Auditors get into trouble when they fail to comply with the standards of the audit profession and the audit doesn’t uncover errors in the financial statements. This happens more frequently than one might think. We’ve found that most auditors are qualified, competent and responsible, so how do audit errors happen?

 

The most common reason for audit errors are:

  • Failure to really understand the business
  • Staff following the prior year audit program without analyzing the current audit evidence
  • Assignment of inexperienced staff without adequate supervision

 

An Example

 

We were asked to review financial statements of a company that had borrowed about $25 million from the bank. The company became insolvent and defaulted on the loan.

 

The company was an importer and processor of food products. The financial statement showed large inventory and accounts receivable that were all worthless.

 

The accounting records were incomplete and late and management didn’t cooperate in answering the auditor’s questions.

 

The accounting firm was sued by the bank and the case settled for a significant amount.

 

When an auditor performs an audit there are certain procedures that should be done to assess the reasonability of the financial statement line items. For example, in assessing accounts receivable, an auditor might check to see that balances in accounts receivable actually exist by matching the invoice amount in accounts receivable to a subsequent bank deposit, or by requesting a confirmation from the customer of the amount receivable.

 

In this case, the auditor might have identified the worthless accounts receivable by performing the following audit procedures:

  • Match bank deposits to invoices in accounts receivable to make sure payments were being made against invoices and check for kiting
  • Obtain customer confirmations for amounts in accounts receivable and reconcile differences between customer responses and company records
  • Check websites and other information to ascertain that customers are real. Some of the customers in this case had Gmail email addresses, which is a clue that something isn’t right.
  • Match shipping documents to invoices

 

In assessing inventory, the auditor could have performed the following procedures:

  • Attend the inventory count and keep completed count sheets
  • Compare valuation of inventory to supplier purchase invoices to match costs

 

The outline above is a very brief summary of the issues and some audit work that could have helped the auditor to identify material misstatements in the financial statements. The steps listed are not intended as a guide to conducting an audit and shouldn’t be relied on as such.