One of your audit clients is Tye Co a company providing petrol， aviation fuel and similar oil based products to the government of the country it is based in. Although the company is not listed on any stock exchange， it does follow best practice regarding corporate governance regulations. The audit work for this year is complete， apart from the matter referred to below.
As part of Tye Co‘s service contract with the government， it is required to hold an emergency inventory reserve of 6，000 barrels of aviation fuel. The inventory is to be used if the supply of aviation fuel is interrupted due to unforeseen events such as natural disaster or terrorist activity.
This fuel has in the past been valued at its cost price of $15 a barrel. The current value of aviation fuel is $120 a barrel. Although the audit work is complete， as noted above， the directors of Tye Co have now decided to show the ‘real’ value of this closing inventory in the financial statements by valuing closing inventory of fuel at market value， which does not comply with relevant accounting standards. The draft financial statements of Tye Co currently show a profit of approximately $500，000 with net assets of $170 million.
For the purposes of this section assume from part （a） that the directors have agreed to value inventory at $15/barrel.
Having investigated the matter in part （a） above， the directors present you with an amended set of financial statements showing the emergency reserve stated not at 6，000 barrels， but reported as 60，000 barrels. The final financial statements now show a profit following the inclusion of another 54，000 barrels of oil in inventory. When queried about the change from 6，000 to 60，000 barrels of inventory， the finance director stated that this change was made to meet expected amendments to emergency reserve requirements to be published in about six months time. The inventory will be purchased this year， and no liability will be shown in the financial statements for this future purchase. The finance director also pointed out that part of Tye Co‘s contract with the government requires Tye Co to disclose an annual profit and that a review of bank loans is due in three months. Finally the finance director stated that if your audit firm qualifies the financial statements in respect of the increase in inventory， they will not be recommended for re-appointment at the annual general meeting. The finance director refuses to amend the financial statements to remove this ’fictitious‘ inventory.
Required：
（i） State the external auditor‘s responsibilities regarding the detection of fraud； （4 marks）
（ii） Discuss to which groups the auditors of Tye Co could report the ‘fictitious’ aviation fuel inventory； （6 marks）
（iii） Discuss the safeguards that the auditors of Tye Co can use in an attempt to overcome the intimidation threat from the directors of Tye Co. （4 marks）
参考答案：
(i)External auditor responsibilities regarding detection of fraud
Overall responsibility of auditor
The external auditor is primarily responsible for the audit opinion on the financial statements following the international
auditing standards (ISAs (UK and Ireland)). ISA (UK and Ireland) 240 The auditor’s responsibility to consider fraud in
an audit of financial statementsis relevant to audit work regarding fraud.
The main focus of audit work is therefore to ensure that the financial statements show a true and fair view. The detection
of fraud is therefore not the main focus of the external auditor’s work. An auditor is responsible for obtaining reasonable
assurance that the financial statements taken as a whole are free from material misstatement, whether caused by fraud
or error.
The auditor is responsible for maintaining an attitude of professional scepticism throughout the audit, considering the
potential for management override of controls and recognising the fact that audit procedures that are effective for
detecting error may not be effective in detecting fraud.
Materiality
ISA 240 states that the auditor should reduce audit risk to an acceptably low level.
Therefore in reaching the audit opinion and performing audit work, the external auditor takes into account the concept
of materiality. In other words, the external auditor is not responsible for checking all the transactions. Audit procedures
are planned to have a reasonable likelihood of identifying material fraud.
Discussion among the audit team
A discussion is required among the engagement team placing particular emphasis on how and where the entity's
financial statements may be susceptible to material misstatement due to fraud, including how fraud might occur.
Identification of fraud
In situations where the external auditor does detect fraud, then the auditor will need to consider the implications for the
entire audit. In other words, the external auditor has a responsibility to extend testing into other areas because the risk
of providing an incorrect audit opinion will have increased.
(ii)Whom to report fraud to
Report to audit committee
Disclose the situation to the audit committee as they are charged with maintaining a high standard of governance in the
company.
The committee should be able to discuss the situation with the directors and recommend that they take appropriate
action e.g. amend the financial statements.
Report to government
As Tye Ltd is acting under a government contract, and the over-statement of stock will mean Tye Ltd breaches that
contract (the reported profit becoming a loss), then the auditor may have to report the situation directly to the
government. The auditor of Tye Ltd needs to review the contract to confirm the reporting required under that contract.
Report to members
If the financial statements do not show a true and fair view then the auditor needs to report this fact to the members of
Tye Ltd. The audit report will be qualified with an ‘except for’ or adverse opinion (depending on materiality) and
information concerning the reason for the disagreement given. In this case the auditor is likely to state factually the
problem of stock quantities being incorrect, rather than stating or implying that the directors are involved in fraud.
Report to professional body
If the auditor is uncertain as to the correct course of action, advice may be obtained from the auditor’s professional body.
Depending on the advice received, the auditor may simply report to the members in the audit report, although
resignation and the convening of an extraordinary general meeting is another reporting option.
(iii)Intimidation threat – safeguards
In response to the implied threat of dismissal if the audit report is modified regarding the potential fraud/error, the
following safeguards are available to the auditor.
Discuss with audit committee
The situation can be discussed with the audit committee. As the audit committee should comprise non-executive
directors, they will be able to discuss the situation with the finance director and point out clearly the auditor’s opinion.
They can also remind the directors as a whole that the appointment of the auditor rests with the members on the
recommendation of the audit committee. If the recommendation of the audit committee is rejected by the board, good
corporate governance requires disclosure of the reason for rejection.
Obtain second partner review
The engagement partner can ask a second partner to review the working papers and other evidence relating to the issue
of possible fraud. While this action does not resolve the issue, it does provide additional assurance that the findings and
actions of the engagement partner are valid.
Resignation
If the matter is serious, then the auditor can consider resignation rather than not being re-appointed. Resignation has
the additional safeguard that the auditor can normally require the directors to convene an extraordinary general meeting
to consider the circumstances of the resignation.