Auditing and Assurance Services Report: Ethics & Inventory

This report provides a comprehensive analysis of ethical issues within auditing and assurance services, using a case study involving OS Ltd. The report identifies ethical breaches related to confidentiality, auditor independence, and potential conflicts of interest. It examines the roles of various parties, including the auditor, the assistant to the managing director, and their relatives, highlighting their actions and ethical implications. The report recommends specific courses of action to prevent future ethical violations, such as maintaining auditor independence, ensuring confidentiality, and adhering to professional standards. Furthermore, the report details the inventory audit procedures for GHT Ltd., emphasizing the importance of physical stocktaking and alternative procedures. It discusses key audit assertions, such as existence, and provides a framework for conducting effective inventory audits, including the potential outcomes of these procedures. This report, available on Desklib, serves as a valuable resource for students studying auditing and finance.

Running Head: Auditing and Assurance Services
Professional Ethics &
Inventory Audit

Auditing and Assurance Services 1
Executive summary:
In this report, the ethical issues involved in the given case of OS Ltd are identified where the
assistant of the managing director of the company has disclosed the insider information of the
company with the external parties i.e. auditor and auditor’s relatives regarding the quotes
bided by the auditor in the tender of provision of auditing services to the company. This
information disclosure has given rise to certain ethical problems for all the parties involved in
such communication. For such ethical problems various courses of actions have been
recommended in this report.
Part A
Introduction:
Andy smith is the senior manager of firm of auditors. The auditor is well known for the
professional and personal skills possessed by him in the areas of auditing. However, Andy
has a weak track record of building a wide client base for the firm. With the intention of
securing the position in the auditing firm, the auditor is proposing to bring some new clients
to the firm. In search of potential clients, Andy has prepared and presented the tender to be
presented to the board of directors of Office Suppliers Ltd, which is a large of furniture and
technology. The company is are considering the idea of replacing their existing auditor.
Silvya, who is the assistant of managing director of the proposed company has communicated
significant matters regarding the MD’s evaluation of proposal of Andy’s firm with respect to
the provision of audit services, to her neighbour who is the relative of Andy’s wife. In this

Auditing and Assurance Services 2
way, Andy has come to know about the points that are being considered by the managing
director of the company.
Ethical issues involved in the case:
Ethics are the moral principles to govern the behaviour of any person conducting any activity.
In this case, the possible ethical issues involved in relation to each of the party mentioned
above will be identified. The professional accountants i.e. the auditors acting in practice are
required to maintain the trust of general public by maintaining highest ethical standards. They
are supposed to follow the basic ethical principles of auditing profession. Those principles
are: Integrity, objectivity, professional competence, confidentiality and the professional
behaviour. The auditor is required to remain honest throughout the course of providing
professional services (Rossouw, Prozesky, Plessis & Prinsloo, 2010). They are required to
respect the confidentiality of their client’s information while they are engaged with such
client to provide the various auditing services. They are also required to apply high level of
competence and due skills to their professional engagement. Moreover, they must act in the
interest of their professional values and hence should not bring any disrepute to the auditing
profession. While complying with these fundamental principles, the auditor may have to face
various potential threats arising due to a wide range of situations and relationships. These
threats may range from self-interest threats to self-review threat, advocacy threat, familiarity
threat and intimidation threat (APESB, 2010).
Ethical issues with Andy, the auditor:
Before accepting the audit engagement the auditor must ensure that whether the client is
replacing their existing auditor or appointing an auditor for the first time. In this case,
auditor’s firm was intended to be appointed in place of existing auditor of OS Ltd. Therefore,
the firm of auditor was under the obligation to determine the reasons for which the existing
auditor is not accepting the engagement for the further periods (Brown, Stocks & Wilder,

