not. According to auditing professional pronouncements, auditors are responsible for detecting all material misstatements that affect the fairness of the financial statements presented by the client company. AICPA PROFESSIONAL STANDARDS, U.S. Auditing Standards AU Section 312.13 (Am. Inst. Of Certified Pub. Accountants (CCH) 1990). The types of errors and irregularities that auditors have failed to detect can be divided into the following four categories: (1) revenue recognition issues; (2) asset valuation issues; (3) other conditions not conforming to GAAP; and (4) other irregularities.
Revenue Recognition Issues: Revenue recognition issues include misstatements that affect the income statement; typically, they inflate revenues as well as profits of the company being audited. One example is an improper sales cutoff. This occurs when a sale by the client company is recognized in the wrong fiscal period (e.g., a 1992 sale is reflected in the 1991 Income Statement, thereby inflating sales for 1991).
In the following three instances, the issue is whether the transactions involved are bona fide sales. The first involves recording a sale under a bill-and-hold agreement. This occurs when the sale is billed to the customer and recorded; however, the merchandise is not shipped at that time. The question is whether title passed when the sale was billed and recorded or when the merchandise was subsequently shipped. In the second instance the issue is whether transections should be recorded as sales when the related shipments are made to third parties who are authorized to accept the goods on behalf of the buyers. In this scenario, the questions are which third parties are "authorized" by the actual customers, and whether these are bona fide sales. The third instance involves the recording of a sale in which there are written or oral rights of return and the chance of such return is not remote. If it is reasonably possible or probable that the merchandise sold will be returned, the issue is whether a sale was actually consummated between the client company and the customer.
Another revenue recognition issue is raised by the treatment of operating leases as sales. An operating lease occurs when the lessor intends that title shall not pass to the lessee at the end of the lease term and no rights to ownership are conveyed to the lessee by the lessor through the terms of the lease agreement. Under an operating lease, the rents should be recorded by the lessor when earned, and no sale of property should be recorded by the lessor. If an operating lease is erroneously recorded as a sale, revenues will be inflated.
Another instance is the non-recording of a sales return. This occurs when merchandise is returned for credit and the return is not recognized, either by the seller failing to issue a credit memorandum or by not recording a credit memo that has been issued. Because gross sales are netted against sales returns to yield net sales, the effect of this error or irregularity is to overstate net sales.
Asset Valuation Issues: A second category of issues includes items that primarily affect the balance sheet, typically inflating the value of the assets listed. As a general rule, GAAP require that most assets and liabilities be reflected in the financial statements at historical cost. DONALD E. KIESO & JERRY J. WEYGANDT, INTERMEDIATE ACCOUNTING 35 (6th ed. 1989). Hence, the first example in this category includes the situation in which there is the improper assignment of costs to the related assets, especially in an account such as inventory.