Auditing Theory and Practice: MYH Case Study and AAA Model Analysis

This report delves into the core concepts of auditing theory and practice, examining the American Accounting Association (AAA) model as a framework for ethical decision-making in auditing. It outlines the seven-step process of the AAA model, starting from establishing facts to making a final decision. The report then explores the implications of inventory overvaluation in financial statements, highlighting the impact on various financial metrics and the auditor's responsibilities concerning internal controls and inventory valuation. A case study involving MYH, Morgan Fertilisers, and Oasis Ltd. is analyzed to determine the potential for auditor negligence when overlooking inventory misstatements. The report also references the case law of Esanda Finance Corporation Ltd v Peat Marwick Hungerfords (1997) to provide context to the auditor's liability to third parties. The report emphasizes the importance of auditor independence, integrity, and objectivity, and the consequences of failing to adhere to these principles.

Running head: AUDITING THEORY AND PRACTICE
Auditing theory and practice
Name of the student
Name of the university
Author note

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Table of Contents
Executive summary....................................................................................................................2
Question 1..................................................................................................................................3
American Accounting Association (AAA) model.....................................................................3
Question 2..................................................................................................................................6
Report to MYH’s managing partner..........................................................................................6
Case law.....................................................................................................................................7
Reference....................................................................................................................................9

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Executive summary
The main objective of this report is to establish the fact regarding the American accounting
association (AAA) model that suggests seven-step procedure for the purpose of decision-
making that takes into consideration the ethical issues. The AAA model starts with Step 1
through establishment of the case’s facts. Step 2 identifies ethical issues of the case. The 3rd
step involves recognition of values, principles and norms of the case and this further involves
establishing the decision in the ethical, social and in few cases, within the context of
professional behaviour. Under the 4th step all the alternative course of the action is
recognized. Next under step 5 the values, principles and norms those were identified under
step 3 are covered within the identified option under step 4. Under step 6, the significance of
the results is taken into consideration. Finally, under step 7, the decision is made taking into
consideration all the relevant facts.
The report will also state the consequences of overvaluation of the inventory in the financial
statement of any company and the auditor’s responsibility regarding the internal control and
valuation of inventories. The report will also state whether the auditor will be charged for
negligence if they overlook the misstatement of inventory valuation with reference to a case
study.

3AUDITING THEORY AND PRACTICE
Question 1
American Accounting Association (AAA) model
The American Accounting Association (AAA) model established from the report for
AAA that was written by Rockness and Langender during 1990. Under the report, it was
suggested by them the seven-step procedure for the purpose of decision making, that takes
into consideration the ethical issues (Abernathy et al., 2015).
The AAA model starts with Step 1 through establishment of the case’s facts. This step
indicates when the process of making the decision initiates and there is no uncertainty exists
regarding what is to be taken under consideration. Step 2 identifies ethical issues of the case.
This step includes the identification of the case’s facts and find out the ethical issues under
stake (Kothari, Mizik & Roychowdhury, 2015). The 3rd step involves recognition of values,
principles and norms of the case and this further involves establishing the decision in the
ethical, social and in few cases, within the context of professional behaviour. In this context,
the professional code of the ethics or social expectation of profession is considered as the
values, principles and norms. Under the 4th step all the alternative course of the action is
recognized. This includes defining each alternative without taking into consideration the
values, principles and norms under step 3 with regard to assure the fact that each of the
outcome is taken into consideration irrespective of the fact that the outcome may or may not
be appropriate (Howard et al., 2016). Next, under step 5 the values, principles and norms
those were identified under step 3 are covered within the identified option under step 4. After
completing these, it shall be possible to identify which option fits under the norms and which
options are not. Under step 6, the significance of the results is taken into consideration.
Finally, under step 7, the decision is made taking into consideration all the relevant facts.

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Facts of the given case
The facts of the case was that the partner of the audit division under MYH, Jacqui
Leak found that one of their client Morgan Fertilisers recently changed their waste
management contractor and entered into the 3 years contracts with Dumparound Ltd. it was
found by Mr. Jacqui that Dumparound is investigated and charged for exceeding the toxic
waste level by local council for one of their sites (Dalton, Davis & Viator, 2015).
Ethical issues of the case
The ethical issues with regard to the case is that whether the auditor shall look into the
fact that the client is a good corporate citizen or not and whether the client is managing its
business ethically or not.
Stakeholder’s list that will be affected
Local community – if the waste management is not carried out properly then the biggest
impact will b eon the local community where the business is being carried out as they have to
suffer the adverse impact of improper waste management
Investors – investors will be affected as the sustainability and environmental lookout will not
be fulfilled and therefore, people will have bad impression regarding the company, which in
turn will affect the investors
Customers – the customers will have a feeling in their mind regarding improper conduct of
the company’s if it does not conform with the environmental issue management requirement
(No et al., 2017).
Major values, rules and principles

