Scenario:

As of October 31, 2023, you are a member of your firm's audit team responsible for reviewing the financial statements of Karke Dikhaao Limited (Karke) for the fiscal year ending on September 30, 2023. It's important to note that Karke is a newly acquired client of your firm, and the following considerations are relevant to the audit.

1. Karke, a UK-based retailer specialising in jewelry, has thrived in previous years due to favourable economic conditions in the country. However, in recent years, it has managed to defy the common trend of declining performance among high street retailers by skillfully integrating highly efficient discounted purchasing practices with outstanding marketing strategies*.

1. In 2002, Karke was established by Prakash and Priya Ramandeep, a married couple who serve as the joint Chief Executive Officers and are two of the four directors of the company. They each possess a 35% stake in the company's share capital. The remaining 30% ownership is distributed among various individuals who have no affiliation with Karke and are unrelated to Prakash and Priya. In 2020, Karke made a substantial investment of 1,200,000 to acquire a minority shareholding in an overseas company known as Moe Ltd. Moe Ltd operates as a holiday villa and camping site operator. At the time of Karke's share acquisition and throughout 2020, Bliss Ltd was turning a profit. However, since that period, it has experienced significant trading losses and continues to operate in an exceedingly competitive market under challenging market conditions.

1. Your firm was appointed as the company's auditor in March 2023, following a loss of confidence in the previous auditors by the company's directors. This loss of confidence stemmed from two main issues. Firstly, the previous auditors declined the directors' request to develop and implement a new computer-based inventory control system, which the directors had anticipated would enhance internal inventory management. Secondly, the auditors failed to detect a fraudulent scheme perpetrated by the company's finance and operations directors who had colluded. Furthermore, the previous auditors were unwilling to acknowledge their responsibility for detecting this fraud. This fraudulent activity led to over-reimbursements of business travel expenses to the operations director for the year ending on September 30, 2021, resulting in a total loss of 8,416 for Karke. The discovery of this fraud occurred when a loyal employee, suspicious of the directors' actions, overheard them discussing the company's expense reimbursement policy. In response to this misconduct, both directors were dismissed. However, no action was taken to recover the misappropriated funds because the former operations director is Prakash's sister.

Discovering that their fellow directors, who have since been replaced, had defrauded the company came as a shock to Prakash and Priya. They had expected the auditors to thoroughly uncover the fraud, but this revelation served as a humbling experience. It prompted them to reevaluate the company's management practices and consider the possibility of other issues that may have gone unnoticed by the previous auditors, potentially leading to further harm, complications, and losses for the company. As a result, they made a deliberate decision to adopt a new governance approach for the company. Part of this new approach involved seeking a fresh external audit firm with the expectation of fostering an informal, cooperative relationship between the directors and the external auditors. They aimed to work closely together for the collective benefit and future success of Karke. After a series of presentations by three audit firms, including your own, your firm was chosen as the new auditors for the company. One of the key expectations of your firm, as perceived by the directors, is a higher level of vigilance in conducting audit procedures to ensure the detection of any fraudulent activities carried out by the company's directors and employees, a degree of certainty that was not achieved by the previous auditors.

1. During a conversation with your firm's audit manager in March 2023, Prakash and Priya acknowledged the typical need for auditors to adopt a suspicious approach when gathering audit evidence to meet their objectives and to approach directors with a zero trust in directors. While they partly anticipated that your firm would follow this approach, especially considering the previous fraud incident involving Karke's former directors, they also held EXPECTATIONS. As joint majority shareholders of Karke, they expected your firm to place a significant degree of trust in the reliability of any written and verbal representations they personally made when obtaining audit evidence. Prakash and Priya both confirmed that every business decision they make is for the benefit of Karke limited, and they needed and EXPECTED your firm to accept they would always be totally honest in their dealings with your firm during the audit of their company's financial statements. In subsequent discussions with the audit manager, the new financial director, Jawad Vaghani, emphasised that all directors shared Prakash and Priya's EXPECTATIONS in this regard. He argued that Prakash and Priya had no incentive to be untruthful when communicating with external auditors, and such an approach could streamline the process of obtaining audit evidence and potentially reduce the audit fee.

