Auditing Theory and Practice Case Study Report - ACCT6006

This report provides an in-depth analysis of auditing theory and practice, examining three case studies to illustrate key concepts. The first case focuses on MaxSecurity Limited, exploring inherent risks and preliminary materiality assessment. The second case delves into the strengths and weaknesses of debtor confirmation processes at MSMG, evaluating its effectiveness in obtaining audit evidence. The third case addresses ethical issues faced by Meg, analyzing potential threats to audit independence and recommending appropriate audit opinions and courses of action based on APES 110. The report covers audit risks, ethical standards, and reporting requirements, offering a comprehensive overview of auditing principles and their practical application. The report concludes with recommendations for addressing the ethical dilemmas presented in the case studies, emphasizing the importance of ethical conduct and adherence to professional standards.

Running head: AUDITING THEORY AND PRACTICE
Auditing Theory and Practice
Name of the Student
Name of the University
Author’s Note

1AUDITING THEORY AND PRACTICE
Table of Contents
Introduction................................................................................................................................2
Answer to Case 1.......................................................................................................................2
Requirement (A).....................................................................................................................2
Requirement (B).....................................................................................................................3
Answer to Case 2.......................................................................................................................4
Requirement (A).....................................................................................................................4
Requirement (B).....................................................................................................................5
Answer to Case 3.......................................................................................................................6
Requirement (A).....................................................................................................................6
Requirement (B).....................................................................................................................7
Requirement (C).....................................................................................................................7
Conclusion..................................................................................................................................8
References..................................................................................................................................9

2AUDITING THEORY AND PRACTICE
Introduction
Auditing profession involves in the examination and inspection of the client
company’s financial statements and records in order to ensure their accuracy and to ensure
that proper accounting regulations have been used in order to prepare them (Knechel &
Salterio, 2016). This report undertakes the analysis of different aspects of auditing such as
audit risks, debtor confirmation process and need to comply with the ethical standards in the
profession. There are three case studies which shows different issues in auditing. The aim of
the first case is to discuss about the major inherent risks in the audit of MaxSecurities along
with the determination of preliminary materiality. The aim of the second case is to discuss
about strengths and weaknesses of debtor confirmation. The aim of the third case is to discuss
about the ethical issued faced by Meg along with the audit report option and
recommendation.
Answer to Case 1
Requirement (A)
The following discussion shows the major inherent risks in the audit of MaxSecurity
that include both industry and entity risk:
The provided case indicates the operation of MaxSecurity in a highly specialized
manufacturing industry and it involves in the manufacturing of high-tech armour-plated
personal carriers. This requires MaxSecurity to keep a secure business environment in order
to protect the confidential and sensitive nature of its vehicles’ designs. This indicates towards
a crucial aspect that this complex nature of the operations of MaxSecurity might be
associated to the complex nature of accounting and financial transactions where the company
is needed to use different accounting estimates and accounting judgments. There can be the

3AUDITING THEORY AND PRACTICE
occurrence of material misstatements in the financial statements in the presence of complex
financial and accounting transactions (Nam, 2014).
The case states that MaxSecurity needs to go through a competitive market tender
process for getting big government contracts and this can lead to inherent risk coming from
external environmental factor. In order to get these orders, MaxSecurity can manipulatively
strengthen their financial statements. This is a crucial aspect that can materially misstate the
financial statements of MaxSecurity in the presence of financial manipulation which can
develop inherent risk of auditing (Brasel et al., 2016).
It can be seen from the case that there has been the installation of an off-the-shelf
costing system in MaxSecurity for supporting its highly sophisticated and cost-sensitive
nature of product design. High reliance of this costing system can be seen on the inputs of
manufacturing units for the calculation and production of database. Integration of this system
can also be seen with the general ledge entries. Therefore, there can be occurrence of
incorrect calculation of database related to product cost and sales price in case of incorrect
general ledger entries. This incidents can materially misstate the financial statements of
MaxSecurity which can develop inherent risk of auditing (Nam, 2014).
Requirement (B)
Audit planning considers the factors that can materially misstate the financial
statements; and this shows the relationship between audit risk level and materiality. The
objective of preliminary assessment of materiality is to establish an appropriate quantitative
level of materiality for audit planning. This puts the obligation on the auditors to take into
account the quantitative threshold which can be considered as a guide to determine
preliminary materiality (Sunderland & Trompeter, 2017). Following are certain quantitative

