Harris decided that the easiest way to make the Fabricator Division appear more

Question

Harris decided that the easiest way to make the Fabricator Division appear more profitable was through manipulating the inventory, which was the largest asset on the books. Harris found that by increasing inventory by 2 percent, income could be increased by 5 percent. With the weakness in inventory control, he felt it would be easy to overstate inventory. Employees count the goods using count sheets, and Harris was able to add two fictitious sheets during the physical inventory, even though the auditors were present and were observing the inventory. A significant amount of inventory was stored in racks that filled the warehouse. Because of their height and the difficulty of test-counting them, Harris was able to cover an overstatement of inventory in the upper racks.

After the count was completed, Harris added four additional count sheets that added $350,000, or 8.6 percent, to the stated inventory. Harris notified the auditors of the “omission” of the sheets and convinced them that they represented overlooked legitimate inventory. The auditors traced the items on these additional sheets to purchase invoices to verify their existence and approved the addition of the $350,000 to the inventory. They did not notify management about the added sheets. In addition, Harris altered other count sheets before sending them to the auditors by changing unit designations (for example, six engine blocks became six “ motors”), raising counts, and adding fictitious line items to completed count sheets. These other fictitious changes added an additional $175,000 to the inflated inventory. None of them was detected by the auditors.

Required:

a. What audit procedures did the auditors apparently not follow that should have detected Harris’ fraudulent increase of inventory?

b. What implications would there be to an auditor of failure to detect material fraud as described here?

c. What responsibility did the auditors have to discuss their concerns with the entity’s audit committee?

Explanation / Answer

a)

The auditors should verify the inventory records with purchase invoices by comparing with physical count as each unit of inventory should be thoughroughly checked, when it is unable to take physical count due to the units are in upper track or unable to count, the auditors should state the same in their auditors' report so that the audit stands incompelete.

So Harris or his staff will provide all the facilities to count the units phisically. The main point that should be noted by the auditors is whatever auditor state or report in audit report should completely checked with supporting invoices and other documentsand along with phisical count of units. These are the procedures that are not followed by auditors.

b)

The auditors should not believe whatever says by Harris as this is one of the main point why Harris doing the fraud and even if he caught by auditors at few instances, he can cover him self and continue to make fraud. So the auditors should only believe when there are supporting proofs and documents showing the actual value of inventory.

If these implications are developed by auditors, the chances of making fraud can be reduced.

c)

It is the responsibility of the auditors to prepare a seperate report stating the issues which they're facing while doing the audit like unable to take physical count for some units and fraud that Harris doing along with audit report should be submitted to the audit committee requesting to take immediate action on Harris.

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