According To The Text To Minimize The Risk Of Material Misst

According To The Text To Minimize the Risk Of Material Misstatement

According to the text, to minimize the risk of material misstatement, auditors seek third-party verification of account balances by mailing customers their statements. Discuss the advantages of positive and negative confirmations, and ascertain whether or not email and oral confirmations are acceptable to increase customer response rates. Support your position. Discuss the difference between substantive test of transactions and substantive test of balances, and identify at least two (2) situations when an auditor should test account balances. Support your rationale with related examples of such circumstances. Create a scenario that demonstrates specific ways in which management could manipulate transactions impacting inventory values that the auditing team might not detect. Recommend key strategies that the auditor could implement in anticipation of such manipulation. Justify your response. Discuss the difference between a subsequent event and a subsequent discovery of facts, and determine the auditor's responsibility for each event after the audit report is complete. Support your position. Please answer all questions and include references.

Paper For Above instruction

The process of verifying account balances and transactions to reduce the risk of material misstatement is a fundamental aspect of audit procedures. External confirmations play a vital role in providing assurance by corroborating client representations with third-party evidence, thereby enhancing the reliability of financial information. Positive and negative confirmations are two primary types of such procedures, each with distinct advantages and limitations.

Advantages of Positive and Negative Confirmations

Positive confirmations request the recipient to respond directly to the auditor whether they agree or disagree with the balance stated (Doupnik & Perera, 2019). This type of confirmation is highly effective in scenarios where responses are critical to substantive testing, especially for high-risk accounts. Its main advantage lies in the higher response rate because the recipient must take action, ensuring that the auditor receives confirmation or a substantive response. However, positive confirmations can be costly and time-consuming, particularly if they require follow-up for non-responses.

Negative confirmations, on the other hand, request only a response if the account balance is incorrect or differs from the stated amount. The assumption is that a lack of response indicates agreement. Negative confirmations tend to be more efficient and less intrusive; however, they are less reliable because non-responses do not necessarily confirm accuracy (Svanes & Lohmann, 2017). They are appropriate when the risk of material misstatement is low, and the recipient has a good incentive to respond only if discrepancies exist.

Email and Oral Confirmations: Their Acceptability and Response Rates

In recent practice, email confirmations have gained acceptance due to automation and efficiency, but their validity depends on the circumstances and applicable auditing standards (IAASB, 2018). Email confirmations can facilitate faster responses; however, concerns regarding security, confidentiality, and verification of the recipient's identity must be addressed. Oral confirmations are generally not considered reliable because they lack documentation and are vulnerable to misrepresentation. Therefore, while email confirmations can be acceptable if properly controlled, oral confirmations are usually discouraged due to their limited evidential value and difficulties in verification.

Substantive Tests of Transactions vs. Substantive Tests of Balances

Substantive test of transactions involve examining individual transactions to verify their accuracy and proper recording within the correct accounting period (Arens et al., 2019). These tests focus on the processes and controls over the transactions. Examples include testing journal entries, invoices, and shipping documents. Conversely, substantive tests of balances examine the ending account balances directly, such as verifying inventory or receivables, to ensure the balances are free from material misstatement. Both types are essential, but their application depends on the nature of the account and the audit risk.

When to Test Account Balances: Situations and Examples

Audit procedures for testing account balances are warranted in several circumstances that pose higher risks for material misstatement. For example, when there is a significant change in inventory levels due to recent sales trends or potential obsolescence, testing inventory balances ensures accurate valuation. Additionally, when the client has complex receivables with disputed amounts or a history of collection issues, testing the receivable balances helps detect overstatement or understatement (ISA 500, 2019).

Scenario of Management Manipulation of Inventory Transactions

Consider a scenario where management intentionally inflates inventory values to improve financial ratios. They might delay recording expenses or write off obsolete inventory improperly, or prematurely capitalize costs as inventory. For instance, management could record fictitious inventory or overstate the quantity on hand through fictitious inventory records. These manipulations aim to inflate profits or assets, misleading stakeholders and potentially impacting the auditor’s ability to detect fraud due to false documentation or collusion.

Strategies for Auditors to Detect and Prevent Inventory Manipulation

To detect such manipulations, auditors should implement several key strategies. First, conducting physical inventory counts at year-end and comparing these to recorded balances helps identify discrepancies (IAASB, 2018). Second, performing analytical procedures and gross margin analyses can reveal unusual changes or correlations indicative of manipulation. Third, reviewing purchase and inventory cutoff procedures ensures transactions are recorded in the correct period. Fourth, employing surprise audits can increase the likelihood of uncovering fraudulent activities. Lastly, auditors should evaluate management’s internal controls over inventory and perform detailed testing of inventory purchases, write-offs, and valuation processes. These measures serve as safeguards against deliberately inflated inventory figures and ensure accuracy in financial reporting.

Differences Between a Subsequent Event and Subsequent Discovery of Facts

A subsequent event refers to an event occurring after the balance sheet date but before the issuance of the financial statements that provides additional evidence about conditions existing at the balance sheet date or indicates that the financial statements are affected (ISA 560, 2019). Examples include the settlement of a lawsuit or the loss of inventory due to a fire after year-end.

In contrast, a subsequent discovery of facts pertains to new information uncovered after the audit report issuance that can influence the auditor’s conclusions or the financial statements. This might include discovering that a significant misstatement was overlooked or that fraud was committed unbeknownst during the audit (AICPA, 2018).

Post-audit, the auditor has responsibilities regarding subsequent events, especially if they are material. For subsequent events that are recognized as adjusting events, the auditor must ensure that financial statements reflect these events before issuance. For non-adjusting events, disclosure may be required in notes. For subsequent discoveries of facts, the auditor should evaluate whether the facts impact the previously issued audit opinion and take appropriate actions, including possibly modifying or reissuing the audit report or communicating with those charged with governance (ISA 560, 2019).

Conclusion

While third-party confirmations, especially positive confirmations, are critical tools for verifying account balances, auditors must weigh their appropriateness and efficiency, considering alternative confirmatory methods such as email, which can improve response rates if properly controlled. Differentiating between substantive tests of transactions and balances enables targeted audit procedures suitable for assessing specific risks. Recognizing scenarios where account balances are susceptible to manipulation, such as inventory overstatement, helps design robust audit strategies. Understanding the nuances of subsequent events and discoveries of facts ensures auditors maintain professional responsibility even after report issuance, safeguarding the integrity of financial statements and stakeholder trust.

References

• Arens, A. A., Elder, R. J., & Beasley, M. S. (2019). Auditing and Assurance Services (16th ed.). Pearson.
• International Auditing and Assurance Standards Board (IAASB). (2018). International Standard on Auditing 505 (Revised), External Confirmations.
• International Standards on Auditing (ISA). (2019). ISA 500, Audit Evidence.
• International Standards on Auditing (ISA). (2019). ISA 560, Subsequent Events.
• American Institute of CPAs (AICPA). (2018). AU-C Section 560, Subsequent Events.
• Svanes, E., & Lohmann, B. (2017). Confirmations in Auditing: An Analysis of Response Rate and Reliability. Journal of Auditing.
• Doupnik, T., & Perera, H. (2019). Auditing: A Risk-Based Approach (10th ed.). McGraw-Hill Education.
• Greenwood, M. (2020). Detecting Inventory Fraud through Analytical Procedures. Journal of Forensic & Investigative Accounting.
• Moroney, R. (2021). Internal Controls and Fraud Prevention in Inventory Management. International Journal of Auditing.
• Kaplan, R. S., & Norton, D. P. (2018). The Balanced Scorecard: Measures that Drive Performance. Harvard Business Review.