Auditing Fundamentals: South African Context

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Auditing Fundamentals in a South African Context: Graded Questions (third edition) Print ISBN: 978-0-190738-58-7 ePUB ISBN: 978-0-190732-21-9 Typeset in ITC Franklin Gothic Std 10.5pt on 13pt Acknowledgements Publisher: Penny Lane Development editor: Edward Ndiloseh Project manager: Lindsay-Jane Lücks Copy editor: Lee-Ann Ashcro Designer: Yaseen Baker Typesetter: Julie Ackermann Cover photo: Tony Sparkes, Shutterstock e authors and publisher gratefully acknowledge permission to reproduce copyright material in this book. Every effort has been made to trace copyright holders, but if any copyright infringements have been made, the publisher would be grateful for information that would enable any omissions or errors to be corrected in subsequent impressions. Links to third party websites are provided by Oxford in good faith and for information only. Oxford disclaims any responsibility for the materials contained in any third party website referenced in this work. Contents in brief PART A: e context within which the external auditor operates Chapter 1 Chapter 2 Chapter 3 Introduction Ethics Legal responsibilities of the auditor PART B: e auditee’s responsibility for nancial information Chapter 4 Chapter 5 Basic concepts of governance and internal control Introduction to risks and internal controls in a computerised environment Chapter 6 Revenue and receipts cycle Chapter 7 Purchases and payments cycle Chapter 8 Inventory and production cycle Chapter 9 Human resources cycle Chapter 10 Investment and nancing cycle PART C: e external audit process Chapter 11 Overview of the audit process Chapter 12 Pre-engagement and planning activities Chapter 13 Audit procedures: Essential concepts Chapter 14 Audit procedures: Speci c considerations Chapter 15 Completion of the audit Chapter 16 e independent review Chapter 17 Additional questions List of references Contents Contents in brief Preface Additional resources About the editors List of contributors PART A: e context within which the external auditor operates Chapter 1 Introduction Questions Question 1 Background to auditing [24 marks] LEVEL 1 Chapter 2 Ethics Introduction Example question SAICA Code of Professional Conduct: CA in practice [12 marks] Guidance Suggested solution Questions Question 1 Question 2 Question 3 Question 4 Question 5 Question 6 Question 7 Question 8 Question 9 SAICA Code of Professional Conduct: Fundamentals and CA in practice [27 marks] LEVEL 1/2 SAICA Code of Professional Conduct: CA in practice [10 marks] LEVEL 2 SAICA Code of Professional Conduct: CA in practice [13 marks] LEVEL 2 SAICA Code of Professional Conduct: CA in practice [15 marks] LEVEL 2 SAICA Code of Professional Conduct: CA in practice [6 marks] LEVEL 2 Suggested solution to question 5 SAICA Code of Professional Conduct: CA in practice [8 marks] LEVEL 2 SAICA Code of Professional Conduct: CA in business [9 marks] LEVEL 2 SAICA Code of Professional Conduct: CA in practice [10 marks] LEVEL 2 SAICA Code of Professional Conduct: CA in practice [10 marks] LEVEL 2 Question 10 SAICA Code of Professional Conduct: CA in practice [10 marks] LEVEL 2 Question 11 SAICA Code of Professional Conduct: CA in practice [18 marks] LEVEL 2 Question 12 SAICA Code of Professional Conduct: CA in business [3 marks] LEVEL 2 Question 13 SAICA Code of Professional Conduct: CA in business [5 marks] LEVEL 2 Question 14 SAICA Code of Professional Conduct: CA in business [12 marks] LEVEL 2 Suggested solution to question 14 SAICA Code of Professional Conduct: CA in business Question 15 [17 marks] LEVEL 2 Question 16 SAICA Code of Professional Conduct: CA in business [22 marks] LEVEL 2 Question 17 SAICA Code of Professional Conduct: CAs in practice and in business [10 marks] LEVEL 2 Question 18 SAICA Code of Professional Conduct and general auditing theory [21 marks] LEVEL 3 Chapter 3 Legal responsibilities of the auditor Introduction Example question Auditing Profession Act 26 of 2005: Reportable irregularity [17 marks] Guidance Suggested solution Questions Question 1 Question 2 Question 3 Question 4 Question 5 Question 6 Question 7 Auditing Profession Act 26 of 2005: Reportable irregularity [8 marks] LEVEL 1 Auditing Profession Act 26 of 2005: Reportable irregularity [6 marks] LEVEL 1 Auditing Profession Act 26 of 2005: Registration as auditor, duties of auditor [14 marks] LEVEL 1/2 Auditing Profession Act 26 of 2005: Reportable irregularity [13 marks] LEVEL 2 Auditing Profession Act 26 of 2005: Reportable irregularity [11 marks] LEVEL 2 Auditing Profession Act 26 of 2005: Legal liability [9 marks] LEVEL 2 King IV™ report [13 marks] LEVEL 1 Question 8 Question 9 Question 10 King IV™ code [10 marks] LEVEL 2 King IV™ report [21 marks] LEVEL 2 King IV™ report [20 marks] LEVEL 2 Suggested solution to question 10 Question 11 King IV™ report [25 marks] LEVEL 2 Question 12 King IV™ report and Companies Act 71 of 2008 [18 marks] LEVEL 1 Question 13 Companies Act 71 of 2008 [10 marks] LEVEL 2 Question 14 Companies Act 71 of 2008 [10 marks] LEVEL 2 Question 15 Companies Act 71 of 2008 and King IV™ report [16 marks] LEVEL 2/3 Question 16 Companies Act 71 of 2008 and Auditing Profession Act 26 of 2005: Reportable irregularity [24 marks] LEVEL 2/3 Question 17 Companies Act 71 of 2008 and King IV™ report [28 marks] LEVEL 2/3 PART B: e auditee’s responsibility for nancial information Chapter 4 Basic concepts of governance and internal control Introduction Questions Question 1 Question 2 King IV™ report [16 marks] LEVEL 1 Question 3 Internal control: Fundamentals [15 marks] LEVEL 1 Question 4 Internal control: Control objectives [11 marks] LEVEL 1 Suggested solution to question 4 Internal control: Fundamentals [19 marks] LEVEL 1 Question 5 Internal control: Components [10 marks] LEVEL 1 Chapter 5 Introduction to risks and internal controls in a computerised environment Introduction Questions Question 1 Question 2 Multiple choice questions addressing multiple concepts [10 marks] LEVEL 2 Physical access controls [18 marks] LEVEL 2 Suggested solution to question 2 Question 3 Question 4 Access controls [16 marks] LEVEL 3 Application controls [12 marks] LEVEL 2 Question 5 Business continuity [10 marks] LEVEL 2 Question 6 System development [10 marks] LEVEL 2 Question 7 Question 8 General controls [16 marks] LEVEL 3 General controls [11 marks] LEVEL 2 Question 9 General controls [19 marks] LEVEL 2 Question 10 Weaknesses in an IT environment [30 marks] LEVEL 2 Question 11 Governance in an IT environment [30 marks] LEVEL 2 Question 12 Application controls and back-ups [22 marks] LEVEL 2 Question 13 Application controls (input controls) [15 marks] LEVEL 3 Question 14 Processing and master le controls [24 marks] LEVEL 2 Question 15 Controls regarding changes to master le data [18 marks] LEVEL 2 Question 16 Application controls (master le) [22 marks] LEVEL 3 Chapter 6 Revenue and receipts cycle Introduction Example Question 1 Internal control weaknesses [8 marks] Guidance Suggested solution Example Question 2 Internal control weaknesses, risks, control objectives and assertions [32 marks] Guidance Suggested solution Questions Question 1 Control objectives [8 marks] LEVEL 2 Question 2 Functional areas and control objectives [18 marks] LEVEL 2 Question 3 Assertions [9 marks] LEVEL 2 Question 4 Purpose of controls, control objectives and assertions [23 marks] LEVEL 2 Question 5 Weaknesses [13 marks] LEVEL 2 Question 6 Risks [25 marks] LEVEL 2 Question 7 Question 8 Risks [15 marks] LEVEL 2 Weaknesses and recommendations [32 marks] LEVEL 2 Question 9 Weaknesses, risks and recommendations [20 marks] LEVEL 2 Suggested solution to question 9 Question 10 Weaknesses, risks and recommendations [23 marks] LEVEL 2 Question 11 Weaknesses, risks, decrease in gross pro t and recommendations [40 marks] LEVEL 3 Question 12 Weaknesses, recommendations, internal controls, role players and documents [41 marks] LEVEL 2 Question 13 Recommendations [14 marks] LEVEL 2 Question 14 Recommendations [22 marks] LEVEL 3 Question 15 Key controls [8 marks] LEVEL 2 Question 16 Key controls and control objectives [10 marks] LEVEL 2 Question 17 Key controls and tests of controls [10 marks] LEVEL 3 Suggested solution to question 17 Question 18 Tests of controls [30 marks] LEVEL 3 Question 19 Tests of controls [15 marks] LEVEL 3 Question 20 Tests of controls [18 marks] LEVEL 3 Chapter 7 Purchases and payments cycle Introduction Questions Question 1 Control objectives [6 marks] LEVEL 1 Question 2 Suggested solution to question 1 Assertions [4 marks] LEVEL 2 Question 3 Weaknesses [7 marks] LEVEL 2 Suggested solution to question 3 Question 4 Risks [3 marks] LEVEL 1 Question 5 Risks [17 marks] LEVEL 2 Question 6 Risks [19 marks] LEVEL 2 Question 7 Question 8 Risks and assertions [20 marks] LEVEL 2 Weaknesses, risks and recommendations [23 marks] LEVEL 2 Question 9 Weaknesses and recommendations [23 marks] LEVEL 2 Question 10 Recommendations [12 marks] LEVEL 2 Question 11 Key controls and assertions [6 marks] LEVEL 2 Suggested solution to question 11 Question 12 Key controls and control objectives [16 marks] LEVEL 2 Question 13 Key controls and tests of controls [30 marks] LEVEL 3 Question 14 Tests of controls [17 marks] LEVEL 2 Question 15 Test of controls and control objectives [13 marks] LEVEL 2 Chapter 8 Inventory and production cycle Introduction Questions Question 1 Purpose and control objectives [11 marks] LEVEL 1 Question 2 Question 3 Control objectives [8 marks] LEVEL 2 Functional areas [10 marks] LEVEL 2 Question 4 Weaknesses [13 marks] LEVEL 2 Question 5 Risks [10 marks] LEVEL 2 Question 6 Weaknesses and risks [8 marks] LEVEL 2 Question 7 Weaknesses and recommendations [15 marks] LEVEL 2 Question 8 Weaknesses and recommendations [13 marks] LEVEL 2 Question 9 Recommendations [21 marks] LEVEL 2 Suggested solution to question 9 Question 10 Key controls [4 marks] LEVEL 2 Question 11 Purpose and tests of controls [25 marks] LEVEL 3 Question 12 Tests of controls [20 marks] LEVEL 3 Question 13 Control objectives, key controls and tests of controls [24 marks] LEVEL 3 Chapter 9 Human resources cycle Introduction Questions Question 1 Risks [15 marks] LEVEL 1 Suggested solution to question 1 Question 2 Question 3 Risks [23 marks] LEVEL 2 Risk of material misstatement at assertion level [12 marks] LEVEL 2 Question 4 Question 5 Weaknesses and risks [30 marks] LEVEL 2 Weaknesses and risks [38 marks] LEVEL 2 Question 6 Weaknesses and recommendations [16 marks] LEVEL 2 Question 7 Weaknesses and recommendations [32 marks] LEVEL 2 Question 8 Recommendations [9 marks] LEVEL 2 Question 9 Key controls and tests of controls [32 marks] LEVEL 3 Question 10 Key controls and tests of controls [28 marks] LEVEL 3 Question 11 Tests of controls [9 marks] LEVEL 3 Question 12 Assertions, key controls and tests of controls [20 marks] LEVEL 3 Question 13 Audit procedures [10 marks] LEVEL 3 Question 14 Risks, internal controls and substantive procedures [25 marks] LEVEL 3 Chapter 10 Investment and nancing cycle Introduction Questions Question 1 Control objectives [11 marks] LEVEL 2 Question 2 Segregation of duties, fraud and error [9 marks] LEVEL 2 Question 3 Question 4 Weaknesses and risks [12 marks] LEVEL 2 Risks: Companies Act 71 of 2008 [12 marks] LEVEL 3 Question 5 Weaknesses and recommendations [11 marks] LEVEL 2 Question 6 Weaknesses and recommendations [33 marks] LEVEL 2 Question 7 Recommendations [18 marks] LEVEL 2 Suggested solution to question 7 Question 8 Recommendations [5 marks] LEVEL 2 Question 9 Recommendations [10 marks] LEVEL 2 Question 10 Tests of controls [10 marks] LEVEL 3 Question 11 Key controls and assertions [11 marks] LEVEL 2 Question 12 Internal control vs test of control, control objectives [9 marks] LEVEL 3 Question 13 Test of control vs substantive procedure, objective of audit procedure [13 marks] LEVEL 3 Question 14 Tests of controls vs substantive procedures [16 marks] LEVEL 3 PART C: e external audit process Chapter 11 Overview of the audit process Introduction Questions Question 1 Stages and steps [13 marks] LEVEL 1 Question 2 Question 3 Audit evidence [7 marks] LEVEL 1 Audit evidence [7 marks] LEVEL 1 Suggested solution to question 3 Question 4 Impact of computerised environment on audit procedures [7 marks] LEVEL 2 Suggested solution to question 4 Question 5 Audit opinion: Modi ed and unmodi ed [4 marks] LEVEL 1 Chapter 12 Pre-engagement and planning activities Introduction Example Question 1 Pre-engagement [10 marks] Guidance Suggested solution Example Question 2 Strategy [4 marks] Guidance Suggested solution Example Question 3 Materiality [10 marks] Guidance Suggested solution Example Question 4 Risk at nancial statement level [6 marks] Guidance Suggested solution Example Question 5 Risk at assertion level [4 marks] Guidance Suggested solution Questions Question 1 Planning materiality [7 marks] LEVEL 2 Question 2 Question 3 Planning materiality [10 marks] LEVEL 2 Planning materiality [11 marks] LEVEL 3 Question 4 Planning materiality [14 marks] LEVEL 3 Question 5 Planning materiality [21 marks] LEVEL 3 Question 6 Pre-engagement [20 marks] LEVEL 2 Suggested solution to question 6 Question 7 Pre-engagement activities [12 marks] LEVEL 2 Question 8 Question 9 Pre-engagement activities [15 marks] LEVEL 2 Pre-engagement activities [13 marks] LEVEL 2 Question 10 Client acceptance decision [26 marks] LEVEL 3 Question 11 Pre-engagement [12 marks] LEVEL 2 Question 12 Risk at assertion level [9 marks] LEVEL 2 Question 13 Risk at nancial statement level [12 marks] LEVEL 2 Question 14 Risk at assertion level, the audit approach and the risk thereto [22 marks] LEVEL 2 Question 15 Risk at assertion level and the response thereto [20 marks] LEVEL 3 Question 16 Risk at assertion level [10 marks] LEVEL 2 Question 17 Risk at nancial statement level [16 marks] LEVEL 2 Question 18 Risk at assertion level [12 marks] LEVEL 3 Question 19 Audit risk overall level [19 marks] LEVEL 3 Question 20 Risk at assertion level [20 marks] LEVEL 3 Question 21 Risk and response at assertion level [17 marks] LEVEL 3 Question 22 Detection risk [22 marks] LEVEL 3 Question 23 Audit strategy [6 marks] LEVEL 2 Question 24 Planning strategy [9 marks] LEVEL 2 Chapter 13 Audit procedures: Essential concepts Introduction Example Question 1 Balances [17 marks] Guidance Suggested solution Example Question 2 Transactions [15 marks] Guidance Suggested solution Questions Question 1 Revenue applying IFRS 15 [14 marks] LEVEL 3 Suggested solution to question 1 Question 2 Revenue [15 marks] LEVEL 2 Question 3 Revenue [13 marks] LEVEL 2 Question 4 Revenue [25 marks] LEVEL 2 Question 5 Revenue [22 marks] LEVEL 2 Question 6 Revenue [28 marks] LEVEL 3 Question 7 Suggested solution to question 6 Commission paid [15 marks] LEVEL 2 Question 8 Purchases and payments balances [18 marks] LEVEL 3 Question 9 Purchases [14 marks] LEVEL 2 Question 10 Substantive procedures: Expenses [20 marks] LEVEL 3 Question 11 Prepaid expenses [8 marks] LEVEL 3 Suggested solution to question 11 Question 12 Prepayments [16 marks] LEVEL 3 Question 13 Wages {25 marks] LEVEL 2 Question 14 Salaries [15 marks] LEVEL 2 Suggested solution to question 14 Question 15 Lifetime expected credit losses [21 marks] LEVEL 3 Suggested solution to question 15 Question 16 Accounts receivable [18 marks] LEVEL 2 Question 17 Provision for future expected credit losses [14 marks] LEVEL 2 Question 18 Accounts receivable [20 marks] LEVEL 2 Suggested solution to question 18 Question 19 Positive con rmation and provision for future expected credit losses [26 marks] LEVEL 2 Question 20 Creditors statement reconciliation [15 marks] LEVEL 2 Suggested solution to question 20 Question 21 Trade payables [12 marks] LEVEL 2 Question 22 Trade and other payables [25 marks] LEVEL 3 Suggested solution to question 22 Question 23 Trade and other payables balance [23 marks] LEVEL 3 Suggested solution to question 23 Question 24 Inventory [18 marks] LEVEL 2 Question 25 Inventory and roll forward procedures [25 marks] LEVEL 2 Question 26 Inventory [16 marks] LEVEL 2 Question 27 Inventory [23 marks] LEVEL 2 Suggested solution for question 27 Question 28 Inventory [15 marks] LEVEL 3 Question 29 Property, plant and equipment [20 marks] LEVEL 2 Suggested solution to question 29 Question 30 Investment property [14 marks] LEVEL 3 Suggested solution to question 30 Question 31 Property, plant and equipment [18 marks] LEVEL 3 Suggested solution to question 31 Question 32 Intangible asset [10 marks] LEVEL 3 Suggested solution to question 32 Question 33 Property, plant and equipment [24 marks] LEVEL 3 Question 34 Goodwill [22 marks] LEVEL 3 Suggested solution to question 34 Question 35 Loans [10 marks] LEVEL 3 Question 36 Long-term borrowings [20 marks] LEVEL 3 Suggested solution to question 36 Question 37 Loans [22 marks] LEVEL 3 Question 38 Interest paid/debentures [25 marks] LEVEL 3 Question 39 Warranty provision [14 marks] LEVEL 3 Question 40 Provision for bonuses [18 marks] LEVEL 3 Suggested solution to question 40 Question 41 Provision created for environmental rehabilitation costs [15 marks] LEVEL 3 Suggested solution to question 41 Question 42 Provision for leave pay [14 marks] LEVEL 3 Question 43 Provision for leave pay/share option scheme [31 marks] LEVEL 3 Question 44 Provision for bonuses [14 marks] LEVEL 3 Suggested solution to question 44 Question 45 Provision for rehabilitation of land [20 marks] LEVEL 3 Question 46 Provision for chemical spill [25 marks] LEVEL 3 Suggested solution to question 46 Question 47 Provision for defective work [13 marks] LEVEL 3 Question 48 Issue of shares: Equity [15 marks] LEVEL 3 Question 49 Equity [21 marks] LEVEL 2 Suggested solution to question 49 Question 50 Other reserves [14 marks] LEVEL 3 Suggested solution to question 50 Question 51 Bank reconciliation [7 marks] LEVEL 2 Suggested solution to question 51 Question 52 Bank con rmation letters [10 marks] LEVEL 2 Suggested solution to question 52 Question 53 Deferred taxation [16 marks] LEVEL 3 Suggested solution to question 53 Question 54 Taxation payable [22 marks] LEVEL 3 Suggested solution to question 54 Question 55 Audit of unlisted investment/accruals [24 marks] LEVEL 3 Suggested solution to question 55 Question 56 Directors emoluments [26 marks] LEVEL 3 Question 57 Audit procedures regarding legal matters [14 marks] LEVEL 3 Suggested solution to question 57 Chapter 14 Audit procedures: Speci c considerations Introduction Questions Question 1 Revenue [15 marks] LEVEL 2 Question 2 Opening balances [16 marks] LEVEL 2 Question 3 Accounts receivable [23 marks] LEVEL 2 Question 4 Accounts receivable [25 marks] LEVEL 2 Question 5 Question 6 Audit procedures [13 marks] LEVEL 2 Audit procedures [15 marks] LEVEL 2 Chapter 15 Completion of the audit Questions Question 1 Series ISA 560 Phase 1–3 (6 scenarios) [66 marks] LEVEL 3 Scenario 1: Subsequent events [10 marks] Scenario 2: Subsequent events [15 marks] Scenario 3: Subsequent events [15 marks] Scenario 4: Subsequent events [8 marks] Scenario 5: Subsequent events [10 marks] Scenario 6: Subsequent events [8 marks] Question 2 Subsequent events [15 marks] LEVEL 3 Question 3 Subsequent events [16 marks] LEVEL 3 Question 4 Subsequent events [17 marks] LEVEL 3 Question 5 Question 6 Subsequent events [17 marks] LEVEL 3 Subsequent events [11 marks] LEVEL 2 Question 7 Going concern [12 marks] LEVEL 3 Question 8 Going concern [18 marks] LEVEL 3 Question 9 Going concern [16 marks] LEVEL 3 Question 10 Going concern [15 marks] LEVEL 2 Question 11 Going concern [21 marks] LEVEL 2 Question 12 Materiality [14 marks] LEVEL 2 Suggested solution to question 12 Question 13 Final materiality [13 marks] LEVEL 3 Question 14 Audit differences [10 marks] LEVEL 2 Question 15 Audit differences [12 marks] LEVEL 2 Question 16 Audit differences [12 marks] LEVEL 2 Question 17 Evaluation of misstatements [15 marks] LEVEL 2 Question 18 Audit conclusion [12 marks] LEVEL 3 Question 19 Reporting [10 marks] LEVEL 1 Question 20 Reporting [11 marks] LEVEL 2 Question 21 Reporting [17 marks] LEVEL 2 Suggested solution to question 21 Question 22 Reporting [21 marks] LEVEL 2 Question 23 Reporting [13 marks] LEVEL 2 Question 24 Reporting [13 marks] LEVEL 2 Suggested solution to question 24 Question 25 Reporting [15 marks] LEVEL 2 Chapter 16 The independent review Questions Question 1 Audit and review engagements [10 marks] LEVEL 1 Question 2 Audit and review engagements [16 marks] LEVEL 2 Question 3 Independent review [14 marks] LEVEL 2 Suggested solution to question 3 Question 4 Report [14 marks] LEVEL 2 Chapter 17 Additional questions Questions Question 1 Internal controls: Various cycles [10 marks] LEVEL 1 Question 2 Internal controls [24 marks] LEVEL 1/2 Question 3 Key controls, control objectives, tests of controls: Receipts [25 marks] LEVEL 2 Question 4 Key controls, control objectives and tests of controls [30 marks] LEVEL 2 Suggested solution to question 4 Question 5 Control objectives and tests of controls [20 marks] LEVEL 2 Question 6 Control objectives and purpose: Computerised systems [18 marks] LEVEL 2 Suggested solution to question 6 Question 7 Control objectives and purpose: Computerised systems [20 marks] LEVEL 2 Question 8 Question 9 Risks and substantive procedures [24 marks] LEVEL 2 King IV™ report [17 marks] LEVEL 3 Question 10 Integrated question [30 marks] LEVEL 2 Suggested solution to question 10 List of references Preface e purpose of this book is to provide undergraduate students with the experience they will need to answer audit questions successfully in tests and exams. e text does not attempt to provide the theoretical background to auditing, as such theory is covered in our companion textbook, Auditing Fundamentals in a South African Context. e chapters in this work correspond to those in the complementary textbook, except for chapter 17 which contains additional questions addressing multiple topics. is question book should be used for the revision and reinforcement of concepts encountered and mastered in Auditing Fundamentals in a South African Context, and for the identi cation of areas requiring additional study. e questions in the text are graded according to levels which correspond with and support the framework of SAICA pro ciency levels. e text is structured in such a way that the question at the lowest level of difficulty is positioned at the beginning of each chapter. ereafter, the questions are graded to ensure that the most difficult question will be the last question in each chapter. It follows, therefore, that second-year students will work through those questions at the beginning of each chapter, while third-year students will probably work through those questions in the latter part of the chapters. Since this book is directed at undergraduate, rather than postgraduate, students, one or two integrated questions have been included for each topic and chapter. Each chapter addresses a different section of the syllabus. e student should rst study the relevant theory in the Auditing Fundamentals textbook before working through the example questions in this book. Example questions and guidance are included in the majority of chapters in order to support students’ development and understanding of how to approach and answer speci c questions. Following engagement with the example questions and the guidance, students should apply these techniques in the questions that follow, working under exam conditions. e Companies Act is not covered in the depth which its scope justi es as this would merit a book on its own. Corporate governance is not covered as a separate chapter, but rather addressed throughout the textbook in the relevant context and sub-components. After careful consideration, corporate governance questions were included in chapter 3. We should like to express our gratitude to the many contributors, from various academic institutions, who have kindly contributed material to this book. A key bene t of material which is authored by a large and diverse group of contributors is that students are exposed to questions which re ect a broad range of styles and approaches. is is valuable preparation for the initial test of competence (ITC) and assessment of professional competence (APC) exams. Future editions of this book will be published at regular intervals in order to ensure they remain relevant and that a continual supply of new content is provided. As can be seen, many new questions have been added to this third edition, and additional notes were also included for the questions that have suggested solutions. Prescribing lecturers can access additional, unseen questions through the Oxford University Press Learning Zone website. At the same website, students may access short, formative questions, which are automatically marked, in order to test their understanding of key concepts. Solutions that are not provided in the text are also available to prescribing lecturers here. Please bear in mind that different universities follow different structures and layouts for suggested solutions. If you should experience any difficulties with either the questions or suggested solutions, or should you wish to raise any queries, please contact us at rolien.kunz@up.ac.za or phamel@uwc.ac.za. We welcome your feedback, as it will assist with future development of the book. We should like to tender our apologies if any case should arise in which an original source of any question concept in this book has unwittingly not been acknowledged. We will be grateful for any information enabling us to rectify this in future impressions. We wish to thank Oxford University Press Southern Africa and its staff who participated in the publication of this edition for their time and patience in ensuring we met our deadlines and answered the many queries which resulted during the revision process. André P. Hamel Rolien Kunz Additional resources All prescribing lecturers will be given access to the Oxford University Press Learning Zone website. is opens the gate to a selection of additional resources for this title. For lecturers, the Learning Zone website provides: A set of Online Questions ese are additional, unseen questions which can be used for assessment, consolidation or extension purposes. ey provide further opportunities for students to apply their newly acquired knowledge and skills across a range of different contexts. A Solutions Manual is comprehensive Solutions Manual provides the answers and/or suggested solutions to both: the questions in the textbook, and the Online Questions mentioned above. For students, the Learning Zone website provides: A Question Bank is Question Bank contains a range of short, formative questions which are marked electronically as students complete them. ese questions provide students with unlimited chances to self-assess their grasp of the key concepts related to auditing. About the editors André P. Hamel (Editor) BCom Accounting (University Johannesburg), BCom Honours Accounting (University Johannesburg), CA(SA) of of André P. Hamel is a Senior Lecturer, and the Subject Head of Auditing in the Department of Accounting at the University of the Western Cape, and a Chartered Accountant. André has extensive lecturing experience at various education institutions in South Africa, and has co-authored several auditing textbooks. He has served as academic representative on the auditing standards committee of the South African Institute of Chartered Accountants for three years and has set, and assisted in setting, questions for the qualifying exams of both the South African Institute of Chartered Accountants and the Independent Regulatory Board for Auditors. Rolien Kunz (Editor) BCompt (University of South Africa), BCompt Honours (University of South Africa), Postgraduate Certi cate in Higher Education (cum laude) (University of Pretoria) MCom Auditing (University of Pretoria), CA(SA) Rolien Kunz is a Senior Lecturer in the Department of Auditing at the University of Pretoria, and a Chartered Accountant. Rolien has lectured at various higher education institutions at undergraduate as well as postgraduate level. She also acts as external examiner for a various higher education institutions. Rolien is a co-author of the companion text to this work, Auditing Fundamentals in a South African Context. Her research interests are focused within accounting educationand for many years, at various levels, she has actively participated in the professional education activities of the South African Institute of Chartered Accountants and the Independent Regulatory Board for Auditors. List of contributors A broad panel of expert contributors, from various South African academic institutions, have authored the questions and solutions which are published in this book and/or on the Oxford University Press Learning Zone website. e questions and solutions which have been placed on Learning Zone complement this third edition as additional supporting material and are available to prescribing lecturers of Auditing Fundamentals in a South African Context: Graded Questions. Barend Barnard BCom (Pretoria), BCompt Honours (South Africa), MCom (Pretoria), CA(SA) Senior Lecturer, College of Accounting Sciences, University of South Africa; Marker, Assistant Umpire and Umpire for both the Initial Test of Competence as well as the Assessment of Professional Competence of the South African Institute of Chartered Accountants and the Public Practice Examination of the Independent Regulatory Board for Auditors. Rika Butler BCom Honours (Accounting) (Pretoria), CTA (Pretoria), MAcc (Computer Auditing) (Stellenbosch), CA(SA) Associate Professor, School of Accountancy, Faculty of Economic and Management Sciences, Stellenbosch University. Cornelie Crous BCompt (Free State), BAcc Honours (Free State), MCompt (cum laude) (Free State) Senior Lecturer, Centre for Accounting, Faculty of Economic and Management Sciences, University of the Free State. Monique du Plessis BCom (North West), BCom Honours (North West), MCom (North West), CA(SA) Senior Lecturer, School of Accounting Sciences, North West University (Vaal Campus). Mandisa Gandela BCom Accounting (Cape Town), BCom Honours Accounting and CTA (Natal), CA(SA) Senior Lecturer, College of Accounting Sciences, University of South Africa. André P. Hamel BCom Accounting (Johannesburg), BCom Honours Accounting (Johannesburg), CA(SA) Senior Lecturer and Subject Head of Auditing, Department of Accounting , University of the Western Cape; current Regional Chairman of the Southern African Accounting Association (SAAA), Western Cape. Phindiwe Kamolane BCom Accounting (Johannesburg), BCom Honours Accounting (Johannesburg), CA(SA) Senior Lecturer, College of Accounting Sciences, Department of Auditing, University of South Africa. Rolien Kunz BCompt (South Africa), BCompt Honours (South Africa), PGC in Higher Education (cum laude) (Pretoria), CA(SA) Senior Lecturer, Department of Auditing, University of Pretoria. Jana Lamprecht BCompt Honours (South Africa), MA Higher Education Studies (Free State), CA(SA) Senior Lecturer, Department of Auditing, University of the Free State. Ismail Mohamed BCom (Cape Town), BCom Honours (Natal), CA(SA) Lecturer, Department of Accounting, University of the Western Cape. Anneke Moolman BCom Chartered Accountancy, BCom Honours CTA, MCom Accountancy (North West), CA(SA) Senior Lecturer, School of Accounting Sciences, North West University. Vincent Motholo BCom Accounting Sciences (Pretoria), BCom Honours Accounting and CTA (Natal), CA(SA) Previously: Senior Lecturer, College of Accounting Sciences, University of South Africa Currently: Audit Senior Manager, Sizwe Ntsaluba Gobodo. Mari Patterson BAcc Honours (Stellenbosch), MComm (Computer Auditing) (Stellenbosch), CA(SA) Lecturer, School of Accountancy, Faculty of Economic and Management Sciences, Stellenbosch University. Gerrit Penning BAcc Honours, CTA (Free State), CA(SA), MCom (UP) Senior Auditing Lecturer, University of Pretoria; serving member of the question-setting team of the Public Practice Examination (PPE) of the Independent Regulatory Board for Auditors. Pranisha Rama BCom, BCom Honours, CTA (Johannesburg), CA(SA) Senior Auditing Lecturer, Department of Accounting, University of Johannesburg. Riaan J Rudman BBus Sc Honours (Cape Town), PGDA (Cape Town), MBus Sc (Cape Town), MAcc (cum laude) (Stellenbosch), CA(SA) Senior Auditing and Information Systems Lecturer, uthuka Senior Project Manager, School of Accountancy, Stellenbosch University. Henriette Scholtz BCom Accounting (Rand Afrikaans University), BCom Honours Accounting (Rand Afrikaans University), MCom Financial Management (Rand Afrikaans University), Adv Cert Tax (South Africa), CA(SA) Senior Auditing Lecturer, School of Accounting, University of Stellenbosch; Member of SAICA ethics committee. Jacques Siebrits BCom (Stellenbosch), LLB (Stellenbosch), BCompt Honours (South Africa), CA(SA) Senior Lecturer, Department of Accounting, University of the Western Cape. Olive Stumke BCom (North West), BCom Honours (UNISA), MCom (North West), Professional Accountant (SA) Internal Auditing and Accounting Lecturer, School of Accounting Sciences, North West University (Vaal Campus). André (JJ) Swart BCom, Honours BCompt (South Africa), MCom (North West), CA(SA), RA Subject Chair for Ethics, External and Internal Auditing, Senior External Auditing Lecturer, School of Accounting Sciences, North West University (Vaal Campus). Alet Terblanche BCom Accounting Sciences (Pretoria), BCom Honours Accounting Sciences (Pretoria), MCompt Accounting Science (South Africa), CA(SA) Senior Lecturer, College of Accounting Sciences, University of South Africa. Judith Terblanche BAcc (Stellenbosch), BAcc Honours (South Africa), MComm (Computer Auditing) (Stellenbosch), CA(SA), PGD eology (Stellenbosch), Diploma in Sport Psychology (BSY(UK)), HED (Stellenbosch) Senior Lecturer, Department of Accounting, University of the Western Cape. Jolandi Volschenk BCom CA, BCom Honours CTA (North West), CA(SA), RA Senior Auditing and Advanced Auditing Lecturer, School of Accounting Sciences, North West University (Vaal Campus). Lyle Weber BCom Accounting (Western Cape), BCom Honours Accounting (Western Cape), MCom Computer Auditing (Stellenbosch), Diploma Itinerant Ministry (Rhema Bible Training College) (USA) Previously: Senior Auditing Lecturer, Department of Accounting, University of the Western Cape. Currently: CEO of LBW Consulting, and traveling Minister. CHAPTER 1 Introduction CHAPTER 2 Ethics CHAPTER 3 Legal responsibilities of the auditor e topics contained in this chapter provide a background to those included in the rest of the book. ese topics are normally not tested on their own, but a thorough understanding of them will enhance your application of them in the chapters to follow. Question 1 LEVEL 1 Background to auditing [24 marks] As an audit partner at OLX Incorporated (OLX), you are responsible for the recruitment of trainee accountants for the rm. You recently attended an open day at one of the universities, during which a confused second-year student approached you with the following questions: A. I found the following de nition in my auditing text book: External audit is a systematic process of obtaining and evaluating evidence and information objectively regarding assertions about economic actions and events to determine the degree of correlation between those assertions and prede ned criteria and to communicate the results in writing to the users of the nancial statements. Could you please explain the de nition to me? (6) B. What are the postulates of auditing, and where do they t into the bigger picture of auditing? (9) C. What is the difference between the South African Institute of Chartered Accountants (SAICA) and the Independent Regulatory Board for Auditors (IRBA), and which other professional bodies related to the accounting profession are there in South Africa? (9) REQUIRED Answer the student’s questions. [24] INTRODUCTION e following question formats are most often used when the SAICA Code of Professional Conduct is examined: Apply information in the question or scenario with reference to the SAICA Code of Professional Conduct. Discuss safeguards that could be implemented where problems have been identi ed. Discuss the theory that you had to study regarding the SAICA Code of Professional Conduct. Variations of the above. A sound knowledge of the SAICA Code of Professional Conduct, as well as the safeguards that could be implemented in order to address identi ed problems, is necessary in order to answer questions in this chapter. ese questions are not difficult if you have properly studied the underlying theory and have worked through a number of them. All the information you need to obtain a good mark is in the question. e crucial thing is to identify the relevant information that you need to apply to the principles set out in the code and to apply it properly. EXAMPLE QUESTION SAICA Code of Professional Conduct: CA in practice [12 marks] Carter & Cash Inc. (CC Inc), a small rm of registered auditors with a single office in East London, is the auditor of the 20X1 nancial statements of Monsterbond Ltd (Monsterbond). Incorporated in 20X0, the company develops small shopping centres in medium-sized towns. Until four years ago, it had been relatively small, and operating only in the Eastern Cape. e company then appointed a new managing director, Mr Garth Groenewald, under whose leadership the company expanded its operations to other provinces, thereby attracting in excess of R250 million in new investments from non-institutional investors. Monsterbond is now CC Inc’s largest client by far. Mr Carter, a CA(SA), has been the engagement partner on the Monsterbond audit since the incorporation of the company. Since the appointment of Mr Groenewald as MD, he has become increasingly uncomfortable with developments within the company. First, Mr Carter has found Mr Groenewald to be abrupt, uncooperative and sometimes aggressive. Second, Mr Carter has experienced problems dealing with Monsterbond’s new computerised accounting system, as he is not comfortable with computer-assisted audit techniques (CAATs). In response to these problems, Mr Carter has been delegating more of the responsibility for the Monsterbond audit to Megan Meek, who is in the third year of her training contract. Megan Meek has been placed in charge of the eldwork for the current year’s Monsterbond audit. Being a rather timid person, she is also struggling to deal with the difficult Mr Groenewald, as well as other senior managers at Monsterbond. When she builds the courage to tell Mr Carter about this problem, he says, ‘Megan, stop moaning. You’re a third-year student now, this is your client, and you must learn to handle senior management.’ REQUIRED Comment on the above scenario with reference to the SAICA’s Code of Professional Conduct. Where relevant, your answer should include references to appropriate safeguards that ought to have been implemented. [12] GUIDANCE Understand the question Comment on the above scenario with reference to the SAICA Code of Professional Conduct. Where relevant, your answer should include references to appropriate safeguards that should have been implemented. Identify the theory applicable to the question, and thus the issue Identify which of the following threats are applicable to the auditor in the scenario: Self-interest Self-review Familiarity Advocacy Intimidation Identify which of the following fundamental principles of the code are threatened by the identi ed issue(s) in the scenario: Objectivity Professional behaviour Professional competence and due care Integrity Con dentiality Discuss whether the level of the threat(s) is signi cant or not and give reasons why. Identify appropriate safeguards for each of the threats identi ed. Read the question It is clear from the scenario that a small-sized audit rm is auditing a client, namely Monsterbond, which has now appointed an aggressive new managing director. Ethical issues have been identi ed during the performance of this audit. ese and other similar ethical issues are experienced on a daily basis by audit rms throughout the country. Chartered accountants (CAs) and/or registered auditors (RAs) should ensure that they comply with the SAICA and IRBA Codes of Professional Conduct, and they should implement appropriate safeguards if any threats to their professional conduct have been identi ed. e objective of this type of question is to test your ability as a student to apply the theory that you have studied to a practical scenario. Exam technique Scrutinise the scenario for possible indications of where there might be threats to the CA or RA’s professional conduct. ese have been marked in bold print below. You should also highlight, or underline, the words indicating possible threats. Carter & Cash Inc. (CC Inc), a small rm of registered auditors with a single office in East London, is the auditor of the 20X1 nancial statements of Monsterbond Ltd (Monsterbond). Incorporated in 20X0, the company develops small shopping centres in mediumsized towns. Until four years ago, it had been relatively small, operating only in the Eastern Cape. e company then appointed a new managing director, Mr Garth Groenewald, under whose leadership the company expanded its operations to other provinces, thereby attracting in excess of R250 million in new investments from non-institutional investors. Monsterbond is now CC Inc’s largest client by far. Mr Carter, a CA(SA), has been the engagement partner on the Monsterbond audit since the incorporation of the company. Since the appointment of Mr Groenewald as MD, he has become increasingly uncomfortable with developments at the company. First, Mr Carter has found Mr Groenewald to be abrupt, uncooperative and sometimes aggressive. Secondly, Mr Carter has experienced problems dealing with Monsterbond’s new computerised accounting system, as he is not comfortable with computer-assisted audit techniques (CAATs). In response to these problems, Mr Carter has been delegating more of the responsibility for the Monsterbond audit to Megan Meek, who is in the third year of her training contract. Megan Meek has been placed in charge of the eldwork for the current year’s Monsterbond audit. Being a rather timid person, she is also struggling to deal with the difficult Mr Groenewald, as well as other senior managers at Monsterbond. When she builds the courage to tell Mr Carter about this problem, he says, ‘Megan, stop moaning. You’re a third-year student now, this is your client, and you must learn to handle senior management.’ Discuss the threat(s) and possible safeguards for each of the issues marked in bold print. Use the following framework for your answer: Start by explaining the type of threat(s) that might exist and the fundamental principle(s) being threatened. Next, state and motivate whether the level of the threat is signi cant or not (certain lecturers, however, might not require this step). Discuss the safeguards that could be implemented. Use the above framework, which has been applied in the suggested solution below, for each of the areas highlighted. In addition, start your answer by indicating why the Code of Professional Conduct will be applicable (refer to point 1 below). SUGGESTED SOLUTION 1. Mr Carter is a CA(SA) and therefore needs to comply with the SAICA Code of Professional Conduct. (1) 2. ere is a self-interest threat1 to independence because Monsterbond is now CC Inc’s largest client by far which might cause independence issues.2 (1) a) is might cause an intimidation or self-interest threat to Mr Carter’s objectivity as his professional judgement might be compromised because of bias.3 (1) b) is might also cause an intimidation or self-interest threat to integrity as Mr Carter might not be honest when reporting on Monsterbond’s nancial statements. (1) c) e level of the threat is signi cant as Monsterbond is the rm’s largest client by far and the newly appointed managing director is described as aggressive.4 (1) d) A possible safeguard5 would be to try actively to increase the rm’s client base. (1) 3. Mr Carter has been the engagement partner since the company’s incorporation, which is a contravention of both the SAICA Code of Professional Conduct as well as the Companies Act, causing independence issues. (1) a) is might create a familiarity or self-interest threat6 to objectivity as such a relationship can in uence Mr Carter’s judgment (although one could argue that the threat is negated by the fact that he does not seem to be getting along with the entity’s senior managers). (1) b) In addition, a self-interest threat to professional behaviour is created as the engagement is in contravention with the Companies Act requirements. (1) c) e level of the threat might be regarded as signi cant as it has been an exceptionally long relationship with no partner rotation.7 (1) d) A possible safeguard8 would be that Mr Carter be replaced as the engagement partner. (1) 4. e client has implemented a new computer system and Mr Carter is not comfortable with CAATs.9 (1) a) is creates a further self-interest threat10 to professional competence and due care as Mr Carter seems to be lacking the necessary knowledge to provide the required services. (1) b) e level of the threat is signi cant,11 because it is stated that the engagement partner is uncomfortable using CAATs but continues with the engagement irrespectively. (1) c) Possible safeguards12 would be to: i) assign a partner with the required skills to the audit, if possible; or (1) ii) seek outside assistance. (1) Available marks [16]; maximum marks [12] QUESTIONS Question 1 LEVEL 1/2 SAICA Code of Professional Conduct: Fundamentals and CA in practice [27 marks] A. In the SAICA Code of Professional framework’ approach is used. Conduct, a ‘conceptual REQUIRED 1. Why is this approach used? (1) 2. List the steps that should be followed when applying the conceptual framework approach. (2) B. e SAICA Code of Professional Conduct consists of four parts: 1, 2, 3 and 4. REQUIRED 1. State what is contained in each part of the code, and to whom it is applicable. (7) 2. What, if any, is the relationship between the SAICA Code of Professional Conduct and the IRBA Code of Conduct? (1) C. Independence is not a fundamental principle in the SAICA Code of Professional Conduct, but many examples are provided of how a member should respond to a threat to his/her independence. REQUIRED 1. What is the connection between independence and the fundamental principle of objectivity? (1) 2. List, and brie y explain, the ve threats dealt with in the SAICA Code of Professional Conduct. (8) D. In an auditing test, Billy Blunder, an accounting student, is required to apply the guidance contained in the SAICA Code of Professional Conduct to the following scenario: Mr Wild is a partner in Wild & Woes, a rm of registered auditors. He has an advertisement placed in Daily Gossip, a low-quality tabloid newspaper, of which the following is an extract: e Big 4? Rather choose us. I did my traineeship with one of those rms, and I saw what they are: lumbering dinosaurs that overcharge their clients for impersonal service. Smaller is better. Try Wild & Woes, where the client is king. e CEO of Cavalier (Pty) Ltd read the advertisement and, after some discussion, the company appointed Wild & Woes as its auditors. Billy Blunder answered it as follows: is is a self-interest threat. I think this sort of thing is dealt with in section 150 of the Code of Professional Conduct. Safeguards: Cavalier should rather get some other auditing rm to audit their nancial statements, because Mr Wild seems to have poor judgement. REQUIRED Comment critically on Billy Blunder’s answer. Question 2 SAICA Code of Professional Conduct: CA in practice [10 marks] (7) [27] LEVEL 2 Elkom (Pty) Ltd (Elkom) was founded in 20X1 in order to support electricity production in the country. Elkom’s nancial manager, Mr Power, approached one of your audit rm’s partners, Ms Spark, in order to be the external auditors of the entity. Mr Power and Ms Spark are good friends and therefore Mr Power sees this as a great opportunity to spend some time together. Your audit rm, AUD Inc. (AUD), was recently founded and therefore the engagement was immediately accepted in order to grow the client database. e audit fee that was contracted with Elkom is the previous audit rm’s fee, increased in line with in ation. Mr Power bought Ms Spark a Rolex watch in order to thank her for accepting the engagement. After the engagement was accepted, the planning phase started immediately, and the preliminary engagement team has been arranged as follows: Ms Spark – the engagement partner Mr Capacitor – the audit manager Mr Volt – the senior audit trainee Mr Cable – the second year audit trainee Ms Bulb – the rst year audit trainee Mr Capacitor was the information technology (IT) director at Elkom two years ago, and therefore has in-depth knowledge of the client. During Mr Capacitor’s directorship, he designed an IT system for Elkom’s nancial reporting, and has since kept the shares that Elkom gave to him as payment for the development of the system. Mr Power requested AUD to issue an assurance report on the effective operation of the IT system. As Mr Capacitor has close connections with the personnel in Elkom, he is currently assisting Mr Volt to nd a job at Elkom once the latter has nalised his articles. REQUIRED Discuss the professional conduct concerns that you may have based on the information provided above. Categorise your concerns based on the type of threat created by your concerns. [10] Question 3 LEVEL 2 SAICA Code of Professional Conduct: CA in practice [13 marks] Mr Basil Blink is a director of Blink & Bowles Inc. (B&B), a small rm of chartered accountants and registered auditors with an office in Century City. During the period of 10–14 August 20X1, the following occurs: 1. 10 August: Mr Blink sends his sister, Rebecca Rossouw, an email. Rebecca is the chief nancial officer of Shoppies (Pty) Ltd (Shoppies), a retail company with seven branches in Cape Town, and an audit client of B&B. In the email he asks her to do her utmost to get Shoppies to give additional work to B&B. e email reads as follows: ‘We will take on accounting work, tax work, consulting work, whatever you have for us. We have two junior trainees who have been idle for the last three weeks and we can’t afford that’. 2. 11 August: Mr Blink gets a call from a friend, Charles Coetzer, who runs a cage diving business in Kleinbaai. Some time ago, Charles had told Mr Blink that he could place a small advertisement on the advertising pamphlets for his cage diving business. Mr Blink then asked Doug du Toit, another friend of his who does marketing, to come up with such an advertisement. On 11 August, Charles calls to say that he got the text for the advertisement from Doug, and that he is having new pamphlets printed that include the advertisement. Mr Blink tells him to go ahead without having seen the text for the advertisement, which reads as follows: ‘You want to see sharks today, but you don’t want your accountant or auditor to be a shark (and many of them are, unfortunately!). So, bring your business to Blink & Bowles, and you won’t be swimming with the sharks’. is is followed by a phone number for the rm. 3. 12 August: In July, a company called Rumble Ltd (Rumble) asked Mr Blink to nd a suitable empowerment partner for the company to whom they could sell a shareholding in the business to improve Rumble’s empowerment status. Having since looked at Rumble’s nancial statements, Mr Blink realises that taking a shareholding in that company would be a very good investment, so he asks a friend, Sipho Dube, to buy the shares on his behalf, but to pretend that he (Sipho) is the buyer. 4. 13 August: Mr Blink calls ve experienced managers who are working for other small rms in Cape Town, and offers each one a director position at B&B on condition that he/she brings clients with a fee income of at least R1.5 million per annum with him/her to B&B. REQUIRED For each of the above situations, identify the threats to Mr Blink’s compliance with SAICA’s Code of Professional Conduct and explain the fundamental principle(s) being threatened. Brie y explain your reason for stating that each threat exists. [13] Note: Your answer does not have to deal with the following: e level of signi cance of the threats. Safeguards to mitigate the threats. Question 4 SAICA Code of Professional Conduct: CA in practice [15 marks] LEVEL 2 REQUIRED 1. List the type of threat(s) that would be created in terms of the SAICA Code of Professional Conduct for each of the following situations. e fundamental principle, the signi cance of the threat and the safeguards that could be implemented in order to reduce the threat to an acceptable level do not need to be addressed. a) A rm has undue dependence on total fees from a client. b) A rm is threatened with litigation by the client. c) A rm has prepared the original data used to generate records that are the subject matter of the assurance engagement. d) A chartered accountant is informed by a partner of the rm that a planned promotion will not occur unless the chartered accountant agrees with an audit client’s inappropriate accounting treatment. e) A rm enters into a contingent fee arrangement relating to an assurance engagement. f ) A member of the engagement team has a close or immediate family member who is a director or an officer of the client. g) A director or an officer of the client, or an employee in a position to exert signi cant in uence over the subject matter of the engagement, has recently served as the engagement partner. h) A rm is threatened with dismissal from a client engagement. i) A rm is concerned about the possibility of losing a signi cant client. j) e rm performs a service for an assurance client that directly affects the subject matter information of the assurance engagement. (10) 2. Benny Edge, a CA(SA) recently quali ed as a chartered accountant, has opened his own auditing rm, U3 Inc. (U3). In an attempt to attract clients, Benny has had high-quality lea ets printed, on which the following information appears: Benny Edge CA(SA): three year training contract done and dusted. e best newly quali ed chartered accountant in town. Fee: Only R1 000 an hour. With reference to the SAICA Code of Professional Conduct, discuss Benny Edge’s ethical conduct in printing such information on the lea ets. (5) [15] Question 5 LEVEL 2 SAICA Code of Professional Conduct: CA in practice [6 marks] Frans van Zyl CA(SA), the audit manager on the audit of Mountain Limited (Mountain) bought 1000 shares in Foothill Limited (Foothill) on 30 April 20X1. Frans was involved in the due diligence review of Foothill, conducted for Mountain, during April 20X1. Foothill was taken over by Mountain on 1 June 20X1. e share price of Foothill before the takeover was 10c per share. It is currently trading for R2,00 per share. REQUIRED Discuss Frans van Zyl’s behaviour with reference to the SAICA Code of Professional Conduct. [6] SUGGESTED SOLUTION TO QUESTION 5 1. Frans van Zyl is a CA(SA) and therefore has to comply with the SAICA Code of Professional Conduct and its fundamental principles. (1) 2. Frans obtained con dential information during the due diligence review which he used for his own bene t. (1) 3. is creates a self-interest threat to con dentiality as he used the information acquired as a result of professional and business relations for his personal advantage. (1) 4. It can also create a self-interest threat to the professional behaviour as his actions might bring the profession into disrepute. (1) 5. Frans has to comply with relevant laws and by using the information to purchase shares, knowing that the share price will probably rise as a result of the takeover, will be transgressing the insider trading act, creating a self-interest threat to professional behaviour. (1) 6. e threat is signi cant, as information obtained from a client was used to purchase shares and the share price has increased because of this. (1) 7. No safeguards can be implemented to reduce the threats to an acceptable level. (1) Available marks [7]; maximum marks [6] Notes: e required does not exclude any points of the framework, thus the signi cance of the threat(s) as well as safeguards need to be included. When looking at the mark allocation, six marks in a Code of Professional Conduct questions could serve as an indication that it probably only deals with one issue. e suggested solution is presented in terms of the framework provided in the guidance question, for example it started with why the Code of Professional Conduct will be applicable, followed by the identi ed issue and the type of threats to the relevant fundamental principles, with an explanation/application of the fundamental principles, followed by the signi cance of the threat and a safeguard. Question 6 LEVEL 2 SAICA Code of Professional Conduct: CA in practice [8 marks] Hush Ltd (Hush) placed an advertisement in a newspaper, after the resignation of its auditors, to call for prospective auditing rms to come and do a presentation on the audit approach they would follow as well as an estimation of their audit fees. Your auditing rm, Rush Inc. (Rush), which is registered with both the South African Institute of Chartered Accountants and the Independent Regulatory Board of Auditors, would like to obtain the audit of Hush and is therefore planning to do a presentation to Hush. You are a CA(SA) and RA, and your plan is to present a fee lower than that charged to current clients. REQUIRED Discuss the above with reference to the SAICA Professional Code of Conduct. Also advise regarding alternative actions and/or steps that could or should have been implemented. [8] Question 7 LEVEL 2 SAICA Code of Professional Conduct: CA in business [9 marks] Mr Bonanza is a chartered accountant employed as the most senior nancial accountant of a signi cant division of Medium Ltd (Medium), a company listed on the JSE Limited. Among other incidents, the following happened to Mr Bonanza in 20X9: 1. February 20X9: Mr Bonanza spends most of February compiling the division’s nancial information, which will feed into Medium’s nancial statements for the nancial year ended 28 February 20X9. Medium’s management awarded Mr Bonanza 300 000 share options in 20X1, which will vest on 30 April 20X9. In February, the share options are ‘in the money’, as they were awarded when Medium’s share price was R7,20 per share, and the share price is now over R11 per share. Mr Bonanza is glad about the amount of money that he is likely to receive when the share options vest, because he was divorced late in 20X3, and needs the money in order to maintain his standard of living. 2. September 20X9 : In September, the chairperson of the board of directors of Large Ltd (Large), a competitor of Medium, calls Mr Bonanza and offers him the position of nancial director of Large. Mr Bonanza views this as a once-in-a-lifetime opportunity. However, there is a condition attached to the offer: he must supply Large with a list of Medium’s clients, showing the amounts that Medium charged each client for services over the last 12 months. REQUIRED Discuss each of the above situations in the light of the relevant guidance in the SAICA Code of Professional Conduct. Mark allocation 1. (5) 2. (4) [9] Question 8 SAICA Code of Professional Conduct: CA in practice [10 marks] LEVEL 2 You are a CA(SA) and registered auditor and were appointed as an audit partner of Frazer Inc. (Frazer), an established auditing rm. e following represents clients and potential clients of Frazer: Shop Ltd (Shop) is a popular grocer and one of the largest retailers in the country, and is the largest client of Frazer. Shop’s audit fees comprise 65% of the auditing fees of the auditing rm. e auditor of Buy (Pty) Ltd (Buy), the holding company of Shop, is retiring. You offered to pay the current auditor of Buy a gratitude fee of 15% of the rst year’s audit fees if he persuades the board of Buy to appoint Frazer as the new auditor of Buy. REQUIRED Discuss any ethical concerns with reference to the SAICA Professional Code of Conduct. [10] Question 9 LEVEL 2 SAICA Code of Professional Conduct: CA in practice [10 marks] GDH Inc. are the auditors responsible for the audit of XXR Ltd (XXR), a manufacturer of luxury cars. John Burton CA(SA) is a registered auditor and the engagement partner on the audit. It is customary for John and Harry, the chairperson of the board of XXR, to play a round of golf together on a Wednesday afternoon. During the course of their last game, Harry made an offer: John could buy the new XXR sports car at cost (the same rate as that offered to company employees, arguing that the auditors are considered part of the business). REQUIRED With reference to the SAICA Code of Professional Conduct, discuss any ethical concerns evident from the above scenario. List any steps that should be implemented in order to reduce the threats to an acceptable level. [10] Question 10 LEVEL 2 SAICA Code of Professional Conduct: CA in practice [10 marks] Smart Books (Pty) Ltd (Smart Books) is a distributor of textbooks to most universities in southern Africa. e entity has only one office in Pretoria, and all orders are placed online, whereafter Smart Books delivers the books to the relevant university. Smart Books is currently expanding into the rest of Africa. e nancial director of Smart Books, Anne Smith CA(SA), has requested your audit rm, Lead Audits Inc. (Lead Audits), to tender for the external audit of the entity for its 30 September 20X1 nancial yearend. As several of the audit rm’s trainee accountants are still studying towards becoming chartered accountants, Anne Smith offered the audit team members a 10% discount on all books ordered through Smart Books. is offer was made during the tender meeting, to which Anne Smith arrived late. At the meeting, the HR director also asked the audit partner, Ben, if he could recommend some hardworking people that Smart Books could employ in order to ll positions for the expansion. Ben and the HR director play golf together every Friday, and therefore the HR director trusts Ben’s opinion. During the coffee break, Ben overheard Anne telling one of her colleagues that she would actually prefer Lead Audits not to be awarded the tender, as she was not at all fond of the way that they had presented themselves at the tender meeting. Anne added that she would rather have Zebra Audits Inc. (Zebra Audits) as external auditors for Smart Books, as she is more comfortable with her brother, James, one of the audit partners of Zebra Audits. James apparently also owns a 5% share in Smart Books, and Anne is sure that he will therefore ‘look after the company’. REQUIRED Discuss any concerns and considerations relating to the SAICA Code of Professional Conduct you may have, based on the information provided. Do not include signi cance and safeguards as part of your answer. [10] Question 11 LEVEL 2 SAICA Code of Professional Conduct: CA in practice [18 marks] e four paragraphs below describe incidents that occurred during a year in the working life of Mr Hentie Hopper, a CA(SA). Hentie started the year as a director of Carradine & Hopper Inc. (CH), a rm of chartered accountants and registered auditors: 1. January: Quicksand (Pty) Ltd (Quicksand), one of CH’s audit clients, is experiencing serious cash- ow problems. Hentie Hopper, who is the partner in charge of the Quicksand audit, recently inherited a substantial amount of money and thus decides to make an interestfree loan of R200 000 to Quicksand, because he is a close friend of Mr Hussey, a major shareholder in the company. 2. 12 March: Mr Jackson, the controlling shareholder in a number of private companies audited by CH, comes to CH’s offices with a carrier bag containing approximately R800 in cash. Mr Jackson asks Hentie Hopper to store the money for him for a few days and not to keep any record of having received the money. Finally, Mr Jackson asks Hentie Hopper to give the money to his (Mr Jackson’s) son should ‘something unfortunate happen to me before I get to collect the money’. REQUIRED With reference to the relevant guidance provided by the SAICA Code of Professional Conduct, discuss any ethical concerns as well as how Hentie Hopper and/or the rm of Carradine & Hopper should have responded to each of the situations described above. Do not discuss the signi cance of the level of threat(s) as part of your answer. Mark allocation 1. (9) 2. (9) [18] Question 12 LEVEL 2 SAICA Code of Professional Conduct: CA in business [3 marks] You have recently been appointed as the head of ethics at a training rm and your main function is to answer queries submitted by CA(SA)s who need guidance regarding ethical issues. e following issue was presented to you: Johan Van Wyk, a CA(SA), was recently appointed as the nancial manager at Rubco Ltd (Rubco), a company that manufactures rubber. Johan’s duty is solely to prepare the nancial statements, while the nancial director, Willem Malherbe, also a CA(SA), is responsible for the review of the nancial statements. Willem, however, felt he needed a holiday, and instructed Johan to take over the preparation and review of the nancial statements. Johan was rather concerned about this, and explained to Willem that he could not perform both functions as it would be considered as a threat. Willem’s response was as follows, ‘I disagree with you. ere is no such a thing. Do as I say or leave the job!’ REQUIRED Comment on the issue with reference to the SAICA Code of Professional Conduct. Do not include safeguards in your answer. [3] Question 13 LEVEL 2 SAICA Code of Professional Conduct: CA in business [5 marks] Eddie Noyons, registered with SAICA as a CA(SA) in business, has recently been appointed as the nancial manager at Raindrops (Pty) Ltd (Raindrops), an irrigation company. e company is a wholly owned subsidiary of Hydro Ltd (Hydro), a listed company. One of his main duties is to prepare nancial statements for submission to the holding company. ese nancial statements are used in the calculation of bonuses which are paid to management of the subsidiary. Upon Eddie’s presentation of the June 20X1 results to Pete Venter, nancial director of Raindrops, Pete suggested to Eddie that he should in ate the pro t gure in order to re ect a higher pro t. Pete whispered to Eddie: ‘Do not forget that managements’ bonuses depend on the pro t, and I strongly suggest you do as I say!’ On his way back to the office, Eddie discussed the matter with a colleague, Ahmed Haji, also a CA(SA). Ahmed’s response was: ‘Just do as you are told, or else Pete will re you. Besides, you are not in the profession any longer. Oh, and on the brighter side, our bonuses will be bigger, and it is not like you’re stealing! Lastly, the auditors are useless so that should not even be a worry to you.’ REQUIRED Discuss the situation that Eddie Noyons is currently in based on the SAICA Code of Professional Conduct. Do not include the signi cance of the threat and safeguards in your answer. [5] Question 14 LEVEL 2 SAICA Code of Professional Conduct: CA in business [12 marks] Jeffrey Wells, a second-year trainee accountant at MMM Inc., is the audit senior on the audit of BGG Limited (BGG). During a visit to the canteen, Jeffrey overhears William Woods, the nancial director, and Matt Walker, the nancial manager, who are both CA(SA)s, discussing their respective weekends. Matt tells his colleague that he had to bribe a traffic officer in order to evade a speeding ne. William acknowledges that he too has done so in the past. In addition, he informs Matt that the editor of Finances magazine offered him R15 000 to tell him (the editor) whether the nancial position of BGG had improved or declined over the past year, which he accepted and so shared the information. REQUIRED With reference to the SAICA Code of Professional Conduct, discuss any ethical concerns arising from the above scenario. Do not include safeguards in your answer. [12] Notes In answering the question, follow the layout explained in the guidance to the example question. When analysing the required, take note of the fact that safeguards are excluded from the required. When looking at the mark allocation, 12 marks in a Code of Professional Conduct question could serve as an indication that it deals with more than one issue (probably two to three), taking into account that safeguards were excluded. SUGGESTED SOLUTION TO QUESTION 14 1. Both William and Matt are professional accountants in business (CA(SA)s); therefore, Part 2 of the SAICA Code of Professional Conduct is applicable to them. (1) 2. Matt made the payment of a bribe to a traffic officer and William acknowledged that he had done the same in the past. (1) a) Such an action could create a self-interest threat to integrity, as they were dishonest in their dealings with their offences and the traffic officers. (1) b) Paying a bribe also causes a self-interest threat to professional behaviour, as such an action is against the law and could discredit the profession. (1) c) e level of the threat is signi cant as in an attempt to protect themselves, they were breaking the law. (1) 3. William has disclosed con dential information to the editor of a magazine in return for R15 000. (1) a) He should not have done so, since this creates a self-interest threat to con dentiality – he disclosed con dential information without the appropriate authorisation. (1) b) In addition, this creates a self-interest threat to professional behaviour, as his unauthorised disclosure will discredit the profession if it becomes public. (1) c) e level of the threat is signi cant as he nancially bene tted from the disclosure. (1) 4. e R15 000 can be regarded as an inducement. In terms of section R250.8, William shall not accept any inducement if a reasonably informed third party would be likely to conclude that it was made with the intent to in uence his behaviour improperly. William is offered R15 000 if he discloses con dential information. A reasonably informed third party would conclude that the R15 000 was offered to in uence him to transgress the code by disclosing con dential information. (2) Accepting the inducement created a self-interest threat to a) integrity, as he was not acting in a straightforward and honest manner by accepting the money in return for the con dential information. (1) b) It also created a self-interest threat to his objectivity, as his judgement was compromised when he accepted the money and shared the information. (1) c) In addition, this will create a self-interest threat to professional behaviour, as the profession’s reputation will be discredited by his actions. (1) d) e level of the threat is signi cant as he acted in his own interest and nancially bene tted from the disclosure. (1) Available marks [15]; maximum marks [12] Question 15 LEVEL 2 SAICA Code of Professional Conduct: CA in business [17 marks] Mr Reserve is a chartered accountant and is employed as the nancial manager at Dodd Ltd (Dodd). Dodd’s warehouse, in which nished products are stored, was ooded in the last month of the nancial year. Dodd was able to keep it out of the news. Mr Reserve is responsible for preparing the draft annual nancial statements and liaising with the external auditors. e chief nancial officer of Dodd instructed Mr Reserve not to make any adjustments to the inventory balance and advised him that no write-offs were allowed to the lowest of cost price or net realisable value. REQUIRED Discuss the abovementioned with reference to the SAICA Code of Professional Conduct. [17] Note: You are not required to discuss the detail of a dispute resolution process. Question 16 LEVEL 2 SAICA Code of Professional Conduct: CA in business [22 marks] Nomvula Phosa CA(SA) was appointed the head of accounting at Kind Hearts NPC on a six-month contractual basis. Kind Hearts NPC is a national non-pro t company involved in the redistribution of unsold food to people in need. e company was speci cally formed in the wake of statistics showing that an immense volume of food that has reached its sell-by date goes to waste, despite still being perfectly suitable for human consumption. To counteract the waste, Kind Hearts NPC will typically obtain the food either for free or at signi cantly reduced prices from retail chains and distribute it to soup kitchens and other charity organisations involved in providing food to the poor. Kind Hearts NPC relies on subsidies from the national lottery, on private donations and on donations from multinational corporations to fund its operations. When the end of Nomvula’s six-month contract was approaching, the nance director of Kind Hearts NPC, Kenneth Wiggins, managed to secure a further six-month contract for her after having gone through immense trouble on her behalf. Soon after her contract was extended, Nomvula came face-to-face with a major ethical dilemma. Upon reviewing the accounting records, she came upon several suspicious and material general journal entries, posted by a person with a username of ‘guestuser001’. e entries were for donations received, but instead of being debited to bank, the receipt was debited to a suspense account. Upon closer investigation, she determined that payments were subsequently made from the suspense account to an unidenti ed personal bank account. Nomvula decided to ask Kenneth Wiggins about the matter. Kenneth simply responded that Nomvula should keep her nose out of journals she did not understand and reminded her that he, Kenneth, was the reason her contract with Kind Hearts NPC was extended. Nomvula approached the chairman of the board, a non-executive director, for guidance on the matter. However, the chairman seemed fearful and told her that ‘some battles in life are too big for us ordinary people to ght’ and recommended that she turn a blind eye to the problem. Nomvula decided not to approach any other party in the company out of fear that she might be made the scapegoat in the matter, especially since she had no evidence to implicate Kenneth in the fraudulent payments. REQUIRED Discuss the ethical issues, aspects to consider and further actions that Nomvula Phosa could possibly take in terms of Part 2 of the SAICA Code of Professional Conduct. [22] Question 17 LEVEL 2 SAICA Code of Professional Conduct: CAs in practice and in business [10 marks] 1. Paddy Lambkin is a rst-year trainee accountant at Abel & Blom Inc., a rm of chartered accountants and registered auditors. Paddy is a member of the audit team for the audit of the 20X1 nancial statements of Really Big Bank Ltd (RBB), a listed retail bank. During RBB’s 20X1 nancial year (but before the start of the audit testing), Paddy went to an RBB branch and applied for a personal loan. He was granted a R15 000 loan which he used to buy shares in RBB. e RBB staff members who dealt with his loan application were unaware of his involvement with the RBB audit. 2. Henry Pollock is a recently quali ed CA(SA) and works as a business analyst in the group schemes department of Solid Ltd, a life assurance company. He is instructed by a senior manager in the department, Mr Grump, to take R250 000 in cash to the head office of a trade union, and to hand it to the trade union’s general secretary. When Henry musters the courage to ask Mr Grump the reason for the payment, the latter answers as follows: ‘So, little Pollock is now asking questions about things that don’t concern him. Shut up and do as you are told, or you will soon be sitting on a street corner with a placard. is is real-world business, which you don’t know anything about.’ REQUIRED Discuss, with reference to relevant guidance in the SAICA Code of Professional Conduct, threats to compliance with the fundamental principles as outlined in the Code by: 1. Paddy Lambkin (5) 2. Henry Pollock (5) Note: Your answers should include relevant safeguards that should have been implemented to mitigate the relevant threats. [10] Question 18 LEVEL 3 SAICA Code of Professional Conduct and general auditing theory [21 marks] Sweetie Jacobs is the marketing manager at Pratt & Whitney (P&W), a recently formed rm of registered auditors operating from offices in Rondebosch, Cape Town. She recently drafted a letter that she intends sending out to a large number of local businesses. e letter reads as follows: Pratt & Whitney P.O. Box 420 Rondebosch 17 January 20X1 [Name and address of potential client] Dear Sir/Madam We are the new kids on the audit block, formed to serve the southern suburbs of Cape Town (for now – we eventually intend to conquer the world of auditing!). The purpose of this letter is to: inform you of our range of top quality services; if you have dealt with the so-called Big 4 before, we promise you vastly better service than you received from those lumbering dinosaurs (in fact, we think they are on the verge of extinction); invite you to make us your business partner; and guarantee our speedy acceptance of appointment (within 24 hours, as outlined below), should you do the sensible thing and choose us as your auditors (and, hopefully, the provider of further services). All you have to do in order to appoint us as your business partner is to complete the short section towards the end of this letter: no mess, no fuss. But hurry, because we are only able to offer the terms and conditions outlined below for a very limited period. (Another reason not to delay, but to act today is that the rst 20 respondents will receive fantastic braai tongs, equipped with a built-in LED light, so you always have a light handy to check the wors.) Some reasons to choose us: As stated above, we are good. In fact, we are more than good: we are (to borrow a line from Tina Turner) simply the best! We are quali ed to perform audits of companies (large, small or anywhere in between) as required by the Companies Act 71 of 2008. But here’s the really good part: our auditing methodology is designed to minimise disruption to your business activities. How do we do this? It’s very simple: being an up-to-date rm, we do controls testing only, which is much more ef cient than the substantive testing methodology used by other rms. Our methodology also ensures the detection of fraud. And, should our testing procedures cause you any degree of inconvenience, we would be happy to modify them to better suit you: no arguments. We are the exible rm, always willing to bend over backwards for you. We pass the savings of our ef cient controls testing methodology on to you, so we will quote you an audit fee at least 15% lower than what you paid for your last audit. Our audit can be extended to include a range of other services, as listed below. It would be sensible for you also to engage us to provide all of these other services, as we reduce our audit fee by 5% for each additional service that you ask us to perform. Do the sums: if you tick all the ‘Yes’ boxes below, you can save a further 20% on our already low audit fees! And there is nothing untoward about this fantastic discount. We can offer it because, if, for example, our tax staff does your tax compliance work, the audit staff will know it’s spot-on, and can then cut back on the related audit work. If you have had a fall-out with your present auditor, partner with us instead. We promise to assist you, not ght with you. After all, you pay your auditor good money, and in return deserve the best service. And don’t just take our word for this: have a look at what one of our many satis ed clients has to say about us: I can’t tell you how much I have enjoyed dealing with Pratt & Whitney. Our previous auditors were expensive, and they found fault with just about everything we did. Pratt & Whitney is so much nicer to deal with: they’re much cheaper, and they hardly bother us at all. And, most importantly, they give us exactly what we want, a clean audit report! For you to complete Indicate which of the following service(s) you require in addition to an external audit (and remember: the more you tick, the more you save!): YES Management consulting Accounting Internal auditing Tax compliance NO Your name: Your email address: We will email you a letter of client acceptance within 24 hours of receipt of the above, and that will serve as a binding contract between ourselves and your company. That’s how easy we make it for you! We look forward to doing business with you, and knocking your socks off. Regards, Pratt & Whitney REQUIRED Guided by the SAICA’s Code of Professional Conduct and general auditing theory, comment critically on the draft letter. [21] 1 2 3 4 5 6 7 8 9 10 11 12 First point of framework. Last section of text highlighted in paragraph 1. First point of framework. Second point of framework. Third point of framework. First point of framework. Second point of framework. Third point of framework. Last section of text highlighted in paragraph 2. First point of framework. Second point of framework. Third point of framework. INTRODUCTION e legal responsibilities of, as well as the requirements to be met by, an auditor are governed by, among other things, the Companies Act 71 of 2008, the Auditing Profession Act 26 of 2005 (APA), and the King IV Report on Corporate Governance™ for South Africa 2016.1 e following types of application questions can typically be asked regarding compliance with the Acts and the King IV™ report: Discuss whether an incident constitutes a speci c event or would give rise to a speci c liability in terms of an Act. Discuss the non-compliance of an auditor, a company, a committee or the directors in terms of an Act or the King IV™ report. Evaluate the conduct of an auditor, a company, a committee or the directors in terms of an Act or the King IV™ report. EXAMPLE QUESTION Auditing Profession Act 26 of 2005: Reportable irregularity [17 marks] You are a director at AuditCorp Inc., which has recently been appointed as auditors of Distron (Pty) Ltd (Distron), a cold beverage wholesale supplier servicing the Gauteng area. You were appointed as the designated auditor. Distron buys its products directly from various beverage manufacturers, and then resells them to independent shops and retail chains. Distron currently owns a eet of 12 delivery vehicles, with which it makes its deliveries to its customers. During your review of the audit le, you could nd no substantive documentation for an amount of R123 456 claimed as a deduction when the second provisional tax return was completed by the nancial manager and signed off by the nancial director, Mrs Botha. Further investigations revealed that this amount was the total of all traffic nes issued during the nancial year to the company’s delivery vehicle drivers. Subsequently, you set up a meeting with Mrs Botha and were stunned by her response: she was of the opinion that traffic nes received by delivery vehicle drivers for speeding, illegal parking and so on could be claimed as a deduction from taxable income. She reasoned that the nes had been issued in the production of income. She argued that the faster the deliveries were made, the more pro table the company would be. Mrs Botha insisted that these deductions be made, as the South African Revenue Service would not pick them up. REQUIRED 1. Discuss whether Mrs Botha’s treatment of the traffic nes constitutes a reportable irregularity in terms of the Auditing Profession Act 26 of 2005. (11) 2. Describe the actions that you should take in terms of the Auditing Profession Act 26 of 2005, if you have concluded that Mrs Botha’s treatment of the traffic nes constitutes a reportable irregularity. (6) [17] GUIDANCE Understand the question 1. Discuss whether2 Mrs Botha’s treatment of the traffic nes constitutes a reportable irregularity3 in terms of the Auditing Profession Act 26 of 2005.4 (11) 5 2. Describe the actions that you should take in terms of the Auditing Profession Act 26 of 2005,6 if you have concluded that Mrs Botha’s treatment of the traffic nes constitutes a reportable irregularity. (6) Identify the theory applicable to the question In order to answer the above question, you need to be familiar with the Auditing Profession Act 26 of 2005, or you will not be able to list the criteria against which Mrs Botha’s conduct will have to be measured when deciding whether or not it is a reportable irregularity. You will also not be able to describe the actions you should take as required in part B. Read the question You are a director at AuditCorp Inc., which has recently been appointed as auditors of Distron (Pty) Ltd (Distron), a cold beverage wholesale supplier servicing the Gauteng area. You were appointed as the designated auditor.7 Distron buys its products directly from various beverage manufacturers, and then resells them to independent shops and retail chains. Distron currently owns a eet of 12 delivery vehicles, with which it makes its deliveries to its customers. During your review of the audit le, you could nd no substantive documentation for an amount of R123 456 claimed as a deduction when the second provisional tax return was completed by the nancial manager and signed off by the nancial director, Mrs Botha.8 Further investigations revealed that this amount was the total of all traffic nes issued during the nancial year to the company’s delivery vehicle drivers. Subsequently, you set up a meeting with Mrs Botha and were stunned by her response: she was of the opinion that traffic nes received by delivery vehicle drivers for speeding, illegal parking and so on could be claimed as a deduction from taxable income.9 She reasoned that the nes had been issued in the production of income. She argued that the faster the deliveries were made, the more pro table the company would be. Mrs Botha insisted that these deductions be made,10 as the South African Revenue Service would not pick them up.11 Exam technique Remember: you need to follow a speci c approach if you are required to describe, or comment on, requirements set out in: Acts, such as the Auditing Profession Act 26 of 2005 and the Companies Act 71 of 2008 the King IV Report on Corporate Governance™ for South Africa 2016. You need to: identify the relevant issue in the Acts and/or the King IV™ code state the relevant theory as stated in the Acts and/or the King IV™ code apply the information in the scenario to the relevant stated theory. If you are asked to comment on the non-compliance in terms of an Act or the King IV™ code, that is exactly what you will deal with: non-compliance. However, if you are asked to evaluate or assess the information in terms of an Act or the King IV™ code, you must include in your answer the instances of both compliance and non-compliance. Remember also to conclude on the compliance and the non-compliance. SUGGESTED SOLUTION 1. ere is an issue that relates to incorrect tax practices, which could possibly prove to be a reportable irregularity.12 a) It must be in the capacity of the auditor of the company. (eory) (1) You were appointed as the designated auditor of Distron. (Application) AND b) An unlawful act or omission must have taken place. (eory) (1) (1) Provisional tax returns were unlawfully completed owing to the deduction of traffic nes from taxable income. (Application) (1) AND c) e unlawful act or omission must be committed by a person responsible for the management of the company. (eory) (1) Mrs Botha was responsible for, and/or fully aware of, the deduction of the traffic (Application) nes from taxable income. (1) AND d) e unlawful act or omission has caused, or is likely to cause, material nancial loss to the entity or to a partner, member, shareholder, creditor or investor of the entity in respect of his/her dealings with that entity. (eory) (1) i) Fines and penalties can be imposed by the South African Revenue Service and Distron will suffer nancial loss. (Application) (1) ii) If returns go through the way they were completed, the South African Revenue Service will suffer a loss, as Distron will pay less tax than that to which the South African Revenue Service is entitled. (Application) (1) OR e) e unlawful act or omission is fraudulent or amounts to theft. (eory) (1) e submission of these falsi ed tax returns might constitute fraud. (Application) (1) OR f ) e unlawful act or omission represents a material breach of any duciary duties. (eory) (1) e submission of falsi ed tax returns represents a material breach of the nancial director’s duciary duty, as it is not in the best interests of the company. (Application) erefore, based on the above, Mrs Botha’s treatment of the traffic nes constitutes (1) a reportable irregularity in terms of the Auditing Profession Act 26 of 2005 (Decision/Conclusion). (1) Available marks [14]; maximum marks [11] 2. eory stated in the Auditing Profession Act 26 of 2005 a) As per section 45 of the Auditing Profession Act 26 of 2005, the existence of a reportable irregularity must be reported to the IRBA without delay. (1) b) Management of Distron must be noti ed (in writing) of the report to the IRBA within three days of the auditor sending the rst report to the IRBA. (1) c) e auditor must, as soon as reasonably possible, but no later than 30 days from the date on which the rst report was sent to the IRBA: (1) i) take all reasonable steps to discuss the report with the management of Distron; ii) afford the members of the management board of Distron an opportunity to (1) make representations in respect of the report; and (1) iii) send a second report to the IRBA stating that: no reportable irregularity has taken, or is taking, place; or (1) the suspected reportable irregularity is no longer taking place, and that adequate steps have been taken for the prevention or recovery of any loss as a result thereof, if relevant; or (1) the reportable irregularity is continuing. (1) Available marks [8]; maximum marks [6] QUESTIONS Question 1 LEVEL 1 Auditing Profession Act 26 of 2005: Reportable irregularity [8 marks] Section 45 of the Auditing Profession Act 26 of 2005 imposes an obligation on registered auditors to report a reportable irregularity to the IRBA if certain requirements are met. REQUIRED List and brie y explain the elements that constitute a reportable irregularity. [8] Question 2 LEVEL 1 Auditing Profession Act 26 of 2005: Reportable irregularity [6 marks] REQUIRED Brie y outline the process that a registered auditor should follow when he/she is under a duty to report a reportable irregularity in terms of the Auditing Profession Act 26 of 2005. [6] Question 3 2 LEVEL 1/ Auditing Profession Act 26 of 2005: Registration as auditor, duties of auditor [14 marks] e three individuals below would like to register with the IRBA. ey are not sure what the requirements are and have asked for your assistance: Franc Massri is a quali ed CA(SA). He has been vigilant in keeping up with his continuous professional development requirements as set out by SAICA. He received his South African citizenship ve years ago and has been working at an auditing rm for the past three years. Jakky Chiang is a South African citizen. He was released from prison in 20X1, after having been sentenced, without the option of a ne, to 25 years in prison for the forging of salary cheques at his previous place of employment. While in jail, he realised his mistake and decided to become an auditor in order to catch fraudsters. He was released on early parole owing to good behaviour and began studying immediately after his release. He is ready to write his professional exams and start his training at an audit rm. Grant orn is a well-known and respected accountant in Johannesburg. He complies with all the SAICA continuous professional development requirements as well as those of the IRBA. He is still waiting for his South African citizenship to be approved, as he is originally from the UK. REQUIRED 1. Discuss each person’s eligibility to be registered as an auditor in terms of the Auditing Profession Act 26 of 2005. Motivate your answer. (9) 2. List the criteria with which an appointed auditor of a company must be satis ed, according to section 44 of the Auditing Profession Act 26 of 2005, before expressing an unquali ed opinion on a company’s nancial statements. (5) [14] Question 4 LEVEL 2 Auditing Profession Act 26 of 2005: Reportable irregularity [13 marks] Mr Murray is the partner in charge of the 20X1 audit of Mega Ltd (Mega). During the course of its 20X1 nancial year, Mega purchased a much smaller company, Micro (Pty) Ltd (Micro). One evening, while the Mega audit was in progress, three staff members of Micro came to Mr Murray’s house. ey showed him convincing-looking documents that indicated that, shortly after Mega took over Micro, an executive director of the former company, a Mr Retief, instructed Micro’s accounts payable clerks to delete from Micro’s records a large number of entries for deliveries received by the company before the takeover. He instructed them to do so because: he hoped that some of the suppliers concerned would not have any record of having made the relevant deliveries to Micro; and he wanted to create discrepancies between Micro’s records and the relevant suppliers’ statements in order to delay having to pay them. REQUIRED Given the above information, discuss whether Mr Murray has a reporting responsibility in terms of the Auditing Profession Act 26 of 2005. Motivate your answer. [13] Question 5 LEVEL 2 Auditing Profession Act 26 of 2005: Reportable irregularity [11 marks] Kelly Auditors Inc. (Kelly) have been the external auditors of the Multicor group for the past four years. Kelly is the external auditors of all the subsidiaries in the group and the audit team is currently busy with the audit of Wonder Ltd (Wonder), one of Multicor’s subsidiaries, for the nancial year ended 31 May 20X1. During the inspection of the minutes of directors meetings, the following information was obtained regarding the remuneration of Wonder’s board of directors and management. e company has six executive directors and one independent non-executive director. e directors had not been satis ed with their current remuneration, as due to the everincreasing cost of living in South Africa, they felt that it had become difficult to maintain their lifestyles. ey had therefore taken it upon themselves to approve a new directors’ remuneration policy. is policy had been developed during the current nancial year by the company’s chief nancial officer, who is also a director, but it had not been approved by the shareholders. e directors of Wonder do not wish to disclose any remuneration in the annual nancial statements of either Wonder or the group. ey are willing to disclose only their basic salary. REQUIRED Discuss whether the lack of approval and disclosure of the directors’ remuneration will constitute a reportable irregularity in terms of the Auditing Profession Act 26 of 2005. [11] Question 6 Auditing Profession Act 26 of 2005: Legal liability [9 marks] LEVEL 2 Mr John Cowboy is a CA(SA) and a registered auditor. In his role as audit partner at John Cowboy Inc., he issued an unmodi ed audit opinion on the nancial statements of Dicey Rock (Pty) Ltd (Dicey) that re ected that the company had a positive nancial outlook, and would be a going concern for the foreseeable future. e audit work performed, however, did not support this statement. e unmodi ed report was issued, despite Mr Cowboy being aware of the fact that Dicey was under severe nancial pressure at year-end. Mr Cowboy was also aware that a nancial company, Capital Ltd (Capital), would rely on the audit report in deciding whether or not to provide Dicey with nancial assistance in the form of a loan. e granting of the loan by Capital was speci cally dependent on Dicey’s latest audited nancial statements, providing assurance that Dicey would be able to operate as a going concern for the foreseeable future. Mr Cowboy was aware that the potential loan from Capital would bring some short-term cash ow relief to Dicey, but that this would be insufficient to restore nancial stability. Based on Mr Cowboy’s audit report, Capital granted the loan to Dicey, as Capital expected the company to be more than capable of servicing the loan repayments. A few months after the loan had been granted, Capital realised that Dicey was not in a position to make the contractual loan repayments. Upon subsequent enquiry, they discovered that Capital had used the loan money to pay administrative expenses, including salaries. REQUIRED Discuss whether Mr John Cowboy will be held liable for the loss suffered by Capital in terms of the Auditing Profession Act 26 of 2005. [9] Question 7 LEVEL 1 King IV™ report [13 marks] You have recently been appointed as an audit manager at the audit rm of General Practitioners of Excellence Inc., which has entrusted you with the audit of Goodies Ltd, a company that was incorporated by its chief executive officer, Mike Goods. Goodies Ltd manufactures and sells ceramic teapots, and was listed on the JSE in 2000. Mike Goods has heard about the importance of the King IV Report on Corporate Governance™ for South Africa 2016 and the so-called ‘combined assurance model’. He feels, however, that King IV™ is not applicable to Goodies Ltd, as the external auditor and the internal audit department work independently with different agendas and goals. REQUIRED Write a letter to Mike Goods in which you explain the applicability of the King IV™ report to the company and describe the concept of and responsibility for combined assurance. [13] Question 8 LEVEL 2 King IV™ code [10 marks] You are a rst-year audit trainee allocated to the statutory aspect of the audit of Kilimanjaro Ltd (KLM). Client: KLM Year-end: 30 June 20X1 Prepared by: A. Trainee Preparation date: 20 July 20X1 Reviewed by: S. Supervisor Review date: 24 July 20X1 X1 Subject: Statutory matters e company secretary provided the following schedule to the board of directors and the risk committee: Board of directors D. Masha – executive director and chairperson A. Anker – chief executive officer (CEO) S. Sighn – marketing director (an executive director) M. Makas – human resources director (an executive director) G. Jones – information technology (IT) director (an executive director) E. Weinstein – risk director (an executive director) W. Derksen CA(SA) – independent non-executive director e position of nancial director has been vacant for nine months after the previous director’s resignation. e CEO, A. Anker, is in the process of interviewing candidates and he will, in due course, appoint the new nancial director. Even though there is only one independent non-executive director in the board, the directors and shareholders are satis ed that the number of directors per company is sufficient and they are not prepared to appoint additional directors. Risk committee D. Masha (chairperson of the risk committee) E. Weinstein W. Derksen e nomination committee has recently been dissolved as the CEO believes he and M. Makas have the ability to handle the appointment process on their own. REQUIRED Brie y describe any concerns that you have regarding the composition and appointments of the board of directors and risk committee. For each concern, provide a recommendation(s) and/or requirement(s) of the King IV™ code and report. Present your answer as follows: Concerns (1 mark each) Recommendations and/or requirements of King IV™ code and report (1 mark each) Communication skills – logical argument, layout and structure (2) (8) [10] Question 9 LEVEL 2 King IV™ report [21 marks] e following information relating to the board of directors of Paino and Later Ltd (P&L) has been presented to you during an audit. You have been assigned the responsibility of investigating compliance with the King IV Report on Corporate Governance™ for South Africa 2016 (King IV™). e company is listed on the JSE. DIRECTOR NAME TITLE/POSITION HELD IN COMPANY INVOLVEMENT IN THE AUDIT COMMITTEE Al Paccino Chairperson and CEO Audit committee chairperson Joe Tick Inc. Secretary and auditors D. Preston Not in the employ of P&L. D. Preston was, however, the CEO up until one year ago, when Al Paccino was appointed as CEO. Audit committee member Joe Marciano – PhD Maths Risk director Audit committee member DIRECTOR NAME TITLE/POSITION HELD IN COMPANY R. Balboa Not in the employ of P&L. He owns 2% of P&L’s shares. This is, however, immaterial to his personal wealth. J. Acker CA(SA) Financial director B. Acker Self-employed. B. Acker is one of P&L’s signi cant suppliers. J. Bolt – MSc Production director M. Advert Marketing director INVOLVEMENT IN THE AUDIT COMMITTEE Audit committee member REQUIRED 1. Classify the directors of Paino and Later Ltd as executive or non-executive in terms of the King IV™ report. Also classify the non-executive directors as independent or not independent in terms of the King IV™ report. Your answer should be presented in the following tabular form: (12) DIRECTOR NAME TITLE/POSITION HELD IN COMPANY INVOLVEMENT IN THE AUDIT COMMITTEE Al Paccino Chairperson and CEO Audit committee chairperson Joe Tick Inc. Secretary and auditors D. Preston Not in the employ of P&L Audit committee member Joe Marciano – PhD Maths Risk director Audit committee member R. Balboa Not in the employ of P&L J. Acker CA(SA) Financial director B. Acker Self-employed J. Bolt – MSc Production director M. Advert Marketing director Audit committee member EXECUTIVE/NONEXECUTIVE MEMBER OF THE BOARD, PLUS MOTIVATION INDEPENDENT/NONINDEPENDENT, PLUS MOTIVATION 2. Discuss any instances of non-compliance with the King IV™ report, speci cally with reference to the composition of the board of directors and the audit committee. e role of the chairperson of the board as well as the CEO should be included in your answer. (9) [21] Question 10 LEVEL 2 King IV™ report [20 marks] You are the audit manager at the audit rm Go ProAudits Inc. (Go ProAudits). Your rm was recently appointed as the external auditors of Pen ’n Pencil Ltd (Pen ’n Pencil) based on the recommendation of the board of directors. Management was very helpful during the planning stage of the audit and assisted in providing the following background information to the senior trainee accountant on the audit team: Background of the entity’s management Pen ’n Pencil is a wholesaler of stationary with 30 branches throughout southern Africa. e entity listed on the JSE in 2010 and has been pro table since its incorporation in 1980. e board declares full compliance with King IV™ in its annual reports. e board consists of the following individuals with their different roles: Ms Danielle Copper – chairperson of the board Mr abo Mofokeng – serves on the audit committee Ms Fatima Naidoo – chief nancial officer (CFO) Ms Marie Swanepoel – serves on the audit committee Mr Siphiwe Makuma – chief executive officer Mr Yusuf Wascowitz – managing director Ms Danielle Copper and Mr Siphiwe Makuma were the founders of Pen ’n Pencil. Both of them separately owned 50% of the entity’s shareholding at inception, but their shareholding has decreased – since the date of listing, they have owned only 7.5% each. Ms Copper is seen as the best candidate to oversee matters in the company due to her involvement in the incorporation. Mr Makuma was appointed as chief executive officer for the same reason. e shareholders at the time therefore elected both of them to their respective positions on the board of directors in 2010. Mr abo Mofokeng is an independent director of Pen ’n Pencil with an extensive background in retail stores. Pen ’n Pencil therefore appreciates his willingness to assist in the day-to-day operation of the entity. Ms Fatima Naidoo has a background in psychology, but is currently studying towards becoming a chartered accountant. She has been in a managerial position at Pen ’n Pencil for the past ve years, and was promoted to CFO after the resignation of the previous CFO. As Pen ’n Pencil aims to maintain a high level of quali cation, Ms Naidoo was requested to further her studies in accounting. Ms Marie Swanepoel is a stay-at-home mom, and also the sister-in-law of Ms Copper. Ms Copper requested Ms Swanepoel to assist on the board in order for them to increase the board’s independence. e compensation of the directors is determined by Ms Copper and is as follows: Executive fees: R1 million per annum Non-executive fees: R500 000 per annum e directors’ fees are appropriately disclosed in the nancial statements by the accounting function, which is responsible for the preparation of the nancial statements. REQUIRED Discuss the corporate governance concerns based on the King IV™ report. Notes: e required asks for concerns based on the King IV™ report. erefore you will only deal with instances of non-compliance in your answer and you will not include a conclusion in your answer. You need to state the relevant King IV™ requirements (theory) in your answer and have to apply the information in the case study to the stated King IV™ requirements (application). Your answer must clearly link the theory to the application. One way of presenting this type of answer is to do it in tabular format, with the theory in the rst column and the application in the second column. When looking at the mark allocation, 20 marks constitutes 10 relevant King IV™ requirements marks and 10 properly applied application marks. SUGGESTED SOLUTION TO QUESTION 10 1. 2. 3. 4. 5. The chairperson of the board is not a non-executive director who is independent, as required by the King IV™ report. (1) Ms Danielle Copper owns a 7.5% share in Pen ’n Pencil, which is material to her personal wealth, and will not be seen as independent. (1) The company should appoint a lead independent member to strengthen the independence of the board. (1) There is no indication of a lead independent board member. (1) The chairperson of the board as well as the CEO should be appointed by the board of directors. (1) It is a concern that the chairperson of the board was elected by the shareholders and not by the board of directors in terms of the King IV™ report. (1) The CEO was also appointed by the shareholders and not by the board of directors, as required by the King IV™ report. (1) The majority of the board members are not non-executive directors. (1) Mr Mofokeng assists with the day-to-day activities of Pen ’n Pencil, and therefore cannot be seen as non-executive. (1) Four of Pen ’n Pencil’s six directors are executive directors (only Ms Copper and Ms Swanepoel are non-executive), and therefore the entity does not adhere to this principle. (1) The majority of these non-executive directors are not independent, as required by the King IV™ report. (1) Neither Ms Copper nor Ms Swanepoel is independent. Ms Swanepoel is remunerated based on the performance of the company and therefore cannot be seen as independent. 6. (Refer to point 1 for the discussion of Ms Copper’s independence.) (1) There should be an effective and independent audit committee. All the (1) members of the committee should be independent and it should be chaired by an independent, non-executive director. The committee should comprise at least three independent, non-executive directors. 7. 8. 9. Only Mr Mofokeng and Ms Swanepoel serve on the audit committee (only two directors). (1) Mr Mofokeng is involved in the day-to-day operations of Pen ’n Pencil, which means he is an executive director (mark awarded in point 4). (1) Ms Swanepoel is remunerated based on the performance of the company and therefore cannot be seen as independent (mark awarded in point 5). She serves on the audit committee. (1) The members of the audit committee as a whole should have the necessary nancial literacy, skills and experience to execute their duties effectively. (1) Ms Swanepoel is a stay-at-home mom and there is no indication that she has nancial literacy, skills and experience. There is also no indication whether Mr Mofokeng has the relevant nancial literacy, skills and experience. (1) Pen ’n Pencil does not have the following required minimum committees according to the King IV™ report: Risk committee Nomination committee Remuneration committee Social and ethics committee (1) (1) (1) (1) The number of breaches of the governance principles in King IV™ detailed above indicates the following: The company either does not have a company secretary or the incumbent is ineffectual. The board does not meet their responsibility for compliance governance as required by King IV™. (1) (1) (1) Available marks [25]; maximum marks [20] Question 11 LEVEL 2 King IV™ report [25 marks] Bookings-R-Us Ltd (BRU) is a travel agent in the South African tourism industry. BRU is listed on the JSE. e board of directors is well aware of the fact that good governance in terms of King IV™ is compulsory for companies listed on the JSE and, as such, has requested your review of the information provided below. e audit committee (sub-committee of the board of directors) e audit committee met on 5 March 20X1 for their annual meeting. e audit committee consists of four members and therefore exceeds the requirement set by King IV™ to have a minimum of three members. e members of the committee are as follows: Mrs Gold – chairman of the board, chairman of the audit committee, chief executive officer (CEO) Mr Black – marketing director (executive director) Mr Green – human resources director (executive director) Mr Red – CA(SA) (independent non-executive director) Mr Red quali ed as a chartered accountant after he nished his training contract seven years ago. However, he then decided to follow his passion of becoming a professional singer. He never kept up to date with the latest changes in the auditing/accounting profession while pursuing his passion as he was not planning on returning to the profession. e following memorandum was presented and discussed at the meeting on the 5 March 20X1: Memorandum To: The audit committee members From: Mrs Gold (on behalf of the board of directors) RE: Functions of the audit committee Dear Member Please take note of the following additional functions required from the audit committee in assisting the board of directors to be effective and ef cient: 1. Assisting the nominations committee in future with the appointment of a company secretary 2. Appointing or renewing the appointment of the external auditors 3. Investigating suspected instances of fraud during the weekly wage pay-out to the workforce 4. Conducting the audit of the interim nancial results REQUIRED Highlight all instances of non-compliance with King IV™ and make recommendations as to how BRU can become compliant with the requirements. [25] Question 12 LEVEL 1 King IV™ report and Companies Act 71 of 2008 [18 marks] Per the King IV Report on Corporate Governance™ for South Africa 2016 (King IV™), a company’s audit committee is supposed to, inter alia, oversee both its external and internal auditors. REQUIRED 1. Answer yes or no. In terms of the Companies Act 71 of 2008, it is compulsory for the following companies to have an audit committee: a) Public companies (1) b) State-owned companies (1) c) Private companies, in the case where the memorandum of incorporation indicates that the company should have an audit committee (1) 2. What are the duties of the audit committee in terms of the Companies Act 71 of 2008? (15) [18] Question 13 LEVEL 2 Companies Act 71 of 2008 [10 marks] As the senior manager in the technical department of the audit rm of Matthews & Mbowene Inc. with expertise in aspects of the Companies Act 71 of 2008, you have received a query from one of your colleagues and an email from another. You need to respond to these queries separately. 1. During the course of a conversation with Meisie Smith, one of the audit seniors at the audit rm, regarding a prospective client, Trophy (Pty) Ltd, a company that performs all types of engraving, especially that of trophies, she told you the following: I have a potential client, Trophy (Pty) Ltd, who approached us to serve as the company secretary. I obtained Trophy (Pty) Ltd’s memorandum of incorporation (MOI), and there is something that is bothering me. e company’s MOI only indicates that the company is prohibited from offering its securities to the public. Am I correct in saying that the company will be seen to be incorporated as a private company in terms of the Companies Act 71 of 2008? 