Auditing and Assurance Services 3
2007). Prior to responding to the tender of the auditing services, Andy must contact with
existing accountant so that inquiries may be done in assessing whether there exists any
professional or other related reasons for which the existing member is disassociating his
name from the proposed client. Andy must have asked the existing auditor to provide such
information and facts, which in his opinion are necessary to be known for the new auditor
before accepting the audit. Also, the member in public practice must take due-permission of
the proposed client, in writing, to communicate to their existing auditor. In the absence of
such permission the auditor will be held guilty for the professional misconduct in carrying out
the professional services in practice. In this case, Andy does not seem to have made
necessary and adequate efforts to communicate to the existing auditor of OS Ltd. and hence
he must be found to be guilty of professional misconduct.
The auditor must be selected as the auditor of the company on the basis of his own
professional skills and competencies and not by the way of soliciting other people associated
with the company for his appointment as the auditor. In this case the auditor’s intention of
getting appointed as the auditor is correct but asking the help of employees of the company to
manipulate would not be an ethical manner of getting appointed as the auditor. Also, the firm
of auditors is charging an unreasonable price for the audit of the proposed company which is
not ethically justified. The involvement of relatives in the professional conduct of services or
for obtaining a client is not an ethical manner of getting an audit appointment.
In the current case the auditor may be influenced by the familiarity threat as it has close
family relationships with a person i.e. Lisa, whose acquaintance i.e. Silvya is the employee of
the proposed audit client i.e. OS Ltd. The idea of points on the basis of which the managing
director of the company was in knowledge of Silvya and therefore it was communicated to
Andy. This communication might have influenced the auditor to amend the tender as per the
client’s evaluation basis merely for the purpose of soliciting the client. Such communication

Auditing and Assurance Services 4
has adversely affected the fair competition principle. Moreover, the auditor had to face the
risk of self-interest because the basis purpose of responding to the tender of provision of
auditing and assurance services to the client was to widen the client base of the company to
secure a safe position in the membership of partnership (Karacaer, Gohar, Aygün & Sayin,
2009).
Ethical issues on Silvya:
Silvya has the major role in promoting the overall unethical behaviour of all the parties that
are involved in the case. She has confused her professional duties with the personal relations
maintained by her which is not at all justified ethically. This act of leaking the private
information of company regarding auditor’s appointment has taken away the spirit of probity
from the entire process. The act of Silvya is against the principles of corporate governance as
issued by Corporate Governance Council of Australia.
The auditor’s wife may indirectly influence Lisa to further influence Silvya to manipulate the
managing director of the company to appoint Andy as the director of the company. Lisa and
Andy’s wife are not obliged to act in accordance with the professional ethics that are
applicable to their relative on whom the standards of professional ethics are applied, they
must act in the manner that is ethically correct.
Further, there is a risk that if Andy’s firm is appointed as the auditor of OS Ltd, they might be
threatened with the risk of self-interest as the managing director of the company can appoint
them as the auditing firm only with the condition that the firm would act in interest of the
company as and when required (Jackling, Cooper, Leung and Dellaportas, 2007). This
condition might adversely impact the independence of the auditor’s firm to form an opinion
on the financial statements of the company. It is also not ethical on part of Silvya to reveal
out the confidential information of the managing director’s evaluation of auditor’s selection

Auditing and Assurance Services 5
to such auditors. The assistant of the managing director must respect the confidentiality of the
company’s matter and they must ensure that such information does not reach out to the
external parties who are no part of company’s management.
Courses of actions to be undertaken to avoid such ethical issues:
In the current case the auditor must ask the managing director of the company for the
permission to communicate with the existing auditor before responding to the tender of
auditing services (Rossouw, Prozesky, Plessis, Prinsloo, 2010). Further, the auditor must
charge a reasonable price for the provision of auditing services which must not be too high or
too low in comparison with the other auditing firms of the industry. The auditor must not
provide any services other than the auditing services or the services for which he is eligible to
provide. Moreover, the auditor must disclose in advance his connection with the employees
of the appointing organisation. The auditing firm must ensure that their independence would
not be affected due to the familiarity between one of the member of the engagement team and
the employees of the appointing company (Falk, Lynn, Mestelman & Shehata, 1999). Silvya
must not confuse personal relations with her professional relations with the auditor or his
relatives.
Before accepting the new engagement the members must ensure that whether the acceptance
would bring any threats to the fundamental principles compliance. The significance of such
threats must be assessed by the engagement member. As per the fundamental principle of
competence and due diligence, the auditors are only supposed to provide those services that
any member in practice is competent to perform. If the auditor has noticed before accepting
the engagement that such acceptance of any audit engagement will impose various threats to
the above discussed fundamental principles. To safeguard himself from the potential threats,
the auditor shall apply comply with the requirements of statute in this regards. They are
required to act in the most professional ways while dealing with such threats. The member in

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public practice must exercise professional judgement to determine what is ethically correct
and how to deal with such threats in the best possible manner to reduce them to the
acceptable level.