Similarly, Jawad discussed with your firm's audit partner prior to the commencement of the audit that Prakash and Priya did not see the necessity for Karke's external auditor to express concerns about the company's business risk profile. He pointed out that the directors were fully aware of the need to identify and mitigate business risks. Prakash had maintained a comprehensive register of business risks faced by Karke over the last 20 years. This register was regularly reviewed and updated following discussions with his co-directors, senior employees, and external consultants. It's a computer-based record containing details about significant business risks, including the likelihood of associated threats adversely affecting Karke, potential impacts on the company's day-to-day operations at both the overall and branch shop levels, and the measures in place to mitigate those risks. Given this situation, the directors confirmed their EXPECTATION that your firm would not need to be involved in identifying and assessing business risks faced by Karke, as they believed they were well-equipped in this area. They simply wanted your firm to focus on auditing the company's financial statements and avoid delving into business risk matters. In line with this, Prakash mentioned that he did not EXPECT your firm to require access to the register of business risks. That being said, Prakash and Priya EXPECTED your firm's audit partner to attend the company's board of directors' meetings and be an integral part of Karke's executive decision-making process concerning the company's strategy for improving profitability and enhancing the company's internal control system.

1. The company operates ten branch shops situated in major cities across the United Kingdom. Each branch is managed by a manager who is supported by one fulltime and one part-time (Saturday only) assistant. Employees at each branch are eligible for individual wage bonuses, which are determined based on monthly sales performance. Approximately 45% of the company's sales are generated from in-person shoppers at the branch locations, with approximately 35% stemming from its online sales operations. The remaining 20% of sales are derived from wholesale exports to various independent boutique design jewelry shops situated in Denmark, Finland, and Sweden. However, Prakash mentioned that following the UK's exit from the European Union, there has been a significant decline in exports to these countries. As a response to this, he has been exploring alternative export markets, including the United States and Indonesia, in an effort to compensate for the lost sales.

1. Karke procures the majority of its merchandise, which includes goods for resale, from suppliers in Africa, Sri Lanka, and China. As a result of this global sourcing, a significant portion of the company's purchase invoices are denominated in foreign currencies. To settle these invoices, the company makes payments in foreign currency through bank credit transfers.

1. In May 2023, with the aim of enhancing the company's gross profit margins by introducing in-house crafted jewelry, Karke issued additional share capital to all existing shareholders, ensuring that each shareholder maintained the same proportion of the company's shares both before and after the issuance. In addition to this, Prakash and Priya extended a long-term loan of 80,000 to Karke, securing the loan by re-mortgaging their home to fund the company's expansion. The infusion of additional share capital and the loan were utilised to establish a jewelry workshop operation. This initiative involved the conversion of the upper-floor accommodations in two of the branch shops into fully equipped workshops. Karke employed four jewelry makers at each location to craft nine-carat gold rings, gemstone necklaces, and bracelets using imported raw materials. The workshops officially commenced operations on July 1, 2023, with each of the eight jewelry makers incurring a gross salary cost of 40,000 per annum for Karke starting from that date. These workshops were outfitted with costly fixtures and advanced security features, as well as state-of-the-art equipment for cutting, coloring, and assembling jewelry. Some of these pieces of equipment were high-end, relatively small, portable, and vulnerable to damage.

1. Prakash and Priya, along with all branch managers and five head office staff members, are individually supplied with company cars. During a meeting with the audit manager, Priya noted that all branch personnel received a yearly raise of 3% in their base salaries compared to the preceding year.

1. Jawad Vaghani, the son of Priya's close friend, is responsible for preparing the company's monthly and annual financial statements. He is supported by two full-time and one part-time accounts assistant. These financial statements are generated using a highly sophisticated computer-based accounting system, which was installed in February 2023 and went live on March 1, 2023, effectively replacing the outdated system previously in use. Prior to joining Karke, Jawad worked as an audit assistant at your firm. He is a friendly individual, currently 29 years old, and possesses a set of three Advanced Level certificates, including one in Accountancy, acquired during his school years. However, he has encountered challenges in making significant progress in his professional accountancy exams (ACCA), despite a decade of effort. Disheartened by this, he was enticed by the prospect of a company car and decided to begin his role as Karke's Financial Director in January 2023. Both Priya and Prakash regard Jawad as a charming and pleasant young man who is committed to working in Karke's best interests. Your firm regretted his departure, as he had been a reasonably effective employee, despite his somewhat lax approach to staying updated on accounting standards.

