Question 1

Leek Ltd (Leek) enjoyed sales revenue of 10 million and profits of 1.5 million for the financial year ended 31 December 2016. However, the financial accountant of the firm has recently been dismissed for allegedly misappropriating company funds. The fraud was carried out over a five-month period in 2016, during which the accountant allegedly colluded with one of the company's salespersons and with a member of staff in an independent debt collection agency engaged by Leek to misappropriate individual sums totalling almost 55,000 received from some of Leek's 1,900 customers. The fraud was uncovered in the course of a business conversation in March 2017, when the chief executive of Leek was hosting a St. Patrick's Day party for some customers. The directors of Leek assert that the auditor was negligent in failing to discover the fraud when auditing the financial statements for the year ended 31 December 2016. The auditors have stated that any system of internal control has inherent limitations, and that they reject the allegation of negligence. They strongly claim that any reasonable independent review of their audit documentation will confirm that they were not negligent in their audit work. Required

(a) Evaluate the inherent limitations in both internal control and the audit process itself, and consider why these may result in even a properly performed audit not detecting a fraud such as the one alleged in this case. (15 marks)

(b) Although the auditors in this case may be convinced that they have acted properly, they may be advised by their legal counsel to offer their client an out-of-court settlement. Discuss the reasons for this and critically assess the effect such uncontested settlements may have on the profession as a whole. (10 marks)