You are an audit partner with Tickett & Run and three months ago you signed off the audit of Blastypot plc, a large engineering group with several subsidiaries. The turnover of the group is £750m and it has reported a profit for the last financial year ended 31 March 2X11 of £22m.

You receive a call from group financial director Rod Sneers who tells you:

• Internal audit have uncovered a fraud in the materials purchasing department of Blastypot. The purchasing manager had secretly set up several companies and had used them to sell materials and services to Blastypot at inflated prices by routing supplies from approved suppliers to his companies and adding on a large margin before selling them on to Blastypot. The manager had been suspended and the company were investigating with a view to prosecution.

• The managing director of one of the subsidiary companies, Big Hole Ltd, an operator of gravel quarries, had admitted that he and the subsidiary’s financial director had falsified the results of the subsidiary for the last two years in order to reach profit targets and be paid a large bonus. In fact Big Hole plc, rather than being profitable, was on the verge of insolvency and will have to be supported by the holding company until it recovers. You recall that your audit team was only at Big Hole for about a week and concentrated on verifying aspects of the Statement of Financial Position and did little systems audit work. Rod says the directors are of the opinion that Tickett & Run were negligent in their audit of Big Hole.

You have just recovered from this call when Sophie, a friend, rings you. She is an audit partner at another firm, Bashit &
Hope, and she says that they have received a notice of claim from a former audit client, Pongo Ltd which had just sold out to Massive plc. Massive alleges that the inventory valuation of Pongo was overstated by £25m and they are looking to her firm, as auditors who signed off a clean audit report on Pongo two months before Massive bought the company, to refund the £25m. She is looking to you for some advice.

Required:

1) Explain the auditor’s responsibility to detect fraud and how you would respond to Rod Sneers in respect of this.
2) What factors would you need to consider in respect of the possible claim against Ticket & Run and their audit of Big Hole Ltd? What will you need to demonstrate in order to overcome such a claim?
3) What information would you need to confirm from Sophie before you can give her advice and what advice would you give her?