Auditing Theory: Ethical Concerns, Risk Assessment, and Controls

This comprehensive report on auditing theory delves into the ethical responsibilities of auditors, particularly in the context of potential environmental violations and manipulative financial practices. It examines the actions an auditor should take when faced with unethical behavior by a client, including assessing financial statements for misstatements and applying appropriate audit procedures. The report also explores auditor independence, addressing threats such as self-review, self-interest, familiarity, and intimidation. Furthermore, the report analyzes various business risks, such as high lease payments, stock obsolescence, cash flow constraints, profit margin drops, and intense competition, and how these risks can lead to material misstatements. Finally, it identifies deficiencies in internal controls and the related business risks, offering a thorough examination of auditing principles and practices.

AUDITING THEORY

Audit theory
Answer part A-1
A whole lot of circumstances should be taken into attention about the client and his business, whenever an
auditor fixes up an appointment with a company. The most crucial point that should be taken into account by
the auditor at the earliest is that all the authorized rules are followed by the management of the company. For
instance, whether the client is keeping a check if his business is in association with the protection of the
environment and no harm is done to the ecosystem. It is important to stay at the distance from the unauthorized
means and manipulative policies (Arens et. al, 2013).
As per the details of the case, the Pharmaceuticals Ltd is found to be guilty of the charge of dispatching its
harmful chemical wastes into the nearby river and thus contributing to water pollution which is a very unethical
practice. Involvement of the management is such a practice and the consequences of this matter should be paid
full attention by the auditor while making an auditing appointment (Heeler, 2009).
It is the duty of the auditor to highlight all the unethical means followed by the company regarding the
destruction of the environment and shown the same in their reports so as to summon the people at large. So it
the responsibility of the auditor to conclude that is the company guilty of the charges that have been put on the
same.
Answer part A-2
In cases similar to the one of Pharmaceuticals Ltd, if on knowing the manipulative and the unethical means
followed by the company on a large scale, if the management is not getting involved in presuming and setting
things correctly, then the auditor should step forward and take the following actions:
 First of all the auditor should look into the financial statements of the company so as to detect any false
data placed in it which did not come into the eye of the management which is enough to fool the shareholders.
 The auditor should efficiently categorize the false data and measure its effect on the auditor’s report. If the
situations are worsening then the auditor has the full right to undertake assessment procedures to fix the
problems.
 It is the duty of the auditor to detect any flaws in the financial statements related to the manipulative data
put up by the management. All the concept of the audit should be thoroughly applied by the auditor under these
circumstances before questioning the reliability of the management of the company (Black, 2010).
2

Audit theory
 It is very obvious that the Pharmaceuticals Ltd would have carried out a number of manipulative
transactions illegally so as to capture and control the seriousness of the matter rather than disclosing it to the
public. It is thus the duty of the auditor to detect all those transactions and also to find the steps deliberately
followed to record such transactions.
 Strictness should be maintained by the auditor in each and every flaw made by the company. As in this
case, it was seen that the management was weak enough so as to control the manipulative steps taken and in
such cases the work of the auditor increases as it is expected that the steps followed by the auditor will be
strictly effective and positive in nature (Messier, 2013).
Answer part A-3
Reaction Pvt Ltd received the appointment letter for conducting an audit in the Billing & Associates Company.
The letter was approved and accepted with respect by the Reaction Pvt Ltd. While carrying out the audit
procedures in order to finalize the report, a situation of absence of documentation aroused which had relation
with the transactional receivables of the company. Under this circumstance, it was decided that a manipulated
report will be shown to the public.
It is also possible that the company can cancel the audit letter and ask the latter to only check the position of the
company which is enough to define its status. This shows that the working of the audit company is very much
confined. It is also seen that the company now proclaims that no audit is needed at this time. This questions the
audit company as to why it accepted the letter if their no need of it at present. But this also highlights that the
Billing & Associates Company is putting effort to conceal its mistakes of the absence of documents. This can be
guaranteed because of the proclamation made by the company just after all the audit procedures have been
strictly completed (Wood, 2011). But it is also necessary to issue the finalized report which was made in
absence of the documents on the part of the invitee company.
Answer part A-4
 Many conditions arise which confine the independence of the auditor with a term involve called “self-
review”. If a company has been following manipulative methods then it is the duty of the auditor to inform the
effects of such practices on the financial statements. But it should be kept in mind that the duty of the auditor is
only to inform the management and not to suggest ways in which the following practices can be controlled and
situations can be made the batter (Cappelleto, 2010). If this happens then the auditor has no right to check the
modified and updated financial statements as he himself had suggested the ways to change it.
3