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thresholds that the auditors of MaxSecurity can use in order to determine preliminary level of
materiality.
 An amount that is larger than or equal to 10% of appropriate base value that may be
recognised as material except proof or considerable arguments is present
(aasb.gov.au, 2019); and
 An amount that is lower than or equal to 5% appropriate base value that may be
recognised as material except proof or considerable arguments is present (Johnstone,
Gramling & Rittenberg, 2013).
While developing the preliminary level of materiality, three particular aspects are needed
to take into account by the auditor of MaxSecurity. These three aspects are qualitative factors,
reliability of management information and any activity that shows that there is any deviation
in the normal business activities of the business (aasb.gov.au, 2019). In spite of the presence
of quantitative factors in the determination of preliminary materiality, it is the obligation on
the auditors of MaxSecurity to taken into consideration the audit outcome and the nature of
material misstatements (Boiral, Heras-Saizarbitoria & Brotherton, 2019).
Answer to Case 2
Requirement (A)
Debtor confirmation is important in auditing and the auditor of MSMG is also needed
to undertake the same. Debtor confirmation is important because of the fact that the auditors
can obtain the required evidence on the assertion of existence regarding accounts receivable
(Kalibayev, 2015). Positive confirmation from the debtors is considered as the external
evidence on the fact that these debtors owe MSMG for providing services. Debtor
confirmation also helps in providing the evidence for verifying the assertions of rights and
obligations in the presence of the aspect that the evidences on whether the debtors own the

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amount to MSMG can be obtained from debtor confirmation. Debtor confirmation does not
provide reliable evidence on the assertions of valuation and allocation.
It is evident from the provided case of MSMG that the total balance of trade
receivable that is $3,974,569 is material. It is also visible in the provided case that the
accounts of many small debtors are overdue for more than 60 days in spite of the fact that the
payment tem is 14 days. This indicates towards the unproductive credit approval as well as
debtor collection in Shady Oaks which can be considered as a key weakness of debtor
confirmation of the same (Miculescu & Grui, 2018). In addition, another crucial aspect is that
the auditor is not able to get any reliable information for the trade receivable assertions of
allocation and valuation from debtor confirmation of Shady Oaks. In Shady Oaks, five
different medical practitioners own 60% of the debtors of $3,974,569 that is $2384741, more
reliable evidence of valuation is required for proceeding further and this leads to doubt on the
recovery. This is another key weakness of debtor confirmation.
Requirement (B)
Chan and Partners has the option of sending debtor confirmation to the large trade
receivable balances in order to gain evidence on their existence. However, additional audit
procedures are required for gathering reliable information on the valuation assertion of these
large accounts balances (Gupta & Paswan, 2016). The time for which these accounts have
been unsettled is not mentioned. There is less probability that there is any doubt on the
recovery of the debtors due within the time of 14 days. However, it is required to mention the
aspect that the additional audit step of reviewing the following receipts would provide the
auditors of Chan and Partners with further audit evidence useful for assessing this kind of
large accounts balance. All these aspects indicate towards the essential fact that it is not
enough to only consider the debtor confirmation for the large trade receivable balances (Zuca,
2013).

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40% of the total debtors that is $1,589,828 is the smaller accounts in the trade
receivables and these accounts are more probable to be in major risk in the presence of the
aspect that most of these smaller accounts have failed to make payment to the company
within the credit term of 14 days. Debtor confirmation can provide the needed evidence to
assess the assertion of existence, but the need for additional procedures cannot be ignored to
assess assertion of valuation. Because of the fact that the company considers the allowance
for doubtful debts directly against the trade receivables, reviewing the trade receivable related
transactions along with the assessment of rationality in appropriate credit control would be
required to undertake by the auditors. Moreover, the auditors must undertake reviewing the
trade receivable receipts while analysing debtors’ characteristics since these processes are
crucial for obtaining evidence on small debtor’s valuation assertion (Patrick & Matthew,
2018).
Answer to Case 3
Requirement (A)
APES 110, Code of Ethics and Professional Accountants puts the obligation on Meg
to comply with the fundamental principles of auditing. These principles are Integrity,
Objectivity, Professional competence and due care, Confidentiality and Professional
behaviour. As per Section 100 of APES 110, certain factors can lead to the threat to the audit
ethical principles along with developing five types of threats to audit independence; they are
self-interest threat, familiarity threat, self-review threat, intimidation threat and advocacy
threat (apesb.org.au, 2019). Among all these threats, the occurrence of two threats can be
seen in case of Meg. They are intimidation threat and self-interest threat. Self-interest threat
can take place in case Meg is not willing to let the CEO down and when the audit firm does
lose the Champion Securities audit. Intimidation threat can take place in case Meg is
threatened by the CEO regarding the valuation. In order to replace Meg and the audit firm,