1. During a talk with Tokoni Malambo from our audit team, a Karke accounts assistant said,

"Using assertions in auditing our financial statements seems unnecessary. Aren't you just checking the numbers for mistakes? It's straightforward - you focus on figures and any errors, regardless of their nature or size. Talking about 'assertions' just complicates things and makes auditing sound more difficult than it is. Auditors only care about assertions when stating them in their report about the directors' honesty and the company's performance. Isn't the purpose of the auditor's report to assure shareholders that the directors fulfilled their responsibilities efficiently?"

1. In March 2023, Karke started a refurbishment (improvement), repairs and decoration project for its branch shops, hiring a national shopfitting firm. The objective is to enhance the appearance of each shop inside and out, aiming for a better customer experience. Currently, four shops have been revamped, and work is ongoing in three others. The costs for this project are significant and material in the context of the company's financial statements.

1. In August 2023, when discussing the forthcoming audit with your firm's audit partner, Prakash commented:"We appreciate your firm's employees will be working hard to complete the audit and, as you've mentioned, on occasion some of the audit team will be working 12-hour days to complete their audit procedures in good time ahead of the date by which we've agreed you'll issue your auditor's report. So, as a token of the directors' appreciation of this we intend to give every member

of the audit team a Karke Jewellery Voucher, with a Karkee of 140, which can be used to purchase any jewellery from our online offering before 30 April 2023. We hope you and your audit team will accept these gifts in the working together spirit in which they're offered "

1. In July 2023, a shopper was badly injured when visiting a branch shop being refurbished, because a recently erected internal wall collapsed and fell onto her. Because of her injuries, it is likely that she will have to endure a prolonged unpaid absence from her place of work. So, she has lodged a claim for compensation against Karke in the sum of 90,000 for negligence on its part in not ensuring adequate safety measures were in place to protect her as a customer at the shop. The company's legal adviser, Leona Lam is Prakash's cousin and a partner specialising in company acquisitions and mergers at a medium sized firm of solicitors. Leona supports Karke's view that the company was not negligent but has informed Karke's directors that a without prejudice/ no blame compensation offer of 35,000 to settle the claim is probably the best way to bring the matter to swift expeditious closure and so avoid potentially higher further litigation costs in defending against the claim. She has entered into detailed correspondence with the claimant's firm of solicitors in this regard and has provided Karke with copies of all correspondence between the two firms. The claimant's solicitors are adamant that Karke was negligent and are threatening to commence court proceedings imminently against the company unless their client's claim is paid. However, in line with the directors' opinion and consistent with Leona's advice, the company has not made any provision for the claim in its year-end financial statements. Jawad has told your firm that it's the director's decision entirely as to whether a provision should be made for the claim in Karke's financial statements. He stated there is no accounting standard ruling that a provision should be made, and the directors consider that actually making a provision in respect of the incident for any amount of damages is tantamount to accepting liability for the customer's losses caused by her injuries and will weaken the company's defence if the claim reaches court. Prakash, Priya and Jawad believe they are acting in all shareholders' interests in not including any provision and they're confident the owners of the remaining 30% of Karke's shares would fully understand and agree with them about this - even if the claim proceeds to court and the company loses the case.

1. The draft financial statements of Karke for the year ended 30 September 2023 report a retained profit for the year of 756,000 and profit before tax of 1,222,000, with all jewellery workshop revenue and capital costs being amalgamated with branch shop revenue and capital costs. The planning materiality threshold for the audit has been set at 5 % of Profit before Tax.

Requirements

1. CRITICALLY explain with justifying rationale as to whether or not the EXPECTATIONS of Karke Limited's directors are reasonable, in the context of external auditors' responsibilities and duties generally with regard to:

1. The actions of the previous auditors in refusing to design and install a new computer- based inventory control system for Karke Limited and in not detecting the directors' fraud; your firm's vigilance to ensure fraud detection, and its audit approach when obtaining evidence.