2. You have received the following email from a colleague: From: gift@mm.co.za To: you@mm.co.za Date: 20X1/07/08 8:15am Subject: Companies Act Query Good morning, Colleague, I have a potential audit client, Seals (Pty) Ltd, who is the sole provider of printed degree certi cates in South Africa. Even though they are registered as a private company, they need to know whether or not they need to be audited according to the new Companies Act. They have provided me with the following information for the nancial year ended 30 June 20X1: Number of certi cates printed during the year under review Cost price per certi cate Sales price per certi cate Average number of employees Total creditors Number of shareholders 40 million R5 R7 40 R20 million 20 Do they need to be audited according to the new Companies Act? Gift Sisulu CA(SA) REQUIRED Address each of your colleague’s queries separately. Mark allocation 1. (4) 2. (6) [10] Question 14 LEVEL 2 Companies Act 71 of 2008 [10 marks] As a member of the audit team of Cheesy Ltd (Cheesy), which manufactures and sells dairy products, you have been assigned to the audit of statutory matters and, as part of your procedures, have extracted some information pertinent to your audit. Group structure Cheesy Ltd owns 80% of the shares in Boxes Ltd, a company responsible for marketing the products of Cheesy Ltd. e other 20% of shares are held by independent shareholders. Directors of Cheesy Ltd Fi Frame Shervani Govender Apple Cruise CA(SA) Directors of Boxes Ltd Fi Frame Apple Cruise CA(SA) Joe Slow Boxes Ltd (Boxes) had to appoint a new auditor during the last annual general meeting, but the shareholders could not come to an agreement as to who the new auditor should be. erefore, they gave the directors authorisation to make an appointment. Listed below are the candidates they are currently considering: Giddy Fellows (Pty) Ltd, a new dynamic rm in the city whose shareholders are Franc Giddy CA(SA), Mary McTree CA(SA) and abo Mzini (BCom) Apple Cruise CA(SA) Badrep, a rm of registered auditors involved since its inception in the supply of secretarial services to the company Brainwaves Inc., a large international rm of registered auditors REQUIRED Discuss the eligibility of the four entities or individuals listed above for the appointment as the auditor of Boxes Ltd in terms of the Companies Act 71 of 2008. [10] Question 15 Companies Act 71 of 2008 and King IV™ report [16 marks] LEVEL 2/3 Wellworthit Ltd (WWI) is one of the top 100 companies listed on the JSE. Its business involves retailing of clothing, food products, groceries and home products to upper- and middle-income customers, and it has operations in South Africa, Namibia, Botswana, Australia and New Zealand. WWI also has an interest in Wellworthit Financial Services (Pty) Ltd, which provides nancial services such as personal loans. At WWI’s nancial year-end (30 September 20X1), WWI’s board consisted of: Mr Archibald – chairperson of the board; non-executive director Mr Brooks – independent non-executive director Ms Calvin – independent non-executive director Mr Du Toit – non-executive director Mr Els – non-executive director Mr Franken – executive director; chief executive officer Mr Goodes – executive director; chief operating officer Ms Hamilton – executive director; head of corporate affairs At 30 September 20X1, the company had the following board committees: Audit, risk and compliance committee members Mr Brooks – committee chairperson Ms Calvin Mr Franken is committee met once during the 20X1 nancial year. Nominations committee members Mr Archibald – committee chairperson Mr Brooks Ms Calvin e nominations committee did not meet during the 20X1 nancial year. Per WWI’s annual report, this committee ‘meets when required, and it was decided that it was unnecessary to have a meeting during the reporting period’. Remuneration committee members Mr Archibald – committee chairperson Mr Isner – WWI’s chief nancial officer Ms Jordan – an executive remuneration consultant who is not a full-time employee of WWI e remuneration committee decides on the remuneration of executive directors. All nonexecutive directors are remunerated with a meeting attendance fee of R20 000 per board meeting and R15 000 per committee meeting. e company also has a social and ethics committee, which it is required to have in terms of the regulations to the Companies Act of 2008. e social and ethics committee members at year-end: Mr Goodes Ms Hamilton Mr Keyser – WWI’s head of compliance management During the year, two independent, non-executive directors resigned from the board. e rst was Mr Langeveld, who did so after it became known that he had been listed in the Companies and Intellectual Properties Commission’s (CIPC’s) register of delinquent directors before he was appointed. WWI’s annual report stated that Mr Langeveld resigned during the reporting period, but did not provide a reason for his resignation. e other director who resigned was Mr Mlambo. WWI made a statement that the reason for his resignation was ‘to free up time to pursue other interests’. is statement was repeated in the annual report. e Black Management Forum issued a statement that accused WWI’s board, and the chairperson of the board in particular, of having been disrespectful towards Mr Mlambo, and called for a boycott of WWI. e company did not respond to the Black Management Forum’s statement. Both Mr Langeveld and Mr Mlambo served on WWI’s audit committee before they resigned as board members. REQUIRED Discuss the governance practices at Wellworthit that you regard as being problematic/unacceptable, given relevant guidance in the King IV™ report and the Companies Act 71 of 2008. [16] Question 16 LEVEL 2/3 Companies Act 71 of 2008 and Auditing Profession Act 26 of 2005: Reportable irregularity [24 marks] Colorz Ltd (Colorz) manufactures ink cartridges for laser jet printers. Colorz has a 28 February 20X1 nancial year-end. e company has been in operation for 20 years, and has been pro table up until the current nancial year when a major global nancial recession hit. e recession, along with the fact that an increasing number of individuals and companies are ‘going green’, has caused a massive decline in pro tability. Mrs Pink, the nancial director and a nancial accountant, provided you with the following extract from the statement of nancial position as at year-end: ACCOUNTS 29 FEB 20X1 (R’000) Inventory R59 157 Debtors R45 178 Non-current assets R125 689 Overdraft R55 431 Creditors R45 682 Non-current liabilities R85 479 During the 20X1 nancial year, Mrs Pink approved a loan to the executive director, Mr Green, to enable him to partake in a new business venture. Mrs Pink approved the loan on 15 April 20X10 without consultation with Ms Yellow (chief risk officer) or Mr Blue (human resources director) as, in Mrs Pink’s opinion, ‘they have limited nancial knowledge’. e loan amounted to R6 million, and is repayable at the end of March 20X1, as this is the month when directors are awarded bonuses. e loan does not carry interest. e loan was funded out of the bank overdraft and Mrs Pink posted the following journal entry in order to record the transaction on 15 April 20X0: Dr Debtors R6 000 000 Cr Non-current liabilities R6 000 000 General journal entry in order to record loan to debtor REQUIRED Note: Ignore any taxation implications. 1. Discuss whether Mrs Pink acted in compliance with section 45 of the Companies Act 71 of 2008. (7) 2. Discuss the effect of your ndings in (1) in terms of section 45 of the Auditing Profession Act 26 of 2005. (17) [24] Question 17 LEVEL 2/3 Companies Act 71 of 2008 and King IV™ report [28 marks] Diversi ed Ltd (Diversi ed), a large logistics company, was listed on the JSE in 1983. e company has expanded into a number of sub-Saharan countries: rst, into the countries neighbouring South Africa, and then into West and East Africa. Generally speaking, the expansion process has been a success. Board composition On its 20X1 nancial year-end date, the board of directors of Diversi ed consisted of: Mr Appleton – chairperson and joint chief executive officer (he was the board chairperson before being made joint CEO) Mr Brundyn – joint chief executive officer (he was an executive director, tasked with stakeholder engagement, before being made joint CEO) Ms Carter – chief nancial officer Mr Dube – non-executive director Mr Engels – non-executive director Mr Franks – non-executive director Mr Gordon – independent, non-executive director Ms Hadebe – independent, non-executive director Mr Irish – independent, non-executive director Half-way through the 20X1 nancial year, Mr James, Diversi ed’s CEO at the time, unexpectedly resigned from the position to which he had been appointed two years ago. Later, it became apparent that Mr James had pushed for the board to remove the company’s chief nancial officer, Ms Carter, and then resigned when the board refused to do so. Mr Appleton, a former chairperson of Diversi ed, has been the joint CEO, with Mr Brundyn, since that time. It is not clear how long this joint CEO arrangement will last. Shortly after Mr James’s resignation, Mr Klein, the chief operating officer at the time and an executive director, also resigned. He reportedly left because he had not been appointed chief executive officer. Apparently, the company does not intend appointing a new chief operating officer. Diversi ed’s share price dropped considerably after the above-mentioned events. Committees At the nancial year-end date, Diversi ed had an audit committee and three board committees, which were constituted as follows: Audit committee: Mr Appleton – chairperson Ms Ludd – chief audit executive Mr Gordon Mr Irish Executive committee: Mr Appleton – chairperson Mr Brundyn Ms Carter Four additional senior managers Nomination committee: Mr Appleton – chairperson Mr Engels Ms Hadebe Mr Langa – head of human resources Remuneration committee: Mr Franks – chairperson Mr Irish Mr Langa – head of human resources During the nancial year, the board decided to do away with both the risk committee and the social and ethics committee. e functions of the risk committee were transferred to the audit committee, while the functions of the social and ethics committee were transferred to the executive committee. Loans to board members After the departure of Messrs James and Klein, the company made loans totalling R100 million to Mr Appleton, Mr Brundyn and Ms Carter in order for them to purchase shares in the company. e minutes of a board meeting held on 1 December 20X1 indicated that these loans were approved by Mr Gordon and Mr Hadebe. e minutes of this meeting did not include anything else relating to the approval of these loans. No notice of this meeting was sent out to the directors. All of the directors were present at the board meeting. REQUIRED Discuss any instances of non-compliance with the King IV™ report and the Companies Act 71 of 2008 with reference to the information provided relating to Diversi ed Ltd. You may assume that the Companies Act requirements relating to quorums of meetings have been met. You are not required to address the issuing of shares in your answer. [28] 1 Copyright and trademarks are owned by the Institute of Directors in Southern Africa NPC and all of its rights are reserved. 2 Requires a decision from you = conclusion. 3 Deals specifically with a reportable irregularity. 4 Criteria stated in the Auditing Profession Act. 5 Actions = what you will do. 6 Stated in the APA = theory. 7 First requirement is met: you are the auditor. 8 Financial director = management is aware. 9 Not in terms of the Income Tax Act = unlawful. 10 Not in the company’s best interest. 11 SARS will lose money. 12 This is the issue, but in this case will not earn a mark as it has been given to you in the required. CHAPTER 4 Basic concepts of governance and internal control CHAPTER 5 Introduction to risks and internal controls in a computerised environment CHAPTER 6 Revenue and receipts cycle CHAPTER 7 Purchases and payments cycle CHAPTER 8 Inventory and production cycle CHAPTER 9 Human resources cycle CHAPTER 10 Investment and nancing cycle INTRODUCTION e basic concepts of internal control provide a background to the topics included in the rest of the book. Although these concepts are not usually tested on their own, a thorough understanding of them will enhance your ability to apply them in later chapters. For guidance on the answering of those questions on governance requiring the application of theory, refer to Chapter 3. QUESTIONS Question 1 King IV™ report [16 marks] LEVEL 1 Your audit rm, Excellent Service, appointed as the auditors of Corporate (Pty) Ltd, has received the following document from their new director with regard to uncertainties or questions in terms of the King IV Report on Corporate Governance™ for South Africa 2016 (King IV™ report). Date 4 February 20X1 Attention: Excellent Service audit team Subject: King IV™ report requirements According to the King IV™ report, corporate governance is de ned as the exercise of ethical and effective leadership by the governing body towards the achievement of the following governance outcomes: ethical culture, good performance, effective control and legitimacy. Based on the above statement, I have the following queries with regard to governance and internal control in terms of the King IV™ report: Query 1 Risks are an integral part of any business striving to achieve its objective. What is the de nition of risk according to the King IV™ report? Query 2 The governing body should exercise ongoing oversight of risk management and ensure that particular objectives are achieved. What are the objectives that should be met in terms of the King IV™ report? Query 3 After the process of risk identi cation and risk evaluation, the entity should decide on an appropriate risk response for each of the risks identi ed. What are the different risk responses available to us as an entity? I look forward to your response. Mr A. Hopeful (Director) REQUIRED Assist the director of Corporate (Pty) Ltd with his queries. Mark allocation Query 1 (5) Query 2 (5) Query 3 (6) [16] Question 2 LEVEL 1 Internal control: Fundamentals [19 marks] e International Standard on Auditing (ISA) 315 (Revised), which identi es and assesses the risks of material misstatement through an understanding of the entity and its environment, requires an auditor to understand an entity’s internal control. ISA 315 (Revised) de nes internal control and deals with the different components thereof. REQUIRED 1. De ne internal control. (5) 2. List the components of an entity’s internal control, and give a brief explanation of each component. (14) (Adapted from ACCA Question 2a, 8 December 2011) Question 3 [19] LEVEL 1 Internal control: Fundamentals [15 marks] You were recently appointed as a partner at the audit rm of Tom, Dick and Harry Inc. One of your duties includes a monthly training session with the trainee accountants in order to resolve their uncertainties regarding, among other things, aspects of internal control. In order to identify problem areas, you distributed a questionnaire among the trainee accountants, the results of which revealed that there are reservations about the bene ts to be derived from the implementation of a computerised system, the type of control activities and the inherent limitations of internal control. REQUIRED Prepare a guideline that could be used as a reference tool during the training session, in which you: 1. describe ve potential bene ts identi ed by ISA 315 (Revised) to be derived from the implementation of a computerised system (5) 2. list the different type of control activities (5) 3. list ve inherent limitations on internal control. (5) [15] Question 4 LEVEL 1 Internal control: Control objectives [11 marks] You have recently been employed as the audit manager responsible for resolving technical issues and overseeing trainee accountants completing their studies part-time through Various University. One of your tasks is to assist the trainee accountants in preparing for their upcoming examinations. One of the areas of concern is their understanding of internal control and, more speci cally, the control objectives relating to internal control. You have been tasked with the preparation of a presentation on control objectives in order to answer the following unrelated questions raised by the trainee accountants. REQUIRED 1. List and de ne the generic control objectives that need to be present in all accounting systems. Bearing in mind that the objectives referred to are those of management, and should not be confused with the assertions that management implies in the nancial statements, answer using this tabular format: CONTROL OBJECTIVE GENERIC DEFINITION OR MEANING Notes: Listing the generic control objectives requires the provision of one word only – the control objective. In de ning the listed items, provide a description of each – the generic description for each of the listed control objectives. Whenever (as in this case) you are required to provide an answer in a certain format, use the format throughout your answer. (9) 2. Explain the rst step (one step only) in the design of a system of internal control and the difference between risks and control objectives. (2) [11] SUGGESTED SOLUTION TO QUESTION 4 1. CONTROL OBJECTIVE Validity Completeness Accuracy GENERIC DEFINITION OR MEANING (1) (1) (1) All transactions and events executed: are properly authorised in accordance with management policy; did actually occur during the period; and (1) (1) are supported by sufficient documentation and evidence. (1) All transactions that actually occurred during the period are recorded in a timely manner. No transactions are omitted. (1) (1) All transactions are: recorded at the correct amounts (quantity, prices and calculations); (1) correctly classi ed in terms of the entity’s chart of accounts; and (1) correctly summarised and posted to the entity’s accounting records. (1) Available marks [11]; maximum marks [9] 2. When designing a system of internal control, the rst step is to formulate control objectives (what the entity wants the system to achieve or ensure) for each class of transaction, or part of the accounting system. (1) Risks are things that could go wrong. (1) Control objectives relate to what management wants the system to achieve. (1) Available marks [3]; maximum marks [2] Note: An understanding of the generic meaning of the three control objectives is of utmost importance, as they are the foundation on which entities, business cycles and the accompanying accounting systems are built. Question 5 LEVEL 1 Internal control: Components [10 marks] REQUIRED List and describe brie y the ve components of internal control according to ISA 315 Revised that should be present in every entity’s internal control system. [10] INTRODUCTION e questions in this chapter deal with information technology. QUESTIONS Question 1 LEVEL 2 Multiple choice questions addressing multiple concepts [10 marks] REQUIRED Answer the following multiple choice questions by selecting the appropriate option: 1. Which of the following statements about the control environment is false? Management’s attitude towards internal control and ethical a) behaviour has little impact on employee beliefs or actions. b) An overly complex or unclear organisational structure could be indicative of more serious problems. c) A written policy and procedures manual is an important tool for assigning authority and responsibility in many organisations. d) Supervision is important in organisations that cannot afford elaborate responsibility reporting, or are too small to have an adequate segregation of duties. (1) 2. All things being equal, a) detective controls are superior to preventive controls b) corrective controls are superior to preventive controls c) preventive controls are equally as important as detective controls d) preventive controls are superior to detective controls. (1) 3. In order to achieve an effective segregation of duties, certain functions should be separated. Which of the following is the correct listing of accounting-related functions that should be separated? a) Control, recording and monitoring b) Authorisation, recording and custody c) Control, custody and authorisation d) Monitoring, recording and planning (1) 4. Which of the following is a control procedure relating to both the design and the use of documents and records? a) Locking blank cheques in a drawer b) Reconciling the bank account c) Sequentially pre-numbering sales invoices d) Comparing actual physical quantities to recorded amounts (1) 5. Which of the following is the correct order of action to be taken when one undertakes a risk assessment, in order to implement an effective system of internal control? Identify threats, estimate risk and exposure, identify controls, a) estimate costs and bene ts. Identify controls, estimate risk and exposure, identify threats, b) estimate costs and bene ts. c) Estimate risk and exposure, identify controls, identify threats, estimate costs and bene ts. d) Estimate costs and bene ts, identify threats, identify controls, estimate risk and exposure. (1) 6. Controls designed to ensure that an organisation’s computer-based control environment is stable and well managed are called a) general controls b) applications controls c) detective controls d) preventive controls. (1) 7. All of the following are effective control procedures in order to ensure that operators do not make unauthorised changes to programs and les except for a) rotating duties b) having multiple operators in the computer room during processing c) requiring formal written authorisation and documentation of any program changes d) maintaining and reviewing a log/register of all operator activity and interventions. (1) 8. Password effectiveness is enhanced by all of the following, except a) frequent changes b) user selection of passwords c) not displaying the password on the screen d) automatic disconnection after several unsuccessful attempts. (1) 9. Controls designed to prevent, detect or correct errors in transactions as they ow through the various stages of a speci c data-processing program are referred to as a) general controls b) application controls c) administrative controls d) data-processing controls. (1) 10. e edit check in order to detect the entry of a customer number that does not exist is called a) a check digit b) a limit check c) a sequence check d) a validity check. (1) [10] Question 2 LEVEL 2 Physical access controls [18 marks] You were recently appointed as chief information systems officer (CIO) of Some Nights Ltd (Some Nights), responsible for the information system controls. Some Nights, a subsidiary of the notorious Black Water Group of mercenaries, is used to raise money with which to fund the clandestine activities of the Black Water Group in countries such as Afghanistan and Syria. e company manufactures historic war memorial gurines (the best-selling ones relate to the American Civil War), and has a modern warfare series. e company’s logo is ‘Listen, boy; this is war!’ Some Nights operates from its head office just outside Langley in Virginia, USA. e building also houses the Black Water Group’s offsite back-up facility. Some Nights employees are not aware that a back-up facility is on their premises; they have simply been informed that they are not allowed into Block B, the research and development section of the company. Similarly, the company does not allow wireless technology or internet connections on its premises. e company has a strict ‘no cellphone or tablet’ policy. Each employee in the computer department has a mini computer connected in real time to the mainframe computer located in a room at head office. Computers are connected via a local area network. e computer room contains an applications server, database and a mainframe computer. is network connects with the back-up service contained in Block B. Users can, by logging on to the network, gain access to various application software programs, as well as data les stored on the computer hardware located in the computer room. A general procedure used by Some Nights in order to verify access to the information system is by means of a password linked to a username. e data administrator is responsible for the maintenance of the computerised information collected during investigations. During the year, the company’s head office came under siege when the computer room was attacked by a gang of ve well-armed men. ey breached the building with military precision in under 15 minutes. Unbeknown to the other staff employed by the company, there was also a break-in at Block B. According to the police, another group of thieves (which is suspected to have included company employees) broke into the building and stole one of the servers and a few back-up hard drives. On the way out, they exchanged re with the police. e company has excellent physical access controls for both blocks A and B, as well as logical access controls to the computer information system. All these controls were designed by the company in collaboration with an external computer specialist. You are, therefore, satis ed that they appear sufficient and effective. is was con rmed by one of the thieves wounded in the gun ght with the police before being arrested. He confessed that, before stealing the hardware, they had hacked the system and removed and changed some of the information in order to make it difficult for the Black Water Group to determine which information had been stolen. REQUIRED 1. Describe the physical access controls (over and above those already mentioned in the scenario) that should have been implemented in order to prevent the break-in and to ensure that the back-ups stored in Block B of Some Nights’ premises could be used for authorised purposes only. Your answer must not address logical access controls. (13) 2. Explain how ‘authorisation matrixes’ could have been used in order to ensure that only valid and authorised changes could be made to the information on the computer system, which could have prevented the thieves from removing and changing information stored on the system. (5) [18] SUGGESTED SOLUTION TO QUESTION 2 1. a) ere must be a formal, documented security policy, distributed to all users, that determines that only authorised staff may have access to and utilise the mainframe computer; and that action will be taken in the event of unauthorised use or access. is policy should be communicated to all staff members. (2) e following physical access controls should be in place in Block B and the back-up store: (1) i) Access to the room must be restricted through keys, magnetic card readers or a security guard with a register. (1) ii) A security guard must be present at the entrance in order to accompany visitors through the building. (1) iii) Doors to the venue must always be locked if the computer is not in use as well as when staff leave the computer room. (1) iv) Only authorised users may have access to keys for the room and/or should have proper control over the registration of magnetic cards. (1) v) Additional security gates must be installed at the entrance to the back-up storeroom. (1) vi) An alarm with motion sensors must be installed. (1) vii) e hardware must be locked when it is not in use (e.g. in a server case). (1) viii) ere must be no place for the insertion of such media devices as memory sticks or DVDs. (1) b) e terminal should be located in a highly visible area where it cannot be hidden, so that unauthorised people approaching the servers are visible. (1) c) All staff should have uniforms and identi cation cards in order to be clearly identi able when entering non-public areas, such as the server room. (1) d) Staff should be allowed to use the computer during operating hours only and have to sign in before entering the computer room; otherwise, the area must be locked. Alternatively, a daily work schedule must be prepared. (1) e) Every computer must have a terminal code. (1) f ) Access outside business hours must be managed by the use of: i) alarms ii) security cameras, and/or iii) security guards who supervise the use of computers, and iv) previously received consent. (ma 2) Available marks [17]; maximum marks [13] 2. An access control matrix (programmed authorisation scheme or CRUD matrix) can contribute in the following ways in order to ensure that only valid changes to the information in the system are made: a) By means of a terminal code, only a speci c terminal would (1) be permitted access to the program’s module that makes information changes possible, thereby restricting such changes to a speci c terminal; (1) b) e employment of a log-in system involving user ID authenticated by a password would restrict: (1) i) the access rights each user has to change information on the system (for example, display and write), and (1) ii) the possibility that an unauthorised staff member could make changes to the information on any of the computers, because he/she would then not have the necessary access rights in order to implement such changes. (1) c) Changes in accordance with the allocated authorisation level should only be allowed to be made on a predetermined day of the month. (1) d) Ad hoc changes should require at least two authorising passwords. (1) Available marks [7]; maximum marks [5] Question 3 LEVEL 3 Access controls [16 marks] You were recently appointed as the computer audit specialist at Marki Ltd (Marki). Marki is known for selling speciality dog food from its store and storeroom located in Canal Walk shopping centre. As part of your rst job, you formulated a strict policy around dismissals and resignations of employees, as well as a security policy. e policy requires that staff’s access to the store be revoked on date of dismissal or resignation. It also includes other disciplinary consequences. In order to obtain a better understanding of how the company operates, you documented the following system description: Dog food is displayed in large containers on shelves in the store. Customers can ll 5 kg bags with dog food from these containers. e 5 kg bags are then taken to a till located at the exit of the store, where a cashier weighs the dog food. Marki also has a self-help express counter at the back of the store where customers can pay exclusively by credit card. Customers can use one of four touch screen computers to place orders for pre-priced vacuum-packed 5 kg, 10 kg, 20 kg and 50 kg packets of speciality dog food. Customers can browse through pictures and descriptions of the available dog food on the touch screen and make selections. e touch screen computers are easy to use and have visual prompt navigation and a help function, and therefore training is not required. Customers who want to use the service must rst register on the touch screen as presented below: Email address: Email serves as username. Create a password: Retype password: Strong passwords contain 7–16 characters. Do not include common words or names. Combine upper and lowercase letters, numbers and symbols. Do not disclose your password to anyone. Alternative email address: Security question: Answer to security question: First name: Last Password changes every three months. name: Address: Province: An sms will be sent to your phone con rming your password, with a one-time pin. Recon rmed password must match. Postal code: Telephone number: Enter characters you see: 45dg7$7 Create account: Click to go to next page. As part of the registration process, customers must capture their credit card information (screenshot not provided), which the system automatically veri es with the bank. ereafter, customers receive a unique username and can select their own unique password. In order to purchase dog food, the customer can click on the relevant product displayed on the screen. e dog food is added to the customer’s electronic basket. is is updated to the mainframe computer and server via the local area network. One of three trained shop assistants receives a picking slip printed in the storeroom and brings the ordered dog food to the customer. In addition to the shop assistants, a shift manager is always on duty. e shift manager reviews and investigates all the available logs (including input logs, error reports and access registers) from the touch screen system. ese are reviewed by the shift manager and he investigates and obtains reasons for unusual access. He is speci cally interested in the following: Activity log that records who logged on, when and for how long Exception reports of all unsuccessful or failed attempts to use a username REQUIRED Identify the access controls you would expect to be in place over the touch screen system as a whole. [16] Question 4 LEVEL 2 Application controls [12 marks] Your rm, Du Toit & Mayane Inc., has been the auditors of JBC Ltd, a company retailing earth-moving equipment, for the past four years. Salaries are a material expense at JBC Ltd, representing 35% of the total expenses of the entity. Management has therefore implemented stringent controls in order to prevent any fraud or error in the payroll system. Currently, the payroll system works as follows: 1. All employees are paid by electronic funds transfer (EFT) via the secure bank software application. Julia Ntembe, one of the payroll clerks, is solely responsible for the EFTs to employees. 2. Fatima Naidoo, another payroll clerk, reconciles these payments by downloading and printing the company’s bank statement via the secure bank software application and reconciling this to the payroll register. 3. e nancial manager, Tim Lake, oversees the payroll process. REQUIRED Describe the application controls that you would expect to nd in place in order to prevent and detect unauthorised access to the company’s secure bank software application as well as the printed bank statements. [12] Question 5 LEVEL 2 Business continuity [10 marks] You were recently appointed internal auditor of 221B Baker Street Ltd (221B Baker Street) founded by Mr Sholmes and Dr Watsup. e company is fairly new and the rst of its kind. Mr Sholmes and Dr Watsup operate a detective service and mostly perform background and credit checks on individuals. ey consider themselves to be ‘consultative detectives’. e company prides itself on being the company that the police call when they cannot crack a case. Mr Sholmes is the brains of the operation, while Dr Watsup is considered to be the muscle. Unfortunately, it has been involved in only two cases. Companies who want to make use of 221B Baker Street’s services can contact them via the company’s website. 221B Baker Street operates from its head office in London. It uses a mini-computer system that is connected in real time to the mainframe computer located in a separate room. Computers are connected via a local area network. e computer room contains various servers and a mainframe computer on which all information is stored. During the year, an attempt was made on Mr Sholmes’ life by Dr James Mortuary, renowned thief and criminal mastermind. In addition, an arsonist was hired to burn down the company’s head office. e re was extinguished by the re brigade two days later, after which the power supply to the building was restored. is resulted in signi cant losses for the company. REQUIRED Brie y describe the business continuity controls that 221B Baker Street could have implemented in order to limit the losses experienced as a result of the re. [10] Question 6 LEVEL 2 System development [10 marks] You are an audit manager at Will.I.Am Inc., located in Cape Town, a company appointed as the external auditor of Agent J & K (Pty) Ltd (Agent J & K) after the previous audit partner passed away unexpectedly. Agent J & K retails a famous brand of black suits. It also sells black accessories, such as sunglasses and shoes, as well as white shirts. Agent J & K’s accounting system is fully computerised. It uses a fully integrated system that consists of various components that perform specialist functions, such as purchases, sales, payroll and so on. ese integrate to maintain one general ledger and produce the nancial statements. Although the company has internet access, Agent J & K does not currently have its own website, although it is considering creating one that will be used as a marketing tool for services and to promote any special offers. A couple of years ago, Agent J & K purchased a biometric timesheet recording module that allows employees to record their working hours on a biometric reader using their thumbs. According to the agreement with the vendor who developed the module, the vendor must email a software patch to Agent J & K’s IT administrator when bugs are detected in the software or when the software requires an upgrade. e IT administrator then loads the patch onto the server and updates the software. During the course of the year, a couple of virus scanner updates were not uploaded by the vendor, which resulted in the biometric system being infected by a virus. In the light of other problems experienced during the uploading of similar patches for some of the company’s other software modules, it was suggested that the company implement the necessary internal controls in order to address these risks. A decision was taken to update the company’s IT procedure manual with these controls. e IT administrator tasked with this responsibility has requested your assistance in formulating the controls. e IT procedure manual already contains sufficient internal controls relating to appropriate user training, and the complete and timely uploading of patches. REQUIRED Describe the additional controls that should be documented in the IT procedure manual in order to address appropriately the risks relating to the uploading of software patches. [10] Question 7 LEVEL 3 General controls [16 marks] You were recently hired as a consultant to I[phone] Ltd (I[Phone]). I[phone] was formed by two entrepreneurs from Technopark, the silicon valley of South Africa, and retails I-phones and other cellular technologies. e company records all its transactions in Excel. is was adequate until the company started to grow and expand. e company has made signi cant investment in its infrastructure to keep up with the growth and is considering implementing alternative record-keeping methods. e following two options are being considered: e company uses a new app from a local bank which prepares a company’s accounting records based on the company’s bank statements and cash transactions. e company purchases a new accounting package developed speci cally for the South African small- and medium-enterprise market. e company could purchase this standard package from Pastel Blue™, a software supplier. e company is making a signi cant investment in all its systems. Considering that the company’s accounting records will be available electronically only, management is worried about the impact of loadshedding on its business activities and the associated risk of loss of information. REQUIRED 1. Describe the additional bene ts to a company buying and implementing a new accounting package developed speci cally for the South African small- and medium-enterprise market. (9) 2. Describe the additional continuity controls that I[phone] must implement in order to sufficiently protect the company against the impact of loadshedding on the business. (7) [16] Question 8 LEVEL 2 General controls [11 marks] Staff Force (Pty) Ltd (Staff Force) is a labour hire entity and connects employers with employees. e entity is the largest of its kind in South Africa and has an annual turnover exceeding R1 billion. Approximately 250 transactions ow through the accounting records of the company on a daily basis. e board of directors states compliance with King IV™ in its annual report, and has therefore focused intensively on eliminating any fraud or error in its nancial statements. In order to meet the increasing demands of the accounting division of Staff Force, the board of directors is considering purchasing a new accounting package, Numberz. A sales representative from Numberz highlighted the following details of the Numberz accounting package: It is suitable for all entities, excluding manufacturing entities. It is competitively priced, especially in light of the fact that it can be customised if required by the entity. Numberz has functionalities to address all accounting needs of entities, from recording of transactions to the preparation of nancial statements. Accounting personnel may phone the support line 0760 784 1249, 24 hours a day, 7 days a week, if any assistance with Numberz is required. e support is provided free for ve years after purchase. is is an attempt from Numberz to remain the leading accounting package in the country. Due to the high quality of Numberz, the program needs 40 gigabytes of computer memory per computer, in order to install and run properly. e accounting personnel at Staff Force previously worked on a simple accounting package that was much smaller than the Numberz package. REQUIRED Discuss the issues the board of directors should consider before buying the Numberz accounting package. [11] Question 9 LEVEL 2 General controls [19 marks] You are the computer consultant on the internal audit team of Marry Me, Darling Ltd (Marry Me). e company operates a weddingplanning business in Stellenbosch. e company was started when the owner, Ms Elza Johnson, realised that there was a need for sophisticated, low-cost wedding planners. She noted, however, that cost was not the only driver of market demand: there was also a demand for weddings that could be arranged at short notice. erefore, if she expanded her company, she would have to place greater reliance on the company’s information system. In addition, she realised that the existing mainframe on which her accounting systems operated would not be sufficient and would require frequent program changes. In order to react proactively to the growth of the company, Ms Johnson had two options: 1. Develop a new system. 2. Make regular changes to the existing system. e nancial director responsible for determining the computerisation needs of the company implemented the following process regarding changes to the application software: STEPS IN THE PROCESS STEPS IN THE PROCESS Requirements Program change requirements must be communicated to the information systems (IS) manager via email. The IS manager prepares the needs assessment. The IS manager engages all affected users. The IS manager determines the cost relating to the program change. Cost is the main consideration in approving a request. If the cost is more than R10 000, approval is needed from the nancial director. Plan The IS manager prepares a project plan incorporating a cost and time budget. This is prepared based on the PRINCE 2 program change standards. Standards The approved request for the program changes, together with the needs assessment, are handed to the programmers. The programmers also have to rely on the PRINCE 2 program change standards when they make program changes. STEPS IN THE PROCESS Librarian controls A librarian supervises and keeps records of the issuing and the coping capacity of programs. The programmer works on a copy of the relevant program and not the live system. Since the programmers require access to all programs and les, they use the administrative password. The copy of the relevant program is kept in source code in the development area of the library. Testing The IS manager reviews the programmers’ work and monitors the compliance of the documentation relating to the program change to the PRINCE 2 program change standards. Once the program change has been completed, both the programmer and IS manager test the coding and the system logic. Approval Only the upgraded program version control list and program description are retained in the library. After a discussion with the internal auditors, users and IS manager, the nancial director approves the testing results. Since there is no need to retain the test results, they are thrown away. Implementation Once approval is obtained, the use of the previous version of the program is immediately stopped and the program change is implemented. STEPS IN THE PROCESS Training Training is provided to all staff. REQUIRED 1. Identify the weaknesses in the controls over changes made to the application software. (13) 2. List the most signi cant risks that should be considered when a new system is developed. (6) [19] Question 10 LEVEL 2 Weaknesses in an IT environment [30 marks] Da Rock Ltd imports exotic cars from Spain for resale in Johannesburg. As Spanish cars have become a fashion item and are gaining in popularity, the company has opened several retail outlets across South Africa, its 20th store being the one that recently opened in Upington. e company does all its distribution from its head office and storage facility in Rosebank, Johannesburg, where its IT department is located. Because of Da Rock’s nationwide expansion, its computer infrastructure has come under pressure. e areas that have been affected are: staffing infrastructure processing. Increased pressure in these areas has resulted in errors occurring. Management doubts that the current system addresses properly all the relevant risks that exist in the computerised information system environment. In order for it to do so, the company approaches you, as a computer consultant, to provide them with advice. e IT programming department, which has been placed at your disposal, has capable personnel with sufficient knowledge and experience in order to develop their own software. Management has stated that, in order to process the transactions, update records, amend the system and so on, staff should be available to work overtime. It is standard practice at Da Rock that, if necessary, management approves overtime, as they prefer to reimburse staff for overtime rather than have them take additional leave. us, staff work overtime if and when available, or when requested to do so by management. e IT department has the following organisational structure: BOARD OF DIRECTORS IT MANAGER: MR T. PITT Programmers: Mr Johnson Ms Nye Ms Makanga Mr Williams Data control clerks: Ms van Rhyn Mr Matshoba Operating personnel: Mr Naidoo Ms Erica Ms Parker Systems analysts: Mr Muhamad Mr Mpondo e IT manager is responsible for the department as a whole, and reports to the board of directors. e current system has been in use for the past 10 years, as a result of which most staff are familiar with the system. Many of them have been performing the same type of work ever since they started working at Da Rock Ltd. When a user identi es problems in the system, or requires a new functionality, he/she can contact a programmer telephonically and request that the error be xed, or the new functionality be added to the system. In terms of the service level agreement with the IT department, all requests should be resolved quickly and the necessary changes made to the software. e agreement also requires that users obtain immediate access to the system. After a period of four hours of inactivity, the IT department must reimburse the user department for the loss of income. is allows users to continue with their work on the system without unnecessary delays. REQUIRED Identify the weaknesses in internal controls of Da Rock Ltd’s computerised information system, and recommend internal controls in order to address these weaknesses. Present your answer in tabular form. [30] Question 11 LEVEL 2 Governance in an IT environment [30 marks] e sustainability of any company, particularly one that is listed, could be threatened by any number of risks. In an information environment, IT risks are becoming more signi cant. In terms of the King IV™ report, the board of a listed company is responsible for responding to these risks in an appropriate manner. It has an overall responsibility for implementing IT governance, and for formulating an IT-governance framework that cannot be generic and should be customised to a particular industry or organisation. Responsibility for the implementation of the IT framework may be delegated to IT management. REQUIRED 1. Identify what IT management of a listed company should be able to demonstrate with regard to responding to the risks arising from the information system detailed above. (4) 2. Identify three high-level information security principles that the IT management system should include. (3) 3. Explain why the implementation of these principles is important for the sustainability of a listed private hospital. (8) 4. Explain the responsibility of the board of directors in terms of IT governance, as well as the responsibilities of the risk and audit committees. (15) [30] Question 12 LEVEL 2 Application controls and back-ups [22 marks] You are a business consultant employed at Dan-o Ltd. e company, which was set up approximately a year ago, sells copyrighted pictures at a xed price to magazine publishers, who can use them in either hard copy or online publications. Dan-o Ltd owns various licences for pictures ranging from cats and dogs to designer artworks. You were approached by staff in the IT department to assist with the design of internal controls for a cloud-based enterprise resource planning system used to manage the company’s sales. ey are currently working on the ordering module of the software. e company prides itself on its state-of-the-art, cloud-based technologies that use the latest assurance logos, rewalls, encryption and virus protection protocols. e network on which the cloud service operates is located in the basement of the company’s premises. e network consists of personal computers linked to a server, which contains the programming of the cloud-based service and an integrated accounting package. Cloud-based service Publishers can install an ordering application (app) from the company’s website onto their system. e app communicates directly with the company’s network and is then used to process orders and to perform various other tasks, such as making payments. Publishers can register for the company’s free cloud service app by submitting their company details, including their name, registration number and delivery address. Publishers must also enter their banking details onto the app. An account is then created. On registration, the system automatically generates a username for the publisher; the username consists of the rst six letters of the company’s name combined with three random numbers. e company can choose its own password. e username must be recorded on the app when orders are placed and electronic payments made. Publishers can search Dan-o Ltd’s website in order to view the available pictures. ey can also view them using the app. Once a publisher has identi ed a picture that it would like to use, it can place an order on the app by selecting the serial number of the picture from a list of available pictures (by means of drop-down boxes, where applicable). is list is automatically updated on a daily basis as new pictures are loaded. When orders are received, a member of staff writes the pictures to a DVD and places it in a bubble-wrapped package for distribution. e DVD is delivered to the publisher by a courier company as soon as the payment of R100 per le has been made electronically. e system then automatically emails an electronic invoice to the publisher’s accounting department. is invoice also serves as a pre-numbered receipt. Virus infection e system was recently infected with a virus that corrupted a large portion of the information on the server, because the company had not loaded the latest antivirus patches. e information lost could not be recovered, as effective back-up procedures had not been put in place. All important information is supposed to be backed up onto a CD at least once a week, but, during busy times, back-ups are not always made, or are lost, and are sometimes not stored safely. REQUIRED 1. Describe the application controls that must be present on the cloud service app in order to ensure that all pictures ordered by publishers are processed accurately and are valid and complete. You must discuss input, processing and output controls. (12) 2. Describe the controls that should be implemented relating to backup procedures and controls in order to prevent back-up CDs from being lost or falling into the hands of unauthorised persons. (10) [22] Question 13 LEVEL 3 Application controls (input controls) [15 marks] You are employed as the IT governance specialist at Super Shirts Ltd (Super Shirts). Since your staff is aware that you are very busy and do not always have time to read everything, they have provided you with the following: a high-level system description and a detailed description of the system. High-level system description Super Shirts operates a self-service kiosk in a large mall in Cape Town. e kiosk has three touch screens on which customers can order and pay for a men’s shirt. e customers’ selection is based solely on the images on the touchscreen. e company’s slogan is: ‘Like shopping on the internet, but not. We provide the human touch’. Once the shirt has been ordered on the touch screen, the kiosk assistant collects the shirt from the storeroom behind the booth and presents it to the customer. Customers do not have access to the shirts and the kiosk assistants do not handle cash. Detailed description of the system Customers must rst register for the service. As part of the registration process, customers must capture their credit card information, which is automatically veri ed with the bank. Customers receive a unique username and can select a unique password. Customers can use one of three touch screen computers to place orders for men’s shirts depending on their size, style and measurements. Customers can browse through pictures and descriptions of the available shirts on the touch screen and make selections. e touch screens are easy to use and have visual prompt navigation and a help function, and therefore training is not required. In order to purchase a product, customers click on the relevant product displayed on the screen from the inventory master le. e product will be added to customers’ electronic baskets. After a customer completes a transaction, the system allocates a sequential number to the transaction. is order number is displayed on the touch screen and a pre-numbered receipt is printed for the customer. e system automatically creates a picking slip in the storeroom behind the kiosk for each order captured. One of the kiosk assistants brings the ordered shirt to the customer and con rms the order details and number on the receipt held by the customer. A shift manager is always on duty, monitoring the kiosk assistants. e shift manager reviews and investigates all the available input logs (including error logs related to inputs) from the touch screen system. REQUIRED Describe the additional input controls which must be present at Super Shirts in order to ensure the completeness and accuracy of sales transactions captured into the touch screen. [15] Question 14 LEVEL 2 Processing and master le controls [24 marks] Two years ago, you were appointed chief operating officer at Honolulu 5.0 Ltd (Honolulu 5.0), after you had resigned from a position as an audit manager in a large auditing rm. Honolulu 5.0 is a chain store group that retails plastic guns, police badges and other such items to the public. e head office of the company, which has shops on the various islands of Hawaii, is located on the main island of Hawaii, in Pearl Harbour. As part of your responsibilities as chief operating officer, you are responsible for the human resources function. You have been able to centralise the salaries and related processes only partially, because of the distances between the shops located on the various islands. As a result, the computer information system used by the group consists of mini-computer systems at the various shops, systems that are linked to the mainframe at head office via a virtual private network. Each shop is responsible for its own staff appointments and for maintaining hardcopy records. Head office also keeps hard copies and electronic staff records for the whole company and is responsible for calculating and paying out the monthly payroll. You are responsible for overseeing this function. e payroll system includes a payroll master le and monthly transaction les. During the month, each shop manager and the departmental manager at head office forwards to you via email all the relevant documentation – such as appointments, resignations, dismissals, retirements, changes to existing employee information and transactional information – relating to staff matters, all of which is captured by one of your employees. Master le changes are immediately recorded on input forms and entered into and processed on the payroll master le. Where possible, payroll information already available on the system is extracted from the master le. Information that requires approval is placed in a computerised suspense le for your approval. e system has an effective report-writing function. Exception reports will, for example, be printed for any error identi ed by the programmed matching and reasonableness tests performed on the input eld. All exception reports generated by the system are reviewed by a manager on a monthly basis, and any unusual items investigated. Reports regarding access violations are also checked. Various other reports, too, are generated, reviewed and investigated. During last month’s review, you were distressed by the errors highlighted in one of the reports relating to salaries and wages. Processing errors occurred during the monthly payroll production run, when the payroll master le was updated with the transaction les. e controls to detect omissions by the calculation of various control totals, among other things, are sufficient, but the internal controls to detect other types of errors are not. Unauthorised staff obtained access to payroll information. You decide to look into the matter further in order to identify the related risks. You would also like to make recommendations with regard to addressing the identi ed problems. To this end, a business consultant has been appointed to investigate any unauthorised activities. REQUIRED 1. List the risks arising when attention is not given to the errors that occur during the updating process of the payroll master le. (7) 2. Recommend internal controls in order to detect weaknesses caused by process errors occurring during the updating of the payroll master le. (5) 3. Describe the additional logical internal controls that should be implemented in order to prevent the unauthorised use of the payroll master le. (12) Note: In all cases, ignore risks, controls and weaknesses relating to the virtual private network. [24] Question 15 LEVEL 2 Controls regarding changes to master le data [18 marks] You are the auditor of Jacobs Ltd, a coffee shop in a well-known Cape Town mall. Jacobs Ltd sells brews made from both locally sourced and imported beans. It also delivers take-away coffee in special heated containers. A couple of months ago, the business implemented a computer system in order to manage orders, suppliers, prices and takeaway delivery drivers. e program integrates with a point-of-sale module linked to an electronic cash register. Clients can order coffee either telephonically or over the counter. Deliveries are made by casual staff. e menu with prices is displayed above the cash register and is also available on the internet. Both the menus and the prices are revised every two months by the shop manager. Most business is conducted by means of cash or credit card payments. However, over the past couple of months, the shop has opened corporate accounts on credit to some local businesses, whose details are recorded on the master le of the computer system before they are allowed to purchase on credit. Before speci c stock levels of coffee run too low, the computer system generates a suggested order, and identi es the most appropriate supplier, the quantity of coffee required and the appropriate price. is information is extracted from the supplier and the product master le. e system relies on a complicated, but accurate, economic orderquantity program. REQUIRED Describe the controls that should be present within the computer system relating to changes to the supplier and product master le information. [18] Question 16 LEVEL 3 Application controls (master le) [22 marks] Lemon Tree Ltd (Lemon Tree) was founded by P.G. Marais and Martinette Marais in Moorreesburg. e business was started after their dog Marki developed a habit of digging holes in their garden, which P.G. lled by planting lemon trees. Over the past few years, the business has grown so much that they now own a small shop in the main street of the town. Lemon Tree uses the lemons to make creams, preserves and jams. e purchases cycle operates as follows: In order to ensure that their stock is fresh, Lemon Tree relies on a computer accounting package which is linked electronically to all its suppliers. At the end of every week, the storeroom assistant extracts a report of all varieties of lemons (i.e. stock items) that have reached their minimum stock levels. e chief storeroom assistant uses the stock codes from these reports to enter orders into the accounting package to be sent to the approved suppliers. Management reviews the approved list of suppliers quarterly. e chief storeroom assistant selects the most appropriate approved suppliers’ codes from a drop-down box when he inputs the order. After the order has been electronically approved and released by the chief storeroom assistant, it is automatically sent to the relevant supplier electronically. A schedule of amounts payable to creditors is prepared on Excel. e schedule indicates each creditor’s supplier code, name and the amount payable. Creditors are paid by making use of an independent internet banking service. Creditors must have been loaded as bene ciaries on the company’s internet banking service facility before payment can be made. Monthly bank reconciliations are prepared and properly reviewed. REQUIRED 1. Describe the additional controls which must be in place at Lemon Tree in order to ensure that only valid amendments are made to the inventory master le. (10) 2. Describe the additional controls which must be in operation over the internet banking service at Lemon Tree in order to ensure that only valid payments are made to creditors. Note: You are not required to discuss the process for the creation of and any changes to bene ciaries. [22] (12) INTRODUCTION e following types of application questions can typically be asked on the business cycles: Describe weaknesses in the control system and recommend improvements by describing the required internal controls. is type of question can also be combined with control objectives and/or account or assertions affected. Identify and describe risks in the cycle. is type of question can also be combined with control objectives and/or account or assertions affected. Design a system of internal controls, both manual and computerised, that will achieve the cycle’s control objectives. Weaknesses in the cycle will always be the starting point for all of the above types of questions. Risks are consequences of identi ed weaknesses and could affect business operations and nancial statements (business risks), or only the nancial statements (risks of material misstatement at the assertion level). By answering the example questions, you will be guided through weaknesses (example question 1) to the risks, the control objectives not being achieved and the account or assertions affected (example question 2). EXAMPLE QUESTION 1 Internal control weaknesses [8 marks] As a trainee accountant at A2Z Inc., a registered audit rm, you were appointed to the audit of Blitz Ltd (Blitz), a wholesale company that sells electrical goods, such as kettles, toasters, stoves, television sets and MP3 players. All sales to customers are made on credit and Blitz is responsible for delivering the goods to its customers. One of the other trainee accountants has already dealt with the following parts of the revenue and receipts cycle: Credit management Receipt of orders from customers Authorisation of sales orders Picking of goods from the warehouse Receipt of cash from customers Recording of receipts in the accounting records Processing and recording of returns and other sales adjustments e audit senior has requested that you assist with the remaining parts of the cycle and provided you with the following abstract of the company’s revenue and receipts cycle description: Dispatch and delivery of goods to customers Upon receipt of the picking slip and the packed goods from the warehouse, the dispatch clerk compares the contents of the goods to be delivered with the picking slip, whereupon he/she signs the slip as evidence of having received all goods from the warehouse. He/she then prepares a sequentially numbered, multi-copied delivery note for the goods to be delivered. After the goods have been loaded onto the delivery vehicle, the driver proceeds to the exit gate, where security guards perform a check on the number of boxes in the truck, following which the goods are delivered to the customer. Upon their delivery, the customer is requested to sign all three copies of the delivery note as acknowledgement of receipt of the goods. e rst copy is retained by the customer; the second is returned to the warehouse, where the status of the delivery is updated to ‘delivered’ (this enables the sales order staff to follow up on longoutstanding orders), and the third copy is submitted directly to the invoicing clerk for the purpose of invoicing the customer. Invoicing Upon receipt of a customer-signed delivery note from the driver, the invoicing clerk les it sequentially in a ‘pending invoice le’. First thing every morning, he/she takes the delivery notes from this le and prepares sequentially numbered invoices for each of them. e invoices are cross-referenced and attached to the original internal sales order and delivery note. Recording of sale in the accounting records Posting the sales transactions to the sales journal takes place once the invoicing clerk has generated the invoices. After preparing them from the delivery notes as described above, he/she records them in the sales journal. He/she also posts the transactions to the debtors ledger and the general ledger. Towards the end of each month, the bookkeeper: accounts receivable performs a debtors reconciliation between the grand total of outstanding debtors balances in the debtor’s ledger (computerised debtor’s listing) and the balance of the trade debtors control account in the general ledger. Any reconciling items are followed up and resolved. After the invoicing clerk has successfully performed the debtors reconciliations, he/she generates debtors statements for each debtor, showing: the outstanding balance (if any) of the debtor brought forward all transactions with the debtor over the past month (including invoices, receipts and adjustments) the outstanding balance, with ageing of the balance, payable by the debtor at statement date. He/she then emails each debtor statement to the applicable debtor. REQUIRED Describe the weaknesses in the above system. [8] GUIDANCE Understand the question Describe the internal control weaknesses1 in the above system description. [8]2 Identify the theory applicable to the question In order to answer application questions, you need to know the theory relevant to the cycle. You need to: understand the nature and the purpose of the cycle identify the major general ledger accounts affected by the cycle understand the accounting treatment required for the recording of revenue identify the cycle’s functional areas identify the documents and records, both manual and computerised, utilised in the cycle, and describe the purpose of each understand the ow of transactions in the cycle through the information system, including its relation to source documents and accounting records and its relation to classes of transactions and events, and balances understand how internal controls may assist in achieving the control objectives in the cycle, and how these control objectives relate to the management assertions in the nancial statements. us, you need to know what the ideal revenue and receipts cycle should look like (your framework), and you will have to measure the system provided in the question against that framework. Internal controls applied incorrectly, as well as internal controls not mentioned in the question, are weaknesses. Read the question As a trainee accountant at A2Z Inc., a registered audit rm, you were appointed to the audit of Blitz Ltd (Blitz), a wholesale company that sells electrical goods, such as kettles, toasters, stoves, television sets, and MP3 players.3 All sales to customers are made on credit4 and Blitz is responsible for delivering the goods to its customers.5 One of the other trainee accountants has already dealt with the following parts of the revenue and receipt cycle: Credit management Receipt of orders from customers Authorisation of sales orders Picking of goods from the warehouse Receipt of cash from customers Recording of receipts in the accounting records Processing and the recording of returns and other sales adjustments6 e audit senior has requested that you assist with the remaining parts7 of the cycle, and provided you with the following abstract of the company’s revenue and receipts cycle description: Dispatch and delivery of goods to customers8 Upon receipt of the picking slip and the packed goods from the warehouse, the dispatch clerk compares the contents of the goods to be delivered with the picking slip,9 whereupon he/she signs the slip as evidence of having received all goods from the warehouse. He/she then prepares a sequentially numbered, multi-copied delivery note for the goods to be delivered.10 After the goods have been loaded onto the delivery vehicle, the driver proceeds to the exit gate, where security guards perform a check on the number of boxes in the truck,11 following which the goods are delivered to the customer. Upon their delivery, the customer is requested to sign all three copies of the delivery note as acknowledgement of receipt of the goods.12 e rst copy is retained by the customer; the second copy is returned to the warehouse, where the status of the delivery is updated to ‘delivered’ (this enables the sales order staff to follow up on long-outstanding orders), and the third copy is submitted directly to the invoicing clerk for the purpose of invoicing the customer. Invoicing13 Upon receipt of a customer-signed delivery note from the delivery truck driver, the invoicing clerk les it sequentially in a ‘pending invoice le’.14 First thing every morning, he/she takes the delivery notes from this le and prepares sequentially numbered invoices15 for each of them. e invoices are cross-referenced and attached to the original internal sales order and delivery note.16 Recording of sale in the accounting records17 e posting of sales transactions to the sales journal takes place once the invoicing clerk has generated the invoices. After preparing them from the delivery notes as described above, he/she records them in the sales journal. He/she also posts the transactions to the debtors ledger and the general ledger. Towards the end of each month, the bookkeeper: accounts receivable performs a debtors reconciliation18 between the grand total of outstanding debtors balances in the debtors ledger (computerised debtors listing) and the balance of the trade debtors control account in the general ledger. Any reconciling items are followed up and resolved. After the invoicing clerk has successfully performed the debtors reconciliations, he/she generates debtors statements for each debtor, showing: the outstanding balance (if any) of the debtor brought forward all transactions with the debtor over the past month (including invoices, receipts and adjustments) the outstanding balance, with ageing of the balance, payable by the debtor at statement date. He/she then emails each debtor statement to the applicable debtor.19 SUGGESTED SOLUTION Remember: a weakness is a control that is incorrectly performed or not performed at all. erefore, it will always be phrased as not being there with nobody performing it or as being performed incorrectly. In this scenario, the following controls are missing: Security guards do not perform spot checks on the contents of the truck by agreeing the goods on the delivery truck back to the delivery note. (1) A senior personnel member does not ensure that invoices have been prepared for all returned delivery notes. (1) A senior personnel member does not ensure that the date on the invoices corresponds with the nancial period in which the deliveries were made (as per the date on the delivery notes). Missing delivery notes (gaps in sequence) are not identi ed and followed up with the (1) dispatch area by a senior personnel member as to why the delivery has not yet taken place. A senior personnel member does not compare (review) the quantities and prices on the (1) prepared invoices to the delivery notes and quoted prices respectively. (1) A second clerk or senior personnel member does not recalculate the costs and calculations on the invoices. (1) A second clerk or senior personnel member does not check the recorded invoices in the sales journal by agreeing the entries to supporting invoices. (1) A second clerk or senior personnel member does not agree the invoice amounts being posted from the invoices to the sales journal and the debtors ledger. (1) A second clerk or senior personnel member does not inspect the numerical sequence of the entries being posted from the invoices to the sales journal and the debtors ledger. (1) e debtors reconciliation is not reviewed by a senior personnel member before monthly statements are prepared for mailing to debtors. (1) Available marks [10]; maximum marks [8] EXAMPLE QUESTION 2 Internal control weaknesses, risks, control objectives and assertions [32 marks] As a trainee accountant at A2Z Inc., a registered audit rm, you were appointed to the audit of Blitz Ltd (Blitz), a wholesale company that sells electrical goods, such as kettles, toasters, stoves, television sets and MP3 players. All sales to customers are made on credit and Blitz is responsible for delivering the goods to its customers. One of the other trainee accountants has already dealt with the following parts of the revenue and receipts cycle: Credit management Receipt of orders from customers Authorisation of sales orders Picking of goods from the warehouse Receipt of cash from customers Recording of receipts in the accounting records Processing and recording of returns and other sales adjustments e audit senior has requested that you assist with the remaining parts of the cycle, and provided you with the following abstract of the company’s revenue and receipts cycle description: Dispatch and delivery of goods to customers Upon receipt of the picking slip and the packed goods from the warehouse, the dispatch clerk compares the contents of the goods to be delivered with the picking slip, whereupon he/she signs the slip as evidence of having received all goods from the warehouse. He/she then prepares a sequentially numbered, multi-copied delivery note for the goods to be delivered. After the goods have been loaded onto the delivery vehicle, the driver proceeds to the exit gate, where security guards perform a check on the number of boxes in the truck, following which the goods are delivered to the customer. Upon their delivery, the customer is requested to sign all three copies of the delivery note as acknowledgement of receipt of the goods. e rst copy is retained by the customer; the second is returned to the warehouse, where the status of the delivery is updated to ‘delivered’ (this enables the sales order staff to follow up on longoutstanding orders), and the third copy is submitted directly to the invoicing clerk for the purpose of invoicing the customer. Invoicing Upon receipt of a customer-signed delivery note from the driver, the invoicing clerk les it sequentially in a ‘pending invoice le’. First thing every morning, he/she takes the delivery notes from this le and prepares sequentially numbered invoices for each of them. e invoices are cross-referenced and attached to the original internal sales order and delivery note. Recording of sale in the accounting records Posting the sales transactions to the sales journal takes place once the invoicing clerk has generated the invoices. After preparing them from the delivery notes as described above, he/she records them in the sales journal. He/she also posts the transactions to the debtors ledger and the general ledger. Towards the end of each month, the bookkeeper: accounts receivable performs a ‘debtors reconciliation’ between the grand total of outstanding debtors balances in the debtor’s ledger (computerised debtor’s listing) and the balance of the trade debtors control account in the general ledger. Any reconciling items are followed up and resolved. After the invoicing clerk has successfully performed the debtors reconciliations, he/she generates debtors statements for each debtor, showing: the outstanding balance (if any) of the debtor brought forward all transactions with the debtor over the past month (including invoices, receipts and adjustments) the outstanding balance, with ageing of the balance, payable by the debtor at statement date. He/she then emails each debtor statement to the applicable debtor. REQUIRED Describe the internal control weaknesses. For each of the identi ed weaknesses, describe the associated risk as well as the control objective not being achieved and the revenue assertion affected in the above system description of the revenue cycle of Blitz. [32] GUIDANCE Understand the question Describe the internal control weaknesses.20 For each of the identi ed weaknesses,21 describe the associated risk,22 as well as the control objective not being achieved23 and the revenue assertion affected24 in the above system description of the revenue cycle of Blitz.[32]25 Identify the theory applicable to the question26 In order to be able to answer application questions, you need to know the theory relevant to the cycle. You need to: understand the nature and the purpose of the cycle identify the major general ledger accounts affected by the cycle understand the accounting treatment required for the recording of revenue identify the cycle’s functional areas identify the documents and records, both manual and computerised, utilised in the cycle, and describe the purpose of each understand the ow of transactions in the cycle through the information system, including its relation to source documents and accounting records, as well as its relation to classes of transactions and events, and balances understand how internal controls may assist in achieving the control objectives in the cycle, and how these control objectives27 relate to the management assertions28 in the nancial statements. us, you need to know what the ideal revenue and receipts cycle should look like (your framework) and you will have to measure the system provided in the question against this framework. Internal controls applied incorrectly, as well as internal controls not mentioned in the question, are weaknesses. You must now also write down what the consequences of the weaknesses (the risks) will be. Read the question Refer to example question 1. SUGGESTED SOLUTION Always remember to make it as easy as possible for the marker to understand what you have done and thus allocate marks. One of the best ways of presenting a weakness29 and its associated risk,30 control objective and assertion question is by presenting it in tabular form. Remember that the control objective needs to relate to one of the three listed above and the assertion to one of the ve revenue assertions listed above. WEAKNESS RISK CONTROL OBJECTIVE NOT ACHIEVED ASSERTION AFFECTED The security guard does not perform spot checks on the contents of the truck by agreeing the goods on the delivery truck back to the delivery note. (1) The goods leaving the premises might not all have been recorded on delivery notes, leaving insuf cient records of the sales that have taken place. (1) Completeness: all goods picked by the storemen are recorded on a delivery note. (1) None: completeness assertion is only affected once the customer has accepted the delivered goods. (1) A senior personnel member does not ensure that invoices have been prepared for all delivery notes returned from customers. (1) The goods leaving the premises might not all have been invoiced, leaving insuf cient records of the sales that have taken place. (1) Completeness: all goods delivered have been invoiced. (1) Completeness of revenue (1) A senior personnel member does not ensure that the date on the invoices corresponds with the nancial period in which the deliveries were made (as per the date on the delivery notes). (1) Deliveries might not be invoiced timeously, resulting in sales possibly being recorded in an incorrect accounting period. (1) Validity: sales are recorded in the period to which the transaction relates. (1) Cut-off of revenue (1) WEAKNESS RISK CONTROL OBJECTIVE NOT ACHIEVED ASSERTION AFFECTED Missing delivery notes (gaps in sequence) are not identi ed and followed up with the dispatch area by a senior personnel member as to why delivery has not yet taken place. (1) The goods leaving the premises might not all have been invoiced, leaving insuf cient records of the sales that have taken place. (1) Completeness: all goods delivered have been invoiced. (1) Completeness of revenue (1) A senior personnel member does not compare (review) the quantities and prices on the prepared invoices to the delivery notes and quoted prices respectively. (1) Invoices might be prepared on incorrect quantities and/or prices, which will lead to the under- or overcharging of customers. (1) Accuracy: all invoices are prepared with accurate quantities and prices. (1) Accuracy of revenue (1) A second clerk or senior personnel member does not recalculate the costs and the calculations on the invoices. (1) The costs and the calculations on the invoices might be inaccurate, which will lead to the under- or overcharging of customers. (1) Accuracy: all invoices are prepared with accurate quantities and prices. (1) Accuracy of revenue (1) A second clerk or senior personnel member does not check the recorded invoices in the sales journal by agreeing the entries to supporting invoices. (1) Postings to the sales journal may be invalid, leading to the overstatement of sales. (1) Validity: only valid sales are posted from the invoices to the sales journal. (1) Occurrence of revenue (1) A second clerk or senior personnel member does not agree the invoice amounts being posted from the invoices to the sales journal and the debtors ledger. (1) Postings to the sales journal may be inaccurate, leading to the under- or overstatement of sales. (1) Accuracy: sales are correctly posted from the invoice to the sales journal and the debtors ledger. (1) Accuracy of revenue (1) WEAKNESS RISK CONTROL OBJECTIVE NOT ACHIEVED ASSERTION AFFECTED A second clerk or senior personnel member does not inspect the numerical sequence of the entries being posted from the invoices to the sales journal and the debtors ledger. (1) Postings to the sales journal may be incomplete, leading to the understatement of sales. (1) Completeness: all sales are posted from the invoice to the sales journal and the debtors ledger. (1) Completeness of revenue (1) The debtors reconciliation is not reviewed by a senior personnel member before monthly statements are prepared for mailing to debtors. (1) Postings to the debtors ledger and control account in the general ledger may be incomplete, inaccurate or invalid. (1) Validity: only valid sales are posted from the invoices to the sales journal. OR Accuracy: sales are correctly posted from the invoice to the sales journal and the debtors ledger. OR Completeness: all sales are posted from the invoice to the sales journal and the debtors ledger. (1) Occurrence of revenue OR Accuracy of revenue OR Completeness of revenue (1) Available marks [40]; maximum marks [32] QUESTIONS Question 1 LEVEL 2 Control objectives [8 marks] Coffee Bean Ltd (Coffee Bean) is the rst roaster of certi ed fair trade coffee and strives to make a sustainable difference in the lives of African coffee producers by personally sourcing quality coffee through direct fair trade. Coffee Bean is a wholesaler of coffee beans and sells on credit to coffee shops. e following internal controls were implemented by Coffee Bean in the revenue and receipts cycle: 1. When a new customer wants to purchase coffee beans on credit, the customer needs to complete a credit application form with trade references. e credit controller performs a background check and con rms the credit status. e credit controller then sets a credit limit for the customer. 2. Sales orders are placed telephonically. e order clerk only accepts orders from customers who are able to provide an account number and who are on the approved customer list. e order clerk asks the customer to con rm certain pertinent details (such as ID number and address). 3. e sales orders are then sent to the warehouse. e warehouse prepares pre-printed and prenumbered picking slips and cross-references these to the sales order. 4. e dispatch clerk completes a pre-numbered and pre-printed delivery note for all the coffee beans dispatched. e driver checks coffee beans against the delivery note and signs the delivery note if it agrees. 5. e customer receives two copies of the delivery note and signs one as proof of acceptance of the coffee beans. 6. e customer-signed delivery note is handed to the invoicing clerk. e invoicing clerk prepares a pre-numbered, pre-printed invoice for each delivery note received. 7. Prices and quantities are included on the invoice with reference to the sales order, delivery note and approved price lists. e second invoicing clerk checks the prices and calculations on the invoice and signs if satis ed. 8. e bookkeeping clerk posts the invoices to the sales journal. A second bookkeeping clerk checks the recorded invoices in the sales journal by agreeing the entries to the supporting invoices. 9. e second bookkeeping clerk also checks the amounts of the invoices posted and checks the numerical sequence of the invoices posted. REQUIRED Formulate the control objective(s) for each of the internal controls listed above in the revenue and receipts cycle of Coffee Bean. [8] Question 2 LEVEL 2 Functional areas and control objectives [18 marks] Business cycles are divided into ‘functional areas’, each of which represents a phase in the cycle through which transactions ow. In order to ensure the achievement of an entity’s control objectives (the validity, the accuracy and the completeness of nancial information), internal controls are implemented in each functional area. e functional areas in the revenue and receipts cycle for Homestyles (Pty) Ltd (Homestyles), a wholesale company selling home appliances and furniture to its retail customers on credit, are: a) managing of credit b) receipt of orders from customers c) authorisation of sales d) picking of goods from the warehouse e) dispatch and delivery of goods to customers f ) invoicing and recording of sales g) posting of sales to the accounting records h) receipt of cash from customers i) recording and posting of receipts in the accounting records j) granting of credit on sales returns and the provision of discounts to customers. Consider the following control activities that have taken place in Homestyles’s revenue and receipts cycle: 1. e driver of the company’s delivery truck requested that a customer sign a copy of the delivery note indicating the quantities and descriptions of goods delivered to the customer. 2. e computer system prevented the sales clerk from processing a sales order received from a customer, because the customer would have exceeded his credit limit. 3. A sign on the cashier’s counter requests that customers insist on a printed receipt when settling their account with cash. 4. e debtors clerk prepared a debtors reconciliation, agreeing the total of the debtors ledger with the balance of the debtors control account in the general ledger. 5. e sales manager approved a credit note requested by a customer who returned faulty goods to the company. 6. e cashbook clerk prepared a monthly bank reconciliation, comparing the cashbook total with the bank balance as per the bank statement. 7. e credit controller assigned a limit to a new customer’s credit account. 8. A shipment of goods leaving the warehouse was recorded on a delivery note by the storeman, which in turn was provided to the dispatch clerk who performed a check in order to ensure that all goods dispatched had indeed been recorded on the delivery note. 9. e computer system requested the invoicing clerk in the accounting department to key in an internal sales order number before the computer allowed her to generate an invoice. 10. e sales clerk requested an account number from a customer who wanted to place an order for goods over the telephone, before proceeding with the order. REQUIRED For each of the 10 control activities referred to in the above scenario, identify the functional area in which the control activity would typically take place and state the control objective(s) achieved by each. [18] Question 3 LEVEL 2 Assertions [9 marks] You are an accountant in public practice, specialising in the provision of accounting and business consulting services to start-up companies. A new client of yours, Woodworks (Pty) Ltd (Woodworks), has recently completed the statutory registration of the company in anticipation of its future manufacturing activities. Its chief executive officer, Patrick Japhta, has requested your advice on the nancial reporting risks the company may face in terms of its recorded sales transactions. REQUIRED List and explain the assertions applicable to the revenue gure in the nancial statements of Woodworks. Categorise the assertions in terms of ‘overstatement of revenue’ and ‘understatement of revenue’. Ignore misstatement risks pertaining to sales returns, and the presentation and disclosure assertions. [9] Question 4 LEVEL 2 Purpose of controls, control objectives and assertions [23 marks] Wooltons (Pty) Ltd (Wooltons) is a producer of wool yarn. e company, which buys wool in large quantities from sheep farmers, produces the yarn before selling it in bulk to clothing manufacturers and haberdashers. Woolton makes deliveries to customers using its own staff and delivery vehicles. Before the start of the nancial year subject to the current audit, Wooltons implemented several new, improved internal controls in its revenue and receipts cycle: INTERNAL CONTROL 1. Wooltons has contracted the services of a credit bureau that runs background checks on the credit status of potential customers wishing to open an account with Wooltons. Based on the results of the checks, the bureau might suggest a credit limit for a particular customer. INTERNAL CONTROL 2. On a monthly basis, referring to a list of debtors identi ed as being at risk of defaulting on their outstanding debts, the nancial manager carefully determines whether long-outstanding debtor balances (or part of a balance) should be included in the allowance for credit losses. 3. The accounting application on Woolton’s computer system does not allow the sales clerk to process a sale to a customer’s account if the account has been agged by the nancial manager (by means of the accounting software application) as at risk of default. 4. Woolton’s senior bookkeeper reviews the le of delivery notes issued to customers upon delivery in order to ensure that the sequence of delivery notes is intact and that for each delivery note a corresponding invoice has been generated on the computerised accounting application. 5. The accounting software application automatically calculates item prices and invoice amounts when customer invoices are generated on the computer by the accounts receivable clerk. This is achieved by referring to the product code entered and the price stored in the price list master le (that is, the clerk does not have to enter product prices manually). 6. The sales manager is required to authorise all sales returns by referring to a goods returned voucher and a copy of the invoice on which the details of the returned goods appear. REQUIRED Describe the purpose of each internal control listed above. In addition, for each control: explain the control objective(s) that management attempts to achieve state the assertion and the account affected by the control. Present your answer in tabular format. [23] Question 5 LEVEL 2 Weaknesses [13 marks] You have recently been appointed as the manager of Queen Fridge Cakes (Pty) Ltd, a cake company that specialises in extended-freshness fridge cakes, which can be stored in fridges for up to six months. You have prepared the following notes to describe extracts of the company’s system of sales: Orders e order clerk receives orders via the telephone from customers. e order clerk records telephone orders on sticky notes which are colour coded. e order clerk only accepts orders from customers who are able to provide an account number and who are on the authorised customer list. If a customer is not on the customer list, the customer is referred to the credit controller to commence the credit application process. You can assume that the credit control department has efficient internal controls in place. As Queen Fridge Cakes (Pty) Ltd has a free delivery policy, most orders will be for cakes being delivered to existing customers. e order clerk will therefore always con rm the delivery address from the customer, con rm the price according to the authorised price list and only then sign the sticky notes as approval of the nal order. e orders are always written down on two different sticky notes: the green sticky note is led in the order department and the pink sticky note is sent to the warehouse department. Warehouse and dispatch e picker in the warehouse uses the pink sticky note to draw up a picking slip. All the cakes are then picked from the fridges as recorded on the picking slip, checked by the picker for expiry dates and signed off on the picking slip. If the storeman cannot nd some of the cakes, he/she highlights it on the picking slips. Once the picking is done, the picker will sign the picking slip to acknowledge the procedures performed. e cakes, together with the picking slip, are then carried to the dispatch bay that is connected to the warehouse area. e dispatch clerk will then sign the picking slip as proof of having taken custody of the cakes that were picked and create numerically sequenced, two-part delivery notes for all cakes being dispatched. e driver and the gate security guard have to observe that the speci ed cakes are loaded onto the delivery truck. e driver will compare the cakes loaded onto the truck with the delivery notes. After the gate security guard has supervised the loading of the truck, he will quickly proceed to open the gate for the delivery truck to exit the premises. e driver will provide the customer with the delivery note and cakes upon delivery. If the customer is satis ed with the delivery, he/she will normally tip the driver as a token of appreciation. REQUIRED 1. Brie y describe the weaknesses in the ‘orders’ function, which forms part of the sales system of Queen Fridge Cakes (Pty) Ltd. Limit your answer to manual controls. (5) 2. Brie y describe the weaknesses in the ‘warehouse and dispatch’ function, which forms part of the sales system of Queen Fridge Cakes (Pty) Ltd. Limit your answer to manual controls. (8) [13] Question 6 LEVEL 2 Risks [25 marks] An entity may have business risks relevant to the various transactions in the business cycles or processes. Management is responsible for the risk management of the company and should implement internal control in order to reduce these risks. ey may appoint internal auditors to perform the risk management process internally. Each risk may have a consequence for, or impact on, the nancial statements and/or operations of the business. e auditor is concerned with the risks that might impact directly on the company’s nancial statements and indirectly on the company’s business processes and operations. e following information is relevant to the company for which you have to supervise the trainee accountants performing the auditing of the sales cycle: Type of company: Manufacturer and retailer with high volumes and low gross pro t margins Gross turnover: R532 936 000 Cash sales: R137 946 258 Credit sales: R394 989 742 Number of outlets or branches: 152 Gross pro t percentage: 12.5% e company operates on a manual system and batches are sent to head office for processing onto the computerised system. In terms of the system: orders are placed telephonically, whereupon an email is sent to the production line for them to produce the products the products are sent either to the retail outlet or directly to the customer, who signs the invoice as proof of delivery, either paying COD or taking the products on credit the credit controller follows up the outstanding amounts after only 60 days the company does not reconcile the invoices issued to the dispatches completed. Owing to the large volumes of sales transactions, the audit partner has instructed the auditor to identify the risks and list the consequences next to each risk, in tabular form. REQUIRED Identify and discuss the risks, relevant to the information given above, that could occur in the sales cycle and list the consequence(s) next to each risk in tabular form. [25] Question 7 LEVEL 2 Risks [15 marks] You are the internal auditor of Fruity Juice (Pty) Ltd (Fruity Juice), a company that manufactures a wide range of fruit juices from its factory located in Elgin. e company has a December yearend. e following is an extract of information that you have obtained from the sales and marketing director of the company: Extract: Revenue and receipts cycle – credit sales Up until April of the current year, all sales were conducted on a cash basis only. The directors approved a resolution at the March board meeting to start selling products to customers on credit from April. The decision was made because the company was losing customers to competitors who sold similar products on credit. Customers are required to submit the following documents to a sales representative of the company via email or post in order to qualify to purchase goods on credit: A completed application form A certi ed copy of their identity document A utility bill indicating where they reside An income and expenditure estimation to determine how much credit the individual should be granted The sales representative is required to review the documentation submitted and grant the customer a credit limit. The customer receives a noti cation of their credit limit via an email and an of cial letter from the company. Credit limits that are granted to customers are capped at a maximum of R100 000. Customers wishing to have their credit limits increased at a later date are required to submit a written request for the increase to the credit manager who reviews the request and, if he is satis ed, increases the limit on the system. He uses his unique user ID and password to gain access to the debtor’s master le to initiate the increase. If the credit manager is away from the of ce, he leaves his unique user ID and password with one of the members of his credit team who is permitted to use the log-in details in order to amend a client’s credit limit by a maximum of R10 000 after reviewing the written request. Credit orders Customers are only able to place orders over the telephone. When an order is received, customers are asked to provide their company’s customer number. If unable to do this, they are asked to provide their company’s name and address in order to identify that they are an existing customer. The order is captured on an internal sales order on the sales system by a sales representative. A noti cation is sent through to the warehouse manager, the dispatch manager and the creditors clerk responsible for handling the customer’s account, informing them that there is a new order. The warehouse manager prints the internal sales order form and hands it to the head picker who is responsible for collecting the bottles of juice to ll the order. Once the bottles of juice have been prepared, the goods are moved to the dispatch department where the bottles are stored until the juice is loaded onto the truck and delivered to the customer. The dispatch manager prepares a delivery note based on the internal sales and hands it to the driver of the delivery truck. At delivery, the driver of the delivery truck hands a duplicate copy of the delivery note to the customer. The customer is given one copy of the delivery note and the driver retains one copy. The driver and the client both sign the delivery to indicate that the driver was at the client’s premises. Recording of the sale Once the driver returns to the premises, he gives the delivery note to the creditors clerk, who prepares the invoice and recognises the sales and corresponding debtor in the accounting records by using the information located on the internal sales order document. The detail located on the delivery note is not reviewed but is simply used to identify that the driver delivered the juice to the client. Collection of payment from customers Customers are able to settle their outstanding amounts by making an electronic funds transfer and using their customer number as their reference. Customers who prefer paying by cash or cheque are able to deposit the money into the company’s bank account and use their customer number as their reference. The bank details are provided to the customer by the creditors clerk over the telephone. Credit allowances at year-end The amount recognised as an allowance for credit losses for the company at year-end was 5% of the amount due to the company. While the assumption that 5% of the debtors will not be able to repay the company may not be entirely accurate, the company does not have enough historic data of credit sales to make a more realistic allowance. The company grants customers 30 days to settle their outstanding balances. If clients fail to do so, the company contacts them to determine the reason they have not settled their outstanding balances. If clients are unable to make their payment, the company starts charging late payment penalties and interest on the amount outstanding. If customers have not settled their account within 90 days, the company recognises 5% of the balance receivable as an allowance for credit losses and contacts a debt collecting agency to assist in the recovery of the amount due to the company. REQUIRED Describe the business risks affecting the revenue and receipts cycle at Fruity Juice (Pty) Ltd. [15] Question 8 LEVEL 2 Weaknesses and recommendations [32 marks] You are the auditor of Family Mag (Pty) Ltd, a company that publishes a monthly magazine aimed at families in South Africa. e following has been brought to your attention about the revenue received by the company in lieu of advertisements: New advertisers A prospective customer contacts the company’s corporate office and indicates that he/she would like an advertisement to be published in the company’s magazine. e prospective customer is then transferred to the marketing department. An employee in the marketing department obtains more details about the advertisement and then emails the prospective customer an application form that needs to be returned in order to register as a customer of the company. In addition to the application, the email also includes: a request for the copy of the advertisement a request that the customer select a username which will be used to identify his/her payments the costs involved to publish the advertisement (mini ads run up to as much as R4 000 and full ads up to R16 000) the details of the company’s bank account, into which the customer is required to make a payment. Once the application has been emailed back to the marketing employee, he/she prints the application form and submits it to the marketing manager for approval. e marketing manager scans the contents of the advertisement as well as the application to register as a customer of the company. If she approves of the new customer, she informs the marketing employee via a telephone call to load the new customer’s details, including his/her username, on the sales system and the amount that she feels that the customer quali es for as his/her initial credit limit. e marketing employee logs on to the sales system by using the general nance department user ID and password to load the new customer on the system. Customers are always granted 30 days to settle their accounts, but the marketing manager has the discretion to issue credit limits up to R10 000. Customers can request to have their credit limits increased. e request should be made via email and directed to the marketing manager at marketingman@fammag.co.za. She makes a decision based on whether or not the customer has placed regular advertisements with the company, in which case she increases the credit limit to R10 000 on her computer by using the general nance department user ID and password to gain access to the system. e credit manager has indicated that he is not pleased with the current system as many of the customers whose credit limits are being increased are actually the ones defaulting on their accounts. For all advertisement requests made by existing customers, the customers email their advertisements through to the marketing manager, who approves the publication after scanning the contents. Recording of the sale At the end of each month, the marketing manager emails a report to the nancial accountant informing him of the advertisements that were published during the month, the username of the customer to whom the advertisement relates and the amount to be charged. e accountant logs onto the revenue system and records the sale by processing a journal entry for the amount noted in the email received from the marketing manager. Collection of cash Customers are permitted to pay their accounts via electronic funds transfer or by direct deposit into the company’s bank account. e nancial accountant logs into the company’s bank account and identi es all payments received with customer usernames, allocates the payments to the customers’ accounts and emails the customers an acknowledgement of receipt. Where the nancial accountant is unable to nd customer usernames on the system, he records the income in a miscellaneous account until the customer contacts the company. If a customer does not contact the company within 90 days of depositing the money for an invoice or an acknowledgement of receipt, the money is moved to a staff party fund. Debtors who have not settled their accounts within 90 days are handed over to the company’s collection agency. Some debtors have contacted the company informing them that they have indeed settled their accounts as agreed via direct bank deposit, but have lost their proof of payment. REQUIRED Identify and discuss the weaknesses in the revenue and receipts cycle above and make suggestions to address them. [32] Question 9 LEVEL 2 Weaknesses, risks and recommendations [20 marks] You are a trainee accountant on the audit of Doorbell (Pty) Ltd (Doorbell) for its nancial year ended 30 September 20X1. Doorbell is a wholesaler of kitchenware, table-top and home décor products. You have been tasked with auditing certain aspects of the company’s revenue cycle. All sales to customers are on credit, and very little computerisation is used in the company’s business processes. From enquiries with client staff and from the observation of cycle activities, you have noted the following: Credit management Retail customers wishing to open a credit account with the company must phone Doorbell’s credit controller and provide their business details. e credit controller then enters the customer’s details on the computer system, and also sets a credit limit for the customer’s account based on the customer’s credit needs. You have determined that sound controls are in place regarding the identi cation of longoutstanding and uncollectable debt. Sales orders and approval Customers place sales orders with Doorbell by telephone. Any one of two sales order clerks writes down the order on a blank notepad after requesting the customer’s account number. e sales clerk ensures that the account exists by referring to an official list of customers (prepared on a daily basis from the debtors ledger by the credit controller) and that the customer is still within his/her credit limit. After writing the order quantities and inventory codes of products ordered, the order clerk signs and dates the order as evidence of approval. You have not identi ed any concerns regarding the picking of goods. REQUIRED Describe the internal control weaknesses and the associated risks in the above system description of the revenue cycle at Doorbell (Pty) Ltd. Also describe the recommended control(s) that should be put in place in order to prevent the consequences associated with each risk for each identi ed weakness. Present your answer in tabular form. [20] SUGGESTED SOLUTION TO QUESTION 9 CREDIT MANAGEMENT 1. a) Weakness i) ii) No credit background checks are performed on the creditworthiness of an applicant. (1) Credit limits are based on the customer’s needs rather than on his/her credit history and/or business references. (1) b) Risk Doorbell (Pty) Ltd risks selling goods on credit to customers who cannot settle their debts, which could lead to possible debt writeoffs and consequent nancial losses. (1) c) Recommendations i) Each potential new credit customer should complete a preprinted credit application form and submit trade references. ii) The credit controller should perform a background check (1) on a potential new customer’s trade references and credit status with credit bureaux. (1) iii) Based on the results of the credit check, the credit controller should set an informed credit limit on the amount of debt a particular customer might incur and record it on the credit application form. (1) iv) The debtors ledger should be reviewed by the nancial manager on a regular basis for new debtors added; in addition, he/she should agree the additions to a supporting approved credit application form. (1) SALES ORDERS AND APPROVAL 1. a) Weakness A pre-printed, sequentially numbered order form is not used to record sales orders from customers. (1) b) Risks i) Sales orders could go missing if there are no means of identifying them owing to their not being numbered sequentially. (1) ii) The potential for errors and missing order information is increased when an order is made out on a blank sheet of paper, as there are then no form details with which to guide the order clerk as to what information is needed (e.g. the account number, the customer’s name and the quantities ordered). (1) iii) It will make it more dif cult to cross-reference other documentation (such as the invoices) to sales orders, thereby increasing the risk of un lled sales orders. (1) c) Recommendation A multicopy, pre-printed, sequentially numbered internal sales order should be completed for each order, with one copy being led in a pending sales order le for follow-ups. (1) 2. a) Weakness No additional validity check besides the request for an account number is performed by the sales order clerk on the customer placing the order. (1) b) Risk Despite providing an account number, the person phoning might not be the genuine customer, which could result in a credit sale that the account holder cannot, or legally will not, settle. (1) c) Recommendation The sales order clerk should request that the customer provide pertinent details (ID number, address, contact details etc.) that should be compared to the information on the of cial list of customers in order to con rm that the customer is genuine. (1) 3. a) Weakness No inventory availability check is performed before the sales order is accepted. (1) b) Risk i) ii) There might be insuf cient inventory and, if the order is processed, there will be short-deliveries leading to possible cancelled sales and/or customer dissatisfaction. (1) A back-order system cannot be maintained effectively if customers are not informed of inventory shortages before an order is accepted, as these shortages might be identi ed too late (owing to the delay, customers might cancel ordered items that are not in stock). (1) c) Recommendation i) ii) SALES ORDERS AND APPROVAL In order to con rm inventory availability, the sales order clerks should have access to an up-to-date of cial inventory list that they should consult while taking down an order. (1) Any inventory shortages should be referred to a back-order system, if the customer agrees. (1) 4. a) Weakness There is an insuf cient segregation of duties between the initiation and the approval of sales orders, as the order clerks who initiate the orders are also allowed to approve them. (1) b) Risk The sales order clerks might make out sales orders to unauthorised parties (customers not on the debtors ledger) or customers who have exceeded their credit limits, which could lead to possible non-payment by such parties. (1) c) Recommendation All sales orders should be submitted to the credit controller for approval before any further processing takes place. (1) Available marks [23]; maximum marks [20] Notes: When looking at the suggested solution you will note that only weaknesses, risks and recommendations relating to credit management and sales orders and approvals were included in the solution. is is because these were the only functions for which information was provided in the case study. You cannot include functions for which there is no information in the case study. Another important aspect to take note of is the fact that one weakness can have more than one risk and more than one recommendation. Question 10 LEVEL 2 Weaknesses, risks and recommendations [23 marks] Leonard Langley was recently appointed as the assistant nancial manager of Trucker Tools (Pty) Ltd (Trucker Tools), a wholesale distributor of vehicle parts serving the trucking and courier industries. One of Leonard’s rst tasks was to solve internal control problems in the revenue cycle. All sales made by the company to its customers are on credit, and the company performs local deliveries using its own staff and delivery vehicles. Computerisation in the company is minimal. Trucker Tools’s revenue cycle, from warehousing to recording of sales, takes the following form: Warehouse, dispatch and delivery e warehouse receives a copy of the picking slip from the sales order department soon after a sales order has been approved. e slip indicates the items to be picked from the warehouse shelves, in addition to the customer’s details and the delivery address. e picking of goods is the responsibility of Henry Crause, the storeman. He also creates a delivery note in duplicate for all the goods picked. After picking, the slip is signed by Henry and led directly in the warehouse manager’s office. e goods are then transferred by trolley from the warehouse to the dispatch area, together with the delivery note. As they enter dispatch, the dispatch clerk, Victor Msimane, immediately starts to pack the goods into boxes. e security guards at the exit gate report to the dispatch area and assist Victor to load the packaged items onto the delivery vehicle, thus saving a considerable amount of time and enabling the security guards to experience the operations of the business rst-hand. Upon delivery of the items to the customer, the driver responsible for deliveries, James Mann, requests him/her to sign the top copy of the delivery note (which carbon-copies the one beneath) and hands the top copy to the customer. e second copy is returned to Trucker Tools. Invoicing Upon returning to the company premises, James Mann hands the second copy of the delivery note – signed by the customer – in at the invoicing office. e invoicing clerk, Bonani Fumba, prepares a pre-printed, sequentially numbered invoice in triplicate for each delivery, cross-referenced to the corresponding internal sales order. In order to expedite the process of debt collection, Bonani sends the original of the invoice to the customer (by postal mail) as soon as possible after invoice preparation. e second copy of the invoice is presented to the bookkeeping office for recording in the nancial records, while the third copy is led in the pending invoice le. On a regular basis, the senior bookkeeper checks the invoices in the pending invoice le for sequential numbering (in order to ensure that there are no missing invoices) and for matching to the delivery note brought back by James Mann after it has been signed by the customer (in order to ensure that an invoice has been created for each delivery note). Recording of sales e accounts receivable clerk, Helen Troy, is responsible for recording sales in the sales journal. After recording invoices for the day, the senior bookkeeper reviews the accuracy, completeness and proper cut-off of the recorded sales in the sales journal by agreeing each entry in the journal with the supporting invoice and delivery note. She also ensures that an entry in the journal exists for each invoice. At the end of the month, Helen prepares debtor statements from the debtors ledger for mailing to customers. Leonard did not nd any particular weaknesses in the credit management and sales returns areas of the revenue cycle. REQUIRED Describe the weaknesses and the associated risks in the above system description of the revenue cycle at Trucker Tools. In addition, for each weakness identi ed, describe the recommended control(s) that should be put in place in order to prevent the risks associated with the weakness. Present your answer in tabular form. [23] Question 11 LEVEL 3 Weaknesses, risks, decrease in gross pro t and recommendations [40 marks] You are an internal audit manager employed at WTK Inc. (WTK), a rm of registered auditors and accountants. One of the rm’s clients is Autonovation (Pty) Ltd (Autonovation), a company that sells vehicle products to the public, operating from large retail stores situated across the country. Each store is responsible for keeping its own set of accounting records, although some reconciliations are performed at head office. e following matters have come to your attention: Extract from the system description of sales function at the Kimberley store Sales to customers can either be on credit (for pre-authorised account holders) or for cash. After selecting products, customers proceed to the sales clerk counters. In order to ring up a sale, a sales clerk logs onto the nancial application on the computer system using a common username and password (the username is saLescLerk123). Credit customers must show a store card on which an account number appears. The clerk keys in the number in order to display the customer’s account details on the screen. New credit applicants are referred to the sales manager’s of ce before being able to buy products on credit. Cash customers do not have to provide any form of identi cation. Products are scanned with a barcode scanner. Should the customer’s credit limit have been reached, the clerk enters an override code if the clerk deems the customer’s reason for exceeding the credit limit to be reasonable. Credit customers receive a printed, sequentially numbered sales invoice. Cash customers receive a printed sales quote. Sales clerks can enter a discount percentage for cash sales by using their discretion, even though (according to sales clerks) this function is never used. (Note: the sales clerks’ commission is based on net sales.) Goods are packed into shopping bags at this stage. Cash customers proceed with their products to a cashier at the exit, hand the sales quote to the cashier and pay the amount due. A sequentially numbered cash invoice is printed by the cashier and handed to the customer after it has been stamped ‘Paid’. The customer then exits the store. Credit customers leave the store directly after receiving their sales invoice from the sales clerk. Extract from the internal audit report on the system of cash receipts at the George store The gross pro t percentage of the George store fell from 30% in quarters one to three to 25% in quarter four (the year-end inventory count has already taken place). A replacement cashier was appointed at the beginning of the fourth quarter, which coincided with a signi cant increase in the issuing of written cash receipts instead of printed cash invoices. Management of the store had not yet detected the decrease in the gross pro t percentage, and showed surprise when asked about the matter. The store manager con rmed that, although head of ce does not generally approve of this, the issuing of manual cash receipts is allowed in emergency cases. As no formal policy document could be provided by the store manager on the regulations applying to the use of manual cash receipts, this query was referred to head of ce. According to the cashier, frequent network failure between his terminal and that of the sales clerks compelled him to write out manual cash receipts, as his terminal is dependent on the sales quote created on the system by the sales clerks. The computer system does not allow him to create a cash invoice if a sales quote has not previously been generated by a sales clerk. (The cashier keys in the sales quote number in order to call up the quote details on the screen.) According to the store manager, she is aware of the network problem. When a computerised cash invoice is created, sales are automatically recorded in a pending sales le. Hand-written cash receipts, however, must be manually recorded in the le, which is posted to the general ledger the next day when the sales amount in the le is reconciled with the cash deposit slip. The cashier is responsible for performing this reconciliation, recording manual receipts to the pending sales le and posting the le to the general ledger. He is also responsible for issuing stationery to company staff. Request by Autonovation to assist with the implementation of the sales returns function e accounting department at the head office of Autonovation has requested your rm to advise the company on the internal controls that should be implemented over its sales returns function. To date, the company has followed an informal approach to sales returns, owing to the limited number of such returns. However, increased sales have necessitated the formalisation of controls for roll-out across all stores. Management is prepared to establish sales returns counters at each store, staffed by a sales returns clerk. e nancial application currently enables the creation of both goods return vouchers and credit notes. Returns are made in person by customers. REQUIRED 1. With reference to the information contained in the extract, describe the de ciencies in the sales function at the Kimberley store. Explain also the risks associated with the de ciencies and describe the recommended controls that should be put in place in order to minimise the risks. (16) 2. With reference to the information provided, discuss what might have led to the decrease in the gross pro t percentage of the George store and the delay in the detection thereof. (Refer to the George scenario, but allow the information in the Kimberley scenario to inform your answer.) 