Audit theory
Maintaining the independence of self-review of the auditors is very much important for an auditor so to present
a checked and legal picture of the company without any flaws.
 A major threat can be a self-interest threat. For instance, if the client asks for the travel services
recommendation and the same is not given by the auditors then it can result in the auditor firm losing its client.
This can be avoided if the auditor is at par with the client and maintains an only professional relationship with
them. It must also be seen that the auditor should reject any piece of work which is not included in the contract.
If any pressure is maintained on the auditor then the audit company must break the contact so as to keep the
independence of the auditor at the first priority (Vause, 2009).
 Familiarity threat can also be a case with an auditor as the wife of one of the auditors is holding a good
amount of shares in the company. This kind of threat takes place when the auditor pays much affection in the
form of affection towards the company so as to safeguard the profits of the ones in close contact (Carcello,
2012).
This can be avoided if any other charted accountant from any other company is appointed in order to check the
reports prepared by the previous auditor who was getting sympathetic towards the company.
 Intimidation threat arises when the auditor hints the fact that he is not going to be paid for all the hard
work he has done. Creation of a doubt is the basis of this threat. Though there is no direct action by the client of
non-payment of the fess the matter is suspected by the auditor due to the course of actions followed by the
client.
This threat can be avoided if the auditor demands his fees from the client before submitting the final report to
the company management. This is done so as to guarantee the fees receiving because if the report is submitted
then there can be a chance that the auditor doesn’t get paid (Church et. al, 2008).
4

Audit theory
Answer Part B
(A) Business Risks (B) how it might lead to the threat of material
misstatement
 High Lease Payments:
Due to the conversion of the premises and the lands
of the company into a residential category, problems
are being faced by the same. The landlord demands
for 50% more rate which could be a choking expense and
and could turn into a massive loss for the company in
the future.
Manipulative or illegal means can be seen to be
adopted and followed by the company as it may try to
Depict false entries in the records and may try to increase the
received amount and thus show a profit on their part. All
this results in a decrease in the losses in the financial
statements which have come into action due to the
uprise in the rent for the company (Elder et. al, 2010).
 High level of stock obsolescence:
As per the thought to increase the profits of the
company, it was seen that CPPL was keen enough to
increase their items present in the market. But the
products have not found value in the market and as a
The result of this the stock obsolescence had
an increase way too high.
Manipulative or illegal means can be seen to be
adopted and followed by the company as it may try to
depict the inventory at a high position and in a healthy
State and thus concealing the stock obsolescence
(Roach, 2010). All this is to depict the company
as a profit-making one and to
keep up the hopes of the investors and attract
the new ones.
 Constrain on the availability of cash:
It is also seen that the company CPPL is facing upsets
From its two trusted suppliers. These suppliers
have deducted the payment time from 30 to 14
days and have also reserved their volume rebates.
There is also a fear that the profits can greatly be
reduced to a minimum in the future if the services are
provided on a regular basis and continuously.
Manipulative and illegal means can be seen to be
adopted by the company in order to depict increased
cash sales in the book of accounts and thus to depict
that ready cash is available with the company to pay
off the debt as the time provided by the creditor
has been reduced (Riddle, 2015).
 Drop in the profit margins: Manipulative and illegal means can be seen to be
5

Audit theory
To survive in the market and shield against the
dominance, the company has concluded to give
value added services. This plan was successful in
attracting the costumes but affected the profitability
by deducting it by 10%.
adopted by the company so as to conceal the losses
From the public. For this alteration can be made in the
Financial statements of the company. All this is to
depict the company as a profit-making one and to keep up the
hopes of the investors and attract new ones (Gay &
Simnet, 2015).
 High level of competition:
A tough level of competition has been seen in the
the market as the expanded companies are dominating
the minor ones by taking over them. There is also a
reduction in the price of the items so as to maximize
The shares in the market by upholding the costumes
It is very much possible that the company is deciding to
Giveaway unexpected discounts in order to avoid them
Dominance faced by it in the market and to keep them
attracted to the company
(Messier, 2013). This can result in an
Increase in expense and this discount can be assumed by
The management as unrecoverable or as bad debts.
6

