Question

5.23     Negligence

StirMed sells a range of medical products mainly through representatives visiting hospitals and doctors. StirMed has been going through lean times recently and managing day-to-day cash flow has become a challenge.

In spite of the cash flow difficulties, the financial report to 30 June 2015 showed reasonable revenue; however, there were high levels of both receivables and payables and the bank overdraft was getting close to its agreed limit. The auditors, Brent, Date and Co, completed their audit for the year ended 30 June 2015 and gave an unmodified opinion.

Within seven months of the year end, StirMed went into liquidation — unable to pay its debts. As part of the liquidator’s investigations, it became apparent that a major fraud had been carried out by two of StirMed’s representatives who had created fictitious sales in order to increase their commission. This resulted in both sales and receivables being overstated by material amounts. The liquidator is questioning the conduct of the auditors in not detecting this fraud. Sales and receivables testing was carried out by Francis, the most junior member of the audit team.

Required

Discuss the legal problems and possible liability of Brent, Date and Co as a result of the above facts.

Answer 1

Fact of the Case: StirMed engaged in Medical products through visiting hospitals and doctors. Day to day operational cash requirement is very high. For th eperiod ended June 2015 Revenue earning are reasonbale good. With High Levels of receivables and payable , Bank Overdraft  on both side Assets and Liabilities. On Apparent Receivable total is almost equal to Payable and Bank Overdraft. After this within short span of time same has been went into liquidation.  Chances of fraud over the Revenue just to increase of personal commission.

As per the scenario, fraud is committed by inside employees for personal benefit through fictitious invoices. Although It is the management responsibility to put in place proper control over the process and oversightedness of the control and its effectiveness.

The Auditor is expected to have sufficient knowledge and skills to conduct the audit but not expected to have expertise in fraud investigator. Here in this case Auditor Brent, Date and Co. fails to supervise over the Internal audit activity and same is handled by its junior auditor , ( Lack of required skill and knowledge)

Secondly on understanding the revenue are outstanding for more than standard  period due to fictitious sale, No written off policy or written back policy referred by the Auditor. Non understandability of policies.

Third, Due diligence is not properly employed or dealt by the auditor by not guiding his junior auditor, looks after the major portion ( material ) facts instead of focusing on overall audit basis.

Majority of the consequences of the Above lack of due diligence is disciplinary actions against the auditor firm or bar it from dealing with further audit over the particuar period. SCN why not same is not identifiable , why due diligence is not exercised. Although Auditor can use the term Scope of limitation, but same is not shown in its " Unmodified Report"