Answer The Following Questions: What Are The Concerns?

Answer The Following Questions11 What Are The Concerns That Lead The

Answer the following questions:

1. What are the concerns that lead the auditor to physically observe inventory? Do you think observing only a sample of inventory is sufficient? Why or why not?
2. As a part of completing the audit, the auditor must obtain a letter from the client's attorney. Discuss the purpose of this letter and, most importantly, the limitations of such a letter. What problems does the auditor encounter in getting an accurate and informative letter? Why?
3. These events take place after the end of field work. How would the auditor be aware of such events? What responsibility does he/she have if he/she is not aware of them? What if the auditor never learns about a fire that destroys the client's inventory after the end of field work, for example? Should he/she rely on the client for such information? Is there a better way to do it?
4. What do you think about the procedures implemented by Auditing Standards in case an auditor discovers that he/she missed certain critical audit procedures after the audit report is issued? Do you think the procedures in place fully address this issue?

Paper For Above instruction

The process of auditing encompasses a myriad of procedures designed to ensure the accuracy, completeness, and reliability of financial statements. Among these procedures, physical observation of inventory, obtaining legal representation letters, and handling post-balance sheet events are pivotal components that directly impact the integrity of the audit opinion. This paper discusses the primary concerns that prompt auditors to conduct inventory observation, examines the purpose and limitations of attorney letters, explores auditor responsibilities regarding subsequent events, and evaluates current standards for addressing missed critical audit procedures post-report issuance.

Concerns Leading to Physical Observation of Inventory

Physical observation of inventory is a fundamental audit procedure primarily driven by the need to verify the existence and condition of recorded assets. The main concerns prompting this practice revolve around the risk of misstatement due to errors or fraudulent alterations in inventory records. Inventory, being a significant and often material component of a company's total assets, warrants independent verification to reduce detection risk and gain audit evidence beyond documents and representations. The auditor’s concern is that without physical verification, there might be hidden obsolescence, theft, or overstatement of inventory values, which could materially mislead stakeholders.

Regarding the sufficiency of observing only a sample, auditors typically employ sampling techniques to mitigate audit risk efficiently. While observing a sample tends to be practical and resource-effective, it must be sufficiently representative of the entire inventory. The sufficiency depends on factors such as the size and diversity of the inventory, inventory turnover, and the materiality of the items. Sampling is acceptable if the auditor concludes it provides reasonable assurance; however, the risk of missing discrepancies in unobserved items necessitates careful sample planning. Random sampling and statistical methods escalate the confidence that the observed sample accurately reflects the state of inventory across the entire pool.

Purpose and Limitations of Attorney Letters in Auditing

Attorneys' letters are obtained during the audit process to corroborate contingent liabilities, litigation, or claims that may impact financial statements. The purpose of these letters is to provide direct communication from the client's legal counsel regarding potential legal issues, ongoing litigations, or threatened disputes that might affect the company's financial position. The auditor relies on this letter to identify liabilities that are not fully disclosed elsewhere, thus helping to ensure completeness of provisions and disclosures.

Despite their utility, attorney letters have notable limitations. They are typically based on the attorney’s knowledge at a certain point in time and depend heavily on what the client has disclosed and the attorney's cooperation. Attorneys may withhold information due to confidentiality, or they may not be fully aware of all legal issues, especially in complex or hidden disputes. Consequently, these letters might not fully disclose the scope of legal risks. Furthermore, attorneys' responses can be overly broad or generic, leaving the auditor uncertain about the materiality or certainty of legal liabilities.

Thus, the auditor faces challenges in obtaining accurate, comprehensive, and current information through these letters. The limitations stem from the legal counsel’s own knowledge constraints, confidentiality concerns, and the inherent unpredictability of legal proceedings. As a result, legal letters are considered one of multiple audit procedures rather than definitive sources of legal risk assessment.

Awareness of Post-Field Work Events and Auditor Responsibilities

Events that occur after the completion of field work, but before the issuance of the audit report, are classified as subsequent events. The auditor’s awareness of such events depends predominantly on ongoing communication with management, review of subsequent period transactions, and ongoing inquiries during the completion phase of the audit. The auditor has a responsibility to identify, evaluate, and consider the impact of subsequent events on the financial statements and the audit opinion.

If an auditor is unaware of an essential event, such as a fire destroying inventory, their responsibility hinges on whether they have exercised due professional care in obtaining sufficient appropriate audit evidence. If the event materially affects the financial statements and the auditor was unaware due to negligence, the auditor could be liable for issuing an inappropriate clean opinion. Conversely, if the event is known or should have been known through audit procedures, failure to incorporate it impairs the audit's appropriateness.

Relying solely on management or client representations for critical information like inventory losses post-balance sheet date is risky because management may withhold or omit information intentionally or unintentionally. The audit standards advocate for procedures such as review of subsequent cash receipts, sales, or other transactions, and inspection of post-balance sheet events through external sources, which can provide more reliable information. Employing continuous communication, review of external evidence, and specialized procedures where necessary constitutes a more robust approach to capture significant events.

Procedures for Handling Missed Critical Audit Procedures Post-Issuance

Current auditing standards, such as those articulated by the PCAOB and IAASB, emphasize the importance of establishing procedures for dealing with situations where critical audit procedures might be missed or discovered to be incomplete after the audit report has been issued. The general consensus is that if the auditor identifies a significant deficiency or omission post-report, they should evaluate the impact on the previously issued opinion and act accordingly—either through a reissuance, amendment, or withdrawal of the audit report.

However, the existing procedures may not be entirely sufficient or practical in all cases. The standards encourage the auditor to perform procedures such as review of subsequent events, re-performance of omitted procedures if feasible, and communicating with those charged with governance. They also recommend timely reporting of identified issues and possible disclosures in standard audit documentation.

Some critics argue that these procedures do not fully address the complexities involved when critical procedures are missed and subsequently discovered. There is a risk of delays in correction and potential liability if issues are discovered after the report release. Therefore, enhancing audit quality controls, fostering a culture of professional skepticism, and adopting more proactive and technology-driven review processes can improve the effectiveness and timeliness of responses to such situations.

Conclusion

In conclusion, the audit process relies heavily on procedures such as physical verification, legal confirmations, and vigilant review of subsequent events to ensure credible financial reporting. While existing standards provide guidance on how to handle discovered errors or omissions, continuous improvement of audit practices is necessary to mitigate risks effectively. The profession must strike a balance between practical constraints and the imperative for high-quality audit evidence, maintaining public trust in financial reporting integrity.

References

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