5AUDITING THEORY AND PRACTICE
The values, principles and norms are considered to have a big impact on the integrity
of the financial statement of the company. As per the APES 110, the auditors are entrusted
with the task of conforming that the working environment of the client has relevant
safeguards and will be varied on the basis of the circumstance. The safeguards for the
circumstance of the working environment include firm-wide safeguards well as the
engagement-specific safeguard. It is found that the company is lacking the safeguard with
respect to both the aspects.
Alternative course of the action
Option 1 is to further investigate the matter and question the management regarding
the justification behind entering the contract with Dumparound. Option 2 is to just ignore the
fact and give their opinion accordingly.
Values and alternative
With regard to maintain the integrity and objectivity of the auditor, the best option
will be further investigate the matter and question the management regarding the justification
behind entering the contract with Dumparound. This decision will help to maintain the
independence, integrity and objectivity of the auditor.
Alternatives access of the consequences
If the option 1 is chosen, then it will help to maintain the independence, integrity and
objectivity of the auditor. The auditor shall further investigate the matter and question the
management regarding the justification behind entering the contract with Dumparound
If option 2 is chosen, though the auditor will not be liable as the auditor’s job is not to
find the fact that whether te client is carrying out its business ethically or not. However, to

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maintain the long-term sustainability of the company, this matter is required to be taken into
consideration.
Making the final decision
The ethical decision is option 1. The auditor to maintain their integrity shall
investigate the matter.
Question 2
Report to MYH’s managing partner
The main issue with regard to the inventory valuation is to recognize the amount that
is to be carried out as the value of the inventory in the balance sheet. As per the accounting
standard, the inventories must be measured at the lower value out of the cost and realisable
value (Onyekwelu & Ugwuanyi, 2014). Further, the inventory which has become obsolete or
which is damaged shall not be considered under the balance sheet of the company. If the
value of inventory is overstated, it will have an impact on the various items of balance sheet
as well as the income statement of the company. For instance, the shareholder’s equity, net
income and retained earnings of the company will also show higher amount. Further, as the
closing inventory of one period will be shown as the opening inventory of next period, the
COGS of that period will also be shown at higher amount, which in turn, will reduce the
gross profit as well as net profit of the company (Gray & Ehoff Jr, 2014).
In the given case study, it is recognized that Morgan Fertilizers are involved in the act
of overstating their inventory in the balance sheet. Knowing the fact, the audit firm MYH did
not raise any issue and stated their opinion on the financial statement of the company without
taking into consideration the fact (Onoja & Abdullahi, 2015). Moreover, based on the audited

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report of the company, Oasis Ltd took over Morgan. However, when they found the fact that
inventory were overstated, they charged the auditor for being negligent. It was found that out
of the total inventories in the balance sheet of the company, 50% of the inventories were
already became obsolete and rest were valued at 35% more that the cost. Further, one major
issue was that even if MYH valued the inventory correctly, they finally accepted the
management’s valuation of the inventory (Haribhai-Pitamber & Dhurup, 2014).
Through the confirmation of the inventory count is the management’s duty and they
are responsible for planning the strategies, through which the inventories will be verified, the
auditor must look into the matter of internal control system of the company and strategies
prepared by the management to minimize the gap in internal control. Further, the auditor shall
look into these matters as they are obliged to apply the professional judgement and
approaches while carrying out the audit (Gu, 2013).
Further, the auditor will not be liable to the third parties for his act and is only liable
to the client. Nevertheless, if the third party is able to prove the following mentioned points,
then the third party can make the auditor liable –
 Third party has taken decision on the basis of the audited statement of the company
 Any negligence done on the part of the employee of the auditor
 Intentionally the financial statement were designed to mislead the third party
 The annual statement was not prepared with true and fair view.
 Errors or misappropriation were there in the statement preparation (Feng, McVay &
Skaife, 2014).

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Case law
In case study of Esanda Finance Corporation Ltd v Peat Marwick Hungerfords
(1997), the applicat, Esanda Finance Corporation, loaned cash to the association in view of
the review report issued by Peat Marwick Hungerfords. In any case, after borrower default on
the instalment, Esanda charged to the auditors on account of the fact that they have issued
loan in light of the issued audit report by the auditor that broke the mandatory accounting
standard. In any case, the High court of Australia expelled the case saying that the loan
specialist as opposed to depending on the auditor’s report could complete the examination all
alone. Further, it was expressed by the court that the evaluators are not in charge of the
obligation of duty to third parties.
With reference to the above case study, it can be commented that as MYH instead of
verifying the inventory correctly, they accepted the value given by the management, which in
turn will affect the integrity, objectivity, honesty and independence of the auditor. Here,
Oasis Ltd. can establish the fact and bring negligence charge against MYH with regard to the
fact that they have taken decision based on the audited financial report of Morgan Fertilizers.
However, it is the court’s decision whether they will charge the audit firm MYH for
negligence or dismiss the case like Esanda Finance Corporation Ltd v Peat Marwick
Hungerfords (1997).

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Reference
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Dalton, D. W., Davis, A. B., & Viator, R. E. (2015). The joint effect of unfavorable
supervisory feedback environments and external mentoring on job attitudes and job
outcomes in the public accounting profession. Behavioral Research in
Accounting, 27(2), 53-76.
Feng, M., Li, C., McVay, S. E., & Skaife, H. (2014). Does ineffective internal control over
financial reporting affect a firm's operations? Evidence from firms' inventory
management. The Accounting Review, 90(2), 529-557.
Gray, D., & Ehoff Jr, C. (2014). Lower Of Cost Or Market Inventory Valuation: IFRS Versus
US GAAP. Journal of Business & Economics Research (Online), 12(1), 19.
Gu, S. (2013). Research and analysis on issued inventory valuation methods of
enterprises. Balance, 50, 541-544.
Haribhai-Pitamber, H. U., & Dhurup, M. (2014). Inventory control and valuation systems
among retail SMEs in a developing country: An exploratory study. Mediterranean
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