a.
i.
Describe the risks at an overall financial statement level for the
7
11
2020 audit of Cappu.
ii.
Describe how the overall risks identified should impact the
4
audit plan of Cappu.
i.
Overall risks
•
There is a risk of non-compliance with King requirements expected of JSE listed
companies, as the holding company is listed on the JSE and therefore Cappu
will have to comply to certain King requirements.
•
There is a risk of error as a new FD have been appointed in May 2020, Mr
Samuels might not have the necessary skills and experience.
•
There is another risk of error to the accounting records as the previous FD was
fired in March and a new FD only hired in May, so there was no one overseeing
the accounting function in April.
•
There is a risk of fraud as management’s integrity is in question as they paid
the staff from cash in order to not disclose revenue from the once-off cash
sales.
•
You are a new audit manager; a risk exists that you don’t have skills and
expertise Cappu which increases risk that misstatement will go undetected.
(detection risk)
•
There is a risk Cappu is presenting themselves as a going concern when they
may not be given that they have been forced to close as a result of corona
virus.
•
There is a risk Cappu has forced employees to take leave illegally and that it is
in breach of basics conditions of employment.
•
There is a risk the lack of non-executive directors and governance committees
increased the risk of fraud.
•
Risk of fraud on all accounts as previous FD committed fraud.
•
Decentralisation of offices which increases the risk that controls can be
overridden, and errors/ fraud goes undetected.
Available 10 (max 7)
ii.
Impact on audit plan
•
Increase substantive procedures to ensure recommendations of King IV
adopted and where not there is an appropriate explanation.
•
•
Assign more senior audit staff to the audit – especially for
accounts that the FD is responsible for
Communicate the need for increased professional skepticism to the audit
1
team because FD is new
•
•
Less reliance on management representations
Decrease materiality
•
Testing across locations
•
Unpredictability testing on payable cycle
•
Adjust going concern assessment to include procedures on the impact of
corona virus on Cappu ability to continue as a going concern.
•
Get opinion of a labor lawyer as to legality of decision and potential impact
of breach of labor law.
Available 9 (Max 4)
b.
In terms of SAICA’s Code of Professional Conduct, discuss any
concerns you have regarding:
i.
Requests for Milpark to perform the year-end inventory count,
assist with the preparation of Cappu’s tax return and meet with
SARS.
ii.
Mr Samuels being appointed as Cappu’s financial director.
16
12
4
i.
To perform Cappu’s inventory count (section 600)
This may lead to a self-review threat to independence as the audit of inventory forms
part of the external audit.
Evaluation (600.5 A1 & 600.7 A3):
- An inventory count forms part of an entity’s internal control, and the client wants
Milpark Auditors to have full autonomy, which will result in accepting management’s
responsibility. This is not allowed.
-
The degree of reliance that the audit team will place on the results of the inventory
count as part of the audit OR whether the outcome of the service affects matters in
the financial statements on which the firm will express an opinion – The client would
prefer Milpark Auditors to use the results of the inventory count as part of the external
audit.
-
The materiality of the related financial statement amounts – the inventory balance
(R18million) exceeds planning materiality (R2.5m)
The above threat may be reduced by the following safeguards:
- Members of the audit firm that are not part of the audit engagement can control the
stock count
- Request management to take responsibility over the inventory count (Milpark Auditors
should not have autonomy over internal control)
2
Students may argue that the threat is too significant and that no safeguards
can be implemented to reduce the threat to an acceptable level, in which
case the non-assurance service should not be accepted.
Max 5 marks
Assist with the tax return (section 604)
Providing tax services to an audit client might create a self-review or
advocacy threat.
However, tax return preparation doesn’t usually create a threat – sec 604.4
A2 as it is based on historic information.
Application: In this case it can be concluded that Milpark Auditors are
required to only complete the tax return, therefore no threat exist.
