Which of the following is the most appropriate potential reaction of the auditor to his assessment that the risk of material misstatement due to fraud is high in relation to existence of inventory?

 Options:

a) Visit location on surprise basis to observe test counts b) Request inventory count at a date close to year-end c) Vouch goods sent on approval very carefully d) Perform analytical procedures.

The Correct Answer Is:

a) Visit location on surprise basis to observe test counts

The most appropriate potential reaction of the auditor to the assessment that the risk of material misstatement due to fraud is high in relation to the existence of inventory is option (a) “Visit location on a surprise basis to observe test counts.”

This choice aligns with the auditor’s need to gather additional evidence and increase the reliability of the inventory count process.

Explanation of Correct Answer: a) Visit location on surprise basis to observe test counts

The option involves a surprise visit to the location, emphasizing the importance of unpredictability to prevent manipulation or collusion that could occur if the timing of the visit were known in advance.

Observing test counts firsthand allows the auditor to directly assess the accuracy of the physical count of inventory items. This on-site observation provides a more reliable source of evidence and helps the auditor to better understand the client’s internal controls and the overall inventory management process.

Explanation of Incorrect Answers:

b) Request inventory count at a date close to year-end:

This option might seem logical as it aims to capture the inventory close to the financial reporting date. However, it lacks the critical element of surprise. If management or staff anticipate the audit and the timing of the inventory count, it raises the potential for manipulation or adjustment of inventory records.

By choosing this approach, the auditor might overlook the risk of collusion or fraud that could occur precisely because the count is expected and planned.

c) Vouch goods sent on approval very carefully:

While vouching goods sent on approval is a valid auditing procedure to ensure the validity of sales transactions, it does not directly address the risk of material misstatement in inventory existence.

This procedure involves verifying that goods sent on approval were indeed approved and returned or accounted for properly. However, it doesn’t specifically target the risk of fraud or error in the physical existence of inventory items at the reporting date.

d) Perform analytical procedures:

Analytical procedures involve assessing relationships between financial and non-financial data, looking for inconsistencies or unexpected fluctuations. Though these procedures are integral to an audit, they might not suffice when the risk of material misstatement due to fraud concerning inventory existence is high.

Analytical procedures rely on historical data and might not capture irregularities that arise from fraudulent activities that specifically affect inventory counts or existence.

In essence, while options b, c, and d are valid audit procedures in certain contexts, they don’t directly address the heightened risk of fraud regarding the physical existence of inventory.

Option a stands out due to its emphasis on surprise and direct observation, which is crucial when addressing the risk of manipulation or misstatement in inventory levels due to potential fraudulent activities.

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