3. Describe the controls that Autonovation should implement in the sales returns function (15) of each store in order to ensure that the control objectives of validity of sales returns recorded in the nancial records are achieved. (Refer to the information provided in the request, but allow the Kimberley and George scenarios to inform your answer. Do not include controls for previously stored transaction and master le data.) (9) [40] Question 12 LEVEL 2 Weaknesses, recommendations, internal controls, role players and documents [41 marks] You are the internal auditor employed by South Peninsula Cleaning Services (Pty) Ltd (SP Cleaning), a provider of cleaning services to office blocks in an around the South Peninsula area. e business has been in existence for the last ve years and has grown 10-fold over that period of time. e administrative function is performed and takes place from the home of the owner and now chief executive officer, Mrs Radcliff. When the business started up, Mrs Radcliff could perform the administrative function because she had only one client. Today, Mrs Radcliff employs the following employees to perform the administrative function of the business: Mrs Bray – administrative clerk Mr Adams – sales and marketing manager Ms Britton – operational staff co-ordinator Mr Jikijela – nancial manager. At the previous nancial year-end, the external auditors were concerned about the revenue and receivables process and requested SP Cleaning to map the process for their review for the following year’s statutory audit (i.e. the current audit). All new and existing business is handled by Mr Adams. In his position as sales and marketing manager, he is authorised to enter into contractual agreements with customers to provide cleaning services to them. Customers can only make use of SP Cleaning if they have a signed contractual agreement with the company. On the rst working day of each month, Mrs Bray creates a manual sales order based on the agreement between the customers and SP Cleaning for cleaning services. e sales order is authorised by Mr Adams after he inspects the agreements to con rm the number of working days. e original sales order is kept in a book and the carbon copy is sent to Ms Britton so that she can co-ordinate the cleaning staff for the month ahead. Upon receipt of the sales order, Ms Britton plans the roster for the cleaning staff. e SP Cleaning model is based on two shifts – an early morning and a late afternoon shift. As only office blocks are serviced, the business model is designed to provide cleaning services in the administrative offices before the customer’s staff arrive for work as well as after the customer’s staff leave work. Ms Britton visits the office block locations on a regular basis to make sure that supervisors and cleaning staff are doing their work and also to handle queries from customers. All customer queries are logged in a query book used by Ms Britton to assess cleaning staff performance and also in cases where disputes arise with the Department of Labour. At the end of each month, all cleaning staff and supervisors complete their monthly time sheets and this is reviewed by Ms Britton. She then uses this information to complete a service delivery form. e service delivery form re ects the following: Sales order number Month of service Cleaning staff and supervisor on duty for the speci c office block Number of hours worked by each staff member based on the authorised time sheets e service delivery form is reviewed and signed off by Mrs Radcliff, who is responsible for all senior staff, including Ms Britton. e service delivery form is then sent to Mrs Bray for processing. At month-end, Mrs Bray creates the sales invoices for customers based on the following documents: Original sales order in the order book Service delivery form sent to her from Mrs Radcliff e sales invoice is made out in duplicate in an invoice book. e carbon copy sales invoice is kept in the invoice book and the original sales invoice is sent to the customer for payment. e general customer payment terms are one calendar month from statement date. e debtor’s statement is created and sent out with the original sales invoice on the last of every month. ere are no unpaid invoices from the previous months as all customers comply with their contractual agreement with SP Cleaning. ere is only a current balance on the debtor’s age analysis as a result of this. Note: All documents are pre-printed and pre-numbered. REQUIRED 1. Identify the internal control weaknesses based on the scenario above. For each weakness identi ed, explain the consequence(s) and make recommendation(s) for improvement. [11] 2. a) Identify the internal controls in the revenue and receivables process of SP Cleaning, as outlined in the scenario, for the following activities: i) Receiving and processing customer orders ii) Granting credit to customers iii) Delivering the service b) For each internal control identi ed, indicate who the role players are and what documents are used in the internal control. Present your answer in the following format: INTERNAL CONTROL ROLE PLAYERS (1 mark for each internal control) (1 mark for each relevant role player) DOCUMENTS (1 mark for each relevant document) [30] Question 13 LEVEL 2 Recommendations [14 marks] You are a rst-year trainee accountant employed by an audit rm to work in its internal audit department. One of your rm’s internal audit clients is GameZone (Pty) Ltd (GameZone), a company that operates in the family entertainment industry. GameZone’s operations include an indoor laser games compound, where people can simulate a battle using laser-beam guns. Each participant receives a laser gun connected to a battery-operated body harness that can detect light beams, upon which the harness registers a shot received from another player. Up to four teams of ve people each can participate in a round lasting 30 minutes and costing R50 per person. During the game, the gameplay computer collects all game data (e.g. those players shot and by whom, how many times a person was hit and the ring accuracy of each person). During busy periods, up to R12 000 a day is collected from the laser games compound. Mr Mark Costa, owner of GameZone, has con ded to you that he believes cash is being misappropriated in the laser games operation. You have obtained the following information: Participating players must pay the required fee before a game commences. Receipts are printed by the compound’s cashier from a stand-alone point-of-sale computer connected to a cash register. Players pay either with cash or with a bank card using a card-swipe machine. Cheques are not accepted. e point-of-sale computer is connected neither to the gameplay computer nor to the computer used by Ms Betty Colt, the bookkeeper. A duty manager oversees the smooth working of all GameZone’s operations, while Mr Costa’s wife, Mrs Arcadia Costa, assists with nances and accounting in general. Ms Colt has told you that she occasionally ful ls the duty of cashier at the laser games compound in the evenings when casual staff members do not show up for work and to ‘supplement my meagre income’. Daily cash takings for all the operations at GameZone are stored in Ms Colt’s office inside a reproof safe, together with the cash receipt report printed out from the point-of-sale computer. Either one of the two keys kept by Mr Costa and Ms Colt respectively can open the safe. Ms Colt is responsible for preparing a deposit slip for each day’s total cash takings. Banking is done weekly, and when the bank-stamped copy of the deposit slip is returned after banking by the company’s messenger, Ms Colt records the deposits in the cash receipts journal. A bank reconciliation is prepared on a quarterly basis by Ms Colt. You have not been able to nd any indication that the past year’s bank reconciliations have been reviewed. REQUIRED Recommend the controls that you would suggest be implemented at GameZone (Pty) Ltd in order to reduce the possibility of the misappropriation of cash in the company’s laser games operation. Ignore the effect of any computerised access or input controls. [14] Question 14 LEVEL 3 Recommendations [22 marks] Handyman Wholesalers (Pty) Ltd (Handyman) distributes a wide range of hardware and paint products to retailers across South Africa. e audit rm by whom you are employed as a senior auditor has been requested to audit the company’s nancial statements for its nancial year ended 30 September 20X1. A trainee accountant on the audit has obtained the following system description of the company’s revenue cycle: Credit management All sales to customers are on credit. e company’s credit management office is staffed by Ms Ellie Amber, the credit controller, who is responsible for: performing creditworthiness checks on credit applicants allocating credit limits to customers’ accounts on the debtors master le ensuring that each new customer receives a unique, computer-generated account number agging accounts on the system of those customers who are behind with payments or have other pending queries against their accounts. Receiving orders from customers e sales order department is staffed by two sales order clerks who report to the department’s supervisor, Mr Loyiso Mkwevu. All orders from customers are received telephonically by either one of the sales clerks on duty. A customer, after reference to a product catalogue, is required to read his/her order to the sales clerk by quoting the product code and quantity, after which the clerk enters the details on an on-screen internal sales order (ISO) on the sales order module of the company’s computerised nancial system. is module is linked to the debtors master le and the inventory master le. A back-order system is not in use. Picking of goods from the warehouse When an ISO has been generated by the system, the storeman, Mr Jimby Zin, receives a message on his computer that there is a pending sales order awaiting processing. He prints a copy of the ISO and picks the ordered goods from the warehouse shelves, whereupon he clicks on the ‘picked’ button on the on-screen ISO and the system automatically prints a multi-copied, sequentially numbered delivery note. Dispatch and delivery of goods to customers Goods are transferred to the dispatch area by Jimby Zin and dispatched via delivery vans, which pass through security checks at the exit gate of the company’s premises. Customers are required to sign the delivery note and retain a copy for their own records. When customersigned delivery notes have been returned to the warehouse, Jimby Zin accesses the computer system and clicks on the ‘ lled’ button on the on-screen delivery note in order to indicate that delivery has taken place. Invoicing and recording of sales A copy of the customer-signed delivery note is submitted to Ms Renée Plait, the invoicing clerk in the nance department, who on a daily basis accesses the invoicing module on the computerised nancial system and selects the ‘Create invoice’ option. A list of all delivery notes in sequential order appears, with those that have been agged as ‘ lled’ by Jimby Zin clearly indicated as such. Next to each lled delivery note, Ms Plait clicks on a button that creates an invoice. At the same time as the invoice is accepted by Ms Plait on the system, the sales journal and debtors ledger are updated with the sale. e nancial manager to whom Ms Plait reports is Mr Suyesh Khare. REQUIRED 1. Describe the computerised access and input application controls required in order to achieve the control objectives of the validity, accuracy and completeness of internal sales orders captured onto the nancial system by the sales order clerk. (12) 2. Describe the computerised input and processing application controls required in order to achieve the control objectives of validity, accuracy and completeness of invoices recorded in the nancial records of Handyman. (10) In both of the above questions, ignore controls relating to screen aids and any controls applicable to amendments to master le data. [22] Question 15 LEVEL 2 Key controls [8 marks] In October, you received the latest copy of the accounting and auditing circular from your rm. e main focus of the circular was key controls. e following extract intrigued you: Extract from accounting and auditing circular Key controls are those internal controls that provide reasonable assurance that material misstatement in the nancial statements (whether owing to fraud or error) will be prevented, or detected and corrected, before the nalisation of the entity’s nancial statements. It follows from this de nition that key controls are those that respond to risks that could result in misstatements in the nancial statements that are considered material. This means that, if a key control fails, there is a reasonable likelihood that material misstatement (error or fraud) may be present in the nancial statements. After you had read the extract, you decided to look at this list of controls as practised by your current client, Hot and Cold (Pty) Ltd (Hot and Cold): 1. Customers should be requested to provide orders by fax, email or physical delivery. 2. All written orders should be completed in blue pen. 3. All products obtained should be compared to the order form received from the sales department before they are moved to the dispatch department. 4. All order forms should be grouped in batches of 10 and bound by an elastic band. 5. Discounts should be authorised by a speci ed personnel member and granted in accordance with the organisation’s policy. 6. e organisation’s discounts policy should be displayed on the back of the sales department door. 7. Customers should always sign the delivery note as proof of having received the goods. 8. Customers may sign anywhere on the delivery note. 9. All delivery notes must be pre-numbered and kept in a locked drawer. 10. e sales department should have a scheduled tea break at 10h00 every morning. REQUIRED Indicate which of the controls listed above are key controls. [8] Question 16 LEVEL 2 Key controls and control objectives [10 marks] During the interim audit of Trust-Us (Pty) Ltd (Trust-Us), you requested system descriptions of all the different business cycles within the company in order to design the appropriate test of controls. An extract of the revenue and receipts cycle is presented below. e extract only deals with the revenue generated through the selling of tickets for speci c fundraising events undertaken by the staff of Trust-Us. Extract: Ticket sales The campaign manager determines the quantity of tickets needed to be sold for the purpose intended. Based on this, the campaign manager orders the appropriate number of booklets. For example, 1 000 pre-numbered booklets for the wheelchair fundraising project (each booklet containing 10 pre-printed and pre-numbered tickets) were ordered from the local printing company. On receipt of the booklets, the printer’s delivery man, as well as two administrative staff members of Trust-Us, count the number of booklets (and, on a sample basis, con rm that each booklet contain 10 tickets). All three applicable persons sign the delivery document of the printing company after the booklets are counted. The secretary of the nance team compiles a booklet register, containing the 1 000 booklets in numeric order. The booklet register is locked in the secretary’s ling cabinet to prohibit unauthorised access. The booklet register contains the following details: booklet number, details of the staff member who receives the booklet, a place for the signature of the staff member who receives the booklet, and lastly a place where the secretary and staff member sign (together with the number of unsold tickets in booklet) when the staff member returns a booklet (with unsold tickets in it). Staff members have ve weeks to sell the tickets and the staff member who sells the most tickets receives a cash incentive. When a staff member has sold all 10 tickets in the booklet, he/she brings the cash to the cash clerk, who records the cash received and issues a receipt (pre-printed and pre-numbered in quadruplicate) for the staff member. One copy of the receipt stays with the cash clerk, one copy is sent to the secretary to ensure that a staff member does not receive a second booklet before he/she has paid the cash of the rst booklet, and one copy is sent to the accountant for independent review purposes. At the end of the ve-week term, all staff members must return the booklets in their possession – the booklet to the secretary and the cash for sold tickets to the cash clerk (process as described above). The accountant performs a reconciliation at the end of the period between the tickets sold according to the secretary’s booklet register and the total cash received (and banked) by the receipts and deposit slips of the cash clerk. The accountant performs a reconciliation between the total tickets sold, total unsold tickets and total tickets available for sale. The accountant investigates any discrepancies found and records his ndings on the reconciliations. The accountant signs the reconciliations and submits it to the nance manager when a fundraising project is nalised. REQUIRED Identify the key controls from the above extract of the revenue and receipts systems description. For each key control identi ed also state the main control objective achieved by the key control. [10] Question 17 LEVEL 3 Key controls and tests of controls [10 marks] You are a member of the internal audit department of Quality Supplies (Pty) Ltd (Quality Supplies), a company that sells a range of household furniture and electronic appliances from its store located in a prominent mall in Durban. e company has a December year-end. e accounting system, which includes a point-of-sales system module, is located on a fully integrated system run on a local area network at the store. Extract: Sales process at company For existing customers At the start of each shift, the salesperson logs onto the point-of-sales system using his/her unique user ID and password, thereby gaining write access to the sales le and read-only access to the inventory and debtor master les. The system shuts down after three failed attempts at entering an unauthorised password. The salesperson asks the client to provide his/her Quality Supplies customer card. When the salesperson scans the barcode on the card, the following details appear on the screen: Name and surname Address Identity/passport number Outstanding balance Available balance Credit limit In cases where customers have left their Quality Supplies card at home, they are requested to produce their identity document, passport or South African driver’s licence. The ID/passport number appearing on the presented document is captured into the system and the same information appears on the screen as if the barcode on the customer’s card had been scanned. The system has logic tests built into it that recognise whether or not a valid ID or passport number has been entered. If the total purchase price does not cause the outstanding balance to exceed the credit limit, the sale will be approved and the customer will take immediate delivery of the goods purchased, unless he/she requires the goods to be delivered, in which case the goods will be delivered within three business days of the date of purchase. When the value of the goods purchased causes the outstanding balance to exceed the credit limit, the sale is loaded onto the system and stored in a sales pending le. At the same time, a noti cation is sent to the email address of Mr Jenkinson, the credit manager. The customer will not be permitted any more sales until his/her credit limit has been increased. The turnaround time for doing so is normally two working days. Mr Jenkinson logs onto the system using his unique user ID and password in order to gain access to the sales module. He reviews all such cases and applies his discretion when increasing the credit limit, subject to certain requirements. Mr Jenkinson documents his reason on the system for increasing the credit limit (e.g. regular payments received to date). In some instances, the customer may be required to provide three months’ bank statements in order to prove his/her increased disposable income. A log is created of all instances where Mr Jenkinson authorises an increase in the credit limit. It is then printed and reviewed by Ms Ballinger, the chief nancial of cer, at the end of each month and all exceptions (such as where there is no valid reason for the increase) are followed up with Mr Jenkinson. Ms Ballinger signs the log in order to indicate that she has reviewed it. Once Mr Jenkinson has documented the reason for the increase and authorised it, a sequentially numbered noti cation is sent to Mr Ndlovu, whose duty it is to capture and update the debtor’s master le. The noti cation received by Mr Ndlovu informs him that he needs to increase the client’s credit limit. Mr Ndlovu has write access to the debtors master le, and uses the authorising email as a debtors master le amendment form. Mr Ndlovu then les the noti cation. The customer is informed via SMS the day after the order has been placed in order to: inform him/her whether the order was successful or not advise him/her if his/her limit has been increased give him/her the date on which he/she will be able to take delivery of the goods. REQUIRED Identify the key internal controls in the sales system as described above and describe a test of control which the internal auditor could perform for each. Present your answer in tabular form. [10] SUGGESTED SOLUTION TO QUESTION 17 KEY INTERNAL CONTROLS TEST OF CONTROL BY INTERNAL AUDITOR The salesperson and Mr Jenkinson log onto the system using their unique user IDs and passwords. (1) Attempt to gain access to the system by using an incorrect user ID and password and observe that it shuts down after three unsuccessful attempts. (1) The salesperson scans the barcode located on the customer’s Quality Supplies card in order to gain access to his/her details. (1) Observe the sales clerk scanning the barcode on the customer’s Quality Supplies card to gain access to the customer’s details. (1) Alternatively the customer’s ID number or passport number is used to call up their details on the sales system. (1) Attempt to input an incorrect ID or passport number into the system in order to call up a customer’s details and observe that the system does call up any customer details. (1) The system performs credit checks before orders are processed. (1) Attempt to process an order for a customer which exceeds his/her credit limit and observe that the order is not automatically approved. (1) A log of all instances where Mr Jenkinson has authorised amendments to the credit limit of existing customers is reviewed by Ms Ballinger and all exceptions are followed up. (1) Inspect the log for Ms Ballinger’s signature. (1) Mr Ndlovu uses the sequentially numbered noti cation received from the system as debtors master le amendment form. (1) Extract a report indicating all customers whose credit limits have been increased during the course of the year and agree them to the corresponding sequentially numbered noti cations. (1) Available marks [12]; maximum marks [10] Notes: e rst important aspect to take note of is that the required asked you to identify key controls, thus controls that will help to ensure that the information in the accounting records and, in the end, the nancial statements are accurate, valid and complete. Another important aspect to take note of is the fact that the required asked for a test of control, therefore you should only have formulated one test of control. Question 18 LEVEL 3 Tests of controls [30 marks] You are the senior auditor on the audit of Quality Clothing (Pty) Ltd (Quality Clothing), a company that sells clothing to the public from its 15 stores located around South Africa and has its corporate head office located in Roodeport. e following is an extract of information that was obtained during the planning phase of the audit: Extract: Revenue and receipts cycle – credit purchases General Customers who purchase goods on credit are required to open an account with Quality Clothing. Authorisation of credit purchases The prospective customer needs to complete a credit application in order to purchase clothes on credit from one of the stores. The credit application may be completed in the store or on the company’s website. The following documentation is required in order to approve an individual as a new credit customer and to determine the customer credit limit: A completed new customer application form A certi ed copy of the customer’s identity document Proof of residential address Three most recent payslips or three most recent bank statements If an individual is unable to provide the documentation required above, the individual will not be permitted to open a customer account. For new customer applications submitted in the store, the documentation is scanned into the system and stored in a new customer pending le. For new customer applications submitted via the company’s website, the application, along with the documents that the prospective customer has loaded onto the system, is stored in a new customer pending le. Once a prospective customer applies to open an account, it takes four to ve business days to process the application. The company has several credit managers who log onto the system using their unique user IDs and passwords. They have read-only access to the information loaded onto the system by the prospective customer. If the credit manager inputs his/her user ID or password incorrectly more than three times, the computer automatically logs off. The credit manager performs the following checks: Con rms that the new customer application form has been completed correctly Inspects the supporting documentation Performs a credit check on prospective customer Once the credit manager is satis ed that the application and supporting documentation meet the company’s requirements, the credit manager approves the application by digitally authorising the application. An employee in the credit department who is responsible for loading the credit limits onto the customer’s account logs onto the system by using his/her unique user ID and password. The employee loads the new customer’s credit limit based on the disposable income noted on the application form as well as recommendations made by the credit manager. The new customer’s account is then moved from the pending le to an approved new customer le. The employee digitally signs off the activation as proof that he/she loaded the new customer’s credit limit in terms of the company’s policy. The new customer is mailed a customer card which takes two to three business days to arrive at the customer’s mailing address and is activated instore with the approved credit limit. The customer is required to come into a store, provide proof of identi cation and swipe his/her customer card in order to activate it. The system logs the date on which the card was activated in the store for the rst time. The system creates a log of all cards that have been issued as well as those cards that have not been activated in the store within 21 days, so that the approved customers can be contacted to determine whether they have received the cards or whether they are still interested in making purchases on credit. The reason why the approved customer has not activated the card is noted on the system. The card and offer to purchase on credit for the rst time expire 90 days after the card was mailed to the individual if the individual has not come into a store to activate the card. Once the 90 days has lapsed the individual is required to reapply. Increasing of credit limit Customers are permitted to request that their credit limits be increased. They are required to submit: motivation for the increase three most recent payslips or the three most recent bank statements. The credit manager reviews the documentation and determines whether or not the approval is warranted. If the credit manager is satis ed that the credit limit increase is valid, he/she completes a credit limit amendment form which is sent to an independent employee in the credit department to load onto the system. The credit manager signs the credit limit amendment form to indicate that he/she has reviewed and approved the increase in credit limit in terms of the company’s policy. An employee in the credit department logs onto the client’s account using his/her unique user ID and password. The employee changes the credit limit by using the information located on the credit limit amendment form. The employee signs the credit limit amendment form and digitally signs the change in credit limit as proof that he/she has made the change. A log of all changes to the credit limit is recorded. The log is reviewed by the nancial manager on a monthly basis and exceptions are followed up. The nancial manager signs the log as proof that he/she has reviewed the log and followed up on any exceptions. Orders Orders are taken in the following manner: By telephone In person When someone calls to place an order, the employee receiving the order follows the following process: Asks the customer for the customer number Repeats the order back to the customer Con rms that it is the customer by asking a series of predetermined security questions (e.g. what was your nickname in high school) Completes the order on an internal sales order form All calls are recorded for legal purposes. Where an order is placed by a customer in person, the customer is required to provide his/her customer card when placing the order, as well as proof of identi cation. Prior to approving the sale, the payment history of the customer is reviewed by the sales representative on the system, and where the customer’s account is in arrears for more than three months, the system will not permit the sale to proceed unless a manager overrides it. The system creates a log of all sales where managers have overridden it, and this log is followed up by the nancial manager on a monthly basis. The nancial manager signs the log as proof that he/she has reviewed the log. Where the purchase results in the customer’s credit limit being exceeded, the system will not process the order. The customer is informed that the order has exceeded his/her credit limit and the customer is requested to pay the balance that exceeds the credit limit. Should the customer not be able to pay for the balance above the credit limit, he/she will be required to reduce the value of the order by removing some products. REQUIRED Identify the key controls as described in the above scenario, and for each key control identi ed, describe the test of control that you would perform to determine if the control was working effectively. [30] Question 19 LEVEL 3 Tests of controls [15 marks] You are the auditor of Juicy M. is business sells a range of juice bottles to both the general public and wholesalers. Credit sales, which make up the majority of the company’s total sales gure, are made as follows: DEPARTMENT PERSON OPERATIONS Order Sales clerk The sales clerk receives orders telephonically, by mail or directly from walk-in customers. These are recorded on the company’s pre-numbered order forms. The company uses two copies: one is sent to the credit department, the other retained in the order department and led in sequential order. Credit Credit manager and debtors clerk Credit limits are determined for all new debtors based on their credit references. The credit manager records this limit in a debtors le. After each transaction, price lists are used in order to calculate the value of the transaction. This total value is used in order to verify whether the customer has exceeded his/her credit limit. If the limit has not been exceeded, the order form is signed by the debtors clerk and sent to the inventory warehouse. If the credit limit has been exceeded, the form is returned to the sales department. The debtor concerned is contacted. Each debtor receives a statement on a monthly basis. Should he/she have any queries about the statement, these are referred to the credit manager, who resolves them in conjunction with the debtors clerk. DEPARTMENT PERSON OPERATIONS Warehouse Storeman Once the signed order form arrives at the warehouse from the credit department, the storeman checks that the items requested are available. If they are, he/she signs the order form and forwards it to the accounting department. If the items are not available, it is returned to the sales department and the debtor concerned is contacted. Accounting Accounting clerk and accountant Once the approved order form has been received, the accounting department prepares a pre-numbered invoice in triplicate. The accounting clerk uses the price list in order to calculate the total amount due. One copy of the invoice is sent to the warehouse, where the goods are packed and distributed. The customer signs this copy as evidence of receipt of the goods and returns it to the accounting department. Once the signed copy of the invoice has been returned, the accounting department sends the original invoice to the customer. The signed invoice, which is led sequentially, is entered by the accounting clerk into the sales journal, where it is also led sequentially. The third copy of the invoice is sent to the debtors clerk, who updates the debtors ledger. At the end of each nancial year, the accountant performs a reconciliation between the debtors ledger and the debtors control account in the general ledger. REQUIRED Formulate the audit procedures relating to the internal control objectives of validity and accuracy that you would perform on the internal controls as contained in the credit sales system described above. [15] Question 20 LEVEL 3 Tests of controls [18 marks] You are the external auditor employed at Furniture Protectors Ltd (FP). You are assigned to audit the sales cycle of FP. FP designs protectors that can be placed on furniture to protect furniture against damage and dirt from young children and animals. It produces and sells a wide variety of protectors for all types and shapes of furniture. e following information relating to the sales system is available: 1. Mr Nieuwoudt, the customer relationship manager, is responsible for dealing with customers who want to make purchases of furniture protectors on credit. Mr Nieuwoudt requires proof of physical address and income as well as a customer identity document before a customer can make purchases on credit. Customers are also required to bring three copies of each of these documents with them, when they present the originals. This is done to reduce FP’s printing costs. The credit bureau is also contacted by Mr Nieuwoudt before setting the credit limit for a customer. A credit form is used, which contains the customer’s information and credit limit. The customer is requested to check and sign the form, which is led in a customer le with copies of the necessary documents listed above. The customer is given the latest price list and a number of pre-numbered order forms. Customers can complete the details of their purchase on the order form. 2. If the customers want to order furniture protectors, they contact the call centre telephonically, reading the number of the order form (which is in their possession) to the call centre agent. The call centre agent then prepares a pre-numbered sales order based on the information received. The call centre agent records the order form’s number as communicated to him/her by the customer on the sales order. Mr Nieuwoudt checks that the customers’ credit limit is not exceeded and authorises the sales order. A copy of the order is sent to the head storeman and to Mrs Marais, the accounting clerk. A copy remains in the call centre. Mr Nieuwoudt frequently performs a sequence check on the sales orders and investigates any missing numbers as well as any long-outstanding sales orders whose delivery notes have not been received. 3. The orders are packed by the storeman and a pre-numbered delivery note is made out. The guard at the gate checks that the goods agree to the sales order and delivery note before the goods leave the premises. The guard signs the delivery note as proof that he has performed the check. A copy of the delivery note is returned to the call centre, two copies are sent to the customer and one remains in the warehouse. 4. The delivery clerk, who is also the driver of the delivery vehicle, compares the delivery note with the original order form as prepared by the customer to ensure that the order is complete. In the event that the goods being delivered differ from the original order form, changes are made to the order form and the customer is required to sign next to the changes. The customer signs the delivery note on receipt of the goods. The delivery clerk signs the original order form and returns the form and a signed copy of the delivery note to the head of ce. These forms are handed over to Mrs Marais. 5. Mrs Marais compares the original order form, delivery note and sales order with one another and investigates any differences. Mrs Marais then makes out a pre-numbered invoice. Mr Benadie checks the calculations on the invoice and that the latest prices were used. Mr Benadie signs the invoice. Invoices are printed and sent to customers. Monthly statements are sent to debtors via email. 6. Mrs Marais posts the invoices to the sales journal and debtor ledger at the end of each week. Mr Swartz, the assistant accountant, posts the sales journal to the general ledger on a monthly basis. Mr Patterson, the accountant, checks the postings on a sample basis. Debtor reconciliations are performed by Mr Patterson, and checked and signed monthly by Mrs Morris. REQUIRED Describe the test(s) of control you would perform to test the operation of each control identi ed above. [18] 1 2 3 4 5 Deal with incorrect controls and/or controls that are not there, and are stated as such by means of the words ‘no’ or ‘not’. 8 marks = 8 weaknesses. Take note of the goods being sold; they might affect the answer, as not all of the goods might be packed in boxes. Start thinking about credit management controls. Thus, dispatch function. 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 These functions can thus not be included in the answer. Identify which are the remaining parts from your framework, as well as the internal controls in those remaining parts. The first part of the cycle that you need to think about deals with controls that should be there: the inspection of goods against the picking slip by the dispatch clerk; numerically sequenced delivery notes based on goods being dispatched; the two functions performed by the security guard; and the customer’s signature on receiving the goods. Well done: control is in place. Another control is in place. The security guard performs only one duty; the other one is thus the first weakness. Control is in place. The second part of the cycle that you need to think about deals with controls that should be there: the signed delivery note filed in a pending file; sequentially numbered invoices prepared; confirmation that invoices have been prepared for all returned signed delivery notes; checking that invoice dates are correct, missing delivery notes are followed up, invoices are cross-referenced to internal sales orders and delivery notes, and quantities and prices on prepared invoices are reviewed, as well as casting and calculations on invoices. Control is in place. Control is in place. Control is in place. The third part of the cycle that you need to think about deals with controls that should be there: the recorded invoices checked by a second employee – agreeing entries to supporting invoices and agreeing invoice amounts to amounts in sales journal; the numerical sequence is inspected; and debtors reconciliation is prepared and reviewed by a senior personnel member. Control is in place. Nothing else is mentioned for this function; the remaining controls, which you expected to find in this function but are not mentioned, are thus weaknesses. Refer to example question 1. Thus each weakness has to be addressed with the information that follows. Refer to example question 2. Linked to the weakness. Linked to the weakness, and specifically referring to revenue. Thirty-two marks divided by four (weakness, control objective, revenue assertion = 8 weaknesses). Refer to example question 1. Validity, completeness, accuracy. Revenue assertions = accuracy, completeness, classification, cut-off and occurrence. Refer to example question 1. Refer to example question 2. INTRODUCTION Refer to the guidance and the example questions contained in Chapter 6, as the principles and the approach remain the same. QUESTIONS Question 1 LEVEL 1 Control objectives [6 marks] Validity, accuracy and completeness of nancial information are the control objectives that management seeks to achieve in order to address the major risks relating to all the cycles. It is the responsibility of the audit manager on the engagement to ensure that the audit team knows which control objectives relate to the speci c cycle being audited, as well as the consequence for the entity’s nancial statements if these control objectives are not achieved. REQUIRED Using the table below, provide a description of the control objectives and the related risks of misstatement for the purchases transactions. CONTROL OBJECTIVE CONSEQUENCE FOR ENTITY’S FINANCIAL STATEMENTS IF CONTROL OBJECTIVE IS NOT ACHIEVED Validity Accuracy Completeness [6] SUGGESTED SOLUTION TO QUESTION 1 CONTROL OBJECTIVE CONSEQUENCE FOR ENTITY’S FINANCIAL STATEMENTS IF CONTROL OBJECTIVE IS NOT ACHIEVED Purchases Validity Invalid purchases: Overstatement of expenditure and accounts payable owing to ctitious recorded purchases (1) Overstatement of expenditure and accounts payable owing to unauthorised recorded purchases (1) Over- or understatement of expenditure and accounts payable if transactions are not recorded in the year to which they pertain (1) Overstatement of expenditure and accounts payable if recorded transactions are not supported by suf cient documentation (1) Accuracy Inaccurate purchases: Over- or understatement of expenditure and accounts payable if transactions are recorded at inappropriate amounts (e.g. calculation errors, incorrect price, incorrect quantity) (1) Under- or overstatement of expenditure and accounts payable due to incorrect classi cation of recorded transactions (1) Under- or overstatement of expenditure and accounts payable as a result of transactions being recorded in the incorrect accounts (1) Completeness Incomplete purchases: Understatement of expenditure and accounts payable due to unrecorded purchases (1) Available marks [8]; maximum marks [6] Notes: Six marks for three control objectives equals approximately two per control objective, but you should know that accuracy and validity have more aspects than completeness. e risk of misstatement is the consequence to the nancial statements. When looking at the suggested solution take note of the way in which it was formulated, for example overstatement and understatement. Question 2 Assertions [4 marks] LEVEL 2 e following scenarios indicate the relevant risk indicators applicable to the payments cycle: 1. Amounts prepared for payment are incorrectly determined. 2. Suppliers that are not on the payment schedule are paid. 3. Fictitious payments that never took place are recorded. 4. Not all payments made are recorded in the nancial records. 5. Fictitious/duplicated invoices are used for payment. REQUIRED For each of the scenarios mentioned above, indicate which assertion(s) will be affected. Provide your solution using the following tabular format: NUMBER ASSERTION(S) AFFECTED [4] Question 3 LEVEL 2 Weaknesses [7 marks] You have recently been appointed as the internal auditor of Minor (Pty) Ltd (Minor). During preliminary discussions with management, it was decided that you would focus on determining the need for goods as well as the ordering and the receiving of goods within the purchases and payments cycle. e following extract relates to a purchase transaction you observed: STAFF JOB DESCRIPTION Mr Radebe Procurement clerk Mr Tobias Warehouse clerk Mr Kromhout Warehouse supervisor Determining the need for goods Solly, the sales representative, wanted to make several photocopies of the recent price lists with a view to distributing them to prospective clients. However, he discovered that there was no more paper left for the machine. He asked Mr Radebe, the procurement clerk, to order 50 boxes of paper in order to be sure that the company did not experience further shortages. Ordering of goods When Mr Radebe received the request from Solly, he assured him that the paper would be ordered. He then proceeded to phone the rst supplier for whom he could nd a number in the Yellow Pages and asked them to deliver the 50 boxes of paper as soon as possible. He did not think it was necessary to complete any documentation. Receiving of goods When the supplier arrived at the warehouse with the boxes of paper, the warehouse clerk, Mr Tobias, realised that the supplier’s delivery man was a childhood friend whom he had not seen in years. He was so delighted to see him that he received the delivery without signing the delivery note. Mr Kromhout, the warehouse supervisor, prepared the goods received note based on the supplier delivery note in duplicate, after which he sent a copy to the accounting department. REQUIRED Identify the weaknesses in the abovementioned system. [7] SUGGESTED SOLUTION TO QUESTION 3 1. Determining the need for goods a) e company does not have a system in place to determine a need for stationery (e.g. regular checks to determine low levels). (1) b) No pre-numbered, multi-copy requisitions are completed and authorised. (1) 2. Ordering of goods a) e company does not have an approved supplier list – the rst available supplier was selected from the Yellow Pages. (1) b) No quotation was requested from the supplier and the availability was not con rmed either. (1) c) No purchase order was prepared. (1) 3. Receiving of goods a) Goods were not received in a designated receiving area. (1) b) Goods were not received by dedicated goods receiving staff. (1) c) e goods received note was not prepared based on the received goods but on the quantities as per the supplier delivery note. (1) d) Goods received were not checked for quantity, quality and description as contained on the delivery note. (1) Available marks [9]; maximum marks [7] Notes: Weaknesses equal functions/duties not performed. You need to have a thorough understanding of the cycles to be able to identify weaknesses, as you have to match your knowledge (framework) to the information provided in the case study. e case study only dealt with the following aspects of the purchases cycle: ‘Determining the need for goods’, ‘Ordering of goods’ and ‘Receiving of goods’, therefore your weaknesses can only include weaknesses in these three functions. Question 4 LEVEL 1 Risks [3 marks] ere are various categories of risks of misstatement relating to the nancial information produced in the purchases and payments cycle. Should a misstatement be material and not be corrected, the nancial statements will not be fairly presented. REQUIRED List the various categories of risks of misstatement, whether owing to fraud or error, that apply to the purchases and payments cycle. [3] Question 5 LEVEL 2 Risks [17 marks] You are the auditor of High Heels Ltd (High Heels), a shoe manufacturer. You identi ed the following weaknesses in the purchases and payments cycle during the audit of High Heels: 1. ere is not a process in place to determine which inventory is required for the production process before orders are placed. Rush orders are sometimes placed at additional cost. 2. Not all orders are placed using a written order form. 3. Not all orders placed are authorised. 4. Orders are placed with only one supplier. 5. A pre-numbered goods received note is not completed upon receipt of the goods by the receiving department. 6. ere is insufficient segregation of duties, as the departmental manager places orders, receives goods and makes payments to suppliers. 7. Goods delivered are not reviewed, nor is a comparison made between what was ordered and what was received. 8. Invoices received from suppliers are not compared with what was ordered and what was received. 9. Creditors’ reconciliations are not performed between monthly statements received from creditors and the creditor control account. 10. e cheque is submitted to the accountant and managing director for signing without any supporting documentation accompanying the payment. REQUIRED For each of the 10 weaknesses, identify the resulting risk(s) on the nancial statements. Note: Number each risk clearly. Question 6 [17] LEVEL 2 Risks [19 marks] You are the internal auditor on the audit of Protector (Pty) Ltd (Protector), a company that manufactures a wide range of protective cases and screens for mobile devices. Protector sells the cases and screens to a number of wholesalers and retailers around the country. e company has a February year-end. e following is an extract of the key points obtained during a discussion held with Mr Sijeke, the inventory controller; Mr Jordan, the chief buyer; and Ms Carter, the nancial accountant in September of the current year: Extract The company is considering implementing a new inventory system as it has not always been able to meet the demands of its customers. It attributes this primarily to the company’s running out of inventory on a regular basis, which results in it not being able to process additional orders. When an employee working on the production line notices that it is running out of a particular item of inventory, the employee calls Mr Jordan and informs him of the need for the inventory. Mr Jordan identi es three suppliers on the approved supplier list that are located closest to the factory and calls them to establish how quickly they would be able to deliver the inventory required. An order is placed with the supplier that is able to deliver the inventory the fastest. If the supplier requires a purchase order, Mr Jordan completes one and faxes or emails it to the sales representative at the supplier. There have been times when the production of certain products has been stopped temporarily while the company waited for the inventory to arrive at the factory. For orders where the production has stopped as a result of running out of inventory The inventory is received in the west wing of the warehouse by Mr Sijeke. The inventory is of oaded from the delivery vehicle and Mr Sijeke performs a quick inspection of the inventory to make sure that it is not damaged. The employee who informed Mr Jordan of the inventory needed is contacted and told to collect the inventory immediately so that production can continue. For normal orders The inventory is received in the west wing of the warehouse by Mr Sijeke. The inventory is of oaded from the delivery vehicle and Mr Sijeke performs a thorough check to see if the inventory is not damaged. The inventory is stored in speci c locations in the warehouse until a request for the inventory is received. The employee who identi es the need for the inventory contacts Mr Sijeke, who in turn has the inventory picked up and delivered to the section of the factory where the employee who contacted Mr Sijeke is located. Recording The creditors clerk records the credit purchase in the accounting records using the information noted on the invoice that is received from the supplier. Where a purchase order was used, the creditors clerk compares the information on the purchase order to the information on the invoice. If a difference is noted, the creditors clerk contacts the supplier to identify the cause for the discrepancy. If a discrepancy is still noted after the call, the creditors clerk records the credit purchase in the accounting records using the information located on the purchase order. Payment of creditors The creditors clerk performs a creditor’s reconciliation on a monthly basis and uses the reconciliation as the basis to determine the amount to be paid to the supplier. The creditor’s reconciliation as well as supporting documentation is presented to Ms Carter for review. If Ms Carter is satis ed that the creditor’s reconciliation has been performed properly and if she agrees with the amount to be paid to the supplier, she signs the creditor’s reconciliation and a cheque made out to the supplier. The supporting documentation and the creditor’s reconciliation are returned to the creditors clerk who is responsible for cancelling the supporting documentation and posting the cheque to the supplier. The company intends moving away from cheque payments to electronic funds transfers in the next nancial year. REQUIRED Describe the business risks affecting the purchases and payments cycle at Protector (Pty) Ltd. [19] Question 7 LEVEL 2 Risks and assertions [20 marks] Sky Paints (Pty) Ltd (Sky Paints) manufactures a range of household paints, for which raw materials in the form of resin, pigment, solvent chemicals and additives are sourced from various local suppliers and stored after receipt in the factory stores until needed in the production process. A procurement department is responsible for submitting purchase orders to suppliers, while an accounting department records all purchases and related liabilities. Controls in place in Sky Paints’ purchases and payments cycle include the following: On a weekly basis, the factory manager, together with the cost accountant, determines what the expected need for raw materials in the production process will be for the week ahead. is production budget is reviewed and authorised by the senior production manager. For orders placed with suppliers of raw materials, the purchase order must rst be approved by the procurement manager, who requires a cross-referenced purchase requisition before he signs the order as evidence of his approval. e procurement manager regularly checks whether the sequence of purchase orders is intact, at the same time matching each purchase order to a goods received note. He also investigates missing purchase orders, or where an order does not have a corresponding goods received note. Buyers in the procurement department are required to obtain at least three quotations from the company’s list of authorised suppliers before submitting the purchase order for approval by the procurement manager. When raw materials are delivered by suppliers and received at the factory stores, a receiving clerk scans a barcode attached to the outside of the packaging. As the materials are being scanned, the computer system automatically allocates the items to a materials received note containing the item code, a description and the quantity received. As part of year-end procedures, a senior staff member in the accounting department matches the date of recorded purchases as per the accounting records, with the date manually written by the receiving clerk on each purchase’s corresponding materials received note. (Note: e control is necessary, as Sky Paints’s purchases are not recorded concurrently with the generating of materials received notes.) Item prices are pre-arranged with suppliers and stored in an item price master le. It is not possible for accounting staff to change prices in the master le and a strict control system over item price amendments is in place. e accounts payable clerk in the accounting department performs monthly supplier statement reconciliations. e nancial manager reviews the reconciliations before payments to suppliers are made. REQUIRED Describe the risks that each of the above internal controls seeks to mitigate, and state the nancial statement assertion(s) affected by each risk. Where no assertion is affected, indicate whether or not the risk is operational in nature. [20] Question 8 LEVEL 2 Weaknesses, risks and recommendations [23 marks] You are one of the internal auditors of Africa Flight Delight Ltd (AFD), a company distributing food to airlines throughout South Africa. e company is fully computerised. One of the directors, Mr T. Mofokeng, approached you to evaluate their purchase cycle (excluding recording of payments). He informed you that, despite the overall effective internal controls that are in place, the company is still facing difficulties concerning its purchasing system, which has resulted in substantial nancial losses to the company. On request of a detailed system description on the purchases cycle of AFD, you received the following working paper: PREPARED BY: D.J. MOLEFE (AUDIT SENIOR) REVIEWED BY: A. DU PLESSIS (AUDIT MANAGER) COMPANY: AFRICA FLIGHT DELIGHT LTD SUBJECT: SYSTEM DESCRIPTION ON PURCHASES Purchase requisition Mr Naidoo (storeman) is responsible for preparing the purchase requisitions every month. Previously, he would telephonically request from the three airlines to which food is distributed the number of food packages required. Mr Naidoo has now simpli ed the process by using budgets based on market research. As a result, he completes the purchase requisition based on these budget gures, les the original requisition in a pending le and sends the other copy to the procurement department. Owing to Mr Naidoo’s workload, he sometimes allows junior warehouse staff members to ll in the purchase requisitions and send them to the procurement department on his behalf. Mr Naidoo commented that, although the process has been simpli ed, AFD still overestimates the quantity of food required, which results in an excess number of food packages being prepared, not sold and eventually exceeding their sell-by date. Ordering goods from suppliers Ms Stumke (buying clerk) electronically processes a purchase order based on the requisition received from Mr Naidoo or the junior staff member. All calculations on the purchase order are automatically performed by the computer, which also performs edit checks on the input of data and automatically addresses the purchase order to the correct suppliers based on the list of preapproved suppliers stored in the supplier master le. The computer also assigns sequential numbers to all system purchase orders thus created by Ms Stumke, who then les the purchase order sequentially so as to allow a senior staff member to follow up on any missing purchase orders on a regular basis. The other copies of the purchase order are then distributed as follows: Copy 1 is sent to the supplier. Copy 2 is sent to the receiving bay of the warehouse. Copy 3 is led as mentioned above. Copy 4 is sent to the accounting department. Copy 5 is sent to the requisition department. Receiving goods from suppliers Mr Swart (goods receiving clerk) is authorised to receive goods at the receiving bay of AFD, which is a separate, fenced-off area manned by a security guard at the main entrance who inspects every delivery vehicle that enters or exits. Accompanied by the delivery personnel, he also inspects supporting documentation. Recently, security cameras were installed to mitigate the theft of goods. Once they have delivered the goods, the supplier’s delivery personnel hand the delivery note to Mr Swart. He scrutinises the note for the reference number of the purchase order, which he enters into the computer. Once the computer has generated an onscreen goods received note (GRN) with standing data of the order, Mr Swart scans all the boxes received from the supplier, whereupon the computer automatically indicates any outstanding items, which are indicated as ‘not received’ on the electronic purchase order. Mr Swart also writes ‘not received’ next to the relevant items on the supplier’s delivery note. If any items scanned do not match the purchase order, the computer raises a warning and Mr Swart does not accept these items. As an additional check, Ms Stumke assists Mr Swart in checking a sample of the boxes scanned in order to perform a quality check and to ensure agreement between the description on the box and its contents. Ms Stumke also has access to the inventory system and can generate a GRN if necessary (e.g. if Mr Swart were off sick). Mr Swart is also responsible for distributing goods received notes to the relevant departments: Copy 1 is sent to the receiving bay. Copy 2 accompanies the goods during transfer to the warehouse. Copy 3 is sent to the accounting department. Copy 4 is sent to the procurement department. Recording of purchase Mr Louw is responsible for reviewing the recording process of purchases in the purchases journal after it has been generated electronically by the computer. The computer application implements the recording of a purchase based on the purchase order and goods received note generated electronically once Mr Swart and Ms Stumke have scanned in the goods received. The computer application automatically uses quantities on the system-stored GRN and the price per unit entered by Mr Louw (obtained from supplier-approved price lists) in order to record nal prices in the purchase journal. Nobody checks the values entered by Mr Louw, as they feel he is intelligent and would notice any error. Mr Louw reviews the electronic recording of the purchase and the corresponding liability (creditor), and ensures that the computer system matches the following documents: The purchase order The delivery note from the supplier, which has been scanned in The goods received note An invoice from the supplier, which has been scanned in Payment preparation Mr Vosi, the accounts payable clerk responsible for payment preparation, les all statements received from suppliers in a pending le, which task he leaves until the end of the month, if possible, or otherwise until he nds himself with time on his hands. Mr Vosi then performs a creditors reconciliation on-screen, where he enters the balance outstanding, as per the supplier’s statement, into the computerised system, where it is compared to the supplier’s balance as per the computerised master le. Mr Vosi follows up manually on reconciling the items. He is aware that most of the time AFD forfeits the discount that they would have received had they paid within 30 days, but has explained that he is struggling with the work overload, and believes the problem will be resolved in the future. Mr Vosi then accesses the supplier payment module on the computer in order to create the payment. He manually types in the name of the supplier that needs to be paid, based on the creditors statements received. The computer subtracts this amount from the creditors reconciliation saved in the master le, whereupon it automatically creates a remittance advice for each supplier needing to be paid. Ms Barnard (senior bookkeeper), who obtains all the relevant documentation received from Mr Vosi, performs the necessary checks. She then accesses the suppliers payment module on the computer system with her own password and indicates that the supplier is ready for payment. Mr Vosi then prints the payment schedule, attaches the supplier’s statements and reconciliation, as well as the relevant goods received note, the supplier invoice, the supplier delivery note and the purchase order for each purchase, making up the balance represented for payment. Paying the supplier Mrs Botha ( nancial manager) receives the relevant documentation from Ms Barnard once the latter has created the ready-for-payment notice. Mrs Botha then reviews the relevant documentation of the payment that needs to be made. If she agrees with it, she logs onto AFD’s bank account using her username and password and creates an ad hoc payment. She then manually types in the details of the supplier, the supplier’s bank account details and the amount that needs to be transferred, and clicks on ‘pay’. REQUIRED Identify and explain the weaknesses in the above purchases system. For each weakness identi ed, you should also recommend improvements to be implemented by Africa Flight Delight. Your report should address computerised controls only. Provide your solution using the following tabular format: NUMBER IDENTIFY AND EXPLAIN WEAKNESS RECOMMENDATION [23] Question 9 LEVEL 2 Weaknesses and recommendations [23 marks] Mystic Falls Beverages (Pty) Ltd (Mystic Falls) is a distributor of a popular beverage, ‘O’ Positive. It purchases its beverages from a supplier called Pure Inc. and various other local manufacturers, and thereafter distributes the beverages throughout South Africa. It is the only supplier in South Africa of ‘O’ Positive. Mystic Falls has an office and warehouse in Saldanha, Western Cape. e beverages are shipped by sea and delivered in South Africa at the port of Saldanha. e beverages are then brought to the warehouse by Cape Winelands Transport where they are stored until they are sold to customers in South Africa. Mystic Falls is a cash-only business and does not provide any credit. Mystic Falls has been in existence for the last three years servicing its numerous customers, but has had no formal control processes in place and has therefore been avoiding the external auditors. e chief executive officer, Damian Salvatore, has decided to legitimise the business and get control processes in place before the external auditors arrive at year-end, 31 March 20X1. Because Mystic Falls does not have any control processes in place, you were approached to provide consulting services. As you were required to assess all the control processes in Mystic Falls, you decided to start off with the purchases and the inventory management processes. You had a meeting with the chief operating officer, Steve Salvatore, the brother of the CEO, and jotted down the following notes of the purchases process: Owing to the long lead times to receive inventory, Bonita Bennett, the administration clerk, places an order via telephone to Pure Inc. to purchase the inventory. is is based on the amount of inventory Mystic Falls will require to service its customers for at least six months. e quantity that Bonita Bennett orders is based on her instruction from the Salvatore brothers. Once the beverages arrive and are delivered to the warehouse, the goods are counted by Jim Gilbert, the warehouse clerk, and stored in the warehouse until they are sold. After Jim Gilbert stores the beverages, he takes the documents he receives to Marc Donovan to update the inventory management spreadsheet that he created in Excel to manage the entire inventory. Customers place orders for beverages with Carol Forbes. After receiving an order, she calls Jim Gilbert and instructs him to send Mystic Falls’s driver to deliver the beverages to the customer. As soon as the driver leaves the warehouse to deliver the beverages, Jim Gilbert calls Marc Donovan to update the inventory management spreadsheet with the quantity of beverages that has left the warehouse. After your meeting, you went to your temporary office in Saldanha and analysed the situation. You are aware that the company’s only assets are the inventory and cash in the safe, as the Salvatore brothers do not have con dence in the South African banking system. All premises in Saldanha are leased and Pure Inc. is not a creditor as debt is settled to a trust, the Original Family Trust, once inventory arrives at the Mystic Falls premises. REQUIRED 1. Identify the weaknesses in the purchases process based on the scenario above. (8) 2. For each weakness identi ed, recommend an improvement(s) to address the identi ed weakness. (15) [23] Question 10 LEVEL 2 Recommendations [12 marks] Your audit client, Universal Ltd (Universal), deals mainly in the retailing of electronic equipment sourced from various local and international suppliers. e company owns a central warehouse in Gauteng, from which it distributes its products to its stores around South Africa. e company follows a set procedure when receiving goods: e goods receiving department receives a copy of an order con rmation from the ordering department. e goods receiving department of the central warehouse has a number of goods receiving clerks working in the warehouse. Upon arrival of the supplier’s delivery vehicle, goods are offloaded into the goods receiving area. Any available goods receiving clerk then obtains the delivery note (two copies) from the supplier’s truck driver and checks that the quantity of the received goods corresponds with the supplier’s delivery note. e goods are then transferred from the goods receiving department to the warehouse. REQUIRED Recommend improvements to the current receiving of goods function of Universal at its central warehouse. [12] Question 11 LEVEL 2 Key controls and assertions [6 marks] Dexford Ltd (Dexford), a paper-manufacturing client based in the Western Cape, has established a division publishing magazines and textbooks. One of the current projects on which it is embarking is the publication of an educational magazine on auditing. Because your audit rm has been engaged in Dexford’s audit for the past three years, the editor in the publishing division has requested assistance in evaluating a case scenario based on the system implemented in his division. You may assume that there is no independence issue that might arise from your participation. A reputable academic in the eld of auditing has supplied the editor with the following de nition of key internal controls: they provide reasonable assurance that material misstatements in the nancial statements will be prevented, or detected and corrected, and respond to risks that could result in misstatements in the nancial statements that are considered material. Case study Management style The division’s management is of the opinion that its recruitment process is of such a high standard that the staff it employs are responsible, which ensures that the company does not have to supervise and police them. The purchases and inventory system is open for all staff to access; as a result, all staff can add and delete master le and transaction data. Requisitioning and ordering of goods and services When inventory is needed, an email is sent to the buyer, who creates an order and emails it to the supplier of his choice. The order is printed and led sequentially. Management does not believe that the system should include an order number, as it might take up more space on the database. The procurement manager is responsible for the manufacturing divisions’ orders; he only follows up on inventory not delivered before year-end. Receiving of goods and services, and recording of purchases The delivery note is signed by the receiving clerk after he has checked the quality and agreed the quantity and description of the received inventory to the details on the supplier’s delivery note. A sequentially numbered goods received note (GRN) is prepared and printed for all inventory received based on the actual quantity received before the goods are transferred to the warehouse. The warehouse clerk is responsible for receiving the inventory items in the warehouse, when they are being transferred from receiving. He compares details of the items transferred to the details as per the GRN and signs the GRN after the comparison has been completed. On a weekly basis, the buyer prints a report that lists deliveries and ordered goods, and follows up on any long-outstanding orders. The accounts payable clerk keeps a le containing all the GRNs received from the warehouse, in numerical order. Upon receipt of the supplier invoices, the invoices are matched to the corresponding GRN and recorded in the purchases journal, whereafter they are automatically recorded in the creditors ledger, the inventory system and respective general ledger accounts by the system. The senior accountant regularly reviews the GRN le for overdue GRNs for which invoices have not been received and follows up on them. REQUIRED Identify and discuss the key internal controls, taking into account the information above, which the auditor can rely on in order to meet the assertions. Ignore those internal controls that are important for management only. Your answer should be presented in such a manner that the key internal controls are discussed per purchase assertion. [6] SUGGESTED SOLUTION TO QUESTION 11 ASSERTION: KEY INTERNAL CONTROL 1. Only genuine purchases are recorded. (Occurrence) (1) Goods received notes are prepared based on actual inventory delivered. (1) 2. Purchases are recorded at the correct amounts. (Accuracy) (1) The warehouse clerk compares the details of the items transferred from receiving to the warehouse to the details as per the GRN. (1) 3. Purchases have been correctly classi ed, summarised and posted by the accounting system. (Accuracy) (1) Purchase transactions are automatically recorded in the creditors ledger, the inventory system and respective general ledger accounts by the system. (1) ASSERTION: KEY INTERNAL CONTROL 4. All purchases transactions are recorded and none has been omitted. (Completeness) (1) The senior accountant regularly reviews the GRN le for overdue GRNs for which invoices have not been received and follows up on them. (1) Available marks [8]; maximum marks [6] Notes: e rst thing you had to determine was the assertions relating to the purchases, thus the transaction assertions. In addition, you had to deal only with key internal controls, and a hint was given in the required stating that you had to ignore those internal controls that are important for management only. If the required asks you to present your answer in a speci c format, present your answer accordingly. In this instance, you had to present your answer according to the assertions. Question 12 LEVEL 2 Key controls and control objectives [16 marks] e following is a description of the purchase system in use at Funky Toys (Pty) Ltd: REFERENCE NUMBER INTERNAL CONTROLS REFERENCE NUMBER INTERNAL CONTROLS 1 Funky Toys purchases only from approved suppliers. The production manager and senior buyer will review all new supplier applications, based on the suitability of their prices and quality of their products. If suppliers are considered suitable, both the production manager and senior buyer will authorise the new supplier by signing off the new supplier application form. 2 All approved suppliers are stored on the company’s computer system based on an authorised new supplier application form. Only the nancial manager and production manager are allowed to capture any new approved suppliers on the computer system. Both managers have unique usernames and passwords assigned to them in order to conduct this procedure. 3 The senior accountant in the accounts department will print out the list of approved suppliers after being informed by the managers of any changes to the list. 4 The senior accountant distributes the list to all the purchase clerks on the oor. 5 The new suppliers normally send Funky Toys some documents on interesting special offers provided, as well as their of cial price list and terms and conditions on deliveries. REFERENCE NUMBER INTERNAL CONTROLS 6 All purchases made by Funky Toys are based on an authorised requisition. The system requires the number of an authorised internal requisition before allowing buyers to initiate the purchase order. The system is also programmed to select the appropriate supplier from the pre-approved suppliers stored on the entity’s computer system. 7 The computer automatically assigns sequential numbers to all system purchase orders created by Funky Toys. 8 The buyers of Funky Toys will complete the onscreen purchase orders by lling in the minimum information not already sourced from the requisition. 9 Once the buyers have completed the on-screen purchase order, the computer will automatically check all calculations on the purchase order. The computer will also conduct edit checks on input data. 10 The senior buyer will print a log of all purchase orders that are without a corresponding goods receiving note (GRN) number to follow up on un lled orders. 11 The receiving area is a clearly designated area which is safely secured. REFERENCE NUMBER INTERNAL CONTROLS 12 Once goods are delivered by the relevant supplier, the goods receiving clerk will obtain the purchase order reference number from the supplier delivery note. The goods receiving clerk will then key in the purchase order number on his/her tablet that will link it to the purchase order. The computer will also automatically populate an on-screen GRN. 13 The receiving clerk will then inspect the quality and the quantity of goods received against the supplier delivery note and purchase order. If the goods receiving clerk is satis ed with the delivery, he/she will tick off the items on the GRN as being received. 14 The computer automatically creates sequentially numbered GRNs upon the capture of details of goods received by authorised goods receiving staff. 15 Goods received are then sent to the warehouse, where the warehouse clerk will check the goods received against the GRN. REQUIRED Prepare a report, addressed to the audit manager, with reference to the above description of Funky Toys, in which you report on the following matters: (1) 1. Identify, by stating the appropriate reference number, the key controls you want to rely on to obtain audit evidence about the validity, accuracy and completeness of purchases; and (7) 2. State the control objective being addressed by each key control. (7) Present your answer in table format, as follows: Reference number (e.g. 1) (1) Control objective [16] Question 13 LEVEL 3 Key controls and tests of controls [30 marks] You are the auditor of Plumb Supplies (Pty) Ltd, a company that manufactures a wide range of plumbing supplies for household and commercial purposes. e manufacturing plant is located in Epping and has a December year-end. e following extract from the purchases and payments cycle was obtained through discussions held with the inventory controller, chief buyer and chief nancial officer: Extract Ordering of goods When an employee identi es that the inventory used by his/her team is running low, he/she completes a requisition on the company’s intranet from the computer located in the breakroom. The requisition is stored on a requisition pending le. An email noti cation of the requisition is sent to the employee’s manager. The manager logs onto the inventory system by using his unique user ID and password and identi es whether or not the inventory levels are low. He has read-only access to the inventory le. He inspects the existing process costing schedules to identify if the company requires the item of inventory being requisitioned in order to ful l orders for the next three months. If he identi es that a need does exist, he digitally authorises the requisition and it is moved to an approved requisition le. A noti cation of the approved requisition is sent to a buyer in the buying department who logs onto the system and inspects the approved requisition. The buyer contacts three suppliers on the approved supplier list for quotes and requests them to email the quotes to buyer@plumbsupplies.co.za. Once the three quotes are emailed to the buyer, he scans them and loads them onto the buyers system. He inspects the quotes and determines the one which best meets the company’s need. He completes an electronic purchase order on the buying system which is sent to the chief buyer for approval. The chief buyer logs onto the system and inspects the purchase order. He compares it with the three scanned quotes and approved electronic requisition, and once he is satis ed, he digitally authorises the purchase. The buyer receives an email noti cation that the chief buyer has approved the purchase order and that the order can be placed by the buyer with the supplier via email. Receiving of goods The goods are delivered to the goods receiving area of the warehouse. On arrival of the goods at the warehouse, the goods receiving clerk asks the driver for the company name and purchase order number. He logs onto the system with his mobile tablet computer by using his unique user ID and password. He has read-only access to the purchase order. He pulls the purchase order up on the mobile tablet computer and proceeds to receive the goods being delivered. Once the goods are of oaded, the goods receiving clerk counts the goods and inspects them to see if they are damaged and if they agree with the purchase order. The goods receiving clerk prepares a delivery note on his mobile tablet computer and both he and the driver sign it. Once the delivery note is signed, a noti cation is sent to the credit clerk stating that the goods have been delivered. The email address to which the buyer sent the purchase order is immediately emailed with a copy of the goods receiving note. The goods are moved from the receiving area to the storage section of the warehouse. A transfer request is signed by the goods receiving clerk and the warehouse clerk on the goods receiving clerk’s tablet after they have both counted the items being transferred. Once the goods are stored in the warehouse, the manager who requested the inventory is informed by the warehouse clerk that the inventory is available and can be collected. The goods are transferred to production after the manager requesting the goods and the warehouse clerk count the goods and sign the transfer request on the warehouse clerk’s mobile tablet device. Recording of creditors Once the creditors clerk receives an email noti cation that the goods have been received, he/she logs onto the system to view the goods received note. He/she has read-only access to the inventory system. He/she compares the goods received note, the approved purchase order, the approved requisition and the invoice for any inconsistencies and signs the invoice as proof that he/she has compared the documents. The creditors clerk re-performs the calculation on the invoice and initials the invoice prior to recording the purchase on the system. Where the detail on the invoice is different to the detail recorded on the goods received note, the client is contacted via email to nd out why the difference arose. If the client is adamant that the invoice is correct, the difference is placed on the creditor reconciliation as a reconciling difference. The purchase is recorded on the system by the creditors clerk and reviewed by the nancial accountant, who digitally authorises the process. Payment of creditors The creditors clerk performs a monthly creditors reconciliation. The creditors reconciliation and the invoices to be paid are handed to the accountant for review. The accountant inspects the invoices and re-performs the logic of the reconciliation and signs the reconciliation as proof of the checks that he performed. The company has a policy of only making payments to suppliers via electronic funds transfer. The nancial accountant loads all suppliers that the company has had dealings with for more than three months as approved bene ciaries on the company’s bank account. The chief nancial of cer reviews the bank details of all bene ciaries that the nancial accountant has loaded onto the company’s electronic funds transfer (EFT) account by inspecting the documentation (e.g. original bank letter) used by the nancial accountant. Once she approves of the details, they are stored on the company’s EFT account. She les a report on a weekly basis, which she signs, indicating all new bene ciaries. The nancial accountant loads all of the payments on the company’s bank account. The chief nancial of cer reviews and approves the payment after she checks a sample of the documentation (e.g. creditor’s reconciliation and invoices). She signs off the documentation she has reviewed. She hands all of the supporting documents back to the creditors clerk for ling purposes. REQUIRED Identify the key internal controls for the purchases and payments cycle included in the above system description and design the appropriate audit tests to determine whether or not the control is functioning as indicated by management. [30] Question 14 LEVEL 2 Tests of controls [17 marks] You have been the external auditor of Olympus (Pty) Ltd (Olympus), manufacturers of Greek statues, since the incorporation of the company ve years ago. e company’s year-end is 30 September. e company’s purchases and payments system operates as follows: DEPARTMENT PERSON OPERATIONS DEPARTMENT PERSON OPERATIONS Production area; purchases department Production foreman; purchases clerk; purchases manager Once he has determined what raw materials (or products) are needed, the production foreman prepares a pre-numbered purchase requisition. When approved, the requisition is sent to the purchases department, where a purchases clerk prepares a pre-numbered purchase order in triplicate. The purchases manager sequence checks the order before signing it. The top copy is sent to the receiving department, while the third copy is led with the requisition. The purchases clerk, who is responsible for checking the invoices, agrees the prices and terms to the original order, and con rms the quantities against the GRN. He checks the calculations and additions on the invoice, whereupon he initials the invoice, which is sent to the payments department. DEPARTMENT PERSON OPERATIONS Receiving department Receiving clerk Once the raw materials have been received, the receiving clerk checks the purchase order and the quality of the goods delivered, and compares the details of the order against the physical inventory. Thereafter, he prepares a pre-numbered GRN in duplicate. He also signs the GRN, one copy of which is sent with the goods to the storeman, while the other is returned to the purchases department. Mail room Clerk On receipt of the invoice, the mail room clerk sends it directly to the purchases clerk in the purchases department. DEPARTMENT PERSON OPERATIONS Payments department Purchases clerk; accountant; nancial director The invoice is recorded by the clerk in the purchases journal and led according to the due date, at which time the accountant issues a number of pre-numbered blank cheques, as required, to the payments department. When the cheques have been made out, the related invoices are stamped as having been paid and are handed, together with the cheques, to the accountant, who checks the sequence of the cheques as well as whether all invoices have been marked ‘paid’. A cheque-signing machine then signs the cheques in the presence of the nancial director. Accounting department REQUIRED Clerk The cheques are handed to the accounting department, where the clerk records them in the payments journal. Thereafter, they are sent back to the payments department, where the payment date and the cheque number are recorded in the purchases journal next to the entry of the relevant invoice. Formulate the tests of controls that you will perform relating to the purchases and payments system for raw materials and/or goods. [17] Question 15 LEVEL 2 Test of controls and control objectives [13 marks] Pinefresh (Pty) Ltd (Pinefresh) is a large wholesaler of commercial and household cleaning products. e company is audited by GPT Inc., which is currently planning the audit of Pinefresh’s 20X1 nancial year. Below is an extract from a system description prepared and updated by a GPT Inc. staff member. It pertains to the purchases cycle at Pinefresh. All key controls are in bold. Extract When goods are received from suppliers at Pinefresh’s central warehouse, the receiving clerk on duty prepares a goods received note (GRN) regarding the quantity, description and quality of items received. The GRN is made out sequentially and in multiple copies, one of which is sent to the accounting department together with a copy of the supplier’s delivery note. On a regular basis, a bookkeeper in the accounting department records purchases in the purchases journal from the details contained on the GRN. On a weekly basis, the assistant accounting manager (AAM) reviews the purchases journal to: check the sequence of the GRNs and to follow up on missing numbers ensure a purchase order exists for the purchase entry perform a check on a sample of purchase entries by comparing the recorded details to the supporting GRN and supplier delivery note. Upon nalisation of the above review, the AAM signs the purchases journal below the last purchase entry reviewed. At the end of each month, the bookkeeper posts the totals in the purchases journal to the general ledger account for creditors and purchases. The bookkeeper also performs a reconciliation between the total balances as per the creditors ledger and the creditors control account in the general ledger. The AAM reviews the reconciliation and signs it as evidence of the review having taken place. According to the AAM, he signed only 10 of the 12 reconciliations during the 20X1 nancial year, even though he reviewed them all. For each supplier in the creditors ledger, a second bookkeeper performs a supplier statement reconciliation between the statement from the supplier and the balance owing as per the creditors ledger. Each reconciliation is then signed by the AAM as evidence of his having agreed the respective balances to the statement and creditors ledger and having scrutinised the statement for any unusual items. REQUIRED For each key control in the scenario (bold), formulate the audit procedure the auditor should perform to test the control. For each test of control, also state the control objective(s) being addressed by the procedure. [13] INTRODUCTION Refer to the guidance and the example questions contained in Chapter 6, as the principles and the approach remain the same. QUESTIONS Question 1 LEVEL 1 Purpose and control objectives [11 marks] Bicyclycy (Pty) Ltd (Bicyclycy), a company that manufactures mountain bikes, stores parts (chains, wheels, etc.) ordered from different suppliers in the raw material warehouse. e assembly factory requests parts from the raw material warehouse as and when needed. Assembled mountain bikes are transferred in batches of 20 from the factory to the nished goods warehouse. REQUIRED 1. Discuss the purpose of the inventory and production cycle. (2) 2. List and discuss the control objectives of Bicyclycy’s inventory and production cycle. (9) [11] Question 2 LEVEL 2 Control objectives [8 marks] Below is a list of controls that could be implemented by the management of various businesses to design a system of internal control in the production and inventory cycle: 1. Counters should have clear instructions to keep obsolete, damaged or slow-moving inventory separately. 2. Branch managers must place an order at the central inventory warehouse by making use of a pre-printed standard order form. 3. With dispatch, the security guard must compare the items being sent with the information according to the delivery note and should not allow any items that do not appear on the documentation to leave the premises. 4. e staff’s personal belongings must be examined when they leave the premises. 5. Logs are kept for all changes to the inventory master le. 6. e warehouse reviewer and the branch managers, respectively, must review the number sequence of order and delivery documents and follow up on missing numbers. 7. Suppliers should be informed that an inventory count is taking place on that speci c day and, where possible, goods should not be delivered that day. 8. When the branch manager receives the goods, he/she must compare the quality and quantity of the items with the delivery note and order form, and initial/sign as proof of duty performed. 9. e storeroom must only have one entrance. Any doors or windows on the outside must have security gates/be closed with iron bars. 10. A price master le should be created on which the current sales price of each inventory item is stored (per inventory code). REQUIRED For each of the internal controls stated above, list the main control objective achieved by each. [8] Question 3 LEVEL 2 Functional areas [10 marks] Maiza (Pty) Ltd (Maiza), a South African company that buys maize from farmers, stores the cereal in silos before it is transferred to the mill. Mr Grain is responsible for determining how much maize needs to be bought from farmers, as well as when maize has to be milled and the quantities involved in each operation. Once the maize has been processed, the meal is poured into bags, which are then transferred to the warehouse, where they are stored awaiting transportation to Maiza’s customers. REQUIRED 1. List the six functional areas of Maiza’s inventory and production cycle. (5) 2. For each functional area listed, describe how it is applied at Maiza. (5) Note: Answer the questions in a tabular format. [10] Question 4 LEVEL 2 Weaknesses [13 marks] Candlelight (Pty) Ltd (Candlelight), which has a 30 June year-end, asked you, as an external consultant, to review the company’s year-end inventory count procedures. During the count, you noted the following: Candlelight has a large warehouse and an inventory value in terms of quantities. As a result, only the high-value items, which constitute 80% of the total inventory balance, have been selected to be counted. During the month of May, the company’s inventory management team had a planning meeting for the year-end inventory count. At this meeting, they discussed: – the date of the count – the staff who would be performing the count – who the inventory count controller, the supervisor and the counters would be – the stationery required for the day of the count. All this information was printed and prepared prior to the count. During the inventory count, which took place on 1 July: – inventory was despatched for delivery to customers and deliveries were accepted by suppliers the inventory count controller issued the three count teams (made up of two members each) with pre-numbered count sheets for the selected inventory to be counted – each team counted the selected inventory items twice – one team member physically counted the inventory, while the other recorded in pen the quantity counted – for the second count, they exchanged tasks – in order to enhance the controlling of the two counts, the count sheets were designed to allow for both counts to be entered onto the same sheet – all goods were tagged as evidence of their having been counted. After the count had been completed, the inventory count controller sent the count sheets to the inventory administration clerk for capturing and comparison with the inventory system. If variances were found, the teams were noti ed and sent back to recount the relevant inventory item(s). – REQUIRED Identify the weaknesses in internal controls of the inventory count evident from the notes that you made. [13] Question 5 LEVEL 2 Risks [10 marks] Stallion (Pty) Ltd (Stallion), a company manufacturing catalytic convertors for an international motor vehicle company, has its factory in Cape Town. Once the convertors have been manufactured, they are shipped free-on-board from Cape Town to the US. e two key components of the cost of the convertors are: 1. the steel, the price of which uctuates weekly 2. labour (there has been labour unrest in the motor manufacturing sector over the last few years, which has put pressure on the industry). Inventory is held until a shipping container has been lled, which is done under the terms of Stallion’s agreement with its American customer in order to keep their transportation costs down. However, the customer charges warehouse rental for the storage and security of the goods up until the convertors are loaded onto the ship. REQUIRED With reference to the information provided: 1. list all possible risks that Stallion could face with regard to the manufacture and sale of convertors to its foreign customer (7) 2. list all possible risks that the foreign customer could face with regard to the purchase of convertors from Stallion. (3) [10] Question 6 LEVEL 2 Weaknesses and risks [8 marks] Flower Power (Pty) Ltd (Flower Power), a wholesale company based in Cape Town that sells arti cial owers and arrangements to companies, buys its raw materials in bulk. Owing to staff shortages, the company’s procurement process currently has a backlog of three months. Orders are placed without supporting documents when the procurement clerk contacts suppliers telephonically for orders below R100 000. In terms of Flower Power’s procurement policy, the procurement clerk is allowed to contact a single supplier. Goods are delivered to Flower Power’s central warehouse, which has a secure receiving area. Once they have been offloaded, they are left in a demarcated area until a purchase order has been loaded by the procurement clerk. is allows the goods to be loaded onto the inventory management system by the warehouse manager. Flower Power has increased its standing in the market as a result of the competitive prices it pays to suppliers, which allow them to sell their manufactured goods at attractive prices. As the company aims to be the leader in the market, it would like to tighten up all its internal controls. REQUIRED 1. Identify the internal control weaknesses evident from the information provided above. (6) 2. With reference to the weaknesses identi ed, describe the risk of material misstatement for the accuracy, valuation and allocation assertion of inventory. (2) [8] Question 7 LEVEL 2 Weaknesses and recommendations [15 marks] You are the auditor of Renewable Energy (Pty) Ltd (RE). RE is a manufacturer of renewable energy products such as solar products and heat pumps. Management has asked you to review the system of internal control. While doing walk-through testing, you compiled the following system description: 1. e sales director informs the production manager on a Friday afternoon of which products sold well during the previous week. Based on this, the production manager allocates responsibilities to the production department. 2. e raw materials used to produce the products are kept in the raw materials warehouse. e raw materials warehouse has a head storeman and two other storemen working there. Whenever raw materials are needed for production, the production foreman requests the items with verbal or written authorisation. 3. No perpetual inventory records are kept, but monthly inventory counts are done. You attended one of the inventory counts and were satis ed with the controls surrounding the inventory count. 4. A re-order level has been set for each product. e head storeman of the raw materials warehouse compares the inventory count sheets with the re-order levels. If the inventory according to the count is less than the re-order levels, then a pre-numbered purchase requisition is prepared by one of the storemen and signed by the head storeman and then sent to the purchases department. REQUIRED List the shortcomings in the system of internal control and make recommendations to improve the purchase, receipt, storage and issue of raw materials. Present your answer as follows: Weaknesses Recommendations [15] Question 8 Weaknesses and recommendations [13 marks] LEVEL 2 Candlelight (Pty) Ltd (Candlelight) will be conducting a year-end inventory count for the rst time. e company has brought you in as an external consultant to review its year-end inventory count procedures. Candlelight has a 28 February year-end. Planning meeting During the month of February, before year-end, Candlelight’s inventory management team had a planning meeting for the year-end inventory count. e following is discussed during the planning meeting: When the count will take place e staff that will be performing the counts Who will be the inventory controller e stationery required for the day of the count Candlelight has a large warehouse in terms of oor space, and it has a large quantity of inventory. As a result, only the high value items are selected to be counted, which constitute 80% of the total inventory balance. Inventory count e inventory count takes place on 1 March. On the day, inventory is still being dispatched out for deliveries to customers and deliveries are being accepted from suppliers. e inventory count controller issues the three count teams (made up of two members each) with count sheets on the selected inventory to be counted. Each team counts the selected inventory twice. Each team member gets a chance to count the inventory while the other team member does the recording. e count sheets are designed to allow for both counts to be counted on the same sheet so that the count can be better controlled. All inventories are tagged as evidence of their having been counted by the count teams. After the count is completed by the team, the inventory count controller sends the count sheets to the inventory administration clerk to capture and compare to the inventory system. If variances are found, the team is noti ed of the variances and is sent back to recount the inventory items. REQUIRED 1. Identify the weaknesses in the internal controls for the inventory count. (4) 2. Recommend improvements to the internal controls for the inventory count procedures. (9) [13] Question 9 LEVEL 2 Recommendations [21 marks] Glister Ltd (Glister), a company manufacturing gold and diamond jewellery for retail stores, has a standard catalogue from which such stores can order jewellery. Appointed as the internal auditor of Glister, you have been assigned the responsibility of reviewing the company’s internal controls over the order, receipt, storage and issue of gold and diamonds (raw materials only). You have received the following notes on the current system: Glister has three vaults: Vault One (referred to hereafter as ‘the store’) is used for the storage of raw materials. e store’s staff, all of whom are trained in the handling and the safekeeping of gold and diamonds, consists of one supervisor and four assistants. Raw materials are removed from the store only upon the verbal authority of one of the production foremen. Vault Two is used for the storage of work in progress, when the jewellers are not working on a speci c piece. Vault ree is used for the storage of nished goods until they are dispatched to retail stores. Because inventory levels are low, no perpetual inventory records are kept, and the staff do not keep records of gold and diamonds received or issued. A monthly physical inventory count is carried out in order to compensate for this. Procedures for this count are effective and reliable. After the physical count, the store supervisor compares quantities counted against a predetermined order level. If the count for a given item is below that level, the supervisor enters the inventory code on a pre-numbered requisition list, which he then sends to the accounts payable clerk, who prepares a purchase order for a pre-determined order quantity for each item before emailing the purchase order to the supplier from whom the item was last acquired. When gold and diamonds ordered are delivered, they are received at the store by any available staff member. ey then count the gold and diamonds and agree the quantity to the supplier’s delivery note, which is initialled, dated and led in the store in case of a dispute. REQUIRED Make recommendations in order to mitigate the weaknesses in the ordering, receiving, storage and issuing of gold and diamonds (raw material only). Do not list the weaknesses. [21] SUGGESTED SOLUTION TO QUESTION 9 1. Ordering a) e pre-determined order levels should be reviewed regularly by a senior staff member so that no under- or overordering takes place. b) Prior to requisitions being made, store or production staff (1) should con rm that the inventory (gold or diamonds) is really needed. (1) c) A buying function should be established in order to ensure that inventory of the highest quality, and at the best prices, is ordered. d) e company should have an approved suppliers list to (1) which the buyer should refer when ordering. (1) e) Even when ordering from an approved supplier, the buyer should contact the supplier in order to con rm availability and delivery dates. (1) f ) All requisition lists and purchase orders should be authorised by a senior staff member. (1) g) Before the order is placed, a supervisor or senior buyer should: i) compare the order to the requisition list for accuracy and authorisation (1) ii) review the order for suitability of supplier, reasonableness of price, quantity and the nature of the goods on order. (1) h) e ordering department should le the requisition lists sequentially and review frequently the les for requisitions that have not been cross-referenced to an order. (1) i) A copy of the order should be led sequentially, checked and frequently cross-referenced to goods received notes in order to con rm that either: i) goods ordered have not yet been received; or ii) the pending le of orders in the receiving area have been reviewed for long-outstanding orders. (1) 2. Receiving a) One of the stores staff (receiving clerk) should be given the task of: i) con rming inventory received. (1) ii) preparing a goods received note based on the actual goods received as indicated on the delivery note. (1) He/she should not be involved in any recording functions. (1) e receiving of goods should be designated to a goods receiving b) section that should be physically secure and have proper access controls. (1) c) A copy of the purchase order should be sent to the goods receiving section so that it can con rm that goods received have in fact been ordered before receiving the goods. (1) d) When receiving goods, the receiving clerk should inspect their quality and compare the quantity and the description of the goods to the delivery note. (1) e) Suppliers’ delivery notes and GRNs should be forwarded to the creditors clerk as evidence that inventory being paid for has been received. (1) f ) On the transference of the goods to the store, the stores clerk should compare the physical goods to the goods received note, acknowledging receipt by signing the GRN. (1) 3. Storage a) Perpetual inventory records should be maintained so that physical counts can be compared to the theoretical records. (1) b) Receipts and issues of inventory should be entered into these inventory records. (1) c) Inventory counts should be carried out frequently by the stores staff, together with an independent person; shortages and surpluses should be reported to, and investigated by, management. Inventory cards should then be adjusted accordingly. (1) d) One of the stores staff (or an independent staff member) should be given the task of maintaining the perpetual inventory, and should have no responsibility for either the receiving or the counting of inventory. (1) 4. Issues a) No issues should be made without a written issue note authorised by one of the production foremen. (1) b) A copy of each issue note should be forwarded to the costing or accounting department for production records. (1) 5. General a) Purchase orders and issue notes should be pre-numbered. (1) b) e sequence of all purchase orders and issue notes should be accounted for. (1) Available marks [26]; maximum marks [21] Notes: e starting point for answering a recommendation question, in which the weaknesses are not required, is rst to identify the weaknesses (but you do not have to include them in your answer) and then to formulate recommendations to address the identi ed weaknesses. An important aspect is the way in which a recommendation is formulated. You will see that each of the recommendations listed above contain the word ‘should’. Question 10 LEVEL 2 Key controls [4 marks] You are the audit senior on the audit of Canfruta Ltd (Canfruta), a company that cans fresh fruit bought directly from farmers. e company distributes the cans to numerous retail shops across South Africa. A rst-year articles clerk has summarised the controls over inventory at Canfruta, but is unsure which controls are key and which are not. Below is an extract from the summarised controls: Extract CONTROL 1 All access to the computerised inventory system is controlled with unique user ID codes and passwords. 