that the company is trying to actively cover the spill
of hazardous waste in water source which could have serious environmental impacts and also
affect the health of humans. Such ethical factors and the case must be considered by the auditor
before accepting the engagement (Pitt 2014).
Part A-2
As per the case study provided, Pharmaceuticals ltd is engaged in the business of
importing pharmaceutical products from foreign countries. in order to cope up with the
fluctuation in prices of foreign currencies the company has engaged in hedging techniques.
However there exists certain errors in accounting for the hedge transactions.
The auditor needs to suggest to the management to develop a strong internal control for
the business so that the errors and mistakes can be avoided. The management needs to review the
transactions which are recorded for hedge transactions so that errors which occurs due to
inexperience or weak internal control can be avoided (Johnston et al. 2014).

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PRINCIPLES OF AUDITING
Part A-3
As per the case study, the auditor Billings and Associates are to conduct an audit for a
new manufacturer whose financial statements have never been audited before. The auditor is
unable to acquire any sufficient appropriate audit evidences for account receivables as there is no
documentations.
The provisions of ASA 705, which deals with Modification of Audit Opinion in an
independent auditor’s report. The standard states that the auditor must issues a modified audit
opinion when there is material misstatement in the financial statement and when the auditor is
unable to collect appropriate audit evidences due to limitation on the part of the management
(Carson, Fargher and Zhang 2016). As provided in the case, the auditor is having problem in
obtaining sufficient appropriate evidences for account receivable for which proper
documentation is not maintained by the business, therefore this can be taken as a limitation on
the part of management. The auditor can therefore issue a modified report and moreover, the
engagement was for the audit which was provided by the auditor prior to commencement of
business. Therefore, on the request the engagement cannot be changed on a review engagement
even if the company is not subjected to audit (Habib 2013).
Part A-4
1. As per the case provided, Hail Pty ltd is engaged has prepared the financial statements of
the company which has been approved by the auditor of the company. However, the
company admits that it might not have calculated the amount of impairment cost
(Paugam and Ramond 2015). As the company is asking the auditor as to how to record
the impairments accurately, the auditor is providing non-audit services to the client which
can be pose a threat to the principle of independence of the auditor.

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PRINCIPLES OF AUDITING
The safeguards which can be suggested so that the independence principle is not violated
is that the auditor should not be providing non-audit services to the client business for which
the auditor is conducting audit.
2. In the given case, Time travel ltd provides travel services to its customers and also acts as
a travelling agent for the auditors of the company. In times of crisis the company has
asked the auditor to recommend the name of the business to other auditors. In the
situation the case reveals conflict of interest on the part of the auditor and this will be
affecting the independence of the auditor (Kouakou, Boiral and Gendron 2013).
The measure which can be suggested in order to protect the independence
principle of the auditor is that the auditor should not take services from the clients so that
no situation of conflict of interest takes place.
3. In the given case, the auditor has taken up an audit engagement for a new business. A
major part of the shareholdings is being hold by wife of the partner of the audit firm. The
basic threat which is associated with the audit of such a company is related to the
principle of member of the audit firms or the family members of the partners of the audit
firm are not allowed to hold shares or any financial interest in the client. The threat is
identified to affect the independence of the auditor of the company (Fiolleau et al. 2013).
In such a situation the audit firm’s partner should be allowed to conduct the audit
of the financial report of the business and the business also use the techniques of audit
firm rotations.
4. In the case given in the question the auditor of the company is facing a problem where
the company is unable to pay the fees of the auditor. This will be resulting in
overdependence of the auditor on the fees which is to be given by the client.

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PRINCIPLES OF AUDITING
Overdependence on the fees of the company might provoke the auditor to improve the
opinion of the financial reports which might be in the favor of the company which affects
the independence principle of the auditor
The measure which can be suggested to the auditor is that the auditor should
apply for the fees as soon as possible as the auditor’s report will not be issued unless the
audit fees are given by the company.
Part B
(a) Deficiencies Explanations (b) Control (c) Test of Control
Website ordering
without Checking
Inventory Records
The risk which is
involved in such a
case is that the
management might
accept order even
though there might
not be stock of
finished goods which
can adversely affect
the business. The
inventory records are
also at risks of
manipulations by the
way of theft or other
unethical practices
The management can
control the situation
if they integrate the
website of the
company with the
ledger. So that the
sales orders are
entered in the
inventory ledger
automatically.
Moreover, such
records are to be
review so that there
are frauds
The test control
which has been
suggested can be
checked by the
entering a fictitious
sales order and see if
the inventory
accounts are verified
and updated
accordingly or not. A
weekly or monthly
review of the ledger
accounts will be
preventing frauds

