CHALIMBANA UNIVERSITY

SCHOOL OF LEADERSHIP AND BUSINESS MANAGEMENT

NAME...................................................EZZY MULAYA

STUDENT ID........................................2102026227

PROGRAM...........................................BSC. IN BANKING AND FINANCE

COUSRE...............................................AUDITING AND ASSURANCE

COURSE CODE....................................BAA 4100

COURSE LECTURER...........................DR KAALA, R.

ASSIGNMENT NUMBER......................TWO

CONTACT............................................0975211523

EMAIL [email protected]
 ASSIGNMENT TWO

QUESTION ONE

1.In the context of financial statements, distinguishing between fraud and error is
crucial for auditors and stakeholders alike. Both terms relate to inaccuracies in
financial reporting, but they stem from different motivations and implications.
Understanding these differences helps in assessing the integrity of financial
information and in implementing appropriate auditing procedures.

Difference Between Fraud and Error

• Fraud refers to intentional misstatements or omissions of amounts or

disclosures in financial statements designed to deceive users (Wells, 2014). It
involves deliberate actions taken by individuals with the intent to manipulate
financial results for personal gain. For example, a company might inflate its
revenue figures to appear more profitable than it actually is, thereby
misleading investors and creditors.

• On the other hand, error denotes unintentional misstatements or omissions that

occur due to mistakes in data processing or judgment (Knechel et al., 2013).
Errors can arise from various factors such as mathematical mistakes,
misunderstandings of facts, or misapplication of accounting principles. For
instance, an accountant may accidentally record a transaction twice, leading to
inflated revenue figures without any intent to deceive.

The key distinction lies in the intention behind the misstatement: fraud is
characterized by deceitful intent while error is a result of oversight or
misunderstanding (Rezaee et al., 2010).

2.Two Types of Intentional Misstatements Relevant to Auditors’ Consideration of

Fraud

• Fictitious Revenues Fictitious revenues involve recording sales that did not
occur. This type of fraud can significantly distort a company’s financial
position by inflating revenue figures. An example would be a company
 recognizing revenue from sales that were never made—such as creating fake
invoices for non-existent customers. This practice not only misleads investors
about the company’s performance but also violates accounting principles like
the revenue recognition principle outlined in ASC 606.

Auditors must be vigilant when assessing revenue recognition practices and should
look for red flags such as unusual spikes in revenue at period-end or discrepancies
between sales records and cash receipts (AICPA, 2020).

• Improper Asset Valuation Improper asset valuation occurs when an entity

overstates the value of its assets on the balance sheet. This can happen through
various means such as inflating inventory values or failing to write down
impaired assets. For instance, a company might report inventory at cost rather
than at lower market value when market conditions have deteriorated.

Such misstatements can lead stakeholders to believe that the company has more
resources than it actually does, potentially influencing investment decisions based on
inaccurate assessments of financial health (Schroeder et al., 2019). Auditors need to
evaluate management’s estimates critically and ensure that asset valuations are
supported by objective evidence.

3.Several red flags have been identified in the scenario at ABC Company that may
suggest potentially fraudulent activity:

• Unusually High Inventory Levels: Elevated inventory levels compared to

historical data may indicate overstatement of assets or potential inventory
manipulation (e.g., inflating inventory figures to improve balance sheet
appearance).

• Significant Increase in Accounts Receivable: A sharp rise in accounts

receivable could suggest that sales are being recognized prematurely or that
there are issues with collections—potentially indicating fraudulent reporting
practices.

• Excessive Sick Leave Taken by Key Employees: An increase in sick leave

among key personnel could signal potential collusion among employees who
may be attempting to cover up fraudulent activities during their absence.
4. The control environment sets the tone for an organization’s internal control system
and influences how control consciousness is perceived by its employees. The seven
factors include:

i. Integrity and Ethical Values: The commitment of management and employees

to ethical behavior influences overall organizational culture.

ii. Commitment to Competence: Organizations should ensure that employees

possess the necessary skills and knowledge for their roles; this includes hiring
practices and ongoing training.

iii. Board of Directors’ Oversight: An active board provides oversight over

management’s activities, ensuring accountability and adherence to policies.

iv. Management Philosophy and Operating Style: The attitudes and behaviors
exhibited by management can impact employee behavior regarding
compliance with controls.

v. Organizational Structure: A clear structure delineates responsibilities and

authority levels which helps prevent conflicts of interest.

vi. Assignment of Authority and Responsibility: Clearly defined roles help ensure
accountability; employees must understand their responsibilities regarding
internal controls.

vii. Human Resource Policies and Practices: Effective HR policies promote ethical
behavior through recruitment, training, evaluation, promotion, compensation
practices, etc., fostering a culture where compliance is valued.

