Case Study: Auditing Theory and Practice - MaxSecurity and Ethics

This case study delves into auditing theory and practice through three distinct scenarios. The first case examines inherent risks within MaxSecurity Limited, a security product manufacturer, and the concept of materiality, exploring factors that influence its assessment. The second case analyzes the strengths and weaknesses of external confirmations as audit evidence, along with alternative procedures and the implications of relying solely on debtor confirmations. The third case focuses on ethical issues faced by an auditor, Meg Lithgow, highlighting violations of professional ethics and the available audit report options. The study emphasizes the importance of ethical conduct, professional competence, and objectivity in the auditing process, providing recommendations for auditors to maintain integrity and adhere to ethical standards. The study also covers the importance of auditing standards and their applications in real-world scenarios.

Running Head: Auditing Theory and Practice 0
Auditing Theory and Practice

Auditing Theory and Practice 1
Executive Summary
Auditing is that part of the process where books of figures are being checked weather being in
the accordance with the rules and standards set by the authorized people. The current report
depicts the three case studies based of different issues related to the practical working issues in
the companies. Case one elaborates the inherent risk in the organisation with the second option
of materiality in the firm. Case two explains the pros and cons of the External or Debtor
Confirmations in the organisation. The next available options with the auditors, if not satisfied
with the evidences available while examining the reports is also included. The last case study
also explains options available to the auditor if not complied with the laws and ethics by the
client or the company.

Auditing Theory and Practice 2
Contents
Introduction......................................................................................................................................2
Caste Study 1: Inherent Risks..........................................................................................................3
Materiality....................................................................................................................................4
Caste Study 2: External Confirmations...........................................................................................5
Strengths of External Confirmations...........................................................................................6
Weakness of External Confirmations..........................................................................................6
Is an only debtor confirmation the option for audit evidence?....................................................7
Caste Study 3: Ethical Issues faced by Meg Lithgow.....................................................................8
Audit Report Options...................................................................................................................9
Megs’ action................................................................................................................................9
Recommendation to Meg.......................................................................................................10
Conclusion.....................................................................................................................................11
Bibliography..................................................................................................................................12

Auditing Theory and Practice 3
Introduction
The accounting of the firm is just the basic part of dealing with the day to day
transactions of the company. The concept of auditing is to check weather the accounting is done
with compliance of the principles or not. The auditing of the enterprise improves the risk
associated, in daily routine operations (Knechel & Salterio, 2016). The risks are being there on
identified, given importance, studied, and related measures are taken. The auditing and
accounting are very apart from each other. The accounting is the process or the way of preparing
the books of accounts, maintain the records, but on contra the auditing is just the check to meet
the records with the code of ethics and fundamental principles (Hay, Stewart, & Botica
Redmayne, 2017).
This report will give the knowledge about the auditing and inherent risks associated with
the auditor, entity and industry as a whole. The concept of the materiality is shown in relation to
primary assessment and the factors affecting materiality for the organisation. External
Confirmation is another method of auditing in the firm or the organisation. Report includes the
strengths and weakness of External Confirmations, continuing with the other available options
other than External Confirmation in the auditing process of the organisation. The ethical issues
with other options and relevant options are also included in the report.
Caste Study 1: Inherent Risks
An audit risk in the enterprise is the one which is pointed out by the auditor in terms of
financial statements. Examples can be cited are: issuing the unqualified report, where the

Auditing Theory and Practice 4
qualified report is required, issue of the unqualified report where qualification was not required.
Inherent risk is the ones which explain the risk of material misstatement in the financials due to
the error of omission or misinterpretation. It includes the result of factors rather than the
controllable failures. These risks are generally considered high degree where, the degrees of
judgment or decision and estimations are included or when the transactions of the entity are
complex in nature (Schmidt & Ruhnke, 2014).
The inherent risk in the MaxSecurity, which deals in the making of the security products,
includes high degree of responsibility. The complex issues related to manufacturing and cost
analysis can lead to inherent risks. The complexity of the parts of the financials, involvement of
the management, old and obsolete technique can generate the inherent risk. The industry of the
whole security is affected in terms of the quality of products and security. The firm will have to
face the risks related to the net-worth, mismanagement, high cost and low profits within the
organisation (Griffiths, 2016).
1. Inherent risk related to auditor - The inherent risk relates the internal control in terms of
the assurance of the effectiveness and efficiency of the organisation, and those which are
not in control of the auditor in person like time limit, sampling risk.
2. Inherent risk at entity level - At entity level inherent risk is posed with the error or
omission in the financials due to controllable factors. It adds up the high degree of
judgement.
3. Inherent risk at industry level - This relates to the change in the external environment of
the organisation such as legal, political, social or economic, technical issues.

