On January 11 at the beginning of Elijah Domacin’s annual audit of the financial statements for the year ended December 31 of Zedruga Manufacturing Company of Skoplje, Serbia, the Company president confides in Domacin that an employee is living on a scale in excess of that which his salary would support.

The employee has been a buyer in the purchasing department for six years and has charge of purchasing all general materials and supplies. He is authorised to sign purchase orders for amounts up to Yugoslavian New Dinar (New Dinar) 1,000. Purchase orders in excess of New Dinar 1,000 require the countersignature of the general purchasing agent.

The president understands that the usual examination of financial statements is not designed, and cannot be relied upon, to disclose fraud or conflicts of interest, although their discovery may result. The president authorises Domacin, however, to expand his regular audit procedures and to apply additional audit procedures to determine whether there is any evidence that the buyer has been misappropriating company funds or has been engaged in activities that involve a conflict of interests.

Required:

A. List the audit procedures that Domacin would apply to Zedruga’s records and documents in an attempt to:

1. Discover evidence within the purchasing department of defalcations being committed by the buyer. Give the purpose of each audit procedure. 

2. Provide leads as to possible collusion between the buyer and suppliers. Give the purpose of each audit procedure.

B. Assume that Domacin’s investigation disclosed that some suppliers have been charging the Zedruga Manufacturing Company in excess of their usual prices and apparently have been making ‘kick-backs’ to the buyer. The excess charges are material in amount. What effect, if any, would the defalcation have upon:

1. The financial statements that were prepared before the defalcation was uncovered; 

2. Domacin’s auditor’s report? Discuss.