Auditing & Assurance Services 6th Edition by Timothy Louwers

Exercise 538

Accusation of Fraud. (This exercise is based on the actual case of Health Management Inc. ) During the audit of the Health Management's 1995 financial statements, $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.
Required:
a. Do legal grounds exist to claim that the auditors committed fraud?
b. What would be the auditors' defense if such grounds exist?