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PRINCIPLES OF AUDITING
(Griffiths 2016). from occurring.
Courier Services does
not record the
signature of the
customers.
The risk which arises
when the signatures
are not taken from the
customers when the
goods are delivered
to them by courier is
that the there is no
proof for the
company that the
goods were actually
delivered to the
customer and not
some other person. If
the goods are
misplaced than it will
attract legal actions
against the company
for return of money
or compensation.
The company needs
to incorporate digital
signature system
mandatory before
goods are delivered
to the customers.
Goods must not be
delivered to the
customer even if the
specific address is
provided, without the
signature of the
customers.
The company can
start its own delivery
services where
without the signature
of the customer
goods are not to be
delivered to them.
Delay between sales
order and receipt of
goods.
Another significant
deficiency in the
internal control of the
The business needs to
formulate a new sales
structure so that the
The management can
check the
effectiveness of the

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PRINCIPLES OF AUDITING
business is the delay
between the sales
order and the actual
goods received by the
customers (Feng et
al. 2014). This
suggest that the sales
and delivery structure
of the business is
weak.
business the gaps in
order received and
delivery of the goods
is removed. The
company also needs
to start its delivery
services which can
help in reducing such
a gap. The new sales
structure will ensure
that the recording of
sales and dispatching
of goods so that it can
be received by
customers.
new sales and
delivery structure by
analyzing the sales
and receiving
feedbacks of the
customers as to
whether they are
satisfied or not.
Allowing of Sales
credit and discounts.
The sales credits are
set by the sales ledger
clerk and also the
sales discounts are
allowed by the sales
team member which
might not be
appropriate. The
The credit policy and
the discounting
policy of the
company should be
set by the top-level
management which
includes the sales
manager or the sales
The credit policy and
discounting policy as
set by the senior level
management will be
more effective. This
can be checked by
analyzing the
departmental meeting

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PRINCIPLES OF AUDITING
decision of the sales
credit and also the
discount policy of the
company needs to be
formulated by the
senior management
like the Sales
manager or the Sales
Director.
director of the
company. They are
responsible for taking
decision in a business
and also policy
estimation and will
be effective if the
credit policy and the
discounting policy is
set by the senior level
management (De
Simone, Ege and
Stomberg 2014).
records to ascertain
whether the decisions
about credit and
discounting policies
are taken by the top-
level management or
not.
Reconciliation of
Supplier Statement
As per the current
policy of TUPL, due
to frequent staff
changes the
maintenance of
purchase ledger
accounts are not done
in an appropriate
manner. In addition
to this the new
The management of
the company needs to
recruit new employee
whose sole
responsibility will be
to update the
purchase ledger and
keep record of every
purchases made by
the company whether
The management can
check whether the
entries of purchase
ledger by conducting
a weekly review to
ensure that the new
recruits are doing
their job perfectly or
not. Moreover, such a
technique will also

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PRINCIPLES OF AUDITING
supplier’s details are
not even added to the
purchase ledger. The
risk which arises due
to this is that, the
details of the
potential suppliers
who have provided
the business with
credit purchases
might get lost and it
will be difficult to
keep track of the total
purchases. This will
in turn affect the
financial statements
of the company as it
will show purchases
with an inaccurate
amount.
in cash or credit. In
addition to this a
weekly review of the
purchase ledger will
result in scrutiny of
the ledger accounts
and ensure that the
entries are accurately
recorded.
ensure that the
transactions in the
purchase ledger are
effectively recorded
and make the work of
the auditor easier in
such areas.

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PRINCIPLES OF AUDITING
Part C
Part C-1
a. As per the case study, Unique Furniture Manufacturing Pty ltd is engaged in the
manufacturing of grandfather clocks. The two assets accounts which are under the risks
of being materially misstatement are:
i. Cash Balance: The cash balance of the business is under the risk of being materially
misstated. As the prices of labour is increasing and also the business imports timber
which is the main raw material for the business in manufacturing has a high cost, the cash
balance might be overstated so that a favorable cash balance is shown. The import of the
timber requires foreign currency which is increasing therefore the cost of imports are also
increasing. The reduction gross margin and the net margin of the company is evidence
that the cost of the company is high and the overall sales of the company are more or less
same (Lobo and Zhao 2013). Hence, the management might want to show a favorable
cash balance in order to give the shareholders hope that the liquidity position of the
company is still secure (Brunnermeier, Gorton and Krishnamurthy 2013).
ii. Inventory Account: As the company follows Sales or Return basis for recording sales
transactions. The inventory account of the business is at risk of being materially misstated
(Knechel and Salterio 2016). The management might accidently or knowingly record the
inventory stock of the company as sales of the business as under the method when the
prices of the finished goods are received then it is considered as sales of the business
otherwise it is kept as stock. The inventory balance might be overstated or understated as
the case may be.

