Question 1
An error or omission causes inherent risk in a financial statement due to issues that have nothing to do with internal control failure. Such risks occur mainly due to complex transactions. Inherent risk is a factor used by an auditor to access the risk of material misstatement related to a certain financial statement line item or audit sector.
A prepaid expense is one of the items that form inherent risk. It is defined as a type of asset in the balance sheet resulting from a business making an advanced payment for products to be received in future. Although prepared expenses are first recorded as assets, they are expensed in the income statement later. Prepaid expenses are assessed as low because such accounts do not involve any complex transactions or contentious accounting problems.
Intangible assets are not physical in nature, and they include the brand name, intellectual property like copyrights and patents and goodwill. As a result, the non-physical nature of these intangible assets causes serious inherent risk concerns. Generally, the accounting rules are complicated and auditing the transactions is hard. The accounting standards require various asset deficiency tests for various classes of intangible assets. So, due to the judgment and complexity related to the valuation and estimation of intangible assets, auditors access the inherent risk as being high.
Question 2
The observation of physical inventory is important because it delivers strong evidence associated with the quality and existence of a client’s physical inventories. Although it’s the duty of the management to deal with inventory count, the observation of physical inventory count is done by an auditor. So, as an auditor of a manufacturing company in KSA, I would first plan for the physical inventory before executing it. Planning would involve reviewing and preparing the clients instructions. Then, when conducting the real physical inventory count, I would first collect sufficient evidence regarding the inventory’s existence and its current condition. Then, I would go ahead to ascertain the management techniques for the inventory count by performing a test on transactions, reviewing the record of prior counts and performing additional tests on the gross profit. This is necessary for assessing if the financial records reflect the count results.
Question 3
Ethical theories offer a great foundation in decision making. They represent the viewpoint from which people seek guidance as they make critical moral decisions. There are four ethical behavior theories helpful during ethical decision making. They include ethical egoism, deontology, altruism and utilitarianism. Each of these theories focuses on different points and different decision-making approach. Ethical egoism theory is the belief that individuals should promote their own good regardless of others. The theory states strongly that it is not moral to make decisions that do not promote one’s own well-being. The deontological theory proposes that actions are considered to be bad or good based on a clear set of rules. Therefore, actions that go hand in hand with these set rules are goo or ethical while those that do not, are not ethical. Altruism, on the other hand, argues that the moral value of a person’s actions depends purely on the impact it has on others, regardless of the impact on oneself. This doctrine focuses on the well-being of others. Finally, utilitarianism doctrine promotes actions that foster pleasure and happiness and opposes those that bring harm and unhappiness. This theory focuses on the betterment of society as a whole.