1. The directors working closely in an informal working partnership with your firm for the greater good and prosperity of Karke Limited, your firm placing a high degree of trust in the verbal and written representations of the directors, ignoring business risks faced by the company and attendance by your firm's

audit partner at Karke Limited's board of directors' meetings

(30 marks)

1. Identify FIVE situations from which business risks arise for Karke Limited which your firm would need to consider when assessing the inherent risks attached to the financial statements of Karke Limited for the year ended 30 September 2023. For each risk situation identified, justify the business risk, and explain the linked inherent risk - being the audit concern(s) with regard to its effect on the company's financial statements. (25 marks)

1. Carry out an analytical review of the Summary Financial Statement of Karke Limited (in the appendix below) for the year ended 30 September 2023 and identify any FIVE specific areas which would cause particular audit concern about material mis- statement. For each area identified explain the nature of the concern and support

your comments with relevant calculations as appropriate. (25 marks)

1. For this requirement you must ANSWER ONLY(a) or (b) or (c)

1. Comment CRITICALLY with justifying rationale, as to the validity of the remarks made by the accounts assistant to Tokoni Malambo, about the interest in and use of assertions by the audit team, the auditor's interest in mistakes in the financial statements, the purpose of the auditor's report and the confidence

it gives a company's shareholders about its directors. (10 marks)

OR

1. Identify any audit concerns arising from the fact that a new computer-based accounting system has been implemented by Karke Ltd, with effect from 1 March 2023 and state the effect that this should have on your firm's' approach to auditing the company's financial statements for the year ended 30

September 2023. (10 marks)

OR

1. Identify and justify in full any concerns your firm has in connection with the absence from the financial statements of a provision for liability in respect of the compensation claim by customer injured at a branch shop. You must explain how this should affect your firm's approach to this part of the audit, identifying audit procedures your team should carry out, considering the view held by Karke Limited's directors. (10 marks)

1. Discuss the reasons how your firm's audit partner should have responded to the directors' offer to provide every member of your firm's audit team with a Karke

Jewellery Voucher worth 140. (10 marks)

(Total 100 marks)

AppendixKarke Limited Summary Financial Statements

	INCOME STATEMENTS... Years to.....
	30/09/2023	30/09/2022	30/09/2021	30/09/2020	30/09/2019
	( Draft ) '000	(Audited ) '000	(Audited) '000	(Audited) '000	(Audited) '000
Sales	11,714	10,552	10,194	9,756	9,562
Cost of Goods Sold	4,578	4,982	4,576	4,582	4,324
Branch Shop / Wages and Salaries	2,064	1,842	1,792	1,722	1640
Depreciation Branch Shop Assets	370	142	138	120	232
Other Branch Shop Costs	392	126	120	114	116
Gross Profit	4,310	3,460	3,568	3,218	3,250
Head Office Salaries	1,488	1,472	1,408	1,354	1292
Directors' Remuneration	970	860	820	700	770
Depreciation	112	118	108	120	116
Loss (Profit ) on Disposal of Assets	152	28	14	-84	-32
Other Head Office Expenses	246	228	242	336	264
Profit before interest	1,342	754	976	792	840
Interest paid	120	56	66	72	80
Profit before tax	1,222	698	910	720	760
Taxation	366	210	274	216	228
Profit after tax	856	488	636	504	532
Dividends	100	120	120	120	120
Retained profit for period	756	368	516	384	412

STATEMENTS OF FINANCIAL POSITION
	30/09/2023	30/09/2022	30/09/2021	30/09/2020	30/09/2019
	( Draft ) '000	(Audited ) '000	(Audited) '000	(Audited) '000	(Audited) '000
Non- Current Assets : Tangible	4,612	2,850	2,532	1658	2570
Investments - Shares in overseas company	2,400	2,400	2,400	2400
Current assets : Inventory	2,098	1,402	1,252	1436	1492
Trade Receivables	890	428	356	494	124
Other Receivables	42	14	64	32	20
Bank and Cash	36	42	484	144	1056
Total Current Assets	3,066	1,886	2,156	2106	2692
Creditors payable within 12 months :
Bank Loan - Secured	180	200	200	200	200
Bank Overdraft - Secured	692	256
Trade Payables	1,242	954	852	548	462
Other Payables (incl. taxation)	686	524	402	298	326
Total Current Liabilities	2,800	1,934	1,454	1046	988
Net current assets/(liabilities)	266	-48	702	1060	1704
Long-term Bank Loans - Secured	1,220	1,060	1,460	1860	1400
Long-term Directors' Loan - Unsecured	160
Provisions for Liabilities & Charges			400
Total assets, less liabilities	5,898	4,142	3,774	3258	2874
Issued Ordinary Share Capital (Ordinary 1 shares)	2,200	1,200	1,200	1200	1200
Revenue Reserves - Retained Profits	3,698	2,942	2,574	2058	1674
Total equity	5,898	4,142	3,774	3258	2874