Max 3 marks
Meet with SARS – act as a representative (section 604.10)
Per 604.10 A1 – providing assistance in the resolution of tax disputes to an
audit client might create a self-review or advocacy threat
R604.11 A firm shall NOT provide tax services that involve assisting with the
resolution of tax disputes to an audit client if :
• The services involve acting as an advocate for the client – per the
scenario, Milpark is requested to meet with the SARS representative
on Cappu’s behalf
And
• The amount is material to the financial statements – the amount is
not clear but it will be qualitatively material if Cappu is not complying
with the Tax Act.
Therefore in this case the threat is too significant and Milpark shouldn’t act
as a representative for Cappu.
Max 4 marks
ii.
Mr Samuels appointed as the FD (section 524)
Section 524.3 A familiarity or intimidation threat might be created if the
director has been an audit team member.
3
Mr Samuels was the audit manager on the Cappu audit before he was
appointed at Cappu as the financial director.
One could ague that as the audit manager becoming a director, he does
exert significant influence over the preparation of the AFS.
Possible safeguards
• Modifying the audit plan
• Assign experienced audit team members to the individual who joined
the client
• Have an appropriate reviewer review work of former audit team
member
Available 20 (Max 16)
c.
Cappu’s
management
decided not
to adopt
certain
King
IV
10
recommendations:
i.
Comment on whether this decision is appropriate.
ii.
Describe the potential benefits to Cappu of appointing non-
4
executive directors and forming an audit committee and
remuneration committee.
6
Note to markers: Marks will be awarded for logic reasoning
i.
King IV is not compulsory for private companies but is recommended. King requires
that if a company decides not to adopt King IV, they have to explain why they are
not adopting King IV.
It should be noted that the holding company is listed and would be required to
comply with King IV requirement based on JSE listing requirements.
From the background information it is noted that Cappu decided not to comply with
certain requirements of King IV. This is permitted if explain why they are not
applying.
There is no audit committee which is acceptable as they are not in contradiction with
Companies Act because the company is a private company
Conclusion: The decision to not adopt all King IV recommendations
appropriate if they explain WHY and if the holding company has complied
with the requirements given they are listed.
ii.
Non-executive directors
– The executive directors have a conflict of interest because they are
4
–
–
–
employed by the company and earn salaries BUT do not own the
business. Therefore, there is a risk they will not make the decisions
in the best interest of all stakeholders.
Non-executive directors are not employed and so help provide non
bias opinion to ensure decisions by the governing body are made in
the best interest of all stakeholders and not just the directors
interests.
King also recommends the majority of the non-executives are
independent and this creates further ensures decision making is
nonbiased and in the best interest of all stakeholders.
This will help create sustainable value for all stakeholders – including
shareholders, employees but also the community and economy in
which Cappu operates.
Audit committee
- Integrity of annual financial statements
- View on quality of the external audit
- Help ensure the external auditor is independent and providing
an audit that is of appropriate quality.
- Can assist with management of internal audit function and
provide oversight of the function, this ensures systems of
internal control are designed and implemented efficiently and
effectively which reduces the risk of fraud and error in Cappu.
- Can provide feedback to board regarding audit findings and
recommend improvements to systems of internal control.
- If work closely with internal audit, the proper functioning of the
internal assurance can reduce costs of external audit in the long
terms thus increasing financial returns to stakeholders.
Remuneration committee
– Oversight of remuneration policy to ensure the employees
(including directors) are paid market related salaries that can be
justified.
This ensures value to shareholders I not destroyed by paying
excessive salaries or bonuses to staff (including directors).
- The remuneration committee ensures remuneration is disclosed in
terms of IFRS, King and companies Act requirements.
- The committee can provide feedback on the appropriateness of
performance measures to ensure they are aligned with the strategy
of the company and ensure value created for all stakeholders.
• The remuneration committee can ensure remuneration policies
are fair for ALL employees and ensure that the difference
between management and lower level staff is justified and
5
ethical.
