Audit and Assurance Practice Exam

What is a consequence of failing to perform inventory observation procedures?

1. Reduced risk of fraud detection

2. Unmodified audit opinion

3. Poor financial reporting

4. Increased reliance on internal controls

The correct answer is: Poor financial reporting

Failing to perform inventory observation procedures may lead to poor financial reporting because inventory is a critical element in the financial statements. Inventory affects both the balance sheet and the income statement; it is reported as an asset and is also used in the calculation of cost of goods sold. Without proper observation, auditors cannot verify the existence and condition of inventory, which can result in misstated financial results. When inventory observation is neglected, it increases the risk that discrepancies, such as overstatement or understatement, may go undetected. This inability to substantiate inventory amounts affects the reliability of financial reporting, potentially leading to significant consequences for stakeholders relying on accurate information for decision-making. In contrast, failing to perform these procedures does not necessarily reduce the risk of fraud detection or enhance reliance on internal controls, as the lack of direct observation compromises the verification process. Furthermore, the report could potentially receive a modified opinion if material misstatements are identified during subsequent assessments, but an unmodified opinion cannot be assured without effective inventory observation.