You are the audit supervisor of SARRAH and are currently planning the audit of an existing client, XXX, whose year end was 30 April 20X5. XXX is a pharmaceutical company, which manufactures and supplies a wide range of medical supplies. The draft financial statements show revenue of $35.6 million and profit before tax of $5.9 million.

XXXs previous finance director left the company in December 20X4 after it was discovered that he had been claiming fraudulent expenses from the company for a significant period of time. A new finance director was appointed in January 20X5 who was previously a financial controller of a bank, and she has expressed surprise that SARRAH had not uncovered the fraud during last years audit.

During the year XXX has spent $1.8 million on developing several new products. These projects are at different stages of development and the draft financial statements show the full amount of $1.8 million within intangible assets. In order to fund this development, $2.0 million was borrowed from the bank and is due for repayment over a ten-year period. The bank has attached minimum profit targets as part of the loan covenants.

During the year, a review of plant and equipment in the factory was undertaken and surplus plant was sold, resulting in a profit on disposal of $210,000.

Question 1. Auditors are required to plan and perform an audit with professional scepticism, to exercise professional judgement and to comply with ethical standards.

Define professional judgement and describe two areas where professional judgement is applied when planning an audit of financial statements.

Question 2. What are SARRAHs responsibilities in relation to the prevention and detection of fraud and error.

Question 3. Independence treats before accepting audit engagements