These factors collectively contribute to establishing a robust control environment that

mitigates risks associated with fraud.

QUESTION TWO

Auditing is a systematic examination of financial statements and related operations to

ensure accuracy, compliance with regulations, and adherence to accounting standards.
The auditor’s opinion on the financial statements is crucial as it provides stakeholders
with an assessment of the reliability of the reported information. According to Arens
et al. (2019), “The auditor’s report is the primary means by which auditors
communicate their findings and opinions about the financial statements.” Below are
explanations of key concepts in auditing along with examples for each.

• Disclaimer of Opinion

A disclaimer of opinion occurs when an auditor cannot form an opinion on the

financial statements due to a lack of sufficient appropriate audit evidence or
significant uncertainties that prevent them from reaching a conclusion. This situation
often arises when there are limitations imposed by management or when there are
unresolved issues that could materially affect the financial statements.

Example: If a company has not maintained adequate records for inventory, making it
impossible for auditors to verify its existence or valuation, they may issue a
disclaimer of opinion stating that they do not express an opinion on the financial
statements due to insufficient evidence.

• Unqualified Opinion

An unqualified opinion is issued when an auditor concludes that the financial

statements present a true and fair view in accordance with applicable accounting
standards without any reservations. This type of opinion indicates that the audit was
conducted in accordance with generally accepted auditing standards (GAAS) and that
no material misstatements were found.

Example: A company’s financial statements are audited, and after thorough

examination, the auditor finds that all transactions are accurately recorded and comply
with GAAP (Generally Accepted Accounting Principles). The auditor then issues an
unqualified opinion stating that the financial statements are free from material
misstatement.

• Adverse Opinion

An adverse opinion is given when an auditor determines that the financial statements
do not present a true and fair view due to material misstatements or non-compliance
with accounting standards. This type of opinion indicates serious issues within the
company’s reporting practices.

Example: If an audit reveals that a company has significantly overstated its revenue
through fraudulent transactions, leading to misleading financial results, the auditor
would issue an adverse opinion indicating that the financial statements are not
reliable.

• Fraud

Fraud in auditing refers to intentional acts by one or more individuals among

management, employees, or third parties involving deception to obtain an unjust or
illegal advantage. Fraud can manifest as misrepresentation of financial information or
manipulation of accounting records.
Example: A manager might inflate sales figures by recording fictitious sales
transactions at year-end to meet performance targets. During an audit, if this
fraudulent activity is uncovered, it would be classified as fraud impacting both
internal controls and overall trustworthiness of the financial reports.

• Audit Verification

Audit verification involves confirming information presented in financial statements

through various methods such as inspection, observation, inquiry, confirmation,
recalculation, and analytical procedures. It ensures that all reported figures are
accurate and supported by appropriate documentation.

Example: An auditor may send confirmation requests directly to customers regarding

outstanding receivables listed on a company’s balance sheet. By verifying these
amounts independently, auditors can ascertain whether they exist and are accurately
reported in accordance with accounting principles.

In summary, understanding these concepts helps stakeholders assess the integrity of

financial reporting and reinforces trust in audited information.

QUESTION THREE

A. In an auditor’s report, two key phrases that hold significant importance are
"opinion" and "financial statements". Below is an explanation of these terms:

1. Opinion:

The "opinion" in an auditor's report represents the auditor's professional judgment

regarding the accuracy and fairness of the financial statements prepared by the entity.
This opinion reflects whether the financial statements provide a true and fair view of
the company’s financial performance and position, in accordance with the relevant
accounting standards (such as IFRS or GAAP). The opinion is a critical element of
the audit report, as it offers the auditor’s conclusion on the reliability of the financial
information presented.

Types of opinions that an auditor may issue include unqualified, qualified, adverse,
and disclaimer of opinion (International Federation of Accountants [IFAC], 2021).

