Audit risk

Response

There is an inherent risk of overstating the expenses. The last CFO of Ratty Ltd left the organisation just before the year end complaining about the fraudulent expenses. This issue was also raised by the newly appointed CFO.

The substantive procedures concerning the test of various expenses must be carried out by the auditors in order to obtain reasonable assurance regarding the presence of fraudulent expenses transactions such as verification of purchase invoices regarding different incurred expenses such as advertising. Confirmation can also be drawn from the vendors if suspicion arises.

Inherent risk in the “Intangible asset” account as the account might be overstated. It is to be noted that within the year, Ratty have incurred a total of £1.2m million towards development of certain new products which are at different stages of development including an unsuccessful attempt of developing a vaccine for Covid-19. The whole amount has been capitalized by Ratty just to portray and added net profit because of the loan covenant where it states of maintenance of a specific amount of net profit every year. This is why the entire amount of £1.2m million has been capitalized and not recorded as an expense which is not advisable according to IAS 38 because the vaccine development attempt has failed and many new products are in different stages of development where there is no fixed proof that the assets have entered it final development phase and ready to be used or sold.

There should be a substantive review of all development expenditure just in order to prove that all assets which has been capitalised met the capitalisation criteria as stated under IAS 38.

Inherent risk in the “Sales account” as there are enhanced reported cases of sales return within the year and post the year end concerning the sales effected during the year. So, there may be situation of overstatement of sales just to enhance and maintain the net profit.

All sales related transactions must be substantially checked in details both concerning the test of balances and test of transactions juts to prove that all sales transactions and sales return transactions have been properly accounted for. There should be “Inspection” of all sales return invoices on a random basis and verified against the transactions passed within the sales ledger to check that all sales returns transactions have been accounted for.

Inherent risk the inventory account. It has been reported by the auditor who attended the inventory count of Ratty stated that there was actual movement of inventory when the count was taking place.

Physical inventory check is to be re-done. Inspection of all relevant documentation concerning the inward and outward movement of inventory is to be checked for both completeness and Accuracy.

Inherent risk within the “Plant and equipment account” as the surplus plant was sold for a profit of £130,000 which is to be investigated.

The documents concerning the sale of the machinery must be reviewed such as sales invoices. An additional “Confirmation” may also be drawn from the purchaser regarding the data and purchase price. The accounting policy especially concerning depreciation must be checked to review the accuracy of the calculation and accounting for the sale of surplus plant.