Question Tag: Management Fraud

Demmy Global Limited, a growth-oriented company controlled by its Managing Director, Mr. Longe, sells mobile smartphones through sales agents on a commission basis. Phones are supplied on a sale or return basis, with sales recognized upon receipt by agents. The company’s growth appears rapid due to fraudulent practices by Mr. Longe, including:

1. Fictitious agents responsible for 25% of revenue.
2. Year-end dispatch of inventories to agents with post-year-end returns recorded as repurchases.
3. Capitalization of 20% of cost of sales by falsifying purchase invoices with suppliers.
4. Director bonuses linked to profits, encouraging uncritical acceptance of rapid growth.

The fraud was concealed by falsified records, bribery, and restrictions on auditor access to corroborate sales and verify contracts.

The external auditor is now sued by a bank that granted a loan to Demmy Global Limited based on interim financial statements reviewed by the auditor, for which a review report was issued.

Required:

1. Discuss the extent to which an auditor is responsible for detecting fraud and error, and the external auditor’s procedure where fraud or error is suspected. (7 Marks)
2. Advise the auditor on strategies to close the expectation gap. (5 Marks)
3. Explain how the ‘review report’ issued by the auditor on the interim financial statements differs in terms of its level of assurance from the auditor’s report on the year-end financial statements. (2 Marks)
4. Evaluate the circumstance and nature of the reports that would have been necessary for the auditor based on the activities of the Managing Director. (6 Marks)