Available 20 (Max 10)
d.
Assuming Milpark designed and performed Cappu’s 30 April 2020
8
inventory count, describe the controls that should have been
implemented to ensure the inventory count was properly performed.
1.
The count staff should have been divided into teams of two, one member being
1
completely independent of all inventory aspects.
2.
All teams should have been provided with a floor plan of the warehouse/store,
1
which should have clearly indicated the inventory locations for which they
would have been accountable.
3.
All inventory should have been counted twice: either by one member counting,
1
the other recording, thereafter swapping roles and recounting the same section
where they were assigned OR teams should have completed their counts,
handed count sheets back to the count controller and sign for an inventory
sheet of another section, thereby doing the second count on a section already
counted by another team.
4.
Through the use of different coloured markers, or a tag system, counters
1
should have marked items counted neatly.
5.
Damaged/unused/excessively dusty products should have been marked as
1
such on the inventory sheets, thereby indicating potential write-downs.
6.
For a sample of boxes in each section of the warehouse, the contents should
1
have been compared with the description on the label of the box, to confirm
that the contents have not been changed/removed and the seal replaced.
7.
The count controller should have:
-
walked through the warehouse/store once the count was completed and
1
should have ensured that all items were marked twice / detachable
portions of all tags have been removed
-
examined the inventory sheets to ensure that the first and second
1
counts agree and that it agrees to the perpetual inventory records
-
instructed count teams to recount inventory items in question where
1
discrepancies were noted
8.
The count controller should have obtained the numbers of the last goods
received note, invoice, delivery note and goods returned note used up to date
of the inventory count.
6
1
9.
No sales from stores / despatches from the warehouse should have occurred
1
on the date of the inventory count (For stores, the count could have potentially
occurred after working hours).
10.
Any inventory received after the count has begun should have been stored
1
separately in the receiving area of the warehouse/store, until the count was
completed, and must not have been put into the warehouse/store. This
inventory must have been counted and added to the inventory sheets after the
count was completed.
11.
12.
The counters responsible for the count sheets should have:
-
Drawn lines through the blank spaces on all inventory sheets, and
-
Sign each count sheet and all alterations
1
1
The inventory controller should have checked that this procedure was carried
1
out and should have sequence tested the inventory sheets to ensure that all
sheets were accounted for.
13.
Count teams should only have been formally dismissed once the count was
1
completed and all queries were attended to.
Available
Max
e.
With reference to WP P2, identify weaknesses in the ordering system
and describe the potential impact of each weakness on Cappu.
Guidance
•
Present your answer in tabular format as below.
•
You should not rewrite Number 1 below.
Weakness (7 marks)
1.
Order
forms
are
sequentially numbered
Impact on Cappu (7 marks)
not
Could accept inventory not
ordered (business risk)
OR
Increases the risk that purchases
are not complete, which would
result in the understatement of
expenses (audit risk)
7
17
8
14
2
Weakness in system of internal
Potential impact on Cappu
control –
Raw material
Production budgets are approved by There is a risk that errors are included
only Don Bean.
in the production budgets resulting in
incorrect orders being placed.
3
Production budgets are uploaded to the There is a risk that errors are included
ordering system by Don Bean without in the production budgets resulting in
incorrect orders being placed.
any independent review.
4
Order forms are not authorised by a Fictitious orders maybe placed by the
senior
member
in
the
order ordering clerk; and
department.
