Audit Inherent Limitations

The process of audit suffers from certain inbuilt limitations due to which an auditor

cannot obtain an absolute assurance that financial statements are free from

misstatement due to fraud or error. These fundamental limitations arise due to the

following factors: -

(1) Nature of financial reporting

Preparation of financial statements involves making many judgments by

management. These judgments may involve subjective decisions or a degree

of uncertainty. Therefore, auditor may not be able to obtain absolute

assurance that financial statements are free from material misstatements due

to frauds or errors.

One of the premises for conducting an audit is that management

acknowledges its responsibility of preparation of financial statements in

accordance with applicable financial reporting framework and for devising

suitable internal controls. However, such controls may not have operated to

produce reliable financial information due to their own limitations.

Consider, for example, that management of a company has devised a control

that all purchase bills should reflect stamp and signatures of an authorised

person in “Goods Receiving Section” of the company stating the date and

time of receiving goods in premises. It is an example of internal control

devised by the company to ensure that only those purchase bills are produced

for payment for which goods have been actually received. Now, what

happens if concerned accountant and authorised person in “Goods Receiving

Section” collude. It is a case of overriding of internal controls devised by the

company due to collusion between two persons. Such a probable collusion is

one of limitations of internal controls itself.

(2) Nature of Audit procedures

The auditor carries out his work by obtaining audit evidence through

performance of audit procedures. However, there are practical and legal

limitations on ability of auditor to obtain audit evidence. For example, an

auditor does not test all transactions and balances. He forms his opinion only by testing samples. It is an example of practical limitation on auditor’s ability

to obtain audit evidence.

Management may not provide complete information as requested by auditor.

There is no way by which auditor can force management to provide complete

information as may be requested by auditor. In case he is not provided with

required information, he can only report. It is an example of legal limitation

on auditor’s ability to obtain audit evidence.

The management may consist of dishonest and unscrupulous people and may

be, itself, involved in fraud. It may be engaged in concealing fraud by

designing sophisticated and carefully organized schemes which may be hard

to detect by the auditor. It may produce fabricated documents before auditor

to lead him to believe that audit evidence is valid. However, in reality, such

documents could be fake or non-genuine.

We have already discussed under section on scope of audit that an auditor is

not an expert in authentication of documents. Therefore, he may be led to

accept invalid audit evidence on the basis of unauthentic documents.

It is quite possible that entity may have entered into some transactions with

related parties. Such transactions may be only paper transactions and may

not have actually occurred. The auditor may not be aware of such related

party relationships or audit procedures may not be able to detect probable

wrong doings in such transactions.

(3) Not in nature of investigation

As already discussed, audit is not an official investigation. Hence, auditor

cannot obtain absolute assurance that financial statements are free from

material misstatements due to frauds or errors. (4) Timeliness of financial reporting and decrease in relevance of

information over time

The relevance of information decreases over time and auditor cannot verify

each and every matter. Therefore, a balance has to be struck between

reliability of information and cost of obtaining it. Consider, for example, an auditor who is conducting audit of a company since

last two years. During these two years, he has sought detailed information

from management of company regarding various matters. During his thirdyear

stint, he chooses to rely upon some information obtained as part of audit

procedures of second year. However, it could be possible that something new

has happened and that information is not relevant. So, the information being

relied upon by auditor is not timely and may have lost its reliability.

(5) Future events

Future events or conditions may affect an entity adversely. Adverse events

may seriously affect ability of an entity to continue its business. The business

may cease to exist in future due to change in market conditions, emergence

of new business models or products or due to onset of some adverse events.

Therefore, it is in view of above factors, that an auditor cannot provide a

guarantee that financial statements are free from material misstatements due

to frauds or errors.