Audit theory
Answer part-C
(A)Deficiency in internal control Explanation of business risk
Arising due to deficiency in
Internal control.
(b) Control (c) Test of control
 Deficiency in the internal
control can be defined
as a situation when the
website of the company
is not aligned with the
inventory status and is
not scanned for results
Whenever an order is
placed.
As mentioned, it can happen
The inventory is not updated as
Per the order paced. This can be
A loss to the company because
A case can arise in which the
Order is accepted by the
Inventory is not in a position to
Dispatch it as it lacks it.
It is advised for the
Company to follow ERP so
As to align the inventory
As per the order which
Will enable it to check the
Present stock status and
Display the correct
Result.
Placing of a practice order
Can be a method which
Will help the management
To conclude that
Whether the inventory is
Potentially in system or
Not which will be helpful
In displaying correctly
Results professionally.
 It may happen in many
cases when the delivery
of a particular product is
made in accordance with
The order placed that the
signatures of the product
receiving person is not
demanded which can
result in costumer
complaints and delay in
The delivery of the
products.
This can result in decrease of
The respect of the company in
The market as the company is
Not at all aware of the products
That has been dispatched for
Delivery and only pay attention
When the customer complaints
As per the cases the company
may lose its customers in the
future which may
be massive in nature
(Matthew, 2015)
The loss to the company.
All the processing as
from the placement of
the order till its delivery,
All the information
should be timely
recorded on the system.
also the mandatory
the sign should be taken and
transferred to the system
online. This helps the
salesman to take the
signature and quickly
update it to the server of
the company. All this
processes helps the
It is duty of the auditor to
analyze the website of the
the company so as to get all
The information about the
transactions carried by the
company (Gay & Simnet, 2015
This is done so
as to detect the delivery
date of the products in
compliance to the placed
order.
If the signatures are done
manually, then random
verification/ checking of
signed receipts shall be
7

Audit theory
company to track the
delivery time in the
future.
done by the audit team.
 Credit limits and also the
Payment date is
Analyzed by the retail
Sellers before an order is
Accepted by them. The
Payment date is
Concluded by the sales
Ledger clerks and not at
Higher levels of the sales
Directors.
A risk prevails in the company
because the authority has
given the concluding power of
The credit limits to a lower level
of staff. Cases may also arise
resulting in credit limits
offered to such person who
have a dark background in
accordance with on time
payments (Geoffrey et. al,
2016).
All the problems arising
Due to the credit limits
Matter can be solved by
The decision that the
Credit limits are to be
Formed by the person
Sitting at the higher
Levels and so it should not be
decided by the lower
Staff.
The auditor shall check the
reconciliations maintained
by the company and
check the same from
invoices held by the
the company as well
(Ghandar & Tsahuridu
, 2013).
 Buying of raw materials
by the company can be
seen with alteration in
ledger department’s
members. The
compilation of the
supplier invoice cannot
be not be done by the
Company anymore.
Noncompilation of the
supplier statements with the
record causes excess or less
payments which cannot be
later verified as lack of invoice
is seen (Heeler, 2009).
All this can be avoided
easily by setting up a
a strong system which will
compile the suppliers
statements with the
company record
whether monthly or
quarterly.
The auditor shall check the
reconciliations maintained
by the company and
check the same from
invoices held by the
the company as well
(Guerard, 2013).
 Due to the alteration in
business over the past
six months, new
equipment have been
purchased in excess
without disposing of the
old ones.
Non-usage of the old
equipment mentioned in the
books is causing depreciation
expense resulting in a deduction
in the company’s profit
(Gilbert et, al, 2005).
All the problems relating
To this can be eliminated
If the out of date
Machinery Is sold as fast
As possible.
All the information required
Can be gathered by the
Looking into the registers,
Records, and the entries.
8