2 All inventory documents (manual or computerised) are prenumbered. 3 Canfruta has a 24-hour call centre, which handles queries relating only to when orders can be expected to be delivered, available to its customers. 4 All inventory items are counted monthly and the actual quantity at hand is compared to the quantity per the perpetual inventory records. Any discrepancies are followed up and corrected, if necessary. 5 All amendments resulting from the inventory count (refer to control 4) are lled out on an inventory amendment form authorised by the warehouse manager before being captured by an independent administrative clerk. All amendments to the inventory le are followed up by the inventory warehouse manager. 6 Canfruta’s delivery system determines the most cost-effective route for each delivery. 7 When information is captured onto the inventory system, appropriate edit checks are performed on the data being captured. REQUIRED Identify ve key controls from the summarised list provided above. [4] Question 11 LEVEL 3 Purpose and tests of controls [25 marks] You are the senior auditor on the audit of Utensils (Pty) Ltd, a mining company that manufactures a wide range of eating utensils. e company is located in Durban and has a December nancial year-end. During the planning phase of the audit, the following internal control questionnaire was used to gain a better understanding of the internal controls in place at the client: Internal control questionnaire NUMBER QUESTION PERSON TO WHOM THE QUESTION WAS POSED RESPONSE 1 How do you ensure that employees will not steal inventory? Mr Rabotli (factory manager) We perform random searches on employees on a daily basis. NUMBER QUESTION PERSON TO WHOM THE QUESTION WAS POSED RESPONSE 2 How does the company ensure that the correct raw material requested by the production manager is transferred from raw material storage to the production facility? Mr Rabotli (factory manager) Both Mr Meyer, the storage manager, and I inspect the raw materials to be transferred and sign the raw materials transfer document as proof that we agree with the amount transferred. NUMBER QUESTION PERSON TO WHOM THE QUESTION WAS POSED RESPONSE 3 How do you ensure that the perpetual inventory records are accurate and kept up to date? Mr Johnson ( nancial accountant) Ms Brittany, the inventory clerk, processes a journal entry after each transfer of inventory, which updates the perpetual inventory records. I compare the journal entry with the transfer documentation, after which I sign off the journal entry as proof that I have reviewed the journal entry processed. NUMBER QUESTION PERSON TO WHOM THE QUESTION WAS POSED RESPONSE 4 How does the company ensure that the cost of the utensils accounted for in the accounting records is accurate? Mr Johnson ( nancial accountant) Ms Coetzee, the cost accountant, performs a calculation of the raw material, labour and overheads to be allocated to the inventory at the end of each month. I review the calculation by checking it to the supporting documents and the assumptions used, and sign the calculation off as evidence that I have inspected the accuracy thereof. NUMBER QUESTION PERSON TO WHOM THE QUESTION WAS POSED RESPONSE 5 How do you ensure that the journal entries processed to update the inventory account are accurate and reasonable? Mr Johnson ( nancial accountant) Ms Coetzee prepares a journal entry based on her calculation and I compare the actual costs to budgeted costs and follow up on material differences, after which I sign off the journal entry as proof that I agree with the accuracy and reasonableness of the journal entry processed. Mr Samson (count controller) We conduct monthly and year-end inventory counts. Mr Samson (count controller) We give the team an instruction list and have a brie ng session indicating what to do during the inventory count. NUMBER QUESTION PERSON TO WHOM THE QUESTION WAS POSED RESPONSE Mr Samson (count controller) Counters are required to sign the count sheet register when they receive the count sheet and when they return it. All count sheets are numerically sequenced and I check the numerical sequence of all count sheets at the end of each count. NUMBER QUESTION PERSON TO WHOM THE QUESTION WAS POSED RESPONSE Mr Samson (count controller) Each inventory item is counted by two counters. Each counter records the amount that he/she has counted on the count sheet and the two counters both sign the count sheet as proof that they agree with the amount recorded on the count sheet. Inventory count supervisors perform spot checks on a sample of inventory items and follow up on differences noted. NUMBER QUESTION 10 PERSON TO WHOM THE QUESTION WAS POSED RESPONSE Mr Samson (count controller) Mr Abrahams, the nancial manager, reviews the reasons for the adjustments and signs off the adjustment sheet as proof that he agrees with the adjustment to be processed. REQUIRED For each internal control documented above, list the purpose of the control (mentioned in the response column) and describe the test of control that you would perform to determine if the control is working as intended by management. [25] Question 12 LEVEL 3 Tests of controls [20 marks] You are the audit manager responsible for the audit of Dreamwedding Ltd (Dreamwedding), a company founded by wedding co-ordinator, Jane Love, when she realised that South Africa did not have a one-stop shop to assist brides and grooms in planning and organising their dream weddings. One of the audit team members has prepared the following list of controls that the company has implemented: Working Paper P2 LIST OF KEY CONTROLS 1 All inventory orders must be authorised by the manager of the department requesting the order, using his/her user ID code and password, before it can be processed. Any order exceeding R20 000 must be authorised online by the senior buyer. 2 When goods are received, both the quality and the quantity have to be checked. A hand-held scanner is used to scan the barcodes on all the items in order to generate a goods received note for the items accepted. 3 A goods received note can be generated by the system only if the inventory received can be linked to an authorised order (using the order number as reference). 4 As soon as the goods received note has been captured, the system automatically posts a journal entry for the liability against the creditor’s account in the creditors ledger as well as one for the asset in the inventory ledger. LIST OF KEY CONTROLS 5 All manual journals (not system generated) required (such as for corrections, write-offs, etc.) must be accounted for on an of cial pre-numbered journal requisition, and supporting documentation must accompany the requisition which, together with the supporting evidence, must be inspected and signed by a manager as proof of authorisation. The journal requisition and supporting evidence are led sequentially according to the journal requisition number. 6 All access to the system is regulated by speci c user ID codes and passwords. Not all users have the same access rights to the system. 7 a) All inventory items are counted at least once a month following counting procedures as set out in the entity’s inventory count manual. Inventory count sheets are signed off by the counting team once they have been completed and are then read into the inventory system before being led according to date. 7 b) The system then generates an exception report of differences between the actual inventory counted and the quantity recorded on the system. Management follows up on all differences and corrects quantities where necessary. All steps taken are documented on the exception report, which is led according to date. REQUIRED Describe a maximum of two tests of control you would perform in order to test the operating effectiveness of each of the controls identi ed in Working Paper P2. [20] Question 13 LEVEL 3 Control objectives, key controls and tests of controls [24 marks] You are an audit manager assigned the responsibility of evaluating the inventory system of MasterCake (Pty) Ltd (MC), a company that bakes and distributes biscuits in the Gauteng region. You have received the following document from the company’s internal audit department listing some of its inventory controls: CONTROL 1 Fixed re-order levels are set for all inventory. The warehouse manager reviews these levels regularly. 2 Before the ordering department places any orders, it con rms that they are goods ( our, eggs, etc.) generally used by MC. 3 The buying department obtains two quotations from authorised suppliers before any order is placed. 4 The ordering department les requisitions sequentially and frequently reviews the le for requisitions that have not been cross-referenced to an order. 5 Computerised perpetual inventory records are maintained. 6 No issuing of inventory from the warehouse to the bakery takes place without an authorised issue note, all of which are led numerically in the warehouse. 7 All documents utilised in the inventory system (such as purchase orders and issue notes) are pre-numbered. The computerised system generates a weekly report of any missing or duplicate numbers. This report is followed up by the head accountant on a weekly basis, signed as proof of his having performed the control and led according to date. CONTROL 8 Whenever an employee performs a control procedure on a document (e.g. compares quantities on the delivery note to the actual quantity), the employee responsible for the control signs the relevant document. REQUIRED 1. For each control mentioned above, list and explain the control objectives MC’s management is attempting to achieve. (15) 2. Indicate for each of the controls listed above whether it is a key control. Provide an explanation for each of your answers. (6) 3. Describe two tests of controls that the audit team could perform on each of the key controls identi ed above. (3) [24] INTRODUCTION Refer to the guidance and example questions contained in Chapter 6, as the principles and the approach remain the same. QUESTIONS Question 1 LEVEL 1 Risks [15 marks] After months of deliberation, you have decided to start an auditing practice with two friends with whom you studied at university, after which each of you completed your training contracts at different audit rms in South Africa. All of you are chartered accountants who have recently registered as auditors with the Independent Regulatory Board of Auditors. Your new rm’s rst assignment involves assisting a nonaudit client with the design of an internal control system for their human resources cycle. You have decided the best approach is to identify the risks in this cycle and thereafter to develop internal controls in order to mitigate these risks. REQUIRED Identify the risks involved in the human resources cycle. [15] SUGGESTED SOLUTION TO QUESTION 1 1. Dishonest, lazy or incompetent workers could be employed, resulting in fraud, errors and inefficient operations which could lead to nancial losses. (1) 2. Family members could be employed, thereby disadvantaging more quali ed (and/or more suitable) candidates, resulting in inefficient operations and in effect less pro t. (1) 3. Fictitious workers could be added to the payroll, resulting in the salaries account being misstated. (1) 4. Incorrect dismissal procedures might be followed, resulting in law suits which could lead to nes and penalties as well as reputational damage. (1) 5. e company could contravene labour legislation, resulting in law suits which could lead to nes and penalties as well as reputational damage. (1) 6. Unauthorised amendments such as salary adjustments could be made to employee records, resulting in the salaries account being misstated. (1) 7. Details in employee records (e.g. the amount of leave taken) might be inaccurate or incomplete, resulting in labour disputes which could cause reputational damage. (1) 8. Wage or salary payrolls might not be reconciled from the previous pay-out to the next, resulting in unauthorised people being paid and the salaries account being misstated. (1) 9. Invalid hours might be recorded on the clock-card system and paid out, resulting in the salaries account being misstated. (1) 10. e hours registered on the clock cards might have been inaccurately calculated and captured, resulting in the salaries account being misstated. (1) 11. e calculation of the payroll might be incorrect (if, for example, the incorrect salary or rate per hour is employed), resulting in the salaries account being misstated. (1) 12. Security might be lacking when cash is drawn or paid out, resulting in theft and nancial losses. (1) 13. Cash could be stolen as a result of a poor segregation of duties, leading to nancial losses. (1) 14. Unclaimed wages could be misappropriated, resulting in nancial losses. (1) 15. Deductions from salaries might be incorrectly made, or deductions payments not made promptly, resulting in nes and penalties and reputational damage. (1) 16. e company might not have all its employees’ permissions on le for all the non-standard deductions to be made, resulting in labour unrest and reputational damage. (1) 17. e payroll printout might not be properly approved before payments are made, resulting in payments to ctitious employees and subsequent misstatement of the salaries account. (1) 18. Security surrounding payroll records, which contain sensitive information, could be lacking, leading to sensitive information being disclosed and resulting in labour unrest and reputational damage. (1) Available marks [18]; maximum marks [15] Note: e risks included above are generic risks, as no case study was provided. If a case study is provided, the risk will relate to the weaknesses identi ed in the case study. In addition, each of the risks contains a consequence (leading to …, resulting in …). Question 2 LEVEL 2 Risks [23 marks] You are the auditor of Lbw Engineers (Pty) Ltd (Lbw Engineers), a civil engineering company whose head office is located in Cape Town. Lbw Engineers employs 1000 employees in various capacities. e following information was obtained during a walk-through, which you conducted, of the payroll cycle: Appointments and employee bene ts When managers identify that they need additional workers for a project, they appoint individuals who they feel are suitably quali ed for the task at hand. For the most part, appointments of this nature are done on a project-by-project basis, but managers are delegated the power to appoint employees on a full-time basis too. Once the appointment has been made, the manager informs a human resources officer to prepare a contract for the new employee using the terms agreed upon between the manager and the new employee. All employees are placed on a three-month probation period, irrespective of whether they have been hired on a permanent basis or for a speci c project, unless the project period is less than three months. e employee is required to provide the human resources officer with the following information: A signed copy of the contract A letter from his/her bank with bank account details A certi ed copy of his/her identity document Proof of address. Once the employee has provided the documentation to the human resources officer, the human resources officer then logs onto the payroll system using his/her unique user ID and password. e human resources officer proceeds to upload the new employee’s details on the employee le. All employees are expected to work a minimum of 40 hours per week. Employees (with the exception of management) are permitted to work up to 10 hours of overtime per week at their own discretion. Employees have the option either to have the overtime paid out at the end of the nancial year or to have it converted into paid days off. Each employee accumulates leave at 1.25 days per month and is entitled to 3 days compassionate leave. e employee’s leave is carried over for a maximum of one calendar year, after which the employee will lose the days not taken. e company pays 50% of the employees’ medical aid contributions as well as 50% of their pension fund contributions. Management and executives at the company qualify for a car allowance and an annual performance-based bonus. All other employees are entitled to a 13th cheque, which is paid in December. e employees can either have the full 13th cheque taxed in December or they can opt to have the tax deferred over the course of the 12 months. Employees are required to sign a letter at the start of the year indicating how they want the tax to be treated on their 13th cheque. Most employees opt to have the full amount taxed at the end of the year as they feel that deferring the tax implications over 12 months affects what they are able to do in their personal lives on a monthly basis. All changes made to employee les are made by the human resources officer. e changes made are based on an instruction received from the nancial manager via email in the case of salary increases and special bonuses, and the returned letter from the employees indicating how they would like the tax on their bonuses to be treated. Dismissal of employees If a manager is not happy with the performance of an employee the process followed depends on how long the employee has worked at the company for: If he/she has worked for three or fewer months, the manager has the power to dismiss the employee with immediate effect. If he/she has worked for four or more months, but not exceeding one year, one weeks’ notice is required. If he/she has worked for more than one year, two to four weeks’ notice is required, depending on the circumstances of the dismissal. Once the employee has been noti ed of the dismissal, the manager informs the human resources officer, whose duty it is to remove the employee from the payroll register. e human resources officer logs into the employees le and changes the employee’s status from ‘active’ to ‘terminated’ and identi es the employee’s last day of employment. Calculation of gross amount to be paid When an employee intends taking leave (e.g. annual leave, maternity or paternity leave, or unpaid leave) during the month, the employee is required to submit a request to take the leave on the leave system. e employee’s manager receives a noti cation of the request and is required to approve the leave prior to the employee taking the leave. In the case of compassionate and sick leave, employees are required to record the days that they were out of work on the system within two days of being back at the office. e system calculates the days worked for the month by deducting the approved leave recorded on the system from the total number of days that the employee was expected to work in the month. e system then determines the amount to be paid by dividing the gross remuneration that would have been paid if the employee worked for the full month by the total number of normal days expected to be worked in a normal working month, and then multiplying the answer by the actual days worked as calculated by the system. When employees work overtime When employees work overtime, they are required to record their hours on the payroll system by using their unique user ID and password. e system automatically calculates the overtime to be paid to them for the month by multiplying the overtime hours by 1.5, unless the hours were worked on a Sunday or a public holiday, in which case the overtime hours are multiplied by 2. Amount to be paid to employees for the month e system automatically identi es the deductions for each employee from the employee’s personnel le and then reduces the gross remuneration by the related deduction. e senior human resources officer logs onto the system using his/her unique user ID and password, and performs a spot check on a sample of employees to determine if the gross remuneration and deductions used in the determination of the amount to be paid is correct. If the senior human resources officer agrees with the amount calculated, he/she digitally authorises the payment, which results in an electronic funds transfer being made to pay the employees. Deductions to be paid over e medical aid and pension fund contribution determined by the company, which is checked by the senior human resources officer, is paid over to the medical aid and pension fund on the same day that the electronic funds transfer is made to pay the employees. Pay-as-you-earn (PAYE), unemployment insurance fund and skills development levy payments are made before the 7th day of the following month. e human resources officer logs onto the company’s e- ling pro le by using the company’s log-in name and password, submits the EMP 201 tax return and immediately processes the payment. Pay slips are generated by the system and granted to employees on the request. REQUIRED Describe the business risks affecting the payroll cycle at Lbw Engineers (Pty) Ltd. [23] Question 3 LEVEL 2 Risk of material misstatement at assertion level [12 marks] You are the supervisor in charge of the audit of Victoria Falls (Pty) Ltd (Victoria Falls) for the year ended 31 December. Victoria Falls outsources its payroll services to LetsPay (Pty) Ltd (LetsPay). LetsPay is a company that offers HR solutions to small and medium-sized companies. LetsPay was established by two university graduate students, Bob and Rob. Both Bob and Rob are the directors of LetsPay and are studying to become chartered accountants. LetsPay was established and commenced with its primary mission of offering payroll services just over a year ago. It is therefore still establishing itself in the market. e company provides a range of payroll services, including preparation of monthly payslips, payment of salaries and duties related to the South African Revenue Service (SARS), such as completion of taxation returns and payment of pay-as-you-earn (PAYE), standard income tax on employees (SITE) and unemployment insurance fund (UIF) amounts. As part of a job creation campaign, Bob and Rob decided to appoint mostly staff members who are part-time accounting or marketing students still in the process of obtaining their degrees. During your discussions with some of the staff at Victoria Falls, it became apparent that: Victoria Falls had to pay penalties on late payments of PAYE, SITE and UIF to SARS as LetsPay did not meet the SARS deadline payment dates at the end of December, the staff members of Victoria Falls received a bonus pay-out, but they complained that the taxation payable on the bonuses was calculated incorrectly one of the members at a well-known newspaper got hold of the salaries and bonus amounts of the directors of Victoria Falls and published these in a story on the front page REQUIRED 1. Describe the risks of material misstatement at the assertion level relating to the salaries balance in the statement of pro t or loss and other comprehensive income for the year ended. (6) 2. For each risk described, identify the applicable assertion. (6) Present your answer as follows: A. DESCRIPTION OF THE RISKS OF MATERIAL MISSTATEMENT AT THE ASSERTION LEVEL RELATING TO THE SALARIES BALANCE (1 MARK EACH) 1.……………………………..…… B. ASSERTIONS (1 MARK EACH) .………………………….……… [12] Question 4 LEVEL 2 Weaknesses and risks [30 marks] You are the senior auditor for a new client, Galv-Tanks (Pty) Ltd (GalvTanks), a company specialising in the installation of galvanised storage tanks built at the company’s warehouse in Blackheath. On completion, the tanks are transported for installation by company personnel. GalvTanks has a December nancial year-end. e following extract of the systems description, compiled by the second-year audit trainee and based on information obtained from Mr Tank, the owner of Galv-Tanks (who is also the chief executive officer), relates to the payroll function of the company: Extract: System description – Human resources cycle Employment of permanent employees All permanent employees have contracts indicating the terms of their employment with Galv-Tanks. The contracts are stored in a drawer by Ms Steel, the person responsible for hiring administration employees and for all remuneration-related tasks (e.g. salaries and wages, and the Unemployment Insurance Fund (UIF) and SARS calculations and payments) for both the salaried and the wage workers at the company. Ms Steel matriculated two years ago and is engaged to Mr Tank’s youngest son, who also works for the company. Mr Tank Snr has delegated the hiring of individuals to the following people: Ms Steel in the HR of ce Mr Cooper in the warehouse Increases Mr Tank Snr and Mr Cooper determine the amount of each employee’s bonus, which is paid in December, as well as the amount of the annual increase to be awarded in the rst month of each new nancial year. The increased rate of pay and the annual bonuses to be paid are emailed to Ms Steel by Mr Tank Snr, whereupon Ms Steel prints the email and uses it in order to compile a document in which she notes the new rate of pay for each individual. She uses this document as the basis for calculating the amount to be paid twice a month to wage employees. She prints the email and stores it in the top drawer of her desk in order to allow for easy access. Employees are informed of their rate increases in letters drafted by Ms Steel and signed by Mr Tank Snr. Ms Steel places copies of these letters into her desk drawer in case an enquiry should arise. Although she sometimes misplaces signed contracts and rate increase letters, she does have soft copies on her computer that she can print out if an employee approaches her for one. Once she has inserted Mr Tank Snr’s signature digitally, she has the employee sign the copy of the contract. The top drawer to Ms Steel’s desk does not have a lock. Employment of temporary employees At those times of the year when business picks up, the company employs additional workers, if it is deemed necessary, in order to ll increased orders. These employees are identi ed and appointed by Mr Cooper, who at the start informs them verbally of the length of their respective employment periods and their hourly rates of pay. A large amount of overtime (as determined by Mr Cooper) is normally worked during these busy periods. On Mr Cooper’s request, these temporary employees provide him with a copy of their ID documents, or their passports if they not South Africans, all of which Mr Cooper stores in his desk drawer. Normally he does not have time to draft their contracts until the conclusion of their employment periods. They are not expected to provide utility bills in order to prove where they live, as payments are not deposited into their bank accounts, but made in cash directly to the employees themselves. Dismissal of employees If an employee transgresses, it is documented in his/her employee le. If the transgression is deemed not severe enough to warrant immediate dismissal, he/she is given a written warning. The company’s policy of issuing three written warnings within a speci c time period before the termination of employment results in the worker being red by either: Mr Tank Snr in the case of permanent employees, or Mr Cooper in the case of temporary employees. A transgression is deemed to be anything that displeases Mr Tank Snr or Mr Cooper. Time-keeping: Warehouse employees All employees are expected to work from 08h00 to 16h30. The company’s clock-card machine ceased operating in June, since when it has not been replaced. Mr Cooper considers the employees so trustworthy that he is content to have them record their times of arrival and departure manually on their clock cards themselves. In the event that a deadline needs to be met, employees are expected to work overtime, which Mr Cooper is responsible for authorising. The clock cards for all employees, including Mr Cooper himself, are placed at the entrance to the warehouse by Mr Cooper and collected by him every Wednesday evening. He uses these cards in order to perform the calculations of the total hours worked. He puts out the new clock cards every Thursday morning. Other information The company has 35 permanent employees, eight salaried individuals and 27 workers who receive their wages twice a month. REQUIRED Identify the weaknesses, as well as the consequences of each weakness, in the human resources cycle described above. [30] Question 5 LEVEL 2 Weaknesses and risks [38 marks] You have been the partner in charge of the audit of Fishy Fisheries Ltd (Fishy) for the last four years. e company has a substantial eet of shing trawlers and processes sh in its factories on the West Coast. You are currently engaged in the March 20X1 year-end audit of Fishy, and have been presented with the following system description, prepared by your audit team. System description of Fishy New workers are employed by the human resources department only after interviews and background checks have been performed in order to establish whether or not they are competent. e shermen and factory workers receive their wages every Friday afternoon. e captain of the trawler or the production foreman at the factory pays out the cash wages of the workers working under his supervision. e captains and the various foremen are paid a xed weekly wage by way of EFTs from the company’s main bank account using one of the terminals situated in the accounting department. Every week, R5 is deducted from each worker’s wage for the end-of-year staff party. Each Monday, it being the start of the working week, the foreman or captain hands blank clock cards to each of the workers under his supervision. ese workers write their names and employee numbers on the cards and use them for that working week. e clocking devices are situated at the entrance to the factory. e shermen on the trawlers, who receive the same kind of clock cards, clock in at the harbour near where their clothing lockers are situated. Workers clock in and out by inserting their clock cards into the clocking machine, which then records times on the card. e following Monday morning, the foreman or captain hands the completed clock cards to the wages clerks, each of whom is responsible for the wages of all the workers at the factory or on the trawlers allocated to him/her. e wages clerks add up the total number of hours worked per clock card and write the total on the relevant clock card, all of which are then sent to head office where the clock card hours are entered into the payroll le on the computer by one of the clerks in the human resources section. In order to ensure completeness of processing, clock cards are batched in groups of 25 during the capturing process. e computer calculates each worker’s gross pay, his/her deductions and net pay by using the latest wage rates and deductions according to the information in the master le. A weekly wages report is printed and led sequentially in the human resources department at head office. After the human resources manager has reconciled differences between the current and the previous week’s wages reports, and initialled the report, he prepares a cash cheque for the exact amount of the week’s net wages. e cheque is then cashed by one of the employees in the human resources department. e computer prints pay envelopes (each bearing a worker’s name and employee number) for all those being paid. Clerks in the human resources department ll the pay envelopes with the cash due to each employee as per the wages report. If there is money unaccounted for at the end, the pay envelopes are double-checked by the clerks and corrections made. e pay envelopes are then sealed. On ursdays, the pay envelopes are collected by the production manager, who then drops them off at the various factories and at the harbour. On Friday afternoons, the pay envelopes are handed to the relevant foreman or captain for the weekly pay-out. Each foreman or captain then hands out the wages to the workers under his supervision. Generally speaking, the foreman or captain calls the workers together and reads out the names one by one. As soon as each employee has received his/her wages, he/she promptly heads for the factory gate. During the course of the year, a power failure occurred at head office, which resulted in wages being paid three days late, on the Monday instead of on the Friday. Since the workers were very unhappy about the late payment, the accountant, Mrs Arendse, authorised an additional R10 per hour payment to each worker for that week only. In order to do this, the assistant accountant changed the pay rate per hour by adding R10 for all workers onto the payroll master le. After the payroll for that week had been nalised, the assistant accountant changed the rate back to the normal rate per hour. REQUIRED Identify the weaknesses in the wages system as described and provide an explanation for each weakness. Ignore unclaimed wages. Use the following format for your answer: WEAKNESS EXPLANATION [38] Question 6 LEVEL 2 Weaknesses and recommendations [16 marks] Payroll-Exact (Pty) Ltd (the company) is an IT company that specialises in payroll outsourcing services. It is responsible for processing electronic payments of wages and salary payrolls, including electronic payments of employee taxes, medical aids and retirement bene ts contributions to the respective third parties. Interested clients provide the company with a password protected csv le consisting of the client’s monthly payroll information such as personnel details (name, surname, personnel numbers and bank account details), monthly gross income and deductions. e company charges 10% of the total gross income as its processing fee. Upon receipt of the csv le, the customer relationship manager (CRM) is responsible for unprotecting the le with a unique password obtained from the shared drive. e csv le is then saved on the shared drive. e CRM checks whether total gross income per the csv le plus the 10% processing fee has been paid to the company’s bank account. Once completed, he prepares a schedule of the lump sum payments to be made to third parties for employee taxes, medical aids and retirement bene ts contributions. is schedule along with the csv le are sent to the nance manager. e nance manager agrees the lump sum payments per the schedule to the totals noted on the client’s csv le and makes EFT payments to the respective parties. In addition, he uploads the csv le onto their payroll software to load and pay net income to the client’s employees. is payment run normally occurs at midnight. e company has experienced two irregularities in the current year: 1. In preparing the monthly bank reconciliation, it was noted that the amount per the bank statement was much less than the amount per the bank account in the general ledger. On further investigation, it was discovered that the client deposited an insufficient amount that did not equate to the total amount paid by the company to the client’s employees and third parties. e contract with this customer had expired before the payments were made. e company’s efforts to recover the shortfall from the client have been unsuccessful. 2. e company received an email from another client who complained that ve of its personnel were not paid. A consultant was hired to investigate this matter and discovered that the creditors clerk had replaced the bank account details on the csv le with her own bank account number. Unfortunately, the software does not check whether duplicate payments are made to one bank account. REQUIRED Identify the weakness in controls implemented by management that caused the company to experience the irregularities and recommend how management can improve its controls. [16] Question 7 LEVEL 2 Weaknesses and recommendations [32 marks] You are the auditor on the audit of Framing Supplies (Pty) Ltd, a company that manufactures a wide range of photo and painting frames at their factory in Epping. e company has a December nancial yearend. Mrs Moodley, the chief executive officer, has requested that you review internal controls that are in place over the payroll system, and to make recommendations where the company can improve. e following has been noted during a walk-through that you performed at the company: Time keeping and supervision Employees gain access to the factory through two entry and exit points. A foreman is present at each entry point from 7:15 am to 7:40 am in the morning and at the exit point from 4:00 pm to 4:20 pm. e foremen are required to attend a compulsory meeting from 7:45 am to 8:15 am each morning and normally try to leave the premises by 4:30 pm to avoid peak hour traffic. Employees are required to complete an eight-hour working day, unless they have decided to work overtime on a particular day. Employees have the option of starting at either 7:00 am and working until 4:00 pm, or 7:30 am and working until 4:30 pm. Blank clock cards are placed in the employee clock card holder on a Monday morning by Mrs Claasen, a payroll administrator. Employees are required to ll in their unique employee number on the clock card with a pen, which is located by the employee clock card holder. Mrs Claasen makes sure that there are sufficient pens available for the 190 employees on a Monday morning. Employees collect their cards and clock in at work on entry to the factory, and they also clock out of work when leaving the factory in the afternoon. Employees are not permitted to take their clock cards home with them. On days where an employee decides that he/she wants to work overtime, he/she is required to leave the premises via the exit on the north side of the factory. He/she is also required to clock out at that exit point. Mrs Claasen collects the clock cards at the end of each week and hands them to Mr Jacobus in the payroll department. Payroll preparation Mr Jacobus logs onto the payroll administration system with his unique user ID and password. He captures each clock card into the system using the employee number located on the clock card. Where duplicate employee numbers are identi ed, Mr Jacobus identi es an individual for whom no clock card has been submitted and allocates one of the clock cards to the individual who he believes wrote down the incorrect employee number. e system automatically calculates the gross remuneration of the employee by using the hours captured (by Mr Jacobus) × rate tariff (located on the employee’s le). e system also automatically identi es the deductions to be made from the employee’s gross remuneration and determines the amount to be paid to the employee via electronic funds transfer at the end of each fortnight. Once the system has determined the amount to be paid to each employee, a noti cation is sent to Ms Arendse, the nancial manager, notifying her that the payroll is ready to be paid. Ms Arendse proceeds to log onto the payroll system using her unique user ID and password, and authorises the electronic funds transfer. Changes to personnel master les Examples of changes made to employee les include, but are not limited to: changes made to the employee’s rate tariff changes made to the deductions affecting the employee change made to the employee’s bank details changes made to the employee’s physical address. Changes can be made to personnel master les by using the general payroll user ID and password. In the past, Mr Jonas was the only one who was able to make these changes, using his unique user ID and password. Owing to his retirement, it was felt that relying on one person to make these changes was inefficient. If the person was away from the company for a week or two while on vacation, for instance, no changes could be made to the personnel master le during this period. e general payroll user ID and password only work on computers located in the payroll department. Changes to personnel master les should only be made on the basis that a payroll master le amendment form has been authorised. e process involved in making changes is as follows: e payroll master le amendment form is approved by management. e approved payroll master le amendment form is handed to Mrs Claasen. Mrs Claasen logs onto the personnel master le using the general payroll user ID and password, and processes the changes from her computer or another computer in the payroll department if her computer is not available (e.g. if her computer is with the IT department for maintenance). Once Mrs Claasen has processed the changes to the personnel master le, she les the payroll master le amendment form in her personal ling cabinet in sequential order. She is not required to le the form in terms of the company’s policy, but does so in case someone wants to check up on the work that she performs. To date, no checks have been made on any of the personnel amendment changes that she has processed. REQUIRED Discuss the weaknesses identi ed during the walk-through and make recommendations to address the weaknesses. [32] Question 8 Recommendations [9 marks] LEVEL 2 Glad Ltd (Glad), a manufacturer of high-end domestic appliances, was recently incorporated and will start manufacturing appliances at the beginning of next month. e following controls have already been implemented: 1. e manufacturing division is divided into ve sections and a foreman has been appointed for each section; 120 wage employees have been appointed. e foreman reports to the factory manager. 2. A clock card system has been purchased and administrative clerks will issue clock cards. 3. e administrative clerk will collect all the clock cards. He will perform the calculations on the clock cards and hours will be approved by the foreman. e clock cards are then handed over to the wage clerks who will prepare the wage journal. e wage journal will be authorised by the accountant. e wage cheque will be authorised by the accountant and the managing director. 4. e wage packets and pay slips will be prepared by the wage clerks. Glad has not implemented controls surrounding the wage pay-out process and has contacted you to assist with this. REQUIRED Design a system of internal control for the wage pay-out at Glad. [9] Question 9 LEVEL 3 Key controls and tests of controls [32 marks] You are the auditor of BBQ Delight (Pty) Ltd, a restaurant that specialises in selling slow-cooked BBQ meals. e company has 10 restaurants which are located in shopping malls around the country. e company has a December year-end. e human resources function is centralised at the company’s head office, which is located in Johannesburg. Appointment of employees e manager at each restaurant is responsible for the appointment of servers (waiters and waitresses) and cooks at the restaurant. Managers and assistant managers are appointed by head office. e process followed when appointing a new server or cook is as follows: All prospective employees are advised to contact their local BBQ Delight restaurant to inquire if any vacancies exist. If a vacancy does exist, the prospective candidate is requested to compile a two-page long curriculum vitae (CV). e prospective employee is asked to submit his/her CV in person at the BBQ Delight restaurant or to email the CV to the manager of the restaurant. e manager reviews all CVs and contacts the prospective employee within two weeks of submission of the CV for an interview. e interview is conducted between the manager and the prospective employee, and the individual is informed within ve working days whether or not his/her application has been successful. All successful applicants are instructed to come to the restaurant and to sign a contract of employment. All successful candidates are required to submit the following information to the manager on their rst day at the restaurant: A copy of the contract A certi ed copy of their identity document A utility bill proving where they reside. If the candidate lives with his/her parents or is unable to provide a utility bill, a sworn affidavit is required. An original bank letter stating the person’s bank account details Every manager at a restaurant has a sequentially numbered checklist which he/she goes through to ensure that all of the information is submitted by the employee. e manager signs and dates the checklist to indicate that he/she has received all the information. e documentation is scanned and emailed to the human resources officer at head office who is responsible for loading the information on the employee personnel system. e checklist, along with the supporting documentation, is led in sequential order in a pending hardcopy le in the manager’s office. e restaurant manager inspects the le on a weekly basis and follows up with the human resources officer to determine how far along in the process they are with loading the new employee on the system. e human resources officer emails the manager to acknowledge receipt of the documentation and the manager les acknowledgment along with the other pending documents. e human resources officer logs onto the payroll system using his/her unique user ID and password and creates the new employee on the system using the information sent through by the manager. e computer system logs out after three incorrect user IDs or passwords have been captured. Prior to the information of the new employee being nalised on the payroll system, the human resources manager, who has read-only access to the new employee le, logs onto the system by using his/her unique user ID and password. e human resources manager reviews the information loaded on the system with the detail sent through from the manager to the human resources officer and digitally authorises the loading of the new employee on the payroll system. Once the human resources manager has authorised the loading of the new employee on the payroll system, an automatic noti cation is sent to the restaurant manager indicating that the employee was successfully loaded on the system. e restaurant manager removes the documents from the pending le and les all the documents as well as the noti cation received in a hardcopy ‘approved employee’ le. All of the restaurants pay their servers the same basic salary. e rest of the servers’ salaries are based on tips that they make during the month. Managers, assistant managers and cooks earn a xed monthly salary. e directors of the company meet at the end of November and decide on the percentage by which all employees’ salaries are to be increased in the next nancial year. e percentage increase in salary is communicated to the human resources manager via email. e human resources manager instructs a human resources officer to calculate the increase for each employee of the company in a spreadsheet and to draft increase letters for each employee. e spreadsheet and increase letters are reviewed by the human resources manager and the letters are signed as proof that the human resources manager agrees that the correct amounts have been transferred to the increase letters that have to be sent to the employees. Each employee receives a letter indicating what his/her increase in salary will be in the next nancial year. e employees are required to sign the letter and to submit it to their respective managers by 10 December. e letters are scanned and emailed to the human resources department. e restaurant managers le the signed letters in their respective offices. Once all of signed letters are returned, a human resources officer completes a salary increase master le amendment form in the second week of January, which the human resources manager authorises by signing the salary increase amendment form. e human resources officer logs on to the payroll system by using his/her unique user ID and password and loads the changes, which are effective at the end of January. e changes are reviewed by the human resources manager, who logs onto the system using his/her unique user ID and password. e human resources manager has read-only access to the system. e human resources manager prints a copy of the changes that have been made and les it along with the authorisation letter from the directors and the salary increase amendment form, after signing the documents as proof that the review has taken place. e chief nancial officer reviews all changes which have been recorded on a log of changes and compares it to the documents that have been led by the human resources manager, and follows up on exceptions. Determination of amount to be paid Managers and cooks and servers – basic salary As they receive a standard salary, the system automatically calculates the amount to be paid by using the information on their employee le. e human resources officer compares the gross amount and deduction rates used by the payroll system to the information in the employee’s le to determine if the correct information has been used. e human resources officer re-performs the calculation performed by the system and any exceptions noted are logged by the payroll system and recti ed immediately. e log is printed by the human resources manager and signed as proof that the human resources manager has reviewed the changes made in terms of the company’s policy. Servers – tips that have been received via credit card e company is unable to account for cash tips received by the servers, but accounts for credit card tips as follows: ey are recorded on the system for each person at payment. e system automatically calculates the amount to be paid over to the employee based on the tip captured at the point of payment. e assistant managers at the restaurants perform a sample check on a selection of receipts which are led sequentially to determine if the correct tip was recorded on the system at the point of payment. ey sign the receipts as an indication of the check performed. Where the assistant manager identi es a difference, he recti es it and documents the reason for the change on the system. All changes of this nature are logged by the system and followed up by the chief nancial officer, who requests a copy of the receipt to be scanned and emailed to him at head office for inspection. He compares the receipt to the amount recorded on the system by the assistant manager and signs the log as proof that he has checked the changes made and approves of them. Where the assistant manager is satis ed with the tip recorded on the system, he/she logs onto the system using his/her unique user ID and password and approves of the tips recorded, at which point a noti cation is sent through to the restaurant manager. e restaurant manager then checks a sample of tips in the same manner as the assistant manager, and if he/she is satis ed, he/she digitally authorises the tips on the system. e tips, once authorised, are automatically included in payroll along with the employee’s basic salary. Payment Salary payments take place on the 25th day of the month. e payroll period runs from the 21st of the current month to the 22nd of the following month. e chief nancial officer logs onto the payroll system by using his unique user ID and password. He has read-only access to the system. He selects a random sample of three employees from each restaurant and reviews the documentation (e.g. receipts for tips and signed increase letters) and re-performs the calculations processed by the payroll system. He signs a control sheet indicating that he has performed the review and agrees with the amount to be paid, and loads the payroll payment onto the company’s bank account by using the company’s con dential bank account login details. REQUIRED Identify the key controls provided in the information above and, for each key control identi ed, describe the tests of controls that you would perform to determine if the control is working as intended by management. [32] Question 10 LEVEL 3 Key controls and tests of controls [28 marks] You are a rst-year audit trainee on the audit of Fresh-Smell (Pty) Ltd (Fresh-Smell), a company that imports body and skin care products from around the world for marketing to retailers in South Africa, where it is one the largest distributors. Allocated the responsibility of auditing the client’s payroll system, you have identi ed the following while in discussion with Mr Kingston, the head of human resources: General Fresh-Smell has 150 permanent employees on its payroll, all of whom receive a salary via EFTs on the 25th day of every month, or on the Friday if the 25th falls on a weekend. All employees are entitled to an annual bonus equal to one month’s salary. e bonus may be taken in full in the month of the employee’s birthday or he/she may opt to take part of the bonus each month of the year. Each employee has an employee le that is stored in a re-proof safe. Access to the safe is limited to authorised individuals only, as con dential information is stored there. In order to gain access to the safe, an authorised individual has to sign the log book and indicate his/her reason for wanting access. Once the log book has been lled out, the chief executive officer’s secretary gives the individual the key to the safe and, on receiving the key back, notes the time at which it was returned. e log book is reviewed on a regular basis by a senior employee of the company, who investigates any unusual activity. He signs the log book at the end of each review, indicating whether or not he is satis ed with the reasons for any such unusual activity. Updating of employee les All changes made to an employee’s pro le are approved at a human resources department meeting. e changes noted are recorded in the signed minutes of the meeting, a copy of which is given to Ms Clarke, who is responsible for completing the triplicate payroll amendment forms. e supervisor, Mrs Kimberly, reviews the information captured in the payroll amendment book and compares it to the authorised minutes. Once she is satis ed that they agree, she signs the payroll amendment forms located in the payroll amendment form book. ese forms are sequentially numbered and the sequences of the forms are inspected on a monthly basis by Ms Clarke’s supervisor for any missing forms. If any are noted, they are investigated and reported to Mr Kingston in a missing payroll amendment form report. One copy of this form stays in the payroll amendment form book, while one each is sent to the master le clerks, Mr Combrink and Ms Clarke. Changes to the employee master le are made by Mr Combrink and Ms Klink. ese changes can be made from their workstations only and require that they log onto the payroll application using their unique user ID. All such changes are logged and reviewed by Mr Kingston on a monthly basis. He compares the changes logged to the copy of the payroll amendment form located in the payroll amendment form book. If he is satis ed with the changes made, he signs the log; if not, he requests from Mr Combrink and Ms Klink reasons for validating the changes. Ms Klink is responsible for loading the changes, which Mr Combrink authorises. e procedure is as follows: Step 1 Mr Kingston sends Ms Klink a sequentially numbered payroll amendment form and a document signed by the employee as to how he/she wishes to receive his/her bonus. e payroll amendment form indicates the new salary or any additional remuneration to be paid to the employee, the date on which the new salary or additional remuneration is to be paid and the appropriate deductions. Step 2 Ms Klink inspects the payroll amendment form to determine whether it has been signed and authorised by Mr Kingston and the head of the department in which the employee works. Step 3 Ms Klink logs onto the payroll system and accesses the payroll master le, to which application she has write access, using her unique user ID. If she inputs her user ID incorrectly three times, the application closes, and she needs to log a request with IT support in order for them to unlock the application. e master le amendment screen is designed to look like the payroll amendment form in order to reduce input errors. Salary changes Ms Klink enters the employee’s employee number into the system in order to access all his/her details. She then inputs the amount to which the salary is to be increased. Both these elds (employee number and the amount to which the salary is to be increased) have inbuilt alphanumeric protection in order to ensure that only numbers are captured. In addition, a logic test ensures that the amount to which the salary is to be increased is not above the set threshold. Ms Klink then makes use of the drop-down date eld in order to select the day on which the change is to be effected. Once she has done so, she clicks on the tab indicating the reason for the change (salary increase or additional remuneration). If additional remuneration is involved, she captures the reason noted on the payroll amendment form. Bonus payment period Ms Klink agrees the payroll amendment form to the document received from the employee with regard to the period over which the bonus is to be paid, and signs the payroll amendment form as an indication that the two agree. She then clicks the bonus drop-down eld, which allows her to select the tab either for payment to be made in the employee’s birthday month or to pro-rata the bonus over a period of 12 months. Once she has processed the increase and the bonus instruction, she clicks ‘enter’, upon which the system prompts her to con rm whether or not she is sure she wants to process the information. If she is, she clicks ‘enter’, but if she is not, she clicks ‘cancel’. Once she clicks ‘enter’ the second time, the information posts to a pending le and Mr Combrink receives an email noti cation of the pending changes. Ms Klink les the copy of the payroll amendment forms sequentially. e sequence is inspected by a colleague of Ms Klink’s on a monthly basis. Any missing forms noted are investigated and reported to Mr Kingston in a missing payroll amendment form report. Step 4 Mr Combrink logs onto the payroll system and accesses the payroll master le using his unique user ID. If he inputs this number incorrectly three times, the application closes and he needs to log a request with IT support in order for them to unlock it. Mr Combrink has read-only access in this le. He compares the changes loaded onto the system to the payroll amendment form. If he is satis ed that the changes are accurate, he clicks ‘accept’ and, following the computer’s prompting, ‘yes’, which updates the employee’s pro le; if he is not satis ed with the changes made, he has the option of rejecting them by indicating his reason(s) in a text box for the relevant employee. After receiving noti cation to correct it, Ms Klink does so. Steps 3 and 4 are repeated until Mr Combrink is satis ed with the changes made. A log of all rejections is recorded and a report prepared by Mr Combrink for Mr Kingston’s perusal. e latter reviews the log, which he signs if he is satis ed with the reasons given. Mr Combrink then les the copy of the payroll amendment forms sequentially. e sequence is inspected by a colleague of Mr Combrink’s on a monthly basis. Any missing forms noted are investigated and reported to Mr Kingston in a missing payroll amendment form report. REQUIRED Identify the key controls in the payroll system mentioned above. For each control identi ed, describe how you would test it. [28] Question 11 LEVEL 3 Tests of controls [9 marks] Happy Chappies (Pty) Ltd (Happy Chappies) is a small entity located near rural areas and was founded in 20X1 in order to reduce local unemployment. Happy Chappies manufactures bubble gum, which is sold internationally. e entity mainly employs people from the rural areas for the production process and suitably quali ed personnel for the nance and management function. e current nancial year-end of Happy Chappies is 31 October. Your audit rm, Tick Away Inc., has been the auditors of Happy Chappies since its incorporation. Happy Chappies’s personnel have always been very helpful during the external audit process. e Happy Chappies audit has been allocated to your audit portfolio in the current year. e previous partner always followed a combined approach and after the planning stage of the audit, you, the new audit partner, concluded that you will also incorporate tests of controls during the audit. e rst-year trainee accountant on your audit team has identi ed the following controls which are relevant to the wage cycle of Happy Chappies for the 31 October year-end: 1. All employees have a signed employment contract, which is authorised by the human resources (HR) manager. 2. All employees are provided with a personnel card, which is used to gain access to the workplace. 3. ere is only one entrance to Happy Chappies, and employees must swipe their personnel card to gain access. A card can only be swiped once. A security guard supervises the entrance at all times. 4. Happy Chappies’s computerised system calculates the hours worked by personnel and prints a report which each division’s head should review. 5. e division heads review all reports for any unusual entries and approve any overtime. 6. After the head has reviewed the hours report and authorised overtime by way of a signature, the report is sent to the nance department for recording. 7. After the payroll clerk has recorded the hours into the accounting records, a reconciliation is prepared which is reviewed by the nancial manager. e nancial manager also re-performs the payroll calculations by comparing them to the authorised hours report. e nancial manager approves the payroll and reconciliation by way of a signature. 8. All payroll payments are authorised by two cheque signatories, who have to: scrutinise the payroll records and reconciliation for unusual items sign the payroll and reconciliation as proof of duty performed. REQUIRED Describe the tests of controls that you will perform in order to ensure that the controls identi ed by the rst-year trainee accountant are operating effectively. [9] Question 12 LEVEL 3 Assertions, key controls and tests of controls [20 marks] You are the audit partner in charge of Best Wares (Pty) Ltd (Best), a company manufacturing hardware products sold to retailers and wholesalers throughout South Africa. e company employs over 200 workers at its factory at Wadeville in Gauteng. e following control activities have been documented by one of your audit trainees regarding timekeeping and payroll preparation: Wages, paid every Friday afternoon, are based on the hours captured on the employees’ clock cards. All clock cards are prepared by the human resources department. A senior employee in the department agrees the number of clock cards per division to the latest list of authorised employees in that division. e human resources officer then enters this number in the clock card register, which he also signs as evidence of a control performed. Afterwards, he takes the clock cards, together with this register, to the foremen of the various divisions, who must then check whether they agree with the number of clock cards given to them and sign the clock card register in order to indicate receipt of the cards. e foremen then place the clock cards on racks at the entry points to their divisions. e workers take their cards at both the beginning and the end of the daily shift and insert them into the clock card machine. Clocking in and out is protected by a turnstile, and is strictly monitored by security personnel. At the end of the week, a staff member from the wages department collects all the clock cards and agrees the number of cards per division to the clock card register and signs the register indicating that the totals have been agreed. e wages clerk then takes these clock cards to the foremen, who scrutinise them for anything out of the ordinary. ey then sign the clock cards as evidence that the cards have been scrutinised, and that overtime has been approved by them. e wages clerk then returns to the wages office, where the payroll for that week is prepared. A supervisor at the wages office will agree the hours worked on the payroll back to the clock cards. After this, he/she veri es any amendments to the payroll back to the approved master le amendment forms. He/she then signs the payroll report as evidence of duties performed. e payroll report is then sent to the human resources department, where a senior official reviews the payroll and performs a week-toweek reconciliation. After testing a sample of changes to approved master le forms, he/she signs the payroll as evidence that payments may now proceed. e cheque for wages is prepared in the accounting office. Attached to the cheque requisition is the approved payroll and the week-toweek reconciliation. Two approved signatories then sign the cheques as well as both the approved payroll and the weekly reconciliation in order to indicate that the cheque amounts agree with those on the payroll printout. REQUIRED By linking them to one of the assertions, discuss the controls implemented by management that the auditor can rely on in the system as described above. In addition, describe the test(s) of control(s) that the auditor can perform for each discussed control. [20] Question 13 Audit procedures LEVEL 3 [10 marks] Audit procedure instructions issued by external auditors: Inspect the signature of the foreman on a sample of clock cards displaying his approval of overtime hours worked. Inquire from the human resources manager what procedures the company has implemented in order to identify employees with criminal records. Inspect a sample of payroll master le changes and agree the log of changes made to approved master le amendment forms. Perform an analytical review of salaries, and compare them to the corresponding period the previous year in order to identify any unusual variances that need to be investigated. Ascertain that the director’s remuneration is properly disclosed in the nancial statements and that such disclosure complies with section 30 of the Companies Act 71 of 2008. Inspect the signature of the factory manager on the payroll printout in order to indicate that he/she veri ed the accuracy of the clock card hours captured, and that the correct rates were employed. Inquire from the wages clerk about procedures followed regarding leave records. Attend a wage pay-out and check that unclaimed pay packets are locked away immediately at the conclusion thereof. Scrutinise the wages control account at year-end for any unusual journals posted and investigate these journals together with supporting documentation. Enquire from the human resources manager what procedures he/she follows in order to ensure that the company complies with labour legislation. REQUIRED Classify the audit procedure instructions in the above scenario as a test of control and/or a substantive procedure and/or a risk assessment procedure. [10] Question 14 LEVEL 3 Risks, internal controls and substantive procedures [25 marks] ree Digital (Pty) Ltd (ree Digital) is a highly technological company working on technological products and market research in its eld. Tangible products, such as 3D printers, satellite components, etc., make up 20% of its business, and 80% is from market research in the eld of new advancements in technologies. All operations take place on its premises in Tokai, south of Cape Town. e premises are split into three oors. e top oor is used for administration and management, and the oor below is for researchers to conduct their research. e ground oor is split between a warehouse, where raw materials and nished goods are stored, and the manufacturing area, where the goods are produced. Access to the premises and the various areas around the building is controlled with staff cards that should be displayed on employees at all times. ese cards are scanned to allow employees access to particular areas. ree Digital uses its website to input data, which is then interfaced with its accounting systems. Access to the website requires a username and password. You read through the policy document and make the following notes to assist you with future internal audits: Manufacturing process Once a sales order is created, an internal job card is created in the manufacturing department. Raw materials are issued against the job card. e hours worked against the sales order are also captured in the online time sheet application. Each staff member logs onto the ree Digital website and allocates his/her time based on a job card number. is is also used to track productivity. e time sheet is then approved by the supervisors for whom the work was performed. Standard costing is used in the process of manufacture. For labour costs, this is based on the job description of each employee as each job description has its own rates. e labour rates are based on actual payments to employees. For overheads, it is based on the at rate per hour determined annually. Once the goods are completed, an internal purchase order is created against the job card and sent to the warehouse in order for the staff there to anticipate the goods to be received. Obtaining components from the warehouse Components are requested on a weekly basis from the manufacturing department via an internal sales order. is is an internal online document between the two departments. It can only be created if the manufacturing department has a valid sales order number. e picker will then pick the goods, based on the electronic picking slip. After he/she picks the components, a noti cation is sent to the warehouse supervisor who then checks whether the picker has picked the correct goods and quantity. After the supervisor’s inspection, he/she approves it. e warehouse assistant creates an internal delivery note, which gets approved by the warehouse manager. A noti cation is then sent to the manufacturing department to collect the goods. When the components are collected, the manufacturing business representative inserts his/her user ID, which serves as acceptance of goods. Additional information All goods are sold at a 100% mark-up. e price is determined based on what the market is willing to pay versus the costs to the manufacturer. REQUIRED 1. Describe the risks to the payroll preparation phase of the payroll process. For each described risk, recommend internal controls to mitigate that risk. [14] 2. ere has been speculation that the wages payments received by the manufacturing department are inaccurate as a result of fraud. Describe the substantive audit procedures you would perform on this engagement to satisfy yourself regarding the following assertions: a) Occurrence of wages b) Accuracy of wages[11] [25] INTRODUCTION Refer to the guidance and example questions contained in Chapter 6, as the principles and the approach remain the same. QUESTIONS Question 1 LEVEL 2 Control objectives [11 marks] You are general manager at a local charity, Help-Mekaar. You are responsible for organising a raffle in order to raise funds for the charity. You were able to arrange donations from a local auditing rm as prizes: tablets with wi and 3G connections, Woolworths vouchers and hampers of homemade dolls. You adapted a system description you found on the internet to suit your needs as follows: Price and proceeds e raffle tickets will be sold from the administration office for R10 each. Tickets are only sold for cash. Bene ciaries of the charity and their families receive a 10% discount on each raffle ticket bought. is was approved by the board of trustees of the charity. e price and discount are advertised along with the terms and conditions on the tickets as well as on all posters. Tickets e secretary who sells the tickets has a set of pre-designed, prenumbered tickets, printed speci cally for the raffle in a book format. e tickets contain the ticket holder’s name, identity number, and contact and residential details. Each ticket has a carbon copy attached to it which will be used for the draw. Safeguarding of cash box e proceeds of the sale will be kept in a cash box, which is kept in a safe. At the end of each day, the secretary clears out her cash box and hands the cash and ticket book to you, the manager. Deposit of cash You are required to record the receipts in the cash book daily. is updates the income system. e cash is then handed to a security guard who deposits the cash. REQUIRED Formulate the internal control objectives for cash receipts from the sale of raffle tickets. [11] Question 2 LEVEL 2 Segregation of duties, fraud and error [9 marks] You are a third-year audit trainee at the audit rm of EWC Inc. (EWC), which has recently been appointed the auditors of Electro-Tricks (Pty) Ltd (Electro-Tricks). Since its inception in 2006, Electro-Tricks has established itself as a leading provider of electrical equipment such as radios, irons, fridges, ovens, cordless telephones and television sets, which the company provides to both the general public and corporate clients. ElectroTricks, which operates through 12 retail stores across South Africa, aims to offer the most competitive prices for quality equipment. e company owns several delivery vehicles for transporting the larger appliances (e.g. fridges and ovens) to its clients. e accounting department operates from the company’s head office in Pretoria. Every so often, Electro-Tricks purchases property, plant and equipment (PPE) items, which include delivery vehicles, desktop computers, laptops, printers, and so on. A PPE acquisition form needs to be completed and approved before any such items may be purchased. A clerk in the accounting department is responsible for updating and maintaining the PPE asset register. On a quarterly basis, a physical inventory of PPE items is taken by a clerk in that same department in order to identify any stolen or broken items, and to reconcile the PPE asset register with the physical items. e manager in charge of the audit assigned you to review the controls that Electro-Tricks currently has in place regarding their PPE, speci cally those relating to the segregation of duties. During the initial audit planning meeting, the manager requested that you explain brie y to the team a few of the principles of the segregation of duties in terms of controls over PPE, as well as the possible errors or fraud that could result if these controls were not in place. REQUIRED List brie y the segregation of duties in respect of controls over property, plant and equipment that you would expect to see at Electro-Tricks (Pty) Ltd. In addition, discuss the possible errors or fraud that could result in the event of each of these duties not being segregated. Answer using the following tabular format: SEGREGATI ON OF DUTIES POSSIBLE ERORS OR FRAUD RESULTING FROM DUTIES NOT BEING SEGREGATED [9] Question 3 LEVEL 2 Weaknesses and risks [12 marks] BaAgi (Pty) Ltd (BaAgi), a construction company whose main business is the development of townhouses in newly established residential areas, is based in Boksburg. e company, which has grown over the years, now employs 320 staff members, including ve directors. e four brothers who founded BaAgi in 1994 are not involved in the day-to-day management of the company. As a member of the audit team responsible for the audit of BaAgi, you were presented with the following information: AMOUNT (R) NOTES Loans to directors 900 000 1 Long-term loans (3 200 000) 2 Machinery 1 200 000 3 Notes: 1. Loans to directors were authorised at a directors’ meeting. No loan agreement was signed by the directors and the company in connection with these loans, however, as the directors believed it to be unnecessary since those awarded the loans are still in the employ of BaAgi. 2. In order to expand into other cities, the directors obtained a ve-year term loan attracting interest at prime plus 2% per annum. No other nancing options were considered. 3. Certain machinery was acquired during the nancial year under review, after a director who is the head of the operations department made a request for their purchase. Purchases of capital expenditure at BaAgi are decided when the head of a department determines the need to acquire additional assets. No budgets are prepared. e machinery was purchased from a company owned by the wife of the director in the operations department (said director did not mention this fact at the meeting). All directors, including the director in the construction department, voted in favour of this acquisition. REQUIRED Identify the weaknesses in BaAgi’s internal control process of the nance and investment cycle. In addition, explain the consequence(s) of the identi ed weaknesses. Present your answer using the following tabular format: WEAKNESES EXPLANATI ON OF WEAKNESES [12] Question 4 LEVEL 3 Risks: Companies Act 71 of 2008 [12 marks] As a rst-year trainee accountant at Deno & Partner Inc. (Deno), a medium-sized audit rm, you are a member of the audit team that is responsible for the audit of Techno Ltd (Techno), a company that sells technological products, such as television sets, music systems and tablets. Techno has a 30 June year-end. You are assigned to audit the share capital account. Share capital Authorised shares 500 000 Issued shares as at 30 June 20X1 480 000 AMOUNT (R) NOTES Opening balance at 1 July 20X1 960 000 1 Additions: see note 2 27 000 2 Closing balance at 30 June 20X2 987 000 Notes: 1. e opening balance represents 480 000 shares at R2 per share. 2. During the year under review, the board passed a resolution to assist two new non-executive directors in acquiring 30 000 shares in Techno. e two directors insisted that the shares be sold to them at 99 cents per share, each of which at that stage was trading at R2.50. A loan of R13 500 per director, payable in 24 monthly instalments earning 1% interest, was approved by the board. e share register was not updated with this share issue. REQUIRED Identify the risks relating to non-compliance of the Companies Act 71 of 2008 as discussed in note 2 above. For each of the risks identi ed, discuss the procedure/steps that should have been implemented in order to eliminate the risks of non-compliance with the Act. Answer using the following tabular format: RISK PROCEDURES/STEPS [12] Question 5 LEVEL 2 Weaknesses and recommendations [11 marks] You are the second-year trainee on the audit of the Yest WEG Group (Yest). Yest is the leading supplier of low-, medium- and high-voltage electric motors, variable speed drives, softstarters, switchgear, transformers, containerised substations, diesel generator sets and cogeneration and energy solutions as well as electrical and instrumentation engineering and project management services in Africa. e following document received from the managing director sets out some of the controls implemented to reduce the risk associated with capital expenditure for the year. Summary of internal controls implemented by Yest to reduce business risks associated with capital expenditure Yest has a capital expenditure committee. The CFO makes recommendations to the board of directors on all capital expenditure. All capital expenditure is approved by the CFO prior to board meetings. The decisions are presented only for noting at Yest’s board meetings. It is a long-standing agreement in the company that any director has the authority to enter into any capital expenditure contract on behalf of Yest without necessarily obtaining the approval of the board. All capital expenditure recommendations are based on the CFO’s best estimate of the expected cost. There is no requirement for detailed budgets and cash- ow projections. The capital expenditure committee has always trusted the CFO to allocate funds as needed, and has seen no need to review the effectiveness of past capital expenditure decisions on a regular basis to ensure that returns on the investments are in line with the expectations of Yest’s shareholders. Yest has a project management policy document; however, this could not be located and provided to the auditors at the time requested. Any available staff at the time are appointed on an available project. The project manager believes he always attracts the best staff and therefore does not feel it is necessary to ensure staff have the relevant quali cation necessary to perform the job. The project manager does not have to present regular progress reports to the capital expenditure committee. The last time he made such a presentation was six months ago due to the fact that he is always busy inspecting projects at the various sites. REQUIRED Identify the weaknesses in the controls implemented by Yest to reduce the risk associated with capital expenditure and provide recommendations to improve them. [11] Question 6 LEVEL 2 Weaknesses and recommendations [33 marks] You are the senior auditor of Supermart (Pty) Ltd (Supermart), a chain of grocery stores located in the Gauteng province while their corporate head office is located in Sunninghill. e company has a December nancial year-end. You met with Mrs Vilakazi, the newly appointed chief executive officer, at the start of the nancial year when she indicated to you that she does not want a repeat of the prior year’s modi ed audit report that arose as a result of material misstatements in xed assets. She has requested you to spend a week at the company visiting stores and head office to identify all of the weaknesses in the current control system and to draft a report including suggestions for improvement which they can implement to ensure that the company receives an unmodi ed audit report in the current year. e following was identi ed during the week spent at the client: Fixed asset acquisitions Where a store manager at the company identi es a need for a xed asset, he/she contacts the closest supplier to nd out if the company has the item in stock. If the supplier indicates that they do, a contract is sent to the manager who has the authority to enter into the agreement on behalf of the company. Once the contract has been signed by the manager, a copy is returned to the supplier and the order for the item is then placed. Once the order is placed, the manager sends a copy of the contract to the accountant at head office. e accountant uses his unique user ID and password when recording the asset on the accounting records. Prior to recording the assets in the accounting records, the accountant inspects the contract to determine if the contract and underlying asset is in the name of the company and uses the detail in the contract (cost, transportation and installation costs) to capitalise the amount to the accounting records. For assets requiring that the full acquisition price must be settled on delivery In some instances, the company is required to settle the full acquisition price on delivery of the asset to a store. Where this is the case, the accountant records the asset on the accounting system on the date that he receives the contract from the manager by using the detail (e.g. cost price, installation costs and delivery costs) in the contract and sets up an automatic electronic payment from the company’s bank account to the supplier for the delivery date recorded in the contract. e asset is immediately recognised in the xed asset register when the asset is recorded on the accounting system. For assets where the acquisition price is to be settled over the course of the useful life of the asset Where the acquisition price of the asset is to be settled over the useful life of the asset, the manager at the store informs the accountant via an email that the asset has been installed. e accountant uses the email instruction as his basis for recording the asset on the accounting system. e asset is immediately recognised in the xed asset register when the asset is recorded on the accounting system. ere have been instances in the past where installation and transportation costs have been handled by third parties (i.e. not the supplier) and store managers have indicated that they were not aware that they needed to furnish the accountant with this information as the delivery and installation was normally handled by a family or friend in order to save the company money. Disposal of assets Where the manager at the store feels that the asset is not producing as much economic bene t for the store as expected, he/she has the right to dispose of the asset to whomever he/she wants. Where the asset has passed its original useful life, the manager has the authority to take the asset for him/herself or to give the asset to an employee at the store. Where an asset has been disposed of for cash or zero value, the manager informs the accountant at head office via email to remove the asset from the xed asset register. e accountant logs onto the system and removes the asset from the accounting system and simultaneously from the xed asset register. e accountant is required to print and le the instruction emailed to him, but it was noted during a discussion with him that there were a few email instructions that were not available. He attributed this to email storage problems and that he must have erroneously deleted the email instructions in order to free up space in his inbox. Depreciation When a new asset is purchased, the accountant inspects the contract with the supplier and, based on the detail located in it, determines the depreciation rate and useful life of the asset. e accountant checks the internet for detail on the residual value of assets of a similar kind and records this in the accounting system when initially capitalising the asset. e system automatically calculates the depreciation for the month and posts the depreciation to the accounting records. Impairment Managers are informed that if they see damaged xed assets at their store, they should take a photo of the asset and email it to the accountant. e accountant assesses whether or not the asset is impaired based on the photo and writes down the asset to the appropriate carrying value amount in the accounting records and xed asset register. e accountant has indicated that it is not feasible to drive out to a store to view the asset, especially considering the time he would have to spend in traffic. REQUIRED Draft a report to Mrs Vilakazi where you identify weaknesses surrounding the xed assets at the company and make recommendations to address them. [33] Note: [2] marks will be awarded for using the correct format. Question 7 LEVEL 2 Recommendations [18 marks] Wowlands Ltd (Wowlands), founded by Wouter Landman, opened its doors for the rst time in Melville, Johannesburg, on 1 February 1998. Today, the company, which is listed on the JSE, is one of South Africa’s leading retail chains with over 60 stores across South Africa. e success of Wowlands is driven by Wouter’s belief that service should be consumer focused and that superior quality food, clothing and home appliances should be made available at reasonable prices. is belief is shared, and upheld, by Wowlands’s board of directors. As a member of the company’s internal auditing department, you are currently busy with the internal audit for the current nancial year. e following breakdown, setting out certain transactions that took place during the current nancial year, was received from management: Transaction 1 Wowlands issued 2 000 8% debentures of R1 000 each during February 20X1 in order to raise long-term debt nancing for an investment in a new branded environmental programme, Enviro-Aware, a programme aimed at communicating environmental issues to customers via the labels and the logos on selected Wowlands products on which customers receive discounts. Transaction 2 During the nancial year, Wowlands purchased a new accounting software system called COMPUWARE from Spectacular Connections (Pty) Ltd as a standard accounting package. Owing to the highly specialised technical nature of the new system, employees involved with its operation had to undergo speci c training. Transaction 3 Wowlands purchased 35 new desktop computers from Spectacular Connections (Pty) Ltd during the year for use in the accounting department. REQUIRED List the key controls that you, as the internal auditor, would want to see relating to: 1. the occurrence and management authorisation of long-term debt nancing in transaction 1 (5) 2. the occurrence and authorisation of the purchase of the COMPUWARE accounting software system in transaction 2 (8) 3. the completeness of property, plant and equipment records for computers purchased in transaction 3. (5) [18] SUGGESTED SOLUTION TO QUESTION 7 1. a) e long-term debt nancing transaction should be properly initiated, reviewed and authorised by the board of directors. (1) b) e authorisation for this nancing transaction should be properly documented and kept as proof thereof (e.g. minutes taken at the board meeting at which approval was given). (1) c) ere should be proper debenture agreements or contracts in place with debenture holders. (1) d) ese agreements or contracts should be signed by authorised individuals from Wowlands as well as the debenture holders. (1) e) e debenture agreements or contracts should set out all terms and conditions, dates of repayment, interest rates, etc. (1) f ) A proper segregation of duties should be in place between the execution of and accounting for this transaction. (1) Available marks (6); maximum marks (5) 2. a) A feasibility study should be performed regarding the accounting software. (1) b) Competitive quotations should be obtained and considered (possibly even tenders). (1) c) ere should be a speci c capital budgeting process and provision speci cally made in this budget for the purchase of the COMPUWARE accounting system. (1) d) e board of directors should take ultimate responsibility for the acquisition of property, plant and equipment (including the purchase of the new accounting system), and this should be set out in the company’s memorandum of incorporation (MOI). (1) e) Approval for purchase should be documented in the minutes of the board meeting at which such authorisation was given. (1) f ) Management should monitor capital expenditure against the budget. (1) g) Special approval and authorisation from the board of directors should be obtained for any overruns on the capital expenditure budget. (1) h) ere should be an authorisation table (setting out which managerial level may approve transactions between certain monetary ranges) based on the size of the capital asset transaction (e.g. only the board of directors may authorise a purchase of property, plant and equipment above a certain amount). (1) i) Both the IT and the accounting departments should have input in the technical speci cations of software and approve it. (1) j) A proper segregation of duties should be in place between the authorisation for and the accounting of transactions. (1) Available marks (10); maximum marks (8) 3. a) Detailed property records (manual or computerised) should be maintained for PPE items, and should be updated with the purchase of the computers. (1) b) e following should be documented in these records: i) Description, location and the asset number (1) ii) Date of acquisition and the cost (purchase and installation costs) (1) iii) Depreciation rate, methods, estimated useful life, etc. (1) c) e PPE subsidiary ledger should be reconciled periodically to the general ledger account in order to ensure that it is complete. (1) d) Periodic comparisons should be performed between the subsidiary ledger and the existing capital assets (from the assets to the ledger). (1) Available marks (6); maximum marks (5) Notes: In order to be able to answer the question, you should have a thorough knowledge and understanding of key controls and the control objectives/assertions. A further point to take note of is the following part of the required: ‘would want to see’, which is another way of asking for recommendations. us there should be ‘shoulds’ in all the controls that you have written down. Question 8 LEVEL 2 Recommendations [5 marks] You are a trainee auditor at TPC & Co. (TPC), a rm of registered auditors assigned to the 20X1 statutory audit of Orange (Pty) Ltd (Orange), whose year-end is 31 August 20X1. e company specialises in a unique South African clothing brand for children that is not only affordable, but also fashionable and functional. Orange trades from its 15 retail stores across South Africa. Each branch has its own account with ABBA bank, which allows it to pay certain expenditures on an ad hoc basis. Both the accounting and the internal audit departments of Orange operate from their head office in Durban. REQUIRED Brie y list the key controls over the branch bank accounts that you would expect to see at Orange. [5] Question 9 LEVEL 2 Recommendations [10 marks] ABC Earthworks (Pty) Ltd (ABC Earthworks) is a civil construction company operating in the eld of road construction, mass earthworks, township development and plant hire. It has extensive experience in all forms of roads and earthworks, including construction, upgrading, rehabilitation and resurfacing. e company operates an extensive eet of modern earthworks plants and equipment, including excavators, graders, loaders, dozers, trucks, crushers, and asphalt and surfacing machinery. e company attracts and retains highly quali ed and experienced individuals with solid track records in the road construction sector. In the current year, ABC Earthworks was awarded a tender worth R150 million to demolish, reconstruct and refurbish rundown buildings in the city centre owned by the local municipality. To meet tender requirements, ABC Earthworks purchased additional earthworks equipment and increased its staff base. REQUIRED List the key controls the auditor can expect over the purchase of the additional earthworks equipment. [10] Question 10 LEVEL 3 Tests of controls [10 marks] You are the independent auditor of Car Manufacturing (Pty) Ltd, a company that manufactures motor vehicles. You intend to place reliance on the investment system of internal control. From the previous year’s working papers, and after discussions with management, you documented the ordering and recording of the xed asset system as follows: Purchases of xed assets are divided into two categories: purchases below R50 000 and purchases above R50 000. Different authorisation levels are required for purchases below and above R50 000. Ordering xed assets All orders of xed assets under R50 000 occur as follows: e nancial officer in each division completes a pre-numbered xed asset purchase requisition and the manager in the division approves the requisition. e requisition is then sent to the purchase division. All orders of xed assets above R50 000 occur as follows: For all asset purchases above R50 000, a xed asset purchase application form is completed by the nancial officer in each division and approved by the manager of that division. e xed- asset purchase application form is then sent to the head of the purchasing division. ere is a xed asset committee that meets once a month and looks at all the xed asset purchase application forms and decides which xed asset items will be purchased. e chairman of the committee signs the xed asset purchase application form and sends it to the purchase division. Purchase division: e purchases clerk receives the purchase requisition form or xed asset purchase applications and completes the prenumbered orders in threefold. Purchases are only made from a list of approved suppliers. e purchases manager compares the requisition or ‘request for purchase’ form, depending on whether the purchase is above or under R50 000, with the purchase order, ensures that the order is placed with an approved supplier and signs the purchase order. One copy of the order is sent to the supplier, one copy is sent to the division that placed the order, one copy is sent to the creditors clerk and one copy remains in the purchase division. e purchase manager regularly follows up on long-outstanding orders and reviews the number sequence of orders. Recording xed assets An invoice is received from the supplier. e invoice is compared to the order and goods received note. e accounts clerk records the purchases in the purchase journal, after invoices are received from suppliers. e general ledger clerk then transfers the transactions to the general ledger. e capitalised xed assets are recorded in the xed asset register and the other purchases of xed assets are recorded as expenses. e accountant reviews the recordings of the xed assets. e calculation of the depreciation is done by the accountant. e nancial manager reviews the calculations. REQUIRED Formulate the tests of controls you would perform on the internal controls for the ordering and recording of xed assets as described above. You have already formulated tests of control for the classi cation and cut-off of transactions. [10] Question 11 LEVEL 2 Key controls and assertions [11 marks] You are a member of the audit team responsible for the audit of Amanzi Ltd (Amanzi), a company that sells natural spring water, for the year ended 30 June 20X2. You are responsible for the audit of the share capital account. Share capital AMOUNT (R) NOTES Opening balance 1 July 20X1 600 000 1 Share issue: general public 300 000 2 Share issue: directors 90 000 3 Closing balance 30 June 20X1 990 000 4 Notes: 1. e opening balance represents 200 000 shares at R3 per share. e share register is updated every time there is a change in shareholding. Every month, the balance in the share register is matched to the share capital account in the general ledger. 2. During the year, 100 000 shares were issued to the general public at R3 per share in order to raise funds for the expansion of Amanzi’s operations. At the time of the new share issue, the company had 250 000 authorised shares, which fact, con rmed by the directors, was in line with the company’s memorandum of incorporation. In order to allow for the additional share issue, the memorandum was amended (by means of a special shareholder’s resolution obtained by the directors prior to the amendment) in order to increase the number of authorised shares to 500 000. Payments made in this regard are matched to the cash book and the proof of payments. 3. An additional 10 000 shares at R3 each were issued to the directors themselves by means of a loan granted to them in order to help them acquire them. For the transactions (which were conducted in line with Amanzi’s memorandum of incorporation stipulations) to be valid, a shareholders special resolution was obtained. e nancial accountant matched all considerations received during the year with regard to share issues to the share issue price as determined by the board and then recalculated the amounts. 4. At year-end, the nancial accountant agreed the balance of the share capital account in the general ledger to the trial balance, the statement of changes in equity and the statement of nancial position. REQUIRED Identify the key controls relating to the share capital account of Amanzi for the year ended 30 June 20X2. For each key control identi ed, allocate the applicable assertion(s). Answer using the following tabular format: KEY CONTROLS ASSERTIONS [11] Question 12 LEVEL 3 Internal control vs test of control, control objectives [9 marks] You are the auditor of Fast Freight (Pty) Ltd (Fast Freight), a freight company well known in South Africa since its incorporation in 20X2 that specialises in sea, air and road freight. Customers, ranging from individuals to large corporations, are all guaranteed valuable advice on the best distribution methods as well as the other options available to them. Although their head office is situated in Pretoria, Fast Freight has branches across South Africa, the rest of Africa and the UK. e company has a large eet of vehicles and operates an innovative system that prints labels, waybills and so on. During the year under review, the following activities took place: 1. A new online tracking system (Track & Trace), which allows customers to log into the system via Fast Freight’s website in order to view the status of their delivery, was purchased. Owing to its highly specialised nature and the value of the purchase, the board of directors was directly involved in authorising the purchase transaction for the addition to property, plant and equipment at a board meeting. 2. e company conducted a physical veri cation of vehicles during the last month of the nancial year. is entailed employees physically inspecting each vehicle in their eet and comparing them to the details in the xed asset register. 3. One of the vehicles in the eet was involved in an accident, during which several items for delivery in the vehicle were damaged. Included in the nancial statements of Fast Freight for the year under review is a provision for damages arising from a pending court case as the driver of the delivery vehicle had been under the in uence of alcohol at the time of the accident. As a result, the company decided to provide for the damages based on the estimated market prices of the affected items. However, the auditors obtained their own estimated market prices for the items and compared them to those provided by the company. 4. Having obtained the company’s insurance register, the auditors noted that, as part of their nancial records, a substantial amount had been included for prepaid insurance. In addition, all new insurance policies were inspected in order to con rm that they had been signed by an authorised individual at Fast Freight. 5. Jamal Daily, a company clerk, is responsible for updating the xed asset register, while Peter Davies, the asset manager, is responsible for authorising the low-value purchases and disposals of any property, plant and equipment. REQUIRED For each of the activities referred to above, state whether it is an internal control or a test of control. In addition, state the control objective(s) applicable. [9] Question 13 LEVEL 3 Test of control vs substantive procedure, objective of audit procedure [13 marks] You are the audit manager assigned to the audit of BWM (Pty) Ltd (BWM) for the nancial year ending 30 June 20X1. Founded in 1998, the company is currently one of the 25 largest vehicle manufacturers in the world. In August four years ago, BWM opened a new manufacturing plant in Johannesburg boasting a high-tech assembly line that carries with it the promise of producing the planned capacity of 230 BWM vehicles per day by December 20X1. e total investment cost relating to the full construction of the plant and machinery totalled R9,8 million for the relevant nancial year. e new assembly line, on which operations are performed by both humans and robots, includes a conveyor belt that transports the vehicles from one station to the next, and allows the vehicles to be tilted and rotated some 90 degrees from the horizontal. e plant is divided into three buildings arranged in a circle around the central office building, an arrangement that divides operations into: the construction of the main framework the paint job the assembly of other remaining car parts. Audit procedures were performed on the new manufacturing plant and related machinery, both of which constitute part of the property, plant and equipment (PPE) account balance in the nancial statements for the year ending 30 June 20X1: 1. Material expenses relating to the new manufacturing plant in Johannesburg (obtained from invoices, contracts, etc.) were compared to approved capital expenditure budgets. 2. Minutes of directors meetings were inspected for approval of the capital expenditure budgets relating to the new manufacturing plant. 3. A sample of plant and machinery assets was extracted from BWM’s asset register (including the material additions for the year); such selected assets were inspected physically and matched to the descriptions in the xed asset register. 4. All purchase documents and documents of title deeds relating to the new manufacturing plant were inspected in order to con rm that they were in the name of BWM. 5. e dates on material purchase documentation (i.e. invoices) for the new manufacturing plant, as well as the dates in the relevant ledger accounts, were inspected in order to verify the accounting period in which these expenses had been incurred. 6. Relevant job descriptions were inspected in order to ensure that the person(s) responsible for the initiation of a capital asset acquisition had not been the same persons responsible for the nal approval thereof. 