Auditing Theory and Practice 5
Materiality
The concept of materiality considers any item material when any income or expenditure
amounting more than a pre-specified percentage of intolerance in the income or expenditure
statement and those items should be shown separately. It depends on the various factors like,
nature of MaxSecurity, the complexity involved, technical issues, framework of financial
reporting required in the business. The size of the enterprise also affects the materiality they all
include the financial numbers, the digits of the top line and every other relatable account. All
these factors determine the materiality and affect the facts and figures of any organisation. The
statutory dues either can be paid or detected to the source, is considered as material in nature in
the organisation (Australian Government, 2015).
Even the small amount of any denomination is considered and is shown separately in the
books of accounts. If misstatements have done at individual level on a repeat manner that
conception is considered as materialistic in nature, and is to be shown correctly in the separate
space. The collective or the aggregate misstatements occurring in the organisation seems to be
taken as material in nature (Lakis & Masiulevičius, 2017).
The benchmarks are identified in order to consider the value of material items, financial
elements are assets, liabilities, capital structure, equity debt, and revenue and expenditure. The
attention seeking points in the financials of the entity, for a reason to visit financials, example for
evaluation of the financial performance users will directly focus on the top line, EBIT or net
assets of the business. The lifecycle of the enterprise and the industry in which, business is
operating, economic environment and factors are kept in mind (Cunningham, Kremin, & Warren,
2019). The capital structure of the firm or enterprise, weather of debt or equity or the
combination makes a difference in materialism. The related volatility also affects the material

Auditing Theory and Practice 6
items in the firm. The other related risk to the firms also matters while taking material things into
consideration (Cunningham, Kremin, & Warren, 2019).
Caste Study 2: External Confirmations
The parties which are not involved with the internal management of the organisation are
termed as external people of the organisation. External confirmation is a process of acquiring and
evaluating audit proof through a depiction of the information or any existing condition directly
from the other than internal party in a revert to a request for the information about a particular
element affecting statements in the financials or related affairs (The Importance of External
Confirmations as Audit Evidence, 2011). Taking decisions in respect of external parties consent,
the auditor considers the feature of the environment in which he is going to audit and the practice
of respondents in dealing with request of direct confirmation.
Strengths of External Confirmations
The audit report if obtained from external sources the audit evidence becomes more
reliable as they are obtained without any personal judgements in the firm.
The audit evidence if obtained from external independent sources, they are more authentic if
directly procured by the auditor. If that same evidence is procured by other person or inference it
becomes less reliable to use. The evidence becomes more reliable if it is presented in terms of
documentary format: weather paper, electronic or any other pre-defined format (Burt, 2016).
Weakness of External Confirmations
There is limited or not sufficient information in the internal sources in the enterprise to
support in the given statements being audited,

Auditing Theory and Practice 7
The internal sources are not that reliable and authenticate to take up the internal
information as evidence for the support of auditing report. The subject matter or the context is
highly subject in nature, or needs to be highly expertise (Putra, 2018).
There are various other factors like frauds related to documents, risk of management of
double or override of internal sources, which is not considered by the auditor from the internal
management in the organisation (Bragg, 2018).
Is an only debtor confirmation the option for audit evidence?
In practical sense, it is not advised to take up only debtor confirmation or receivable
confirmation as the solo audit proof of which existing bills or receivables confirmations will not
provide sufficient evidence of the correct valuation and allocation verification for the required
account receivables. As the receivables are material in nature, so the evidences are required.
The auditor in the firm is required to reconsider the data, numbers, assumptions and
methods which are being used up by the management in order to comply with sections and
authenticity.it is also advised to discuss the approach to available doubtful debt and continue
with the process to comply for the correct valuing (Benge, 2019).
The addition methods or the procedures to obtain the account receivables the summed up
balance will be inclusive of analysis of the required receipts and moreover the further receipts of
receivables from customer to the extent of the large outstanding balance from few practitioners
can be considered for the collectively (Benge, 2019).
This case focuses Auditing Standard ASA 230 Document, more specifically related to
paragraph 9 in referencing the nature, time and the extension of auditing procedure, recorded by
the auditor himself. the auditor can make notes of the following things such as the time and date