2. Financial Statements:

The "financial statements" are formal records that summarize the financial activities
of an entity. These include key documents such as the balance sheet, income
statement, cash flow statement, and statement of changes in equity. These documents
are essential for stakeholders such as investors, regulators, and creditors to assess the
financial health of the entity. The auditor’s role is to evaluate these statements to
ensure that they are free from material misstatement and comply with the applicable
financial reporting framework (American Institute of Certified Public Accountants
[AICPA], 2022).
B.There are four types of audit opinions: unqualified, qualified, adverse, and
disclaimer of opinion.Each type reflects a different level of assurance and has distinct
implications for the audited entity.Let’s break them down.

• Unqualified Opinion

An unqualified opinion, AKA a clean opinion, is the best type of audit opinion a
company can receive.It indicates that the auditor found the financial statements to be
fairly presented in all material respects, as required by the applicable financial
reporting framework.When an auditor issues an unqualified opinion, they have found
no material misstatements during the audit. It also implies that the company has
adhered to the generally accepted accounting principles (GAAP) when preparing its
financial statements.

-Implication-can enhance the company's reputation and boost investor confidence.

• Qualified Opinion

A qualified opinion is issued when the auditor has identified material misstatements in
the financial statements, but these misstatements are not pervasive. In simpler words,
the financial statements are still largely reliable despite the identified issues.This type
of opinion is also issued when the auditor cannot obtain sufficient audit evidence for a
specific aspect of the financial statements. Still, the potential impact of the missing
information is not pervasive.

-Implication- can raise red flags about the company's financial health and
governance.On top of this, the type of audit opinion can hugely impact the company's
access to capital.

• Adverse Opinion

An adverse opinion is the most severe type of audit opinion. Something has definitely
hit the fan. Contrary to what I said earlier, this may be the best type of audit opinion–
at least for those with a penchant for chaos. It is issued when the auditor has identified
material and pervasive misstatements in the financial statements. This means that the
financial statements do not present a fair view of the company's financial position and
performance.

-Implication-An adverse opinion can have serious implications for the company,
including loss of investor confidence and potential legal consequences. It may also
trigger regulatory scrutiny.

• Disclaimer of Opinion

A disclaimer of opinion is issued when the auditor is unable to obtain sufficient audit
evidence to form an opinion, and the potential impact of the missing information is
pervasive. This could be due to limitations imposed by the company or circumstances
beyond the auditor's control.
-Implication-Similarly to an adverse opinion, a disclaimer of opinion can have serious
implications for the company. It indicates a significant limitation in the audit, which
may undermine stakeholders' confidence in the financial statements.

C.The following are the key components of the auditors report:

• Title

The auditor’s report should have an appropriate title that helps the reader to identify
itand easily distinguish it from other reports, such as that of management. The
mostfrequently used title is “Independent Auditor” or “Auditor’s Report” in the title
todistinguish the auditor’s report from reports that might be issued by others.

• Addressee

The report should be addressed as required by the circumstances of the engagement

andthe local regulations. The report is usually addressed either to the shareholders or
supervisory board or the board of directors of the entity whose financial statements
have beenaudited. In some countries, such as The Netherlands, auditor’s reports are
not addressedat all because the reports are meant to be used by (the anonymous)
public at large.

• Opening or Introductory Paragraph

The report should identify the financial statements that have been audited. This
shouldinclude the name of the entity and the date and period covered by the financial
statements. The report should include a statement that the financial statements are the
responsibility of the entity’s management.

• Scope Paragraph

Scope refers to the auditor’s ability to perform audit procedures deemed necessary in
thecircumstances. The scope paragraph is a factual statement of what the auditor did
inthe audit. This provides the reader assurance that the audit has been carried out
inaccordance with established standards or practices for such engagements.

The scope paragraph should include a statement that the audit was planned
andperformed to obtain reasonable assurance about whether the financial statements
are freeof material misstatement and that the audit provides a reasonable basis for the
opinion.The use of these phrases, or similar wording, means that the audit provides a
high level ofassurance, but it is not a guarantee.

• Opinion Paragraph

The opinion paragraph of the auditor’s report should clearly indicate the
financialreporting framework used to prepare the financial statements (including
identifying thecountry of origin of the financial reporting framework when the
framework used is notInternational Financial Reporting Standards) and state the
auditor’s opinion as towhether the financial statements give a true and fair view (or
are presented fairly, in allmaterial respects) in accordance with that financial reporting
framework and, where appropriate, whether the financial statements comply with
statutory requirements.

• Date of Report

The report must be dated. The auditor should date the report as the completion date
ofthe audit (usually the last date of field work). This informs the reader that the
auditor hasconsidered the effect on the financial statements and on the report of
events or transactions about which the auditor became aware and that occurred up to
that date. Sincethe auditor’s responsibility is to report on the financial statements as
prepared andpresented by management, the auditor should not date the report earlier
than the date onwhich the financial statements are signed or approved by
management.

