Advanced Audit and
Tuesday 3 June 2008
Section A – BOTH questions are compulsory and MUST be attempted
1 You are a senior audit manager in Mitchell & Co, a firm of Chartered Certified Accountants. You are reviewing some
information regarding a potential new audit client, Medix Co, a supplier of medical instruments. Extracts from notes
taken at a meeting that you recently held with the finance director of Medix Co, Ricardo Feller, are shown below:
Meeting notes – meeting held 1 June 2008 with Ricardo Feller
Medix Co is a provider of specialised surgical instruments used in medical procedures. The company is owner
managed, has a financial year ending 30 June 2008, and has invited our firm to be appointed as auditor
for the forthcoming year end. The audit is not going out to tender. Ricardo Feller has been with the company
since January 2008, following the departure of the previous finance director, who is currently taking legal
action against Medix Co for unfair dismissal.
Medix Co manufactures surgical instruments which are sold to hospitals and clinics. Due to the increased
use of laser surgery in the last four years, demand for traditional metal surgical instruments, which provided
75% of revenue in the year ended 30 June 2007, has declined rapidly. Medix Co is expanding into the
provision of laser surgery equipment, but research and development is at an early stage. The directors feel
confident that the laser instruments currently being designed will eventually receive the necessary licence for
commercial production, and that the laser product will replace surgical instruments as a leading source of
revenue. There is currently one scientist working on the laser equipment, subcontracted by Medix Co on a
freelance basis. The building in which the research is being carried out has recently been significantly
extended by the construction of a large laboratory.
A considerable revenue stream is derived from agents who are not employed by Medix Co. The agents earn
a commission based on the value of sales they have secured for Medix Co during the year. There are many
suppliers into the market and agents are used by all manufacturers as a means of marketing and distributing
The company’s manufacturing facility is located in another country, where operating costs are significantly
lower. The facility is under the control of a local manager who visits the head office of Medix Co annually for
a meeting with senior management. Products are imported via aeroplane. The overseas plant and equipment
is owned by the company and was constructed 12 years ago specifically for the manufacture of metal surgical
The company has a bank overdraft facility and makes use of the facility most months. A significant bank
loan, which will carry a variable interest rate, is currently being negotiated. The terms of the loan will be
finalised once the audited financial statements have been viewed by the bank.
After receiving permission from Medix Co, you held a discussion with the current audit partner of Medix Co, Mick
Evans, who runs a small accounting and audit practice of which he is one of two partners. Mick told you the following:
‘Medix Co has been an audit client for three years. We took over from the previous auditors following a disagreement
between them and the directors of Medix Co over fees. As we are a small practice with low overheads we could offer
lower fees than our predecessors. We could also do the audit very quickly, which pleased the client, as they like to
keep costs as low as possible.
During our audits we have found the internal systems and controls to be quite weak. Despite our recommendations,
there always seemed to be a lack of interest in making improvements to the accounting systems, as this was seen
to be a ‘waste of money’. There have been two investigations by the tax authorities, which we did not deal with, as
we are not tax experts. In the end the directors sorted it all out, and I believe that the tax matter is now resolved.
We never had a problem getting access to accounting books and records. However, the managing director, Jon Tate,
once gave us what he described as ‘the wrong cash book’ by mistake, and replaced it with the ‘proper version’ later
in the day. We never found out why he was keeping two cash books, but cash was an immaterial asset so we didn’t
worry about it too much.
We are resigning as auditors because the work load is too much for our small practice, and as Medix Co is our only
audit client we have decided to focus on providing non-audit services in the future.’