AAA – May 2025 – Professional – SC – Q6 – Advanced Audit Planning and Strategy, Communication with Those Charged with Governance, Forensic Auditing, Emerging Issues in Audit and Assurance

Evaluate auditor objectives, analyse governance responsibilities, explain fraud non-detection, and develop procedures to reduce expectation gap in Tanke Pharmaceutical's audit scenario.

Question

As part of the requirements of the International Standards on Auditing (IAS), before commencement of any statutory audit, Cole & Co (Chartered Accountants), the external auditor to Tanke Pharmaceutical has held a pre-audit meeting with the Audit Committee of the company on the scope, timing of the audit and communication of likely significant risks identified by the auditor during the risk assessment process. Tanke Pharmaceuticals has being experiencing theft of finished products in the previous year to the extent that some of its products were sold at cheaper prices outside the company’s premises which created problem for distributors of the products leading to loss of revenue for the company. The marketing teams were also accused of collecting commissions and transport expenses which did not reflect in the sale proceeds achieved by them. There was increase in payables for inventory items purchased, which were in most cases not delivered. Added to the above, there was a huge suspense receivable account balance emanating from information technology update in the books of the company.

The members of the Audit Committee believe that if the auditors had done their work as expected, such issues would have been discovered earlier. A member of the Audit Committee doubted whether the new and revised standards issued by the International Auditing and Assurance Standards Board were being applied on the audit of the company or even whether expected audit strategies were followed. A suggestion was made that rather than increasing audit fee in line with inflationary pressure as requested by the auditors, the company should rather reduce audit fee to compensate for the loss due to their (auditors‟) negligence.

The members of the Audit Committee were supposed to meet at least five times in a year, but they met only three times and when they met, they hardly spent enough time to go through internal audit reports or review management accounts. Only one member of the Audit Committee is financially literate. The directors‟ meetings were rarely held, as most of them (directors) went on long overseas vacations, thus leaving the operational activities of the company totally to the discretion of management.

The member of the audit committee were of the opinion that the management letter issued by the external auditors should have provided detailed internal control weaknesses which they would have acted upon.

Required:

a. Evaluate the overall objectives of an auditor in the above scenario. (3 Marks)

b. Analyse the responsibilities of those charged with governance. (4 Marks)

c. Explain why the auditors may not detect fraud.

(3 Marks)

d. Develop the procedures to reduce the expectation gap identified. (5 Marks)

Answer

The overall objectives of an auditor in the above scenario are to:

i. obtain reasonable assurance about whether the financial statements as a whole are free from material misstatement, whether due to fraud or error;

ii. issue an auditor’s report that includes the auditor’s opinion; and

iii. state in the auditor’s report whether or not the audit evidence obtained is sufficient and appropriate to provide a basis for the auditor’s opinion.

The responsibilities of those charged with governance are to:

i. oversee the strategic direction of the entity and obligations related to the accountability of the entity. This includes overseeing the financial reporting process;

ii. promote good corporate governance practices;

iii. acknowledge responsibility for the financial reporting process, including the implementation of appropriate internal controls to prevent, detect and correct misstatements due to fraud or error;

iv. provide the auditor with access to all relevant information, such as records and documentation, and persons within the entity from whom the auditor determines it necessary to obtain audit evidence;

v. identify and assess the risks of material misstatement of the entity’s financial statements due to fraud;

vi. design and implement internal controls to prevent and detect fraud; and vii. assess the integrity of management and, where appropriate, those charged with governance.

The auditors may not detect fraud because: i. audits involve sampling, not exhaustive examination of all transactions; ii. management or employees can collude to conceal fraud; iii. fraudsters often use sophisticated methods to hide their actions; iv. auditors rely on representations from management, which may be false;

v. audit procedures are designed to detect material misstatements, not necessarily all fraud; and vi. inherent limitations of internal controls can be overridden.

The procedures to reduce the expectation gap identified:

i. communicate clearly the scope and limitations of the audit in the engagement letter;

ii. educate stakeholders through reports and meetings about what an audit entails and its limitations;

iii. issue a detailed management letter highlighting internal control weaknesses and recommendations;

iv. enhance transparency by discussing audit findings and risks with the Audit Committee regularly;

v. use plain language in audit reports to avoid misunderstandings; vi. conduct stakeholder training sessions on financial reporting and audit roles;

vii. regularly update audit methodologies to align with new standards and share these updates with clients; and

viii. encourage feedback from stakeholders to address misconceptions promptly.

Uploader: Samuel Duah