• Auditor’s Address

The report should name a specific location, which is usually the city in which the
auditor maintains an office that serves the client audited. PCAOB’s Auditing Standard
No. 115 also requires that an auditor include the city and state (or city and country, in
the caseof non-US auditors) from which the auditor’s report has been issued. Note: In
somecountries it is not required that the audit report give the specific address for the
auditor.

• Signature

The report should be signed in the name of the audit firm, or the personal name of
theauditor, or both, as appropriate. The auditor’s report is ordinarily signed in the
name ofthe firm because the firm assumes responsibility for the audit. Note: In several
countries(e.g. the USA, the UK, the Netherlands) it is currently not required that the
personalname of the auditor be signed. Inclusion of the name in a reference is
sufficient.

QUESTION FOUR

1.An external audit of financial statements provides multiple benefits to businesses

like the partnership between Mulopwe and Maimbo. Some key benefits include:

• Enhancing Credibility and Reliability of Financial Statements

An external audit ensures that financial statements present a true and fair view of the
business’s financial position (Arens et al., 2020). This enhances credibility among
stakeholders, including investors, customers, and regulatory bodies.Example: If
Mulopwe and Maimbo’s financial statements are audited and found reliable, the
international company considering the acquisition will have greater confidence in
proceeding with the deal.

• Compliance with Regulations and Standards

External auditors ensure that the company adheres to local and international
accounting standards such as the International Financial Reporting Standards (IFRS)
and Generally Accepted Accounting Principles (GAAP) (Hay et al., 2019).Example:
If the cleaning company were to expand internationally, compliance with these
regulations would make cross-border transactions smoother and avoid penalties.

• Detection and Prevention of Errors and Fraud

External audits can help identify financial misstatements, fraud, or unintentional

errors (Gray & Manson, 2019). Auditors apply procedures such as substantive testing
to detect fraudulent activities.eg, If an employee were inflating expense claims, an
external auditor could detect this and recommend internal control improvements.

• Facilitating Business Transactions and Investment Decisions

Audited financial statements provide assurance to potential investors, lenders, and

buyers (DeAngelo, 1981). This increases the likelihood of securing financing or
closing business deals.for example,the international cleaning company has requested
an audit before finalizing the takeover, highlighting the role of external audits in
mergers and acquisitions.

(b)External auditors are granted several rights under professional auditing standards to
ensure they can conduct their work effectively. Key rights include:

• Right to Access All Financial Records and Documents

Auditors have the legal right to inspect all financial records, including invoices, bank
statements, and contracts (ISA 500, Audit Evidence).Example: If Mulopwe is hesitant
to disclose financial details, auditors can legally demand access to ensure a thorough
review.

• Right to Obtain Explanations and Information from Management

Auditors can request clarifications from management and employees regarding

transactions and financial decisions (Arens et al., 2020).Example: If there is an
unusual expense entry in the financial statements, auditors can question Mulopwe or
the finance team for an explanation.

• Right to Attend and Be Notified of General Meetings

Auditors have the right to be present at general meetings where financial matters are
discussed (Companies Act, 2017).

• Right to Issue an Independent Audit Opinion

Auditors must provide an unbiased opinion on whether the financial statements are
free from material misstatements (ISA 700, Forming an Opinion and Reporting on
Financial Statements).Example: If the audit reveals that the company’s revenue is
overstated, the auditors can issue a qualified or adverse opinion.

(c) With the growing importance of corporate social responsibility (CSR), businesses
are increasingly required to conduct social and environmental audits. These audits
assess the company’s impact on society and the environment.

• Social Audit-A social audit evaluates how a company treats its employees,
supports the community, and maintains ethical labor practices (Owen & Swift,
2001).
Example: The new owners may want to ensure that the cleaning company provides
fair wages, safe working conditions, and avoids child labor.

• Environmental Audit-An environmental audit examines whether a company

follows sustainable practices and minimizes environmental harm (Gray et al.,
1995).

Example: If the cleaning company uses hazardous chemicals, the new owners may
need an environmental audit to assess pollution risks and compliance with
environmental laws.

Benefits of Social and Environmental Audits:

I. Regulatory Compliance: Ensures the company adheres to labor and

environmental laws.