Errors in the transfer of data from the
raw material request form to
the order form
5
No access controls, user ID and
password required for staff
There is a risk that other employees
place fictitious orders
6
No screen check performed by Ed
Spresso, reconciling the data on the
screen to the raw material request
form after completion of inputs OR
the request form is manually input
into the ordering system as opposed
to be automatically prepopulated
No indication of any edit checks
performed on raw material request
forms or order forms to ensure all
fields are accurate
Ed Spresso selects suppliers based on
personal preference and not an
authorised supplier list
There is a risk of inaccurate information
being included in the ordering form
7
8
9
10
Inaccurate information is processed in
the system which could result in the
incorrect orders being placed
Receive inferior quality inventory, or
over-priced inventory which would
result in a write down to NRV at year
end,
Late delivery that delays production
and could result in lost customers; and
Ed Spresso places supplier orders and There is a risk Ed Spresso can
performs the reconciliation between
fraudulently manipulate the
request forms and outstanding orders. reconciliation to conceal fraud.
Receiving clerks agree the
inventory received to the delivery
note, not to the order
Accept inventory not ordered
8
11
12
13
14
15
16
17
f.
Only one receiving clerk checks the
goods for quantity and quality, thus
lack of segregation of duties
Accept inventory not ordered
No mention of security and access
controls in the receiving area
The database does not generate a
pre‐ populated goods received note
based on the original order
The recording of the purchase is
done manually by Candy Milo and not
automated when the raw material is
received.
Theft of raw materials
No review of the logs performed by
the system
No errors or fraudulent transactions
picked up
Maximum (7)
Available (16)
Maximum (7)
Available (20)
Theft or errors by the receiving clerk
Accept inventory not ordered
There is a risk of error in the recording
of the purchase.
There is a risk the inventory is
recorded in the incorrect period if there
is a timing delay between receiving
and recording.
There is no review of raw materials
There is a risk that purchases and
recorded vs raw materials received OR inventory are understated.
no review of “purchase alerts” that
remain open on Candy Milo system.
There is a risk purchases and inventory
are recorded in the incorrect period.
No reconciliation of inventory received Incomplete purchases or
to supplier invoices
understatement of purchases
With reference to WP P2 and WP P3, describe the substantive audit
15
procedures that should be performed to verify the valuation of
inventory at 30 April 2020. Marks are allocated as follows:
i)
ii)
General procedures, and
Specific procedures on raw materials, work in progress and
finished goods.
5
10
General procedures
• Obtain a management representation letter with regards to the valuation of
inventory
• Obtain a detailed inventory valuation schedule from management and using CAATS
− Cast and cross cast the schedule
− Agree the total amount per the schedule to the inventory amount in the
general ledger, trial balance and annual financial statements
− Agree the opening amount per the schedule to the closing balance in
the prior periods annual financial statements
• Extract a report of any negative stock values (quantities/prices) and follow up
9
•
•
•
•
•
•
•
with management
Perform the following analytical review procedures to obtain an understanding of
the reasonability of inventory valuation:
− Compare the value of inventory in the current financial period to the
value in the prior period to determine if reasonable in terms of
quantity on hand in the current period and prior period
− Any valid AR example will receive a mark
Max 5
Raw materials
Select a sample of raw material items on hand and trace the cost price to
supplier invoice
Agree that all directly attributable costs (import duty/transfer costs/insurance)
that are allowed to be capitalised, to invoices and supporting documents and
ensure included in the cost of the RM by inspecting the descriptions
Select a sample of foreign purchases and agree the spot rate at the date risk and
rewards transfer to the spot rate from a reputable financial institution
Reperform the translation to ensure correctly calculated
Reperform the FIFO calculation at year end and compare to the cost recorded in
the accounting records
Follow up on significant differences in the calculation with management
Work in progress
•
•
•
•
•
•
•
Obtain an understanding of the method used by management in valuing WIP by
discussions with management
Obtain managements calculation/report and using CAATs:
− Cast and reperform the calculation
Consider the use of an expert to determine the value based on the percentage
complete
Work in progress and finished goods