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Part B
Executive summary:
In this report, the procedures to carry the audit of inventory held by GHT Ltd. have been
discussed. This reports sets out the importance of physical stock taking as the audit procedure
in the conduct of overall audit of the company. It also covers the other alternative procedures
that needs to be applied in the impracticability of attending the physical inventory count at
the reasonable intervals of the management. While forming an audit opinion on the
genuineness of financial statements of the company the auditor must not blindly rely on the
management’s contention that the stock has been physically verified by them at reasonable
time intervals and it has not found any material discrepancies.

Auditing and Assurance Services 8
Table of Contents
Executive summary:..............................................................................................................................6
Introduction:..........................................................................................................................................8
Key financial report audit assertions:....................................................................................................8
Inventory Audit Procedures:..................................................................................................................9
Outcomes of audit procedures:...........................................................................................................11
Conclusion:..........................................................................................................................................12

Auditing and Assurance Services 9
Introduction
Audit assertions are the claims of both implicit and explicit nature, made by the management
of the client entity of the auditor, regarding the appropriateness of different elements of
entity’s financial statements and their disclosures. As the management of the company is
involved in the preparation and presentation of financial statements of the company, it makes
various assertions in relation to the recognition and measurement criteria and the presentation
of all the elements of financial statements such as assets, liabilities, incomes and expenditures
etc. The management also make claims for the adequate disclosure of such elements in the
financial statements in accordance with appropriate financial reporting framework applicable
on the entity.
Key financial report audit assertions
Following are the key financial reports assertions and their objectives for the audit of
inventory of GHT Ltd.:
Existence of inventory in the company’s warehouses: Inventory audit is carried to verify
whether the inventory shown in the financial statements of the company actually exists in the
warehouses of the entity. For this purpose the data sheet of stock records GHT Ltd is not
sufficient to provide a reasonable assurance on the true existence of inventories rather
physical inventory taking must be attended to confirm the existence of the inventory.
Completeness of records regarding the inventory: Another objective of inventory audit is
to ensure whether the all the inventories units and items that must have been recorded, have
been completely recognised in the company’s financial statements. Moreover, the inventory
units that are lying with the third parties on behalf of the present company have been
incorporated in inventory balances (Quizlet, 2018). The completeness of the records must be
checked using the stock data provided in the excel sheet provided by the company.

Auditing and Assurance Services 10
Rights and obligations of company regarding inventories: The next audit objective is to
determine whether the client is owning and controlling the inventory that has been actually
recognised in the financial statements of the company. It must also be ensured that the
inventory held by the company on behalf of other parties is not recognised as the part of
company’s inventory in the financial statements (Arens, et al., 2007). The legal entitlement of
the inventory can be judged on the basis of supporting documents i.e. invoices and tax
certificates. But the inventory data provided in the excel sheet cannot be used to obtain
reasonable assurance for the same.
Valuation of inventories: It must be ensured that the inventories of the company are
recorded at the appropriate values as per the relevant accounting standards in the financial
statements of the company. Any cost component that could not be adequately allocated to the
cost of production and any abnormal wastage is excluded from the inventory’s cost. Also, the
the appropriateness of the method of inventory valuation must also be examined. As in the
present case, the management of the company has employed FIFO method of inventory
valuation so it is to be checked whether the said method is reasonable to be applied to the
inventory of the company on the basis of its nature (Accounting Simplified, 2013).
Accuracy of records of inventories: It is to be evaluated whether the inventory records are
maintained with complete accuracy without any significant arithmetical or logical errors. All
the inventory balances are posted to the appropriate accounts with proper classification
(DeHoratius & Raman, 2008).
Inventory Audit Procedures:

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To achieve all the above discussed audit objectives necessary audit procedures will have to
be applied. As inventories are the significant part of entity’s business, it must be ensured by
the auditor of the company that these are recorded, valued and disclosed in the financial
statements appropriately. Hence, it is required to apply both test of controls and other
substantive procedures such as test of details and analytical procedures to obtain evidences
based on which it can be concluded that financial statements are not misstated in the areas of
inventories (Office of auditor general of Canada, 2017).
The internal controls of the company in the areas of inventory must be tested to check the
correctness and completeness of inventory records. Since it is not possible for the auditor to
attend the physical stock taking due to time or inventory locational constraints, the auditor
must consider applying additional auditing procedures to verify the existence and condition
of the inventory so that the inability of attending the physical stock count does not cast any
limitation on the scope of audit (Choy, Lee & Cheung, 2004). In such case, the forward
calculations can be made taking the amount of closing inventory from the financial
statements prepared as on 31.03.2018. This figure of closing inventory can be adjusted for the
purchases and sales figures taken from the data sheet provided by the management, to
determine the amount of inventory available at the date of physical stock count. This method
is known as backward calculation. The figure so obtained can be reconciled with the actual
physical stock on that particular date. This procedure can provide a reasonable level of
assurance about the existence of inventory as on 31.03.2018.
The (Hoffman & Zimbelman, 2009). Moreover, the auditor must reconcile the inventory
records with the relevant invoices in such context. The invoices of purchase and sale of goods
helps the auditor to identify the actual inward and outward movement of inventories during
the period covered under audit (Louwers, Ramsay, Sinason, Strawser &Thibodeau, 2008).