Audit theory
Answer to Part-D
Low materiality range clearly depicts that more work is necessary, more issues and matters may
arise, and therefore, the auditor must follow some conservative measures. In contrast to this, high
range of materiality portrays that lesser work is necessary, lesser issues and matters may arise,
and hence, the auditor must follow a lesser conservative strategy (Guan et. al, 2008).
Sequence Case Materiality impact Clarification
1. In the year June 2017,
the finance manager
of Sali had resigned
and no alternative has
been found since such
time
The level of
materiality shall
decrease in relation to
the prevalence of
material misstatements
in the financials.
The financial manager is not
present in the company since the
last month and therefore, there are
higher probabilities of material
misstatements that have been
undertaken by the concerned
employees
(Hoffelder, 2012). Besides, such
finances must have been
supervised by the department’s
junior authority that clearly assures
they have influenced the relevant
facts and figures in order to
conceal errors or frauds. Therefore,
this can result in a decline in
materiality, as additional work will
be needed to seek evidence.
2. The HR manager of
Sali had resigned in
June 2017 but his
alternative was
In this case, there will
not be any impact on
materiality.
There are various qualitative
attributes prevalent in Case I that
can possess an influence on the
company’s financials. However,
9

Audit theory
successfully found in
July.
the HR manager’s responsibility is
to manage and recruit the
employees and therefore, in his
absence, the recruitment may be
undertaken by other superior
authorities. Therefore, no impact
on financials will occur.
3. During the
performance of a
complete
reconciliation of
relevant information
on SuperD to
information on
SuperB in the year
June 2017, two
material variances
were found. Phil
(auditor) has made
inquiries with the
management who has
verified the fixation
of such errors.
The impact must be a
decline in the level of
materiality in relation
to material
misstatements in the
financials.
Two significant variances were
found in the transferred data
because of errors in the software or
intentional frauds on the part of
superior authorities liable for such
data transfer from SuperD to
SuperB. Therefore, a thorough
evaluation is necessary to
scrutinize the influence of such
variances
(Johnstone et. al, 2014).
4. Absence of purchase
vouchers of the
unlisted investments
from Dune Ltd that
consists of fourteen
percent of the net
There may be an
increment in the
materiality level.
The finalization of audit on July
2017 and receipt of purchase
voucher from the company was
undertaken even though such
document was not present during
the audit process
10

Audit theory
investments (Jubb, 2012). However, before
termination of the audit, the same
was made available and hence, a
thorough assessment is necessary
to prevent decline of materiality.
11

Audit theory
References
Arens, A. A, Best, P. J, Shailer, G. E. P & Loebbecke, J. K, 2013, Assurance Services and
Ethics in Australia, 9th ed, Australia: Pearson.
Black, W. K 2010, Epidemics of “Control Fraud” lead to Recurrent, Intensifying Bubbles and
Crises, Working paper, University of Missouri-Kansas City.
Cappelleto, G. 2010, Challenges Facing Accounting Education in Australia, AFAANZ,
Carcello, J 2012, ‘What do investors want from the standard audit report?’, CPA Journal vol.82,
no. 1, pp. 7-12
Church, B, Davis, S & McCracken, S 2008, ‘The auditor’s reporting model: A literature
overview and research synthesis’, Accounting Horizons vol. 22, no. 1, pp. 69-90.
Elder, J. R, Beasley S. M.& Arens A. A 2010, Auditing and Assurance Services, Person
Gay, G & Simnet, R 2015, Auditing and Assurance Services, McGraw Hill
Geoffrey D. B, Joleen K, K. Kelli S & David A. W 2016, ‘Attracting Applicants for In-House
and Outsourced Internal Audit Positions: Views from External Auditors’, Accounting Horizons,
vol. 30, no. 1, pp. 143-156.
Ghandar, A & Tsahuridu, E 2013, The Auditing Handbook 2013, Australia: Pearson.
Gilbert, W. Joseph J & Terry J. E., 2005. The Use of Control Self-Assessment by Independent
Auditors. The CPA Journal, 3, pp. 66-92
Guan, L, Kaminski, K. A & Wetzel, T. S 2008, ‘Can Investors Detect Fraud Using Financial
Statements: An Exploratory Study’, Advances in Public Interest Accounting vol. 13, pp. 17-34.
Guerard, J 2013, Introduction to financial forecasting in investment analysis, New York, NY:
Springer, pp. 78-81
Heeler, D 2009, Audit Principles, Risk Assessment & Effective Reporting. Pearson Press
Hoffelder, K 2012, New Audit Standard Encourages More Talking, Harvard Press.
12