Accusatioper of Fraud. (This exercise is based on the actual case of Health Management Inc.)

During the audit of the Health of Management's 1995 financial statement $1.8 million of inventory in transit was included on the entity's balance sheet. The auditors never obtained evidence of the existence of this inventory even though several questions had been raised concerning the excessively large amount of inventory in transit at year-end. In 1996, Health Management announced that it had discovered a series of accounting irregularities.

a.Do legal grounds exist to claim that the auditors committed fraud?

Yes, because it said that the auditors didn't confirm or obtain evidence of the $1.8 million of inventories on the 1995 financial statement event though questions were raised.

b.What would be the auditors' defense if such grounds existed?

The auditors could claim that they performed in good faith and with reasonable care with the information given.