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PRINCIPLES OF AUDITING
b. The prior period figures of sales and inventory might be materially misstated as the
company follows Sales or Return basis under which sales is only to be recorded when the
price for the same is received (Johnstone, Gramling and Rittenberg 2013). There is a
chance that due to inexperience of the accountant potential inventory under this method
might be recorded as sales of the business.
c. The three factors which can bring in the going concern concept of the management under
question are given below:
i. The net profit margin and gross profit margin of the business suggest that the
company is not able to make much profits as the company is incurring high costs.
Moreover, as mentioned in the case study the management of the company is unable
to recover amount of cost from the customers which is a factor which contributes to
the low profits of the business.
ii. The increasing cost of materials of the business which the management imports. The
foreign exchange prices of the imports are increasing which is also contributing to the
high cost of companies.
iii. The availability of cheap labour is also a difficult for the business and the cost of
skilled labour is very high and also contributes to the cost of the company.
d. The audit planning process will be carried out considering all the factors which affect the
cost of the company. In addition to this, the auditor needs to have a clear understanding
of the Sales or Return basis policies which the business follows and ensure that such a
basis is constantly applied for measuring the sales transaction of the business (King,
Oracle International Corp 2014). The auditor also needs to plan for the valuation process

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PRINCIPLES OF AUDITING
of the inventory of the business and also plan the substantive and compliance level of
audit procedure for collection of audit evidences.
Part C-2
a. As per the case provide in the question, the system of recording of sales transaction
which is on sales or return basis, therefore proper records of stocks are to be maintained
by the management of the company. The recording of sales transactions can be improved
so that no discrepancies occur in the records.
b. The bonuses which is allowed by the management of the company for increase over the
budgeted sales can be manipulated as the inventory which are not returned can be shown
as sales for the month and bonuses can be claimed. Secondly, there is a risk of
manipulating the sales entries by the marketing manager as he has the power to approve
goods sent on sales or return basis as sales when the goods are not returned with in a
period of 60 days even if price for the products are not received.
c. The account balance which is at risk of being manipulated is the balance of sales as per
the case given in the question. The risk that the bonuses which are given to the
marketing staff and the marketing manager might be manipulated is there. For the
bonuses to be earned the sales of the company should be higher than the budgeted sales
figure of the business which might not be the case.
d. The audit procedures which can by the auditor to ensure that any fraudulent activities of
the business are kept in check are a detailed examination of the sales ledger and all the
ledger associated with the same such as debtor ledger, cash books to ensure that all the
transaction recorded are on genuine. The entries which are passed for Sales or Return
basis are to be examined.

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PRINCIPLES OF AUDITING
For the purpose of reviewing the auditor will be applying vouching techniques for
sales transactions and also use external confirmation technique to satisfy himself that the
entries of sales are appropriate and correctly recorded.
Part D
Event Description Impact on Materiality Explanation
Sale’s Finance
Manager resignation
with no replacement
made.
The sales finance
manager of the
company is
responsible for the
sales activities of the
business and also
looking after
financing
requirements of the
sales team.
No impact on
materiality
The sales finance
manager’s
resignation will not
affect the materiality
of the components of
the business (William
Jr, Glover and Prawitt
2016).
Resignation of HR
manager
The HR manager of
the company is
concerned with the
recruitment process
of employee and the
HR manager of Sail
ltd resigns.
No impact on
materiality
There will be no
impact on the
materiality
component but the
recruitment process
of employees might
suffer (Eilifsen and

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PRINCIPLES OF AUDITING
Messier Jr 2014).
Material Variances
detected in
reconciliation of data
between SuperD IT
and SuperB IT.
The business is in
transition from
SuperD IT to SuperB
IT which is supposed
to improve the
business.
Increases the
materiality on the
area of reconciliation
of data
Th auditor needs to
increase the audit
process which is
applied on Data
Reconciliation
between SuperD IT
and SuperB IT. The
auditor needs to
conduct substantive
process on the area.
No purchase
Documents on a
transaction
Out of the sample
size of 40, a
transaction with Dune
ltd makes a 14%
unlisted investment
for which no
purchase documents
are present and as per
the management a
week is needed for
the documentation to
arrive (AICPA 2017).
Increase in the level
of materiality of the
business.
The area of the
purchase is an
important area of
concern for the
business and
therefore the auditor
needs to provide
ample audit
procedures on the
same (Leung et al.
2014).

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PRINCIPLES OF AUDITING
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PRINCIPLES OF AUDITING
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PRINCIPLES OF AUDITING
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