7. e minutes of directors meetings were inspected in order to ensure that all purchases relating to the new manufacturing plant upon which the directors agreed were recorded in the nancial records of BWM. 8. Amounts in the general ledger (relating to the purchases of the plant and the machinery) were agreed to the minutes of the directors meetings, the capital expenditure budgets, the invoices, the contracts and other relevant documentation. REQUIRED For each of the audit procedures listed above, state whether the audit procedure is a test of control or a substantive procedure, and explain what the objective of the audit procedure is. [13] Question 14 Tests of controls vs substantive procedures LEVEL 3 [16 marks] Owing to the uniqueness of transactions in the investment and nancing cycle as well as the fact that the number of transactions that take place in this cycle is considerably smaller than in other business cycles, the functional areas depend on the type of transaction. Authorisation, which is an example of one such area, depends on the type of transaction. When a company intends issuing shares, the authorisation might have to come from the board of directors and may also be subject to other authorisation requirements as laid down in the company’s memorandum of incorporation. On the other hand, authorisation for a prepayment of insurance might only include the signature of an individual authorised staff member. Although the functional areas are unique, internal controls are still implemented by management in each of them in order to ensure the achievement of an entity’s control objectives (occurrence and authorisation, accuracy and the completeness of nancial information). Auditing the investment and nancing cycle may be divided into three categories: 1. Audit of certain current and non-current assets, such as prepaid expenses, intangible assets, goodwill, property, plant and equipment 2. Audit of nancial instruments, shareholders’ equity, long-term liabilities and statement of comprehensive income accounts 3. Audit of cash and investments Bearing this in mind, consider the following scenario. Rent-a-Car (Pty) Ltd (Rent-a-Car), one of the leading car rental companies in South Africa, offers a eet of approximately 16 000 vehicles at over 98 locations throughout South Africa. In the performance of your duties as the company’s auditor during the year-end audit, you have: 1. examined copies of debenture agreements in order to con rm that they were in the name of Rent-a-Car (Pty) Ltd 2. inspected a sample of monthly bank reconciliations for the signature of the person performing the authorisation 3. observed whether the function of initiating a property, plant and equipment acquisition had been segregated from the nal approval thereof 4. examined the minutes of the board of directors meetings, as well as any communication with Rent-a-Car’s legal counsel, in order to determine whether or not there was any pending litigation with regard to trademarks, patents and/or copyrights 5. veri ed the mathematical accuracy of the last bank reconciliation for the year under audit and agreed the balance to the general ledger, trial balance and nancial statements 6. determined the basis for valuing investments by tracing values to published quotations for marketable securities 7. inspected the minutes of meetings of the board where the acquisition of a long-term loan had been authorised by the directors 8. compared the schedule of provisions for the current nancial year to that of the previous year, following up on any provisions not included on the current year’s list or those that had changed signi cantly in value 9. traced the proceeds from the disposal of vehicles in the eet to the bank statements of the company 10. con rmed the market value for the listed shares in which the company had invested by means of an inspection of the relevant stock exchange publications. REQUIRED For each of the 10 audit procedures provided above, identify the category of the investment and nancing cycle in which the audit procedure would typically be performed, stating whether such a procedure is a test of control or a substantive procedure. Present your answer in tabular form. [16] CHAPTER 11 Overview of the audit process CHAPTER 12 Pre-engagement and planning activities CHAPTER 13 Audit procedures: Essential concepts CHAPTER 14 Audit procedures: Speci c considerations CHAPTER 15 Completion of the audit CHAPTER 16 e independent review CHAPTER 17 Additional questions INTRODUCTION e topics contained in this chapter provide a background to those included in the rest of the book. Normally, they are not tested on their own, but a thorough understanding of them will enhance your application of these topics in later chapters. QUESTIONS Question 1 Stages and steps [13 marks] LEVEL 1 External audit is a systematic process of obtaining and evaluating evidence and information objectively regarding assertions about economic actions and events in order to determine the degree of correlation between those assertions and prede ned criteria, and to communicate the results in writing to the users of the nancial statements. REQUIRED List the phases of the audit process and discuss the steps or considerations appropriate to each phase. [13] Question 2 LEVEL 1 Audit evidence [7 marks] In order to demonstrate compliance with the International Standards on Auditing when conducting an audit, an auditor is required to prepare and to retain audit documentation, which is presented in the form of working papers kept in an audit le. REQUIRED List examples of audit documentation that should be prepared and retained by an auditor and explain why an auditor should prepare audit documentation in a timely manner. [7] Question 3 Audit evidence LEVEL 1 [7 marks] An auditor’s audit opinion and report are based on audit evidence that the auditor collected during the ‘obtaining audit evidence’ phase of the audit process and which is contained in his/her working papers (audit documentation). REQUIRED Describe the requirements for audit evidence. [7] SUGGESTED SOLUTION TO QUESTION 3 1. e audit evidence needs to be: a) sufficient (the measure of quantity); and (1) b) appropriate (the measure of quality). (1) 2. e sufficiency and appropriateness of audit evidence are interrelated. (1) 3. e quantity of audit evidence required is affected by the auditor’s assessment of the risk of material misstatement (the higher the assessed risks, the more audit evidence is likely to be required). (1) 4. e quantity of audit evidence required is also affected by the quality of such evidence (the higher the quality, the less audit evidence may be required). (1) 5. When determining the quality (appropriateness) of audit evidence, the relevance, as well as the reliability, of such evidence needs to be taken into account. (2) 6. e relevance of audit evidence refers to the logical connection to, or bearing upon, the purpose of the audit procedure and, where appropriate, the assertion under consideration. (1) 7. e reliability of audit evidence is in uenced by the source and the nature of the evidence. (1) Available marks [9]; maximum marks [7] Note: As the concepts/principles of sufficient and appropriate audit evidence are important, they should be kept in mind when formulating audit procedures in chapters 13 and 14. Question 4 LEVEL 2 Impact of computerised environment on audit procedures [7 marks] Most entities have their nancial statements prepared using accounting software packages. As a result of using these packages for generating the nancial statements subject to audit, the auditor has to consider the impact of the computer environment on the audit process. REQUIRED Indicate and discuss the impact/effect of the computer environment on the audit process during the four phases of that process. [7] SUGGESTED SOLUTION TO QUESTION 4 1. Pre-engagement activities a) Prior to accepting the audit engagement, the auditor needs to consider the existence of the computer environment and the complexity thereof, which will in uence his/her consideration of his/her professional competence to conduct the audit with proper care, and speci cally the need for an information technology (IT) specialist (expert), and the availability thereof. (1) b) If the auditor concludes that an IT specialist is required, but such a specialist is not available at the time of the audit, the audit should not be accepted. (1) 2. Planning During the planning stage of the audit process, the auditor will a) consider the in uence of the computer environment when identifying and assessing the risk of material misstatement (i.e. inherent and control risk). (1) b) Suitable audit procedures should be formulated in order to respond to the assessed risks, which may include testing the computerised controls implemented by the management of the auditee. (1) 3. Obtaining audit evidence a) In obtaining audit evidence that is sufficient and appropriate, the auditor may consider the use of computer-assisted audit techniques (CAATs) in a case where the auditee stores nancial information electronically. (1) b) CAATs may be used to perform both tests of controls and substantive procedures. (1) c) CAATs are audit procedures performed through the use of software in order to gather audit evidence in a computerised environment when it is impractical or inefficient to obtain audit evidence manually. (1) d) In order to obtain evidence about the effectiveness of the computerised control environment and control activities, the auditor will use system-orientated CAATs. Data-orientated CAATs are used in order to perform mainly substantive procedures and, in some instances, also tests of controls. (1) e) e evaluating, concluding and reporting phase of the audit process is not affected signi cantly by the existence of the computer environment. (1) Available marks [9]; maximum marks [7] Question 5 LEVEL 1 Audit opinion: Modi ed and unmodi ed [4 marks] An audit opinion is an opinion expressed by an auditor in an audit report as to whether the nancial statements of an entity are fairly presented or not. e auditor can express either an unmodi ed or a modi ed audit opinion. REQUIRED Discuss the difference between an unmodi ed and a modi ed audit opinion and list the different types of modi ed audit opinions. [4] INTRODUCTION e following types of application question may typically be asked regarding the pre-engagement and planning phase of an audit: Discuss the factors to be considered prior to accepting an audit engagement. Discuss the strategy that an auditor will follow for a speci c audit. Calculate the planning materiality gure for a speci c audit. Describe the audit risk or the risk of material misstatement at nancial statement level. Assess the audit risk or the risk of material misstatement at nancial statement level. Describe the risk of material misstatement at assertion nancial statement level. EXAMPLE QUESTION 1 Pre-engagement [10 marks] Solomon & Phillips (S&P) is a rm of registered auditors with offices in Pretoria, Bloemfontein and East London. In October 20X6, S&P was awarded a tender to be the statutory auditors of Zondi Ltd (Zondi) for the 20X5 nancial year, after the previous auditors resigned, as they could not provide Zondi with a quality audit service as a result of staff shortages. Zondi, a company listed on the JSE, supplies paper manufactured at their plant in Mpumalanga, and has distribution outlets in 10 major South African cities. Zondi’s clientele comprises, among others, universities and corporate organisations. e chief executive officer of the company is a quali ed chartered accountant who is highly regarded in the industry. Since his appointment 12 years ago, Zondi has been reporting favourable results and has awarded its shareholders a handsome dividend. S&P has allocated eight audit team members, including the partner in charge, who has a 7.5% shareholding in Zondi, to the audit for the year ended 30 June 20X5. REQUIRED Discuss the factors S&P should have considered prior to accepting the statutory audit engagement of Zondi for the year ended 30 June 20X5. [10] GUIDANCE Understand the question Discuss the factors1 S&P should have considered prior to accepting2 the statutory audit engagement of Zondi3 for the year ended 30 June 20X6. [10] Identify the theory applicable to the question In order to answer a pre-engagement question, you should know the pre-engagement steps, namely: Does the auditor want to perform the audit? Can the auditor perform the audit? Are there any ethical reasons why the auditor should not perform the audit? Are there any statutory reasons why the auditor should not perform the audit? Remember that the last action during the pre-engagement phase of the audit is to nalise the terms of the engagement by means of an engagement letter. In order for you to identify the relevant information in the scenario, you should also know what each of the above-mentioned steps involves. For example, in order to know whether the auditor wants to perform the audit, you will need to establish: whether the auditor is satis ed that his/her rm is not prohibited from performing the audit in terms of the ISA 210 requirements whether the auditor wants to be associated with this industry whether the auditor wants to be associated with the owners or management of the entity (you need to remember that the auditor would not want to be associated with management if there were indications that they lacked integrity: refer to ISQC 1 Guidance on Management’s Integrity) what the nature of the client–auditor relationship is likely to be any signi cant risks of material misstatement that the auditor might be aware of at this stage whether taking on the engagement would be a sound business decision (i.e. whether the company would be willing, and able, to pay the audit fee). Read the question Solomon & Phillips (S&P) is a rm of registered auditors with offices in Pretoria, Bloemfontein and East London.4 In October 20X5, S&P was awarded a tender to be the statutory auditors of Zondi Ltd (Zondi) for the 2016 nancial year after the previous auditors resigned, as they could not provide Zondi with a quality audit service5 as a result of staff shortages. Zondi, a company listed on the JSE, supplies paper manufactured at their plant6 in Mpumalanga and has distribution outlets in 10 major South African cities.7 Zondi’s clientele comprises, among others, universities and corporate organisations. e chief executive officer of the company is a quali ed chartered accountant who is highly regarded in the industry.8 Since his appointment 12 years ago, Zondi has been reporting favourable results and awarded its shareholders a handsome dividend.9 S&P has allocated eight audit team members, including the partner in charge, who has a 7.5% shareholding in Zondi,10 to the audit for the year ended 30 June 2016. Exam technique In general, there is not a lot of examination technique involved in a preengagement question. However, in order to obtain the maximum marks, structure your answer according to the steps set out above under the heading Identify the theory applicable to the question. When dealing with the auditor’s ethical issues, remember to structure your answer according to the Code of Professional Conduct’s conceptual framework: Identify the issue. State the type of threat and the fundamental principle being threatened. Consider the signi cance of the threat and, if it is signi cant, deal with the safeguards. SUGGESTED SOLUTION 1. Zondi: the industry11 S&P will not have a problem associating itself12 with Zondi, as the paper manufacturing and supply industry within which it operates is not a dubious one. (1) 2. e integrity of Zondi’s management13 e CEO of Zondi appears to have integrity, as he is a quali ed chartered accountant14 who is highly regarded in the industry. (1) 15 3. Communication with the previous auditor S&P needs to contact the previous auditor in order to identify whether or not there is any reason why the audit engagement of Zondi should not be accepted. It is unlikely that there is a reason16 not to accept the audit engagement, as the previous auditor resigned as a result of not having adequate staff with which to service Zondi. (1) 4. Zondi’s ability to pay the audit fee17 Zondi will be able to pay the audit fee, as the company has been paying its shareholders handsome dividends for the past 12 years.18 (1) 5. Auditor’s ethical requirements19 a) e partner in charge of the audit engagement of Zondi has a 7.5% shareholding in the company. (1) b) is might create a self-interest threat to objectivity. (1) c) e threat could be regarded as signi cant. (1) 20 d) e safeguard that could be applied in this regard is to let the partner dispose of the shareholding, or not to let him/her be involved in the statutory audit of Zondi. (1) 6. e auditor’s skills, competence and resources21 S&P needs to consider if it has the adequate skills, the competencies and the resources to service Zondi by taking into account the fact that: a) the previous auditors resigned owing to a shortage of staff22 (1) b) Zondi has a manufacturing plant located in Mpumalanga and distribution outlets in 10 major cities across South Africa. (1) 7. Engagement letter23 When it is comfortable with accepting the statutory audit of Zondi, S&P needs to draft an engagement letter highlighting, among other issues, (1) a) the responsibility of Zondi’s management and that of the auditors of S&P b) the duty of S&P to report a reportable irregularity, if it exists. (1) Available marks [12]; maximum marks [10] EXAMPLE QUESTION 2 Strategy [4 marks] You have been the audit partner of Pink Boyd (Pty) Ltd (Pink Boyd) for the past ve years. Recently, the company decided to expand its business, not only by selling music both online and in its stores, but also by providing online lessons for various instruments. is has made it necessary for you to obtain knowledge of the new expansion, in the process of which you gathered that: 1. Pink Boyd (Pty) Ltd has branches in 10 different cities throughout South Africa 2. the maintenance of the application programs used for online sales are subcontracted to Help Inc. REQUIRED Explain how each of the above instances will in uence your audit strategy. [4] GUIDANCE Understand the question Explain how each of the above instances24 will in uence your audit strategy. [4] Identify the theory applicable to the question In order to answer the question, you need to know that the audit strategy typically consists of: the scope of the audit (what has to be performed) the timing of the audit (by when it needs to be performed) the direction of the audit (how it is going to be performed) the resources to be deployed in order to perform the audit. Read the question You have been the audit partner of Pink Boyd (Pty) Ltd (Pink Boyd) for the past ve years. Recently, the company decided to expand its business, not only by selling music both online and in its stores, but also by providing online lessons for various instruments.25 is has made it necessary for you to obtain knowledge of the new expansion, in the process of which you gathered that: 1. Pink Boyd (Pty) Ltd has branches in 10 different cities26 throughout South Africa 2. the maintenance of the application programs27 used for online sales are subcontracted to Help Inc. Exam technique ere is not a speci c way of answering audit strategy questions. In general, though, because the necessary information is provided in the scenario, you need only to identify the issues and explain how they will affect the audit strategy and thus the scope, the timing and the direction of the audit, as well as the resources allocated to the audit. SUGGESTED SOLUTION 1. a) is will affect the scope of the audit, as all the branches will have to be visited28 in order for inventory counts to be performed and their internal controls reviewed. (1) b) erefore it will have to be ascertained whether or not there are enough staff members29 available in order to perform all 10 audits c) Timing is also of the essence, as the branches will have to be (1) visited both during the course of the year and at year-end,30 which places a burden on human resources. (1) 2. a) is will affect the scope, as the auditors would have to gain an understanding of both the general and the application controls (computerised controls)31 at Help Inc. in order to ensure that they can place reliance on the latter’s internal controls. (1) b) e auditors might have to make use of a computer audit specialist32 to help with the evaluation of the general and application controls (computerised controls) at Help Inc. (1) Available marks [5]; maximum marks [4] EXAMPLE QUESTION 3 Materiality [10 marks] You are a rst-year trainee on the audit of Zondi Ltd (Zondi), a company listed on the JSE that supplies paper manufactured at their plant in Mpumalanga. Zondi’s clientele comprises, among others, universities and corporate organisations. Your audit rm has recently been appointed as the auditors of Zondi. e following is an extract from the company’s nancial information: BUDGETED JUNE 20X1 R’000 AUDITED JUNE 20X0 R’000 Revenue 12 000 9 500 Gross pro t 9 600 7 600 Operating expenses 4 650 3 850 2 830 1 820 45 000 28 000 32 000 19 000 Pro t before tax Total assets Total liabilities e actual 20X1 nancial results are not yet available, as management is currently nalising the closing entries. Notes: 1. It is anticipated that the sales volume of paper for 20X1 will increase by at least 10%, as a result of Zondi being able to sell paper in Lesotho and Swaziland. 2. Zondi plans to purchase new machinery to be used in the production of paper, in order to meet increased demand. Your audit rm applies the following percentages in calculating planning materiality: Revenue 0.5–1% Gross pro t 1–2% Pro t before tax 5–10% Total assets 1–2% REQUIRED Discuss, with calculations, the planning materiality gure for Zondi for the 30 June 20X1 year-end audit. [10] GUIDANCE Understand the question Discuss, with calculations,33 the planning materiality34 gure for Zondi Ltd for the 30 June 20X1 year-end audit. [10] Identify the theory applicable to the question In order to calculate planning materiality, you need to know the steps involved in calculating the gure, as well as the reasons for using certain information ( gures, etc.): Choose a set of nancial statement gures to use in the calculation. Choose a base component within the set of nancial statements selected. Determine a range for the base component. Calculate and conclude on a planning materiality gure within the range (remember to take the inverse relationship between audit risk and materiality into account). Conclude on performance materiality and clearly trivial matters. You also need to know that planning materiality consists of both overall and performance materiality, and that the latter will always be lower than the overall materiality gure. Read the question You are a rst-year trainee on the audit of Zondi Ltd (Zondi), a company listed on the JSE that supplies paper manufactured at their plant in Mpumalanga. Zondi’s clientele comprises, among others, universities and corporate organisations. Your audit rm has recently been appointed35 as the auditors of Zondi. e following is an extract from the company’s nancial information: BUDGETED JUNE 20X1 R’000 AUDITED JUNE 20X0 R’000 Revenue 12 000 9 500 Gross pro t 9 600 7 600 Operating expenses 4 650 3 850 2 830 1,820 45 000 28 000 32 000 19 000 Pro t before tax Total assets Total liabilities e actual 20X1 nancial results are not yet available, as management is currently nalising the closing entries. Notes: 1. It is anticipated that the sales volume of paper for 20X1 will increase by at least 10%, as a result of Zondi being able to sell paper in Lesotho and Swaziland. 2. Zondi plans to purchase new machinery to be used in the production of paper in order to meet increased demand. Your audit rm applies the following percentages36 in calculating planning materiality: Revenue 0.5–1% Gross pro t 1–2% Pro t before tax 5–10% Total assets 1–2% Exam technique Remember: As the calculation of planning materiality is a matter for the auditor’s professional judgement, you need to motivate the decisions taken in calculating such materiality. Also remember to deal with the inverse relationship between audit risk and materiality, and to consider both overall and performance materiality. SUGGESTED SOLUTION 1. Decision on nancial results to use in calculating planning materiality37 a) e choice38 is between the current year’s budgeted gures and the previous year’s audited results, since the actual results of the current year are not yet available. (1) b) e current year’s budgeted gures will be the most appropriate to use, since they take into account the 10% growth in sales volumes and the acquisition of the new machinery.39 (1) c) e current year’s budgeted gures also appear to be stable when compared with the previous year’s audited gures, and no other adjustments will be necessary, as the gures already include the changes in circumstances (the 10% growth in sales volumes and the acquisition of the new machinery).40 (1) 2. Choose a component in the set of gures selected a) Zondi is a pro t-orientated entity, therefore it would be appropriate to use components from the statement of comprehensive income. (1) b) Pro t before tax can be considered to be the most appropriate benchmark, because Zondi is a pro t-orientated entity. (1) 3. Determine a range for the selected component 5–10% of R2 380 000 = R119 000 to R238 000 (1) 4. Calculate a materiality gure within the range a) Given the fact that this is a new audit engagement, inherent risk41 is assessed as high. (1) b) As a result, it will be appropriate to consider a planning materiality gure towards the lower end of the range.42 (1) c) e lower planning materiality will allow the auditor to obtain sufficient and appropriate audit evidence to address the high inherent risk, thereby reducing the audit risk. (1) 5. Conclusion on planning materiality gure43 Based on the calculation above and the discussion on the high inherent risk the overall planning materiality44 for Zondi will be set at R119 000. (1) 6. Conclusion on performance materiality gure 75% can be applied to the planning materiality gure to arrive at performance materiality. A performance materiality gure of R89 250 has thus been calculated for Zondi’s audit. (1) 7. Clearly trivial matters Clearly trivial matters will be those below R2 380 (2% of materiality) unless they are qualitatively material. (1) Available marks [12]; maximum marks [10] EXAMPLE QUESTION 4 Risk at nancial statement level [6 marks] You are the auditor of Fixit Ltd (Fixit), a company listed on the JSE with a nancial year-end at the end of February. You are busy with the planning of the audit for the nancial year ended 28 February 20X1. For ve years, Fixit, the holding company for a group of smaller companies, had the contract to supply repair and maintenance services to 15 municipalities in Gauteng. When the contracts expired in February 20X1, the company had gentlemen’s agreements with all the municipalities that the contracts would be renewed. In February 20X1, when 13 of the municipalities put their repair and maintenance contracts out to tender, Fixit won only ve contracts. At the end of January 20X1, the purchase manager had imported R800 000 worth of inventory from China on credit. is bulk purchase had been estimated to be sufficient in order to conduct repairs for all 15 municipalities over the following 18 months. Payment for the bulk purchase, on which penalties and interest are payable on late payment, is due on 1 May 20X1. As Fixit will receive retention fees from the municipalities by the end of March 20X1, the company is expected to be able to meet the payment deadline. As a result of the loss of clients, Fixit has implemented an incentive scheme: all managers who achieve a total pro t of R500 000 for their department for the year ending February 20X1 will each receive a bonus of R50 000. While updating your knowledge of the business questionnaire, you have determined that the company has a lack of internal controls in various departments. e 20X1 audited nancial statements are required by 31 March 20X1. REQUIRED Describe the risk of material misstatement at overall nancial statement level. [6] GUIDANCE Understand the question Describe the risk of material misstatement45 at overall nancial statement level.46 Identify the theory applicable to the question In order to answer the question, you need to know the difference between two important concepts in auditing: 1. Audit risk versus the risk of material misstatement 2. Risk at overall nancial statement level versus risk at assertion level Audit risk comprises three components: 1. Inherent risk 2. Control risk 3. Detection risk e rst two can be controlled by the company, and the third by the auditor. Risk of material misstatement refers to the rst two components only. us, the nancial statements could be misstated materially as a result of: fraud error, or the incorrect preparation of the nancial statements on the going concern basis instead of on the liquidation basis. You also need to know, and understand, the difference between risk at overall nancial statement level and risk at the assertion level: Risk at overall nancial statement level refers to risks associated with the nancial statements as a whole and/or risks that cannot be linked to a speci c line item. Risk at the assertion level refers to risks associated with speci c line items, which could normally be linked to a speci c assertion as well. Read the question You are the auditor of Fixit Ltd (Fixit), a company listed on the JSE47 with a nancial year-end at the end of February. You are busy with the planning of the audit for the nancial year ended 28 February 20X1. For ve years, Fixit, the holding company for a group of smaller companies,48 had the contract to supply repair and maintenance services to 15 municipalities in Gauteng. When the contracts expired in February 20X1, the company had gentlemen’s agreements with all the municipalities that the contracts would be renewed. In February 20X1, when 13 of the municipalities put their repair and maintenance contracts out on tender, Fixit won only ve contracts.49 At the end of January 20X1, the purchase manager had imported R800 000 worth of inventory50 from China on credit. is bulk purchase had been estimated to be sufficient to conduct repairs for all 15 municipalities51 over the following 18 months. Payment for the bulk purchase, on which penalties and interest are payable on late payment, is due on 1 May 20X1. As Fixit will receive retention fees from the municipalities by the end of March 20X1, the company is expected to be able to meet the payment deadline. As a result of the loss of clients, Fixit has implemented an incentive scheme: all managers who achieve a total pro t of R500 000 for their department for the year ending February 20X1 will each receive a bonus of R50 000.52 While updating your knowledge of the business questionnaire, you have determined that the company has a lack of internal controls53 in various departments. e 20X0 audited statements are required by 31 March 20X1.54 nancial Exam technique When required to describe the risk of material misstatement at nancial statement level, you need to establish the indicators that increase the risk of material misstatement (thus inherent risk and control risk). erefore, read the scenario line by line and identify such indicators. Remember that you are looking for indicators that might indicate that the nancial statements are materially misstated as a result of: fraud error, or the incorrect preparation of the nancial statements on the going concern basis instead of on the liquidation basis. You cannot write down the indicator only and expect to earn marks (unless you are required merely to list the indicators). As part of your answer, you need to: write down the indicator link it to fraud, error or the incorrect preparation of the nancial statements on the going concern basis instead of on the liquidation basis explain how the indicator would lead to the risk mentioned (e.g. fraud, error or the incorrect preparation of the nancial statements on the going concern basis instead of on the liquidation basis). When required to describe audit risk, follow the same approach described above. However, you need to establish the indicators that increase detection risk. erefore, read the scenario line by line and identify such indicators. Remember that you are looking for indicators that might show that the auditor’s procedures might not detect material misstatements in the nancial statements. You need to: write down the indicator link it the auditor’s procedures that might not detect material misstatements in the nancial statements explain how the indicator would lead to the auditor’s procedures not detecting material misstatements in the nancial statements. When required to assess or evaluate the risk of material misstatement or audit risk, you need to establish the indicators that increase and decrease the risk of material misstatement or audit risk. In addition, you need to reach a conclusion about the risk, indicating whether it is high, medium or low. Read the scenario line by line and identify the indicators. Remember: this time you are looking for indicators that might increase or decrease the possibility that the nancial statements are materially misstated as a result of either: fraud error, or the incorrect preparation of the nancial statements on the going concern basis instead of on the liquidation basis. If asked to do so, look for audit risk indicators that might increase or decrease the possibility that the auditor’s procedures might not detect material misstatements in the nancial statements. SUGGESTED SOLUTION 1. As Fixit is listed on the JSE,55 the company’s nancial statements might be materially misstated as a result of fraud56 perpetrated in order to adhere to the JSE’s listing requirements.57 (1) 2. As the company is listed on the JSE,58 the company’s nancial statements might be materially misstated as a result of fraud59 perpetrated in order to improve the nancial results with a view to increasing the share price, thereby attracting investors.60 (1) 61 3. Fixit was contracted to ve municipalities only, which might lead to a major loss of income and pro t;62 therefore, the company’s nancial statements might be materially misstated as a result of the incorrect application of the going concern assumption.63 (1) 4. e company has already imported inventory for the repairs and maintenance for the contracts that they did not win;64 therefore, the company will not generate any income,65 and they have already incurred expenses on which penalties and interest are payable, if late payments are made. e company’s nancial statements might be materially misstated as a result of the incorrect application of the going concern assumption.66 (1) 5. Fixit has a lack of internal controls;67 therefore, their nancial statements might be materially misstated as a result of errors and fraud,68 as a lack of internal controls make it easier to commit fraud. Errors will not be picked up.69 (1) 6. Fixit is the holding company for a group of smaller companies.70 Consolidation requires specialised knowledge,71 and mistakes could be made that might lead to material misstatement in the nancial statements as a result of error.72 (1) 7. e company requires the audited nancial statements within a month of year-end,73 which constitutes a tight audit deadline that might lead to mistakes being made by the compilers of the company’s nancial statements,74 the outcome of which might be material misstatement resulting from error.75 (1) 8. Incentive bonuses based on pro ts are payable to the managers,76 which might lead to material misstatement in the nancial statements as a result of fraud 77 perpetrated in order to increase the pro ts with a view to achieving the required pro t and thereby the award of incentive bonuses.78 (1) Available marks [8]; maximum marks [6] EXAMPLE QUESTION 5 Risk at assertion level [4 marks] You are working on the audit of Inkwe Ltd (Inkwe), a company that has been listed on the JSE for the past ve years. Recently, Inkwe decided to buy a total of 100 properties for use as storage space. As the properties, the majority of which were nanced through the raising of mortgage bonds, are situated across South Africa, it will be impossible for you to visit them all. REQUIRED Describe the risk of material misstatement at the assertion level for property, plant and equipment (PPE). [4] GUIDANCE Understand the question Describe the risk of material misstatement79 at the assertion level for property, plant and equipment.80 Identify the theory applicable to the question Refer to the discussion of theory for the previous question. Read the question You are working on the audit of Inkwe Ltd (Inkwe), a company that has been listed on the JSE for the past ve years. Recently, Inkwe decided to buy a total of 100 properties for use as storage space.81 As the properties, the majority of which were nanced through the raising of mortgage bonds,82 are situated across South Africa, it will be impossible for you to visit them all.83 Exam technique When required to describe the risk of material misstatement at assertion level, establish the indicators that increase the risk of material misstatement (inherent risk and control risk). Read the scenario line by line and identify the indicators. However, remember to include the inherent risks, such as accounting standards and requirements. In general, look for indicators that might show that the speci c line item might be materially misstated as a result of error or fraud. You cannot write down the indicator only and expect to earn marks (unless you are required merely to list the indicators). In your answer: write down the indicator link it to fraud or error explain how the indicator could lead to the risk mentioned (e.g. through fraud or error) state the relevant assertion. When required to describe the audit risk, follow exactly the same approach described above. However, you also need to establish the indicators that increase the detection risk. erefore, read the scenario line by line and identify these indicators. Remember: you are looking for indicators that might show that the auditor’s procedures might not detect material misstatements in the nancial statements. In your answer: write down the indicator link it the auditor’s procedures that might not detect material misstatements in the nancial statements explain how the indicator could lead to the auditor’s procedures not detecting material misstatements in the nancial statements state the relevant assertion. When required to assess or evaluate the risk of material misstatement or audit risk, establish the indicators that increase and decrease the risk of material misstatement or audit risk, and conclude whether the risk is high, medium or low. Read the scenario line by line and identify the indicators. Remember that this time you are looking for indicators that might increase or decrease the possibility that the speci c line item is materially misstated as a result of fraud or error. If asked to do so, look for audit risk indicators that might increase or decrease the possibility that the auditor’s procedures might not detect material misstatements in the nancial statements. SUGGESTED SOLUTION 1. ere is a risk that the properties were not accounted for at the correct amounts,84 because all the costs on acquisition of the properties might not have been included in the cost of the properties, or might have been included incorrectly in the cost of the properties (valuation and allocation).85 (1) 2. ere is a risk that the properties were not accounted for at the correct amounts,86 because the useful life of the properties87 might have been incorrectly estimated (valuation and allocation).88 (1) 3. ere is a risk that the properties were not accounted for at the correct amounts,89 because their residual value90 might have been incorrectly estimated (valuation and allocation).91 (1) 4. ere is a risk that the properties were not accounted for at the correct amounts,92 because the depreciation method selected93 in order to depreciate them might not re ect the manner in which they decrease in value (valuation and allocation).94 (1) 5. ere is a risk that the properties were not accounted for at the correct amounts,95 because the borrowing costs on the mortgage bonds96 might have been incorrectly allocated (valuation and allocation).97 (1) Available marks [5]; maximum marks [4] QUESTIONS Question 1 LEVEL 2 Planning materiality [7 marks] You are the auditor of Took his Toll (Pty) Ltd (Took his Toll). e company, which is responsible for the maintenance of toll roads, receives a signi cant amount of fees (turnover) by requiring motorists using the toll roads to pay a minimum fee at the applicable toll gates. Besides spending approximately 40% of the fees received on the maintenance of the toll roads and approximately 20% on their labourintensive site workers, Took his Toll has invested a signi cant amount of its pro t accrued over the years on tollgate buildings, including an offsite cafeteria for its employees. Appointed as the audit manager responsible for the planning of Took his Toll’s audit for the year ending 31 March 20X1, you have obtained the following gures from management on their management accounts of Took his Toll for the period 1 April 20X0 to 30 September 20X0: BUDGET FOR THE YEAR R ACTUAL YEAR TO DATE R BUDGET YEAR TO DATE R Gross revenue 10 000 000 4 617 853 5 000 000 Construction costs 3 800 000 1 662 428 1 850 000 Gross pro t 6 200 000 2 955 425 3 150 000 Operating 3 460 000 1 223 571 1 842 000 expenses (labour and overheads) Pro t before taxation 2 740 000 1 731 854 1 308 000 Property, plant and equipment 4 400 000 4 816 577 4 600 000 Long-term loans 945 000 1 016 561 875 000 1 050 000 1 255 872 900 000 Accounts receivable After reviewing the above gures, you believe them to be reasonably accurate. In addition, you anticipate that Took his Toll will achieve the budgeted gures for the year ending 30 March 20X1. You have assessed the overall risk of material misstatement as high. According to audit rm policy, the following indicators and percentages may be used in order to calculate materiality: 0.5–1% of turnover 1–2% of gross pro t 5–10% of operating pro t before tax 1–2% of total assets 2–5% of equity REQUIRED Determine the planning materiality gure that needs to be used during the planning phase of the audit of Took his Toll for the year ending 31 March 20X1. Give detailed reasons for your answer, providing all relevant steps in determining the planning materiality gure. Base your materiality calculation on the guidelines provided above. [7] Question 2 LEVEL 2 Planning materiality [10 marks] You are the senior auditor on the newly awarded audit of Budget Fly Ltd (Budget Fly). e company has been listed on the JSE for ve years and has a December nancial year-end. Your audit rm was appointed as auditor in October. e previous audit rm was a well-established audit rm with a reputable reputation. e previous auditors issued an unmodi ed audit opinion in prior years and the former engagement partner has agreed to communicate with our rm with regard to previous audit work conducted by her rm. e following information was obtained during the planning stage of the audit: DESCRIPTION AUDITED RESULTS (PRIOR YEAR) RAND BUDGETED (CURRENT YEAR) RAND UNAUDITED RESULTS (CURRENT YEAR) RAND Revenue R980 million R1.2 billion R1.4 billion Pro t before tax from continuing operations R25 million R50 million R53 million R9 billion R9.9 billion R10 billion Total assets Additional information: e current year’s unaudited results are not nalised as the management of the company are still in the process of updating the nancial accounts for the last month of the nancial year and will do so after returning from their end-of-year vacation. Budget Fly expanded their ying routes to include two locations outside South Africa: – three ights a week to Namibia – two ights a week to Zanzibar e budgeted gures for the current year take into account the impact of these additional international ights. Budget Fly acquired two additional aircrafts in December of the current year. ey each seat 125 economy class and 32 business class passengers, which enabled Budget Fly to increase the number of local ights offered on the Johannesburg-to-Cape Town and Johannesburg-to-Durban routes. It is estimated that the aircraft will have a 20-year useful life and a 10% residual value. e company obtained a R1.8 billion loan from a bank in Switzerland to acquire the two additional aircraft. e acquisition of the two additional aircraft was not included in the 20X6 budgeted gures. It is your rm’s audit policy to use the following benchmark percentages when calculating planning materiality: DESCRIPTION PERCENTAGE Revenue 1–2% Gross pro t 1–2% Pro t before tax from continuing operations 5–10% Total assets 1–2% Your overall assessment of the risk of material misstatement is high for the current year. REQUIRED Discuss, with calculations, the planning materiality gure for Budget Fly for the December year-end audit. [10] Question 3 LEVEL 3 Planning materiality [11 marks] You are an audit partner at Du Toit & Mbeka Inc., a medium-sized audit rm in Cape Town. Go Travel (Pty) Ltd (Go Travel) was recently allocated to your portfolio during the year and you requested an audit trainee to commence with the planning of the audit after the preengagement activities were successfully performed. e audit trainee prepared the following working paper: Working paper P-1 Client: Go Travel (Pty) Ltd WP P-1 Financial year-end: 31 March 20X1 Prepared by: A.C. Lerk Section: Understanding of the entity and its environment Date prepared: 15/04/20X1 Reviewed by: Date reviewed: Go Travel was founded in April two years ago and is situated 15 km outside Cape Town Its main business activity is a travel agency for outside Cape Town. Its main business activity is a travel agency for international tours. This will be the rst year that an audit will be conducted on the nancial statements. The previous year’s gures were independently reviewed by other external auditors and no concerns were highlighted in the review report. Go Travel earns between 5 and 10% commission on all tours, depending on the agreement with its travel partners. The entity is run by Chloe Vermaak ( nancial director) and Chris Moloi (executive director), who are also the founders and shareholders of the entity. Chloe and Chris are planning to expand Go Travel rapidly and require the audited nancial statements within two weeks after year-end in order to apply for additional nancing from Money Bank. Previous communication from Money Bank stated that additional funding would be considered when healthy solvency and pro tability indicators were achieved. e directors provided you with the following extract from the nancial statements: Extract from the nancial statements ACCOUNTS 31 MARCH 20X1 31 MARCH 20X0 Commission earned (turnover) R552 749 R305 285 Other expenses R95 489 R76 587 Total assets R157 931 R125 879 Total liabilities R105 682 R117 859 During the 20X1 nancial year, Go Travel was awarded a R100 000 one-off contract in order to perform travel arrangements for a soccer team. Du Toit & Mbeka Inc. applies the following percentages in calculating planning materiality: Turnover 0.5–1% Gross pro t 1–2% Pro t before tax 5–10% Total assets 1–2% REQUIRED Calculate, properly motivated, the planning materiality to be used for the audit of Go Travel for the period ending 31 March 20X1. Ignore taxation for purposes of the question. [11] Question 4 LEVEL 3 Planning materiality [14 marks] You are the audit senior on the audit of Pro Gear Ltd (Pro Gear), a company which manufactures a wide range of sporting apparel and footwear, and supplies it to wholesalers around the country. Pro Gear has a 30 September nancial year-end and is listed on the JSE. e company is highly leveraged. e following schedule was compiled by you during the planning stage of the current year’s audit, re ecting actual and budgeted nancial gures of Pro Gear: DESCRIPTION AUDITED (PRIOR YEAR) 12 MONTHS RAND BUDGETED (CURRENT YEAR) 12 MONTHS RAND UNAUDITED (CURRENT YEAR) 9 MONTHS RAND Revenue R750 million R850 million R630 million Pro t before tax from continuing operations R22 million R29 million R97 million Total assets R1.15 billion R1.4 billion R1.3 billion It is your rm’s policy to use the following benchmark percentages when calculating the planning materiality level: DESCRIPTION PERCENTAGE Revenue 1–2% Pro t before tax from continuing operations 5–10% Total assets 1–2% It is also the rm’s policy to reduce the calculated planning materiality gure by 50% in order to determine performance materiality, while the clearly trivial level for the audit is calculated at 10% of the performance materiality gure. Note: Management of the company decided at the March board meeting that it was unnecessary for the company to own a Citation X private plane. Subsequently, the company was able to sell the plane for R125 million on 1 April 20X1. is resulted in the company making a pro t of R75 million, calculated as follows: Cost price of R200 million less the accumulated depreciation up to 31 March 20X1 of R150 million equals the carrying value of R50 million. Sales price of R125 million less the carrying value of R50 million equals the pro t of R75 million. R10 million depreciation is charged to the asset on an annual basis. e sale was not budgeted for and is therefore not included in the company’s current year budget appearing above. All effects of the sale are however, included in the nine months’ unaudited gures. Your rm’s past experience as the auditor of Pro Gear has shown that the company’s sophisticated budget process normally provides an accurate re ection of the actual nancial results and position of the company presented in the nal nancial statements. Your overall assessment of the risk of material misstatement was set as ‘high’ for the current year. REQUIRED 1. Explain the difference between a factual and likely error. 2. Explain the difference between a qualitative and quantitative misstatement that might arise in a set of nancial statements. 3. Discuss with detailed workings how you would calculate the planning materiality, performance materiality and clearly trivial level for the audit of Pro Gear. [14] Question 5 LEVEL 3 Planning materiality [21 marks] You are the external auditor of Natasha’s Gambling Palace (Pty) Ltd (Natasha’s Gambling Palace) located in Cape Town. Natasha’s Gambling Palace’s operations consist of various casinos that conduct business across the Western Cape. e company is listed on the JSE. Its largest development is located at the Western Grand entertainment complex. Natasha’s Gambling Palace owns its own equipment, while the buildings from which it operates its casinos are leased from the company’s main investor. During the 20X1 nancial year, Natasha’s Gambling Palace opened a new casino, also in one of the main investor’s hotels where it leases business space. For this purpose, it took out a sizable loan from AfriBank Ltd to fund the addition of new roulette tables, slot machines and other equipment for the gaming area. You have just completed the assessment of internal controls for all the business cycles within the company and concluded that control risk should be provisionally evaluated as ‘low’, while the susceptibility of all account balances and classes of transactions to material misstatement, without considering internal control, is ‘high’ in general. e audit partner instructed you to calculate planning materiality using the following guidelines: Income 0.5–1% Gross pro t 1–2% Pro t before taxation 5–10% Total assets 1–2% Although the statement of comprehensive income has been fairly unstable over the past three years, the company has been able to manage and maintain its gross pro t percentage to the extent of remaining consistent. Regardless, the company’s nancial situation has changed signi cantly from the prior year: the statement of nancial position is not as strong as the directors would like it to be as the company is running a large overdraft and its trade creditors are long outstanding. Also during the 20X1 nancial year, the company’s main investor invested in improving the infrastructure of the buildings from where Natasha’s Gambling Palace operates – in order to increase the lease income potential of the buildings. e investor built, among others, an amphitheatre next to one of its hotels which can seat 50 000 people. us far, shows hosted at the amphitheatre by Natasha’s Gambling Palace have been mostly booked out, with artists like PitBull, Nivo & Vinz, Fallout Boys and 1Direction (less one member) having performed there. It is expected that these developments will improve income during the next couple of years. You obtained the following actual nancial statement gures from the chief accounting executive: 31/10/20X1 UNAUDITED R’M 31/10/20X0 AUDITED R’M Extract of statement of comprehensive income Income 1 452 1 582 Gross pro t 832 870 Pro t before tax 195 230 Extract of statement of nancial position Property, plant and equipment 211 180 Total current assets 575 650 Equity 250 250 Non-current liabilities 211 160 Total current liabilities 464 420 During preliminary enquiries to the accounting staff about the company’s nancial performance and position, they commented that several errors were made in drafting the actual nancial statements. ese have not been corrected as yet: 1. It is likely that errors have occurred in the debtors’ book, included in current assets, because a new accounts receivable clerk was appointed at the beginning of the nancial year. 2. Income in the amount of R500 000 was not recorded and is not re ected in the gures above. e effect of this error on gross pro t amounted to R275 000. 3. ‘Operating expenses’ of R700 000 were re ected under ‘other expenses’. REQUIRED: 1. Calculate, with proper motivation, taking all information into account, the planning materiality gure for the 20X1 nancial statement audit of Natasha’s Gambling Palace. 2. Brie y explain the relationship between ‘materiality’ and ‘audit risk’. [21 marks] Question 6 LEVEL 2 Pre-engagement [20 marks] You are a rst-year trainee accountant at Ofentse & Kelebohile Inc. (O&K), a rm of registered auditors recently appointed the statutory auditors of Foodworth Ltd (Foodworth) for the 30 June nancial yearend. Foodworth is a retail company that manufactures its mainly organic food products and sells them to upper- and middle-income customers. Foodworth, which has 32 outlets situated in upper class suburban areas country-wide, has a factory in Cape Town and a farm on the outskirts of the city, where it grows its products. Head office is in Johannesburg. e company has been listed on the JSE since 1999. O&K became aware that Foodworth would be changing its statutory auditors when Mrs Jacobs, the wife of the audit partner in charge of the audit of Foodworth, advised him to tender for the audit. She considered O&K to be the most appropriate auditors for the company, as the majority of O&K’s clients are in the food retail industry. Mrs Jacobs is the chief nancial officer (CFO) at Foodworth. After O&K was awarded the tender, Mrs Jacobs requested O&K to assist the company with the following non-assurance services: e identi cation of potential investors to invest in Foodworth (the investments will be used to expand into the East African market) e preparation of the company’s tax returns (the CFO will take full responsibility for the returns, including any signi cant judgement made) For the year ended 30 June, Foodworth’s reported pro t for the year was R13 million. e processing of all transactions is done using DataAdapta-System (DAS) accounting software, and, in order to create a greener environment and cut down on the use of paper, all communications with suppliers and bankers are electronic. Foodworth has a strong, competent internal audit department that assists in evaluating and monitoring the assessed risks. e team members for the Foodworth audit comprise the audit partner, the audit manager and you. e CFO has informed the audit partner that the audited nancial statements, which will be used in order to assist the management of Foodworth on strategies for expanding its market share in South Africa, as well as the signed audit report, are required three weeks after year-end. REQUIRED Discuss the factors that O&K should have considered prior to accepting the statutory audit engagement of Foodworth for the year ended 30 June. [20] Note: Refer to example question 1 for guidance on how on to approach answering this question. SUGGESTED SOLUTION TO QUESTION 6 1. O&K should have considered the ethical requirements. a) i) ere is a familiarity threat to the independence of the audit partner, as the CFO of Foodworth is married to the audit partner in charge of the company audit. (2) ii) Safeguard: e audit partner should not have been involved in the audit. (1) b) i) ere is an advocacy threat to the objectivity of O&K, as identifying potential investors in Foodworth could be seen as promoting Foodworth’s shares. (2) ii) Safeguard: O&K should not have been involved in identifying any potential investors in Foodworth. (1) c) e audit rm will be providing the tax services (the preparation of tax returns) for Foodworth. In terms of SAICA’s Code of Professional Conduct, the preparation of tax returns will not create any threat to independence, as the CFO is taking responsibility for the returns, including any signi cant judgement made. (2) d) i) O&K should have considered whether there would be any con ict of interest between Foodworth and existing clients in the food retail industry, which might create a self-interest threat to O&K’s objectivity and con dentiality. (1) ii) Safeguards: Notifying all the relevant parties that O&K will be acting for two or more parties; the use of separate engagement teams. (2) e) As Foodworth has reported pro ts for the year of R13 million, its ability to pay the audit fee is not in question. (1) f ) O&K should have considered whether there was a vacancy for the appointment of a statutory auditor in terms of the Companies Act 71 of 2008 prior to accepting the audit engagement of Foodworth. g) O&K should have contacted the previous auditors in order to (1) identify whether there was any reason not to accept the statutory audit engagement of Foodworth. (1) h) Foodworth is in the food industry. ere is nothing that suggests that the audit rm would not want to associate itself with this industry, given the fact that it has other clients in the same industry. (1) 2. e rm should have considered its skills, competencies and resources. a) ree people are not sufficient to audit an entity the size of Foodworth. (1) b) As the audit needs to be completed three weeks after year-end, this will be a tight audit deadline and, given the limited number of audit team members, the deadline might not be met. O&K should have considered increasing the number. (1) c) e audit rm should have considered whether it had the necessary auditing software in order to audit the nancial data stored in the DAS accounting software. (1) d) Consideration should have been given to engaging an IT expert to assist with auditing the computerised controls. (1) e) O&K should have considered the in uence that work performed by the internal audit would have on the statutory audit. (1) 3. O&K should have given consideration to drafting an engagement letter highlighting, among other issues: a) the responsibilities of both the auditor and management (1) b) the duty of the auditor to report any reportable irregularity (1) c) the tax return services to be provided. (1) Available marks [23]; maximum marks [20] Question 7 LEVEL 2 Pre-engagement activities [12 marks] Feldmans Inc. has been the auditor of the Eastland Dairy Ltd group (Eastland Dairy) for the past four years and is currently considering whether to accept reappointment as the company’s auditor for its September 2015 nancial year-end. Company background Eastland Dairy was incorporated 22 years ago and is listed on the JSE. Down Under Investment Ltd, a company based in Sydney, Australia, owns 65% of the company’s shares and the remaining 35% of the shares are owned by members of the South African public. e entities in the Eastland Dairy group produce a wide range of cheese, butter, yoghurt, milk and ice cream products. e group sells its products both in local and in the Zambian, Namibian and Botswanan markets. Some of the products sold in these foreign markets are produced in the other countries by dairies owned by the group, while other products are imported from South Africa. Eastland Dairy has level 1 BBBEE contributor status and was recently recognised for its efforts in leading the industry in the area of corporate social responsibility. Other pertinent company information During the nancial period (in July), the company recalled its strawberry yoghurt product sold in South Africa after it emerged that some consumers had become seriously ill after eating it. It was subsequently discovered that an ingredient used in manufacturing the strawberry yoghurt was contaminated. e recall cost the company millions of rands, but the company’s chief operating officer, Mr Ryan, was quoted as saying that the ‘health and safety of the public was more important to the company than the bottom line’. e company has sourced a new supplier of the ingredient and plans on re-launching the product in the next nancial year. e recall of the yoghurt product had an effect on the public’s con dence in the other products sold by the group, which resulted in the group losing a portion of its market share to smaller dairies in South Africa. e company migrated its accounting records from an old accounting system it had used for the past 10 years to a newly developed in-house accounting software package. e migration was done in stages and completed in June during the nancial year. Audit-related aspects Ms Kelly has been the engagement partner on the audit of Eastland Dairy for the past three years, while Mr Milner was appointed as the human resources director of Eastland Dairy at the start of the 20X5 nancial year. e two were introduced at a Christmas party at the end of the previous nancial year and got engaged in April of the 20X5 nancial year. e interim audit is scheduled to take place during the rst two weeks of July 20X5. Feldmans Inc. does on occasion make use of component auditors to assist it with audit work to be performed in regions located outside South Africa. As part of planning the audit, signi cant reliance has been placed on the internal control audit procedures performed by Eastland Dairy’s internal audit department during the nancial year. A representative of Down Under Investment Ltd has indicated that it requires audited nancial statements by the end of the third week of October in order for the company to consolidate its results. REQUIRED Discuss the matters that Feldmans Inc. would have considered prior to accepting the reappointment as auditor of Eastland Dairy for the 2015 nancial year. [12] Question 8 Pre-engagement activities LEVEL 2 [15 marks] You are a manager at Ace Audits Inc. (Ace Audits) a medium-sized audit rm with offices in Johannesburg, Pretoria and Cape Town. Ace Audits Inc. is currently considering whether to accept the appointment as external auditor of All Bronze Ltd (All Bronze) for All Bronze’s nancial year ending 31 January 20X6. is is as a result of Mr Peach, the chief executive officer (CEO) of All Bronze, asking Jakes Apricot in January 20X6 to have Ace Audits tender for the position of external auditor. Jakes Apricot is a trainee accountant at Ace Audits and the nephew of Mr Peach. Mr Peach also requested that Ace Audits should perform some secretarial and taxation services for All Bronze. All Bronze is an entity manufacturing chutney and was formed in the early 1980s. e company had a turbulent period during the rst decade of operation, but pro tability has increased steadily. Currently, the entity is highly pro table. All Bronze owns approximately 35% of the chutney product market of South Africa and faces only one noteworthy competitor, Mr Molls (Pty) Ltd. All Bronze’s manufacturing plant is in Johannesburg, and its head office is in Pretoria. e entity imports all product ingredients from various countries around the world in order to ensure high quality of its nal product. Management has always promoted a strong internal control environment and therefore all import transactions are hedged. Management also strives to fully comply with the requirements of King IV™ and communicates ethical codes to all levels of employees at All Bronze. e deadline for completion of the nancial statements is strictly adhered to in accordance with the Companies Act. Most of Ace Audits’ clients’ year-ends are between the end of December and the end of February each year, and its clients’ type of industries range vastly, from retail to manufacturing to investments. e previous auditors of All Bronze resigned due to a staff shortage, but are willing to meet Ace Audits, with All Bronze’s permission, in order to provide Ace Audits with relevant information and prior year working papers. REQUIRED Discuss whether Ace Audits should accept the audit engagement of All Bronze for its 31 January 20X6 nancial year. [15] Question 9 LEVEL 2 Pre-engagement activities [13 marks] You are an audit manager at KBNV Inc. (KBNV), which operates primarily from Port Elizabeth and has been assigned to the 29 February 20X1 audit of Fresh Air Ltd (Fresh Air), a company that has been providing the South African public with a wide range of fragrant solutions since the company was incorporated 20 years ago. e company listed on the JSE 10 years ago and has a March year-end. It is the rst year that the audit rm you work for will be auditing Fresh Air. e company is 65% owned by the Fresh family, from where the company draws its name, and the remaining 35% is owned by other investors. From your initial discussions with the chief operating officer (COO) of Fresh Air, you gathered the following information: Product information e company’s products are produced in a variety of forms and fragrances, from robust aerosols to slow releasing gels. A total of 75% of its products are manufactured at the company’s newly completed factory located at Coega, near Port Elizabeth, in the Eastern Cape. e remaining 25% of the products are produced at the company’s other factories located in Cape Town and Johannesburg. Fresh Air aims to have all production moved to the new facility over the course of the next two years. e products are sold to both wholesalers and retailers around the country. Marketing information Fresh Air was forced to reconsider its sales and marketing strategy at the start of the 20X1 nancial year due to an unexpected increase in market competition. e increase came about as a result of a number of new fragrance suppliers importing cheap products from the Far East and then selling these to wholesalers and retailers at prices much lower than that of Fresh Air’s products. e company implemented a new state-of-the-art supply chain management computer system during July 20X0. e new system has enabled the company to produce more products at a reduced cost, which may result in greater market share through increased sales. All employees involved in the supply chain process were sent on rigorous training courses. e change in sales and marketing strategy as well as the implementation of the new supply chain management computer system has ensured that the company has remained pro table in the midst of the new competition. Other pertinent information Mrs Nel, the marketing director, recently got married to Mr Nel, an audit partner at KBNV not assigned to the audit of Fresh Air. KBNV was appointed as the company’s external auditor at the company’s annual general meeting held in June 20X0. It was announced at the annual general meeting that the 20X1 audit was awarded to KBNV as a result of the rm’s excellent reputation and great technical ability. KBNV increased the number of audit trainees it appointed at the start of the 20X1 calendar year from 50 to 75 new trainees. e decision was made to ensure that the existing employees of the rm do not work unreasonable hours for months on end. Fresh Air was previously audited by Canister Inc. (Canister). e engagement partner at Canister, who was the designated auditor for Fresh Air, indicated at the above annual general meeting that Canister had resigned as a result of the audit rm changing its focus and strategy: it has decided to grow its advisory services division and to decrease the amount of time spent on external audits. e partner thanked the board of directors for their commitment to business excellence and for always paying the audit fees on time, and he wished the executive leadership and shareholders all the best for the future. REQUIRED Discuss the matters that KBNV would have considered prior to accepting the appointment as the auditor of Fresh Air for its 20X1 nancial year. [13] Question 10 LEVEL 3 Client acceptance decision [26 marks] You are a partner at FZ, a rm of chartered accountants and registered auditors, and you are a member of a three-person panel tasked with deciding whether or not new clients should be accepted by the rm. e information below relates to three prospective clients that have to be assessed for client acceptance by the panel of which you are a member: 1. LifeAfrika Ltd (LifeAfrica), a JSE-listed company, markets life assurance products and related nancial services in South Africa and 14 other countries on the African continent. LifeAfrica was recently ned an amount of US$2.6 billion by regulators in one of the countries where it operates (one of the most populous countries in Africa), and may lose its licence to provide services in that country. LifeAfrica’s management released information about the ne only after journalists became aware of the ne having been imposed and started contacting the company for comment. LifeAfrica was also ned by regulators in another country less than two years ago. 2. Breadwinners Ltd (Breadwinners), a JSE-listed company, is a diversi ed food group. In the previous nancial year, the company had problems with acquisitions that did not prove as successful as had been hoped, impermissible accounting practices, and lowerthan-expected demand in its substantial milling division. In response to these problems, Breadwinners red its auditors (after the conclusion of the prior year audit), and all three of its executive directors (the chief executive officer and managing director, the chief nancial officer and the chief operating officer) who served on the company’s board resigned in the past year. e company’s chairman, who used to be its chief executive officer, has been acting as its chief executive officer for the past six months. 3. Upinsmoke (Pty) Ltd (Upinsmoke) is a manufacturer of cheap cigarettes that it distributes in the major cities of South Africa. Upinsmoke was founded three years ago by former senior management-level staff members of a multinational cigarette manufacturing company, and has gained a good market share since then. e company has informed you that it needs loan funding to expand its manufacturing plant in Germiston and will be presenting its next set of audited nancial statements to a number of banks as part of that process. e managing partner of FZ is a close friend of Upinsmoke’s chief executive officer and is strongly in favour of taking the company on as a client. REQUIRED Discuss how the information provided above would in uence your judgement on the acceptance decision relating to each of the prospective clients. [26] Question 11 LEVEL 2 Pre-engagement [12 marks] As the audit partner in the medium-sized audit rm of Perfect Services Inc. (PSI), you have had a discussion with a friend who has recently completed her electronic engineering degree. ree years ago, together with fellow students from the same faculty, she registered a private company, Special Speech (Pty) Ltd (Special Speech), a company specialising in speech technology services that has shown signi cant growth in the last two years. Transactions are processed using a Unix system. Because her previous auditors did not apply International Financial Reporting Standards (IFRS), which would have presented the company in the most favourable light, she asked you to perform the audit. You asked the audit senior at PSI to contact your friend with a view to drawing up a potential client pre-acceptance working paper. Working paper Prepared by: H.D.C. du Plessis (audit senior) Date: 15 March 20X1 Subject: Pre-acceptance working paper SUITABLE CRITERIA SATISFIED Independence of the auditor YES Special Speech (Pty) Ltd has demonstrated the ability to settle the audit fees YES Issue of engagement letter agreeing to the engagement terms YES REQUIRED Describe any additional pre-engagement activities that need to be considered and addressed before you accept the auditing engagement of Special Speech. [12] Question 12 LEVEL 2 Risk at assertion level [9 marks] Mereki Platinum Mines Ltd (Mereki) is a small platinum mine situated in Rustenburg, North-West Province with head offices in Johannesburg. e company, which was established in 1989, is listed on the JSE. As a rst-year trainee accountant at Mbatha Inc. (Mbatha), which has been the auditors of Mereki for ve years, you are responsible for the 30 June audit of the property, plant and equipment section. You have been provided with the following information: AMOUNT (R) NOTES Property 41 250 000 1 Plant 39 689 890 2 Equipment 27 100 300 3 Total 108 040 190 4 Notes: 1. ‘Property’ relates to the land on which the mining operations take place and on which the head offices are located. 2. ‘Plant’ relates to the actual mine and warehouse, which have been provided as security for the bank loan acquired that year. 3. During the course of the year, additional mining equipment was acquired from a supplier in Germany, as a result of which such costs as import duties and transportation were incurred. Settlement was made in euros. In order to ensure that they operate optimally, the machines undergo maintenance every six months. 4. Mereki follows IFRS. Property, plant and equipment (PPE), which is measured at a cost model, is depreciated using the estimated useful life of each signi cant component, after the residual value has been deducted on a straight line method. REQUIRED Describe the risks of material misstatement at the assertion level for property, plant and equipment of Mereki Platinum Mines for the year ended 30 June as evinced in the above scenario. [9] Question 13 LEVEL 2 Risk at nancial statement level [12 marks] As a rst-year trainee accountant at Motholo Inc. (Motholo), you are currently assigned to a team responsible for the audit for the nancial year ended 30 June of BesaNama (Pty) Ltd (BN), whose nancial statements have not been audited before. An entertainment outlet that provides facilities for braaiing and for having one’s car washed and valeted while one enjoys a drink (either non-alcoholic or alcoholic) and snacks, BN operates weekdays between 11h30 and 22h00, and on weekends between 11h30 and 02h00. On Saturdays and Sundays, which are the busiest days for BN, customers are entertained by a live band. BN’s operations are based in Tembisa, a township in the Ekurhuleni municipality, and Mamelodi, a township in the City of Tshwane municipality. e company, which was established 15 years ago, is a family business managed by the husband and wife team of Mr and Mrs Chauke. Until just over a year ago, when an accounting software system was purchased, Mrs Chauke was responsible for handling BN’s nancial affairs, manually recording all transactions. en, when abo Chauke, the couple’s son, who had just completed Grade 12, was appointed nancial manager, he took over responsibility for the company’s nancial affairs and the recording of all transactions. Although he attended a training course in order to become acquainted with the newly acquired accounting software system, abo has acknowledged that he is not as yet fully au fait with the system, as a result of which he sometimes makes mistakes while capturing transactions. In addition, as a result of the high volume of transactions and his being the only responsible person (apart from a cousin who helps with the capturing of transactions at the Mamelodi outlet) for the recording of transactions, he was not able to record all such transactions. abo and his cousin are paid an annual bonus based on pro ts for the year. BN’s monthly revenue averages R600 000. Sometimes, however, when the company operates on weekends beyond 02h00 in order to sell alcoholic drinks in contravention of the South African Liquor Act, this gure can rise to R1 000 000. e company has seen a gap in the market and intends to grow its business to other townships in Gauteng. In order to do so, BN has applied for a bank loan, approval of which depends on its audited nancial statements. REQUIRED Identify the risk indicators evinced in the above scenario. In each case, describe the risks of material misstatements at overall nancial statement level of BN the year ended 30 June. Answer using the following tabular format: RISK INDICATOR RISK DESCRIPTION [12] Question 14 LEVEL 2 Risk at assertion level, the audit approach and the risk thereto [22 marks] Dikoloi Ltd (Dikoloi) is an automobile-, motorcycle- and enginemanufacturing company founded in 20X2 with its head office and manufacturing plant in Brits, North-West Province. Dikoloi adopts IFRS in preparing its nancial statements. As a rst-year trainee accountant at Phillips & Sons Inc. (Phillips & Sons), you have been assigned to the team responsible for the audit of Dikoloi for the year ended 30 June. You are tasked with the audit of the following accounts: Inventory AMOUNT (R) NOTES Raw material 410 000 000 1 Work in progress 320 000 000 2 Finished goods 860 000 000 3 Total Notes: 1 590 000 000 1. Raw material is sourced both locally and in Germany with the German account being settled in euros. Such costs as import duties and transportation are incurred when raw material is purchased from the foreign supplier. At year-end, there was inventory, purchased free on board from the supplier, that was still at sea. 2. Work in progress represents automobiles and motorcycles that are incomplete and therefore not yet ready to be sold. 3. Dikoloi follows a standard costing method in order to account for the allocation of costs to its nished goods. Loan Two years ago, Dikoloi obtained a ve-year term loan from ABBA Bank in order for the company to increase production. e loan attracts interest at 12% per annum, with interest payable twice a year. Share capital During the year under review, additional shares were issued in order to raise funds to open an additional plant in East London. e directors issued the shares without rst con rming that there were enough unissued shares for issue in terms of Dikoloi’s memorandum of incorporation. Salaries and wages AMOUNT (R) NOTES Salaries 5 600 000 1 Wages 3 280 000 2 Total 8 880 000 3 Notes: 1. Salaries are payable at the end of each month to permanent employees, who are paid according to set salary scales. 2. Dikoloi has over 500 employees who earn wages, which are paid weekly on a Friday. Such employees are employed on a contract basis and earn a speci ed rate per hour. A higher rate is paid to employees who work overtime. 3. ere are such third-party costs as PAYE and medical aid contributions that Dikoloi withholds from the payment of employees in order to pay the amount over to the respective authorities. REQUIRED 1. Describe the risks of material misstatement at the assertion level relating to the identi ed accounts at Dikoloi as evinced in the above scenario for the year ended 30 June. Link each of the risks to an assertion. (11) 2. Describe the audit approach/responses appropriate to addressing the risks of material misstatements identi ed in the rst question. Detailed audit procedures are not required. (11) [22] Question 15 LEVEL 3 Risk at assertion level and the response thereto [20 marks] You are the audit senior on the audit of Leading-Page (Pty) Ltd (Leading-Page). e company, which is growing at a rapid rate, manufactures coated paper that it distributes throughout Africa. e company has a March nancial year-end. e following information was brought to your attention during a meeting held in November with the chief nancial officer of the company: Leading-Page obtained a loan from Financial Bank in the US for $1 million. e four-year loan is payable annually in arrears at a rate of 12% per annum on the outstanding balance. e funds from the loan were used to purchase several of the latest paper-manufacturing machines from a supplier in the US at a cost of $125 000 each. Four of the eight machines ordered had arrived by year-end, while the remaining three are scheduled to arrive in June of the next nancial year. e company has two production facilities: one in Cape Town, which specialises in the production of graphic paper, and the other in Johannesburg, where a range of coated paper is manufactured. Leading-Page uses several logistics companies for the transportation of paper within South Africa and to neighbouring countries. In the case of those foreign cities/towns located more than 4 000 km away, the company makes use of sea freight in order to transport the paper to the closest port of entry for that country, after which it is the buyer’s responsibility to arrange transport of the imports to their nal destination(s). All sales to buyers outside South Africa are concluded in US dollars. Leading-Page hedges 40% of its foreign transactions. As the company does not accept cash or cheque payments, all sales are concluded via EFTs. e credit terms stated in the contracts between Leading-Page and its buyers determine the amounts due and the dates by which payments are required. A select group of buyers has been granted the right to hold 30% of the inventory ordered on consignment on a trial basis. If it proves to be pro table, the company might increase the number of such buyers. REQUIRED Describe the risk of material misstatement at assertion level as evidenced in the above scenario, in each case giving your responses thereto in your capacity as the auditor of the company. [20] Question 16 LEVEL 2 Risk at assertion level [10 marks] You are commencing your third year as a trainee accountant. e senior manager on the client has selected you to plan the current year’s audit of the Gold Group (Pty) Ltd (Gold Group). e company has a December year-end. You obtained the following information while preparing your planning working papers: Inspection of the prior year audit le e company was incorporated eight years ago and owns a large number of retail stores in South Africa. e company’s stores are located in and around shopping malls across South Africa. e Gold Group is made up of the following companies: – Gold’s Elegant (Pty) Ltd sells high-end clothing from 10 stores with a target market being young and seasoned professionals. – Gold’s Bridal (Pty) Ltd sells male and female bridal apparel from ve stores with a target market being engaged couples. – Gold’s Sporting (Pty) Ltd sells both sporting apparel and a limited number of sporting goods from 10 stores with a target market being sportsmen and -women of all ages. – Gold’s Urban and Youth (Pty) Ltd sells urban clothing from 15 stores with a target market being youth and young adults. Customers can acquire products from any of the stores in the group by either paying cash or buying on credit when using their Gold’s customer card which has a predetermined credit limit on it. Customers who acquire products on credit are charged interest on their outstanding balance. – e interest is compounded on a daily basis. – e interest charged on the outstanding amount is based on the customer’s risk pro le and could be charged up to the maximum interest rate allowed in terms of the National Credit Act. – Where the customer defaults on a monthly payment, penalty interest will be charged using the maximum interest rate allowed in terms of the National Credit Act. Customers qualify for loyalty programme discounts when purchasing certain products. Customers are permitted to return products up to 60 days after acquiring them. All returns must be accompanied by an original receipt and are subject to a quality control check. e chief nancial officer estimates that 10% of the products purchased will be returned and it is the company’s policy to recognise only 90% of the sale until the 60 days has passed by. Products sold by the stores within the Gold Group are acquired from local suppliers and foreign suppliers in the Far East. Products purchased from foreign suppliers are generally shipped freight on board to Durban harbour before being distributed to the various stores. – Discussion with the chief nancial officer e group attributes its success to having built up relationships with good suppliers in the Far East. It is the group’s policy to make use of foreign exchange hedges to mitigate the effect of exchange rate movements. e group hedges 50% of its foreign purchases as their transactions are denominated in US dollars. e company’s primary focus is the sale of clothing to the South African public, but it recently acquired the Home Specialist Store, a private company with 10 stores around the country which specialises in supplying kitchen and bedroom related products. – Customers are able to use their existing Gold Store customer cards to purchase goods on credit from the Home Specialist Store. – e ‘Home Specialist Store’ had sold products only for cash prior to being acquired by the Gold Group. e company obtained a R15 million loan from the Industrial Development Corporation in October of the current nancial year in order to acquire the Home Specialist Store. e loan is repayable over the loan term of seven years with interest charged at prime +2% payable on a monthly basis. REQUIRED Describe the factors that increase the risk of material misstatement at account and assertion level. [10] Question 17 LEVEL 2 Risk at nancial statement level [16 marks] You have recently been appointed as auditor of Mobile Connectivity Ltd (Mobile Connectivity). e company is one of the largest internet service providers in South Africa and was incorporated 10 years ago. e company was listed on the JSE two years ago. During the preliminary engagement procedures, you held discussions with senior personal. Ms Brittany Sumrall, the chief executive officer, indicated the following: e company’s central administration office is located in Durbanville and it has several branches located in shopping malls in and around South Africa, as well as four branches in Namibia from which the products (ADSL available in both South Africa and Zimbabwe, bre optic cables and wi on-the-go currently available only in South Africa) are sold. e company signed an agreement with the Western Cape Provincial Government to supply bre optic cables to several underdeveloped urban areas in and around the City of Cape Town. e project will grant thousands of people access to high speed internet which they normally would not have had and is part of a drive by the local government to uplift the social standing of individuals in the province. e contract was awarded to the company as a result of its excellent track record, the integrity of management, and the fact that the company is a leader in the eld of corporate social responsibility. e company expanded its ADSL services to Zimbabwe by opening two branches in Harare and two in Bulawayo. e company has a seven-year plan to expand its footprint into other neighbouring countries. Invest PLC, the majority shareholder in Mobile Connectivity, requires the audited nancial statements within three weeks of the December nancial year-end in order to meet its reporting deadline. Mr abo Vilakazi, the chief nancial officer, indicated the following: e pro t margin of the company increased slightly over the past year even though there was an increase in the number of smaller service providers entering the industry. e company’s management took a strategic decision half way through the year that it would reduce its rates substantially in order to compete with the rates being offered by the smaller service providers. e company imports its bre optic cables from Fibre Corp, a manufacturer of bre optic cables, in Dallas, Texas. e uctuation of the rand has caused the directors of the company to reconsider the current policy of hedging 25% of foreign purchases. Mr James, the human resources director, indicated that the company’s bonus structure works in the following way: Employees of the company, other than executive directors and senior management, receive a bonus equal to one month’s salary in the month of their birthday. Executive directors and senior management receive a bonus linked to the pro t generated by the company during the nancial year. Additional information: Mobile Connectivity’s previous auditor resigned after servicing the company for nine years. e previous auditors determined that it was not able to service a client of this size appropriately any longer. e senior engagement partner on the audit has indicated that his audit rm is willing to assist your audit team with information regarding previous audits, but has requested that such assistance be communicated in a timely manner as all of his managers are generally extremely busy at that time of the year. e rm will make use of an audit rm in Zimbabwe to assist in the performance of audit procedures that are required to be completed at these branches. Mobile Connectivity’s reporting currency is South African rand. REQUIRED Describe the factors that increase the audit risk at the statement level. nancial [16] Question 18 LEVEL 3 Risk at assertion level [12 marks] e following paragraphs provide information about Collectors’ Emporium (Pty) Ltd (Collectors’ Emporium). e business is managed by Mr Jonah Abercrombie, who has been involved in art and book dealing for more than 30 years. He also has a 50% shareholding in Collectors’ Emporium. Collectors’ Emporium’s nancial year-end date is 31 December: 1. Collectors’ Emporium’s business involves dealing in collectible books and artworks. 2. Books and artworks are imported from and exported to a number of countries. Items are transported by plane, as far as possible. Items that are sold are despatched or released to the buyer only after receipt of payment, and such items generally are despatched within 48 hours after receipt of payment. e business closes two weeks before Christmas and re-opens only in the third week in January. 3. Not long before Collectors’ Emporium’s nancial year-end date, Flossie Visagie, the company’s bookkeeper, managed to delete all Collectors’ Emporium’s receivables records while trying to make backups. She has since tried her best to reconstruct the receivables records, but due to her poor record-keeping, the process involved a considerable degree of guesswork. 4. e business operates from Mr Abercrombie’s sprawling house in Houghton, Johannesburg, with most of the rooms used to display business inventory. Mr Abercrombie is a collector himself, and many of his own artworks are displayed in the rooms where the business inventory is displayed. 5. Mr Abercrombie takes items in for selling on a consignment basis, but these items are not kept in a de ned area. 6. Collectors’ Emporium employs a full-time art and book restorer, who is known for the high quality of his work. He restores only books and artworks that form part of Collectors’ Emporium’s inventory. REQUIRED Explain how the information in each of the numbered paragraphs increases the risk of material misstatement at the assertion level in the nancial statements of Collectors’ Emporium. Note: Your answer should not deal with risk at the overall nancial statement level. Use the following tabular layout for your answer: AFFECTED ASSERTION(S) EXPLANATION 1. 2. [12] Question 19 LEVEL 3 Audit risk overall level [19 marks] You are a senior manager under the employment of Boswell & Sons Audits Inc. (Boswell & Sons). Boswell & Sons has been recently appointed as the auditors of Sniffindale Ltd (Sniffindale) for the 20X0 nancial year-end. Sniffindale is a ski resort located in a very small town called Sniffindale, South Africa. Sniffindale attracts thousands of local and overseas tourists and has been in operation for 15 years. e entity is a subsidiary of a group that is listed on the Australian stock exchange. In order for all entities in the group to have the same year-end, Sniffindale changed its nancial year-end during the current year from 28 February 20X1 to 31 December 20X0. In order to complete the consolidation, the Australian holding company requested Sniffindale’s nancial statements to be nalised at 21 January 20X1. Sniffindale reports in rand. Sniffindale’s management promotes a strong internal control environment. e accounting function has 10 highly competent, quali ed and experienced accountants. As Sniffindale strives to promote care for the environment, all transactions within the company occur on a fully integrated, computerised system, limiting any paperwork to the minimum. Previously management received earnings-based bonuses. However, on 1 January 20X0, the policy was amended and management currently earns bonuses based on customer satisfaction. During the 20X0 nancial year, a global recession hit and Sniffindale had approximately 25% less customers than previous years. Sniffindale therefore had to arrange for overdraft facilities at Money Bank, which requires a liquidity ratio of at least 2:1. REQUIRED Evaluate the audit risk at the overall nancial statement level of Sniffindale, for the 31 December 20X0 nancial year-end. [19] Question 20 LEVEL 3 Risk at assertion level [20 marks] You are the audit senior on the audit of Poison Ltd (Poison) for the year ending on 31 October 20X1. e company manufactures poisons for use against intrusive plants and weeds. Poison was established approximately seven months ago by a group of friends who recently obtained their BSc degrees. ey inadvertently and successfully developed the new poison as a result of a failed experiment during which they initially attempted to develop a kitchen cleaning product. ey subsequently formed the company. e company has been experiencing nancial difficulties and has not made a pro t to date. e company found it difficult to gain market share due to strong market competition. As a result, an audited set of nancial statements is required for submission to the bank to negotiate additional nancing. e company is also struggling to collect debts, with an average outstanding debtor period of 101 days at year-end. e above matter also impacted the company’s ability to pay suppliers. Two large suppliers have already refused to supply Poison with any further products until the outstanding debts have been settled. e current creditor payment period is 79 days. e directors have, however, told you that the board managed to source two suppliers located in China due to past trade talks initiated during a visit by South Africa’s minister for trade and industry and his business delegation. e products will be imported by Poison free-on-board to South Africa. e minister’s delegation was able to negotiate a 60-day credit term on behalf of Poison. REQUIRED Describe the factors that will increase the risk of material misstatement on assertion level for inventory, accounts payable and accounts receivable in respect of the audit of Poison for the year ending 31 October 20X1. Ignore control risks. Structure your answer as follows: FACTOR THAT WILL INCREASE RISK OF MATERIAL MISSTATEMENT ACCOUNT(S) AFFECTED ASSERTION(S) AFFECTED [20] Question 21 LEVEL 3 Risk and response at assertion level [17 marks] You are the senior auditor on the audit of Power (Pty) Ltd (Power), a company that distributes generators and transistors to wholesalers and the public from its warehouse in Durban. e company has a December nancial year-end. e company was incorporated seven years ago by two friends, Miss Chumanga and Mr Casey, on completion of their undergraduate studies at the same local university. ey both have an equal stake in the company. Miss Chumanga is the marketing director at the company, as she obtained a marketing degree, and Mr Casey is the chief nancial officer, as he obtained a degree in accounting. ey both receive a bonus linked to the revenue generated by the company over the course of the nancial year. e company obtained a R40 million loan from the Industrial Development Corporation on 1 July in order to nance a plant from which it intended to mass produce generators instead of purchasing generators from the Far East. It has not yet started constructing the plant and therefore plans to start producing generators and transistors only in the next nancial year. e terms of the loan are as follows: e loan draws interest of 22% per annum. e interest and a portion of the capital on the loan are payable monthly in arrears. e loan must be paid back in full within seven years from the date of receiving the loan. e Industrial Development Corporation requires signed nancial statements within 30 days of the nancial year-end. e Industrial Development Corporation can demand immediate settlement of the loan if Power’s current ratio drops below 2.5:1. Should the loan be recalled at the year-end, Power’s current liabilities would exceed its current assets by a substantial amount. Neither Miss Chumanga nor Mr Casey has any additional money to contribute to the business – part of the loan conditions from the Industrial Development Council required that they invest R10 million each into the project. e company hedges 45% of the generators and transistors purchased in the Far East with forward exchange contracts which it takes out with the company’s local bank. e generators and transistors normally take 1.5 months to arrive in Durban from the date that the goods leave the supplier’s warehouse and an additional week to clear customs. ereafter, the generators and transistors are transported to the company’s warehouse from which they are sold to the wholesalers and public. R2 million worth of generators and transistors were on route from the supplier in the Far East to the Durban warehouse at year-end. Power saw an increase in its sales during the winter months as a result of promotions that it ran during the month. ese included granting customers up to 5% off from their initial invoiced cost if they settled their accounts within 30 days from the date of purchase. e discounts were approved at the director’s board meeting held on 5 April. REQUIRED Describe the factors that increase the risk of material misstatement at assertion level and brie y how you, as auditor, would respond to the risk. [17] Question 22 Detection risk [22 marks] LEVEL 3 HKL Auditors Inc. (HKL), with its main office in Johannesburg, is currently engaged in planning the audit of Diamond Hardware (Pty) Ltd (Diamond Hardware) for the client’s 31 December 20X1 nancial year. Diamond Hardware is a large wholesaler of hardware equipment and is also situated in Johannesburg. During the audit planning meeting, where only some of the junior audit team members were present, the susceptibility of the client’s nancial statements to material misstatement was discussed. e engagement partner, Hein Williamson, addressed the audit team members present and made the following comments, inter alia: The budget for the 31 December 20X1 year-end audit of Diamond Hardware is unfortunately very tight. The two owner-managers of the company have speci cally asked me to keep the audit fees the same as last year, otherwise HKL might get replaced by another audit rm next year. This, despite Diamond Hardware having installed a new accounting system in 20X1, which meant a change to a signi cant part of the company’s system of internal controls. I would also like to announce that Karina McKay, a second-year trainee accountant at our rm, will be the responsible audit senior on the audit seeing that the prior year’s audit senior is currently on study leave. In addition, the audit manager, who is newly assigned to the audit, should not be bothered with any questions except in very important cases, as she will be too busy on other audits at that time. Karina, although we know you have not been on the audit in any prior year, we are forced to throw you into the deep end. We trust that you will be able to cope! To take some pressure off the audit team, I will ensure that the sample sizes used in substantive audit procedures are smaller than usual. Also keep in mind that the audit manager on the prior year’s audit of Diamond Hardware, Terence Radebe, has recently been appointed as the nancial manager of Diamond Hardware. As you might know, Diamond Hardware’s previous nancial manager was dismissed two months prior to the 20X1 year-end as a result of possible fraud that took place in the company’s accounting department. They needed a person with Terence’s skills to restore order in their accounting function. Please note that we will be making use of many rst-year trainee accountants on this assignment to save on costs. More experienced, senior audit staff members will be too expensive. REQUIRED Identify and explain the factors that increase detection risk on the audit of Diamond Hardware for its 20X1 nancial statement audit, evident from the scenario. Structure your answer as follows: FACTOR THAT INCREASES DETECTION RISK EXPLANATION (WHY DOES THE FACTOR INCREASE DETECTION RISK?) [22] Question 23 LEVEL 2 Audit strategy [6 marks] You were recently appointed as the auditor of People Ltd (People). As part of the planning of the audit, you are trying to gain an understanding of the company’s operations. e following information has been brought to your attention. People Ltd is a holding company with ve subsidiaries, two of which reside outside South Africa. Your audit rm will be responsible for the audit of the holding company only and not the subsidiaries. REQUIRED Indicate how each of the above pieces of information will affect your audit strategy. [6] Question 24 LEVEL 2 Planning strategy [9 marks] You are an audit manager at the audit rm of UHK Inc. (UHK) and have been assigned to the audit of CashNow Bank Ltd (CashNow), a registered bank in South Africa. CashNow provides banking, insurance and investment products and services to retail, commercial, corporate and public sector customers. CashNow has a 31 December year-end. You acquired the following information during the preliminary engagement phase of the 2015 audit: 1. e bank is listed on the JSE. 2. It has four divisions, three subsidiaries and two associates. One of the subsidiaries is audited by another audit rm, while all other entities are audited by UHK. 3. CashNow’s trading systems are fully computerised. 4. CashNow has an internal audit department which focuses on areas relating to nancial reporting identi ed by its audit and risk committee. 5. As a result of an unfavourable economic environment, CashNow has been experiencing high levels of bad debt write offs and has incurred losses during the 20X1 nancial year. 6. e audit reporting deadline is 10 February. REQUIRED Explain how each of the matters listed in points 1 to 6 affects the scope, timing and/or direction (whichever is relevant) of the 20X1 audit of CashNow. [9] 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 Either good or bad. Pre-engagement. Use the information contained in the scenario. Where the audit firm is located could also be an indication of the size of the firm. This indicates that it was not as a result of wrongdoing on the part of management. As this is not a dubious industry, S&P should not have a problem being associated with Zondi. Does S&P have the resources to travel to all of the outlets? As a CA(SA), he is bound by SAICA’s Code of Professional Conduct, which is an indication of management’s integrity. This indicates that the company will be able to pay the audit fee. This is an ethical issue for the auditor to consider. Structured according to the pre-engagement steps. You need to supply the information contained in the question, and apply it to the preengagement steps. Structured according to the pre-engagement steps. Given that he is a CA(SA), he is likely to have integrity. Structured according to the pre-engagement steps. Given that they resigned as a result of staff shortages, it is unlikely that there is reason not to accept the engagement. Structured according to the pre-engagement steps. It should thus be able to pay the audit fee. Structured according to the pre-engagement steps. Following the Code of Professional Conduct’s conceptual framework. Structured according to the pre-engagement steps. S&P might thus not have adequate resources. Remember to include the engagement letter as part of the pre-engagement steps. 24 Deal with each instance separately. 25 Background information: the two instances mentioned below are what are required. 26 Scope (what needs to be audited) = branches in 10 cities = resources needed in order to perform the audit. 27 Scope (what needs to be audited) = maintenance of application programs that are outsourced = resources needed in order to perform the audit. 28 Information contained in the scenario is linked to what needs to be done. 29 This adds in human resources. 30 When it needs to be done. In addition, it adds in human resources. 31 Information contained in the question is linked to what needs to be done. 32 It adds in human resources. 33 You need to do (and explain your reasoning behind) the calculations, thus motivating your decisions. 34 Thus overall as well as performance materiality. 35 New auditor = high audit risk. 36 Use this in your calculation. 37 Choose a set of financial statement figures to use in your calculation. 38 Give the different options. 39 This indicates which is the most appropriate, in addition to motivating why it is. 40 Stable plus motivation. 41 It is appropriate, plus there is motivation. 42 Inverse relationship with risk. 43 Determine a range in which to work. 44 This provides an overall planning materiality figure in addition to motivation. 45 Describe risks only: in other words, those indicators that increase risk plus the risk associated with those indicators. 46 Deal specifically with those indicators affecting financial statements as a whole, or with indicators where you cannot pinpoint risk to a specific line item. 47 This indicates possible fraud perpetrated in order to meet listing requirements and to attract investors. 48 This is an indication of possible errors, as consolidations are complex. 49 It indicates possible going concern problems, the risk that financial statements might be incorrectly prepared on a going concern instead of a liquidation basis. 50 Specific line item = assertion level. 51 This indicates possible going concern problems, the risk that financial statements might be incorrectly prepared on a going concern basis instead of on a liquidation basis. 52 It indicates possible fraud perpetrated in order to receive incentive bonuses. 53 Indicates possible fraud and error. 54 Indicates errors. 55 Indicator. 56 Risk. 57 Explanation. 58 59 60 61 62 63 64 65 66 67 68 69 70 71 72 73 74 75 76 77 78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 Indicator. Risk. Explanation. Indicator. Explanation. Risk. Indicator. Explanation. Risk. Indicator. Risk. Explanation. Indicator. Explanation. Risk. Indicator. Explanation. Risk. Indicator. Risk. Explanation. Inherent and control risk. Remember the balances assertions. PPE accounting requirements, such as depreciation method, residual value, useful life, allocation of costs, etc. = inherent risk. Borrowing costs incorrectly allocated = inherent risk. Detection risk. Explanation, error. Assertion. Explanation, error. Indicator (accounting requirement). Assertion. Explanation, error. Indicator (accounting requirement). Assertion. Explanation, error. Indicator (accounting requirement). Assertion. Explanation, error. Indicator (accounting requirement). Assertion. INTRODUCTION Substantive questions fall into two main categories: 1. ose regarding balances or items appearing on the statement of nancial position at year end 2. ose regarding transactions or items included in the statement of pro t or loss for the nancial year end It is important to identify whether a substantive question relates to balances or to transactions, since the framework to be applied in answering questions referring to both types will differ according to the audit assertions. Example question 1 provides the framework to be applied in answering those questions regarding balances, while example question 2 provides the framework for answering questions regarding transactions. Important in an analysis of what, and how much, to write is the mark allocated to each question. Although a detailed answer may be required if the mark allocation is 20 (for example), the answer should be limited to the essentials if only ve marks have been allocated. Remember that the solutions provided in this chapter, which have been suggested by the compilers of the questions themselves, are merely guides to the types of procedures that should be performed. No solution to substantive questions can be comprehensive, as many other procedures may exist. In addition, because each student communicates differently, the examiner will not expect him/her to produce an answer set out exactly as in the suggested solution. EXAMPLE QUESTION 1 Balances [17 marks] Your rm was recently appointed as auditors of Quench (Pty) Ltd (Quench), a company manufacturing a range of beverages at its plant in Atlantis. e company, which has a December year-end, has a fully integrated computerised system that runs on local area network (LAN). You have been assigned to audit the purchases and payments cycle. In the course of the planning stage of the audit, you met with the chief nancial officer, Mrs Price, and the chief buyer, Mr Pravesh, in order to gain an understanding of this cycle. Extract from a meeting held with Mrs Price and Mr Pravesh on 5 October All the ingredients needed in order to produce the beverages are purchased from local suppliers, most of which are paid via EFT. However, a few of them still prefer cheque payments. The receiving process is as follows: The ingredients and the pre-labelled bottles are delivered to the warehouse situated next to the manufacturing plant. On the arrival of goods at the warehouse, the receiving clerk calls up the purchase order on a tablet computer in order to generate a pre-numbered GRN. The computer, which connects to the intranet via 3G cards, has an application loaded onto it that enables the receiving clerk to access the order after he/she has input the purchase order number, whereupon the accounting system is immediately updated. Additional information Your rm conducted the inventory count on 31 December, during which it was noted that the last GRN number was XJ 10980. You have received a listing of all the trade payables at both the current and the previous yearends. In addition to the credit manager, Mr Paton, the credit department comprises two other staff members, namely Ms Louwrens and Mr Tabane. Trade payables at 31 December are stated as R9 350 000 (previous year: R12 345 000). REQUIRED Describe the substantive audit procedures that you should perform in order to verify (a) the trade accounts payable balance at year end, and (b) that the amount is not understated. [17] GUIDANCE Understand the question Describe the substantive audit procedures that you would perform in order to verify (a) the trade accounts payable1 balance at year end, and (b) that the amount is not understated.2 Identify the theory applicable to the question In order to answer substantive questions, you need to: understand the speci c audit assertions to be addressed understand the audit procedures that are usually relevant to the speci c item(s) being audited identify the speci c issues and risks that need to be addressed identify the IFRS criteria identify the speci c audit standards applicable to the scenario. e best way to prepare yourself for tests/examinations is to work through as many substantive questions under examination conditions as possible, noting the different frameworks and the procedures applicable in the various types of questions. Read the question Your rm was recently appointed as auditors of Quench (Pty) Ltd (Quench), a company manufacturing a range of beverages at its plant in Atlantis. e company, which has a December year-end, has a fully integrated computerised system that runs on local area network (LAN). You have been assigned to audit the purchases and payments cycle.3 During the planning stage of the audit, you met with the chief nancial officer, Mrs Price, and the chief buyer, Mr Pravesh, in order to gain an understanding of this cycle. Extract from a meeting held with Mrs Price and Mr Pravesh on 5 October4 All the ingredients needed in order to produce the beverages are purchased from local suppliers, most of which are paid via EFT. However, a few of them still prefer cheque payments. The receiving process is as follows: The ingredients and the pre-labelled bottles are delivered to the warehouse situated next to the manufacturing plant. On the arrival of goods at the warehouse, the receiving clerk calls up the purchase order on a tablet computer in order to generate a pre-numbered GRN. The computer, which connects to the intranet via 3G cards, has an application loaded onto it that enables the receiving clerk to access the order after he/she has input the purchase order number, whereupon the accounting system is immediately updated. Additional information Your rm conducted the inventory count on 31 December, during which it was noted that the last GRN number was XJ 10980.5 You have received a listing of all the trade payables6 at both the current and the previous yearends. In addition to the credit manager, Mr Paton,7 the credit department comprises two other staff members, namely Ms Louwrens and Mr Tabane. Trade payables at 31 December are stated as R9 350 0008 (previous year: R12 345 000). Exam technique 1. Use the audit assertions of balances as a framework for your answer: Completeness and existence Obligations Valuation Disclosure Note: Each assertion contains one or more substantive procedures. Since the scenario indicates a possible risk of understatement of accounts payable, more procedures than usual apply to the completeness and existence assertion. However, this is not the case when auditing accounts receivable (management usually overstates trade debtors in order to increase pro ts), with the result that fewer procedures need to be performed for the assertion. Both the obligations and the disclosure assertions are usually covered by one procedure each. Valuation, the most important one to address, contains the most procedures, since material misstatement could easily occur. Study your textbook in order to: understand the subtle changes in the auditor’s approaches to substantive testing, and ensure that you become familiar with these procedures. 2. Start your sentences with the words: inspect inquire re-perform observe scrutinise select a sample (or extract) OR agree (or match).9 If you start your sentence with ‘ensure’, ‘check’, ‘con rm’ or ‘verify’, you risk losing marks, since they indicate that you are not tackling the speci cs of how to perform the procedure. Furthermore, the words ‘Check that cut-off procedures were properly performed at year-end for revenue’ will mean nothing to someone with no experience in that speci c eld. erefore, describe your audit procedure as if you were explaining it to a novice. 