Question

The officers of an oil refiner, trader, and hedger based in New York were arrested by the FBI for committing massive financial statement fraud. The executives used many schemes to perpetuate the fraud, one of which was to hide a $30 million accounts payable from the auditors and show it as a payable arising in the following year. To conceal the fraud, they altered purchasing records, using correction fluid, and provided only photocopies of the records to the auditors. The Big 4 firm that audited this company was later sued for audit negligence in not finding this fraud. In your opinion, were the auditors negligent for accepting photocopies of purchasing records and not detecting this accounts payable understatement?

Answer 1

Any auditor has to follow the following assertions while auditing the items of Financial statements and these are:-

1. Occurrence: Transactions shown in financial statements have occurred and relate to the entity.

2. Completeness: All transactions that were supposed to be recorded have been recognized in the financial statements and further, transactions have been recorded in correct accounting period. All assets, liabilities have been recognized.

3. Measurement: Transactions have been recorded accurately at their appropriate amounts and further, transactions have been classified and presented fairly in the financial statements.

4. Existence: Assets, Liabilities and equity exist at the balance sheet date.

5. Valuation: Assets, liabilities and equity balances have been valued appropriately.

When auditing the accounts payable Auditor needs to check the following things:-

1. Ensure that trade payable ledger reconciles with general ledger
2. Investigate reconciling items, if there are journal entries in the accounts payable accounts.
3. Match purchase/expense vouchers to gate passes or vice-versa to ensure that they are recorded in correct accounting period.
4. Search for unrecorded liability.
5. Obtain direct confirmations.
6. Perform analytical procedures like ageing analysis, compare with past trends etc.

It appears that auditors have shown negligence on various aspects while auditing the accounts payables. Further accepting the photocopy instead of original records is also a huge mistake. This defeats the assertions of Occurrence and very essential principle of skepticism,

Yes, the auditors will be held negligent on various aspects.