7AUDITING THEORY AND PRACTICE
the CEO’s statement can be regarded as threat which can eventually contribute towards
damaging audit objectivity by Meg in order to comply with the request of the CEO (Ottaway,
2014).
Meg has the option to take certain actions for adhering to the principles of APES 110.
First, she may ask another audit engagement team for joining her to review the audit of
Champion Securities so that the CEO can be effectively dealt with. Second, Meg can ask for
another Indepdent asset valuation of the audit client. Third, Meg can take the matter to the
Board of Directors and Audit Committee of Champion Securities. Fourth, Meg can take the
help of ASIC to resolve this issue. Fifth, she can ask for the permission to take the matter to
the AGM of Champion Securities. Sixth, she always has the option to resign form her post
(Bing et al., 2014).
Requirement (B)
Four types of audit options are available to Meg. First, in case there is an agreement
between her and the CEO regarding the appropriate valuation of asset, she can provide
unqualified opinion. Second, if there is an agreement in the presence of key uncertainty on
going concern of the firm, she can provide disclaimer of opinion (Chen et al., 2016). Third, in
case the wrong asset valuation does not have large impact on the financial statements of
Champion Securities, Meg can provide qualified audit opinion. However, this kind of opinion
cannot be issued when there is acute nature of valuation involved. Lastly, in case the wrong
asset valuation negatively affect the financial statements of Champion Securities in a key
way, Meg can issue adverse audit opinion (Tahinakis & Samarinas, 2016).
Requirement (C)
The recommended course of action for Meg would be to take the assistance of the
Board of Directors of Champion Securities and other audit engagement partners of the audit

8AUDITING THEORY AND PRACTICE
firm to solve the issue and to ensure the disclosure of appropriate asset valuation in the
client’s financial reports. In addition, issuing the disclaimer of audit opinion would be
appropriate for Meg where the obligation on Meg would be to ensure adequately disclose the
going concern uncertainty in the presence of the issue of valuation. In case the relationship
between Meg and the CEO worsens, then Meg would be recommended to resigning as the
auditor of Champion Securities while issuing adverse audit opinion. It is essential to mention
the fact that Meg should not come to an agreement with the unethical request of the CEO to
overstate the asset as this is against the ethical principles of the accounting profession.
Conclusion
The above discussion shows that complex nature of business can materially misstate
the financial statements of a company through complex processes of financial reporting. It
also shows that both the quantitative thresholds and qualitative matters are considered for the
determination of preliminary audit materiality. The above discussion shows the importance of
debtor confirmation in audit planning, but it also shows the debtor confirmation is not always
applicable when there is large account balances as this need additional audit procedures. The
above discussion also indicates towards the importance of adhering to the fundamental ethical
principles of auditing since non-compliance can lead to the occurrence of threat to audit
independence.

9AUDITING THEORY AND PRACTICE
References
Aasb.gov.au (2019). Materiality. Retrieved 21 August 2019, from
https://www.aasb.gov.au/admin/file/content102/c3/AASB1031_9-95.pdf
Apesb.org.au. (2019). APES 110 Code of Ethics for Professional Accountants. Retrieved 21
August 2019, from
https://www.apesb.org.au/uploads/standards/apesb_standards/23072019055710_APE
S_110_Code_of_Ethics_for_Professional_Accountants_December_2010_-_Final.pdf
Auasb.gov.au. (2019). Materiality and Audit Adjustments. Retrieved 21 August 2019, from
https://www.auasb.gov.au/admin/file/content102/c3/AUS_306.pdf
Bing, J., Huang, C. X., Li, A., & Zhu, X. (2014). Audit quality research report. Australian
National Centre for Audit and Assurance Research, Canberra.
Boiral, O., Heras-Saizarbitoria, I., & Brotherton, M. C. (2019). Assessing and improving the
quality of sustainability reports: The auditors’ perspective. Journal of Business
Ethics, 155(3), 703-721.
Brasel, K., Doxey, M. M., Grenier, J. H., & Reffett, A. (2016). Risk disclosure preceding
negative outcomes: The effects of reporting critical audit matters on judgments of
auditor liability. The Accounting Review, 91(5), 1345-1362.
Chen, P. F., He, S., Ma, Z., & Stice, D. (2016). The information role of audit opinions in debt
contracting. Journal of Accounting and Economics, 61(1), 121-144.
Gupta, R., & Paswan, A. K. (2016). Audit Quality, Auditor's Independence and Other
Parties. AAYAM: AKGIM Journal of Management, 6(2), 16.
Johnstone, K., Gramling, A., & Rittenberg, L. E. (2013). Auditing: a risk-based approach to
conducting a quality audit. Cengage learning.

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Kalibayev, M. K. (2015). Audit of accounts receivable as an essential element of organization
management. Актуальні проблеми економіки, (6), 370-379.
Knechel, W. R., & Salterio, S. E. (2016). Auditing: Assurance and risk. Routledge.
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Nam, L. H. (2014). Earnings management and audit fee responses in New Zealand. In 2014
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Ottaway, J. (2014). IMPROVING AUDITOR INDEPENDENCE IN AUSTRALIA: IS
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Patrick, K., & Matthew, K. (2018). Value for Money Auditing and Audit Evidence from a
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Tahinakis, P., & Samarinas, M. (2016). The incremental information content of audit
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Zuca, S. (2013). AUDIT PROCEDURES-RECEIVABLE AND SALES. Romanian
Economic and Business Review, 184.