4 (a) Contrast the role of internal and external auditors. (8 marks)

　　(b) Conoy Co designs and manufactures luxury motor vehicles. The company employs 2，500 staff and consistently makes a net profit of between 10% and 15% of sales. Conoy Co is not listed; its shares are held by 15 individuals， most of them from the same family. The maximum shareholding is 15% of the share capital.

　　The executive directors are drawn mainly from the shareholders. There are no non-executive directors because the company legislation in Conoy Co‘s jurisdiction does not require any. The executive directors are very successful in running Conoy Co， partly from their training in production and management techniques， and partly from their ’hands-on‘ approach providing motivation to employees.

　　The board are considering a significant expansion of the company. However， the company‘s bankers are concerned with the standard of financial reporting as the financial director (FD) has recently left Conoy Co. The board are delaying provision of additional financial information until a new FD is appointed.

　　Conoy Co does have an internal audit department， although the chief internal auditor frequently comments that the board of Conoy Co do not understand his reports or provide sufficient support for his department or the internal control systems within Conoy Co. The board of Conoy Co concur with this view. Anders & Co， the external auditors have also expressed concern in this area and the fact that the internal audit department focuses work on control systems， not financial reporting. Anders & Co are appointed by and report to the board of Conoy Co.

　　The board of Conoy Co are considering a proposal from the chief internal auditor to establish an audit committee. The committee would consist of one executive director， the chief internal auditor as well as three new appointees. One appointee would have a non-executive seat on the board of directors.

　　Required：

　　Discuss the benefits to Conoy Co of forming an audit committee. (12 marks)5 One of your audit clients is Tye Co a company providing petrol， aviation fuel and similar oil based products to the government of the country it is based in. Although the company is not listed on any stock exchange， it does follow best practice regarding corporate governance regulations. The audit work for this year is complete， apart from the matter referred to below.

　　As part of Tye Co‘s service contract with the government， it is required to hold an emergency inventory reserve of 6，000 barrels of aviation fuel. The inventory is to be used if the supply of aviation fuel is interrupted due to unforeseen events such as natural disaster or terrorist activity.

　　This fuel has in the past been valued at its cost price of $15 a barrel. The current value of aviation fuel is $120 a barrel. Although the audit work is complete， as noted above， the directors of Tye Co have now decided to show the ‘real’ value of this closing inventory in the financial statements by valuing closing inventory of fuel at market value， which does not comply with relevant accounting standards. The draft financial statements of Tye Co currently show a profit of approximately $500，000 with net assets of $170 million.

　　Required：

　　(a) List the audit procedures and actions that you should now take in respect of the above matter. (6 marks)

　　(b) For the purposes of this section assume from part (a) that the directors have agreed to value inventory at $15/barrel.

　　Having investigated the matter in part (a) above， the directors present you with an amended set of financial statements showing the emergency reserve stated not at 6，000 barrels， but reported as 60，000 barrels. The final financial statements now show a profit following the inclusion of another 54，000 barrels of oil in inventory. When queried about the change from 6，000 to 60，000 barrels of inventory， the finance director stated that this change was made to meet expected amendments to emergency reserve requirements to be published in about six months time. The inventory will be purchased this year， and no liability will be shown in the financial statements for this future purchase. The finance director also pointed out that part of Tye Co‘s contract with the government requires Tye Co to disclose an annual profit and that a review of bank loans is due in three months. Finally the finance director stated that if your audit firm qualifies the financial statements in respect of the increase in inventory， they will not be recommended for re-appointment at the annual general meeting. The finance director refuses to amend the financial statements to remove this ’fictitious‘ inventory.

　　Required：

　　(i) State the external auditor‘s responsibilities regarding the detection of fraud; (4 marks)

　　(ii) Discuss to which groups the auditors of Tye Co could report the ‘fictitious’ aviation fuel inventory; (6 marks)

　　(iii) Discuss the safeguards that the auditors of Tye Co can use in an attempt to overcome the intimidation threat from the directors of Tye Co. (4 marks)