3. Communicate properly. If the examiner is able to write HOW, WHAT or WHY next to your answer, you will forfeit marks. For example, in the sample answer already quoted (‘Check that cut-off procedures were properly performed at year-end for sales’), he/she is able to discern the WHY (the cut-off of sales), but not the HOW (the last 20 delivery notes before and after year-end) or the WHAT (the dates on the delivery note). SUGGESTED SOLUTION 1. Completeness and existence a) Obtain a management representation10 letter with speci c reference to the completeness and existence assertion for trade accounts payable. (1) 11 b) Inquire from Mr Paton about any explanations for the material decrease in the creditors balance from R12 345 000 (previous year) to R9 350 000 (current year), and follow up his explanations with supporting documentation.12 (1) c) Compare the list of creditors at 31 December to the previous year’s working listing for:13 i) creditors on the latter list who do not appear on the former (1) ii) creditors balances that are signi cantly smaller at 31 December than during the previous year. (1) Elicit reasons from the creditors clerks and corroborate them with Mr Paton where they are material or necessary. Obtain supporting documentation for all explanations given. (1) d) Extract a listing of creditors from the creditors master le that has an entry in the disputes eld. By means of the number, trace the dispute to the correspondence or supporting documents. Follow up on the status of disputed accounts with both Mr Paton and the creditor. (1) 14 e) Perform analytical review procedures on the creditors balance and follow up on such material uctuations as those revealed when comparing current year purchases and creditors, as well as those for previous years. (1) f ) Inspect working papers relating to the inventory count for any instances where physical inventory materially exceeded theoretical inventory,15 which could indicate purchases that were received before year-end but were not raised as a liability at year-end. (1) g) After stratifying the purchases journal for January, select a sample of 20 material purchases and trace them to the GRNs. Con rm that the GRN numbers are greater than XJ 10980,16 and that the dates on the notes and the supplier’s delivery notes are later than 31 December, the nancial year-end. (1) h) Select a sample of 20 material payments made subsequent to 31 December, and by means of an inspection of the dates on the corresponding GRNs and the supplier delivery notes, con rm whether or not the goods were received prior to 31 December and if the corresponding creditors had been raised at year-end. (1) 2. Obligation Inspect from the samples17 selected that source documentation was made out in the name of Quench (Pty) Ltd. (1) 3. Valuation a) Extract and cast the creditors balances of the creditors located in the master le and agree them to the creditors control account in the general ledger. (1) b) Re-perform a sample of the cross cast (days outstanding) on the master le. (1) c) Scan the master le for such error conditions as duplicate supplier numbers and duplicate addresses. (1) d) Inspect the master le for debit balances, follow up on the reasons for them with Mr Paton, and reclassify the remaining debit balances to accounts receivable.18 (1) e) Scrutinise the creditors control account for unusual entries (particularly rounded-off amounts) and follow up with supporting documentation. (1) 19 f ) Select a sample of creditors reconciliations at 31 December (which includes reconciliations prepared by both the clerks) and: i) ii) test logic, and re-perform the casts on the reconciliations (1) agree the balances on the reconciliations to the creditor’s statements and the listing of creditors (1) iii) inspect the validity of the reconciling items by reference to supporting documentation. g) Extract from the listing of creditors any to whom payment is outstanding signi cantly (1) beyond the credit terms granted to Quench, upon which follow up with Mr Paton and the creditors clerk in order to establish the correct status of the amount due. (1) 4. Disclosure Inspect the correct disclosure of revenue in the nancial statements, including the accounting policies.20 (1) 21 Any other valid procedures. (1) Available marks [22]; maximum marks [17] EXAMPLE QUESTION 2 Transactions [15 marks] You are a senior auditor on the audit of Gracys Ltd (Gracys), a company with a September yearend. Your audit rm has been Gracys auditors for the past ve years. e company sells clothing, shoes and beauty products at 22 branches located across the country as well as from their virtual store at which online sales are made. Management usually pays close attention to the sales gures, as the manager of each store receives a performance bonus that is linked to sales. Sales e chief nancial officer, Mr Chris Tommylin, has indicated that total sales (R833 million) for the year have increased by 7% over those of the previous year (R778 million). e accounting systems of the company, whose head office is located in Cape Town’s central business district, are fully integrated and run on a wide-area network. e points-of-sales systems at each of the stores are connected to Gracys intranet via Telkom’s virtual private network. In-store purchases In-store purchases are made with cash, on credit and by using either the Gracys customer store card (on which a pre-determined credit limit has been set) or the customer’s bank credit card. Once a transaction has been processed, the sale is immediately posted to the sales account with a unique branch code in order to identify the branch to which the sale relates. A copy of the invoice handed to the customer is automatically generated at head office at the conclusion of the transaction. ese copies are archived electronically until needed. Online purchases Online purchases are concluded by the customer inputting his/her credit card details. Deliveries are made to South African addresses only. Noti cation is sent to the store located closest to the customer whenever an approved order is received. A designated sales clerk at the store then processes the order based on the information received in the noti cation. ree delivery notes are generated, after which a courier delivers the product(s) to the address indicated by the customer. However, before the courier leaves the company’s premises, the security guard at the gate checks the description of the goods on the delivery note against the goods in the courier’s vehicle, signing the delivery note as proof that he/she has performed this task. Upon receiving the goods, the customer signs all three copies of the delivery note, one of which he/she retains. e other two copies are returned to a designated sales clerk at the store from which the products were delivered. e sales clerk then captures the delivery date on the system and scans one of the delivery notes onto the system in order for it to serve as proof of delivery. e accounting system then generates an invoice (much like the invoice for in-store sales). At the end of each week, the sales clerk les one copy of the signed delivery note, sending the third to head office, where it is led. e sales manager at head office, Mrs Kobe, has indicated that her team performs weekly reconciliations between the delivery notes that arrive via courier and those scanned into the system at the store. To date, they have discovered no discrepancies. REQUIRED Describe the substantive audit procedures that you would perform in order to verify sales as part of your year-end audit. Ignore goods returned. [15] GUIDANCE Understand the question Describe the substantive audit procedures that you would perform in order to verify sales22 as part of your year-end audit. Ignore goods returned. Note: e previous example was the audit of balances. We are now going to focus on audit transactions. Identify the theory applicable to the question Once again, because it is important to know the theory relevant to the auditing of the item at hand, you need to: understand the speci c audit assertions that need to be addressed understand the audit procedures that are usually relevant to the speci c item(s) being audited identify the speci c issues and risks that need to be addressed identify the IFRS criteria applicable to your answer identify the speci c audit standards applicable to the scenario. Read the question You are a senior auditor23 on the audit of Gracys Ltd (Gracys), a company with a September year-end. Your audit rm has been Gracys auditors for the past ve years. e company sells clothing, shoes and beauty products at 22 branches24 located across the country as well as from their virtual store at which online sales are made. Management usually pays close attention to the sales gures, as the manager of each store receives a performance bonus25 linked to sales. Sales e chief nancial officer, Mr Chris Tommylin, has indicated that total sales (R833 million) for the year have increased by 7% over those of the previous year (R778 million). e accounting systems of the company, whose head office is located in Cape Town’s central business district, are fully integrated and run on a wide-area network. e points-ofsales systems at each of the stores are connected to Gracys intranet via Telkom’s virtual private network. In-store purchases 26 In-store purchases are made with cash, on credit and by using either the Gracys customer store card (on which a pre-determined credit limit has been set) or the customer’s bank credit card. Once a transaction has been processed, the sale is immediately posted to the sales account with a unique branch code in order to identify the branch to which the sale relates. A copy of the invoice handed to the customer is automatically generated at head office at the conclusion of the transaction. ese copies are archived electronically until needed. Online purchases27 Online purchases are concluded by the customer inputting his/her credit card details. Deliveries are made to South African addresses only. Noti cation is sent to the store located closest to the customer whenever an approved order is received. A designated sales clerk at the store then processes the order based on the information received in the noti cation. ree delivery notes are generated, after which a courier delivers the products to the address indicated by the customer. However, before the courier leaves the business premises, the security guard at the gate checks the description of the goods on the delivery note against the goods in the courier’s vehicle, signing the delivery note as proof that he/she has performed this task. Upon receiving the goods, the customer signs all three copies of the delivery note, one of which he/she retains. e other two copies are returned to a designated sales clerk at the store from which the products were delivered. e sales clerk captures the delivery date on the system and scans one of the delivery notes onto the system as proof of delivery. e accounting system then generates an invoice (much like the invoice for in-store sales). At the end of each week, the sales clerk les one copy of the signed delivery note, sending the third to head office, where it is led. e sales manager at head office, Mrs Kobe, has indicated that her team performs weekly reconciliations between the delivery notes that arrive via courier and those scanned into the system at the store. To date, they have discovered no discrepancies. Exam technique 1. Use the audit assertions of transactions as a framework in answering the question: occurrence accuracy classi cation28 cut-off completeness disclosure 2. Start your sentences with: inspect inquire re-perform observe scrutinise select a sample (or extract) OR agree (or match).29 3. Communicate properly. Note: Although a lot of information was given in the question relating to the internal control of Gracys, this will be relevant only if the auditor needs to perform test of controls. If the questions are substantive, you may ignore this information, since it will have no relevance to your answer. SUGGESTED SOLUTION (Note the difference in headings from the previous example question.) 1. Occurrence30 a) Obtain the sales schedule from Mr Chris Tommylin and cast31 it. (1) 32 b) Agree the total of R833 million to the general ledger and the trial balance. (1) c) Scrutinise the sales schedule for any such unusual entries as duplicate sales invoices, duplicate account holders and duplicate addresses. (1) 33 d) Stratify the in-store sales further (e.g. per region and branch) and select a sample of invoices to be tested. (1) e) Print the sample selected and, using the invoice numbers noted on the sales schedule, agree the invoice numbers to the signed led invoices or delivery notes (which have been sent to head office by the store from which the goods were delivered), in order to con rm that the debtor has acknowledged the debt or the transfer of risk. (1) 34 2. Accuracy For a sample of invoices selected: a) cast the invoices (1) b) recalculate the VAT on them (1) 35 c) agree the sales prices on the invoices to the approved sales price listing (1) d) scrutinise the sales account for any suspicious journal entries (1) e) follow up on items noted on any exception reports affecting sales. (1) Identify the key information (such as product sold, quantity, date, etc.) recorded on the invoices selected and agree the key information to the detailed audit trail of each sale recorded in the accounting records. (1) 36 3. Classi cation Scrutinise the sales account in the general ledger for non-revenue items incorrectly posted to sales, such as dividend income and interest received. (1) 4. Cut-off a) In-store sales As management receive bonuses,37 select a sample of 20 invoices from one month prior to and one month after year-end and trace them through to the sales account in order to determine whether the sales were recorded in the correct nancial period. (1) b) Online sales Select a sample of 20 signed delivery notes from one month prior to and one month after year end and trace them through to the invoices and the sales account in order to determine by an inspection of the dates on the delivery notes whether the sales were recorded in the correct period. (1) 5. Completeness a) For a sample of delivery notes and invoices: i) inspect the sequences for missing numbers, and, where exceptions arise, follow up on them with management; and (1) ii) reconcile the delivery notes and invoices in order to ensure that all transactions are accounted for. (1) 38 b) Perform the following analytical review procedures: i) For each store: Make a year-on-year comparison of credit sales, cash sales, total sales and online versus in-store sales in order to obtain reasons for any unexpected uctuations. (1) ii) For each region: Make a year-on-year comparison of credit sales, cash sales, total sales and online versus in-store sales in order to obtain reasons for any unexpected deviations. (1) Any other valid procedures. (1) 6. Disclosure Inspect the correct disclosure of revenue in the nancial statements, including the accounting policies. (1) Available marks [20]; maximum marks [15] QUESTIONS Question 1 LEVEL 3 Revenue applying IFRS 15 [14 marks] Trackster Ltd (Trackster) operates in the private security sector. e company’s external auditor is currently auditing the revenue gure disclosed in Trackster’s draft annual nancial statements for the nancial year ended 30 September 20X1. Trackster earns revenue in two ways: the sale of GPS-based tracking services and the sale of emergency roadside kits, accounted for in two separate general ledger accounts. Trackster applies IFRS 15. Tracking services GPS-based tracking services involve Trackster installing a GPS-based tracking device in a customer’s vehicle in a position that makes the device difficult to nd. When a customer’s vehicle is stolen, the customer can identify its location by means of Trackster’s smart phone app and, at the same time, alert Trackster to the theft. Trackster will send out an armed response team to attempt a retrieval of the vehicle. In order to obtain a tracking device, a customer must subscribe to a 12-month contract priced at R100 per month, invoiced at the beginning of a month. Should the customer want to make use of a discount of 20%, he/she must pay a one-off (up-front) fee of R960 at the beginning of the 12-month contract and does not have to pay any monthly fee thereafter. e tracking device remains the property of Trackster throughout the subscription period. New customers must sign a written sales agreement either at a Trackster retail outlet or in the comfort of their homes in the presence of a Trackster sales agent. All prices charged are the same as in the 20X0 nancial year. Trackster records the details of all subscribers’ contracts, including amounts recognised each month as revenue, in a contracts spreadsheet. Emergency roadside kit Another product which Trackster offers is an emergency roadside kit for everyday use, sold at a standard price. A kit consists of various items that enhance vehicle safety, including a re extinguisher, emergency belt cutter with attached glass breaker, re ective jacket and triangle warning sign, medikit, jumper cables and a ashlight. In past nancial years, an average of 10% of kits were returned to Trackster for refunds due to product faults and unhappy customers. Total sales from emergency roadside kits for 20X1 amounted to R1 785 400. REQUIRED 1. Discuss in detail why Trackster will not be able to recognise the full R1 785 400 revenue from emergency roadside kits for the 20X1. (3) 2. Describe the substantive audit procedures which Trackster’s auditor must perform in order to test the occurrence, accuracy and cut-off of revenue derived from the sale of GPS-based tracking services and recorded in Trackster’s annual nancial statements. Note: Ignore the cost implications of the GPS tracking device for Trackster and do not address the testing of the presentation assertion or related disclosures in your answer. SUGGESTED SOLUTION TO QUESTION 1 [14] (11) 1. Revenue from emergency roadside kits a) In terms of the requirements of IFRS 15, the amount of revenue that Trackster earns from the sale of emergency roadside kits constitutes a ‘variable consideration’. (1) Variable consideration can only be included to the extent that it is ‘highly probable that its inclusion will not result in a signi cant revenue reversal in the future when the uncertainty has been subsequently resolved’ (IFRS 15:56). (1) b) Due to a history of refunds of the kits, i.e. a likelihood of future reversal of the revenue (10% are brought back by customers), there will be a limit on the amount of revenue that can be recognised from the sale of the kits. (1) c) erefore, because 10% of products are usually returned and the kits are all sold at a standard price, Trackster will likely only be able to recognise R1 606 860 in the 20X1 nancial year (R1 785 400 less 10%). (1) Available marks [4]; maximum marks [3] 2. Revenue from GPS-based tracking services a) Obtain the contracts spreadsheet from management and select a sample of both ongoing and new subscriber contracts. (1) Agree the contract details on the spreadsheet to the sales agreement, ensuring that: i) a sales agreement exists for the contract, signed by both customer and Trackster (occurrence) (1) ii) the type of the contract, invoiced month-to-month or paid up-front, is accurate (1) iii) the amount recorded is supported by the same amount on the agreement to which the customer agreed (R100 per month or R960 one-off recognised at R80 per month) (accuracy) (1) iv) the agreement pertains to the 20X1 nancial year (either still ongoing with reference to the date started or signed in the 20X1 nancial year). (occurrence and cut-off ) (1) b) For a sample of contracts on the contract spreadsheet, agree the amounts recorded to the cash book and bank statement to ensure a receipt exists for the revenue. (occurrence) (1) Note: Service renewals might not involve the signing of a new contract, therefore for contracts renewed in the 20X1 nancial period, the above procedure in combination with an inspection of the sales agreement will verify the occurrence assertion. (1) c) Inspect the contracts spreadsheet for evidence that the contracts invoiced on a month-tomonth basis are recognised at R100 per month and that the contracts invoiced annually have been recognised at R80 per month and not as R960 in the month the contract was signed for. (accuracy) (2) d) Recalculate the contracts spreadsheet by casting each month’s revenue recognised in the 20X1 nancial year. (1) Add up the 12 months’ recalculated totals to arrive at the total annual revenue recognised and agree this total to the general ledger account for GPS tracking services and trial balance. (1) e) Inspect the minutes of the board meeting where the decision was taken not to increase the monthly and annual subscription fees for 20X1 and ensure at the same time that the same fee structure as for 20X0 still applies in 20X1. (accuracy) (1) f ) Perform analytical procedures on the revenue recognised for GPS tracking services by creating an expectation of what the revenue should be with reference to the number of contracts active in 20X1 and follow up any unexpected differences with management. (1) g) Obtain a written representation letter from management in which they con rm the occurrence, accuracy and cut-off assertions for GPS tracking services revenue. (1) Available marks [14]; maximum marks [11] Question 2 LEVEL 2 Revenue [15 marks] Prompt Health (Pty) Ltd (Prompt Health), a private hospital founded 15 years ago, focuses on neonatal and neurological cases. In addition, the company is the 100% owner of a pharmacy, Health Products (Pty) Ltd (Health Products), located on its premises, to which it sells medicines and related products at a 5% mark-up. With the exception of a handful of private patients, all Prompt Health patients have medical aids. Before a patient in the latter category is admitted, authorisation for treatment is obtained from his/her medical aid. Although medical aids are able to pay outstanding amounts within 30 days, private patients need to pay in advance. Currently employed at Auditors4U Inc., you have already completed the rst two years of your three-year articles. Owing to your knowledge and experience, you have been appointed as the senior on the audit, for which the revenue and receivables sections have been assigned to you. After performing walk-through tests on all the relevant sections, the audit manager has concluded that a substantive-based audit will be performed for the 30 September 20X1 year-end audit. You have received the following trial balance extracts from the nancial manager of Prompt Health: ACCOUNT NUMBER ACCOUNT DESCRIPTION 20X1 ESTIMATED R’000 20X0 AUDITED R’000 BS-025 Gross debtors 25 586 21 586 BS-085 Provision for bad debts 3 587 2 897 IS-001 Revenue 152 475 141 586 IS-042 Finance income 1 475 1 986 IS-095 Bad debts 1 748 1 875 REQUIRED Describe the substantive audit procedures that you would perform with regard to the 20X1 yearend revenue gure of Prompt Health in order to obtain appropriate audit evidence regarding the relevant audit assertions (excluding classi cation). [15] Question 3 LEVEL 2 Revenue [13 marks] Flowers.Net (Pty) Ltd (Flowers.Net), specialists in the online retailing of owers and gifts, has appointed RightWay Incorporated (RightWay) as its external auditors for the 30 June 2016 yearend audit. e auditing rm was appointed by the shareholders of Flowers.Net at the annual general meeting held on 30 September 20X1, after the decision had been taken to rotate external auditors in terms of the Companies Act. Flowers.Net’s sales system operates as follows: Cash sales only are made. Customers (mainly private individuals) need to register on Flowers.Net’s website before gaining access to its catalogue of gifts. is is done in order to build up a database so that customers may be emailed about special offers. After customers have placed goods in their online baskets, their credit card details are required before sales may be transacted. A number of edit checks exist on the system, with the result that orders are accepted only if all the necessary details (delivery addresses, customers’ names, contact numbers, etc.) have been supplied. Sales are processed once con rmation has been received from the customers’ banks that the transactions have been approved. Customers are emailed automatically with con rmations and the reference numbers for the orders. Orders are logged automatically onto Flowers.Net’s computer system. e system automatically generates a picking slip, which is used to pick the goods in the warehouse and signed by the picker. A warehouse clerk produces a printout of all picking slips. e goods are delivered to customers by Flowers.Net’s couriers. Staff members in the delivery section generate a duplicate delivery note from the invoicing module, one copy of which is signed by the customer on receipt of the goods. is copy is returned with the delivery staff. REQUIRED Describe the substantive audit procedures that you would perform with regard to the sales system of Flowers.Net in order to obtain audit evidence regarding the following revenue assertions: Occurrence Accuracy Completeness [13] Question 4 LEVEL 2 Revenue [25 marks] As the audit manager, you are currently busy with the year-end external audit of Advertising Space (Pty) Ltd (Advertising Space), a company selling advertising space on billboards along the highways of South Africa. e company was formed by an entrepreneur who wanted to create direct competition to ‘Below the belt advertising’ CC, which he believed provided a poor service to its customers. Advertising Space earns commission on every square metre of billboard space that it sells. Since the commission account is considered a high-risk balance, you decided to audit the balance yourself. You are busy with the substantive procedures of the commission account in the statement of comprehensive income for the year ended 31 October. Since Advertising Space does not have the necessary capital with which to build its own billboards, it has signed contracts with billboard companies (operators) in terms of which Advertising Space sells the billboard spaces (referred to henceforth as packages) on their behalf. Fees vary, depending on the nature of the billboards, their location, whether they are static or electronic, etc. Advertising Space, which has seen much growth of late, has several packages on its books. Commission on the packages is earned through selling them to clients from other operators. Once the sale of a package has gone through, a contract is concluded between the operator and the client, the commission being calculated as a percentage of the purchase price of the package. Clients are obligated to pay a deposit of 10% of the purchase price of the package on top of the commission to be paid to Advertising Space. e company uses a bank-clearing account system that records all monies deposited by customers and generates a pre-numbered receipt, a copy of which is sent to the client as proof of the receipt of payment. Advertising space then transfers a portion of the amount due to the account of the relevant operator. e commission owing to Advertising Space is paid into its current bank account by means of a cheque. No electronic payments, cash payments or transfers are made. For each transaction, a sales le is maintained, in which all details of that transaction are led, including a copy of the contract, details of the terms and conditions and the terms of payment. REQUIRED Describe the substantive procedures you would perform in order to audit the commission account in the statement of comprehensive income for the year ended 31 October. [25] Question 5 LEVEL 2 Revenue [22 marks] You are the audit manager on the 20X1 year-end audit of DreamHomez (Pty) Ltd (DreamHomez), a company with a 31 December year-end that specialises in domestic design and interior decoration. As DreamHomez believes in investment in the local economy, all building materials are purchased from South African suppliers. You have assigned one of your second-year trainees, Tim Hanks, to the revenue cycle. After discussions with the client, Tim drafted the following working paper. Client: DreamHomez (Pty) Ltd Year end: 31 December 20X1 Description: System Description: Income Prepared by: Tim Hanks Reviewed by: Working paper B4 Date: 21-11-20X1 1. All sales are made on credit. Potential clients complete credit application forms. The credit clerk, Tom Willings, allocates credit terms and a credit limit to each customer after verifying their creditworthiness with the credit bureaux. After ensuring that all the necessary information and documentation has been received from the client, the credit manager, Sandy Lee, signs the application form as approval of the credit terms and limit. DreamHomez provides nancing to creditworthy clients. 2. DreamHomez provides clients with pre-numbered, obligation-free quotations. Once a client has accepted and signed the quotation, the project manager, Thabo Mhlangu, veri es his/her creditworthiness on the approved credit application form and signs the quotation as proof of his having performed the check. 3. After having received an approved quotation, the legal department draws up a contract, which is signed by both the credit manager and the client, thereby legally binding the latter to the repayment of the loan and the payment of all costs relating to the work done. 4. 5. Revenue recorded is based on the percentage of completion. Clients are invoiced monthly on pre-numbered invoices. Interest on the loans accrues from the date of invoicing. The nancial manager performs monthly debtor reconciliations, which she signs as proof of performance. REQUIRED Design the audit procedures that should be performed in order to obtain sufficient, appropriate audit evidence regarding the revenue gures of DreamHomez for the 31 December 20X1 nancial year-end, indicating in each case whether it is a substantive procedure, a test of control or a dual-purpose test. [22] Question 6 LEVEL 3 Revenue [28 marks] You are employed as the auditors of TOP Fashion (Pty) Ltd (TOP Fashion). TOP Fashion became a market leader in fashion after it launched its TCL reality show: Say heck yay to the shirt. e company provides fashion advice and tips to clients. TOP Fashion has two main income streams. One-third of the income is generated from consultation fee income and ad hoc services the company provides during consultations. e other two-thirds of the company’s income is generated from the personal shopping service TOP Fashion provides to its customers. Income generated during consultation TOP Fashion sends a consultant to a client’s house to review the client’s wardrobe. e consultant then provides the client with feedback on which clothes would t them the best. e feedback is contained on a printed feedback report. e report contains a description of the clothes, recommended sizes and measurements, colours, etc. Consulting fees are payable, quarterly in advance. Various packages can be purchased, each with a different number of visits. Entry-level packages allow for two annual visits, while the superior packages include monthly visits plus two additional ad hoc specialist consultation visits that focus on evening wear for special events. If the ad hoc specialist consultation visits are not utilised, the sessions are forfeited. Consultants also provide various value-added services during the consultation. ey provide: a cleaning service to clean one or two clothing items required at short notice (the consultant cleans the clothing item at the client’s premises) a tailoring service to jazz up a clothing item or make necessary alterations. ey also carry a line of costume jewelry and semi-precious gems with them, which they can sell to clients during consultations. Income generated from the personal shopping services e feedback report received by the clients after a consultation can either be used by clients to purchase their own clothing at a retailer of their choice, or clients can make use of TOP Fashion’s personal shopping service. TOP Fashion has buyers who will source the recommended clothing from various suppliers around South Africa. TOP Fashion guarantees the best possible price. Clients who would like to make use of the personal shopping service must review the feedback report, make any amendments (if necessary) and then sign and date it. It is returned to the consultant, who issues the client with a quotation based on the signed feedback report. e quotation includes time required to provide the personal shopping service and the cost per hour. If the client accepts the quotation, a date for the tting of the clothing is recorded on the quotation. A TOP Fashion personal shopper sources the clothing and a tting is held in the comfort of the client’s home on the agreed date. Once the tting is complete, the quotation for the personal shopping service is stamped with a date stamp by the personal shopper and placed in a suspense le until invoiced, if not invoiced immediately. Two pre-numbered invoices are prepared by the personal shopper based on the completed quotation. A copy, payable in 30 days, is given or sent to the client, and the other is attached to the stamped quotation. Clothing sold to the client is invoiced separately, as it must be paid cash on delivery (COD), since TOP Fashion cannot return worn clothing to its suppliers. A sales invoice is issued immediately together with a cash receipt. e invoices for sale of goods and for services rendered are recorded daily by the accounting department. REQUIRED 1. Discuss the risks (other than those relating to the presentation assertion) which will increase the chances of material misstatement on account/assertion level in respect of revenue generated during consultations. Also, list the assertion(s) affected by the risk. (8) Presentation (table and assertion) (1) 2. Assuming that the general procedures have already been performed, formulate the substantive procedures that you would perform in respect of the revenue from services provided. In documenting the test of details, clearly show how the requirements of IFRS have been met. (18) Presentation (application of requirements of IFRS) (1) [28] SUGGESTED SOLUTION TO QUESTION 6 1. Audit risk at account and assertion level The risk exists that consulting fee income is not recognised accurately and completely according to the different performance obligations: consulting fees, cleaning services, sewing services, etc. Risk exists that revenue is overstated and revenue recorded where consultations did not take place. Alternatively, excessive hours can be recorded to render the service. The risk exists that income from the various services and sales are incorrectly classi ed as: consulting income sale of goods, or service income. A risk exists that income is recognised when it is invoiced and not when the service is rendered and incorrectly classi ed as income rather than income received in advance. The risk exists that income did not actually occur and that not all fees have been paid, since depending on the consultation, fees are payable at different frequencies, while ad hoc payments must also be accounted for. (1) Accuracy and completeness of revenue (1) (1) Occurrence of sale (1) Classi cation of revenue (1) (1) (1) Cut-off and classi cation of revenue (1) (1) Occurrence and completeness of revenue (1) Presentation (table and assertion) (1) Available marks [11]; maximum marks [9] 2. Income from services rendered Analytical procedures a) Develop an expectation for the revenue from services based on your knowledge of business and operations, previous year’s revenue from services and budgeted gures as well as industry norms. (1) b) Calculate the following ratios for the current year, prior year (previous year’s working papers) and budgeted gures and compare them with each other: i) Total revenue from services rendered ii) Revenue from services rendered month to month iii) Revenue from services rendered per month as a percentage of total revenue from services rendered iv) Revenue from services rendered as a percentage of total income v) Net pro t percentage (max 2) c) Compare the data used to calculate the ratio(s) above with the nancial information system. (1) d) Evaluate the results of the ratio analysis and investigate any unusual uctuations. (1) Tests of detail Identify the contract with the customer: e) Select a sample of transactions from the revenue journal and perform the following: i) Check that the invoice is made out in the name of TOP Fashion (Pty) Ltd. (1) ii) Agree the details on the invoice to the signed feedback report and signed quotation. iii) Agree the amount on the invoice to the bank statement. (1) (1) f ) Select a sample of invoices from the revenue journal and inspect whether the revenue as per the invoice has been recorded in the correct account as revenue from services rendered and not sales. (1) Identify the performance obligations in the contract: g) For the sample of invoices: i) Inspect the details on the invoice and con rm that they relate only to services rendered and not goods sold, which is invoiced separately. (1) ii) Inspect the date of the invoice and the date stamp of the signed quotation to con rm the transaction is recorded in the correct period. (1) Determine the transaction price: h) For the sample of invoices: i) Recalculate the income as per the invoice by multiplying the price for services rendered with the hours worked as per the quotation. (1) ii) Agree the amount on the invoice to that in the revenue journal. (1) iii) Calculate a reasonable time required to provide the service to evaluate the reasonability of the time allocated to render the service. (1) iv) Agree the price on the invoice to the historic prices on the database underlying the feedback report. (1) Recognise revenue when the entity satis es the performance obligation: i) Select a sample of stamped quotations before year-end and after year-end and inspect the date stamped on the completed quotations. Follow through to the invoice and con rm whether the invoice has been recorded in the correct period in the income journal. (1) j) Select a sample of signed stamped quotations and corresponding invoice, and recalculate the income. Con rm whether the income has been recorded in the income journal and debtors ledger. (1) k) Select a sample of completed stamped quotations awaiting an invoice (suspense le) and con rm whether these have been recorded in the revenue journal. Enquire from management about outstanding invoices. (2) l) Perform a sequence check on invoices and con rm that all invoices have been recorded in the revenue journal. (1) m)Select a sample of receipts from the bank statement and agree the receipt to the corresponding invoice. Note the date of the service rendered and con rm that the income has been recorded in the revenue journal and has been correctly classi ed as revenue from services rendered. (2) Presentation (application of requirements of IFRS) (1) Available marks [23]; maximum marks [19] Question 7 LEVEL 2 Commission paid [15 marks] You are currently engaged on the audit of Mobile mania (Pty) Ltd (Mobile mania), a company, which was incorporated in 2002 by Mr Jenkinson and Mr Sotherby, selling a range of mobile phones, tablet computers and laptops from their 20 branches located in shopping malls across South Africa. All of the branches are linked to head office in Sunninghill via a virtual private network. e company’s nancial accounting system (LAN) is housed at head office, where all personnel les are stored. All administration and nance staff earn a monthly salary and an annual bonus. Employees are paid via EFTs on the 23rd of each month. While branch managers earn a monthly salary and receive a bonus based on the performance of the branch during the course of the year, the sales representatives at the branches earn a basic salary and earn a commission on each sale made. At the conclusion of a sale, the client receives a hard copy of the contract, while a duplicate is led at the applicable branch. e information recorded on the hard copy contract is captured onto the system by the sales representative, who inputs his/her staff number and the sale code, thereby ensuring that he/she receives the commission due to him/her for the sale. e next day, the branch manager validates the legitimacy of the sale by comparing the original hard copy contract to the information loaded onto the system. Once the sale has been validated, the commission on the sale is posted to the commission account, whereupon the system identi es all commission due to each sales representative by the payroll run date and the amount is allocated as part of his/her monthly salary. Administration and nance staff, as well as the branch managers, belong to the company’s provident fund and medical aid. Sales representatives do not receive this bene t, as they tend to be students who usually leave the job after a year or two. REQUIRED Describe the substantive audit procedures you would carry out in respect of commission paid during the nancial year under review. [15] Question 8 LEVEL 3 Purchases and payments balances [18 marks] You are the auditor of Packaging Solution (Pty) Ltd (Packing Solution), a South African company that supplies the public and wholesalers with a wide range of packaging products. e company has a 30 September nancial year-end. You are responsible for the audit of the trade payables balance on the audit engagement and the only outstanding audit work is the substantive audit procedures to be performed on the creditor reconciliations at year-end. e following is an example of a creditor’s reconciliation that you obtained from Mrs Mary Mhlongo, the credit manager, who is responsible for approving all pending payments to creditors after she has reviewed each creditor reconciliation: CORI SUPPLIES CC Description Amount Explanation by the client’s creditors clerk Balance per statement on 30 September R297 000 Goods received after year-end: invoice 244 (R47 000) Invoice 244 was not recorded because the goods ordered (high-gloss paper material) were still en route from Cape Town to our production facility in Johannesburg at year-end. The goods arrived on 10 October. Error: invoice 227 (R35 000) Invoice 227 indicated that Cori Supplies CC charged Packaging Solution for 10 pallets of high-gloss material, but we received only 9 pallets on 28 September. Each pallet has 1 000 sheets of high gloss paper on it at a cost of R35 a sheet. Goods returned: invoice 229 (R74 000) High-gloss paper was delivered to Packaging Solution on 22 September. However, the items were of an incorrect colour. The whole shipment was subsequently returned to Cori Supplies CC by way of goods returned note 76. Cori Supplies CC indicated that it would write us a credit note (for invoice 229), but by year-end the supplier has not yet done so. Payment (R52 000) Payment made to Cori Supplies CC on 28 September not taken into account on the supplier statement. Balance as per creditors ledger on 30 September R89 000 M Mhlongo REQUIRED 1. Describe what the term ‘dual-purpose test’ means. (1) 2. Describe two tests of controls you could perform on the creditors reconciliation of Cori Supplies CC. (2) 3. Describe the substantive audit procedures you would conduct on the creditors reconciliation of Cori Supplies CC. Assume that computer-assisted audit techniques (CAATs) will not be used in the testing of the reconciliation. (15) [18] Question 9 LEVEL 2 Purchases [14 marks] You are the auditor of Fitness Supplies (Pty) Ltd (Fitness Supplies), a company with a December nancial year-end that supplies a range of personal training equipment to the public. Although the company imports its equipment from suppliers in China and the USA, all purchases are denominated in US dollars. As a result of an increase in demand for training equipment, Fitness Supplies imported more goods in the current year than in the previous three years combined. e goods are sold from its stores located in shopping malls across the country. e company’s integrated computerised system links all the stores’ individual computer systems. When the inventory level for a particular item of equipment reaches the economic order quantity level pre-set into the computer system, an order request is sent through to the chief buyer. Once he/she has signed his/her approval, the order is placed with the relevant overseas supplier. Once the equipment reaches South Africa and has been cleared by the customs division of SARS, it is delivered to the company’s warehouse in Epping, Cape Town, in one section of which the administration office is located. e following reports are then sent to the creditors department: A completed GRN e customs report e clearing agent’s invoice e logistics company’s invoice e warehouse manager dispatches inventory to the relevant stores. Once the invoice for the equipment has been received from the supplier, a corresponding creditor is recognised by the accountant using the information (the rate of exchange, the transaction date, etc.) located on the order form, the delivery note and the invoice. REQUIRED Discuss the substantive audit procedures that you would perform on the purchases recorded for the nancial year under review. In answering the question, make use of general audit software as far as possible. [14] Question 10 LEVEL 3 Substantive procedures: Expenses [20 marks] You are the audit senior on the audit of Open Oceans (Pty) Ltd (Open Oceans) for its 30 November 20X1 nancial year. Open Oceans is a deep-sea shing and sh processing company which is situated close to a large harbour. Its facilities consist of a processing and sh-freezing factory, which includes several cold rooms and an ice plant (for making arti cial ice). Open Oceans is registered as a VAT vendor. e company’s operations are electricity intensive. e total electricity expense recorded for the 30 November 20X1 nancial year amounted to R1 278 400, which is material for audit purposes. Included in this total is R245 390 spent on diesel that was used to power generators during periods of load shedding. Management prepared a spreadsheet to show how the dieselrelated expense was allocated to the electricity account from diesel purchases. e spreadsheet shows the litres of diesel used by the generators, the cost allocated per litre for a particular month and the quantity of kilowatts generated as per the generators’ built-in meters. Municipal and diesel expenses are recorded separately in the general ledger account. Electricity bills are received from the local municipality on a monthly basis, but at the time of the audit in January 20X2, the invoice for November 20X1 has not yet been received by Open Oceans. Accordingly, management created an accrued expense in the amount of R85 500 relating to November 20X1. REQUIRED Describe the substantive audit procedures that should be performed to test the electricity expense recorded by Open Oceans for its 30 November 20X1 nancial year. Structure your answer in terms of the relevant assertions and include any relevant general procedures. [20] Question 11 LEVEL 3 Prepaid expenses [8 marks] You are a second-year trainee accountant at Q&Z Inc. and are currently busy with the audit of A2Z Ltd (A2Z) for the 28 February 20XX nancial year. A2Z is a clothing wholesale retail company and sells its products to clothing retail companies across the country. You are responsible for the audit of the company’s accounts receivable balance as at year-end. You obtained the schedule below, detailing the general ledger accounts that represent the accounts receivable balance contained in the statement of nancial position as at year-end, from the company’s accountant: GENERAL LEDGER ACCOUNT NUMBER DESCRIPTION R 1011 Trade debtors control account 58 985 356 1014 Prepaid expenses – Note 1 175 982 Accounts receivable balance – 28 February 20XX 59 161 338 You have already performed all the necessary procedures regarding the company’s trade debtors. Note 1: is amount consists of additional amounts which the company paid on its municipal and telephone accounts. REQUIRED Formulate the substantive procedures that you should perform to obtain sufficient and appropriate audit evidence regarding the company’s prepaid expenses included in the statement of nancial position as at 28 February 20XX. [8] SUGGESTED SOLUTION TO QUESTION 11 1. Obtain a list from management of all the items included in the prepaid expense balance on 28 February 20XX and recalculate the total on the list. (1) 2. Compare this list to last year’s working paper for completeness purposes. Discuss any changes with the accountant and corroborate his/her reply with invoices/statements. (1) 3. Agree the total on the list to the balance re ected in the prepaid expense account in the general ledger and on the trial balance. (1) 4. Inspect correct opening balance to working paper of previous year and con rm this opening balance was reversed at the beginning of the nancial year. (1) 5. Re-perform the calculation on the list to check that it adds up to R175 982. (1) 6. Agree the amounts on the list for the water and electricity and telephone accounts to the actual statements on 28 February 20XX. (1) 7. Inspect the water and electricity, telephone and other periodic expense accounts in the general ledger to determine whether all amounts have been correctly included (e.g. 13 payments instead of 12). (1) 8. Perform an analytical review of the prepaid expenses in the current year to the prepaid expenses of the previous nancial period for reasonableness and investigate any variances. (1) 9. Obtain a management representation letter regarding the existence, completeness, accuracy, valuation and allocation, rights and obligations, classi cation and presentation of the prepaid expenses balance at 28 February 20XX. (1) 10. Inspect the nancial statements and the notes to the nancial statements to ensure the prepaid expenses have been included as a separate line item in the accounts receivable balance note. (1) Available marks (10); maximum marks Question 12 (8) LEVEL 3 Prepayments [16 marks] You are the audit senior on the audit of Peru Rocks (Pty) Ltd (Peru Rocks). e company has been your client since your rst year of articles. Peru Rocks imports rocks from South America, against the hills of Machu Pichu, to sell across South Africa. e rocks are used in building projects, gardens, landscaping and other similar projects. Peru Rocks discloses two prepaid balances on the face of its statement of nancial position. Marketing campaign e company has seen a drop in sales and as a result, the sales director approached a marketing company to run a marketing campaign. Peru Rocks had never previously relied on any form of marketing other than word of mouth. e marketing campaign would run for a 10-month period. e contract consisted of two elements. An amount of R250 000 was payable ve months after the commencement of the campaign. is amount was payable only if Peru Rocks realised an increase in sales of R1 million. If this target was reached, Peru Rocks could decide whether it wanted to extend the contract for another ve months for an additional amount of R250 000, due when the target was reached. Peru Rocks saw an increase in sales in excess of R1 million four months after the commencement of the campaign and as a consequence decided to make the additional payment a month before year-end, while the contract still had a further four months to completion. Other prepayments Peru Rocks pays various other smaller expenses in advance, which include, inter alia, rental and insurance payments. REQUIRED 1. Assuming you have already completed the general procedures relating to the marketing campaign account, formulate the substantive procedures you would perform in respect of the prepaid marketing campaign expense account in the statement of nancial position. (10) 2. Formulate analytical procedures that you would perform in respect of the other prepayments in the statement of nancial position. (6) [16] Question 13 LEVEL 2 Wages [25 marks] You are the audit manager on the audit of Playground (Pty) Ltd (Playground), a manufacturer of self-assembly playground equipment. You are currently busy with the audit for the year ended 31 December. e preliminary work performed by one of the audit trainees involved the documentation of the client’s wages system for its 40 wage employees. After evaluating the system description and following discussions with the trainee, you decided that a substantive-based audit approach with limited reliance being placed on substantive analytical procedures would be the most appropriate. Documentation of the wages system of Playground All potential employees are interviewed by management, after which reference checks are performed. As a result of the number of high-pro le credential frauds published in the media recently, the company has over the past few months placed greater emphasis on verifying the credentials of each applicant. Once an offer of employment has been made, both the personnel manager and the new employee sign a letter of appointment, which is led in the personnel department. Annual performance evaluations are performed by the production supervisor and the production manager. ese are used in order to determine annual increases, which are communicated to the personnel department. After the personnel manager has approved them, the wage increase letters are led in the personnel department. Most employees, who are required to wear red overalls while on duty, work in the factory. In order to ensure that no injuries occur during working hours, all work-based activities are monitored through the deployment of CCTV cameras. No employee is required to work overtime, but may do so voluntarily. At the beginning of each week, the wages clerk prepares the wage journal, calculating the gross wage of each employee by multiplying the hours worked – information on which is gleaned from the computerised clock-card system – by the appropriate hourly rate. At the same time, deductions for income tax and medical aid contributions are made. Both the personnel manager and the nancial manager sign the weekly net payment schedule that is sent to the bank. A copy of the schedule is led in the personnel department. e company uses a wages control account in order to control the payment of wages, which is made by the bank directly into each employee’s bank account at the end of each week. REQUIRED Formulate the substantive procedures that you would perform on the wage expense of Playground. You are not required to address salaries or the directors’ remuneration. [25] Question 14 LEVEL 2 Salaries [15 marks] You are currently engaged on the audit of Maxi-Med Ltd (Maxi-Med), the 10th largest private hospital group in the world. With nearly 6 300 beds in 32 multidisciplinary hospitals in South Africa and Namibia, Maxi-Med employs approximately 7 600 people. Payroll e accounting system, which includes a payroll module, is run on a LAN at head office in Durban. e payroll expense for the current nancial year end is R3 955 229 340 (the previous year was R3 638 610 839). All employees are paid via EFT on the 25th of each month. An employee’s signed contract and appointment letter, which are led at the administration office at the hospital in which he/she works, are scanned by the administration clerk at that particular hospital and emailed to the human resources (HR) officer at head office. e HR officer inspects the letter for the signatures of both the hospital manager and the employee, and, if he/she is satis ed, inputs the data into the payroll master le system. REQUIRED Describe the substantive audit procedures you would carry out in respect of salaries at year-end. [15] SUGGESTED SOLUTION TO QUESTION 14 1. In order to establish if an employee is a genuine employee of Maxi-Med Ltd (Occurence): a) After stratifying the salaries le by hospital (e.g. per hospital name), extract the name of an employee and request that the hospital where his/her original documents (employment contract, letter of appointment, certi ed copy of ID document, etc.) are kept courier the original documents to head office. (1) b) Inspect the documents for validity. (1) c) Inspect all third-party correspondence (e.g. with SARS) in order to con rm validity. (1) d) Perform a positive identi cation of salary earners whilst visiting hospitals randomly selected during the audit. (1) e) rough discussion with the staff in the human resources section and an examination of the authorised employment and dismissal documentation, con rm that staff are introduced to, and removed from, the salaries register within the correct time period. (1) f ) Using general audit software, identify whether or not any employees have been noted with, for example: i) duplicate identity numbers ii) missing names iii) duplicate addresses iv) missing tax numbers. (2) 2. In order to con rm accuracy: a) agree the total salaries expense of R3 955 229 340 (the previous year it was R3 638 610 839) for the year to the trial balance, the general ledger and the annual nancial statements (1) b) by inspection, agree the employee’s gross salary paid to that authorised in the employee’s contract, and vice versa (1) c) compare all deductions (e.g. PAYE/SITE, pension and medical aid) to the appropriate tables and to the authorised deduction form at the human resources department, inquiring into any discrepancies with human resources and, if necessary, the employee (1) d) recalculate a sample of the deduction calculations (1) e) re-perform some calculations on both the salaries account and the monthly payroll printouts (1) f ) re-perform a sample of postings from the salaries account to the general ledger in order to determine that postings have been correctly performed (net salaries and all deductions). (1) 3. In the case of classi cation, scrutinise the payroll accounts for any unusual entries and wrong postings. (1) 4. In order to con rm completeness and cut-off: a) establish that the payroll account has 12 salary debits for the year in order to ensure completeness of payroll expense (1) b) scrutinise monthly reconciliation reports where the current month’s salary has been reconciled to the previous month’s with regard to new employees, employees dismissed, changes in salary rates, bonuses paid, etc. (1) c) trace a sample of these changes to master le amendment forms and supporting documentation, or personnel les. (1) 5. During analytic procedures, compare: a) the salaries for Maxi-Med Ltd on a month-to-month basis and investigate any large uctuations by means of supporting documentation (1) b) the salaries for each hospital on a month-to-month basis and investigate any large uctuations by means of supporting documentation. (1) Available marks [19]; maximum marks [15] Question 15 LEVEL 3 Lifetime expected credit losses [21 marks] You are auditing Zazo (Pty) Ltd (ZA), a group of exclusive fashion boutiques that operates shops at all the main shopping centres in South Africa. ZA is a subsidiary of a Spanish company which has been in the fashion industry for over ve decades. e company allows sales on credit to customers to maximise sales. Before customers can purchase on credit, they must complete a credit application form which will be followed up by head office’s credit department. Only creditworthy customers will then be allocated a credit limit which is strictly enforced by the company. ZA’s nancial year-end is 30 June. Trade receivables e company will be using a provision matrix approach to calculate the lifetime expected credit loss on trade receivables as stipulated in IFRS 9. e trade receivables age analysis has the following balances at year-end: R EXPECTED DEFAULT RATE Amounts owing 1–30 days 15 000 000 0.3% Amounts owing 31–60 days 7 500 000 1.6% Amounts owing 61–90 days 4 000 000 4.6% Amounts owing 90–120 days 2 500 000 3.6% Amounts owing 120+ days 2 700 000 12.6% e expected default rate as shown above was determined by the procurement manager at head office. Your audit rm has performed tests of controls on the revenue/trade receivables cycle of ZA. REQUIRED 1. Calculate the lifetime expected credit loss at year-end, using the provision matrix approach on the information supplied in the question.(3) Also discuss the taxation effect of this provision on the current year as well as the next nancial year. (3) 2. Describe the audit procedures to verify the valuation of the lifetime expected credit loss as calculated in (1) above. (15) [21] SUGGESTED SOLUTION TO QUESTION 15 1. Provision matrix 1–30 DAYS 31–60 DAYS 61–90 DAYS 91–120 DAYS 120+ DAYS TOTAL Default rate % 0.3 1.6 4.6 3.6 12.6 Gross carrying amount 15 m 7.5 m 4m 2.5 m 2.7 m 31.7 m Lifetime expected credit loss 45 000 120 000 184 000 90 000 340 200 779 200 Marks: R779 200 (or R780 000 rounded) (2 marks); framework used (1 mark) Available marks [3]; maximum marks: [3] Taxation effect on taxable income Section 11(j)(i)(aa)(A) applies Taxable income will decrease by (779 200 @ 40%) R311 680 in the current year is amount must be added back to taxable income in the following year. e percentage used can increase to 85% if a directive is obtained from SARS. (2) (1) (1) Available marks [4]; maximum marks [3] 2. Valuation procedures for calculation above Audit of default rate percentage a) e 3.6% used in the above calculation is suspect and shows bias. It should have been between 4.6% and 12.6%. (2) b) Enquire from the procurement manager how he decided on the default rate percentages. Corroborate his explanation with supporting documentation. (1) c) Determine the competency and experience of procurement manager to calculate the default rate percentage by investigation of previous work prepared by him/her. (1) d) Investigate the actual defaults in the current year and compare them to the default rate percentages used in the prior year. is will indicate how accurate the default rate percentage was calculated in the previous year. (2) e) Follow up payments after year-end by debtors and have discussions with debtors clerks regarding possible defaults. Also take into account accounts handed over to attorneys for collection and disputes with debtors. Up to now, we have only covered possible bad debt that already existed at year-end. Certain ‘good debt’ will also go bad later after yearend. e auditor must estimate a provision for these losses. (4) f ) Also investigate any other subsequent events after year-end which indicate that debtors need to be impaired. (1) g) For example, if you calculated that lifetime expected credit loss amounts to R1 200 000 based on procedures performed under points (e) and (f ) above, then you know the amount calculated by the client of R779 200 used in the provision matrix is too low. (2) h) Follow up any large discrepancies as revealed by procedures in (e) above with the CFO. If the CFO does not rectify the matrix, take audit difference to unders/overs schedule. (1) Audit of gross carrying amount i) Inspect each amount in the matrix to the amount in the debtors age listing. (1) j) Agree the total of R31.7 million to amount in the debtors control account/TB. (1) k) Re-perform the debtors aging to dates on invoices/delivery notes to verify correctness of aging. (1) Audit of lifetime expected credit loss l) Re-perform the calculation on the matrix to verify amount is R779 200. (1) m)Agree the total of R779 200 in the matrix to the amount in the general ledger’s provision for lifetime expected credit losses. (1) Available marks: [19]; maximum marks: [15] Question 16 LEVEL 2 Accounts receivable [18 marks] Soft Cloud (Pty) Ltd (Soft Cloud) is a manufacturer and wholesaler of high-quality mattresses, whose clients comprise such bulk-buyers as hotels and game lodges. You were appointed as the audit senior on the 31 August 20X1 year-end audit. In the course of the planning phase of the audit, the nancial manager, Mr Zuchter, who assigned the revenue and receipts cycle to you, informed you that during the nancial year Soft Cloud adopted a new bad-debt provision policy. e following extract from the trial balance was provided to you by Mr Zuchter: TRIAL BALANCE AS AT 31 AUGUST UNAUDITED 20X1 R’000 AUDITED 20X0 R’000 Credit sales 142 582 125 879 Cash sales 59 142 65 475 Inventory 32 125 25 154 Debtors 52 175 49 487 Allowance for credit losses 11 154 10 475 REQUIRED Describe the substantive procedures that you would perform in order to obtain appropriate and sufficient audit evidence for the valuation assertion with regard to the net debtors balance of R41 021 000 at year-end. [18] Question 17 LEVEL 2 Provision for future expected credit losses [14 marks] You are the auditor of Cape-Dairy (Pty) Ltd (Cape-Dairy), a company producing organic milk at its facility in Durbanville. e company has a December nancial year-end. e only audit work performed on the allowance for credit losses balance at year-end was an analytical review procedure: Extract from the analytical review procedure performed by the auditors Expectation: We expect the allowance for credit losses to increase in line with the industry average of 11%. Accepted deviation: Up to 2% either side of the expectation; that is, 9% or 13% Actual allowance calculated by management: R10 000 000 (gross receivables) @ 7.5% = R750 000 Action: Follow up with management and corroborate explanations through the performance of substantive audit procedures. Extract from a discussion held with the chief nancial officer Auditor: My ndings following an analytical review procedure indicate that the allowance for future expected credit losses for the current year is 7.5% of gross receivables, which is substantially lower than the industry average of 11%. Chief nancial of cer: Based on my experience in the industry, and the fact that we have an aggressive collections policy, I do not see any valid grounds for increasing the allowance for future expected credit losses, as this would not be a fair re ection of what is taking place within our company. In any event, if we are wrong, the difference should not be material. We provided for 7.5% in the previous year when the industry average was 10%, with which gure your rm was satis ed. So I don’t see that there is any valid reason for increasing the allowance for the credit losses gure in the current year. Other information During the performance of subsequent events testing, it was brought to your attention that a debtor included in the 60-days total at year-end had become insolvent, which served to strengthen your view that the provision for future expected credit losses at the company was understated. You informed the chief nancial officer about the debtor and that you believed that the industry average percentage of 11% would be more reasonable in determining the allowance for credit losses. e chief nancial officer indicated that he did not agree and refused to make any additional adjustments. e provision for future expected credit losses for the previous year was R525 000. Extract from the electronic age analysis CURRENT 30 DAYS 60 DAYS > 90 DAYS R4 760 000 R740 000 R875 000 R625 000 68% 10.5% 12.5% 9% R5 400 000 R3 250 000 R500 000 R850 000 54% 32.5% 5% 8.5% Age analysis: previous year Rand value of debtors % of total amount receivable Age analysis: current year Rand value of debtors % of total amount receivable REQUIRED Discuss the substantive audit procedures that you would perform on the allowance for the credit losses gure at year-end. [14] Question 18 LEVEL 2 Accounts receivable [20 marks] An audit manager at Audit Inc., a rm of registered auditors based in Cape Town, you have reached the completion stage of the December year-end audit of Saucy Ltd (Saucy). A company listed on the Alternative Exchange (AltX), Saucy manufactures a variety of condiments that it sells to wholesalers, retailers, restaurants and hotels. Your audit rm has been Saucy’s auditors for the past ve years. All audit work has been sufficient and effectively completed (including a positive and negative debtors circularisation), except for the outstanding work to be performed on the valuation assertion for accounts receivable. Accounts receivable e company’s accounting systems are fully integrated and run on a local area network (LAN). Sales are made on a credit basis only. By the end of November, customers have been supplied with a product catalogue, together with the following year’s approved price list. Although prices are generally xed, they may change, depending on the quantities purchased and the discounts granted. Each prospective client completes a credit application. Mr Melapo, the credit manager, compares the information noted on the form to the information obtained from the credit bureaux in order to determine whether or not he/she should be granted credit. For each applicant whom he approves, he requests one of the debtors clerks (Ms Mokumbe, Mr Pienaar or Mr Adams) to load the client onto the system with a pre-approved credit limit. In addition to all customers receiving 30-day settlement accounts, it is company policy to make an allowance for credit losses against the customer if he/she has not settled his/her debt within 90 days. In the previous year, the allowance for credit losses amounted to R220 500. e current year age analysis obtained from Mrs Newton, the chief nancial officer, is as follows: ACCOUNTS RECEIVABLE (R) CURRENT > 30 DAYS > 60 DAYS > 90 DAYS > 120 DAYS 4 275 000 2 308 500 1 325 250 342 000 171 000 128 250 54% 31% 8% 4% 3% CURRENT > 30 DAYS > 60 DAYS > 90 DAYS > 120 DAYS 2 131 500 1 065 750 257 250 109 000 111 500 58% 29% 7% 3% 3% Percentage of total debtors e previous year’s age analysis reads: ACCOUNTS RECEIVABLE (R) 3 675 000 Percentage of total debtors REQUIRED Describe the substantive audit procedures that you would perform in order to satisfy yourself that the accounts receivable balance is valued correctly at the December year-end. [20] SUGGESTED SOLUTION TO QUESTION 18 1. In order to establish the gross amount: a) extract a list of accounts receivable from the accounts receivable master le and agree the total of R4 275 000 on the list to the accounts receivable control account or trial balance b) review the list for credit balances, obtain the reasons from Mr Melapo and, if material, (1) request a reversal of the amounts (1) c) reclassify remaining credit balances to the accounts payable balance (1) d) scrutinise the accounts receivable control account for debtors with unusual credit limits; if there are any, follow up on them with Mr Melapo (1) e) re-perform casts of the control account and the accounts receivable list (1) f ) compare the balances on the list of accounts receivable to the responses received from debtors circularisation. Follow up on any queries or reconciling items. (1) 2. In order to establish provision for future expected credit losses: a) by inquiring from Mr Melapo and an inspection of the previous year’s working papers: i) establish the method and the procedures (all balances exceeding 90 days) adopted by Mr Melapo in determining the allowance for credit losses of R299 250 (R171 000 + R128 250) (1) ii) assess the basis, the method and the procedures for reasonableness and consistency with the previous year’s balance of R220 500 (R109 000 + R111 500) (in this scenario, it is consistent) (1) iii) evaluate the effectiveness and reliability of the procedures adopted in order to authorise the allowance for future expected credit losses by management (1) iv) select a small sample of accounts receivable and, by tracing the amounts owed back to the invoices and the subsequent receipts, con rm that the manual ageing of the amount agrees with the ageing as calculated per the master le. (1) b) using general audit software, stratify the debtors master le into the following categories: i) A debtor’s amount in an age eld that exceeds the accounts receivable individual credit terms (1) ii) A debtor’s amount in the over-90-days age eld (1) c) for each debtor identi ed above, discuss with Mr Melapo his/her historical payment history and the likelihood or not of him/her paying the outstanding amount (1) d) inspect Saucy’s legal and customers correspondence les in order to identify disputes with customers, and (1) if there are any, follow up with the Mr Melapo in order to obtain the latest information on the state of the disputes (1) e) compare the amount written off in the current year to the allowance made in the previous year in order to assess management’s ability to provide realistic provision for future expected credit losses (1) f ) perform analytical review procedures on the accounts receivable balance and the provision for future expected credit losses (2) g) calculate the days outstanding and compare them to those of the previous year (1) h) compare the R299 250 to the R220 500 provision (1) i) compare the accounts receivable age analysis to that of the previous year (1) j) compare the accounts receivable to the credit sales for both the current and the previous year (1) k) for all of the above, obtain reasons from management for any unusual variances, and follow up on their explanations employing source documentation (1) l) after performing all the above procedures, determine one’s own provision for future expected credit losses based on the audit evidence obtained, comparing that allowance to the R299 250 calculated by management. 3. Follow up any difference with management, and then conclude. 4. Any other valid procedures (1) (1) Available marks [25]; maximum marks [20] Question 19 LEVEL 2 Positive con rmation and provision for future expected credit losses [26 marks] You are the audit senior on the external audit of Leep Frog Ltd (Leep Frog), a company that owns and leases buildings across South Africa. During the current year, there was a signi cant decrease in the number of properties leased as a result of declining interest rates. Consequently, the company’s rentals in arrears account has grown dramatically over the past few months. In response, the audit manager has decided to send out positive con rmation letters to lessees. e lease system in place at Leep Frog operates as follows: New applications and approvals Once a prospective tenant has completed a rental application form and successfully undergone a credit check, a rental agreement, which is pre-numbered, is entered into with the lessee and signed by both parties. A copy of the agreement, as well as the rental application form, is led in a correspondence le for the lessee, who is assigned a unique lessee number. Invoicing e accounting department at head office maintains a rent register in which all rentable office space is listed, along with the details of all lessees. On the rst day of every month, an invoice serving as a reminder of the rent due on or before the fourth day of the month in terms of the rental agreement, is mailed to each lessee. In addition, the invoice is debited to the lessee’s account in the rent register. Receipts Rentals are paid directly to head office. When payment has been received from a lessee, it is credited to the client’s account in the rent register. Month-end procedures All lessees with outstanding rent payments receive a monthly statement prepared and mailed on the 10th of each month. Copies of these statements are led in the respective correspondence les of the lessees. Additional information e credit manager determines the provision for future expected credit losses by inspecting the age analysis at year-end and considering the recoverability of all individual lessee amounts outstanding for more than 90 days. According to the audit program, you should perform the following audit procedures: Verify the existence of lessees and rental in arrear balances relying on positive circularisations. With regard to the provision for future expected credit losses, inspect and test the procedures performed by the audit client when calculating such a provision. REQUIRED 1. Describe the procedures that you would perform in respect of the positive con rmation by lessees of the gross amount of rental in arrears. (11) 2. Formulate the substantive procedures that you would perform at year-end relating to the provision for future expected credit losses. (15) [26] Question 20 LEVEL 2 Creditors statement reconciliation [15 marks] A junior trainee accountant assigned to the 31 December 20X1 audit engagement of Raffles (Pty) Ltd (Raffles), a large retailer of furniture and electronic appliances with outlets across the country, you have been allocated to the testing of trade payables and will perform the audit of Raffles’s creditors reconciliations in mid-January 20X2. e following creditors statement reconciliation, performed for a supplier, Furnley Ltd, by the Raffles creditors clerk, was included in a sample for testing. e reconciliation for January 20X2 for Furnley Ltd, which closed down on 23 December 20X1, is not yet available. DESCRIPTION NOTE Balance as per Furnley Ltd statement 23/12/20X1 R 466 980 Add: Goods received note GRN681 not yet invoiced 113 750 Correct mathematical adding error on supplier’s statement 15 789 Correct posting error (invoice FRN1078 from Furnley Ltd) 1 75 380 2 55 320 Less: Discount allowed on invoice FRN1105 not on statement EFT payment to supplier on 30/12/20X1 Debit note RFL540D for goods returned to supplier Balance per creditors ledger account CR408, 31/12/20X1 184 100 3 80 550 351 929 Notes: 1. e creditors clerk at Raffles erroneously posted the amount charged as per Furnley Ltd’s invoice FRN1078 to the creditors ledger account of Hautmanns (Pty) Ltd, indicating the correction on the reconciliation only. FRN1078 has not yet been settled. 2. Raffles quali ed for a 5% discount on invoice FRN1105 as a result of making a payment to Furnley Ltd within 30 days of the invoice date, which Furnley Ltd did not take into account on its statement. 3. Raffles purchased several LED television sets from Furnley Ltd. According to Raffles, some of the goods received were older models than those originally ordered. However, Furnley Ltd disputes this claim, saying that Raffles never indicated the model number on its order. REQUIRED Describe in detail the substantive audit procedures you will perform on the creditors statement reconciliation for Furnley Ltd prepared by the creditors clerk of Raffles (Pty) Ltd. Consider all amounts and reconciling items material, ignoring any VAT implications. [15] SUGGESTED SOLUTION TO QUESTION 20 (Notes within brackets are for informational purposes only and do not form part of the required answer.) 1. Agree the supplier’s balance of R466 980 as per the reconciliation to Furnley Ltd’s statement, con rming that the date on the statement is 23 December 20X1. (1) 2. Agree the balance of R351 929 per Raffle’s reconciliation to the creditors ledger at 31 December 20X1. (1) 3. Re-perform the casting of the reconciliation, testing the logic of the calculations (i.e. where items fall under the heading ‘Less’, that these were indeed subtracted and not added) in order to ensure mathematical accuracy. (1) 4. Inspect the supplier’s statement for amounts incorrectly duplicated on the reconciliation as well as other unusual entries not adequately addressed on the reconciliation (e.g. GRN681’s invoice should not appear on the supplier’s statement as well). (1) 5. With reference to the goods received note: a) inspect GRN681 for the date of the delivery of the goods in order to con rm Raffles’ acknowledged receipt of the shipment in December 20X1 (the test for cut-off ) (1) b) request from the creditors clerk the client’s calculation of the amount of R113 750 and agree items/quantity on the supplier’s delivery note and prices to such supporting evidence as the invoice subsequently received in January 20X2 (Note: the supplier delivery note might not contain item prices). (1) 6. Recalculate the supplier’s statement in order to con rm that he/she made a mathematical error and agree the result (R15 789) with the correction as per Raffle’s calculation. (1) 7. With reference to the correction of posting error: a) inspect invoice FRN1078 for the amount of R75 380 in order to con rm that the date shown is within the 20X1 nancial year. Alternatively, ensure that the invoice appears on Furnley Ltd’s December 20X1 statement, as it should do (1) b) recommend to the client a correction to the creditors ledger accounts of both Furnley and Hautmanns, as currently the former’s account is understated and Hautmanns’ overstated by R75 380 (Note: this entry on the reconciliation should be removed once the correction to the accounting records has been made). (1) 8. With reference to the discount allowed: a) inspect the invoice, the supplier contract or other correspondence between Raffles and Furnley Ltd for evidence that Raffles quali es for a 5% payment discount should it settle an invoice within 30 days of the invoice date (1) b) compare the date on invoice FRN1105 to the payment date on the bank statement in order to verify that payment took place within 30 days of the amount having been invoiced (1) c) recalculate the discount by multiplying the discount percentage by the invoiced amount in order to arrive at the discount amount of R55 320. (1) 9. With reference to the EFT payment: a) con rm from the December 20X1 bank statement that payment of R184 100 took place in the 20X2 nancial year (1) b) agree the amount paid to the corresponding invoice from Furnley Ltd in order to verify that the payment relates to debt owing to Furnley Ltd and not to another supplier. (1) 10. With reference to the debit note: a) con rm from the goods return voucher that the goods sent back to Furnley Ltd were returned before the 20X1 year end, which therefore justi es the recording of a debit note b) if the goods were not returned in the 20X1 nancial year (this seems likely, though, (1) owing to the dispute between Raffles and Furnley Ltd) or returned only in January 20X2, recommend to management a reversal of the debit note (Note: in terms of generally accepted accounting practice, a debit note may not be processed if the goods have not been returned) c) inspect the original purchase order for an indication that the model number of the (1) affected television sets was not speci ed by Raffles, as this will lend support to Furnley’s refusal to accept the returns, thereby warranting a reversal of the debit note (1) d) if the recording of the debit note is justi ed, recalculate the debit amount with reference to the quantity and the description of the goods returned and the original invoiced item prices. (1) Available marks [18]; maximum marks [15] Question 21 LEVEL 2 Trade payables [12 marks] You are responsible for the audit of trade payables of Neoplats Trading (Pty) Ltd (Neoplats Trading). e audit manager requested that you read through the debenture agreements to identify loan covenants that will affect the audit of trade payables. While reading the agreements, you came across the following section: Loan covenants The Borrower undertakes that for each accounting period ending, its nancial position shall have been such that: a) the ratio of net cash ow to debt service liability shall not be less than 1.3:1; and b) the current ratio (current assets over current liabilities) shall not be less than 1.5:1. Upon inspection of Neoplats Trading’s preliminary annual nancial statement, you noted that current liabilities consisted of trade payables and provisions. rough discussions with management, you discovered that management only raises a provision for management fees payable to its holding company. e provision for management fees was audited by your audit senior who was satis ed that it was not understated. However, you are now concerned that trade payables may be understated in order to improve the current ratio. REQUIRED Formulate audit procedures that you will perform to test for the completeness of trade payables at year end. [12] Question 22 LEVEL 3 Trade and other payables [25 marks] You are an audit manager at Q&Z Inc. and are currently busy with the audit of Pick-A-Party Ltd (Pick-A-Party) for the 28 February 20XX nancial year. Pick-A-Party is a wholesale company which buys snacks, sweets, cold drinks and themed party items such as paper plates, plastic glasses, serviettes, balloons, etc. on credit from various local and overseas suppliers, which are then sold by Pick-A-Party to retail companies and the public across the country. REQUIRED 1. Discuss the assertion(s) which will normally be at risk when auditing the trade creditor’s balance of a company. (3) 2. Describe the substantive procedures that the audit team should perform to obtain sufficient and appropriate audit evidence regarding the creditors balance re ected in Pick-A-Party’s notes to its nancial statements at year-end. (22) [25] SUGGESTED SOLUTION TO QUESTION 22 1. High risk assertion(s) a) Completeness is normally at risk when auditing the trade creditors balance as companies generally tend to overstate assets and understate liabilities such as trade creditors. (1) b) In addition to the general tendency to understate liabilities, companies might record trade creditors based on invoices (which might only be received after year-end) and not on goods received notes, which are prepared as the goods are received. (1) Depending on whether it is a new creditor or a current creditor who already has an account c) in the company’s books, the late recording of the purchase and the corresponding entry in the creditors account will affect either the completeness (new creditor) or the accuracy, valuation and allocation (current creditor) assertion. (2) Available marks [4]; maximum marks [3] 2. Substantive procedures Completeness a) Compare the list of creditors at the current year-end to the previous year-end and identify: i) creditors on the previous list who do not appear on the current list (1) ii) creditors balances which are signi cantly smaller at the current year-end than at the previous year end (1) iii) and by enquiry from management and inspection of the necessary supporting documents, determine and evaluate the reasons for the differences. b) Obtain the list of goods received notes (GRNs) which were unmatched to invoices at yearend and inspect the journal entry which was raised for the corresponding creditors at yearend. (1) c) Recalculate the amount owed as recorded in the journal with reference to price of the goods received (from the order or pricelist or corresponding invoice if it has arrived) and the quantity as indicated on the GRN. (1) d) Select a sample of large payments from the cash payments journal for the month(s) after the nancial year-end and inspect the GRN and delivery note to con rm that if the payment relates to goods or services received prior to year-end, the corresponding creditor had been raised at year-end (subsequent payment testing). (1) Accuracy, valuation and allocation e) Compare a sample of individual creditors’ balances on the list according to the creditors ledger to the individual creditor’s account in the creditors ledger. (1) f ) Compare the list of individual creditors’ balances according to the creditors ledger to the balance in the creditors control account in the general ledger. (1) g) Compare the balance of the creditors control account in the general ledger to the creditors balance on the trial balance. (1) h) Recalculate the balance of the creditors control account in the general ledger and the total of the creditors list obtained from the creditors ledger. (1) i) Select a sample of creditors (which includes the company’s major suppliers) from the creditors list and obtain the year-end creditors reconciliations performed by the creditors clerks and perform the following procedures: i) Re-perform the logic of the reconciliations. (1) ii) Recalculate the calculations on the reconciliations. (1) iii) Agree the balances on the reconciliations to the balances as per the creditors statements and the creditors listing. (1) iv) Inspect supporting documentation and/or enquire regarding the reconciling items on the reconciliations. (1) j) Select a sample of overseas creditors from the creditors list and inspect the creditors statements at year-end (28 February) to determine the amounts owed to the creditors in the foreign denominated currency. (1) k) Obtain the applicable foreign currency exchange rate at nancial year-end (28 February) and using the obtained rate, recalculate the amounts owed to the creditors at the nancial year-end in rands (local currency). (1) l) Compare the recalculated amounts to the amounts recorded for the creditors on the creditors list. (1) m)Inspect the creditor’s correspondence le for correspondence relating to unsettled disputes with suppliers, and by discussion with management, determine whether any adjustments to creditors are required. (is could also address accuracy, valuation and allocation if the actual delivery or condition of the goods delivered is disputed.) (1) n) Inspect the creditors control account in the general ledger for any unusual debit entries and enquire from management. (1) Rights and obligations o) Inspect the supporting documentation such as the creditors statements while auditing the creditors reconciliations to make sure that the documents are addressed to Pick-A-Party Ltd (this also addresses existence). (1) Classi cation p) Identify any debit balances on the creditors list and request management to transfer the balances to trade debtors. (1) Presentation q) Inspect the notes to the nancial statements to ensure that creditors are included as part of the company’s current liabilities. (1) General r) Obtain a management representation letter addressing the existence, completeness, accuracy, valuation and allocation, classi cation, rights and obligations and presentation assertions of the creditors balance as at year-end. (1) s) Perform analytical procedures and obtain supporting documentation for any material uctuations, for example: i) current year’s purchases and creditors at year-end to prior years (1) ii) creditors as a percentage of current liabilities at year-end to prior years. (1) t) If necessary, obtain con rmation of balances directly from a sample of creditors, i.e. conduct a positive creditors con rmation. (It may be appropriate to obtain direct con rmations of nil balances; major creditors (to con rm that the balances are not understated despite being large); balances which have signi cantly reduced since the prior year, and creditors for which there are no statements.) (1) u) Scrutinise the creditors ledger and the trade creditors control account in the general ledger for any abnormal entries and con rm any material adjusting entries with supporting documentation. (1) Available marks [26]; maximum marks [22] Question 23 LEVEL 3 Trade and other payables balance [23 marks] You are a trainee accountant at Q&Z Inc. and are currently busy with the audit of Pick-A-Party Ltd (Pick-A-Party) for the 28 February 20XX nancial year. Pick-A-Party is a wholesale company which buys snacks, sweets, cold drinks and themed party items such as paper plates, plastic glasses, serviettes, balloons, etc. on credit from various local suppliers, which are then sold by Pick-A-Party to retail companies and the public across the country. As part of the substantive testing of the trade and other payables balance at year-end, you have selected the following creditors reconciliation for testing: Creditors reconciliation – Paper Plates Galore (Pty) Ltd CREDITORS RECONCILIATION: FEB 20XX Name: Paper Plates Galore (Pty) Ltd Account nr: P078 Address: PO Box 2954, Pretoria, 3265 R Balance according to creditor statement dated 28/02/20XX Invoices: Incorrectly invoiced for goods purchased by Pick-Your-Party (Pty) Ltd – invoice nr INV09678 (23/02/20XX) Overcharging on invoice nr INV0567 – Note 1 146 493.36 (17 964.00) (5 920.50) Payments: Direct electronic transfer – 28/02/20XX (57 541.73) Goods returned: Goods returned in respect of invoice nr INV04512 – (8 975.00) Balance according to creditors ledger on 28/02/20XX 56 092.13 Note 2 Note 1: is overcharging resulted from an order for 15 boxes of themed serviettes at R499.00 per box which was received by Pick-A-Party but Paper Plates Galore incorrectly invoiced Pick-A-Party for 51 boxes. Note 2: e delivery of the salt biscuits, with comic characters’ pictures printed on them, relating to this invoice took place on 26/02/20XX, but while moving the boxes to the warehouse, the warehouse clerk noticed that the sell- and use-by date was 31 January 20XX. Paper Plates Galore was noti ed and acknowledged the mistake and collected the expired salt biscuits from Pick-A-Party on 28 February 20XX – goods returned note number GRN0478. REQUIRED 1. Explain what external con rmations are and why external con rmations are normally obtained as part of the substantive procedures for debtors, but not for creditors. (3) 2. Describe the substantive procedures that should be performed on the creditors reconciliation of Paper Plates Galore (Pty) Ltd for the 28 February 20XX nancial year-end. (20) [23] SUGGESTED SOLUTION TO QUESTION 23 1. a) External con rmations are written responses obtained directly from a third party, for example a debtor, and are used by the auditor to obtain evidence regarding the entity’s account balances, etc. (1) b) When auditing debtors, all the supporting documentation supporting the debtors balances are generated within an entity, for example delivery notes, invoices and debtors statements. One way of con rming these debtors balances is by speaking to the debtors directly. (1) c) Creditors normally send creditors statements to an entity, which serves as external con rmation, which is then used by the auditor when auditing the creditors reconciliations. (1) 2. Substantive procedures – creditors reconciliation General a) Inspect Paper Plates Galore’s creditor statement to con rm that: i) it is issued to Pick-A-Party Ltd (1) ii) the date on the statement is 28 February 20XX (1) iii) the balance owing on the statement is R146 493.36 as re ected on the reconciliation. b) Inspect Paper Plates Galore’s account in Pick-A-Party’s creditors ledger (and list of (1) creditors) as at 28 February 20XX and con rm that the balance is R56 092.13 as re ected on the reconciliation. (1) c) Re-perform the logic of the reconciliation and the reconciling items, assessing logic and reasonableness. (1) d) Recalculate the calculations on the reconciliation. (1) e) Inspect Paper Plates Galore’s March 20XX creditor statement/creditors reconciliation to con rm that all the February 20XX reconciling items were resolved. (1) f ) Inspect the creditors correspondence le for any correspondence relating to the reconciling items. (1) Invoice INV09678 g) Inspect the goods receive note for any deliveries on 22 to 24 February 20XX from Paper Plates Galore and inspect that such a delivery was not received. (1) h) Inspect the invoice (if available) and con rm that Pick-Your-Party was invoiced and not Pick-A-Party. (1) INV0567 (note 1) i) Obtain INV0567 and inspect for the corresponding goods received note number. Inspect the relevant goods received note to con rm: i) the description of the goods received (themed serviettes) (1) ii) that 15 boxes were received. (1) j) Inspect invoice number INV0567 from Party Plates Galore and con rm that Pick-A-Party was invoiced for 51 boxes. (1) k) Inspect the inventory records to con rm the accurate recording of the 15 boxes received. l) Recalculate the reconciling item amount (51 − 15 = 36 × 499.00 = R17 964.00). (1) (1) Direct electronic transfer m)Inspect the February 20XX creditors statement to check that the payment of R57 541.73 has not been accounted for in the balance. (1) n) Obtain the payment requisition/bank statement/proof of payment and con rm that: i) the transfer took place on 28/02/20XX (1) ii) payment was made to Paper Plates Galore (1) iii) the amount of the payment was R57 541.73. (1) Goods returned o) Inspect goods returned note number GRN0478 to con rm that: i) it was signed by a Paper Plates Galore representative, acknowledging receipt of the returned goods (1) ii) it was for the quantity as indicated on invoice number INV04512 (1) iii) the date returned was 28/02/20XX. (1) p) Inspect the inventory records to con rm that the salt biscuits were not included in the inventory balance as at year-end. (1) Available marks [23]; maximum marks [20] Question 24 LEVEL 2 Inventory [18 marks] Berck (Pty) Ltd (Berck) is a leading company for innovative and top-quality high-tech products in healthcare, life science and performance materials. A substantial part of the business consists of the manufacturing of medical supplies such as medicine. A large portion of the inventory balance at year-end is made up of medicinal products. e schedule below is an extract from the notes to the draft 20X1 nancial statements detailing the medicine inventory balance: Extract from the draft 20X1 nancial statements Medicine Inventory at 29 February 20X1 prior to adjustments Sundry write-downs: damaged packaging R179 352 177 607 R181 153 262 Inventory obsolescence entry (net realisable value) Inventory at 29 February 20X1 according to nancial statements R2 017 663 325 R177 153 361 020 e inventory obsolescence entry is an accounting estimate to write down the remaining inventory to the lower of cost and net realisable value at year-end. is method of calculation has been consistently applied over the years. To this end, you were provided with a detailed age analysis of all the inventory items. e inventory obsolescence entry is based on the age of the inventory items and an estimate of an immediate sales trend of a product on hand older than 100 days. If a product does not sell, Berck may be left with particular medicine supplies on hand which will soon reach expiry date and therefore cannot be sold. Once a sales projection of product items is made and the slow movers are extracted from the inventory list, the inventory obsolescence entry is calculated. You also have access to the inventory database and the necessary audit software to retrieve any information you may require for your audit procedures. REQUIRED Describe the substantive audit procedures you would perform to test the reasonableness of the inventory obsolescence entry (net realisable value) disclosed in the draft nancial statements in the amount of R2 017 663 325. [18] Question 25 LEVEL 2 Inventory and roll forward procedures [25 marks] CleanWorxx (Pty) Ltd (CleanWorxx) is a company in the technical industry that specialises in the selling of industrial cleaning equipment. e company has a 31 December 20X1 nancial yearend. Concerned about inventory levels, the MD of CleanWorxx, Mr Zumba, has requested that a full stock count take place on 30 September 20X1 and not at year-end, as is normally the case. Mr Yoga, the engagement partner on the audit, has agreed to this, as CleanWorxx has a record of clean audits, and the internal control environment of the company is satisfactory. Assigned as audit manager on the 20X1 year-end audit, you have requested your second-year trainee, Ms Kickbox, to prepare an inventory audit working paper setting out the audit evidence that she plans to obtain over the year-end balance of inventory. She has produced the following preliminary working paper: Client: CleanWorxx WP BS-05 Financial year-end: 31 December 20X1 Prepared by: Section: Inventory Reviewed by: Audit procedures on inventory: 1. Attend the inventory count on 30 September 20X1. 2. Verify ownership of inventory at 31 December 20X1. 3. Verify that inventory is carried at the lower of net realisable value or cost. 4. Verify that no equipment is allocated as inventory, and vice versa. REQUIRED Redraft audit working paper BS-05 in order to set out the audit procedures you would need to perform with a view to gathering sufficient, appropriate audit evidence with regard to the gross inventory balance of CleanWorxx as at 31 December 20X1. Disregard the provision for obsolete stock. [25] Question 26 LEVEL 2 Inventory [16 marks] You are the senior on the audit of Grand Dairy Ltd (Grand Dairy), a company with a September nancial year-end. e dairy, which has ve plants across the country, is one of the larger ones in South Africa, and was incorporated in 2000. e company, known for its superior quality products, has won several awards at the prestigious SA Dairy Championships: a testament to the company’s ability to compete with the best in the industry. e company sells a variety of products: cheeses, milks (long-life and avoured), yoghurts and butter. Grand Dairy’s accounting records are fully computerised and include a perpetual inventory module. e accounting systems installed at the plants are linked to one another via Telkom VPN Professional. e main accounting and administration functions are handled at head office in Port Elizabeth. Inventory In addition to a year-end inventory count, the company performs cyclical counts at all of the plants on the last Saturday of every month. All differences identi ed during the counts are recorded on the inventory system, so that quantities on the system re ect the actual quantities at hand. Accounting policy is to value inventory on the rst-in- rst-out (FIFO) method. e inventory master le includes the following information: Inventory description Milk Inventory item code MO1Y22 Inventory category Milk Quantity on hand 1 400 000 litres Unit cost R6.50 per litre Selling price R8 per litre Date inventory was received 30 December Quantity sold year to date 13 302 342 litres During the year-end inventory count, no material differences were noted by the audit team. REQUIRED Describe the substantive procedures that you would perform in order to satisfy yourself regarding the valuation assertion of inventory of Grand Dairy Ltd at year end. [16] Question 27 LEVEL 2 Inventory [23 marks] You are an audit manager at Q&Z Inc. and are currently busy with the audit of Dizzy Fizzy Ltd (Dizzy Fizzy) for the 28 February 20XX nancial year. Dizzy Fizzy is a wholesale company which buys cold drinks and avoured sparkling mineral water from local suppliers, which are then sold by Dizzy Fizzy to retail companies across the country. e company’s inventory is recorded on the rst-in, rst-out (FIFO) cost basis. Dizzy Fizzy makes use of a perpetual inventory system. Regular inventory counts are performed, and the differences identi ed as a result of the counts are investigated and corrected. In addition, year-end inventory counts are performed by the company. REQUIRED Describe the substantive procedures that the audit team should perform after the inventory count attendance to obtain sufficient and appropriate audit evidence regarding the inventory balance re ected in Dizzy Fizzy’s nancial statements at year-end. [23] SUGGESTED SOLUTION FOR QUESTION 23 Accuracy, valuation and allocation 1. Compare the quantities of inventory items on the auditor’s copies of the inventory sheets (obtained during the inventory count) to the client’s quantities on the inventory records. (1) 2. Recalculate the calculations on the inventory system (e.g. quantity × cost) for each inventory item on each item’s inventory record and the total of the inventory value in the extension column on the inventory list (adding all the totals per individual inventory records). (1) 3. Compare the totals as per the individual inventory records to the totals as per the inventory list. (1) 4. Review the inventory list for any negative inventory item values and follow up with management. (1) 5. Compare the total inventory value per the inventory list to the inventory account in the general ledger and on the trial balance. (1) 6. Select a sample of inventory items on the inventory list and compare the price on the inventory records to the related suppliers’ invoices. (1) 7. Inspect the selected suppliers’ invoices for any relevant costs (e.g. transportation) that should be included in the cost of the inventory items. (1) 8. Select a sample of inventory items on the inventory list (or use the same sample that was previously selected) and obtain the selling price of the selected items from the authorised price list or the most recent sales invoices. (1) 9. Compare the obtained selling prices for the selected inventory items to the cost prices on the selected inventory’s inventory records. (1) 10. Enquire from management regarding: a) the process used to determine the inventory obsolescence allowance and evaluate the process for reasonableness and consistency with prior years (1) b) the procedures in place for the approval of the nal inventory obsolescence allowance (1) c) any speci c events which may have occurred during the year which may have an impact on the allowance (1) d) any speci c inventory items which may already be obsolete (or soon will be) and how this has been recognised in calculating the allowance for inventory obsolescence. (1) 11. Perform analytical procedures to con rm the reasonableness of the inventory obsolescence allowance (e.g. by comparison of current year gures and/or ratios to prior year gures/ratios). For example: a) compare the current year’s inventory obsolescence allowance to the previous year’s (1) b) compare the inventory obsolescence allowance as a percentage of total inventory for this year to that of the previous year. (1) 12. Enquire from management regarding indicators of inventory obsolescence problems such as no recent sales or purchases of particular items, products which have reached their sell by dates in the post-reporting period, or correspondence relating to inferior products supplied to customers. (1) 13. Compare the inventory obsolescence allowances raised in prior years to the actual write-offs in subsequent years. (1) 14. Inspect the inventory obsolescence allowance for the inclusion of the inventory items that were identi ed as damaged/obsolete/slow moving during the attendance and test count at the year-end inventory count as per the audit working papers. (1) 15. Recalculate the inventory obsolescence allowance and compare to the amount calculated by management. (1) Rights and obligations 16. Obtain a listing of inventory of goods in transit at the nancial year-end and enquire from management or inspect the relevant orders/contracts to determine whether ownership has passed to the Dizzy Fizzy. (1) 17. Inspect minutes of directors meetings and bank con rmations to establish whether inventory is in any way encumbered (e.g. offered as security). (1) Presentation Inspect the nancial statements as well as the notes to the nancial statements for the following: 18. Inventory is a separate line item under current assets on the face of the statement of nancial position and is shown net of impairments. (1) 19. e disclosure in the notes re ects inventories before and after the inventory impairment allowances. (1) General 20. Obtain a management representation letter addressing the existence, completeness, accuracy, valuation and allocation, classi cation, rights and obligations, and presentation assertions of the inventory balance as at year-end. (1) 21. Perform analytical procedures and obtain supporting documentation for any material uctuations, for example: a) current year’s inventory at year-end to prior years (1) b) inventory as a percentage of current assets at year end to prior years. (1) 22. Scrutinise the inventory records and the inventory control account in the general ledger for any abnormal entries and con rm any material adjusting entries with supporting documentation. (1) Available marks [27]; maximum marks [23] Question 28 LEVEL 3 Inventory [15 marks] You are an audit manager at Q&Z Inc. and are currently busy with the audit of Dizzy Fizzy Ltd (Dizzy Fizzy) for the 28 February 20XX nancial year. Dizzy Fizzy is a wholesale company which buys cold drinks and avoured sparkling mineral water from both local and overseas suppliers, which are then sold by Dizzy Fizzy to retail companies across the country. e company’s inventory is recorded on the FIFO cost basis. Dizzy Fizzy makes use of a perpetual inventory system. Regular inventory counts are performed and the differences identi ed as a result of the counts are investigated and corrected. In addition, year-end inventory counts are performed by the company. REQUIRED 1. Describe the substantive procedures that the audit team should perform during the attendance of Dizzy Fizzy’s year-end inventory count which will assist them in obtaining sufficient and appropriate audit evidence regarding the inventory balance re ected in Dizzy Fizzy’s nancial statements at year-end. (5) 2. Describe the substantive procedures that the audit team should perform to obtain sufficient and appropriate audit evidence regarding the accuracy, valuation and allocation of the inventory balance re ected in Dizzy Fizzy’s nancial statements at year-end. Exclude any procedures dealing with the inventory obsolescence allowance from your answer. (10) [15] Question 29 LEVEL 2 Property, plant and equipment [20 marks] You are the auditor of Fitness Extreme (Pty) Ltd (Fitness Extreme), a company that was launched 15 years ago with 10 branches across South Africa. Since then, a further 35 branches have been opened, making it the second largest tness club in the country. e company’s head office is in Sandton, Johannesburg, where the account system, which runs on a LAN, is housed. Fitness Extreme has a March year-end. Each branch is run as a pro t centre, with branch managers being held accountable if pro t targets are not achieved. Fitness Extreme has the following categories of property, plant and equipment (PPE): Buildings Training equipment Computer hardware Office furniture Asset procurement process e branch manager completes and submits a budget to the chief nancial officer at head office by no later than 31 January. e board of directors reviews the budget and authorises it at a board meeting held in the last week of February each year. An asset requisition is completed by the branch manager electronically, after which the nancial manager at head office receives noti cation of the request to purchase. He logs onto the budget master le in order to determine if the request was approved by the board of directors in February. In the event of it having been approved, the nancial manager approves the requisition, whereupon the buyer receives noti cation to place an order for the asset required. In the event that the asset was not originally budgeted for, the branch manager needs to motivate why it was not and reallocate funds from an asset previously budgeted for. e chief nancial officer has the authority to authorise a reallocation up to an amount of R150 000. After the branch manager has scanned the original goods received note into the system, he couriers the original document to head office, where the asset will be loaded onto the system. e training equipment master le contains the following elds: Asset description Treadmill ADZ 350 Asset number 45693 Branch code KznBell Original cost R28 000 Date of purchase 14 Jan XXXX Date of disposal Not applicable Depreciation method Straight line (25% per annum) Current year depreciation Rand amount Accumulated depreciation Rand amount Carrying value Rand amount REQUIRED Describe the substantive audit procedures you will perform in respect of property, plant and equipment at year-end. Disregard depreciation and impairment of assets procedures. [20] SUGGESTED SOLUTION TO QUESTION 29 1. Valuation Cost a) Compare the opening balances for each category of property, plant and equipment (PPE) to the previous year’s working papers and xed asset register. (1) b) Re-perform a sample of calculations of the carrying value eld for all PPE categories. (1) c) Agree the total of the lead schedule per the PPE category to the closing balance in the xed asset register. (1) 2. Additions a) Occurrence and completeness i) Stratify the asset accounts (the land and buildings, the training equipment, the computer hardware and the office equipment) per region (e.g. per branch name or the branch with the most valuable PPE assets). Having done so, select a sample and agree the assets purchased to the minutes of the board of directors meeting and capital budget for evidence of the authorisation to acquire the asset selected for testing. (1) ii) Inspect the purchase contract in order to con rm that the contract or the invoice is made out to Fitness Extreme, and (1) that it matches the detail of the asset selected in the sample (asset number, erf number, description, etc.). (1) iii) Agree the new assets on the insurance document of the client to the list of the additions prepared by management. (1) b) Accuracy i) Con rm that the amount posted to the relevant asset account excludes VAT, and that it agrees with the purchase price re ected on the contract or the invoice and the xed asset register. (1) Recalculate the calculations and any applicable discounts on the invoices or the ii) contracts. (1) 3. Disposals a) Occurrence and completeness i) Obtain con rmation from Fitness Extreme’s insurers of all the assets that have been removed from the list of those assets insured during the course of the year and compare this to the list of disposals. (1) ii) Scrutinise any assets that: have a date of purchase exceeding the original useful life of the asset category (e.g. if treadmills have a three-year life-span, search for a treadmill that still appears on the asset register six years after the date of purchase) do not have disposal dates. If any are found, follow up on them. (1) iii) Inspect the date of disposal eld for any disposal dates during the current nancial year. Compare these to the list of disposals prepared by the client. (1) iv) Review the minutes of the board of directors meeting for all the disposals that were authorised during the course of the year and compare them to the list of disposals in the asset register. Follow up on any discrepancies. (1) b) Accuracy i) Con rm that the amount posted to the relevant asset account agrees with the sales price re ected on the contract or the invoice. (1) ii) Recalculate the pro t or loss on the sale and compare this to the general ledger account regarding pro t or losses on disposals. (1) iii) Scrutinise the xed asset account for the month immediately following the sale of the asset in order to determine whether or not the asset has been correctly removed from the xed asset register. (1) 4. General a) Using general audit software, scan each of the master les on PPE owned by Fitness Extreme for: blank or missing elds (asset number, asset description, etc.) duplicated asset numbers negative carrying values. (2) b) Inspect the asset accounts for any repairs and maintenance expenses incorrectly capitalised. (1) c) Con rm that the accounting policy used with regard to PPE is consistent with that of the previous year. (1) 5. Existence Physically inspect a sample of high-value items in the xed asset register, noting their condition for testing reasonableness of carrying value of the asset. (1) 6. Rights a) Inspect that all invoices for new additions are made out in the name of Fitness Extreme. b) Obtain a certi cate from the bank in order to identify assets pledged as security. If (1) there are any, they must be disclosed in the nancial statements. (1) 7. Disclosure Inspect the correct disclosure of PPE in all nancial statements, including accounting policies and notes. (1) Available marks [24]; maximum marks [20] Question 30 LEVEL 3 Investment property [14 marks] You are an audit manager assigned to the audit of HighRise (Pty) Ltd (HighRise) for its 20X1 nancial year. HighRise operates in the real estate sector. It owns several residential apartment buildings as well as commercial office complexes that it rents out to tenants under operating leases. (e company refers to these properties as its ‘rental properties’.) During a recent discussion about how HighRise accounts for its properties, the company’s chief executive officer made the following statement to you: HighRise accounts for its rental properties as investment properties in terms of IAS 40. In addition, we use the fair value model to measure these assets subsequent to initial recognition. During the 20X1 nancial year, the company was faced with the following two matters in regard to its properties: 1. We moved HighRise’s administrative headquarters to one of the office complexes which the company rented out up to that point. All tenants who occupied the complex were given the legal notice period to vacate the premises after which HighRise moved in. e board of HighRise decided to continue accounting for this property as ‘investment property’ for 20X1, because we think it is still a very good investment despite the change in the nature of the occupancy! 