Auditing Theory and Practice: Analyzing Financial Misstatements

This report analyzes several financial transactions to determine if misstatements made by management are judgmental or errors. It covers wrongly recorded sales transactions, warranty expense misstatements, incorrect charging of redundancy expenses, and failure to record impairment losses due to drought-induced recession. The auditor's role in advising management on necessary adjustments is discussed, emphasizing adherence to accounting principles and standards like AASB 136. The report also details how these misstatements affect specific accounts, such as sales, cash, warranty expenses, rental expenses, and asset values, and suggests corrective actions like adjustment entries and proper recognition of impairment losses to ensure a true and fair financial statement presentation. Desklib provides a platform for students to access this and similar solved assignments.

Running head: AUDITING THEORY AND PRACTICE
Auditing Theory and Practice
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1AUDITING THEORY AND PRACTICE
Table of Contents
Answer to Question 1......................................................................................................................1
Answer to Question 2......................................................................................................................3
Reference.........................................................................................................................................4

2AUDITING THEORY AND PRACTICE
Answer to Question 1
The main purpose of this assignment is to analyze the transactions which are shown in
the financial statement of the business and comment whether the misstatements which the
management of the company made in the financial statements are judgmental misstatements or
errors. The different transactions are recorded in the auditing working papers so as to clearly
identify the transactions (Lenz, 2013). The various transactions are explained shown and
discussed below:
1. The management has wrongly recorded sales transaction for the month of July in the
month of June. The amount of sales which is misstated is shown to be $ 5,50,000 which
is material enough. This can be judgmental misstatement on the part of the accounting as
he took the sales for the month of July in the month of June (Knechel & Salterio, 2016).
The auditor in such a situation would advise the management to make necessary
adjustments so as to ensure that the financial statements are represented in a fair way.
2. As per the situation the warranty expenses are shown to be $ 1,50,000 for June 2017 and
the provisions made is shown to be $ 1,00,000. However, the provision is expected to rise
as there is still cases of disputes which is ongoing with the customers. The auditor
estimates that such misrepresentation may be a result of judgmental misstatement on the
part of the management (Christensen, Elder & Glover, 2015). As per the principles of
accounting businesses should record any probable losses which the business is likely to
face in future. Therefore, the provision for losses needs to be increased by the correct
amount. The auditor will be advising the management to make the appropriate changes in
the reporting and recording of provisions.

3AUDITING THEORY AND PRACTICE
3. In this transaction Redundancy expenses are wrongly charged to rental expenses. This is
an error on the part of the management which will be misstating the profit or loss of the
business and thereby not enabling true and fair view of the financial statement (Barndt,
Fuller & Flynn, 2016). The auditor in such a case will advice the business to pass
adjustment entries so that the transaction can be reversed and appropriate transaction can
be passed.
4. As per the transaction no impairment loss has been recorded in the financial statements of
the business even though there has been a severe drought which has affected property
values in the regional areas where the company has 8 branches. The management of the
company needs to record such impairment losses as this will materially misstate the value
of the assets of the business and misrepresent the balance sheet of the business. The
auditor needs to determine the exact amount of losses following AASB 136 Impairment
of assets requirement (Bond, Govendir & Wells, 2016).
Answer to Question 2
The judgmental misstatements and errors which have been identified by the management
in the financial statement of the company will be affecting the following accounts
 The sales transaction for the month of July is presented in the month of June which will
be overstating the sales value of the business during the year and also affect the cash
account balances thus overstating them as well. If the sales are on credit basis that
account receivables will be affected. The management can rectify the same with passing a
reverse entry in both the accounts.

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 The warranty expenses which are estimated by the business for which the management
needs to create appropriate provisions. This will affect the warrant expenses account in
general ledger account and also profit and loss account of the business. The same can be
corrected by passing entries for creating provisions.
 The redundancy expenses will have a contra effect as it will lower the office and
administration expenses and overstate the rental expenses of the business. This will also
be affecting the profit and loss account not the balance but misrepresentation of the
values in the financial statement. The management of the company can pass adjusting
entries so as to facilitate rectification of the error.
 The omission of impairment loss from the financial statements of the business will be
misstate the assets of the business and the balance sheet of the company. The
management needs to follow AASB 136 and recognize impairment losses accordingly.

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Reference
Barndt, R. J., Fuller, L. R., & Flynn, K. E. (2016). Teaching Inherent Risk and Tolerable
Misstatement in Auditing: A Modified Delphi Method as a Teaching Tool. In Advances in
Accounting Education: Teaching and Curriculum Innovations(pp. 125-140). Emerald Group
Publishing Limited.
Bond, D., Govendir, B., & Wells, P. (2016). An evaluation of asset impairments by Australian
firms and whether they were impacted by AASB 136. Accounting & Finance, 56(1), 259-288.
Christensen, B. E., Elder, R. J., & Glover, S. M. (2015). Insights into large audit firm sampling
policies. Current Issues in Auditing, 9(2), P7-P18.
Knechel, W. R., & Salterio, S. E. (2016). Auditing: Assurance and risk. Taylor & Francis.
Lenz, R. (2013). Insights into the effectiveness of internal audit: a multi-method and multi-
perspective study.