II. Enhanced Corporate Image: Companies with strong CSR attract customers
and investors.

III. Operational Efficiency: Identifies areas to reduce waste and improve

sustainability.

IV. Investor Confidence: Investors prefer companies that follow ethical and
environmental best practices.

D.According to ISA 500, financial statement assertions are assertions by

management,explicit or rwise, that are embodied in the financial statements. They can
be categorized as follows:

(1) Assertions about classes of transactions and events for the period under audit

■ Occurrence – transaction and events that have been recorded have occurred and
pertain to the entity. For example, management asserts that a recorded sales trans
action was effective during the year under audit.

■ Completeness – all transactions and events that should have been recorded have
been recorded. For example, management asserts that all expense transactions are
recorded,none were excluded.
■ Accuracy – amounts and other data relating to recorded transactions and events
have been recorded appropriately. For example, management asserts that sales
invoices were properly extended and the total amounts that were thus calculated were
input into the system exactly.

■ Cutoff – transactions and events have been recorded in the correct accounting
period.For example, management asserts that expenses for the period are recorded in
that period and not in the next accounting period.

■ Classification – transactions and events have been recorded in the proper

accounts.For example, management asserts that expenses are not recorded as assets.

(2) Assertions about account balances at the period end

■ Existence – assets, liabilities and equity interests exist. For example, management
asserts that inventory in the amount given exists, ready for sale, at the balance sheet
date.

■ Rights and obligations – an entity holds or controls the rights to assets, and
liabilities are the obligations of the entity. For example, management asserts that the
company has the legal rights to ownership of the equipment they use and that they
have an obligation to pay the notes that finance the equipment.

■ Completeness – all assets, liabilities and equity interests that should have been
recorded have been recorded. For example, management asserts that all liabilities are
recorded and included in the financial statements, that no liabilities were “off the
books”.

■ Valuation and allocation – assets, liabilities, and equity interests are included in the
financial statements at appropriate amounts and any resulting valuation or allocation
adjustments are appropriately recorded. For example, management asserts that their
accounts receivable are stated at face value, less an allowance for doubtful accounts.

(3) Assertions about presentation and disclosure

■ Occurrence and rights and obligations – disclosed events, transactions, and other
matters have occurred and pertain to the entity. For example, management asserts that
events that did not occur have not been included in the disclosures.
■ Completeness – all disclosures that should have been included in the financial
statements have been included. For example, management asserts that all disclosures
that are required by IFRS are made.

■ Classification and understand-ability – financial information is appropriately

presented and described, and disclosures are clearly expressed. For example,
management asserts that all long-term liabilities listed on the balance sheet mature
after one operating cycle or one year and that any special conditions pertaining to the
liabilities are clearly disclosed.

■ Accuracy and valuation – financial and other information are disclosed fairly and
at appropriate amounts. For example, management asserts that account balances are
not materially misstated.

REFERENCES
Arens, A. A., Elder, R. J., & Beasley, M. S. (2020). Auditing and Assurance Services:
An Integrated Approach. Pearson.

DeAngelo, L. E. (1981). Auditor size and audit quality. Journal of Accounting and
Economics, 3(3), 183-199.

Gray, R., Owen, D., & Maunders, K. (1995). Corporate Social Reporting: Accounting
and Accountability. Prentice Hall.

Gray, I., & Manson, S. (2019). The Audit Process: Principles, Practice, and Cases.
Cengage Learning.

Hay, D., Knechel, W. R., & Willekens, M. (2019). The Routledge Companion to
Auditing. Routledge.

International Standards on Auditing (ISA) 500. Audit Evidence.

International Standards on Auditing (ISA) 700. Forming an Opinion and Reporting on

Financial Statements.

Owen, D. L., & Swift, T. (2001). Social and Environmental Reporting: A Review of
the Literature. Corporate Governance: An International Review, 9(3), 137-145.

AICPA. (2020). Audit Risk Alerts: Industry Developments. American Institute of

Certified Public Accountants.

Knechel, W.R., van Staden, C., & Zhaohui, Y. (2013). Auditing: Theory and Practice.
Routledge.

Rezaee, Z., Elam, R., & Szendi, J.Z. (2010). Financial Statement Fraud: Prevention
and Detection. Wiley.

Schroeder, R.G., Clark, M.W., & Cathey, J.M. (2019). Financial Accounting Theory
and Analysis: Text Readings. Wiley.

Wells, J.T. (2014). Principles of Fraud Examination. Wiley.