2. One of the company’s residential buildings, located in Milnerton, Cape Town, was identi ed as having the potential to be sold, at a good pro t, in the next year or two. We decided rather to account for this property on the cost model in the 20X1 nancial year and going forward, until it is sold. You have been provided with a list of properties that make up the total investment property balance of R145 800 000 disclosed in the 20X1 nancial statements of HighRise. e list contains seven properties, indicating the registered erf number and address of each. It also includes the above two properties mentioned by the CEO. Audit procedures have already been performed on the opening balance of investment properties, while the closing balance as per the above list has been agreed to the general ledger account for investment properties, the trial balance and nancial statements. REQUIRED 1. State whether you agree or disagree with the CEO regarding the accounting treatment of the two matters pertaining to the head office and Milnerton properties and explain your answer. (5) 2. Describe the additional substantive audit procedures that should be carried out to test the existence, rights and obligations and completeness assertions relating to the investment property balance of R145 800 000 disclosed in the 20X1 annual nancial statements of HighRise. Ignore procedures to test the presentation assertion and related disclosures. (9) [14] SUGGESTED SOLUTION TO QUESTION 30 1. a) I do not agree with the CEO on either of the matters. (1) b) HighRise cannot continue accounting for its head office as an investment property as it does not comply with the de nition of ‘investment property’ in terms of IAS 40 anymore. As the property has become ‘owner occupied’, it should now be accounted in terms of (1) IAS 16 Property Plant and Equipment. (1) e CEO seems to be under the impression that ‘investment property’ means that a property is a ‘good investment’; however, this is a misinterpretation, as the term ‘investment property’ for accounting purposes has a speci c meaning in terms of IAS 40.8 and does not describe an economic investment. (1) c) HighRise will not be able to account for the Milnerton property in terms of the cost model, as IAS 40 makes it clear that one valuation model should be adopted for all investment properties. (1) IAS 40 further notes that it is ‘highly unlikely’ that a change from the fair value model to the cost model will result in more appropriate presentation. (1) Available marks [6]; maximum marks [5] 2. Additional substantive procedures Existence a) Obtain from management the list of investment properties making up the total balance in the nancial statements and physically inspect each property for existence. Note: (1) depending on physical inspections in prior years, a sample may be selected; however, all new investment properties to be inspected at a minimum; (2) the head office will be tested under IAS 16 procedures. (1) b) Inspect the bank statement and cash book for evidence of large receipts of funds which could indicate that an investment property might have been sold during the year and therefore should have been derecognised as an asset. (1) Rights and obligations c) For all properties on the list, request the title deeds from the deeds office and inspect each deed for evidence that the property is registered in the name of HighRise and that the erf number, property description and address agree with that on the list. (2) d) rough inspection of the property’s title deed, minutes of the board meetings, correspondence documents with nancial institutions and enquiry with management, verify that no encumbrances or mortgages exist over the properties. (1) Where mortgages exist by means of long-term borrowings, inspect loan statements from nancial institutions to ensure HighRise is not behind on any instalment payments. (1) e) Request the rental agreements for each investment property on the list and ensure the landlord (owner) is stipulated as HighRise. (1) Completeness f ) rough enquiry with management, verify that no other investment properties should have been recorded that are not on the list (e.g. property acquisitions). (1) Inspect rental expense accounts to identify properties rented by HighRise under an operating lease which may comply with the de nition of investment property and ensure these have been disclosed as investment properties accordingly (IAS 40.6). (1) g) Request a schedule of properties from the deeds office registered in HighRise’s name and agree each property on the schedule that quali es as an investment property to the list of investment properties provided by management. (1) h) Compare the current year list provided by management to the prior year working papers on investment properties and obtain reasons for any properties which appear in the prior year working papers, but not on the current year’s list. (1) Available marks [11]; maximum marks [9] Question 31 LEVEL 3 Property, plant and equipment [18 marks] You are a trainee accountant assigned to the audit of Bastion City College Ltd (BCC). e nancial year being audited ends 31 October 20X1 and you have been allocated the task of auditing the balance relating to vehicle assets as disclosed in BCC’s nancial statements. BCC is a large private institution that offers tertiary education to several thousand students across three campuses located in the province of Gauteng. BCC has a eet of vehicles it owns, used for various purposes, including staff and student transport, security services, maintenance, official travel, etc. e balance for vehicle assets, included in property, plant and equipment, is re ected in the trial balance as at year-end as follows: 20X1 Vehicles R10 750 000 20X0 R12 500 000 During the 20X1 nancial year, the company acquired three new minibuses, each at a cost of R450 000, utilised for transporting students between certain pick-up locations in cities and its campuses. At year-end, BCC owned 40 vehicles in total that are recorded in a xed asset register which provides details of each vehicle, including registration and licensing numbers, descriptions, acquisition and disposal dates, accounting values, etc. According to BCC’s nancial manager, there were no disposals of vehicles during the year of which he is aware. BCC makes use of AutoSure, an insurance company specialising in providing insurance for corporate vehicle eets. Each campus has a facilities management complex where vehicles are cleaned and kept and from where they are signed out by staff authorised to make use of BCC-subsidised transport. At any given point in time, some vehicles might not be on any particular campus (e.g. they have been signed out and are located off-campus). Some vehicles may also be off-campus at vehicle servicing and repair shops, undergoing routine maintenance, or having faults that have been discovered, or being repaired after an accident. According to a report by the main campus’s facilities manager, who oversees all facilities management complexes, one vehicle sustained severe damage in an accident during the 20X1 nancial year, but is still listed on the xed asset register. e manager con rmed that the accident was reported to AutoSure and that a response from the insurer was sent to the nance department. According to BCC’s accounting policy disclosed in its prior year audited nancial statements, it accounts for all its assets on the cost model. Carrying value is arrived at by subtracting amortisation (at 20% straight-line per year) and any impairment losses. e following substantive audit procedures have already been performed: Agree the opening balance for vehicles in the general ledger to the opening balance as per the xed asset register and the prior year audit working papers (‘lead schedule’). Recalculate the general ledger account for vehicles. Obtain a written representation from management in which they con rm the existence, rights and obligations, completeness and accuracy, valuation and allocation assertions for vehicles. REQUIRED Describe the substantive audit procedures that should be performed to verify the fair presentation of the balance relating to vehicle assets included in property, plant and equipment in the nancial statements of Bastion City College Ltd. Ignore the following in your answer: Testing of the presentation assertion and disclosures relating to all other assertions Tax effects e use of computer-assisted audit techniques Procedures already performed [18] SUGGESTED SOLUTION TO QUESTION 31 Existence of vehicles and occurrence and cut-off of purchase transaction for new vehicles 1. For a sample of vehicles selected from the xed asset register, physically inspect the vehicles for existence. (1) Include the three new minibus vehicles in the sample. (½) During physical inspection, for each vehicle, agree the VIN (vehicle identi cation number) and licence plate number as per the xed asset register to the numbering on the vehicle itself. (1) Note: the VIN is usually visible where it is embedded in the dashboard towards the bottom of the windscreen, whereas the licence plate number should also be con rmed on the licence disc attached to the inner side of the windscreen. For vehicles selected that are off-campus on the day the test is performed, request management to arrange for the vehicles to be available on a particular day when the inspection will be nalised. (1) 2. For the three new minibus vehicles, obtain the purchase documentation (invoice(s) from supplier of the vehicles) and verify that: a) the buyer is BCC (occurrence) (½) b) the invoices are dated within the 20X1 nancial year (tests cut-off ). (1) 3. Inspect the cash book for large receipts from vehicles sold and correspondence with AutoSure of vehicles written off/stolen and, if any, verify through inspection of the xed asset register that these vehicles are shown at zero carrying value at year-end. (1) Rights and obligations 4. For the sample of existing vehicles selected above, inspect their licence renewal documentation to verify that the assets are still registered in the name of BCC. (1) For the three new minibuses, inspect their registration documents (original licensing documentation) to verify the vehicles are registered in the name of BCC. (1) 5. Inspect correspondence from nancial institutions from which BCC borrows money (if any), minutes of board meetings and minutes of the capital acquisitions committee for indications that any vehicle assets might be encumbered or have been offered as security. (1) Accuracy, valuation and allocation of vehicles and accuracy and classi cation of transactions for new vehicles Cost 6. Inspect the purchase documentation relating to the three new minibuses and to ensure that: a) the cost of each vehicle is R450 000 (1) b) any additional costs relating to the purchase of the vehicles that can be capitalised have been included in the cost (e.g. delivery charges, sales fees, etc.) (1) c) the total cost of each vehicle has been correctly transferred to the general ledger account for vehicles/PPE. (1) Carrying values 7. Recalculate the xed asset register for vehicles by subtracting depreciation and impairment losses from opening carrying value, in order to arrive at closing carrying value and re-perform all castings. (1) Depreciation and impairment losses 8. Recalculate the depreciation charge for each vehicle (a sample could also be considered) by applying 20% to the cost of the vehicles as per the xed asset register. (1) For vehicles purchased or sold during the year, apportion the depreciation calculation based on the number of months the asset was in use by BCC. (1) 9. For the three vehicles that are in for repairs at the ‘shop’, inspect maintenance records for any indication of possible impairment and follow up on this procedure by discussing with management the necessity to impair the assets if applicable. (1) 10. For the vehicle that was damaged in an accident, inspect the correspondence from the insurer (AutoSure) to verify whether it has certi ed the vehicle as ‘written off’ or repairable. (1) If a ‘write-off’, request management to remove the vehicle from the accounting records or, if repairable, discuss with management the need for impairment of the asset. (1) 11. Enquire with management whether they have reviewed the useful lives and residual values of all vehicles and inspect that there have not been any changes in the accounting policy for vehicles. (1) 12. During physical inspection of vehicles across the three campuses, note any indication of possible damage to vehicles or vehicles which appear not to be in working condition and, if any, discuss with management the necessity for impairment. (1) Completeness 13. Inspect the latest list of insured vehicles received by BCC form AutoSure and agree all vehicles on the list to the xed asset register to verify the register is complete. (1) 14. Enquire from the facilities manager and client staff assigned to assist the auditor with physical inspection of vehicles whether they are aware of any other vehicles which might not be on the campuses at the time of physical inspection and which are not in the xed asset register. (1) Available marks [22]; maximum marks [18] Question 32 LEVEL 3 Intangible asset [10 marks] You are the trainee accountant assigned to the audit of Veripoint (Pty) Ltd’s nancial statements and have been tasked with the audit of its intangible asset balance. Veripoint (Pty) Ltd (Veripoint) is an importer of electronic ‘gadgets’, security systems and remote-controlled toys. It sells its products through Veripoint outlets located in malls throughout the country. e company’s year-end is 31 December 20X1. On occasion, Veripoint also buys patents that describe ‘high-tech’ gadgets destined for future release onto the market. e latest patent that Veripoint acquired during the current nancial year documents a new invention for a sophisticated ‘security drone’ used with alarm systems. is drone can automatically proceed along a pre-programmed path of a building’s perimeter towards the area where motion has been detected by the alarm system, taking video footage as it proceeds. e patent was bought from an American company specialising in product design and development. e total purchase price was $150 000, or R2 100 000, and the patent was registered in the name of Veripoint on 1 July 20X1. e patent has an expected useful life of 10 years. At year-end, Veripoint disclosed the above security drone patent as an intangible asset at R1 995 000 in its nancial statements, after having expensed the appropriate amortisation. e accounting policy of the company indicates that intangible assets are measured using the cost model. REQUIRED Describe the substantive audit procedures necessary to test the transaction relating to the acquisition by Veripoint in the current nancial year of the security drone patent. [10] SUGGESTED SOLUTION TO QUESTION 32 is answer is limited to the acquisition of the intangible asset only, not the audit procedures at year-end on the balance. 1. Inspect the minutes of the board meeting where the decision was taken to acquire the security drone patent and verify that the board authorised its acquisition. (1) 2. Inspect the sales agreement between Veripoint and the American company which sold it the patent for evidence that: a) the buyer is Veripoint (½) b) the purchase price is $150 000 (½) c) the date of transfer of ownership is 1 July 20X1 (½) d) both parties’ representative signed the contract. (½) 3. Inspect the letters patent (the legal document evidencing the registration of the patent) to ensure it has been registered in the name of Veripoint (Pty) Ltd, effective 1 July 20X1. (1) 4. Obtain in the nancial media the rand:dollar exchange rate applicable on 1 July 20X1 to verify that the correct exchange rate (R14) was used in the calculation of the rand value of the patent. Recalculate the conversion of the purchase price of R2 100 000 ($150 000 × R14). (1) (1) 5. Inspect the minutes of the board meeting (or sales agreement) for an indication that the expected useful life of the patent is 10 years and discuss with management the reasonability of this assumption. (1) Recalculate the amortisation expense of R105 000 (R2 100 000 over 10 years, apportioned for six months in 20X1 since its acquisition). (1) 6. Enquire from management whether there has been any change at year-end in the future economic bene ts expected from the patent, which may necessitate an impairment charge. 7. Corroborate management’s answer with a prepared discounted cash ow forecast to (1) verify that future bene t will exceed amount capitalised as at year-end. 8. Inspect that items appearing on discounted cash ow forecast with supporting evidence, for example sales with future sale forecasts, expenses taking in ation into account, etc. (2) 9. Obtain from management a written representation letter on the occurrence, accuracy, classi cation and cut-off assertions pertaining to the acquisition of the security drone patent. Transactions and events assertions are con rmed, as a transaction is tested instead of a balance. (1) Available marks [12]; maximum marks [10] Question 33 LEVEL 3 Property, plant and equipment [24 marks] You recently quali ed as a CA(SA) and accepted full-time employment at Patagonia CA(SA) Inc. Patagonia CA(SA) Inc. has been the auditor of Ice CAPS (Pty) Ltd (Ice CAPS). Ice CAPS consists of a group of companies that imports bottled water harvested from the glaciers in the Patagonia Mountains in Argentina, near Ushuaia. ese bottles are then resold to supermarkets across South Africa. During the course of the previous nancial year, Ice CAPS launched a new line of avoured water. Ice CAPS used a previously dormant company in the group to house the production. e only asset on the dormant company’s statement of nancial position at the beginning of the nancial year was land and buildings purchased 10 years ago. In order to add the avour to the water, Ice CAPS purchased two machines. One machine was purchased locally from a registered VAT vendor and the other imported from Ushuaia for Argentinian pesos. In terms of the group policy, land and buildings that are in use should be revalued annually by independent experts, while other assets are depreciated over their economic useful life on the straight-line method, depending on the class of the asset. Expected residual values are taken into account in determining the depreciable values of assets. Patagonia CA(SA) Inc. makes use of its own independent, suitably quali ed expert to determine the value and the residual value of assets. REQUIRED Formulate the substantive procedures that you will perform relating to property, plant and equipment of the dormant company owned by Ice CAPS. You are not required to address substantive analytical procedures, nor procedures relating to the disclosure and presentation assertion. [24] Question 34 LEVEL 3 Goodwill [22 marks] You are the auditor of Global Furniture Ltd (GB), a large listed entity. e company’s year-end is 30 September. You have been the auditor of GB for the last three years. Over more than a few decades, GB has developed into a global retailer that provides everyday household products at affordable prices, serving customers at their convenience. GB aims to be the number one retailer of choice for household goods for quality and value, with more than 8 500 stores in more than 22 countries. To achieve this, various subsidiaries were acquired during the previous few years. Two loss-making subsidiaries were also sold during the current year. To obtain nance for these acquisitions, numerous shares were issued during the last ve years. GB disclosed R85 million goodwill at year-end, that was all related to acquisition cost when subsidiaries were acquired all over the world. GB’s main objective is to provide everyday products at discount prices. From big box destination stores, to store-in-store concepts, to focused speciality stores, GB’s goal is to make shopping as easy and convenient as possible. Customers can view, experience and buy in ways that are most convenient to them. Shopping can be done in-store or online, with purchases being delivered to homes, or collected in-store via click-and-collect. To support the retail stores and ultimately provide the best shopping experience to customers, GB has a well-established supply chain in place. is means that various specialist group divisions ensure that the nal product is provided at the best quality and price. ese divisions control or manage everything from raw material sourcing, manufacturing and product sourcing to shipping and delivery. Owning or managing these activities not only enhances the group’s ability to deliver, but also bene ts the customer in terms of providing products at affordable price points. REQUIRED Describe the substantive procedures you would perform to gather sufficient appropriate evidence regarding the R85 million goodwill amount in the consolidated accounts of GB. [22] SUGGESTED SOLUTION TO QUESTION 34 Opening balance 1. Agree opening balance to prior year working paper. (1) Current year Valuation Impairments made in the current year by management: 2. Recalculate all impairments made by management in the current year. (1) 3. Inspect cash ows and other documentation (e.g. budgets, marketing reports) to verify their impairments made. (1) Audit of impairments: 4. Inspect working paper of goodwill that all possible impairments have been calculated: a) Inspect discounted cash ows of every division/subsidiary to verify that future bene ts/pro ts will exceed amount capitalised at year-end. (1) b) Agree discount rate used to that used on popular sites like Moneyweb and to rates used on other audits where discounted cash ows were used. Also obtain rates used by merchant banks which are involved with takeovers and mergers. (1) c) Inspect marketing reports of every division/subsidiary to verify that revenue stated in cash ows is achievable. (1) d) Inspect current year’s budgets regarding expenses of every division/subsidiary to verify that expenses adjusted for in ation stated in cash ows are achievable. (1) e) Enquire from divisional managers and perusing operating reports the reasonableness of the assumptions made in the cash ows. (1) f ) If a division/subsidiary is continuously making a loss, its goodwill should be impaired. (2) g) If future pro ts of a division/subsidiary do not exceed the amount capitalised at period end, calculate the amount that needs to be impaired. (1) h) Discuss your possible additional impairments with the audit committee since there might be other factors that you did not consider. (1) i) After your discussion, calculate nal impairments that need to be made. If management is not prepared to adjust, take differences to overs/unders schedule. (1) j) Scrutinise that GB is not trying to write back goodwill which was previously impaired since this is not allowed. (1) Additions 5. Inspect contracts for any new subsidiaries acquired in the current period and recalculate goodwill on purchase date. (2) 6. Inspect management’s goodwill calculation and compare this to your calculation made in 8 above. Discuss any variances with CFO. (1) Disposals 7. Inspect contracts for any disposals of subsidiaries in the current period. 8. Inspect that all goodwill amounts relating to disposals have been removed in the general ledger account. 9. Inspect minutes for board approval for any disposals. (1) (1) (1) Rights 10. Inspect shareholders’ registers and minutes of board meetings that GB does hold substantive rights to control all the subsidiaries where goodwill was calculated. (1) Completeness 11. Compare this year’s goodwill working paper that you prepared to that of last year to verify any goodwill that might have been left out. (1) 12. Write to the legal advisors and merchant banks regarding any new or any disposal of subsidiaries/divisions that needs to be taken into account. (1) General 13. Obtain a management representation letter regarding the valuation of all goodwill. 14. Agree the balance of the goodwill as calculated on your working paper to the amount disclosed as goodwill in the statement of nancial position as at year-end. (1) (1) Disclosure 15. Inspect that goodwill has been properly disclosed in the statement of nancial position under non-current assets. (1) 16. Inspect that a note shows all the movements in the goodwill amount for the 12 months ended (IFRS 3 – par. B67). (1) Available marks [27]; maximum marks [22] Question 35 LEVEL 3 Loans [10 marks] You are the auditor of Hip & Hap (Pty) Ltd, a company that sells a wide range of clothing from its stores located in shopping malls around the country. e company has a December year-end. e company’s majority shareholder is Mr Hip, the founder of the company, who owns 51% of the company. e remaining 49% is owned by 37 other shareholders. In order to fund the expansion plans of the company, the following two loans were made during the course of the year (the schedule was prepared by Mr Jones, the nancial manager): DESCRIPTION LOAN NUMBER RAND Foreign loan 1 R10 664 202.25 Loan from Industrial Development Corporation 2 R9 796 084.68 Loan balance as disclosed in the nancial statements R20 460 286.93 Loan 1 e company obtained a loan from Mr Hip’s uncle in London to the amount of £500 000 on 1 July of the current year. e loan is repayable over a period of ve years with equal monthly instalments at an interest rate of 1%. e rand:pound exchange rate at the initiation date of the loan was R20.50:£1. e loan was therefore recognised in the accounting records at R10 250 000 on 1 July. e balance on the loan at 31 December was £459 663.89. e rand:pound exchange rate at 31 December was R23.20:£1. e balance of the loan is therefore stated at R10 664 202.25 on 31 December in the nancial statements. Loan 2 e company obtained a loan of R10 million from the Industrial Development Corporation on 1 August of the current year. e loan is repayable over a period of seven years with equal monthly instalments at an interest rate of prime + 3%. e ruling prime lending rate at the time of taking out the loan was 9.5% and it has remained unchanged at year-end. e balance of the loan is therefore stated at R9 796 084.68 on 31 December in the nancial statements. General Both loans are loaded into the loan system by Mrs Naicker, the accountant, who uses her unique user ID and password to gain access to the loan system. e system automatically calculates the interest charged on the loan using the detail loaded onto the system, which is based on the terms located in the loan contracts. Payment is made via EFT into the bank accounts stated on the contracts. Mrs Naicker processed a manual journal entry at the end of the nancial year to take into account the foreign exchange loss made on the rst loan as a result of the rand depreciating in value. REQUIRED Describe the substantive procedures that you would perform on both loans at year-end. [10] Question 36 LEVEL 3 Long-term borrowings [20 marks] You are a trainee accountant employed by an audit rm and have been assigned to the audit of Letsatsi Printing (Pty) Ltd (Letsatsi) for its nancial year ended 31 October 20X1. Letsatsi owns several premises throughout South Africa from where it provides printing and copying services to government departments and schools. In order to fund its properties, Letsatsi makes use of loans it acquires from various nancing institutions. In this respect, mortgages (long-term borrowings) exist over all its properties. You are in the process of auditing Letsatsi’s long-term borrowings, disclosed under liabilities in its 20X1 annual nancial statements. Management provided you with a list of what the year-end balance of R12 340 000 for long-term borrowings comprises: Provider of loan Samatra Mutual Note 1 R R 20X1 20X0 4 500 000 - African Investments Inc. 2 990 000 3 100 000 Easbank Financiers 3 650 000 4 200 000 Gerald Dean 2 1 200 000 1 200 000 Second National Bank 3 - 3 500 000 Topstarr Holdings 3 - 1 950 000 12 340 000 13 950 000 Notes: 1. e loan from Samatra Mutual was obtained during the 20X1 nancial year in order to fund a newly acquired property. 2. e account for the loan from Gerald Dean did not show any movement during the year. Gerald Dean is the chief executive officer of Letsatsi. e nancial manager indicated that there is no written loan agreement for this amount and that it was provided by Dean based on a verbal agreement between him and Letsatsi. 3. Both loans from Second National Bank and Topstarr Holdings were settled in full during the 20X1 nancial year. REQUIRED 1. Explain why, in general, it may be challenging for an auditor to obtain sufficient appropriate audit evidence regarding the completeness assertion for long-term borrowings. (4) 2. Describe the substantive audit procedures that should be performed to verify the fair presentation of long-term borrowings as disclosed in the annual nancial statements of Letsatsi. Assume the nominal and effective interest rates of each loan are the same. Exclude from your answer: procedures relating to the testing of opening balances analytical procedures. (16) [20] SUGGESTED SOLUTION TO QUESTION 36 1. a) Management may have an incentive to keep long-term borrowings off the statement of nancial position in order for the nancial statements to re ect a stronger net asset position. (1) ey may therefore engage in active manipulation of the long-term borrowings balance by attempting to hide some loans from the auditor. (1) Because the direction of testing for the completeness assertion generally is from supporting documentation to the nancial records, the hiding of evidence will result in the auditor nding it particularly challenging to test for completeness of long-term borrowings. b) e non-recording of loans may encompass error rather than fraud: there is the (1) possibility that management might not be aware of all the company’s long-term borrowings and, as a result, the loans do not all get recorded. (1) Where a company’s system of internal control fails to identify long-term borrowings or misidenti es them as not being long-term borrowings, the possibility exists that not all loans are recorded. (1) Available marks [5]; maximum marks [4] 2. Substantive audit procedures Existence and rights and obligations a) For the newly obtained loan on the list of long-term borrowings (from Samatra Mutual), obtain the underlying loan agreement between Letsatsi and the provider of the loan. Inspect each loan agreement for: (1) i) the parties to the loan and signatures of each party’s representative (½) ii) the initial loan amount and repayment details (½) iii) interest rate and any special clauses that may affect the rate (½) iv) loan period, including nal repayment date. (½) Inspect the company’s memorandum of incorporation to ensure the board has the authority to obtain new loans and that they have not exceeded the company’s borrowing powers by obtaining the loan from Samatra Mutual. (1) Inspect the bank statement for the month when the loan was received to verify receipt of the R4.5 million in funding. (1) b) Obtain the original loan agreements between Letstatsi and the nancial institution for each loan not yet settled at year-end and verify that the agreement is in the name of Letsatsi as borrower of the loan. Note: e extent of this procedure will depend on the audit evidence obtained for long-term borrowings on previous years’ audits and the risk of material misstatement. (1) c) Consider the need to request positive con rmations from all the providers of the loans on the list to verify the outstanding balance and to con rm that the provider has made the loan to Letsatsi. Also addresses the accuracy, valuation and allocation assertion. (1) Request from the CEO, Gerald Dean, a written con rmation that he has provided a loan to Letsatsi, in addition to the amount outstanding, requesting any additional information on repayment terms, etc. (1) Accuracy, valuation and allocation d) For each loan, obtain the latest loan statement (will likely have been sent by the provider to Letsatsi) and agree the outstanding balance as per the statement to the year-end balance recorded by Letsatsi on the list. (1) Note: Where loan statements do not cover the month of October 20X1 (i.e. year-end statements will only be received after the audit procedures are performed), obtain a direct con rmation from the lender. e) Request from management an amortisation schedule (or draw up amortisation schedules) for each long-term loan and recalculate the year-end balance with reference to the particulars of the loan as per the latest loan statement from the nancial institution. (1) Follow the amount through from the recalculated amortisation schedule to the list of longterm borrowings obtained from management. (1) Agree the total (year-end balance) of the loans on the list to the corresponding account in the general ledger account and the trial balance. (1) Completeness f ) Inspect the minutes of the board meetings and if applicable, capital acquisitions committee as well as the xed asset register, for indications of new properties bought during the year and any decision taken on the source of funding of the asset. (1) Note: Since the company nances all properties with long-term borrowings, each property likely will have a corresponding loan. g) Inspect the general ledger account for interest paid on long-term loans and reconcile all interest to a corresponding loan on the list of long-term borrowings. (1) h) Inspect the bank statements for the year and cash book for indications of large amounts of funding received, discuss the nature of these receipts with management and agree the receipts to the list of long-term borrowings (new loans obtained). (1) i) Compare the prior nancial period’s list of long-term borrowings with the current year’s list to ensure that all loans have been included in the current year, except where settled in 20X1. Presentation and disclosure (1) j) Inspect the (draft) nancial statements of Letsatsi to ensure that management has disclosed the short-term portion of the loans under current liabilities. (1) With reference to the amortisation schedules used above, recalculate the short-term portion of each loan, consisting of the outstanding capital amount repayable within 12 months from year-end. (1) k) Inspect the notes to the nancial statements for evidence that management has disclosed the details of security (properties) provided for loans. (1) General l) Obtain a written representation from management in which they con rm the existence, rights and obligations, accuracy, valuation and allocation, completeness and presentation assertions regarding Letsatsi’s long-term borrowings included in the company’s 20X1 nancial statements. (1) Available marks [20]; maximum marks [16] Question 37 LEVEL 3 Loans [22 marks] One of your audit clients is experiencing nancial difficulties. You are the engagement partner on this audit. During the course of the previous nancial year, the company which you now have to audit took out a R5 million long-term loan with Zero Bank to ease its short-term cash ow burden. e loan bears interest at prime minus two basis points per annum and is repayable in 20 equal instalments of which the rst is payable three months after year-end. e full loan amount received was used to settle some of its overdue short-term debts and purchase much needed inventory. e audit client has no other long-term liabilities, however in a discussion, the chief nancial accountant informed you that the company is in the process of obtaining additional nancing in the form of other long-term loans from external parties, while also making arrangements with Zero Bank and current trade creditors on extended repayment terms. Management is also trying to convince debt suppliers to grant the company a debt holiday so that the company can trade out of its current nancial difficulties. Debt suppliers will then be required to sign subordination agreements regarding debt amounts that do not have to be paid till the company is once again nancially secure. Management is prepared to give certain of its assets as security to debt suppliers. REQUIRED 1. Formulate the substantive procedures your audit team have to perform in respect of the longterm loan as at year-end. (11) 2. Describe the additional audit procedures you would perform in order to substantiate management’s statements relating to the additional nancing arrangements. Do not address any Companies Act requirements. (11) [22] Question 38 LEVEL 3 Interest paid/debentures [25 marks] You have recently been promoted to audit manager at the auditing rm Brazil Inc. You are excited because the promotion comes with an office with a lovely view. You are busy planning the year-end external audit of Rio (Pty) Ltd (Rio). Rio imports parrots from South America to be sold as pets in South Africa. During the middle of the nancial year, Rio sold three of its delivery vehicles for R1 800 000. e CEO wanted to use the funds to expand inventory of parrots, however the nancial director heard of a good investment opportunity. Rather than use the proceeds from the sale of the delivery vehicle to purchase inventory, the nancial director decided to invest the proceeds in a debenture and borrow money for inventory from Bankrupt Bank, since the interest rate offered on the debentures exceeded the borrowing costs from the bank. is would be Rio’s rst investment in debentures, and therefore would be recorded at amortised cost. You may assume that the IFRS requirements have been met. Loan from Bankrupt Bank Rio negotiated a 9% xed interest rate per annum on the loan from Bankrupt Bank. e interest is calculated monthly on the outstanding balance of the loan in arrears. Interest is payable before the 10th of the following month. Rio receives a monthly loan statement from the bank. Investment in debenture Rio purchased a ve-year debenture with a nominal value of R2 000 000 at a discount of 10% and therefore recorded a rst-day pro t in its general ledger. Rio would incur transaction costs payable on initial of the transaction. e debentures bear interest at 13% on the nominal value of the debenture, payable biannually in the middle of the year and at year-end. A market-related interest rate on similar investments was 15% per annum (compounded biannually). Rio received its rst coupon payment at year-end, much to the excitement of the nancial director. REQUIRED 1. Formulate the substantive procedures you would perform regarding the interest paid expense included in the statement of comprehensive income of Rio. You are not required to provide analytical procedures. (10) 2. Formulate the substantive procedures you would perform in respect of the journal entries relating to the debentures in which Rio invested during the current nancial year. Ignore any Companies Act requirements, as well as allowances for credit losses. (15) [25] Question 39 LEVEL 3 Warranty provision [14 marks] RCA Stores (Pty) Ltd (RCA Stores) is a large retailer of electronic equipment and appliances to the public. It operates from several stores located in malls across the country. Each year, the company includes a provision for warranty claims in its nancial statements based on an estimate of the costs the company could incur on faulty products returned by customers. e draft 20X1 nancial statements of RCA Stores indicate a provision for warranty repairs of R1 150 000. e previous year’s audited nancial statements included a provision of R1 100 000. While waiting for the audit senior to brief him on the audit procedures for warranty provisions, Jeff Solomons, a trainee accountant assigned to the audit of the company’s 20X1 nancial year, made the following remarks to other team members: I think it is unnecessary for me to be briefed on audit procedures for the warranty provision, because the auditing of estimates involves low risk. In fact, it is an area where an auditor can save much time on an engagement by simply ticking the boxes. In the case of RCA Stores, the increase of R50 000 in the provision for warranty claims is in line with a 5% in ation adjustment and may therefore be considered reasonable. All I have to do is to obtain a written representation letter from management con rming that they have taken the necessary care in calculating the estimate and that the data on which the estimate is based are complete and accurate. I then simply recalculate management’s estimate in order to ensure mathematical accuracy. REQUIRED 1. Discuss why Jeff Solomons’ views are inappropriate, not only as to the audit of estimates generally but also to RCA Stores’s 20X1 warranty provision in particular. (8) 2. Describe brie y the additional substantive audit procedures that should be performed in order to determine the reasonableness of RCA Stores’s 20X1 provision for warranty claims. (6) [14] Question 40 LEVEL 3 Provision for bonuses [18 marks] Poolsure Ltd (Poolsure) is a manufacturer of chemicals used in the treatment of swimming pool water (i.e. chemicals such as chlorine, sodium bicarbonate (baking soda) and stabilising agents). e company has a large footprint on the African continent and supplies its products to 15 countries. Its head office is situated in Johannesburg, while three factories are located across South Africa. e company employs over 270 salaried and 180 wage employees and has a nancial year-end of 31 December. You have been assigned to the audit team that audits Poolsure’s 20X1 nancial year, in your capacity as a trainee accountant. One of your rst tasks is to audit the bonus accrual included in Poolsure’s nancial statements as a provision under current liabilities. e balance included in the notes to the draft nancial statements appears as follows: 20X1 20X0 Provisions Bonus accrual 2 175 200 1 854 500 Bonuses are payable to all salaried employees in January of each year in addition to their normal remuneration for that month. A bonus equals the preceding December’s salary, excluding bene ts. However, employees who are appointed during a nancial year receive a bonus that is apportioned in accordance with the number of months they have worked for the company up to the end of December. In order to determine the total provision for bonuses for the year, the nancial manager of Poolsure logs in to the human resources system and generates, from the December payroll, a list of all salaried employees. e list displays each employee’s gross remuneration including bene ts, together with the amount excluding bene ts, equalling the provision required. e total on the list becomes the ‘new’ provision balance for the year, consisting of the bonus accruals of around 270 salaried staff members. e monthly payroll for salaried staff is generated by the computer from the employee master le. Standing information for each employee in the master le is supported by a paperbased employment contract and salary adjustment form indicating the latest approved gross salary of the employee and shows the various bene t amounts included. Salary increases occur only at the beginning of July of each year. One of your fellow trainee accountants was unsure as to whether a provision for bonuses is allowed as an acceptable accounting practice. e trainee argued that a payment for the bonuses will take place in a subsequent nancial year, which therefore does not pertain to the 20X1 nancial year of Poolsure and which should therefore rather be expensed in its 20X2 nancial year. REQUIRED 1. Explain, from an accounting perspective, why Poolsure may recognise a provision for bonuses at year-end. (3) 2. Describe the substantive audit procedures that should be performed to obtain sufficient appropriate audit evidence about the provision for bonuses included in current liabilities in Poolsure’s 20X1 nancial statements. Ignore the following: Tax implications and the use of computer assisted audit techniques Procedures relating to the audit of the presentation assertion (15) [18] SUGGESTED SOLUTION TO QUESTION 40 1. Recognition of a provision Poolsure may create the provision for bonuses at year-end given that the amount complies with the de nition of a ‘provision’ in accordance with IAS 37.14: a) A legal, present obligation has arisen at year-end to pay future bonuses as a result of a past event, the signing of a contract with employees in which Poolsure promises to pay salaried employees a bonus in January of each year. (1) b) Payment is probable as there are no indications the bonuses are not paid every year. (1) c) e amount can be reliably estimated, given that the amount is clearly equal to one month’s salary excluding bene ts. (1) Available marks [3]; maximum marks [3] 2. Substantive procedures: bonus provision a) Obtain and inspect Poolsure’s company policy on bonus payments and verify that: i) salaried employees are entitled to a bonus in January of each year (1) ii) wage workers are not entitled to a bonus payout (1) iii) bonuses are calculated on an employee’s December gross monthly remuneration excluding bene ts (1) iv) there has been no change from the prior year in how bonuses are accounted for. (1) b) Obtain from the nancial manager the December 20X1 provision list which indicates the provision to be created and: i) inspect the list for any unusual entries (as it is a computerised list, it is unlikely that a casting of the list will be performed, especially if reliance is placed on general controls) ii) agree the total on the list to the gross remuneration excluding bene ts as per the (1) payroll for December 20X1 (1) iii) agree the number of salaried employees on the list to the number of salaried employees on the December 20X1 payroll (1) iv) re-perform all calculations on the list (1) v) agree the total provision as per the list to the corresponding general ledger account and the trial balance. (1) c) For a sample of employees selected from the provision list, perform the following: i) Agree the gross remuneration of each employee as per the list to the gross remuneration on their employment contract in their employee le. (1) ii) Subtract their bene ts as per their employment contracts from gross remuneration and compare the amount excluding bene ts to the amount displayed on the provision list. iii) For employees whose employment contracts indicate they have been employed (1) during the nancial year (date of appointment in 20X1), recalculate their provision by apportioning their gross remuneration excluding bene ts in terms of the months they have been working at Poolsure and agree this amount to the provision list. (2) d) Select a sample of salaried employees from the December 20X1 payroll and agree their details against the provision list to ensure they have been included. (Completeness) (1) Inspect the bonus provision general ledger account to ensure the prior year’s provision has been reversed and for any unusual entries (especially abnormal debit entries decreasing the balance). (1) e) Perform analytical procedures by comparing the bonus provision made in the 20X1 nancial year to the provision made in 20X0 and discuss unexpected differences if any with management, taking into account: (1) i) the average increase in salary in July 20X0 (½) ii) the average number of employees across the two years. (½) f ) Obtain a written representation letter from management with regard to the existence, rights and obligations, completeness and accuracy, valuation and allocation assertions pertaining to the provision for bonuses. (1) Available marks [18]; maximum marks [15] Question 41 LEVEL 3 Provision created for environmental rehabilitation costs [15 marks] You are the audit manager on the 20X1 audit of Ityuwa Lakes Ltd (Ityuwa), a company that manufactures table salt. Ityuwa owns several large salt evaporation ponds in the Eastern Cape from which it extracts and harvests the salt and from where it is sent to a nearby factory for further processing. Most of Ityuwa’s products are manufactured for the export market. During the 20X1 nancial year, Ityuwa established a new salt evaporation pond after limited rock salt deposits were found next to a natural lake near Coega. However, before it could commence with evaporation activities, in a designated area to the side of the lake, the company had to agree to terms and conditions laid down by the Department of Environmental Affairs. e agreement indicated the various aspects of rehabilitation required. An important condition was that Ityuwa had to rehabilitate the land after 10 years of operation when the rock salt deposits were expected to become depleted. e company obtained the services of Jerome Randall, an environmental engineer employed by an external company, Green to Go Consultancy Inc., to determine the amount of the provision that needs to be created in the 20X1 nancial year. In his report, Mr Randall indicated that the provision to be accounted for covers the following rehabilitation costs: Drying of the salt evaporation pond Levelling of any sand banks created Re-establishment of the natural vegetation Consulting fees of conservation specialists who will assist with the rehabilitation At rst, management of Ityuwa questioned Mr Randall’s calculation of the provision, indicating that it appeared too high compared to what it cost to establish the evaporation pond in the rst place. However, management nevertheless relied on Mr Randall’s calculations and recorded a provision for rehabilitation costs at R3 350 000 in the company’s 20X1 nancial year. REQUIRED 1. Describe in general why a company’s management might want to understate a provision for environmental rehabilitation costs in its nancial statements. (3) 2. Describe the substantive audit procedures that should be performed to verify the existence and accuracy, valuation and allocation assertions relating to the provision for environmental rehabilitation costs as disclosed by Ityuwa in its 20X1 annual nancial statements. Ignore any tax implications and the future value of the provision. Do not address related disclosures or the presentation assertion in your answer. (12) [15] SUGGESTED SOLUTION TO QUESTION 41 1. Incentives to understate the provision a) Management may want to overstate the net assets of the company, in order to portray a stronger nancial position to potential nanciers and shareholders, perhaps with the aim of obtaining additional nance. (1) b) Management may want to overstate net pro ts by reducing the expense associated with the recording of the provision in order to earn greater bonuses or other pro t-based remuneration. (1) c) Management may want to downplay the impact of future rehabilitation costs, which, if very high, may put off potential investors, who may doubt whether the company will be able to comply fully with future mandatory rehabilitation requirements. (1) Available marks [3]; maximum marks [3] 2. Substantive procedures to audit the provision: existence and accuracy, valuation and allocation a) Perform the following procedures to determine whether reliance can be placed on the environmental specialist, Mr Jerome Randall, as a professional: i) Evaluate Mr Randall’s competence and expertise by requesting and inspecting evidence of his quali cations and certi cation with professional bodies. (1) Furthermore, request his curriculum vitae or client portfolio and inspect the document for evidence of environmental assessments he undertook for similar projects in the past. (1) To assess his reputation and reliability as a professional, contact, with permission, previous clients of his and enquire about the quality of his service. (1) ii) Evaluate Mr Randall’s objectivity by enquiring from both his employer and management of Ituywa whether he has performed any previous work for Ituywa and the nature of the work if relevant as well as the effect of any possible personal and professional relationships with Ituywa personnel. (2) b) Evaluate the scope, adequacy and correctness of Mr Randall’s work by inspecting the report he prepared and in which his calculations of the provision appear. (1) i) Scrutinise the report for any indications of restrictions placed by Ituywa management on his work. is may also be determined through discussion with the expert. (1) ii) Determine whether the assumptions and data used in the calculation appear reasonable and complete. (1) iii) Recalculate any calculations Mr Randall performed in order to arrive at the provision he proposed and agree the result to the R3 350 000 recorded in the accounting records. c) i) Inspect the report for the ‘aspects of the rehabilitation’ (what the provision consists (1) of ) and agree these to the agreement between Ituywa and the Department of Environmental Affairs for completeness (i.e. this procedure will affect the accuracy and valuation of the provision). (1) ii) Inspect the agreement for any other pertinent requirements relating to the department’s conditions of establishing the evaporation pond, including the date of the agreement and signatures of the parties involved. (1) d) With reference to other audit evidence obtained during the course of the audit, and in light of the auditor’s experience and knowledge of similar provisions created, consider whether the conclusions reached by Mr Randall in his report appear reasonable and appropriate. e) i) Recalculate the provision for rehabilitation costs account in the general ledger and (1) agree the amount to the balance in the trial balance. (1) ii) Scrutinise the provision for rehabilitation costs account in the general ledger for any unusual or unexpected entries and discuss these with management. (1) f ) Obtain a written representation letter from management in which they con rm the existence and accuracy, valuation and allocation assertions for the provision for rehabilitation costs balance as per Ituywa’s 20X1 nancial statements. (1) Available marks [15]; maximum marks [12] Question 42 LEVEL 3 Provision for leave pay [14 marks] You are a trainee accountant employed by the audit rm of Sabata & Lerato Inc. and have been assigned to the audit of Tecnika (Pty) Ltd (Tecnika) for the company’s 31 December 20X1 nancial year-end. It is your task to audit the provision for leave pay. Tecnika employs about 200 permanent staff members. Each staff member may take 21 days’ vacation leave per annum, of which 10 days may accrue during a calendar year (i.e. 10 of the 21 days’ leave may be untaken and rolled over to the next year). Seeing that accrued leave will have to be paid out to a staff member should he/she leave the employment of Tecnika, the company creates a provision at year-end for all leave days which have not been used during the year, but which have accrued to its personnel. e amount provided per staff member is based on a staff member’s monthly salary payable for the last month of the year divided by 21 business days, multiplied by the number of leave days that have accrued as at year-end. At 31 December 20X1, the ‘provision for leave pay’ balance amounted to R1 204 290 as per the trial balance. You are aware that, in the prior year and pertaining to the previous provision, the audit team found that: some employees were never included in the provision for some who were included in the provision, the incorrect number of leave days accrued was used in the provision calculation – in all cases, fewer days than should have been used. e following is an example entry for a staff member on the schedule of accrued leave pay. e schedule is maintained in electronic format using a spreadsheet application installed on the company’s computer system: EMPLOYEE CODE EMPLOYEE NAME EMP114 H.G. Wellz SALARY DECEMBER 20X1 SALARY PER DAY LEAVE DAYS ACCRUED AT 31 DECEMBER 20X1 PROVISION FOR LEAVE PAY R58 625.00 R2 791.67 8 R22 333.33 Each staff member has a paper-based employee le stored in the office of the human resources manager. Inside the le, there are, among other documents, printouts of monthly pay slips and a leave schedule for each employee indicating leave days taken and leave days accrued at the end of each month. REQUIRED 1. Describe the major risks of material misstatement relating to the provision for leave pay created by Tecnika for its 20X1 nancial year, evident from the information provided. (2) 2. Describe the substantive audit procedures that should be performed to verify the existence, completeness and accuracy, valuation and allocation assertions relating to the provision for leave pay balance as at 31 December 20X1. (12) Do not use computerised assisted audit techniques in your answer and ignore any tax implications. [14] Question 43 LEVEL 3 Provision for leave pay/share option scheme [31 marks] You are an audit specialist employed by the Zondo Inc., a forensic auditing rm. You have been tasked by the newly appointed CEO of a state-owned entity (SOE) Gold Pot Power Utility to review its human resource policies and, in particular, its remuneration policy. e new CEO was appointed after a whistleblower implicated some of the senior management team of the SOE in state capture and self-enrichment. One senior management team member had been implicated in a ctitious employee scheme worth millions of rands. e CEO also requested that you formulate substantive procedures that the internal auditors could perform that would form the foundation of work that the SOE’s external auditors could place reliance on during the next nancial audit. e SOE has a 30 June year-end. e CEO provided you with the following information relating to the most recent nancial year: e SOE employs 291 employees and consists of a senior management team of eight members. All permanent employees receive a basic salary, which includes a 13th cheque. All employees are entitled to receive a long-service award equalling one month’s extra salary every 10th year of employment. At the most recent directors meeting, the company approved a general increase of 12% in the basic salaries of all staff. e increase was signi cantly above in ation due to pressure from the unions following labour action. e SOE is expecting further labour action because of a change in the leave policy of the SOE. e change in the policy resulted in a decline of the provision for leave pay in the statement of nancial position. As from 1 July, it was decided that only the senior management team are allowed to transfer their leave from one nancial year to the next, whereas previously, all personnel were allowed to transfer unused leave from one year to the next. Other than the senior management team, no other members of staff receive bonuses. In terms of their employment contract, the senior management team receive bonuses and share options. A new incentive scheme was approved at a directors’ meeting for the senior managers at the beginning of the nancial year. At the beginning of the nancial year, each senior management team member will be entitled to 20 000 share options. is will allow them to purchase shares after a three-year period at R55 per share, provided they remain employed by the company and reach their annual individual sales targets during this period. At the end of the nancial year, the programme was amended to reduce the purchase price by R10. None of the senior staff from the senior management team had resigned or had been red since the inception of the scheme. One senior management team member who had been implicated in state capture did not reach his individual target. e fair value of the share options is being determined by independent professional valuers. REQUIRED Assuming the external auditors will rely on the work performed by the internal auditors: 1. Formulate only the general (generic) substantive procedures that you would recommend be performed to substantiate the amount shown in the statement of nancial position for both the senior managers’ share option scheme and the provision for leave pay. (6) 2. Other than the procedures in part (1) above, formulate the additional substantive procedures that you would perform to substantiate the amount disclosed in the statement of nancial position for the senior managers’ share option scheme. You are not required to formulate substantive analytical procedures, nor any procedures relating to the Companies Act. (9) 3. Other than the procedures in part (1) above, formulate the additional audit procedures you would perform in respect of the provision for leave pay. You are not required to formulate substantive analytical procedures. (9) 4. Using computer-assisted audit techniques, list the exception reports the external auditors would extract, to determine whether ctitious employees are present on the payroll system. (7) [31] Question 44 Provision for bonuses LEVEL 3 [14 marks] Given all the accounting scandals that have occurred in South Africa recently, your audit practice has gone through hard times. Your practice has lost some clients, however you were able to retain some of your long-standing ones. One of these is Stones, Rocks & Tiles (Pty) Ltd (Stones, Rocks & Tiles), a retailer of tiles and stone cladding, situated outside Paarl. Stones, Rocks & Tiles has a 30 September year-end. You have completed the audit of payroll. You followed a system based audit approach. e test of controls con rms the preliminary low control risk assessment. You only need complete the audit work relating to the provision for the bonuses. Stones, Rocks & Tiles has had a good nancial year and the management decided to pay bonuses to all employees. e payment is expected to be included on the December payslip. Permanent employees receive a 13th cheque equal to one month’s salary at date of payment. Casual employees will receive a gift worth 25% on their net wage of the last work week in December. e only requirement for a bonus to be paid is that the employee should still be employed at payment date. Management indicated that historic resignation patterns show that approximately 10% of the casual staff and 5% of the permanent employees would resign before payment date. ey used this assumption when raising a provision for bonuses at year-end. REQUIRED Formulate the substantive procedures you would perform in respect of the provision for bonuses. You are not required to perform substantive analytical procedures. [14] SUGGESTED SOLUTION TO QUESTION 44 1. Obtain a schedule from HR manager of the bonus provision calculation and re-perform all calculations and castings. (1) 2. Agree the total of this schedule to the account in the general ledger, trial balance and nancial statements. (1) 3. Obtain a management representation letter con rming the completeness and accuracy of the provision. (1) 4. Inspect minutes of meetings of the board for any reference to the bonuses and the approval of them. (1) 5. Inspect the nancial statements to con rm whether the provision has been disclosed as a current liability in accordance with IFRS. (1) 6. Enquire from management to gain an understanding of the process management used to calculate the provision. Evaluate the reasonableness of the estimate based on your knowledge of the business. (1) 7. Select a sample of employees from management’s schedule and con rm the payroll (for both permanent employees and casual staff ) for existence of the employees (or by physical veri cation). (1) 8. Select a sample of employees from the bank statements and con rm that they appear on the schedule. (1) 9. For a sample of employees on the schedule: Agree the monthly salary for December as used in the calculation with the payroll for a) December. (1) b) Recalculate the salary to be paid out in December (taking into account potential increases in salary) and the cost of the gift (being a week’s wages × 25%). (1) c) Should employees receive an increase after year-end, obtain a copy of any approved increase letters in recalculating the adjusted salary. (1) d) Con rm the nature of employment (permanent vs casual staff ) by inspecting a sample of employees’ appointment letters in their staff les. (1) 10. Inspect the payroll and employee records between year-end and payment date to identify resignations. (1) 11. Enquire from the human resources department of any resignations after year-end, other than the two resignations that you are aware of. (1) 12. Con rm the reasonableness of the management’s percentage (%) of resignations before payment date by inspecting the employee records for the trends in resignations during the year as well as after year-end. (1) 13. Develop an expectation of a reasonable bonus and provision by discussions with management, industry knowledge, etc. (1) 14. Calculate the following ratios: a) Bonuses as a percentage of salaries b) Bonuses per class of employee (e.g. permanent vs casual staff ) Investigate any unusual uctuations through discussion with management and obtaining corroborating documentation. (max 2) Available marks [18]; maximum marks [14] Question 45 LEVEL 3 Provision for rehabilitation of land [20 marks] Your rm, UNIVEN Inc., specialises in high-risk audit clients. It has a team of specialists, each focusing on a speci c industry. Your area of expertise is the specialised weapon industry and you have been asked to assist one of your clients, Denel Advanced Weapons SA Ltd (DAW), in the audit of a provision for the rehabilitation of land around DAW’s advanced weapons development facility in Somerset West. New weapons are developed and tested at the advanced weapons development facility. During the course of the nancial year, an environmental pressure group began protesting outside the gates of the advanced weapon development facility. ey claim that one of DAW’s facilities, where the chemical weapons and weapons of mass destruction are tested, is polluting the environment and killing the native species of tortoises. Publically, DAW is denying any responsibility. Internally, a con dential memo from DAW’s lawyers con rms the following: DAW has a 20-year lease of the land from the Western Cape government that contains a clause that any damage, caused by DAW’s activities, to the land and surrounding areas must be recti ed. Statements in DAW’s previous integrated reports that they are a socially responsible company that causes no harm to anyone gives rise to a constructive obligation for DAW to rehabilitate the land. An environmental study conducted by DAW’s maintenance department found sufficient evidence that DAW is having a negative impact on the surrounding environment. Moreover, they prepared a discounted cash ow calculation of the expected cost to rehabilitate the land when the lease expires. e maintenance department is headed by an environmental specialist who reviewed the study. Although DAW does not want to admit guilt, the nancial director decided to raise a provision for the rehabilitation of the environment. REQUIRED Formulate the audit procedures that you would perform in respect of the provision for rehabilitation. [20] Question 46 LEVEL 3 Provision for chemical spill [25 marks] You are an audit manager at Mabusa Inc., a medium audit rm situated in Cape Town. You are currently at one of your clients, African Chemicals (AC), performing the audit of a provision for the rehabilitation of land around AC’s testing facility in Paarl. e company’s year-end is 30 April. Mabusa Inc. has been the auditor of AC for the last four years. New chemicals are developed and tested at the Paarl facility which caused damage as discussed below. e site manager at the Paarl facility has alerted the management of AC regarding a chemical spill at the facility during the year, which polluted the environment and killed the indigenous species of plants and various small animals. e groundwater has also been affected, which resulted in livestock from neighbouring farms also dying. Publically, the rm is denying any responsibility regarding damages. A letter from AC’s lawyers con rms, however, that the site manager is correct in his assessment that environmental damage did occur. Some of the farmers in the vicinity sent water samples to a laboratory, which found traces of toxic chemicals used by AC and con rmed that their livestock were killed from drinking it. An environmental study was conducted by an external environmental expert regarding possible damage that needs to be recti ed. Moreover, he prepared a discounted cash ow calculation of the expected cost to rehabilitate the land where the Paarl facility is situated as well as to clear the groundwater of the toxic chemicals. e expert estimates that it will take at least three years to eradicate the effects of this chemical spill. Although AC does not want to admit guilt to the farmers, the chief nancial officer (CFO) decided to raise a provision of R14.2 million at year-end for the rehabilitation of the environment. REQUIRED Formulate the audit procedures that you would perform in respect of the R14.2 million provision for rehabilitation at year-end. [25] SUGGESTED SOLUTION TO QUESTION 46 Obligation/existence 1. Obtain legal representative’s letter where it was stated that the chemical spill did have a negative impact on the environment. (1) 2. Inspect correspondence and other audit evidence from farmers indicating damage due to chemical spill. (1) 3. Obtain and analyse laboratory reports indicating that toxic chemicals used by AC were found in the groundwater. (1) 4. Enquire from the site manager at the Paarl facility how he discovered the environmental damage due to chemical spill. (1) 5. Conclusion: All the above clearly indicate a present obligation which will lead to future payments that can be reasonably estimated. (1) Completeness/cut-off 6. Inspect the site and ask the site manager if there are other areas of AC that also experienced damage. (1) 7. Inspect board minutes for any discussion on the additional provision that is needed regarding the rehabilitation of the environment. (1) 8. Inspect claims from farmers who surround AC’s facility to determine the total extent of damages that need to be recti ed. (1) Valuation 9. Obtain a schedule of the discounted cash ow calculation from the external expert and reperform the calculations on the discounted cash ow calculation. (1) 10. Enquire from the environmental specialist about the assumptions used and evaluate the reasonability of these assumptions to source documents and reports/claims from farmers in the surrounding area. (1) 11. Determine that the damage to groundwater was included in the cash ow forecast. Chemicals tend to in ltrate the groundwater, which has led to death of livestock on the surrounding farms and claims for losses suffered by farmers. (2) 12. Enquire from the external expert about the procedures and methods that were followed in the preparation of the discounted cash ow forecast. Scrutinise the logic of these procedures and methods used; for example, was in ation taken into account? (1) 13. Was livestock loss on neighbouring farms veri ed to claims instituted by farmers? (1) 14. Evaluate the reasonableness of the estimates in the cash ow, relying on your knowledge of the business, the environmental expert’s report and discussions with the Paarl site manager. (1) 15. Corroborate the cost estimates by inspecting the underlying documents/quotes/invoices to repair damage to the environment and contaminated groundwater. (1) 16. Compare the discount rate used with that of a similar market rate obtain from a nancial institution. (1) 17. Verify the reliability of expenses on cash ow to payments already made after year-end regarding cleaning up of chemical spill. (1) Conclusion: After performing all the procedures on cash ow as mentioned above, the auditor must determine his/her own point estimate with ranges which can be supported by audit evidence obtained. If AC’s point estimate of R14.2 million does not fall within this range, discuss with the CFO and resolve the difference, otherwise take difference to overs/unders schedule. (2) 18. Before you can rely on the environmental expert’s workings you must: consider his independence/objectivity by doing a background check determine his quali cations and membership of a professional body and corroborate with the professional body determine his experience in this industry and reputation by obtaining his CV and investigate any internet posts regarding this determine any possible bias when he prepared the report determine his reputation and standard of work previously performed on similar engagements. (max 5) 19. Inspect the minutes of the audit committee meeting approving the present value of the cash ows and the provision itself. (1) 20. Enquire from the external expert and site manager about the nature of the rehabilitation required and extent of work required to rehabilitate the environment. (1) 21. Con rm the discussion with the expert and site manager by inspecting relevant correspondence and corroborative technical documentation. (1) Analytical review 22. is is the rst year that this provision is raised and therefore no analytical review will be possible. Disclosure 23. Inspect the note disclosure relating to the provision of R14.2 million as a long/short-term liability in the nancial statements and con rm the compliance with IFRS. (1) General procedures 24. Compare the total of the calculation to the year-end balance of R14.2 million in the general ledger and trial balance. (1) 25. Obtain a letter of representation from management con rming the completeness and accuracy of the provision. (1) Available marks [31]; maximum marks [25] Question 47 Provision for defective work LEVEL 3 [13 marks] You rm, UNIVEN Inc., specialises in high-risk audit clients. It has a team of specialists, each focusing on a speci c industry. Your area of expertise is the specialised weapon industry and you have been assigned to the audit of Big Guns SA Ltd (Big Guns). Big Guns sells customised heavy calibre weapons to clients across South Africa. Clients can order heavy calibre weapons from Big Guns with any speci cations they might require. Big Guns holds a large inventory of weapons and spare parts and if it does not have a particular weapon or spare part in its inventory, it can source it from reliable suppliers. It is rumoured that Big Guns even has some illegal gun dealers on its books. Big Guns does not assemble the weapons itself, rather sub-contracting this task. Big Guns then sells the weapons to licensed dealers approved by the government. At the beginning of the nancial year you are currently auditing, Big Guns sold a vehicle with a mounted high-calibre machine gun with extended ammunition storage to a security company. Since this was the rst time it mounted a weapon on a vehicle, Big Guns subcontracted the assembly as well as the mounting of the weapon on the vehicle to Vin Petrol, an auto body shop. Big Guns struggled to nd a body shop that was willing and able to mount the weapon. Vin Petrol agreed to mount the weapon only after an immunity agreement was signed in terms of which no claim could be instituted against it. e vehicle was delivered in the middle of the year. Shortly after receiving the vehicle, the security company complained that the gun kept on jamming and that the weapon had become faulty due to the vibration of the vehicle. In terms of Big Guns warranty policy, it appears as if Big Guns is responsible for rectifying any product defects. Because of the immunity agreement signed with Vin Petrol, Big Guns will not be able to recover anything from Vin Petrol. One of Big Guns’ supervisors inspected the vehicle and the weapon and concluded that the jamming resulted from poor workmanship of a sub-contractor that installed the large ammunition storage unit and Vin Diesel’s assembly. He also contracted an independent specialist who con rmed this and recommended that the vehicle undergo a full inspection. Recti cation work will be necessary to reduce the impact of the vibration on the assembly unit which attaches the weapon to the vehicle. Shortly before year-end, a new contactor was appointed to perform the necessary work. He commenced the work but still had a lot of work to complete after year-end. e independent specialist prepared an estimate of the total costs involved, which was approved by management and formed the basis of the provision. Estimated cost of remedial work to be incurred 550 000 Inspection costs of independent specialist Costs of other work done to date 22 000 22 500 594 500 REQUIRED Describe the audit procedures you would perform in respect of the provision for defective work at year-end. [13] Question 48 LEVEL 3 Issue of shares: Equity [15 marks] You are a trainee accountant at the audit rm of Glass and Cupp Inc. and have been assigned to the audit of High Lights (Pty) Ltd (High Lights), a wholesaler of electrical lights and ttings. e company’s nancial year under consideration ends 31 December 20X1. During the year the following two transactions, which require your further attention, occurred: Issue of shares According to your prior scrutiny of High Light’s memorandum of incorporation (MOI), the company had 500 000 authorised and issued shares as at July 20X1, the day its board of directors decided to issue another 100 000 shares. In terms of the decision, the shares are to be issued at R10 each and no directors are allowed to take up any of the shares. You also con rmed through inspection of the MOI that the directors do not have the power to change the number of authorised shares. After the necessary legal requirements were considered, all shares were duly issued and monies received in full. Inspection of the general ledger revealed that the share capital account was credited with R1 million and the bank account debited with the same amount. Dividends declared In December 20X1, the board of directors declared the only dividends for 20X1, payable to all shareholders, at R3 per share. e amount of the dividends declared has not yet been paid by the time the dividend declaration was audited. REQUIRED Describe the substantive audit procedures that should be performed to test the fair presentation of the transactions in High Lights relating to: the issue of shares in July 20X1 (9) the declaration of dividends. (6) Do not repeat any procedures already performed as per the above scenario and ignore any procedures relating to presentation and disclosure of the matters in the nancial statements. [15] Question 49 LEVEL 2 Equity [21 marks] Greyfox Protection Services Ltd (Greyfox) is a large, but unlisted company that provides security services throughout the country. e auditor of Greyfox required audit evidence for the following matters that applied during the course of the company’s most recent nancial year: NO. MATTER MARKS: DOCUMENT(S) MARKS: EVIDENCE a. The board of directors resolved to issue an additional 200 000 shares in Greyfox (the only share issue that took place). (½) (2) b. The shareholders have allowed the above shares to be issued. (½ × 2) (4) c. Some of the above shares were issued to directors of Greyfox. (½) (1) d. Funds were received from all shareholders who took up the above shares. (½ × 2) (1) e. The shares taken up by each shareholder were documented by Greyfox. (½) (1) f. A dividend was declared for the 2019 nancial year. (Note that you have already con rmed that (½) (1) g. The company had the nancial means to pay the above dividends. (½ × 2) (3) h. The nance committee of Greyfox, carrying out its mandate as obtained from the board, decided to obtain a long-term loan for Greyfox from West-end Bank and subsequently agreed to terms and conditions with the bank for the loan. (½ × 2) (2) there are no restrictions to this extent in company’s MOI.) REQUIRED For each of the above controls/activities: 1. name the document on which you will nd evidence for the matter (6) 2. for each document named, brie y describe the nature of the evidence that it provides for audit purposes. (15) [21] Note: More than one document may apply for each matter. Do not address matters for which you have already obtained audit evidence as described in the scenario. SUGGESTED SOLUTION TO QUESTION 49 NO. (1) DOCUMENT(S) (2) NATURE OF THE EVIDENCE NO. (1) DOCUMENT(S) a. Minutes of the board meeting b. (½) MOI (½) Minutes of the shareholders’ meeting (½) (2) NATURE OF THE EVIDENCE Evidence of a resolution by the directors to issue shares (1) Any pertinent matters relating to the share issue, including whether shares are to be issued to directors, share price, nancial assistance to any party to take up shares, etc. (1) Any restrictions that may apply to the directors’ ability to issue shares (1) Evidence of there being a suf cient number of authorised shares in respect of the prospective share issue (1) Rules regarding the directors’ ability to change the MOI in order to increase the authorised number of shares (otherwise, a special resolution by shareholders will be required) (1) Evidence of the shareholders’ approval, by means of a special resolution, to increase the authorised share capital should there not have been a suf cient number of authorised shares (1) c. Minutes of the shareholders meeting (½) Evidence of the shareholders’ approval, by means of a special resolution, either for this particular issue of shares, or made within the past two years, allowing the directors to take up shares in the company (1) d. Bank statement Cash book (½) (½) The bank statement provides evidence that funds were in fact received from shareholders and the cash book provides evidence that the receipts were recorded in the accounting records. (1) e. Shareholders’ register (½) The shareholders’ register is prepared by Greyfox to record the particulars of each shareholder, including the number of shares held by each.(1) Note that the number of shares can also be calculated by taking the total amount of funds received and dividing it by the share price. However, this is a calculation more so than a ‘document’. f. Minutes of the board meeting (½) Evidence of a resolution passed by the directors to declare a dividend (1) NO. (1) DOCUMENT(S) (2) NATURE OF THE EVIDENCE g. Minutes of the board meeting Trial balance (½) at time of dividend declaration/other valid accounting information (½) Evidence that the directors applied the solvency and liquidity test as per section 4 of the Companies Act (1) Indication that the board, subsequent to the performing the test, concluded that Greyfox will satisfy the solvency and liquidity test immediately after completing the proposed distribution (1) Evidence that the assets of the company, as fairly valued, equal or exceed the liabilities of the company, as fairly valued and it appears that the company will be able to pay its debts as they become due in the ordinary course of business for a period of 12 months following the distribution of the dividends to shareholders (1) h. Minutes of the nance committee’s meeting (½) Loan agreement with West-end Bank (½) Evidence of approval for the loan to be acquired from Westend Bank (1) Indication that both parties (Greyfox and the bank) agreed to the terms of the contract and that an authorised representative of Greyfox signed for the loan (1) Available marks [21]; maximum marks [21] Question 50 LEVEL 3 Other reserves [14 marks] Matchstix Ltd (Matchstix) is a large manufacturer of matchsticks used for lighting res. During its most recent nancial year, the company’s auditor was concerned about the board of directors’ treatment of the following matters affecting the 20X1 statement of pro t and loss and other comprehensive income and statement of changes in equity: e company owned three properties during its 20X1 nancial year, consisting of open pieces of land in the following locations: Midrand, Pretoria and Mbombela. By year-end, the company owned only two of these properties as the land in Pretoria was sold. Further details are as follows: A revaluation surplus to the value of R380 000 existed on the Pretoria property at the time when it was sold. e Pretoria property was last revalued seven years ago. is surplus amount was transferred to the 20X1 retained earnings through pro t and loss. e directors decided to revalue the Midrand property on which the company is planning to build a future match stick factory. As a result, the board requested property agent Mark Shaw, a cousin of the chief executive officer, to perform the revaluation. e revaluation resulted in the Midrand property increasing in value by R550 000 and was duly recorded as such in the 20X1 nancial statements. e Mbombela property was not revalued for the 20X1 nancial year. REQUIRED 1. Discuss the possible reasons as to why the auditor of Matchstix was concerned about the company’s accounting treatment of the matters relating to the three properties. (5) 2. Describe the substantive audit procedures you would expect the auditor of Matchstix to have performed to gather sufficient appropriate audit evidence about the accuracy, valuation and allocation assertion and related disclosures of the revaluation surplus of R550 000 (Midrand property) recorded in the nancial statements. Assume all amounts are material and that use will not be made of an auditor’s expert. Ignore any tax consequences. (9) [14] SUGGESTED SOLUTION TO QUESTION 50 1. Other concerns of the auditor a) e auditor may have been concerned that the accounting policy of Matchstix Ltd did not allow for the revaluation of land, i.e. that the cost model is in fact used for the accounting of land and not the revaluation model. (1) b) e motives for why the directors would transfer the Pretoria property’s revaluation surplus through pro t and loss seems questionable, given that IAS 16.41 requires a revaluation surplus on disposal to be transferred directly to retained earnings, but through other comprehensive income and not through pro t and loss. (1) c) According to IAS 16.31, under the revaluation model which Matchstix seems have adopted, revaluations should be carried out regularly, ‘to avoid instances where the carrying amount of an asset differs materially from its fair value’. However, the disposed Pretoria property was last valued seven years ago, begging the question as to whether other classes of properties subject to the revaluation model may also have been valued too long ago, resulting in understatement of assets. (2) d) e auditors may have been concerned about whether the R550 000 revaluation surplus of the revalued Midrand property was appropriately transferred through other comprehensive income and accumulated in equity under a revaluation surplus, rather than through pro t and loss (IAS 16.39). (1) e) ere is a possibility that the Midrand property’s revaluation surplus is materially overstated, given that the property valuator is not independent from the CEO (his cousin performed the revaluation), which could have provided opportunity for upward manipulation of the amount. (1) f ) If an asset is revalued, the entire class of assets to which that asset belongs should be revalued, according to IAS 16.36. However, the Mbombela property was not revalued during the year under audit. (1) Available marks [7]; maximum marks [5] 2. Substantive audit procedures: revaluation surplus of R550 000 a) Discuss with management any concerns about the objectivity of the property valuator who valued the property, given that he is the cousin of the CEO, and consider any measures taken by management to mitigate the risks of a con ict of interest. (1) b) Request from Mark Shaw, the property agent and valuator who performed the revaluation, evidence of his quali cations and experience and inspect the evidence to determine whether he: appears competent and skilled in property valuations (1) is registered or certi ed with a professional property valuation body. (1) c) Request from management the agreement signed between Mark Shaw and Matchstix to determine whether the scope of the property valuator’s work is adequate and enables the valuator to perform his work without restrictions or in uence from management. (1) Discuss with Mr Shaw whether he was free to perform the valuation without limitations placed on his work. (1) d) Inspect the valuator’s valuation report and: i) con rm by means of this inspection that the Midrand property’s fair value at year-end results in an increase in R550 000 as per the accounting records (1) ii) recalculate any calculations made by the valuator in the report (1) iii) assess the reasonability of any assumptions used by the valuator given the auditor’s knowledge of the industry and any other audit evidence obtained during the course of the audit of Matchstix. (2) e) Inspect the statement of other comprehensive income and note the increase of R550 000 transferred through retained earnings. (1) f ) Inspect the statement of changes in equity and note the increase in R550 000 under revaluation surplus. (1) Available marks [11]; maximum marks [9] Question 51 LEVEL 2 Bank reconciliation [7 marks] You are a second-year trainee accountant at Q&Z Inc. and are currently busy with the audit of NOCDE Ltd (NOCDE) for the 28 February 20XX nancial year-end. NOCDE is a clothing retail company with branches across the country. You are responsible for the audit of the company’s bank balances at year-end and were presented with the following bank reconciliation by the company’s accountant: BANK RECONCILIATION – BMX BANK: FEB 20XX R Balance according to bank statement 28 Feb 20XX Less: outstanding electronic fund transfers EFT transfer nr 749 EFT transfer nr 752 EFT transfer nr 756 R 146 493.36 1 794.68 746.96 5 590.25 (8 131.89) Plus: outstanding deposit 28 Feb 20XX 7 541.73 Plus: other adjustments Bank charges Feb 20XX 897.50 Balance according to cash book 28/02/20XX 146 800.70 REQUIRED Describe the substantive procedures that you should perform on the bank reconciliation presented to you as part of obtaining sufficient and appropriate audit evidence regarding the company’s bank balance at year-end. [7] SUGGESTED SOLUTION TO QUESTION 51 General 1. Obtain a bank con rmation con rming the balance according to the bank statement on 28 February 20XX and agree the bank balance per the reconciliation to the balance on the bank statement or the bank con rmation as at 28 February 20XX. (1) 2. Recalculate the calculations on the reconciliation. (1) 3. Re-perform the logic of the bank reconciliation and the reconciling items on the reconciliation. (1) 4. Agree the balance according to the cash book on the reconciliation to the balance in the cash book as at 28 February 20XX. (1) Outstanding electronic funds transfers 5. Follow the outstanding electronic funds transfers as at 28 February 20XX through to the March 20XX bank statements. (1) 6. Agree the date and the amount of the outstanding electronic funds transfers to the February 20XX cash payment journal. (1) Outstanding deposits 7. Agree the amounts of the outstanding deposit to the March 20XX bank statements. (1) 8. Agree the date (28 February 20XX) and the amount R7 541.73 to the cash receipt journal to ensure that it was recorded in the correct period. (1) 9. Inspect the deposit slip for the amount of R7 541.73 and the date of the deposit (28 February 20XX). (1) Bank charges 10. Agree the amount of the bank charges (R897.50) to the February 20XX bank statement. (1) Available marks [10]; maximum marks [7] Question 52 LEVEL 2 Bank con rmation letters [10 marks] You are a second-year trainee accountant at Q&Z Inc. and are currently busy with the audit of NOCDE Limited (NOCDE) for the 28 February 20XX nancial year-end. NOCDE is a clothing retail company with branches across the country. e company has multiple bank accounts and you are responsible for the audit of the company’s bank balances as at year-end and are in the process of preparing bank con rmation letters for the company’s bank accounts at year-end. REQUIRED 1. List and explain the assertions relating to the cash and bank balance contained in the nancial statements for which evidence will be obtained by means of bank con rmation letters. (2) 2. Discuss any other information (other than the cash and bank balance) which will also be obtained as part of the bank con rmation process and how it can be used by the auditor. (8) [10] SUGGESTED SOLUTION TO QUESTION 52 1. a) Existence, as the banks will con rm that the bank accounts existed at year-end (1) b) Accuracy, valuation and allocation assertions, as the banks will be con rming the balance of the various bank accounts at year-end (1) Available marks [2]; Maximum marks [2] 2. a) Interest paid and received during the nancial year for all the entity’s bank accounts (1) is will be used by the auditor to verify the occurrence, completeness and accuracy of the entity’s interest expenses and interest revenue. (1) b) Details of any pledged and ceded balances and any collateral provided for liabilities (1) is can be used to verify the accuracy and completeness of disclosure and the presentation of, inter alia, contingent liabilities in the nancial statements as well as rights and obligations and completeness of the related assets and liabilities. (1) c) Details of any forward contracts (1) is can be used to verify the nancial instrument, including the relevant year-end disclosures and presentation in the nancial statements. (1) d) Available overdraft facilities that the entity may use and the date of the review of these (1) is can assist in the going concern evaluation because it provides information regarding the availability of short-term funding to the entity. (1) e) Information regarding the authorised signatories on the entity’s bank accounts (1) is can be used during the audit of payments made by the entity during the year to identify invalid payments which would assist in the identi cation of fraudulent transactions. (1) Available marks [10]; maximum marks [8] Question 53 LEVEL 3 Deferred taxation [16 marks] Since you recently completed your MCom (Taxation) the audit partner on the audit of Screen Capture (Pty) Ltd (Screen Capture) requested that you assist in the audit of the deferred taxation asset balance. Screen Capture is a rm of private investigators that specialise in electronic surveillance. Following the revelations of the State Capture commission of bribery, fraud and corruption by government officials, Screen Capture has seen a signi cant increase in demand for special investigations and has been awarded various contracts to conduct electronic surveillance. In order to store all the data that is generated by the new contracts, Screen Capture purchased 10 new servers during the nancial year. Electronic equipment is written off on a straight-line basis over the period of expected use and is impaired where necessary. Screen Capture estimates that the expected period of use of the electronic equipment is shorter than the write-off period allowed by the South African Revenue Service. e nancial directors recommended that the equipment be written off using the official tax wear-and-tear rates, however the board of directors agreed that the actual useful life would result in a better re ection on the statement of nancial position. is resulted in a deferred taxation asset, arising from the deductible temporary differences in respect of the servers purchased. REQUIRED Assuming that the xed assets have already been audited and that the deferred taxation asset account is separately disclosed from the deferred taxation liability account, formulate the substantive procedures that you would perform in respect of the deferred taxation asset account. [16] SUGGESTED SOLUTION TO QUESTION 53 1. Scrutinise the general ledger account (for both the deferred taxation liability and asset accounts) for unusual entries and enquire from management about any such entries. (1) 2. Inspect the deferred taxation liability account as well as the related deferred taxation liability calculation for any unusual items. (1) 3. Inspect all material journal entries processed during the preparation of the nancial statements and enquire from management about their purpose. (1) 4. Obtain the deferred taxation calculation; 5. agree its total to the general ledger, trial balance and nancial statements. (1) 6. Recalculate the: a) carrying amount of the asset b) tax base c) deferred tax asset. (max 2) 7. Compare the tax rate and wear-and-tear rate used in the calculation with current (‘enacted or substantially enacted’) legislation. Note the date of the enactment. (2) 8. Obtain forecasts from management and review whether it is probable that sufficient taxable income will be earned in future, against which the temporary difference can be deducted. a) Enquire from the accountant about the procedures and methods that were followed in the preparation of the forecast. (1) b) Enquire from the accountant about the basis of the assumptions made in respect of the taxability, tax planning events, probabilities, possible variances and timing of future cash ows, and compare it with trends and industry norms considering the knowledge of the business and the industry. (1) c) Compare the discount rate used by the accountant with the ruling interest rate in the media or on the internet. (1) d) Recalculate all calculations and projections. (1) e) Con rm the details in the projections with the underlying evidence and consider the taxation impact of the projections (evaluate whether there will be sufficient taxable pro t earned, against which deductions can be set off; also refer to other requirements of IAS 12, para 36) and the recoverability of the deferred taxation asset. (max 2) f ) Evaluate events after year-end that provide additional information in respect of the abovementioned assumptions (e.g. changes in the interest rate and the economy which may impact future sales and sales volumes; timing when temporary difference could potentially reverse; tax planning opportunities) in order to con rm that the loss will be realised. g) Inspect the minutes of management meetings to verify that the requirements of (max 2) IAS 12, para 36 are discussed. (1) 9. Inspect the disclosure of the deferred taxation in the nancial statements to con rm that it is disclosed in accordance with IFRS. (1) Available marks [18]; maximum marks [16] Question 54 LEVEL 3 Taxation payable [22 marks] You are the audit senior employed by Wingman Accounting Inc. (Wingman). Wingman received a phone call from the local university. e chairman of the School of Accountancy at the university urgently needs a guest lecturer with taxation experience as well as audit experience. Wingman’s managing partner suggests that you present the lecture, since it would assist Wingman’s recruitment activities on campus. e brief you received from the university via email states the following: Dear Wingman Thank you for agreeing to lecture next week. I would like to request that you give a 50minute lecture on the various forms of taxation, and since we (at the university) have started implementing the CA2025 framework, you must please integrate taxation with auditing during your lecture. Please focus on substantive procedures. Integrated thinking is a key principle in the CA2025 framework. Thank you again. Regards Chairperson of School of Accountancy In preparing for the lecture, you decide to explain the substantive procedures using a case study of a company that had seen an increase in revenue and a decline in expenses due to cost-cutting measures. Payments to SARS consisted of provisional payments for income tax as well as payments made for penalties and interest incurred during the year. In order to make the scenario more realistic, you decide that the company will pay penalties and interest only when it receives a request for payment from SARS, however the company does not raise a provision for potential penalties nor interest due. REQUIRED Ignoring capital gains taxation and other taxes, formulate the substantive procedures which you would include on your lecture slides to audit the SARS balance in the statement of nancial position giving consideration to the facts in the scenario. You are not required to formulate analytical procedures. Moreover, do not address the disclosure and presentation assertion. [22] SUGGESTED SOLUTION TO QUESTION 54 1. Obtain the calculation of the tax liability and recalculate the amounts on the schedule. (1) 2. Compare the balance in the tax calculation with the balance in the general ledger to the trial balance and nancial statements. (1) 3. Inspect the general ledger account to identify any unusual entries. Enquire from management reasons for the unusual entries. (1) 4. Obtain a management representation letter con rming the completeness and accuracy of the tax liability. (1) 5. Compare the opening balance of the general ledger to the balance in the prior year’s signed nancial statements as well as the prior year’s tax return and assessment received. (2) 6. Recalculate the amount of any over/under provision and compare it to the amount in the general ledger account. (1) 7. Inspect the journal entries transferring over/under provisions to the statement of nancial position to ensure that these are not carried forward. (1) 8. Compare all the payments (provisional taxation) in the general ledger with: the bank statement as well as with the receipt as received from SARS (1) the provisional returns completed by the client (1) statements from SARS in respect of penalties and interest and with the amount of interest and penalties as recalculated by you. (1) 9. Inspect the SARS general ledger account to con rm that payments for penalties and interest made during the year are not allocated to this account, but rather expensed. (1) 10. Obtain a schedule with the income taxation calculation and recalculate the income tax expense by multiplying the taxable income with the statutory rate. (1) 11. Inspect income taxation calculation: Agree the pro t before taxation with the amount in the statement of comprehensive income. (1) a) Evaluate the nature of all items and i) con rm the classi cation and treatment of non-taxable items against supporting documentation (1) ii) con rm that all items that are non-deductible are added back (1) iii) con rm that all special allowances are appropriately claimed. (1) b) Review the detailed nancial statements for any other items requiring adjustment. (1) c) Enquire from management whether there are any other items that are non-taxable/nondeductible. (1) 12. Recalculate the amount of capital allowances. (1) 13. Inspect the general ledger and ensure that the taxation expense per the tax calculation (per schedule) agrees with the entry/journal of the provision in the general ledger. (1) 14. Enquire from SARS or investigate documentation and payments after year-end to identify any unrecorded outstanding penalties and interest. (1) 15. Compare the balance on the nancial statements to the amount on the tax return as well as assessment. (1) a) Inspect the prevailing tax legislation for the prevailing tax rate and other relevant provisions. (1) b) If necessary, obtain the assistance of a tax expert. (1) c) Review the calculation for completeness and reasonableness using your taxation knowledge. Inspect last year’s tax calculation and return, and enquire from management regarding any differences (i.e. new or missing amounts). (2) Available marks [27]; maximum marks [22] Question 55 Audit of unlisted investment/accruals [24 marks] LEVEL 3 You are working for a small audit rm, FMA Inc. You are currently busy with the audit of Body Beautiful (Pty) Ltd (BB). e company has a 30 June year-end. FMA Inc. has been appointed as the new auditor in the current year. Background information BB was established eight years ago by Mr Mangaliso, the company’s largest shareholder. e purpose of the company was to import into South Africa Chinese products which had a price advantage compared to other similar products available in the South African market. Due to the poor quality of certain of these products, this was not a satisfactory long-term proposition. Currently weight-loss products are very popular in South Africa. ese products supposedly act as appetite suppressants, fat burners, metabolism enhancers and energy boosters. BB has therefore changed its strategy and now only focuses on these products. BB imports these products from suppliers in China that it has worked with previously and with which it has good working relationships. Investments ree years ago, BB made a 10% investment in Wonder Slim (Pty) Ltd (Wonder Slim). At yearend, the investment is stated at R2 250 530 in the general ledger. ere was no movement in this account during the current nancial year. Accruals Mr Mangaliso provided you with a list of accruals as at year-end that he had prepared himself, because the post of chief nancial officer is currently vacant. He ‘hopes’ the balance of R245 540 includes all the relevant accruals at year-end. Your audit senior has now delegated the task of verifying the accruals amount to you. You have already agreed the balance of his list of R245 540 to the accruals amount per the trial balance and general ledger. REQUIRED 1. Describe the audit procedures that you would perform to verify the valuation of the investment of R2 250 530 of BB at year-end. (12) 2. Describe the audit procedures that you would perform to verify the accruals of BB at year-end. (12) [24] SUGGESTED SOLUTION TO QUESTION 55 1. Audit of investments – valuation assertion only As this is a new audit, the opening balance of valuation needs to be veri ed to check for any material misstatement: a) Agree opening balance of R2 250 530 to previous year’s closing balance in the general ledger investment account and AFS. (1) b) Investigate and obtain corroborative supporting documentation for any difference relating to the above. (1) c) Inspect share certi cate to verify the 10% shareholding and investment amount at year-end. (1) Valuation assertion only Obtain audited AFS for Wonder Slim and perform the following: d) Inspect that equity/net asset value is at least R22 505 300 to justify investment amount of R2 250 530 at year-end. (2) e) Perform a valuation to verify 10% holding of at least R2 250 530 by using: i) the discounted cash ow model (1) ii) the price-earning model (1) iii) the dividend yield model/Gorden growth model (1) to identify if any impairment is needed. f ) Inspect the statement of comprehensive income to verify that Wonder Slim is making a reasonable pro t and that no impairment is needed. (1) g) Inspect the AFS to verify that Wonder Slim is a going concern to verify that no impairment is needed. (1) h) Scrutinise chairman’s report to determine viability and pro tability of future operations to verify that no impairment is needed. (1) i) Inspect that an unmodi ed audit report was issued. (1) j) If not, determine what effect the quali cation will have on the equity and pro t gures, to verify that no impairment is needed. (1) k) If management are not prepared to do the necessary impairments identi ed in your audit work above, take amount to overs/unders schedule. (1) Available marks [14]; maximum marks [12] 2. Substantive procedures regarding accruals As this is a new audit, the opening balance of accruals needs to be veri ed to check for any material misstatement: a) Obtain a list of opening balances from the previous auditor or management or prepare your own list. (1) b) Inspect the accuracy of this list with payments made subsequent to last year’s year-end to verify the accuracy of the opening balance of accruals. (1) c) If there is any material difference regarding the above (or procedures performed below), discuss with management and take any audit differences to overs/unders schedule. (1) d) e current year-end accruals list was prepared by a person who is not a quali ed accountant, therefore extended audit procedures need to be performed. (1) e) Cast the current year’s list and agree if total does add up to R245 540. (1) f ) Compare the list of accruals given to you by Mr Mangaliso and compare the list that you prepared regarding opening balances; identify and follow up differences with Mr Mangaliso. (1) g) Since Mr Mangaliso ‘hopes’ the list is correct, which does not inspire any con dence, extended procedures will need to be followed to identify further the completeness of the list, therefore review telephone, electricity, rent and other expenses to verify 12 payments/debits were made during the year, otherwise follow up differences with Mr Mangaliso. (2) h) Review all agreements, contracts, board minutes, etc. to determine whether the accruals list is complete. (1) i) Select invoices and statements for services rendered, and other documentation received before year-end to ensure these are recorded as accruals at year-end. (1) j) Trace payments after year-end to identify payments made regarding accruals that existed at year-end but which do not appear on the list of Mr Mangaliso. (1) k) Enquire from staff members/payments clerk whether they are aware of any unrecorded accruals at year-end. (1) l) Trace the amounts on the list of Mr Mangaliso and test them to invoices, statements and other supporting documentation. (1) m)Re-perform calculations on documents above to con rm accuracy of accrual amount. (1) n) Perform an analytical review of each accrual and inspect documentation for any abnormal increases/decreases that are not in line with in ation. (1) Available marks [15]; maximum mark [12] Question 56 LEVEL 3 Directors emoluments [26 marks] Nat Jafta Kitchen Cupboards (Pty) Ltd (Nat Jafta) engaged your rm to perform the external audit for the nancial year ending 31 December. e company was founded by Mr Nathaniel Jafta and his wife. Nat Jafta manufactures custom-made kitchen cupboards from its warehouse in Rylands. ere are 61 permanent employees working in the warehouse, including ve administrative staff members. Nat Jafta also employs ve four-man crews that install the cupboards at client’s premises. Nat Jafta had a good nancial year with revenue doubling. e growth in sales started after Mr Jafta was selected as one of the Mail & Guardian Top 200 entrepreneurs and a SAICA Top under-35 nalist. A month before the close of the nancial year, Mr Jafta wanted to thank his employees for their hard work and made an announcement that all salaried employees would receive a cash bonus, payable two months after year-end. e bonus was calculated pro-rata on the employees’ December salary, based on the number of months they were employed during the nancial year ending 31 December. e employees were excited since it was the rst time that they received a bonus. ere were, however, two employees who had resigned after year-end and were unhappy since they were not included in Mr Jafta’s calculation of the bonus payable (i.e. ‘provision for employee bonuses’). Mr Jafta argued that they did not qualify for the bonus since they would no longer be on the company’s payroll. Moreover, he decided not to include the directors in the bonus payment. e following procedures have already been performed regarding the disclosure of salary- and remuneration-related balances: 1. Obtain a payroll printout of all salary and remuneration amounts (including bonuses) and supporting calculations and re-perform all calculations and castings. Agree the totals of these schedules and supporting calculations to the relevant account in the general ledger, trial balance and nancial statements. 2. Review the relevant general ledger accounts of all salary- and remuneration-related balances (including bonuses) and investigate any unusual entries, including journals. 3. Obtain a management representation letter con rming all relevant assertions relating to all salary- and remuneration-related amounts (including bonuses). 4. Inspect minutes of meetings of the board and the remuneration committee for any reference to salary- and remuneration-related matters (including bonuses). 