a) Implications of the Fraud for Audit Completion

If the full extent of the fraud is GH¢50,000, then the audit team is correct to determine that the fraud is immaterial to the financial statements. However, without performing further procedures, it is not possible to reach that conclusion. There is no auditor-generated evidence to support the assertion that GH¢50,000 is the total amount of stolen funds. Relying solely on a conversation between the finance director and the finance officer who carried out the fraud and a list of invoices provided by the finance director is not acceptable as this evidence is not sufficiently reliable.

Indeed, the finance director could be involved with the fraud and is attempting to deceive the auditor and minimize the suspected scale of the fraud in order to deter further procedures being carried out or prevent any investigation or actions being taken. The auditor should approach the comments made by the finance director with an attitude of professional skepticism, especially given that he has asked the audit team not to investigate further, which raises suspicion that he may be covering up the fact that the fraud was on a larger scale than has been made known to the auditor.

There are two courses of action for the auditor:

1. Further Investigations: Independent investigations should be carried out to obtain sufficient and appropriate evidence relating to the amount of the fraud. This is particularly important given that the finance director seems unwilling to make any adjustment to the financial statements. If the fraud is actually more financially significant, the financial statements could be materially misstated, but without further audit evidence, the auditor cannot determine whether this is the case.
2. Reporting Requirements: ISA 240, The Auditor’s Responsibilities Relating to Fraud in an Audit of Financial Statements, requires that when fraud has taken place, auditors shall communicate these matters on a timely basis to the appropriate level of management in order to inform those with primary responsibility for the prevention and detection of fraud of matters relevant to their responsibilities. Given that the finance director alerted the auditor to the fraud, it seems likely that management and those charged with governance are already aware of the fraud. However, the auditor should consider whether a formal, written communication is needed.

In addition to reporting to management and those charged with governance, ISA 240 requires that the auditor shall determine whether there is a responsibility to report the occurrence or suspicion to a party outside the entity. The auditor’s duty to maintain the confidentiality of client information makes such reporting potentially difficult, and the auditor may wish to take legal advice before reporting externally.
Further, anti-money laundering legislation is likely to impose a duty on Posterity Chartered Accountants to report suspected money laundering activity. Suspicions relating to fraud are likely to be required to be reported under this legislation. Therefore, Posterity Chartered Accountants should consider whether reporting the fraud on this basis is necessary.
(6 marks)

b) Development Costs Audit Evidence

i) Sufficiency and Appropriateness of Audit Evidence Obtained

Given that the development costs are material to the financial statements of Security-Watch Ltd, more audit work should have been carried out to determine whether it is acceptable that all, or some, of the GH¢1,000,000 should have been capitalised. There is a risk that research costs, which must be expensed, have not been distinguished from development costs, which can only be capitalised when certain criteria have been met. Currently, there is not sufficient, appropriate audit evidence to conclude that the accounting treatment is appropriate, and intangible assets could be materially misstated.

Agreement of amounts to invoices provides evidence of the value of expenditure but does not provide sufficient, appropriate evidence as to the nature of the expenditure, i.e., the procedure is not necessarily an evaluation of whether it is capital or revenue expenditure.

Performing an arithmetic check on a spreadsheet does provide some evidence over the accuracy of the calculations but does not provide sufficient, appropriate evidence on the validity of the projections. In particular, there is no evidence that the assumptions are sound. Given that the finance director has not allowed the audit team access to information supporting the spreadsheet and has refused to answer questions, he may have something to hide, and the audit of the projection should be approached with a high degree of professional skepticism. The assumptions may not be sound and may contradict other audit evidence.

The attitude and actions of the finance director, which indicate a lack of integrity, should be discussed with the audit committee, as the committee should be in a position to discuss the situation with him, with the objective of making all necessary information available to the audit team.

Finally, there appears to be over-reliance on a written representation from management. ISA 580, Written Representations, states that written representations should be used to support other audit evidence and are not sufficient evidence on their own. In this situation, it appears that the representation is the only evidence which has been sought in regard to the likely success of the new product development, which is inappropriate.
(10 marks)

ii) Further Evidence for Development Costs

Further evidence should be obtained to distinguish between research costs and development costs, and to support whether the development costs meet the recognition criteria in IAS 38, Intangible Assets, and to confirm whether all of the GH¢1,000,000 should be capitalised. Further evidence should include:

1. Discussion with the Project Manager: Obtain their view on the likely launch date for the new product, anticipated level of demand, and any problems foreseen with completion of the project.
2. Review of a Sample of Costs: Further review a sample of the costs included in the GH¢1,000,000, including evaluation of whether the costs are capital or revenue in nature. (4 marks)