During audit of Himani Electronics Ltd., the auditor identifies that several purchase bills bearing proper stamps and signatures of authorised…

The auditor cannot obtain absolute assurance that financial statements are free from material misstatement because the process of audit suffers from certain inbuilt or inherent limitations. Preparation of financial statements involves making many judgments by management. These judgments may involve subjective decisions or a degree of uncertainty. Therefore, the 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 for preparation of financial statements in accordance with the 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. In Himani Electronics Ltd., management devised a control that all purchase bills should reflect stamp and signatures of an authorised person in the “Goods Receiving Section" stating the date and time of receipt of goods. This control was meant to ensure that only those purchase bills are processed for payment for which goods have actually been received. However, the concerned accountant and authorised person in the “Goods Receiving Section” colluded, and false bills were stamped and processed. This is a case of overriding of internal controls due to collusion between two persons. Such probable collusion is itself a limitation of internal controls. Because such collusion and control failures can occur, an audit provides only reasonable assurance. The existence of proper controls does not eliminate the inherent limitations of audit, nor does it guarantee detection of all frauds or errors. Hence, the auditor cannot obtain absolute assurance that financial statements are free from material misstatement.