It is 1 July 20X5. You work in the audit department of Saul & Co. The Goodman Group (the Group) is an audit client of your firm and the audit for the financial year ended 31 December 20X4 is in the completion stage. The Group, which is not listed, installs and maintains security systems for businesses and residential customers.

Materiality for the audit of the Group financial statements has been determined to be GHC400,000. You are reviewing the audit working papers, and have gathered the following information:

Fraud
The Group finance director has informed the audit team that during the year, a fraud was carried out by a manager, Mike Trout, in one of the Group’s procurement departments. The manager had raised fictitious supplier invoices and paid the invoiced amounts into his personal bank account. When questioned by the Group’s finance director, Mike Trout confessed that he had stolen GHC40,000 from the Group. The finance director asked the audit team not to perform any procedures in relation to the fraud, as the amount is immaterial. He also stated that the financial statements would not be adjusted in relation to the fraud.

The only audit evidence on file is a written representation from management acknowledging the existence of the fraud, and a list of the fictitious invoices which had been raised by the manager, provided by the finance director. The audit working papers conclude that the fraud is immaterial and no further work is needed.

Development costs
In August 20X4, the Group commenced development of a new security system, and incurred expenditure of GHC600,000 up to the financial year end, which has been capitalised as an intangible noncurrent asset. The only audit evidence obtained in relation to this balance is as follows:

– Agreement of a sample of the costs included in the GHC600,000 capitalised to supporting documentation such as supplier invoices.
– Cash flow projection for the project, which indicates that a positive cash flow will be generated by 20X8. The projection has been arithmetically checked.
– A written representation from management stating that ‘management considers that the development of this new product will be successful’.

You are aware that when the Group finance director was asked about the cash flow projection which he had prepared, he was reluctant to answer questions, simply saying that ‘the assumptions underlying the projection have been agreed to assumptions contained in the Group’s business plan’. He provided a spreadsheet showing the projection but the underlying information could not be accessed as the file was password protected and the Group finance director would not provide the password to the audit team.

Trade receivables
Trade receivables recognised in the Group’s current assets includes a balance of GHC500,000 relating to a specific customer, Hamlyn Co. Audit procedures indicate that at 31 December 20X4, the balance was more than six months overdue for payment. In relation to this balance, the following procedures have been performed:
– Agreement of the balance to invoices and original customer order.
– Discussion with the Group credit controller who states that ‘we are in discussions with

Hamlyn Co and we are confident that some or all of the amount due to us will be paid. We have always allowed this customer extended credit terms and they have always paid eventually.’
Hamlyn Co was included in the trade receivables direct confirmation audit procedure, whereby a sample of customers were asked to confirm the outstanding balance, but no reply was received.

Required:
(a) (i) Discuss the implications of the fraud for the completion of the audit, and the actions to be taken by the auditor.(4 marks)

In respect of the development costs and trade receivables:

(ii) Comment on the sufficiency and appropriateness of the audit evidence obtained, and
(iii) Recommend the actions to be taken by the auditor, including the further evidence which should be obtained. (10 marks)

(b) The audit work is now complete and the Group auditor’s report is due to be issued in the next few days. Materiality for the audit of the Group financial statements has continued to be determined to be GHC400,000. You have been tasked with reviewing the draft auditor’s report and the following supplementary information which has been prepared at the end of the audit:
– The audit partner has concluded that the fraud is immaterial and that all necessary work has been performed by the audit team.
– Further audit procedures were successfully performed on the development costs, and a conclusion was reached by the audit team that the recognition of the GHC600,000 as an intangible asset is appropriate.
– A letter was received from Hamlyn Co’s administrators on 29 July 20X5, stating that Hamlyn Co is in liquidation, and that its creditors will receive a payment of 10% of outstanding balances. The audit team has concluded that GHC50,000 can remain recognized as a trade receivable, and that GHC450,000 should be written off as irrecoverable. However, the Group refuses to make any adjustment, and the full GHC500,000 remains recognised as a trade receivable in the final Group financial statements.

Draft auditor’s report
Based on the above conclusions, the audit supervisor has drafted the auditor’s report which includes the following extract:

Basis for opinion and opinion
Audit procedures indicate that trade receivables are overstated by GHC500,000. For this reason we consider that the Group financial statements are likely to be materially misstated and do not fairly present the financial position and performance of the Group for the year ended 31 December 20X4.

Emphasis of matter
There are two matters to which we draw your attention:
1. A fraud was discovered, as a result of which we have determined that GHC40,000 was stolen from the Group. This does not impact the financial statements but we wish to highlight the illegal activity which took place during the year.
2. The Group finance director obstructed our audit by refusing to allow access to audit evidence. He has also refused to adjust the financial statements in relation to the material misstatement of trade receivables, which led to the qualified audit opinion being issued. For this reason, we wish to resign as auditor with immediate effect.

Required:
Critically appraise the extract from the proposed auditor’s report of the Goodman Group for the year ended 31 December 20X4.

Answer rating: 100% (QA)

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