QUESTION 2
You are an audit senior at Trumps Auditors Incorporated (B&K), currently involved in the
finalisation stage of the statutory annual audit of Pfixer and its two subsidiaries, Moderney
Medical Scheme and Lohnson and Lohnson which produced vaccines for Covid 19,
Monkey pox and the HIV virus for the financial year ended 30 June 2024.
All the pharmaceuticals are listed on the Johannesburg Stock Exchange (JSE) listed
company in the health care industry of South Africa with Moderney being on the
Alternative Stock Exchange (AltX). They recently branched off their operations to invest
in Neural ink, a brain chip that would help the crippled and visually impaired. Quite
recently a paraplegic had gained full function of their arms, back and legs due to this new
technology.
The final materiality for the 2024 statutory annual audit is set at R3 billion for Moderney
was R1,2 billion for Lohnson and Lohnson for the consolidated financial statements of
Pfixer.
Moderney is an independent non-profit medical scheme governed by the Medical
Schemes Act and regulated by the Council for Medical Schemes. It has assisted United
nations in various wars in the Democratic Republic of Congo, Palestine, Ukraine and
Libya. It has a good record of diligently paying their clients’ qualifying medical costs and
providing excellent service to its members.
By separating medical scheme and administration functions between Moderney and
Lohnson, the Pfixer group of companies has been able to gain a significant competitive
advantage by expanding its offerings to the health care market without contravening the
Medical Schemes Act. These services and products include for example the purchase
and repackaging of vitamins as well as endorsed weight management products leading
to huge profit margins.
Several pharmaceuticals entered into the market reducing Pfixer profit margin. In order
to secure their share prices, Pfixer doubled the actual value of their earnings per share.
You found discovered that the CEO of Pfixer Lucius Black substituted important
ingredients in their vaccines with cheaper less efficient ones. Moreover, they had
exaggerated the efficacy of their vaccines. A decision was taken at a board meeting
before year end, to procure the necessary repackaging and labelling old drugs and
marketing them as new innovations that would cure mental illness. Lucius had a 25 % of
Pfixers while his son held 10%. Lucius emoluments were not disclosed in the notes to
financial statement.
His best friend Vivek headed the audit committee. Lucius and Vivek had extravagant
holidays spending up to R1 million which they justified as necessary since they brought
in billion dollar revenues. Hunter his stepson owned the marketing company that
rebranded and advertised the old drugs as new, exaggerating their efficacy. Hunter gave
his father a lucrative discount. A whistleblower working in the laboratories recently died
in a car crush.
REQUIRED
(a) Determine whether a reportable irregularity exists in terms of the Auditing Profession
Act regarding Pfixers operations (13)
(b) Recommend an audit engagement strategy suitable for this scenario(13)
(c) Discuss the audit evidence and sampling techniques you would use in this case
study(10)
(d) Show how you will use information technology throughout the audit process(9)
(a) In this scenario, there are several red flags that indicate a reportable irregularity exists in terms of the Auditing Profession Act regarding Pfixer's operations. Some of these irregularities include:
1. Substitution of important ingredients in vaccines with cheaper less efficient ones.
2. Exaggeration of the efficacy of vaccines.
3. Procurement of repackaged old drugs marketed as new innovations that would cure mental illness.
4. Lack of disclosure of the CEO's emoluments in the financial statements.
5. Lack of independence and conflict of interest among key personnel, such as the CEO and his son, as well as the CEO's best friend heading the audit committee.
6. Questionable business relationships, such as the CEO's stepson owning the marketing company that rebranded and advertised the old drugs as new.
7. Suspicious death of a whistleblower working in the laboratories.
These irregularities should be reported to the appropriate authorities as required by the Auditing Profession Act.
(b) Given the high-risk nature of the irregularities uncovered in the scenario, it is recommended to implement a thorough audit engagement strategy. This may include:
1. Conducting a detailed assessment of the risks associated with Pfixer's operations and financial statements.
2. Performing extensive substantive testing to verify the accuracy and completeness of financial information.
3. Engaging forensic auditors to investigate specific allegations of irregularities.
4. Enhancing communication with the audit committee and board of directors to address governance issues.
5. Considering the need for legal advice to navigate potential legal implications of the irregularities.
(c) In order to gather appropriate audit evidence in this case study, the following audit evidence and sampling techniques can be used:
1. Analytical procedures to identify unusual fluctuations in financial data.
2. Confirmation of key balances and transactions with third parties.
3. Inspection of documentation supporting key transactions, contracts, and agreements.
4. Observation of physical inventory counts and processes.
5. Reperformance of calculations and tests performed by the client.
6. Use of computer-assisted audit techniques to analyze large volumes of data and identify anomalies.
7. Sampling techniques such as statistical sampling to ensure representativeness of the audit sample.
(d) Information technology can be utilized throughout the audit process in the following ways:
1. Data analytics tools can be used to perform substantive testing and detect anomalies in financial data.
2. Electronic workpapers and audit documentation software can facilitate the organization and review of audit evidence.
3. Use of secure communication and file sharing platforms to exchange sensitive information with the client.
4. Electronic confirmations to obtain audit evidence directly from third parties.
5. Use of blockchain technology to verify the authenticity and integrity of digital records.
6. Computer-based simulations for testing the effectiveness of internal controls.
By incorporating information technology in the audit process, auditors can increase efficiency, accuracy, and effectiveness in their procedures.