Harlem
a) Fraud and errors
It is auditors’ responsibility to detect fraud and error while providing assurance to the entity,
according to ISA 200.
One of the audit risks, risk of material misstatement is led when the financial statements are
materially misstated. This will be due to fraud and errors occurring during the financial year. The
auditor can identify and assess the material misstatement through understanding the entity and its
environment, including the entity’s internal control.
Hence, the auditor must obtain sufficient and relevant audit evidence regarding the risks accessed
by fraud and error. Each transactions should be thoroughly examined and responded to the entity
about detected fraud and errors properly.
The auditor must follow professional scepticism while obtaining assurance throughout the audit
procedure. The auditor should be free from the engagement of management teams while following
audit procedures that would not prevent from the detection of frauds and errors.
b) Ratios 20x5 20x4
Gross profit margin 19% 21%
Inventory holding period 41 days 34 days
Gearing 130% 116%
Interest cover 10 times 18.4 times
c) Audit Risks and auditor’s response
1) The company purchased a patent for $ 800,000 and which was capitalized in prior period as
intangible assets.
The auditor should see the document purchased and see the price and agreement whether it’s
for 4 years, then the amount should be amortized for 4 years as it is intangible asset. Discuss
with management for amortized cost and written down value if it’s correct or not.
2) The surplus item of plant and machinery were sold off resulting disposal loss of 160,000.
The auditor should see the invoice for disposal of plant and machinery and see if the amount is
correct. Then, this loss should be seen Profit or Loss statement in the financial statements of the
company.
3) In 20X5, finance controller of Herlem Co was dismissed after being alleged for fraudlent
transactions though she was denying for it.
The auditor must thoroughly see ledger of finance controller, and find out if any suspicious
transactions were carried out other than his/her remunerations. After confirming the
transactions only, the auditor should give report if she was involved in self-interest. If she wasn’t
involved in such activities then she should not face unfair dismissal then auditor should give
assurance about her ethics.
4) A significant costumer is taking 6 months of credit period due to financial difficulties.
The credit period for trade receivables of Herlem is of prior year to that customer, which should
be 38 days that differs by 142 days. Hence, this should be asked to management for quick
settlement.
5) Herlem Company intends to restructure the debt finance. However the gearing has been
increased from 116% to 130%.
The audit team should ensure that the debts are not understated. The estimates and judgments
should be made regarding misstatement risks.
6) Herlem Co has issued shares during the year through bonus issues. Hence the equity of the
company should be increased while reserves should be decrease.
Review board minutes for bonus issue and approval by the board of directors. Also, see if the
bonus issue have been increased in share number and also to concern shareholder’s share
certificate.
7) The prior year audit had highlighted an issue regarding purchase cycle. The cost of sales,
expenses, trade payables may not be complete or accurate.
Discuss with management team whether the purchase cycle recommended by Brooklyn & Co
had been implemented successfully or not. If the methods not followed, calculate the costs
accuracy of cost of sales, expenses and trade payable.
8) Herlem co had some issues regarding production which affected quality of tyres. The inventory
holding period has been increased from 34 to 41 days.
The auditor should discuss with finance director whether any write downs regarding affected
tyres will be made or not. Also, the testing should be undertaken for Net realizable value that
undergoes in closing inventory.
D) Trade receivables
- Discuss with finance director that the allowances for trade receivables should not be
increased.
- Review the aged trade receivable ledger to identify any slow moving or old balances. The
status should be discussed with credit control department.
- Discover the receivables which are potentially not recoverable and should be discussed with
management if material or not.
- Review if any after financial year end date receipts from sundry debtors that were disputable.
d) Plant and Machinery
- Obtain a breakdown of disposals, cast the list and review the non‐current assets register to
confirm that all assets have been removed.
- Select a sample of disposals and agree sale proceeds to supporting documentation such as
sundry sales invoices.
- Recalculate the profit/loss on disposal and agree to the trial balance and statement of profit
or loss.
- Review the disclosure of the disposals in the draft financial statements and ensure it is in
line with IAS 16 Property, Plant and Equipment
