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Analysis of the use of the scientific method in an audit

The scientific method
The scientific method is a widely used technique for the determination of a cause of an event. This method can be used in scientific inquiries as well as business analysis (the process of auditing a firm would be an example) to determine its characteristics. There is a step by step process in the scientific method which allows us to initially develop an hypothesis concerning an event and then to test that hypothesis to determine if we can disprove it and thus must look in another direction for a solution to the issue at hand. In our testing of the hypothesis we must always remember that the hypothesis cannot be proved only that we do not have sufficient information to disprove it. The scientific method consists of the following steps:
a. Ask a question concerning the issue.
b. Do background research in relationship to the issue to get a more in-depth understanding of the situation.
c. Construct a Hypothesis concerning the issue which we will use to test our data against.
d. Test your Hypothesis by doing experiments of the population we are focused on.
e. Analyze your data and draw a conclusion concerning the population under study.
f. Communicate your results.
The below link provides you with a more detailed explanation of the scientific method for your review. Following your review of the link proceed to the following problem demonstrating your use and understanding of the scientific method in an auditing environment.
The Scientific Method
http://www.sciencebuddies.org/mentoring/project_scientific_method.shtml

Analysis of the use of the scientific method in an audit situation:
The auditor, in order to mitigate their audit risk, is to presume that there is fraud in the reporting of revenues for a firm. Consider a company that manufactures high-tech fiber-optic gear. Assume that the Wall Street analysts believe the industry has good growth prospects. The audit client is predicting a 20% increase in sales and a 27% increase in profits for the year under audit. The auditor is planning the audit and knows the following:
a) 65% of all sales are made to just five customers.
b) There are three companies with very similar products. One has a moderately larger market share and the other has a significantly smaller market share.
c) There are indications that the economy is slowing down and it is expected that a slowdown would affect the market for high-tech products that the company sells.

Following the scientific method in this example, what steps would you as an auditor take to assure you have minimized the potential for audit risk (making a positive evaluation of the firm's financial status when it is in fact negative)? Provide the questions you would ask in order to determine the potential for fraud. Identify in your evaluation what questions you would ask in your process of determining the Hypothesis for your evaluation. Once you have determined the hypothesis, what actions would you take to test the hypothesis? Following your test what actions would you take if the hypothesis must be rejected given the outcome of the test?

Solution Preview

Following the scientific method in this example, what steps would you as an auditor take to assure you have minimized the potential for audit risk (making a positive evaluation of the firm's financial status when it is in fact negative)?

Ask a question: Are the financial statements materially misstated?

Background study: Review the inherent and control risks of the business to get an in-depth understanding of the business. Assess the level of inherent and control risk and use this to determine the detection risk needed to get an overall audit risk at acceptable level (usually 5%). Plan audit steps to attain the detection risk resulting from preliminary assessment of inherent and control risk.

Hypothesis: The financial statements are free of material misstatements.

Test: Conduct tests of controls and tests of transactions and balances to try to disapprove the hypothesis. Concentrate in areas that pose greatest risk (more ...

Solution Summary

Your tutorial is 506 words contains some general comments about how the audit process fits into the scientific methods, eight potential questions that would likely be asked and how to handle a rejected audit hypothesis.

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