Select a sample of work in progress items and finished goods on hand and trace to
the manufacturing budget and % completion job card or production schedule
Select a sample of raw material items used in production from the job card, and
trace:
−
the quantity to the request form sent to warehouse holding
−
the price to the supplier invoice
Select a sample of hours recorded on the job card, and trace:
−
the hours to the employee clock card
−
the rate to the employees contract
Obtain managements schedule for overheads allocated to the cost of inventory
and review for reasonability based on your understanding of the manufacturing
process
Recalculate the amount to be capitalised to inventory and the amount to be
expensed
10
Net Realisable value (NRV)
•
•
•
•
•
Using CAATs, select a sample of inventory items and agree the selling price in
the stock master file to the latest sales invoice
Agree costs to sell to the latest invoice/transportation documents
Recalculate the NRV for all inventory items (Selling price less costs to sell)
extract a report of any stock items where NRV is less than cost price
Request management to adjust stock to lower of cost and NRV for items above
Obsolete stock
•
•
Enquire with management as to the method for identifying obsolete stock
To determine the reasonability of the allowance, using CAATs:
−
compare the actual write off of stock in 2020 with the allowance
created in 2019
− compare the inventory days ratio in the current financial period to the
inventory days in the prior financial period
• Extract a report of stock items that have not moved or have shown little
movement in the current financial period and consider whether they may still be
in condition for sale
• Extract a report of all stock items that exceed their expiry date, and request
management to write off the stock
• Physically inspect goods to identify any damaged goods
Available 24 marks (Max 10 marks)
11
g.
With reference to WP P4:
i.
17
Describe further audit procedures you would perform on the
6
unresolved matters.
ii.
If management refuses to make any adjustments, explain the
6
potential impact on the audit opinion.
iii.
Discuss whether any reportable irregularities exist.
5
i. Unrecorded salaries and cash sales
•
•
•
•
Through discussions with employees and management, determine if the R500
000 sale was the only ad hoc bonusses that were paid (completeness)
Involve tax expert to assess the tax implication of the unrecorded sale and
bonus paid to staff or recalculate the tax impact
o Recalculate the income tax including the cash sale and determine the
difference
o Recalculate the PAYE including the bonus paid and determine the
difference
Have a discussion with Mr Samuels that the omission of the revenue and bonus
is illegal an in contravention with IFRS and the Tax act – irrespective of the
value omitted.
Communicate with the other directors the error identified and Mr Samuels view
to not adjust for it/ to assess whether they are aware.
Leave provision
•
Perform the following procedures on the calculation received from the payroll
department:
o Agree opening balance of R4.5million to the prior audited annual
financial statements
o Through discussions with Payroll determine if leave days are the same
for all staff
o From the calculation – select a sample of employees and recalculate the
accrual by taking leave days accrued x pay rate
o Follow up on differences
o From the calculation – select a sample of employees with leave taken
(manufacturing + other employees) – inspect their authorised leave
forms and agree the amount of leave days taken with that on the
calculation
o Follow up on difference
o Recalculate the total leave balance provision
Max 6 (available 12)
ii.
Unrecorded salaries and sales
•
•
•
•
Matter is quantitively immaterial as it is less than materiality
This matter is qualitatively material as management was intentionally
understating revenue and salaries and is fraudulent.
This matter is not pervasive as it is isolated to revenue and salaries expense
only. OR students could argue it is pervasive as involves management and is
intentional breach of IFRS.
As a result, if it remains unadjusted the opinion could remain unqualified with
an “except for” paragraph (if students concluded not pervasive) OR would
result in an adverse opinion (if students argued material and pervasive)
12
Leave provision
•
•
•
•
The matter is quantitatively immaterial as the audit difference of R2m is below
materiality.
The matter should also be qualitatively assessed as it is not clear why the FD
does not want to adjust for the audit difference, therefore is it intentional?
The matter is not pervasive at it only relates to the leave provision account.
In aggregate the matters are quantitatively immaterial but qualitatively
material, therefore the auditor will still issue an unmodified audit opinion with
an except for paragraph that provides details on the issues.
Max 6 (available 7)
iii.