Auditing and Assurance Services 12
To check the correctness of the inventory records, the internal control system in regards to
inventory will be checked. If internal controls in these areas are found to be weak the auditor
will have to substantive audit procedures such as test of details and analytical procedures
(Whittington & Pany, 2010). Under the analytical procedures the auditor will make the
comparable studies of inventory records to understand the basic trend followed every year in
the business (AS 2510)
The cut off analysis can be undertaken using the stock data provided in the excel sheet. Under
this analysis the cuts off can be set for the sales figures and cost of sales figures. In the excel
sheet the filter to the column of purchase and sales date will be applied to verify the last
purchase and sales transactions that have impact on the available inventory and the
transactions that occurred before and after the month of march are identified separately with
different colours and their impact on the overall financial results has been removed (Chung &
Monroe, 2001). The sales figures for post period 31.03.2018 have been added back and
purchase figures have been deducted to incorporate the reversal impact are reversed back to
remove their impact on financial results. The similar process was applied to transactions
before the month of March to ensure that no transaction is recorded in the books. This reverse
calculation is performed because of the fact the company in case operates on perpetual stock
taking approach. Therefore, the sales and transactions entered in the periods prior to the
commencement of concerned year have already been accounted for in the prior period itself
as per the perpetual approach.
Outcomes of audit procedures:
The value of the inventory held by GHT Ltd at the end of the year is not in accordance with
the relevant accounting standards. The inventories must be valued at lower of cost and net
realisable value of such inventories. Through the use of this method the value of inventory
has been identified as $ 622532 whereas as per the financial statements prepared and

Auditing and Assurance Services 13
presented by the management of the company the inventory is valued only at $ 455319.55.
This undervaluation of inventory has made the financial statements to be materially misstated
and therefore they are not depicting the profitability of the company. Moreover, the inventory
records are also not containing the accurate data as there is a negative figure shown in the
sales quantity for order number 364163 and 3788411. The sales quantity cannot be negative
in any case. It has been observed that the company has a wide range of products in which it is
dealing which shows that the company has weak internal controls in these areas to classify
the inventories according to the nature and purpose of such inventories. Audit materiality for
sales transactions has been determined at $10000 and therefore sales transactions made for $
10000 or more during the year have been critically analysed using detailed audit procedures
to the authenticity of the inventory records. The inventory items for which the company has
reported gross loss have also been evaluated critically by identifying the reasons of such loss
and its impact on the overall profitability of the company. The gross profit and loss has been
determined in the excel sheet. It was found that company has incurred higher cost of
production due to the abnormal wastage of inventory items and due to allowance of excessive
discounts to the buyers and it has therefore lead to the operating losses. The detailed audit
procedures in these particular cases have been applied such as analytical procedures to
identify the past trend of operating profits and losses of the company (Gay and Simnett,
2005).
Conclusion:
The ultimate objective of conducting the audit of any entity is to enable the auditor to form an
opinion on the true and fair view of financial statements of the company. In the present case,
the inventory value in the financial statements is highly misstated and therefore the financial
statements are depicting quite low profitability of the company. This might have been done

Auditing and Assurance Services 14
by the management with the intention to show reduced profits to avoid the heavy tax
obligations. The auditor must ask the management to make the requirement adjustments to
the inventory values to make the financial statements free from material misstatements.
However, since the identified material misstatements are significant enough to be
communicated to the users of auditor’s report and hence the auditor must issue the adverse
opinion in this case to show the impact of undervaluation of stock for the purpose of
preparation and presentation of financial statements. Since the identified material
misstatement does not only impact the value of inventory but it has material influence on
other aspects of financial statements the auditor cannot issue a mere qualified opinion.

Auditing and Assurance Services 15
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