You have just been appointed as a junior Audit Partner at Mahdi and Co, an audit firm.

Mahdi and Co is in reality a sole practitioner, Mr Mahdi, who has been auditing businesses in your suburb for 20 years. He is considered by locals to be a very nice man with a strong reputation for honesty.

In late April, the firm is approached by Mr Bamboozle, the Chairman of the Board of Grifters Company Ltd (GC), a real estate investment business, to conduct the audit of GC. Mr Bamboozle explains that the previous auditor had expressed a desire to retire from the audit, and they are looking for a replacement audit. Mr Mahdi asks you to undertake the preliminary review.

As part of your review of GC you undertake enquiries of businessmen in the neighbourhood. There is nothing directly adverse known about GC, and Mr Bamboozle is considered to be a very astute businessman.

However, one person who you know who worked with Mr Bamboozle previously had a short private conversation with you. From this conversation it becomes clear that Mr Bamboozle expects the companies he runs to appear perfect to outsiders. He will not accept situations that run counter to his views. In fact there was a feeling within the Accounting Department of GC that the accounts needed to be drawn in such a way as to satisfy Mr Bamboozle regardless of the true situation.

On behalf of Mr Mahdi, you approach Mr Bamboozle to obtain a letter of authority to the previous auditor to discuss the audit history with you. Mr Bamboozle explains that he does not wish to give such a letter as he does not trust the previous auditor to be honest in his dealings with Mahdi and Co as they would be jealous and are incompetent fools. He therefore will not give you the letter. On being told this, Mr Mahdi says: We can do a much better job than him, I will consider accepting the audit!

Question 1

Required:

Prepare a report to advise Mr Mahdi as to whether Mahdi and Co should accept GC as a client. In your report critically analyse the reasons for accepting or declining the audit. In your answer cover the ethical obligations and how these may have been compromised.

Mr Mahdi accepts the audit.

Question 2

Required:

Explain in detail what Mahdi and Cos next step should be immediately after deciding to accept the audit.

While Mr Mahdi visits the client, you begin preliminary planning and as part of that planning you obtain some initial analytical review data which is set out below:

GCIndustry Average

Current Ratio0.51.5

Quick Ratio0.451

Debt to Equity5:13:1

Interest as a % of Debt3.5%7%

Question 3

Required:

Analyse with explanations the above ratios, and indicate with reasons which balances and transaction cycles the above information will cause you to concentrate your audit activities on.

Mr Mahdi asks you to come into his office so that he can plan the audit of GC with you. He says you should principally undertake to prove the assets and liabilities listed in the Balance Sheet. If you cannot, then you should ask Mr Bamboozle for guidance. You ask about controls and Mr Mahdi replies, we do not have to consider controls. No one has ever sued an auditor for failing to point out poor controls.

Question 4

Required:

Draft a memo to Mr Mahdi critically setting out the requirements of the auditing standards regarding controls rebutting his statement that no one has ever sued an auditor for failing to point out poor controls. You should quote the relevant case law.

Mr Mahdi reads your memo and decides that he should also test the controls of GC. He sends you out to test the controls. You visit the company and ask Mr Bamboozle about the companys internal controls. He calls in the office manager, Mr Sting, who pulls a thin dusty manual from the bookshelf labelled Grifters Company Ltd Internal Control Manual 2002. You take this to Mr Mahdi who reads the manual and advises you that the controls appear to be not worth relying on.

Question 5

Required:

(a) Explain in detail the audit strategy you propose to implement based on Mr Mahdis decision. Include the types of tests that will now be undertaken

During the next meeting with Mr Mahdi, you discuss proving the Statement of Profit or Loss. As you leave Mr Mahdi says: Please sent me an Audit plan for the Statement of Profit or Loss setting out which assertions you intend to prove.

Question 6

Required:

Prepare a memo to Mr Mahdi listing the management assertions surrounding the Statement of Profit or Loss, and a basic statement explaining each assertion.

You set out to confirm the high value transactions. You do this by taking a sample of documents advising charges under contractual arrangements and confirming the existence of an invoice for each item and that all invoices have a matching journal entry. All the journal entries are then matched to a corresponding ledger posting. The ledgers are then proved to the trial balance. When you finish, Mr Mahdi advises that you have now proved completeness of the revenue items.

Question 7

Required:

With a full explanation, detail whether you have proved completeness.

Question 8

Required:

Give a full and detailed explanation of how the assertion of Cut Off would be proved for the monthly lease revenue accounts.

It is now the end of July, and you are finalising the audit. On 15th July, one of GCs investment properties was having the foundations dug for a new garage, when the adjacent house slipped into the foundation hole and was destroyed. GC would normally be considered responsible for the event but insurance does not cover the huge amount of loss, and there is an extreme material discrepancy between the expected insurance payout and the loss.

Question 9

Required:

Explain what you expect GCs management to do relative to the accounts in this circumstance.

Mr Bamboozle has been asking Mr Mahdi daily when he might be ready to sign the audit report.

As the accounts seem to be in order, Mr Mahdi is putting pressure on you to finish the working papers and hand them to him so that he can sign off the audit. You note that the Final Accounts as submitted to you by Mr Bamboozle do not mention the post balance date event, and draft the audit report accordingly then finish tidying up, and prepare to give the working papers and draft report to Mr Mahdi tomorrow. As it is late you decide to drop by a local restaurant on the way home. While eating your meal you are joined by a local person whom you know was recently released from jail following his conviction for assault. This person explains that GCs accounts are not going to mention the loss due to the fire, and perhaps the audit report should not mention this loss either.

Question 10

Required:

(a) Write a detailed report to Mr Mahdi explaining what type of audit report he should give.

(b) Discuss the ethical implications of your evening meal.