Reportable Irregularity
It should have been considered if the requirements in respect of a reportable
irregularity in terms of s45 were met and it appears as though they were given that:
Act is unlawful or omission:
• The non‐disclosure of cash revenue is not in compliance with the Income Tax Act,
therefore this constitutes an unlawful act. (1) or
• Revenue was omitted from the tax return resulting in non‐compliance with Income
Tax Act (1) AND IFRS.
Committed by someone responsible for the management of the entity:
• The financial director, Mr Samuels is responsible for the non‐disclosure. (1)
Leads to material financial loss for members or creditors:
• Receiver of revenue may lose out on income tax, and will therefore suffer a
financial loss (1)
• The company would have to pay penalties and interest to SARS. (1)
• Shareholders, reduced dividends/decline in share values as a result of claims
against the company by SARS. (1)
This constitutes a fraudulent act/illegal act as it is in contravention of the income tax
act. (1)
• This represents breach of fiduciary duty owed by management, as they failed to act
in the best interest of the company. (1)
Therefore, a reportable irregularity exists (1P)
Max 5 (available 9)
13
h.
i.
Discuss what Cappu’s management should have considered before
deciding that all the factory workers had to take annual leave or
unpaid leave as a result of the COVID-19 factory closure.
Your discussion should include:
i.
Legal considerations;
ii.
Ethical considerations and;
iii.
Financial considerations.
9
3
3
3
Legal considerations
Management should have considered whether they are permitted to force
employees to take leave – whether paid or unpaid in terms of the basic conditions
of employment act.
Management should obtain opinions from their lawyers as to whether the decision
to force employees to take leave is permitted and legal.
Management could have meetings with employee unions to discuss whether the
decision is legal and the impact of the decision or discuss alternate options prior to
forcing employees to take unpaid leave.
Although, under normal circumstances, this may be seen as trading recklessly, the
commissioner did inform stakeholders that no prosecution will take place for
reasons due to COVID-19, and the announcement can therefore be considered
legal.
ii.
Ethical considerations
In terms of King IV, ethics is defined as considering what is good and right for the
self and all stakeholders (employees included).
This maybe a good decision for the company in terms of cashflow BUT not be good
to staff as they have personal expenses, and this is out of their control so they
didn’t provide for this.
Cappu is protecting their jobs by not retrenching them, but it is uncertain when
they will be paid again, and this impacts their ability to support their families.
It could negatively impact the staff morale if they believe the directors protected
their own interest by still paying the directors, administrative and sales staff but
did not help the factory employees.
Management should consider negotiating with all stakeholders to help with
reducing cashflow requirements over the lockdown period and NOT just the factory
employees – this could include changing creditor payment terms, renegotiating
14
rental obligations, negotiating SARS payment deadlines and reducing pay for the
directors and head office staff.
This way – the impact of the lockdown is shared across ALL stakeholders and not
just management.
iii.
Financial considerations
Management should consider whether employees will seek alternate
employment and the impact of this on their ability to reopen the factory
when the time arises.
Management should have considered whether the company could afford
to keep paying employees (whether full or a % of salaries) for a longer
period to assist them in meeting living expenses – they could do cashflow
forecasts looking at how long the current cash reserves could last while
they kept paying employees.
Management should consider trying to submit UIF TERS claims to government to
assist in paying employee salaries.
Management could consider applying for other business relief funding to help
ensure that they are able to continue to pay employees for a longer period before
cutting all salaries.
Management could consider taking salary cuts themselves (or for all management/
head office staff) to help ensure the company can continue to pay factory staff for
a longer period or during lockdown.
Management could consider renegotiating payment terms with other stakeholders
to help reduce cashflow requirements of the business, thus extending the ability of
the company to last longer with current cashflow reserves.
This will have an immediate cashflow relief, but the cost to the company
will be greater due to manufacturing that stopped and will then have
delayed revenue in the future
Max 17 (available 9)
15