Auditing Theory and Practice 8
of completion of the task allocated, who was the person behind doing the task, identification of
the characteristics of the items being taken into the consideration, can enquire the person behind
the review of the task of the auditing performed, the date and the extension or details about the
notes to the report can be asked (Moroney, 2017).
Auditor can also intervene into the working and the reports which are mentioned into the
reports of auditing for that period. The auditor should be doing the verification via other parties,
the authenticity and the reliable of the available data and information can also be cross checked.
It should be done in order to make compliance justice with that huge amount stated in the case
study itself. The auditor should be ensured by checking the facts and figures by other sources and
above stated method.
Caste Study 3: Ethical Issues faced by Meg Lithgow
APES 110, the Code of Ethics for the Professional Accountants (Code) is issued by
APESB or Accounting Professional & Ethical Standards Board. APESB is an independent body
rooted as an initiative of CPA Australia, is responsible to develop and issue professional &
ethical standards in the general interest of public that is being applied to the bodies of
accounting. This code of ethics is precisely based on the CEPA, Code of ethics for Professional
Accountants issued by IESBA, International Ethic standards Boards for Accounts of IFAC,
International Federation of Accountants (Tsahuridu, 2014).
The firm should follow the following five stated fundamental principles issued by Code; they
are

Auditing Theory and Practice 9
 Integrity- is said when a person have the quality of honesty and follows the principles
strongly,
 Professional competence with due care- it includes the trait of being above average in the
terms of professionalism and taking care of each other in order to prevent any harm to
others,
 Objectivity- it defines the concept of follow the true and independent from individuals
subject to perception, thoughts, emotions or related terms,
 Confidentiality- means to have the trust of being privacy into the organisation and stick to
the norms of personal information,
 And, practice of professional behavior in the organisation (International Federation of
Accountants, 2019).
Here, in the Megs story the principle of Objectivity and professional competency are ignored.
She was not allowed to follow the set of auditing principles and make a report which is complied
with reliability and authenticity (Marx, Schonfeldt, Watt, & Dyk, 2014). Code of conduct
provides a framework based on a concept, auditors identify, examine and make a possible
solution to the threats while working in the organisation. It also defines the requirements and
applicability for identifying material and relevant topics to help members (Marx, Schonfeldt,
Watt, & Dyk, 2014).
Audit Report Options
Audit Report is the authentic source of the information gathered by the auditor for use of
the general public. This report is important as it includes all the source of information in
compliance with the code of ethics or fundamental standards by an authorized person say,

Auditing Theory and Practice 10
Auditor. This document is important for the potential investors in the equity market for that
company.
Megs’ action
Meg delivers authentic and reliable report to the CEO (Chief Executive Officer) of
Champion Securities, but he denies the report stating the reason being the false interpretation and
valuation of the assets in the scenario of the down market of the economic market. Under this
current scenario, she can now either make that unqualified report to the qualified or can
withdraw from engagement if no action for correction in the financial statements of the company
is taken (Ferrell, 2016).
Recommendation to Meg
The ethical recommended solution which can be done by Meg is that she can walk away
from the organisation in which such embezzlement occurs at top level of management.

Auditing Theory and Practice 11
Conclusion
The concept of auditing can be understood with the help of the given three case studies.
The report makes the study of keeping the books correlate with the principles related to its use
and making process. The auditing when done in the business or a firm, they need to follow some
principles to meet certain standards and principle. And with pre-defined norms the auditor need
to check it reliability and authenticity. Report included the inherent risk covered in order to
minimize the occurrence during the working operations in the business. Giving brief about the
Debtor Confirmation, with the positive and negative points are mentioned in the report. The
another case study talked about the Meg Lithgow, the service provided by her was correct but the
CEO due to its ill behavior the report made by the lady was not regarded as appropriate and was
commented not good. She now can either withdraw from engagement or continue if the CEO
agrees to the required changes.