You have been asked to carry out an investigation by the management of Adepa Ltd. One of the company’s subsidiaries, Papa Engineering Ltd, has been making losses for the past years. Adepa’s management is concerned about the accuracy of Papa Engineering’s most recent quarter’s management accounts.

The summarized income statements for the last three quarters are as follows:

Quarter to                                                        30/09/17          30/06/17          31/03/17                                                                                                                                                                                   GHS000          GHS000            GHS000

Revenue                                                          860                  668                  686

Opening inventory                                          360                  326                  331

Materials                                                         636                  468                  475

Direct wages                                                   124                  142                  148

                                                                        1,120               936                  954

Less: Closing Inventory                                 (324)               (360)               (326)  

Cost of goods sold                                          796                  576                  628

Gross profit                                                    64                    92                    58

Less: overheads                                              (126)               (150)               (164)

Net Loss                                                          (62)                 (58)                 (106)

Adepa’s management board believes that the high material consumption as a percentage of revenue for the quarter to September 2017 is due to one or more of the following:

1. Under-counting or under-valuation of closing inventory
2. Excessive consumption or wastage of materials
3. Materials being stolen by employees or other individuals.

Papa engineering has a small number of large customers and manufactures its products to each customer’s specification.

The selling price of the product is determined by:

1. Estimating the cost of material
2. Estimating the labour cost
3. Adding a mark-up to cover overheads and provide a normal profit.

The estimated costs are not compared with actual cost. Although it is possible to analyze purchase invoice for materials between customer’s orders, this analysis has not been done. A physical inventory count is carried out at the end of each quarter. Items of inventory are entered on stock sheets and valued manually. The company does not maintain perpetual inventory records and a full physical count is to be carried out at the financial year end, 31st December 2017.

The direct labour cost included in the inventory valuation is small and should be assumed to be constant at the end of each quarter. Historically, the cost of materials consumed has been about 70% of revenue.

The management accounts to 30 June 2017 are to be assumed to be correct.

1. Define ‘forensic auditing’ and describe its application to fraud investigations.
2. Identify and describe matters you should consider and procedures you should carry out in order to plan an investigation of Papa Engineering Company’s losses.
3. i. explain the matters you should consider to determine whether closing inventory at 30/09/17 is undervalued.

Describe the tests you would perform to qualify the amount of any undervaluation