Your firm has recently been appointed as auditors of Kentronics Ltd$,$ a large company which markets sophisticated electronic equipment for heavy industry as well as the mining equipment industry. The previous audit firm lost the audit as a direct result of a conflict with Bradley Cosmas, the managing director of Kentronics Ltd$,$ over the adoption of various accounting policies by Kentronics Ltd$.$ The conflict had become very heated, due mainly to Bradley Cosmas$$s aggressive nature, and had led to a qualified audit report. Whilst familiarising yourself with the company and its environment you discover that:

$1.$ Bradley Cosmas had risen up through the ranks of Kentronics Ltd with ruthlessness and determination. On the way, he had built his personal wealth on a foundation of shares in Armtronics Ltd$.$

$2.$ He has surrounded himself with an aggressive team of loyal managers. You consider that their loyalty is partially due to the fact that management are not paid a salary but are given a monthly retainer, superior fringe benefits and a percentage of reported profits.

$3.$ Much of the sophisticated electronic equipment is imported from the China, Japan and Taiwan whilst exports, particularly mining equipment, are made to the governments of African countries.

$4.$ You also discover that one of the divisions of the company namely the $$Foreign Development Division$$ sells mining equipment exclusively to companies who in turn sell to mercenary and guerrilla organisations. Bradley Cosmas commented that $$the world mining equipment market is cut$-$throat and secretive$,$ provided that our government customers don$$t find out who we supply $$ no problem! We cover our tracks pretty well$.$

$5.$ Bradley Cosmas places little emphasis on $$historical accounting figures$$ despite the reasonably sophisticated computer facilities available. The vast majority of computer time is used for forecasting and analysis of worldwide economic trends within the electronics industry. As Bradley Cosmas says $$accountants and bankers deal with history $$ you$$ve got to be a prophet to make a profit!$.$

$6.$ Kentronics Ltd has an audit committee which consists of three non$-$executive directors, all of whom are experts in the mining equipment manufacture industry, and Brendon Rusike, Bradley Cosmas$$s brother$-$in$-$law, who is the chairman.

$7.$ Over the years Kentronics Ltd has reported figures better than its competitors but for the last two years profits have receded. Although there appears to be no real threat of going concern difficulties, liquidity has tightened significantly. The company is heavily committed to long$-$term borrowings and the company$$s bankers have indicated that their continued financial support will be reviewed in the light of the audited financial statements for the year under audit.

$8.$ Bradley Cosmas appears unconcerned about the drop in profits. He has responded to your enquiries by saying $$the company is in good shape, the Heavy Industry Division is solid. The mining equipment Division is thriving with the mines in Africa. Last year Kentronics Ltd concluded the first of many contracts with Cosmas Mining Equipment Ltd$,$ which is based in Botswana, for the supply of mining equipment to various worldwide governments. The Foreign Development Division $$ we won$$t talk too much about that!$$

Required

Evaluate the risk that the annual financial statements of Kentronics Ltd contain material misstatements as a result of fraudulent financial reporting. Your answer should consider the following:

$$ the incentives$/$pressures on the company to engage in fraudulent financial

reporting;

$$ situations or conditions which provide the opportunity; and

$$ the attitudes of management which may suggest fraudulent financial reporting.

$[25$ marks$]$

Answer rating: 100% (QA)

Risk of Material Misstatements in Kentronics Ltds Financial Statements There is a significant risk that the annual financial statements of Kentronics ... View the full answer