5. Review the nancial statements and complete the rm’s standard disclosure checklist based on the disclosure in the nancial statements. Con rm that all salary- and remunerationrelated matters (including bonuses) have been disclosed in accordance with IFRS. 6. Compare the salary- and remuneration-related payments (including bonuses) and related disclosures to that as disclosed in the prior year’s nancial statements and investigate variances. REQUIRED 1. Draft a working paper that describes the additional substantive procedures that you would perform in respect of the directors’ remuneration account in the statement of nancial performance. You are not required to describe any substantive analytical procedures, nor any substantive procedures relating to the presentation and disclosure assertions. (14) 2. Describe the risks of material misstatement at account and assertion level in respect of the provision for employee bonuses in the statement of nancial position. You are not required to describe risks relating to the presentation and disclosure assertions. (6) 3. Assume that sufficient appropriate audit evidence has already been obtained in respect of salary records of both employees and directors, and formulate the additional test of details that you will perform in respect of the provision for employee bonuses in the statement of nancial position. You are not required to describe any substantive analytical procedures, nor any substantive procedures relating to the presentation and disclosure assertions (6) [26] Question 57 LEVEL 3 Audit procedures regarding legal matters [14 marks] You are the audit manager on the 31 December year-end audit of OwnWay (Pty) Ltd (OwnWay), a company founded 20 years ago that owns most of the country’s school tuck shops. During the planning phase of the current audit, while you were inspecting the minutes of the company’s board meetings, the following transactions came to your attention: Transaction A Bob Owny, the managing director, borrowed R50 000 from the company in order to purchase a boat. e loan was approved by the directors at an interest rate of 1.5%. Transaction B OwnWay declared a dividend of 50 cents per share during the year. Transaction C Carli von Dagel, one of the executive directors, proposed a contract with SweetsUnlimited (Pty) Ltd (SweetsUnlimited) for the supply of crisps to OwnWay. Although Carel von Dagel owns 55% of the shares in SweetsUnlimited and is married to Carli, the contract was approved by the board. REQUIRED 1. Based on the information supplied, discuss in terms of the Companies Act requirements and contraventions (the theory and the application thereof ) the validity and the consequences of: a) transaction A (5) b) transaction B. (4) 2. Formulate the audit procedures that you would perform in order to obtain sufficient, appropriate audit evidence as to the legality of transaction C. (5) [14] Note: Although audit procedures include tests of controls and substantive procedures, transactions regulated by the Companies Act occur only once in a while, as a result of which there are no internal controls to test. Your approach in answering this type of question is to verify compliance with the Companies Act. SUGGESTED SOLUTION TO QUESTION 57 1. a) i) As the award of the loan made to the director was not within the scope of the normal trading activities of OwnWay, it was not in the ordinary course of business. (1) ii) OwnWay is not a bank or a nancial institution in terms of section 45(1)(a) of the Companies Act 71 of 2008. (1) iii) Although the loan was approved by the directors, it should have been authorised by means of a special resolution of the shareholders in accordance with section 45(3)(a) (ii). (1) iv) As the loan was approved at an interest rate of 1.5%, which is much lower than the repo rate, the terms may not be considered reasonable and fair to the company (section 45(3)(b)(ii)). (1) v) e loan is thus void (invalid). (1) vi) e directors, whether they approved of or failed to vote against the loan, could be held liable. (consequence) (1) Available marks [6]; maximum marks [5] b) i) Inspect the minutes of meetings of the directors for: the board resolution authorising the distribution (1) the acknowledgement of the application of the solvency and liquidity test immediately after the proposed distribution was completed as well as the conclusion that the company satis ed the solvency and liquidity test. (1) ii) Having recalculated the solvency and liquidity ratios, agree them to management’s calculation in order to verify that the company was solvent and liquid after the distribution. (1) iii) Inspect the bank statement in order to verify that the distribution was made within 120 days of the solvency and liquidity test having been performed or inspect the minutes of board meetings for references to the subsequent solvency and liquidity test. (1) iv) Inspect the memorandum of incorporation in order to verify whether there are any restrictions on interim distributions. (1) Available marks [5]; maximum marks [4] 2. a) Inspect the minutes of the board meeting in order to verify that Carli: i) disclosed her interest in the contract (1) ii) disclosed all the necessary details and information regarding the contract (1) iii) left the boardroom after the disclosure of her interest (1) iv) formed part of the quorum of the meeting, but did not take part in the vote on this contract. (1) b) Inspect the con ict register in order to verify that Carli registered her interest in the contract. (1) c) Inspect the memorandum of incorporation in order to verify that there are no restrictions with regard to contracts involving con icts of interest. (1) Available marks [6]; maximum marks [5] 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 Auditing of a balance. In order to detect possible understatement, more completeness procedures need to be performed. You are a member of the audit team. All this is irrelevant, since you have to perform substantive procedures and not tests of controls. Use this information in your cut-off procedures. Use this information in your answer. Use Mr Paton’s name in your answer. As the amount is lower than that of the previous year, the completeness assertion needs more procedures. In performing substantive tests, the auditor will try to obtain external audit evidence with a date as close as possible to year-end. This is the only time you will earn a mark in tests and exams if you start your sentence with the word ‘obtain’. You are not required to write ‘Obtain an invoice for’ and then ‘Inspect an invoice for’ when describing substantive procedures. Inquiry from management is a poor audit procedure, since they may tell the auditor what he/she wants to hear, rather than the truth. Your procedure should therefore include a follow-up in order to corroborate management’s answers. This is essential in order to earn a mark, since answers to inquiries from management are poor audit evidence. By performing these procedures, the auditor is testing for possible understatement, as required in the question. Always mention analytical review procedures if they are relevant. This procedure specifically addresses the risk of understatement presented in the scenario. Observe how the information contained in the question was brought into the solution. Samples are often taken, since it is impossible for the auditor to inspect all documentation. This procedure is applicable only to accounts payable and accounts receivable. This procedure is unique to accounts payable. This is a generic procedure that you may mention if the item is separately disclosed in the financial statements. This serves only to indicate that many other alternative procedures exist. Audit of transactions. 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 You are the senior auditor on this audit. Remember to address this issue in your cut-off and analytical review procedures. Management has therefore an incentive to overstate sales. This detailed information is not really needed, since the question does not ask for test of controls. This detailed information is not really needed, since the question does not ask for test of controls. Notice the three different assertions in auditing transactions compared to balances. When auditing transactions, the auditor is vouching for many of the company’s internal documents. By comparison, when auditing balances, he/she is trying to obtain external audit evidence. Occurrence is used as a heading since the auditor is verifying transactions. The mark is allocated for ‘cast’ and not ‘obtain’. This is a generic statement that may be used for most substantive questions. Usually no mark is allocated for this. In this scenario, where the client has 22 outlets, you will need to stratify. Accuracy is used as a heading since the auditor is verifying transactions. Using information given in the scenario. Classification is used as a heading since the auditor is verifying transactions. This is a risk identified in the scenario. Once again, discuss analytical review procedures. Note: In this solution, it has been given its own heading, which you can do if you forget to address analytical review procedures. INTRODUCTION is chapter also deals with substantive procedures. QUESTIONS Question 1 LEVEL 2 Revenue [15 marks] You have recently been appointed as an audit manager at Sexy Audit Inc. Your rst audit client is Investex Ltd (Invest), a company that sells investment textbooks. e audit for the year ended 31 September is almost complete, with only the audit of the asset management fee accounts still outstanding. Investex has a R15 million investment on the statement of nancial position at year-end. e investment, which was acquired four years ago as capital reserves and has already been veri ed, is classi ed and recognised as available-for-sale in terms of International Accounting Standards (IAS) statements. e investment is managed by Investex at a fee of 0.5% per month calculated on the market value of the said investment. e fee is payable in cash 15 days after month end. An audit trainee accountant has requested your assistance in auditing this balance. REQUIRED Formulate the substantive procedures that you would perform relating to the asset management fee in the statement of comprehensive income. [15] Question 2 LEVEL 2 Opening balances [16 marks] CA(SA) Inc. was appointed as the external auditor of Corricraft (Pty) Ltd (Corricraft) on 1 April. e success of the company, which sells the furniture it manufactures at its Durban plant from showrooms across South Africa, lies in the fact that its products are durable. In addition, lounge suites have removable, washable covers. e company’s yearend is 31 December. During the planning phase of the current year’s audit, the CA(SA) Inc. audit team experienced difficulty in reconciling opening balances to the nancial statements audited by the previous auditor, who had issued a quali ed audit opinion of the previous nancial year. In an attempt to resolve the issue, CA(SA) Inc. contacted the previous auditor, who replied in writing that he had resigned from the audit, and that there is no reason why CA(SA) Inc. should not accept the appointment. As he was now retired, he was not able to assist with them further. During the course of the previous nancial year, Corricraft had embarked on a large capital expenditure expansion project with a view to improving aspects of its infrastructure, the result of which, it was hoped, would be an increase in sales and a decrease in costs. In anticipation of this, at the time of the previous nancial year-end, Corricraft had large inventory, accounts receivable and PPE balances. Although increased sales did materialise after the expansion, customers purchasing on credit with 24 months to repay struggled with repayment, which resulted in signi cant credit losses for the company. Management uses a provision matrix that speci es xed provision rates (based on past experience and industry trends) for the number of days a debt is overdue. REQUIRED Formulate the substantive procedures you would perform during the current year’s audit on the opening balance of trade accounts receivable. You are not required to perform substantive analytical procedures or consider the presentation and disclosure assertions. [16] Question 3 LEVEL 2 Accounts receivable [23 marks] For the past three years, your audit rm has been the external auditor of Pamala Ltd (Pamala), a company that owns and leases buildings across South Africa. During the current year, there has been a signi cant decrease in the number of properties leased as a result of declining interest rates, with the result that it has become more cost effective for those seeking office space to purchase premises. e company’s yearend is 31 August. e company’s draft nancial statement re ects the following balances: Income Rent received** R4 656 641 Current assets Rent in arrears # R341 000 Current liabilities Rent received in advance R93 500 VAT payable R264 000 **The income gure was obtained from the monthly rental registers. # Rent in arrears refers to the unpaid invoices for August as well as those for previous months. e rental system operates as follows: New applications and renewals Once a prospective tenant has completed a rental application form and successfully undergone a credit check, a rental agreement, which is prenumbered, is entered into with the lessee and signed by both parties. A copy of the agreement as well as the rental application form is led in a correspondence le for the lessee, who is assigned a unique lessee number. Invoicing e accounting department at head office in Johannesburg maintains a rent register in which all rentable office space is listed, along with the details of the lessees. On the rst day of every month, an invoice, serving as a reminder of the rent due on or before the 5th of the month in terms of the rental agreement, is mailed to each lessee. In addition, the invoice is debited to the lessee’s account in the rent register. Receipts Rentals are paid directly to head office. Pamala’s policy is to grant terms of rental payable in advance only. When a payment is received from a lessee, it is credited to the client’s account in the rent register. Month-end procedures All lessees with outstanding rent payments receive a monthly statement prepared and mailed to the lessee on the 15th of each month. Copies of these statements are led in the correspondence les of the lessees. REQUIRED Describe the substantive procedures you would perform in respect of the gross amount of rentals in arrears before any provision for irrecoverable losses is included in the statement of nancial position for the year ended 31 August. You are not required to address any matters concerning either taxation or the procedures relating to debtors con rmation letters. [23] Question 4 LEVEL 2 Accounts receivable [25 marks] You are a second-year audit trainee on the audit of ComfortAir (Pty) Ltd (ComfortAir), the largest supplier of commercial and residential air conditioners in southern Africa. e company, which has a December year-end, requires the nancial statements by the third week of January. As a result of the tight year-end, your audit rm opted to con rm the existence of debtors at 30 September during the interim audit conducted during the rst two weeks of October. Roll-forward procedures for October, November and December were performed during the year-end audit. e reason for adopting this approach was the delayed response from debtors returning debtors con rmations for the previous nancial year, which threatened to delay the issuing of the audit report. e following additional information is available at year-end: ComfortAir signed contracts with several commercial building developers and building suppliers, who sell directly to the public in Namibia and Zimbabwe, to supply them with air conditioners. e rst purchases, which, as with all transactions, were settled in US dollars, were made in February of the current nancial year. Although it is not the policy of ComfortAir to hold air-conditioning units on a consignment basis, Building Warehouse Supplies (Pty) Ltd (BWS), which accounts for 32% of the total accounts receivable balance at year-end, requested that an exception be made for it. e directors of ComfortAir approved this request at a board meeting held in January of the current nancial year, since which date all goods to BWS have been held on a consignment basis. ComfortAir’s accounts receivable master le contains the following elds: FIELD EXAMPLE Account number Prod430 Name Productive (Pty) Ltd Address and contact details 430 S Poplar Avenue, Parow 7501 Date account opened March 20XX Total amount owed R53 000 Aging of total amount owed 52 days Credit limit amount R120 000 Credit terms 30 days REQUIRED 1. Discuss the audit procedures you would have performed during the interim audit in order to con rm the existence of the accounts receivable balance on this date. (6) 2. Discuss the audit procedures you would perform in order to con rm the valuation of the accounts receivable balance. In answering the question, use general audit software as far as possible. (19) [25] Question 5 LEVEL 2 Audit procedures [13 marks] You have been the auditor of the ABC Ltd Group (ABC), a company with a 30 June nancial year-end, for the last six years. ABC is a leading toy manufacturer in Africa with ve manufacturing facilities, three of which are located in South Africa, one in Kenya, and one in Nigeria. e company has production capabilities for a wide variety of toy products. It employs a substantial workforce. ABC’s products are renowned for their quality and affordability. Results from research conducted by the South African Bureau of Standards show that no toxic paints are used in toys manufactured by ABC. In addition, they have no small parts that could be harmful to children. During the course of the current year, ABC implemented a new payroll system that is more effective than that used over the last seven years. All payroll data is now stored at PayrollCloud Inc., a designated cloud site. Extract from minutes taken at a directors meeting held on 8 June 20X1 Note 1: Feedback on new payroll system All payroll applications and modules have been successfully transferred from the previous payroll system to the new. The initial problem encountered with PayrollCloud Inc. over the storage of the payroll data has been successfully resolved. As far as we are aware, there have been no other malfunctions. From that, we conclude that everything is functioning normally. Note 2: Consultation with labour unions It was decided that all workers at the Cape Town manufacturing facility will be retrenched on 30 June owing to this facility making continuous losses. Since the retrenchment packages, which were approved by the labour union, will be paid out only during July (after the year-end), it was decided by management that no provision needs to be made for this at year-end. REQUIRED Discuss the impact that Note 2 above would have on your audit, and describe the audit procedures that you would perform in order to verify the retrenchment payment. [13] Question 6 Audit procedures LEVEL 2 [15 marks] For the rst time, your audit rm will be conducting the audit of XARO Ltd (XARO), a South Africa-based group specialising in the mining of coal. You are a junior audit clerk assigned to the 30 June 20X1 year-end audit. Because the company is currently the largest coal producer in the country, EXCOM, the national power utility, as well as several other municipal power stations, are XARO’s biggest clients. e company has been listed on the JSE for the last seven years. On 5 April 20X1, a strike involving approximately 2 000 miners took place at the Arnox mine in Mpumalanga, one of six mines owned by XARO. e strike, sparked by the non-payment of performance bonuses as a result of certain operations not achieving their performance targets, led to a production stoppage of several weeks. In addition, the event gained international attention after the strike, which had become violent, had led to the serious injury of 38 striking mineworkers. Legal action against XARO resulted, with the men claiming damages of R23 million for injuries sustained during the strike. According to XARO’s legal advisors, the mineworkers have a 90% chance of being granted compensation. Consequently, XARO raised a provision for R23 million in its nancial statements for the year ending 30 June 20X1. Working Paper H/100 provides a breakdown of the audit procedures performed: Working Paper H/100 Entity name: XARO Ltd Year-end: 30 June 20X1 Prepared by: J. Jackson Date: 2 August 20X1 Reviewed by: P. Masanabo Date: 4 August 20X1 WP H/100 Page 1 of 1 Audit section: Provisions Activity 1: Audit procedures performed on provisions in general AUDIT PROCEDURE PERFORMED TYPE OF AUDIT PROCEDURE ASSERTION/CONTROL OBJECTIVE ADDRESSED Compared the schedule of provisions for the current year to that of the previous year. Certain major provisions for the previous year were not present in the current year. No further audit work was performed on these provisions, as they had no impact on the current year’s audit. Test of control Valuation of provisions Discussed with the previous auditor the process used to Test of detail: substantive procedure Segregation of duties develop provisions, including the approval process thereof. Activity 2: Audit procedures speci cally performed on the provision for R23 million raised in the nancial statements for the year ending 30 June 20X1 with regard to damages for injuries sustained during the strike AUDIT PROCEDURE PERFORMED TYPE OF AUDIT PROCEDURE ASSERTION/CONTROL OBJECTIVE ADDRESSED Obtained the schedule from management making up the balance of R40 million for this provision. Reperformed all calculations on the schedule. Test of control Presentation and disclosure Evaluated, tested and discussed the basis on which the amount of the provision was determined in order to decide whether Analytical procedure: substantive procedure Isolation of responsibilities or not it is a reliable estimate. REQUIRED Discuss the concerns you have with the audit procedures, the type of audit procedures and the assertions or control objectives addressed as documented in Working Paper H/100. Where there are concerns, make recommendations on how these could be mitigated. Present your answer in tabular form. [15] QUESTIONS Question 1 LEVEL 3 Series ISA 560 Phase 1–3 (the same scenario will be used and tailored to explain the various possibilities) [66] SCENARIO 1 OF 6: SUBSEQUENT EVENTS [10 marks] You are a chartered accountant and an audit manager at Audit Inc., a medium-sized audit rm. One of your major audit clients is FlyAway Ltd (FlyAway), a listed company. FlyAway is an airline company that specialises in providing an exclusive private jet service to wealthy individuals, including government officials and celebrities. FlyAway’s assets include a eet of luxury jets and, as it has been in operation for a number of years, it also has access to a substantial network of other luxury aeroplane service providers. e following dates are relevant to the audit: ACTIVITY DATE Financial year-end 30 September 2019 Financial statements to be approved by board of directors 30 November 2019 Financial statements to be sent to shareholders 5 December 2019 e nal and overall materiality gure for the nancial statements was calculated as R8.5 million. e audit eldwork has been completed and you are reviewing the completion and nalisation ndings. Below is Working Paper L1 – LITIGATION AND POSSIBLE CLAIMS, which you are currently reviewing: Working paper Client name FLYAWAY LTD Prepared by M Hilton Date prepared Yearend 30 September 2019 Reviewed by You Date reviewed Audit section LITIGATION AND POSSIBLE CLAIMS 25 October 2019 Discussions with the company’s legal advisor revealed the following: L1 A legal claim has been made against the company by six passengers who assert that the airline served them contaminated food. It came to management’s attention that the passengers were admitted to hospital shortly after landing in Durban on 28 August 2019. The passengers have instituted a claim for damages against the company. The medical reports, dated 3 October 2019, revealed that the passengers suffered from food poisoning. Upon investigation, traces of an industrial cleaning chemical were found in the food that the passengers were served. The legal advisor is of the opinion that the passengers will be successful in their claim, however the value of the claim could not be determined at year-end. On 15 October 2019, the following estimate of the claim was made by the legal advisor: R10 million. This estimate was based on other similar cases in the past. This estimate is considered to be reasonable for audit purposes. Management disclosed a contingent liability in the draft nancial statements regarding this matter. REQUIRED Discuss the appropriate audit responses (all steps and further audit procedures) in reaction to the relevant information provided. Assume the date is 27 October 2019 today for the purpose of answering the question. (10) Notes: Ignore any taxation and deferred taxation implications of this information. Ignore any aspects regarding possible fraud or a reportable irregularity. Ignore the effect of the matter on the formulation of the audit opinion. SCENARIO 2 OF 6: SUBSEQUENT EVENTS [15 marks] You are a chartered accountant and an audit manager at Audit Inc., a medium-sized audit rm. One of your major audit clients is FlyAway Ltd (FlyAway), a listed company. FlyAway is an airline company that specialises in providing an exclusive private jet service to wealthy individuals, including government officials and celebrities. FlyAway’s assets include a eet of luxury jets and, as it has been in operation for a number of years, it also has access to a substantial network of other luxury aeroplane service providers. e following dates are relevant to the audit: ACTIVITY DATE Financial year-end 30 September 20X9 Financial statements approved by board of directors 30 November 20X9 Financial Statements to be sent to shareholders 5 December 20X9 e nal and overall materiality gure for the nancial statements was calculated as R8,5 million. You have issued an unmodi ed audit report (dated 1 December 20X9) pertaining to the 20X9 nancial year. On 2 December 20X9, you read the following in the newspaper: ere is a legal claim against the company by six passengers who assert that the airline served them contaminated food. It came to management’s attention that the passengers were admitted to hospital shortly after landing in Durban on 28 August 20X9. e passengers have instituted a claim for damages against the company. e medical reports, dated 3 October 20X9, revealed that the passengers suffered from food poisoning. Upon investigation, traces of an industrial cleaning chemical were found in the food that the passengers were served. Legal experts whom this newspaper interviewed are of the opinion that the passengers will be successful in their claim. e claim is estimated to be R10 million according to the legal experts. Management did not disclose this information to the audit team during the audit, nor was it disclosed in the audited nancial statements. REQUIRED Discuss the appropriate audit responses (all steps and further audit procedures) in reaction to the relevant information provided. Assume the date is 2 December 20X9 today for the purpose of answering the question. (15) Notes: Ignore any taxation and deferred taxation implications of this information. Ignore any aspects regarding possible fraud or a reportable irregularity. Do not discuss detailed audit procedures as per ISA 540. Do not address the formulation of the audit opinion. SCENARIO 3 OF 6: SUBSEQUENT EVENTS [15 marks] You are a chartered accountant and an audit manager at Audit Inc., a medium-sized audit rm. One of your major audit clients is FlyAway Ltd (FlyAway), a listed company. FlyAway is an airline company that specialises in providing an exclusive private jet service to wealthy individuals, including government officials and celebrities. FlyAway’s assets include a eet of luxury jets and, as it has been in operation for a number of years, it also has access to a substantial network of other luxury aeroplane service providers. e following dates are relevant to the audit: ACTIVITY DATE Financial year-end 30 September 20X9 Financial statements approved by board of directors 30 November 20X9 Financial statements sent to shareholders 5 December 20X9 e nal and overall materiality gure for the nancial statements was calculated as R8,5 million. You have issued an unmodi ed audit report (dated 1 December 20X9) pertaining to the 20X9 nancial year. On 6 December 20X9, you read the following in the newspaper: ere is a legal claim against the company by six passengers who assert that the airline served them contaminated food. It came to management’s attention that the passengers were admitted to hospital shortly after arriving in Durban on 28 August 20X9. e passengers have instituted a claim for damages against the company. e medical reports, dated 3 October 20X9, revealed that the passengers suffered from food poisoning. Upon investigation, traces of an industrial cleaning chemical were found in the food that the passengers were served. Legal experts whom this newspaper interviewed are of the opinion that the passengers will be successful in their claim. e claim is estimated to be R10 million according to the legal experts, based on similar cases in the past. REQUIRED Discuss the appropriate audit responses (all steps and further audit procedures) in reaction to the relevant information provided. Assume the date is 6 December 20X9 today for the purpose of answering the question. (15) Notes: Ignore any taxation and deferred taxation implications of this information. Ignore any aspects regarding possible fraud or a reportable irregularity. Do not discuss detailed audit procedures as per ISA 540. Do not address the formulation of the audit opinion. SCENARIO 4 OF 6: SUBSEQUENT EVENTS [8 marks] You are a chartered accountant and an audit manager at Audit Inc., a medium-sized audit rm. One of your major audit clients is FlyAway Ltd (FlyAway), a listed company. FlyAway is an airline company that specialises in providing an exclusive private jet service to wealthy individuals, including government officials and celebrities. FlyAway’s assets include a eet of luxury jets and, as it has been in operation for a number of years, it also has access to a substantial network of other luxury aeroplane service providers. e following dates are relevant to the audit: ACTIVITY DATE Financial year-end 30 September 20X9 Financial statements approved by board of directors 30 November 20X9 Financial statements to be sent to shareholders 5 December 20X9 e nal and overall materiality gure for the nancial statements was calculated as R8,5 million. You have issued an unmodi ed audit report (dated 1 December 20X9) pertaining to the 20X9 nancial year. In the chairman’s report, there is a section that deals with ‘ ight incidents’. In that section, the company’s chairman highlighted that during the current nancial year, there was one incident ‘where passengers did not feel well after a ight to Durban’. He also stated that ‘the matter was investigated and preventative measures were instituted’. On 2 December 20X9, you read the following in the newspaper: A legal claim has recently been laid against FlyAway Ltd by six passengers who assert that the airline served them contaminated food. It came to the company’s attention that the passengers were admitted to hospital shortly after landing in Durban on 28 August 20X9. e passengers have instituted a claim for damages against the company. e medical reports, dated 3 October 20X9, revealed that the passengers suffered from food poisoning. Upon investigation, traces of an industrial cleaning chemical were found in the food that the passengers were served. A legal expert whom the newspaper interviewed is of the opinion that the passengers will be successful in their claim. e claim is estimated at a value of R4,5 million, given similar cases in the past. REQUIRED Discuss the appropriate audit responses (all steps and further audit procedures) in reaction to the relevant information provided. Assume the date is 2 December 20X9 today for the purpose of answering the question. (8) Notes: Ignore any taxation and deferred taxation implications of this information. Ignore any aspects regarding possible fraud or a reportable irregularity. Do not discuss detailed audit procedures as per ISA 540. Do not address the formulation of the audit opinion. SCENARIO 5 OF 6: SUBSEQUENT EVENTS [10 marks] You are a chartered accountant and an audit manager at Audit Inc., a medium-sized audit rm. One of your major audit clients is FlyAway Ltd (FlyAway), a listed company. FlyAway is an airline company that specialises in providing an exclusive private jet service to wealthy individuals, including government officials and celebrities. FlyAway’s assets include a eet of luxury jets and, as it has been in operation for a number of years, it also has access to a substantial network of other luxury aeroplane service providers. e following dates are relevant to the audit: ACTIVITY DATE Financial year-end 30 September 20X9 Financial statements to be approved by the board of directors 30 November 20X9 Financial statements to be sent to shareholders 5 December 20X9 e nal and overall materiality gure for the nancial statements was calculated as R8,5 million. e audit eldwork has been completed and you are reviewing the completion and nalisation ndings. Below is Working Paper L1 – LITIGATION AND POSSIBLE CLAIMS that you are currently reviewing: Working paper Client name FLYAWAY LTD Prepared by M Hilton Date prepared Yearend 30 September 20X9 Reviewed by You Date reviewed Audit section LITIGATION AND POSSIBLE CLAIMS 25 October 20X9 L1 Discussions with the company’s legal advisor revealed the following: There is a legal claim against the company by 60 passengers who claim that the airline served them contaminated food. It came to management’s attention that the passengers were admitted to hospital shortly after landing in Durban on 3 October 20X9. The passengers have instituted a claim for damages against the company. The medical reports, dated 5 October 20X9, revealed that the passengers suffered from food poisoning. Upon investigation, traces of an industrial cleaning chemical were found in the food that the passengers were served. On 15 October 20X9, the following estimate of the claim was made by the legal advisor: R60 million. This estimate was based on other similar cases. For audit purposes, this estimate is considered reasonable. REQUIRED Discuss the appropriate audit responses (all steps and further audit procedures) in reaction to the relevant information provided. In addition, discuss the impact on the audit report. Assume the date is 27 October 20X9 today for the purpose of answering the question. (10) Notes: Ignore any taxation and deferred taxation implications of this information. Ignore any aspects regarding possible fraud or a reportable irregularity. SCENARIO 6 OF 6: SUBSEQUENT EVENTS [8 marks] You are a chartered accountant and an audit manager at Audit Inc., a medium-sized audit rm. One of your major audit clients is FlyAway Ltd (FlyAway), a listed company. FlyAway is an airline company that specialises in providing an exclusive private jet service to wealthy individuals, including government officials and celebrities. FlyAway’s assets include a eet of luxury jets and, as it has been in operation for a number of years, it also has access to a substantial network of other luxury aeroplane service providers. e following dates are relevant to the audit: ACTIVITY DATE Year-end 30 September 20X9 Financial statements approved by board of directors 30 November 20X9 Financial statements send to shareholders 5 December 20X9 e nal and overall materiality gure for the nancial statements was calculated as R8,5 million. e audit eldwork has been completed and you are reviewing the completion and nalisation ndings. Below is Working Paper L1 – LITIGATION AND POSSIBLE CLAIMS that you are currently reviewing: Working paper Client name FLYAWAY LTD Prepared by M Hilton Date prepared Yearend 30 September 20X9 Reviewed by You Date reviewed Audit section LITIGATION AND POSSIBLE CLAIMS 25 October 20X9 L1 Discussions with the company’s legal advisor revealed the following: There is a legal claim against the company by one passenger who asserts that the airline served him contaminated food. It came to management’s attention that the passenger was admitted to hospital shortly after landing in Durban on 28 August 20X9. The passenger has instituted a claim for damages against the company. The medical reports, dated 3 September 20X9, revealed that the passenger suffered from food poisoning. There was, however, evidence of several other food products in the contents of the passenger’s stomach. These food products were not served during the ight. At the moment, the value of the claim cannot be estimated as legal discussions are still in progress. Legal counsel did, however, conclude that they think there is an 85% probability that FlyAway will have to make a payment. Although the amount is still unknown, the legal counsel expects with 90% certainty that the amount to be paid as an out-of-court settlement will be less than R100 000. REQUIRED Discuss the appropriate audit responses (all steps and further audit procedures) in reaction to the relevant information provided. In addition, discuss the impact on the audit report. Assume the date is 27 October 20X9 today. Notes: Ignore any taxation and deferred taxation implications of this information. Ignore any aspects regarding possible fraud or a reportable irregularity. (8) [66] Question 2 LEVEL 3 Subsequent events [15 marks] GLTM Inc. was appointed as the auditor of Perfect Tile Ltd (Perfect Tile), a national retailer of tiling products, for the 20X8 nancial year. e nal (performance) materiality gure set by the auditor amounted to R1,5 million. e following timeline exists: 31 December 20X8: Financial year-end 27 January 20X9: Commencement of eldwork at client’s premises 10 February 20X9: Last day audit team was present at client’s premises 4 March 20X9: Financial statements signed off 4 March 20X9: Audit report signed off 11 March 20X9: Financial statements distributed and made available to shareholders and other stakeholders Several events occurred after Perfect Tile’s year-end of 31 December. None of these matters were addressed in any form in the 20X8 nancial statements by Perfect Tile: 1. In January 20X9, Perfect Tile acquired the outstanding noncontrolling interest in one of its subsidiaries, Tile-O-Matic (Pty) Ltd (Tile-O-Matic). e purchase price is R3,6 million, payable over a three-year period and subject to Perfect Tile achieving predetermined levels of nancial performance as per the sales agreement signed on 21 January 20X9. 2. On 5 February 20X9, the management informed the auditor that revenue amounting to R720 000 was overstated in the month of October 20X8 as a result of a junior salesperson who manipulated sales gures in order to obtain a larger performance bonus. e salesperson resigned in November 20X8. By 4 March 20X9, management was still in the process of investigating the matter. 3. On 9 March 20X9, the nancial manager phoned the engagement partner on the audit. Sounding embarrassed, he informed the partner that a rental expense amounting to R162 500 for December 20X8 and pertaining to one of Perfect Tile’s branches was accidentally not recorded in the nancial records. e audit team did not detect this misstatement. 4. On 21 March 20X9, the engagement partner read an article in the business section of a newspaper stating that several of Perfect Tile Limited’s creditors have applied to have the company liquidated due to outstanding debt. REQUIRED Discuss, with reasons, GLTM Inc.’s responsibilities in regard to each of the above-mentioned events that took place at Perfect Tile after the 20X8 nancial year-end. Detailed audit procedures are not required. Assume that management is amicable to any full amendment or disclosures to the nancial statements, where required, for the matters at hand. [15] Question 3 LEVEL 3 Subsequent events [16 marks] You are the senior auditor on the audit of Strawbs (Pty) Ltd (Strawbs), which has a 31 December nancial year-end. e company is one of the largest suppliers of strawberries in South Africa. e company supplies many of the major local shopping chains as well as several foreign grocery stores. e fresh strawberries are harvested from their farms from October to March of each year. In addition to the sales made to the stores, the company allows members of the public to pick their own strawberries at the company’s farms from November to January. Mr and Mrs Strawbs started the business 25 years ago. e equity of the company is currently divided as follows: Harvest Limited Group: 66% Mr Strawbs: 17% Mrs Strawbs: 17% A representative of Harvest Ltd has requested that the audit be completed by the third week of January as the group’s results are to be released to the public at the end of the last week of January. An unmodi ed audit report was submitted to the chief nancial officer of Strawbs on 21 January. e annual general meeting will be held on 31 January. e following two unrelated articles appeared in a local newspaper on 24 January and were brought to your attention for the rst time by a rst year audit trainee the following morning: Extract from article 1 which relates to one of Strawbs’ creditors Fire destroys Somer-grocers, a community grocery store that has served the community of Somerset West for over 30 years. A re broke out in the early hours of Friday morning and by the time the re department reached the premises, the entire building with all its products were destroyed. Extract from article 2 Strawbs’ spokeswoman Ms. Sharon Mhlanga stated, ‘A lawsuit was led against us on 28 December and we decided not to announce it until some background checks had been performed. A family of ve people claim that while picking strawberries at one of our farms they were poisoned by the methyl bromide pesticide that we use on the strawberries, but we cannot provide any further comment at this point as the legal process is underway.’ Additional information Somer-grocers Somer-grocers owed Strawbs R75 000 at year-end. e company was up to date with its payments at year-end. Law suit Two members of the family are still in hospital recovering from the poisoning. e remaining three were released from hospital after spending two weeks under the watchful eye of specialists. e family’s cumulative medical bill to date exceeds R3 million. e family is suing Strawbs for R10 million to cover their total medical costs, damages suffered due to not being able to return to work on time and inconvenience caused. Legal representatives con rmed that there is a 90% probability that Strawbs will have to pay the R10 million. e materiality gure at the client for the December nancial year-end was calculated as R2,5 million. REQUIRED Discuss the impact of the two newspaper articles on the current year’s audit of Strawbs. [16] Note: You are not required to discuss whether the requirements for IAS 37: Provisions and contingent liabilities are applicable. You are also not required to draft detailed audit procedures. Question 4 LEVEL 3 Subsequent events [17 marks] You are an audit manager at Lbw Auditors. e information below relates to two unrelated audit clients of yours. e audit senior requested your assistance. Company 1 – Terminator Pest Control (Pty) Ltd Terminator Pest Control (Pty) Ltd (Terminator Pest Control) is currently involved in discussions to have its controlling interest acquired by Diverse Investments (Pty) Ltd (Diverse Investments). Terminator Pest Control is the largest pest control company in the Western Cape and was incorporated 15 years ago. It has a December year-end. Diverse Investments indicated that it would be relying on the nancial statements when making its decision. Ms Turner, the chief operating officer of Terminator Pest Control, has indicated that she would like to submit the nancial statements to Diverse Investments on 28 January so that they can nalise the acquisition by the middle of February. As another matter, Mr Warner, the company’s chief executive officer, resigned on 29 January. He indicated that his decision was based on his wanting to spend more quality time with his family and that he would complete his four weeks’ notice. Mr Warner is entitled to receive two months’ worth of untaken leave, which equates to R200 000, when he officially leaves the company. You were informed of Mr Warner’s resignation on 30 January. e nal materiality gure for the audit is R150 000. Company 2 – Electro Frames (Pty) Ltd Electro Frames (Pty) Ltd (Electro Frames) assembles and distributes digital photo frames from the warehouse located in Epping and has a December year-end. e company sold a large portion of its inventory at below the inventory’s cost during the month of January. A second-year audit trainee enquired of the chief nancial officer on 1 February if this was an indication that inventory was valued at an amount above the net realisable value at year-end. e chief nancial officer responded by saying that such a question was a clear indication that we did not know what we were doing and that he would ensure that we were not reappointed as the company’s auditors in the following year. e audit trainee has indicated that she believes that inventory is overstated by R650 000 at year-end. e nal materiality gure for the audit is R600 000. REQUIRED Discuss the impact of the information noted above on the nancial statements of each of your clients for their respective nancial years under review. [17] Question 5 LEVEL 3 Subsequent events [17 marks] You are the audit manager on the audit of Citrus Fruits (Pty) Ltd (Citrus Fruits), a company which exports the majority of its harvest to Europe from its farm in the Northern Cape. e company has a February yearend. e nancial statements were issued on 4 April. e following matters were brought to your attention by a member of your audit team at the end of April: Settlement of a contingency e company created a provision for damages of €500 000 (R7,5 million) at year-end, assuming a 60% probability that it will lose the legal case made against it by a customer in Europe who claims that the fruit was contaminated with fungal black spot disease. e disease is harmless to humans, but has the ability to affect the quality and quantity of the harvest. e exchange rate used in providing for the damages at yearend was R15: €1. e court ruled against Citrus Fruits on 23 April. Damages suffered On 17 April, a portion of the production plant was severely damaged by ooding caused by heavy rains. e cost of the damage to the building was R10 250 000. It is expected that the proceeds from the insurance claim will cover only about 60% of this. A provision has not been made in the nancial statements regarding this loss. REQUIRED Discuss the impact of the two issues identi ed by your audit team member at the end of April on the current year’s audit, assuming nal materiality was set at R4 million. You may assume that the company does not intend to recall the nancial statements to make the necessary amendments. [17] Question 6 LEVEL 2 Subsequent events [11 marks] You are a partner at the auditing rm Karma and Partners and responsible for the audit of Woods (Pty) Ltd (Woods). Woods has a 31 October year-end. In carrying out the post balance sheet review, you identi ed the following issue: Wood supplies imported wood to manufacturers of furniture and other wooden products. At year-end, a large amount of inventory of wood was on hand. On 1 December 20X1, certain trading restrictions on wood were lifted, causing the cost of these products to drop drastically. REQUIRED 1. Discuss the above situation, indicating how the matter should be dealt with in the nancial statements for the year-end 31 October. (5) 2. List the procedures commonly performed by the auditors to identify subsequent events. (6) [11] Question 7 LEVEL 3 Going concern [12 marks] You are the manager on the 20X9 audit of Lead Balloon Ltd (LB), a company that provides administrative services to larger South African municipalities on a contract basis. ese contracts are renegotiated on an annual basis. Below is LB’s statement of nancial position at 31 March 20X9, drafted on a going concern basis after the company’s management did its going concern assessment: 20X9 (R) 20X8 (R) 4 879 000 4 694 000 Intangible assets 320 000 2 686 000 Deferred tax 416 000 2 852 000 5 615 000 10 232 000 Inventory 0 76 000 Current tax receivable 0 1 328 000 Trade and other receivables 6 328 000 14 988 000 Cash and cash equivalents 4 563 000 1 422 000 10 891 000 17 814 000 16 506 000 28 046 000 18 122 000 18 122 000 Assets Non-current assets Property, plant and equipment Current assets Total assets Equity and liabilities Capital and reserves Share capital BEE reserves (9 923 000) (9 923 000) Revaluation reserve 1 706 000 615 000 Retained earnings (30 963 000) (21 677 000) (21 058 000) (12 863 000) Interest bearing borrowings 86 000 22 760 000 Deferred tax 478 000 1 543 000 564 000 24 303 000 906 000 1 768 000 Interest bearing borrowings 23 678 000 88 000 Trade and other payables 12 416 000 14 750 000 37 000 000 16 606 000 16 506 000 28 046 000 Non-current liabilities Current liabilities Current tax payable Total equity and liabilities Additional information: the R23 678 000 current liability as at March 20X9 relates to preference shares that are all held by a single shareholder and are redeemable on 1 October 20X9. REQUIRED 1. Per the International Standards on Auditing, what are the auditor’s general responsibilities regarding the going assessment that was done by the client entity’s management? (3) 2. Given the nancial information provided to you, what further audit work would you do regarding Lead Balloon Ltd’s going concern status? (9) [12] Question 8 LEVEL 3 Going concern [18 marks] You are the auditor manager assigned to the audit of Super Cabs (Pty) Ltd (Super Cabs), a privately owned taxi cab service. e company has a eet of 50 vehicles which operates in Cape Town and Johannesburg. e nancial year under audit is 31 December 20X8. e company has a wide range of vehicles available and operates from 5 am until midnight, seven days a week. Prospective customers are able to reserve a cab via the company’s website or by calling the company’s central operations office. e company employed a software developer to build an application for mobile devices which will offer customers a third option for requesting a cab. e developer indicated that he hopes that the application will be ready by the middle of 2020. Super Cabs applied for a transport licence from OR Tambo and Cape Town international airports, which would have allowed the company to pick up customers on the airports’ premises. However, the company was allowed only the right to drop customers off at the airport, not to do pick-ups. e reason given by the airports for declining the licence, which would have meant lucrative business for Super Cabs, is that too many private licences had already been issued to other transportation companies. During the nancial year, legal proceedings were initiated against Super Cabs by one of the approved transportation companies regarding illegal pick-ups made at the Cape Town International Airport. e pickups in question were made whilst Super Cabs awaited the approval of its transport licence. e value of the lawsuit is R100 000. e increasing popularity of individuals registering with the Ubuntu transport network system, a major competitor of Super Cabs, has seen a massive decrease in the number of customers using the company’s services and has translated in the company recording its rst nancial loss since incorporation. e Ubuntu transport system give customers with smart phones the ability to submit a trip request which is routed to Ubuntu drivers in close proximity of where the request was made. e Ubuntu drivers use their personal cars to transport customers to destinations. e company signed a two-year contract, which is set to start on 1 January 20X9, with a large luxury hotel in Cape Town as the sole shuttle service for the hotel. e contract was awarded on the basis that Super Cabs purchased two luxury vehicles which were to be used solely for transporting the hotel’s guests over the next two years. e company purchased the two vehicles at a cost of R500 000 each in December 20X8. Certain drivers at the company have demanded an increase in wages as a result of their having to drive certain ‘dangerous’ routes at night. ey have indicated that if their 10% wage increase is not met in January 20X9, they will refuse to drive these routes or may embark on a wage-related strike. Super Cabs defaulted on payment of its petrol bill in November 20X8. is outstanding bill amounts to R100 000. e company has indicated that it needed to retain cash funds in its bank account in order to qualify to purchase the two additional vehicles needed for the contract with the luxury hotel. e petrol supplier indicated that it is no longer allowed to purchase petrol on credit and has initiated legal proceedings against Super Cabs in order to collect the outstanding bill. e company is currently purchasing petrol at other petrol stations on a cash basis for its ongoing operations. e chief operating officer has indicated that the company fully intends on settling its account within the next few months and hopes that the petrol supplier will understand that withholding payment was purely a business decision and that the company hopes to be able to resume the regular agreement once payment has been made. e chief nancial officer of Super Cabs resigned from the company two months before year-end and, to date, a suitable replacement has not been found. A consultant has been contracted who comes in one week a month to review the nancial accounting records processed by the accounting clerk (a part-time nancial accounting student in his second year of studies). e company does not have access to any other funds as its bank overdraft has been fully extended at year-end. All of the company’s vehicles are under three years old, are in good condition and can be sold for cash quite easily, albeit at an accounting loss. e following is a schedule of key nancial gures extracted from the annual nancial statements at year-end: DESCRIPTION Total assets RAND 12 000 000 Current assets 450 000 Total liabilities 11 000 000 Current liabilities Total equity 540 000 1 000 000 REQUIRED Discuss whether or not Super Cabs will be able to disclose in its 20X8 nancial statements that it will continue as a going concern into the foreseeable future. [18] Question 9 Going concern [16 marks] LEVEL 3 You are the auditor of SA Videos (Pty) Ltd (SA Videos), a provider of home movie and video game rental services. e company has 125 video rental stores located across the country. Its nancial year currently subject to audit ends 31 December 20X8. e company was incorporated in 1982 and was the number one video rental chain in the country for many years, boasting as many as 275 video rental outlets at one point. With the increasing number of options being made available to the South African market to stream movies and TV shows via their smart televisions and mobile devices, the company has been making a loss for the past two years and has seen 25 of its outlets being closed down during the 20X8 nancial year. Mr Hoskins, the former chief operating officer, retired in October 20X8 after faithfully serving the company for 20 years and is intent on travelling the world from 20X9 onwards. Mr Hoskins was replaced by Mrs Plaatjies as the chief operating officer on 10 November 20X8. Mrs Plaatjies is known as a visionary and the board of directors is con dent that, with her leading the company, it will be pro table again in the near future. Mrs Plaatjies believes that the vast majority of South Africans are not able to stream movies and TV shows due to the high cost of internet services compared to other countries as well as the current bandwidth restrictions in the country. She is of the opinion that the company needs to reconsider the current manner in which it offers its products to customers. Mrs Plaatjies appointed Mr Stewart, a marketing expert, to rebrand the company beginning in the 20X9 nancial year, with the aim of better servicing the needs of its customers. is includes launching a website as well as having a greater social media presence. During Mrs Plaatjies’s short tenure at the company, she has been able to negotiate contracts with several petrol stations, convenience stores and large grocery stores to house automated video and game rental kiosks on their premises. e rst rental kiosks are expected to be installed by the end of January 20X9. Mrs Plaatjies envisions having 1 000 mobile kiosks installed by the end of the 20X9 nancial year. e board voted ve to one in favour of the project. One of the board members had a concern about the new project as it requires customers to use their credit cards in order to rent the movies or games at the rental kiosks, instead of having a cash option too. She felt that the South African market was not ready for a product of this nature. Mrs Plaatjies indicated that the reason why rentals had to be made using a credit card arose due to the possibility of customers not returning the products on time or at all. A credit card allows a ‘deposit’ to be reserved when the transaction takes place. Where a customer returns the product within four days, the customer will receive his/her deposit back via the credit card and will be charged a rental fee only for the four days. Where a customer fails to return the product within four days, his/her credit card will be charged the full reserved deposit price, equal to acquiring ownership of the product. A customer who falls into this category will not be permitted to return the product to the rental kiosk from where he/she obtained the product. e company suffered losses in the past when customers did not return movies and games, and Mrs Plaatjies envisions rolling this particular payment system out to local stores too in the next couple of years. For this purpose, SA Videos approached its bank for a R5 million loan, but was rejected as the company’s credit was already totally extended. e company was able to negotiate a loan with another bank on 30 December 20X8, despite the company having made losses over the past two years. e bank indicated that the money will be paid into the company’s bank account on 2 January 20X6. e bank manager indicated that the reason he is willing to grant the loan is based on Mrs Plaatjies’s reputation – he believes that she will ensure that the company honours its monthly repayments until the loan is settled in ve years’ time. Part of the money will be used to fund the initial roll-out of the mobile kiosks and the remainder of the loan will be used to settle some of the company’s existing debt, which it was unable to repay over the past six months. e company has been informed by one creditor, whom it owes R250 000, that if it is not able to settle its debt by 15 January 20X9, the creditor will be forced to take steps to make sure that the company is put into liquidation. e shareholders of SA Videos are unable to contribute any more money to the company and are hoping for a quick turnaround in the nancial situation as they have not received a dividend in nearly three years. e following is a summary of the key nancial gures of the company at year-end: DESCRIPTION RAND Total assets 14 500 000 Current assets 1 050 000 Total liabilities 12 000 000 Current liabilities 1 600 000 Total equity 2 500 000 REQUIRED Discuss whether or not SA Videos will be able to disclose in its 20X8 nancial statements that it will continue as a going concern into the foreseeable future. [16] Question 10 LEVEL 2 Going concern [15 marks] You are a partner at the auditing rm Karma and Partners and responsible for the audit of Universal Projects (Pty) Ltd (Universal Projects), a company that specialises in organising large corporate events. You are currently busy with the nal phase of the audit for the 30 October year-end. You have identi ed various issues concerning the nancial position of the company, including the following: e company has a very signi cant long-term loan that is due to be repaid. e cash ow of the company has suffered severely due to fewer projects being undertaken this year and, as a result, it appears that the repayment terms may not be met. e liquidity ratio is less than favourable and far below the industry norm. ere is a large claim against the company. Inspection of the letter from the company’s attorneys con rmed that the company will most likely lose the case and will have to settle. e settlement is substantial and will severely impact its trading future. After issuing the appropriate audit report to the client but before the release of the report to the organisation, you read a report in a nancial newspaper regarding the liquidation of one of the largest debtors of Universal Projects. You are aware that if this debt is not recovered, the company will not be able to continue trading. REQUIRED List the additional procedures that you, as the auditor, would perform in order to assess the ability of the company to continue as a going concern. [15] Question 11 Going concern [21 marks] LEVEL 2 You are the audit manager on the 31 December 20X8 audit of Seatron (Pty) Ltd (Seatron), a manufacturer of specialist vehicle seats. Responsible for producing the complete seating structure, including the frame, the adjustment mechanism, the safety systems, the upholstery and the head restraints, the company supplies the completed seating units (according to strict design speci cations) to vehicle manufacturers, who install them into their vehicles with virtually no need for further modi cation. At present, Seatron supplies products to one customer only, DNW Ltd (DNW), an international manufacturer of luxury motor cars with a plant situated close to Seatron’s own factory. Although DNW exports most of the vehicles it manufactures to Europe and Asia, the company indicated early in 20X8 that it might relocate its manufacturing operations from South Africa to South America in 20X9 as a result of continuous local labour problems. Accordingly, the management of Seatron has entered into negotiations with DNW with a view to continuing to supply their seating units to DNW at their proposed South American plant. However, Seatron intends retaining their factory in South Africa. e news that DNW will discontinue its South African manufacturing operations has led to several technicians and engineers leaving Seatron in order to join their biggest overseas competitor. As a result of the consequent skills shortage, some manufacturing errors in seat production have occurred, with the result that DNW have had to return faulty units to Seatron. In addition, Seatron’s sales to DNW have steadily decreased during 20X8 owing to a worldwide drop in demand for the latter’s luxury vehicles. Seatron’s pro t margins have thus become tight, as attempts at cutting costs have proven futile. e above difficulties prompted Seatron’s management to prepare a going concern assessment, in which it outlined the current risks to the company’s ability to continue operations into 20X9. In addition, the assessment includes a pro t forecast detailing Seatron’s expected sales and pro ts, as well as a description of several mitigating factors that management hopes will ensure that the company remains viable: Headhunting experts from across the globe and offering them competitive remuneration packages in order to replace those staff members who have resigned Entering into negotiations with other manufacturers of luxury vehicles in South Africa with a view to supplying them with seating units Expanding into additional and highly pro table lines of business, such as advanced vehicle audio and digital electronics, which, it is hoped, will increase sales and customer base Despite the challenges facing the company, Seatron’s management prepared the company’s 20X8 nancial statements on the going concern basis of accounting. e company has two non-executive directors on its board. REQUIRED 1. With reference to the information provided, describe the detailed audit procedures you will perform on the appropriateness of the going concern assumption used in the 20X8 annual nancial statements of Seatron (Pty) Ltd. (16) 2. Discuss the effect of the audit report on Seatron’s 20X8 nancial year should it be concluded that material uncertainty exists about the company’s ability to continue as a going concern. (5) [21] Question 12 Materiality [14 marks] LEVEL 2 You are the audit manager on the audit of Teatime (Pty) Limited (Teatime), a company that produces tea and related products at its manufacturing facility in Malmesbury. Teatime has a March nancial year-end. Final materiality has been calculated at R200 000. In order to nalise the audit, you have requested the third-year audit trainee to summarise all the misstatements arising from the individual audit sections that were audited. She presents you with the following: Matter 1 e nancial manager presented the audit team with the following schedule in respect of the building in which the tea is processed: Opening balance 13 390 000 Add: improvements 210 000 Less: depreciation 1 000 000 Closing balance 12 500 000 Sufficient audit evidence has been performed on the opening and the closing balances for the year under review. e R210 000 capitalised by the chief nancial officer relates to material and labour costs incurred repairing a portion of the building damaged by re, costs that neither improved the capacity of the building nor resulted in Teatime being able to process more tea. e improvements were completed on 30 June of the current year, and the company started accounting for depreciation on the improvement from 1 July. e total depreciation expensed through the statement of comprehensive income for the current nancial year under review was R1 million, of which R5 250 related to the improvements. Matter 2 During the course of the year, the company installed a new machine that increases the rate at which tea is processed by 20%. e total cost of the machine was R1,5 million. e company paid a logistics rm R25 000 to transport the machine to Malmesbury from Durban, whereupon an engineer from the manufacturer installed it at a cost of R75 000. e machine was available for use on 31 March. No journal entries were processed by the nancial accountant relating to the machine purchased. It is company policy to depreciate such machines over a period of ve years. Matter 3 As a result of an inspection of the minutes of board of directors meetings and discussions held with the chief nancial officer, it was established that Teatime has been sued by a Mr Samuels for an amount of R5,5 million. Mr Samuels claims that he had to undergo an emergency operation after drinking tea processed by Teatime. e application was served on the company during February of the current nancial year. e hearing is scheduled to take place in June of the following nancial year. e claim, if successful, will settle Mr Samuels’s outstanding medical bills and compensate him for lost remuneration. e man claims that he purchased caffeine-free tea, as he is allergic to caffeine, but caffeinated tea had been incorrectly packaged in a caffeine-free box. Based on the evidence presented to them, legal advisors have indicated that there is a 95% possibility that Mr Samuels’s claim could be successful. A provision for the lawsuit was not made by year-end. REQUIRED Discuss the materiality impact of each misstatement identi ed on the nancial statements of Teatime for the nancial year under review. [14] SUGGESTED SOLUTION TO QUESTION 12 Matter 1 Maintenance a) It is a factual difference. (1) b) e building account is quantitatively misstated. is arose as a result of management inappropriately capitalising maintenance costs. e amount is above the nal materiality gure. (1) c) Each of the building and the maintenance accounts is overstated by R210 000. (1) d) e management of Teatime will be required to adjust the nancial statements in order to achieve fair presentation. (1) Depreciation a) It is a factual difference. (1) b) e depreciation is overstated by R5 250 and is immaterial. c) e management of Teatime is not required to make (1) any adjustments. e amount may be transferred to the overs/unders list. (1) Matter 2 a) It is a factual difference. (1) b) e machinery account is quantitatively misstated. is arose as a result of management not processing any journal entries related to the acquisition of the machine. e amount is above the nal materiality gure. (1) c) e machinery account is understated by R1,6 million (R1 500 000 + R25 000 + R75 000). (2) e management of Teatime will be required to adjust the d) nancial statements in order to achieve fair presentation. (1) Matter 3 a) It is a judgemental difference. (1) b) e provision for the lawsuit is quantitatively misstated. is arose as a result of management not providing for the lawsuit. e amount is above the nal materiality gure. (1) c) e provision for the lawsuit is understated by R5,5 million. d) e management of Teatime will be required to adjust (1) the nancial statements in order to achieve fair presentation. (1) Combined effect of immaterial errors e only error is the R5 250 depreciation, which will not be material. Available marks [17]; maximum marks [14] Question 13 (1) LEVEL 3 Final materiality [13 marks] Central Prime Ltd (Central Prime) owns and manages a number of shopping malls and office buildings across the country. e company’s nancial year currently under audit by Barnes and Belken Inc. ended 31 December. e planning materiality level for the audit was set at R8,5 million by means of applying the revenue gure of R850 million (1%) in the draft set of nancial statements as a benchmark. e company’s revenue consists primarily of rental income on its various properties. During the course of the audit, it was discovered that the nancial accountant, who had been appointed during the nancial year, had erroneously misapplied accounting standards, with the result that the revenue gure had to be restated. Accordingly, the audited revenue gure amounted to R730 million, and not R850 million as per the draft set of nancial statements. e assistant audit manager proposed that the audit team ‘not waste time’ in considering adapting the materiality level of R8,5 million, despite the restatement of the revenue gure. In the assistant audit manager’s opinion, no adjustment to materiality is necessary owing to the planning work papers on the audit le having already been reviewed and signed off by the engagement partner. REQUIRED 1. Comment on the assistant audit manager’s opinion that it is not necessary to consider adapting the planning materiality level for the audit. Provide reasons for your answer in terms of the International Standards on Auditing. (6) 2. Discuss in broad terms the impact that the revelation of the erroneous application of the accounting standards will have on audit risk and the extent of audit procedures. (3) 3. State whether the materiality level should be increased to R9 million if, by the conclusion phase of the audit, the audited revenue gure of Central Prime for its nancial year ended 31 December was R900 million, adjusted from R850 million as a result of the misapplication of accounting standards. Explain your answer brie y. (4) [13] Question 14 Audit differences [10 marks] LEVEL 2 You are the partner in charge of the audit of the nancial statements of Blunder Ltd (Blunder) for the year ended 31 December 20X1. You are now busy with the evaluating, concluding and reporting stage of the audit process, and have to consider the impact on the audit report of misstatements as per the schedule of unadjusted audit differences. Final materiality for the audit has been set at R6 000 000. Scenario 1 e schedule of unadjusted audit differences re ects that: the sales line item has been overstated by R7 200 000 the cost of sales line item has been overstated by R7 800 000. Scenario 2 e schedule of unadjusted audit differences re ects that: the property, plant and equipment line item has been overstated by R2 900 000 the inventory line item has been overstated by R900 000. Scenario 3 e schedule of unadjusted differences re ects that the company incurred a ne of close to US$1,5 million during the 20X1 nancial year. Management is unwilling to disclose this in the nancial statements and you are of the opinion that it is highly unlikely that the company will be able to pay the ne amount when it becomes due the next month. REQUIRED For each of the above scenarios, discuss the impact of the information provided on the audit report. [10] Question 15 LEVEL 2 Audit differences [12 marks] You are the senior auditor on the audit of Linen World (Pty) Ltd (Linen World), a company that sells a wide variety of linen from its stores located around the country. e company has a December nancial year-end. e materiality at the company has been set at R300 000. During the completion stage of the audit, the following audit difference was brought to your attention by the audit team: 1. In order to increase the company’s net asset value, the directors changed the accounting policy for the buildings owned by the company from the cost basis to the revaluation basis. e company revalued all of its buildings on 31 March and stopped depreciating its buildings on the same date. Management has indicated that they have not processed any depreciation as the revaluation method of accounting indicates that they do not have to. e total depreciation that should have been expensed through the statement of comprehensive income should have been R 800 000 had the revaluation basis been applied properly. 2. e company changed the useful life of its entire delivery vehicle eet from ve years to 10 years. Management could not justify why they changed the useful life of all the vehicles and it is your opinion that the depreciation charge for the year has been understated by R200 000. 3. e executive directors at the company refuse to disclose their remuneration separately in the company’s year-end nancial statements and have opted to disclose their remuneration and other emoluments along with the other employees’ salaries at the company. e total of directors emoluments for the current year is R800 000. REQUIRED Discuss the impact the audit differences had on the audit opinion. In doing so, compile a summary of these unadjusted audit differences. From the summary, conclude if these differences are individually material and indicate the impact it will have on the audit opinion. [12] Question 16 LEVEL 2 Audit differences [12 marks] You are the senior auditor on the audit of Tasty (Pty) Ltd (Tasty). e company supplies a wide range of spices and condiments to wholesalers as well as the public. Materiality has been set at R500 000 for the current year’s audit. e audit has reached the nalisation stage and the following has been documented on le: Improvements made to the administration building e buildings account has been satisfactorily audited but the following has not yet been resolved. An amount of R700 000 has been capitalised as improvements to the building. On further investigation, the audit trainee found that the amount related to repairs that were made to the administration building as a result of a re which had destroyed a portion of the building. A faulty cable caused the re. Impairment of assets Machines with a collective carrying value of R2 100 000 (cost: R3 million; accumulated depreciation: R900 000) were damaged beyond repair or salvage when a sprinkler system malfunctioned in a section of the production facility three days before year-end. e chief nancial officer processed the following journal entry for the affected machines: DESCRIPTION DEBIT Retained income R2 100 000 Accumulated depreciation Assets CREDIT R800 000 R3 million Allowance for credit losses Tasty’s allowance for credit losses provided for in the statement of comprehensive income during the current year is R750 000. e value determined by a member of your audit team for the allowance for credit losses amounts to R1 100 000. Labelling on certain condiments It was brought to your attention by one of the audit trainees that the label used on certain of the products manufactured was in fact misleading as the ingredients that were used the most were stated last on the list instead of rst as prescribed by regulation R146 in terms of the South African food labelling regulations. REQUIRED Advise the audit clerk what he/she should do and what the impact would be on the audit report if Tasty failed to heed the advice (where applicable). All audit differences must be discussed in isolation and income tax implications should be ignored. [12] Question 17 Evaluation of misstatements [15 marks] LEVEL 2 You are the manager on the 28 February 20X1 audit, currently in its nalising phase, of Musicon (Pty) Ltd (Musicon), a national retailer of music CDs and DVDs. e following misstatements in the nancial statements have not been corrected by management: 1. Musicon purchased a large number of CDs featuring the music of an international artist, Frightening Freddy, who was due for a concert tour of the country in March 20X1. However, the tour was cancelled after Freddy became embroiled in a scandal involving him locking his girlfriend in a closet for almost a whole day after a domestic altercation. A public outcry followed, with even ardent fans boycotting Freddy’s music. Audit evidence suggests that Musicon’s inventory consisting of Freddy‘s music CDs at 28 February 20X1 should be valued at R500 000 at year-end, instead of the recorded value of R750 000. is is based on calculations by Musicon’s sales department which show that the CDs will not trade if they are not sold below cost. 2. In February 20X1, Musicon was sued by a customer for R500 000 in damages when the facility that allows customers to preview music malfunctioned: the volume of the music automatically rose so high that the customer experienced a degree of hearing loss. e company’s legal representative indicated to the audit team that at year-end it was highly likely that the aggrieved customer would be successful in his lawsuit. e management of Musicon has not recorded any compensatory amount or made any disclosure in its 20X1 nancial statements, in relation to the lawsuit. 3. Inspection of the bank statement for April 20X1 revealed a payment of R150 000 made by Musicon to a supplier for inventory recorded as assets (and a related trade creditor raised) at 28 February 20X1. Further investigation revealed, however, that the GRN generated for said inventory was signed and dated 3 March 20X1. e nal materiality for Musicon’s 20X1 audit is R350 000. REQUIRED 1. Discuss the materiality and the nature of the above misstatements, both separately and on aggregate. Ignore any VAT implications. (12) 2. Assuming that management will correct misstatements 1 and 3, but not misstatement 2, discuss the effect that misstatement 2 will have on the audit report to be issued for the 20X1 nancial statements of Musicon. (3) [15] Question 18 LEVEL 3 Audit conclusion [12 marks] You are an audit manager at a well-known audit rm. e following matters have been brought to your attention in the nalising of the audits of several of your clients with a September 20X1 year-end: Company 1 – Light Distributors (Pty) Ltd Light Distributors (Pty) Ltd (Light Distributors) has used Super Logistics CC to transport lights from its warehouse to retailers for the past ve years. However, Super Logistics CC was put into sequestration on 25 September. Light Distributors was unable to nd another transport company capable of satisfying its logistical needs. As a temporary emergency measure, the company subsequently decided to lease two trucks on 28 September. e lease contract was for one month and ended on 28 October. e trucks were not depreciated, but were capitalised at R220 000 each at year-end. You advised the chief nancial officer of Light Distributors that the treatment of the trucks was not in accordance with International Financial Reporting Standards, but he indicated that the company is not willing to amend the nancial statements. e nal materiality for the audit has been set at R200 000. Company 2 – Dynamic Investments Group Dynamic Investments (Pty) Ltd (Dynamic Investments), a holding company in the Dynamic Investments Group being audited, is 51% owned by Mr Jack Peterson (who is also the company’s chief operating officer) and Mrs Betty Peterson (who is the chief nancial officer). e remaining shares are held by 19 other investors. e company acquired a controlling stake in Cape Town Diners (Pty) Ltd (Cape Town Diners), a well-established restaurant chain located in the Western Cape. e acquisition was concluded on 5 September of the year under audit, when the R12 million acquisition price was settled. Dynamic Investments has, however, not consolidated its new investment at the end of the nancial year into the group nancial statements, stating that due to Dynamic Investments and Cape Town Diners having two different nancial year-ends, it will be too complex to consolidate the results. Mrs Peterson has indicated that they plan on changing Cape Town Diners’ year-end in the next year in order for consolidation to be possible going forward. e investment in Cape Town Diners is accounted for at cost in Dynamic Investments’s nancial statements at year-end. e following note has been included in the nancial statements: Note 24: Acquisition of new business Dynamic Investments (Pty) Limited has acquired Cape Town Diners (Pty) Limited during the nancial year. This is the company’s biggest acquisition to date and the board of directors believe that the return on investment for shareholders as a result of this acquisition will be signi cant. Due to differing nancial year-ends however, the investment will not be consolidated into the group nancial statements. e nal materiality for the consolidated nancial statements of the Dynamic Investments Group has been set at R1 500 000. Company 3 – Wealthy Investments (Pty) Ltd Wealthy Investments (Pty) Ltd has been forced to shut down temporarily while investigations are being conducted by the South African Police Service. e police allege that the company is being used to launder money from illegal activities conducted by friends of the company’s chief executive officer. e police seized all of the company’s accounting records on 7 October and have indicated that they will return the records once the police investigation has been completed, which is expected to take at least two months. e year-end audit commenced on 5 October and the nancial statements were expected to be signed off by 24 October, as the company’s bank requested a copy of the nancial statements on this date. e audit rm you are employed at was appointed one month before year-end and an interim audit was therefore not possible. e nal materiality level for the audit of Wealthy Investments has been set at R3 000 000. REQUIRED Discuss the impact that each of the above-mentioned matters will have on the audit opinion of the respective clients. [12] Question 19 LEVEL 1 Reporting [10 marks] e International Standard on Auditing (ISA) 700 (forming an opinion and reporting on nancial statement) states that an auditor should form an opinion on the nancial statement based on the evaluation of the conclusion drawn from the audit evidence. REQUIRED Consider whether the following statements are true or false, and if false, motivate your answer. e auditor shall evaluate whether: 1. the nancial statements adequately disclose the signi cant accounting policies selected and applied 2. sufficient appropriate audit evidence has been obtained 3. the accounting policies selected and applied are consistent with the applicable nancial reporting framework and are appropriate 4. all material events occurring 12 months after the reporting date have been appropriately dealt with 5. all qualitative aspects of the entity’s accounting practices, including indicators of possible bias in management judgement, have been considered 6. the information presented in the nancial statements is relevant, material, complete and understandable 7. all misstatements (including clearly trivial misstatements) which have been identi ed during the audit result in a material misstatement of nancial information 8. the nancial statements, including the related notes, represent the underlying transactions and events in a manner that achieves reasonable presentation 9. the accounting estimates made by management are reasonable 10. the terminology used in the nancial statements is appropriate. [10] Question 20 LEVEL 2 Reporting [11 marks] Rhaindeer (Pty) Ltd (Rhaindeer) manufactures a wide range of clothing for the local and overseas market. For its 20X1 nancial year, ending on 31 December, its auditor came to the conclusion that a material uncertainty exists which may cast signi cant doubt on the entity’s ability to continue as a going concern. Management did not disclose this observation in the nancial statements, but did mention the possible going concern difficulties in the directors’ report. Since the matter affects the auditor’s opinion, the auditor concluded, based on audit evidence obtained, that Rhaindeer’s nancial statements as a whole are not free from material misstatement. e auditor further concluded that the effect is material, but not pervasive. is decision was based on the following pertinent information: Rhaindeer incurred a loss of R32 593 400 in its 20X1 nancial year. Liquidity is under signi cant pressure as a result of an inability to sell inventory and collect long-outstanding debts from its trade debtors. e company has lost much of its overdraft facility and creditors have restricted their credit terms. Subordination agreements from large creditors and Rhaindeer’s parent company have been sought, but to no avail. ese agreements are important in the company’s ability to remain technically solvent. A long-term loan of R20 million becomes payable on 30 April 20X2. Management is in the process of negotiating extended terms – an important factor in ensuring solvency. e nancial manager of Rhaindeer made the following comments during a meeting with senior staff (of Rhaindeer) and the engagement partner on the audit: It is ridiculous to think that an auditor should report on the going concern ability of a client company. e auditor is there to report on the nancial statements – not the business itself. Auditors should involve themselves with the accounting aspects of a company and leave the running of the business to management. REQUIRED 1. Prepare the ‘basis for quali ed opinion’ and ‘quali ed opinion’ paragraphs for inclusion in the audit report that will be issued along with the 20X1 nancial statements of Rhaindeer. 2. State whether you agree or not with the comments made by the nancial manager of Rhaindeer and provide reasons to support your answer. You are not required to address matters impacting on the Companies Act 71 of 2008. [11] Question 21 LEVEL 2 Reporting [17 marks] PART A e engagement partner on the audit of Burtrams (Pty) Ltd (Burtrams) concluded that a quali ed audit opinion should be expressed on the company’s nancial statements for the year ended 30 September 20X1. e auditor obtained sufficient appropriate audit evidence in order to conclude that Burtrams will more than likely not be able to nance its operations in the near future or pay off its short-term debt, as the company has been unable to extend its bank overdraft facilities or renegotiate an extension of a short-term loan that becomes payable in full on 14 November 20X2. Additional nance is necessary in order to acquire inventory and continue payment of month-to-month expenses, including salaries and wages, and it is as yet uncertain whether the additional nance can be obtained. In formulating his opinion, the engagement partner considered the following four scenarios: A: The use of the going concern assumption is appropriate, but material uncertainty exists, and disclosure in nancial statements is adequate. B: The use of the going concern assumption is appropriate, but material uncertainty exists, and there is inadequate disclosure in nancial statements. C: The use of the going concern assumption is inappropriate, but nancial statements have been prepared on the going concern basis of accounting. D: The auditor is unable to obtain suf cient appropriate audit evidence in order to support the going concern assumption. The effect is pervasive in nature. REQUIRED 1. Describe the effect that each of the four scenarios above will have on an auditor’s report. (6) 2. Given the conclusion reached by the engagement partner, draft the appropriate Basis for Quali ed Opinion paragraph for inclusion in the audit report to be issued for the 201X1 nancial statements of Burtrams. (3) PART B Nortums (Pty) Ltd (Nortums) is incorporated in South Africa, while its holding company, Gordums Holdings (Gordums), which has an 80% shareholding in Nortums, is registered in the Bahamas. Gordums issues consolidated nancial statements. A South African-based audit rm was appointed to express an opinion on the separate annual nancial statements of Nortums in terms of the International Financial Reporting Standards (IFRS). e audit engagement team noted the following from Nortums’s 20X1 draft nancial statements: 1. No disclosure is made of the relationship between Nortums and its parent company, Gordums. In addition, purchases by Nortums from Gordums to the value of R2.5 million were not disclosed, even though the transactions were fully recorded in the subsidiary’s nancial records and included in its statement of pro t and loss. e amount is below the nal materiality level. 2. Despite Nortums’s requiring a statutory audit in terms of the Companies Act 71 of 2008, no separate disclosure is made in the nancial statements of directors’ emoluments. However, the applicable amounts are included under expenditure in the statement of pro t and loss. Management indicated that they are not willing to make any amendments to the nancial statements in relation to the above issues. REQUIRED Discuss separately the effect that the two issues above will have on the audit opinion and audit report for the 20X1 nancial statements of Nortums. (8) [17] SUGGESTED SOLUTION TO QUESTION 21 PART A 1. For A to C, ISA 570 (Going Concern) outlines the requirements in relation to the audit report. a) A: An unquali ed opinion will be expressed on the nancial statements, (1) but an Emphasis of Matter paragraph highlighting the existence of a material uncertainty as disclosed by management in the nancial statements will be included. (1) b) B: Either a quali ed opinion or an adverse opinion will be expressed on the nancial statements, depending on the pervasiveness of the non-disclosure. (1) In such a case, ISA 570.20 further requires the auditor to state in his/her report (in the Basis for Quali ed Opinion paragraph) that there is material uncertainty that could cast signi cant doubt on the entity’s ability to continue as a going concern. (1) c) C: An adverse opinion on the nancial statements will be expressed. (1) d) D: A disclaimer of opinion will be expressed on the nancial statements. (1) 2. Basis for Quali ed Opinion e company’s nancing arrangements expire, and amounts outstanding are payable on 15 November 20X2. e company has been unable to renegotiate or obtain replacement nancing, which indicates the existence of a material uncertainty that could cast signi cant doubt on the company’s ability to continue as a going concern. erefore, it may be unable to realise its assets and discharge its liabilities in the normal course of business, which is not disclosed in the nancial statements. (3) Available marks [6 + 3]; maximum marks [9] PART B 1. Failure to disclose related party transactions a) In terms of IAS 24.9, Gordums is a related party to Nortums, and this relationship should be disclosed as such in the notes to the nancial statements (IAS 24.13). (1) b) e purchase transactions undertaken by Nortums from Gordums should be disclosed separately from their inclusion in the statement of pro t and loss. (1) c) Both the subsidiary–parent relationship and the purchase transactions are qualitatively material (that is, material in nature), as users of Nortum’s nancial statements will likely be interested to know not only about the ultimate controlling entity of Nortums, but also the extent of intercompany transactions. (1) d) A quali ed opinion will therefore have to be expressed on the nancial statements of Nortums should management not be willing to correct this matter. (1) e) In the Basis for Quali ed Opinion paragraph, the auditor will state the details around the non-disclosure of the related party, as well as the nature of, and the amounts involved in, the related party transactions. (1) 2. Failure to disclose directors’ emoluments a) In terms of IAS 24.17, a company has to disclose the compensation paid to its key management personnel, which includes remuneration paid to its directors. (1) i) e non-disclosure of the remuneration, despite it having been recorded in the accounting records and included in the statement of pro t and loss, results in a qualitative material misstatement (and a quantitative one, should any or all of the amounts in question be above the nal materiality level). ii) e auditor will express a quali ed opinion on the (1) nancial statements and the auditor will describe the reasons for the quali cation in the Basis for Quali ed Opinion paragraph, (1) since the misstatement is con ned to a speci c element of the nancial statements only, and is therefore not pervasive in nature. (1) (b) i) In addition, section 30(4) of the Companies Act 71 of 2008 requires companies subject to a statutory audit to include particulars of their directors’ remuneration in its annual nancial statements. (1) ii) Non-disclosure will give rise to a reportable irregularity, which will have to be reported in a paragraph under the Report on Other Legal and Regulatory Requirements included in the audit report. (1) Available marks [11]; maximum marks [8] Question 22 LEVEL 2 Reporting [21 marks] You are the manager on the 31 December 20X1 statutory audit of Ithuta Education Ltd (Ithuta), an unlisted national company providing private schooling services. Based on the conclusions reached from the audit evidence obtained, an unquali ed audit opinion is to be expressed on the nancial statements. A reportable irregularity did exist, in that the directors knowingly held back returns from SARS relating to VAT on account of cash ow constraints. e reportable irregularity was reported to the Independent Regulatory Board for Auditors. No material misstatement to the nancial statements resulted. A junior trainee accountant on the audit, who requested an opportunity to draft the audit report in order to expand his understanding of the reporting phase of the audit, has submitted the following report: Report of the External Auditor To the board of directors of Ithuta Education Ltd We have audited the nancial statements of Ithuta Education Ltd as set out in the annual report, which statements comprise the statement of nancial position as at 31 December 20X1, the statement of comprehensive income, the statement of changes in equity and the statement of cash ows for the year then ended. Directors’ responsibility for the nancial statements The company’s directors are responsible for: the preparation and fair presentation of these nancial statements in accordance with International Financial Reporting Standards and the requirements of the Companies Act of South Africa; and such internal control as the directors deem necessary in order to enable the preparation of nancial statements free from material misstatement, whether as a result of fraud or error. The auditor hereby does not accept any responsibility for either the fair presentation of the nancial statements or the effectiveness of internal controls. Basis for unquali ed opinion As a result of the suf cient appropriate audit evidence obtained, there was no reason to modify the audit opinion. A clean audit report is therefore issued. Unquali ed opinion In our opinion, the nancial statements present fairly, in all material respects, the nancial position of Ithuta Education Ltd as at 31 December 20X1, as well as its nancial performance and cash ows for the year then ended in accordance with International Financial Reporting Standards and the requirements of the Companies Act of South Africa. Emphasis of matter The International Standards on Auditing require us to alert users of the nancial statements where any form of non-compliance with laws and regulations have occurred. We hereby emphasise the fact that a reportable irregularity took place, in that the board of directors did knowingly hold back returns from the South African Revenue Service relating to value-added tax in contravention of the Value Added Tax Act 89 of 1991. [Insert auditor’s signature here] JDF & Lovitz Incorporated Registered Auditors Per: S Johnston CA(SA) RA: Director 31 Graceway Blue Hills Crowburgh REQUIRED Indicate the errors in, and omissions from, the draft 20X1 audit report of Ithuta Education Ltd submitted by the junior trainee accountant, describing the appropriate treatment for each error/omission identi ed. A rewrite of any particular paragraph is not required. [21] Question 23 LEVEL 2 Reporting [13 marks] You are an audit manager at Tickbird Inc. (Tickbird). e following issues have been brought to your attention in the nalising of the audits of three of your December year-end clients: Client 1: Fast-Food (Pty) Ltd (Fast-Food) A class A lawsuit has been brought against Fast-Food. Mr Roberts, the attorney representing the class, has indicated that over the course of the year claimants had received spam SMSs offering fast-food deals, with some customers receiving up to 10 SMSs over a period of a few weeks. As a result, many of the claimants had suffered a lack of sleep. He indicated that the franchise had obtained the claimants’ mobile numbers when they had requested that orders be delivered. e total value of the lawsuit at year-end was R10 million. Mrs Leagel, the attorney for Fast-Food, has advised that the company is likely to be found guilty as charged, but could not give an estimate of the damages to be awarded. Owing to the fact that the matter was still unresolved at year-end, the directors are not willing to account for or disclose this transaction. Final materiality for the Fast-Food audit has been determined at R6.7 million. Client 2: Easy-Travel (Pty) Limited (Easy-Travel) e pro tability of the travel agency has been greatly affected by the increasing number of individuals making use of online resources when planning and booking vacations, because often they are able to obtain better rates than those offered by Easy-Travel. e company has disclosed in the annual nancial statements the impact that the decrease in the number of clients has had on the ability of the company to continue as a going concern. e nancial statements have been drafted accordingly. Client 3: Island Hospitality (Pty) Ltd (Island Hospitality) e only hotel operated by this company burnt down two hours before the end of the nancial year when a sprinkler system malfunctioned after a re broke out during a New Year’s Eve party. Although there were no casualties, by the time the re department arrived, 95% of the hotel (including the office where all the accounting records had been stored) had burnt down. e nancial statements have been prepared from the information that the accountant had stored on his personal computer. REQUIRED Discuss the impact that the above-mentioned issues will have on the audit opinion of the respective clients. Mark allocation Client 1 (5) Client 2 (4) Client 3 (4) [13] Question 24 LEVEL 2 Reporting [13 marks] e audit team engaged in the external audit of Rolotech (Pty) Ltd (Rolotech) for its nancial year ended 30 September 20X6 is currently nalising its audit. During the year, Rolotech suffered a re at head office that caused the destruction in its accounting department of some master le data relating to the company’s accounts receivable and inventory. Unfortunately, management’s attempts at restoring backups were largely unsuccessful, as a result of which the audit team is unable to audit a signi cant part of the accounts receivable and inventory balances. A rst-year trainee accountant on the audit made the following comment: Companies should take greater care in protecting their nancial data. Rolotech (Pty) Ltd would not have been subject to data loss of this magnitude if it had had stronger internal controls over its backup procedures. We should therefore express an adverse opinion on Rolotech (Pty) Ltd’s 20X6 nancial statements in order to make it clear to shareholders the extent of our difficulty in obtaining audit evidence about debtors and inventory. REQUIRED 1. State the three different types of modi cations to an audit opinion. (2) 2. Explain the terms ‘scope limitation’ and ‘pervasive’ in the context of modi cations to audit opinions. (5) 3. Explain why the rst-year trainee accountant’s comment is misguided as to the type of modi ed audit opinion that should be issued for the 20X6 nancial statement of Rolotech (Pty) Ltd. (3) 4. Assuming that the auditor will disclaim his/her opinion on the nancial statements of the company, draft the audit opinion paragraph – with a heading – for inclusion in the audit report. (3) [13] SUGGESTED SOLUTION TO QUESTION 24 1. Quali ed opinion Adverse opinion Disclaimer of opinion (1) (1) Available marks (3); maximum marks (1) (2) 2. a) A scope limitation applies where an auditor is unable to obtain sufficient appropriate audit evidence for speci c amounts and/or disclosures in the nancial statements on which to base the audit opinion. (1) b) e auditor will conclude that the possible effects on the nancial statements of undetected misstatements, if any, as a result of the limitation of scope, are either: material but not pervasive, in which case the auditor will express a quali ed opinion; or (1) ii) pervasive in nature, in which case the auditor will disclaim his/her audit opinion accordingly. (1) c) ‘Pervasive’ is a term used to describe the effects of uncorrected misstatements on nancial statements, and the effects of possible undetected misstatements (in the case of the latter, as a result of a scope limitation). (1) d) Such misstatements are typically not con ned to speci c aspects of the nancial statements only, but are rather substantial in proportion to the nancial statements as a whole or are fundamental to the users’ understanding. (1) e) Where misstatements are pervasive in nature, the auditor either expresses an adverse opinion or disclaims his/her opinion. (1) i) Available marks (6); maximum marks (5) 3. a) As the audit was subject to a scope limitation, either a quali ed opinion or a disclaimer of opinion (and not an adverse opinion), depending on the pervasiveness of the scope limitation, is required. (1) b) An adverse opinion does not signal an auditor’s inability to obtain sufficient appropriate audit evidence. (1) Such an opinion is expressed rather when the auditor did obtain sufficient appropriate audit evidence, but concluded, as a result of the evidence, that the nancial statements were materially misstated in a pervasive way. (1) Available marks (3); maximum marks (3) 4. Disclaimer of Opinion (1) Because of the signi cance of the matters described in the Basis for Disclaimer of Opinion paragraph, we have not been able to obtain sufficient appropriate audit evidence in order to provide a basis for an audit opinion. Accordingly, we do not express an opinion on the nancial statements. (2) Available marks (3); maximum marks (3) [13] Question 25 LEVEL 2 Reporting [15 marks] You are the nancial accountant at Saniprise Ltd (Saniprise), a large, unlisted manufacturer and exporter of hand-sanitising and chemical cleaning products. e company’s nancial year end was 30 September 20X1, and it is management’s intention to issue the nancial statements to shareholders on 1 December 20X1. It is now mid-October 20X1 and the draft nancial statements have been prepared for the purpose of the external audit, which is due to commence shortly. However, the following issues have not yet been dealt with in the 20X1 nancial statements: On 6 October 20X1, management declared cash dividends to the value of R22.5 million, payment of which to shareholders is due on 5 December 20X1. On 17 October 20X1, one of Saniprise’s debtors, KayLee Distributors (KayLee), with an outstanding balance of R17.4 million (as disclosed in the draft nancial statements), entered into business rescue. Saniprise’s attorneys indicated that it was premature to assume that Kaylee would be liquidated, given the nancial support that the company has received from its business associates. However, the attorneys did not rule out a potential loss for Saniprise, which has, without success, struggled since July 20X1 to collect the debt in question. On 12 October 20X1, a re engulfed one of Saniprise’s chemical raw materials warehouses, leading to what the media dubbed a ‘spectacular explosion visible from kilometres away’. According to the company’s inventory records, material worth R32 million was destroyed in the blaze. e company’s insurer indicated that Saniprise would more than likely be able to recover most of the losses by means of an insurance claim. However, as a result of re damage to surrounding buildings not owned by Saniprise, litigation is expected to be instituted by third parties against the company. On 5 October 20X1, Saniprise repaid in full loan debt to the value of R15.8 million, using internally generated cash resources. e debt, recognised as short-term debt in the draft 20X1 statement of nancial position, was previously acquired from a third party nancial institution. e R15.8 million was the only short-term borrowings Saniprise had at 30 September 20X1. Inventory disclosed in the draft nancial statements at R11.25 million had to be sold at a loss on 10 October 20X1 as a result of a production error discovered shortly after year-end. e sales price of the affected inventory amounted to R8.5 million. On 16 October 20X1, the company’s board of directors announced that, after negotiations that had begun in April 20X1, they had signed an agreement with the shareholders of Elmo Chem (Pty) Ltd to purchase 100% of the shares in Elmo Chem (Pty) Ltd for a total consideration of R32 million. REQUIRED Discuss the effect that each of the above issues will have on the 20X1 nancial statements of Saniprise. Consider all information and amounts as being material. [15] QUESTIONS Question 1 LEVEL 1 Audit and review engagements [10 marks] Consider the following statements: 1. e practitioner expresses a conclusion on the fair presentation of the nancial statements. 2. Quality control systems, policies and procedures in terms of the International Standard on Quality Control 1 (ISQC 1) apply to the engagement. 3. e practitioner expresses reasonable assurance on the fair presentation of the nancial statements. 4. e practitioner needs to comply with relevant ethical requirements concerning independence when performing the engagement. 5. Client management needs to con rm in writing that they accept responsibility for the preparation and the fair presentation of the nancial statements. 6. e practitioner designs and performs primarily inquiry and analytical procedures in order to address all material items in the nancial statements. 7. e practitioner determines materiality for the nancial statements as a whole. 8. e greater the reliance a practitioner wishes to place on an internal control’s operating effectiveness, the more persuasive evidence he/she needs to obtain in this regard. 9. In performing the engagement, the practitioner considers the entity’s ability to continue as a going concern. 10. e practitioner reports that nothing has come to his/her attention that causes him/her to believe that the nancial statements have not been prepared, in all material respects, in accordance with the applicable nancial reporting framework. REQUIRED For each of the above, indicate whether it applies to an external audit engagement, an independent review engagement, or both. [10] Question 2 Audit and review engagements [16 marks] LEVEL 2 As a senior trainee accountant at the rm of Doodles Inc. (Doodles), you have been assigned to the review engagement of Scribbles (Pty) Ltd (Scribbles). When the company’s nancial statements were audited last year, a substantive audit approach was followed. However, owing to a change in its public interest score, the company now requires an independent review for its 31 March 20X1 nancial year, which it has requested that your rm perform. e manager on the review engagement, Kevin Karr, who has already performed the necessary engagement continuance and planning procedures, has: citing a lack of time on his part to design procedures speci cally for the review engagement, instructed you to refer to the previous nancial year’s audit le and simply to duplicate the procedures performed during the 31 March 20X0 audit for the purpose of gathering evidence for the 20X1 review; and stated that review engagements are ‘not as complicated as audits’ and ‘would therefore only require a few rst-year trainee accountants to do most of the work’, explicitly stating that he would thus not expect either you or him to be involved in the engagement to any signi cant extent. REQUIRED 1. Discuss the validity of the engagement manager’s instructions as evinced in his rst comment. Your answer should be substantiated by an explanation of the typical procedures commonly performed on a review engagement in terms of the International Standards on Review Engagements. (8) 2. Discuss in detail the merits of the statements made by the engagement manager in his second comment. In formulating your answer, include reference to the typical procedures performed on a review engagement and the use of professional judgement by a reviewer. (8) [16] Question 3 LEVEL 2 Independent review [14 marks] You are an audit manager at the rm Trolls Inc. (Trolls), a well-known audit rm in Johannesburg, one of whose clients is Toshoes (Pty) Ltd, a shoe manufacturer whose public interest score is 250. e audit partner who completed the pre-engagement activities for this client has provided you with the following approach and strategy document: Client: Toshoes (Pty) Ltd Prepared by: Partner Date: 31 May 20X1 Year end: 28 February 20X1 Reviewed by: Date: 31 May 20X1 Subject: Approach and strategy document A3 After analytical procedures were performed on the linked information (not provided for the purpose of the question), the following line items were considered for additional review procedures: Trade and other receivables Since the balance is above our expectation, additional review procedures will be performed. Trade and other payables Since the balance is above our expectation, additional review procedures will be performed. Revenue Since the revenue is above our expectation, additional review procedures will be performed. REQUIRED 1. Discuss the additional review procedures that you would perform on trade and other receivables. (6) 2. Discuss the additional review procedures that you would perform on trade and other payables. (4) 3. Discuss the additional review procedures that you would perform on revenue. (4) [14] SUGGESTED SOLUTION TO QUESTION 3 1. a) e monthly age analysis for the 12 months should be scanned: i) in order to compare the totals as per the age analysis with the previous month’s; and (1) ii) for such unusual items as debtors with credit balances that should be reclassi ed to creditors, since this will in uence the outcome of the review procedures. (1) b) Management should be asked: i) if the items mentioned in 1(a)(ii) above had been noted and addressed by them; and (1) ii) with regard to individual debtors, where the balances decreased or increased signi cantly from month to month, substantiating their explanation by obtaining supporting documentation. (1) c) e client’s calculation for the allowance for doubtful debt should be obtained and the debtors age analysis at year-end scanned for customers with an outstanding balance above 120 days. (1) d) e debtor’s supervisor or credit manager should be asked about debtors over 120 days not included in the allowance for doubtful debt, and their answers analysed. (1) e) e correlation between debtors and revenue should be investigated (since revenue is above expectation, it is not unusual for debtors also to be above expectation). (1) Available marks [7]; maximum marks [6] 2. a) e age analysis should be scanned for unusual items; for example, creditors with debit balances that should be reclassi ed to debtors since this will in uence the outcome of your review procedures, inquiring from management if such items had been noted and addressed by them. (1) b) e current year’s creditors age analysis should be compared to the previous year’s age analysis, and inquiries made with regard to signi cant creditors in the previous year who are not on the current year’s creditors list. (1) c) e creditors reconciliation for the 10 highest creditors should be scanned for unusual items, and inquiries made as to whether such items had been noted. (1) d) e correlation between creditors and revenue should be investigated (because revenue is above expectation, it is not unusual for creditors also to be above expectation, since more goods need to be purchased in order for the higher revenue gure to be achieved). (1) Available marks [4]; maximum marks [4] 3. a) e sales report for the current year should be scanned for: i) signi cant credit entries; and (1) ii) large credit notes that were processed, as these need to be investigated. (1) b) e sales manager should be asked if unusual items had been noted and followed-up with supporting documentation. (1) c) Analytical procedures on the gross pro t percentage ratio and the correlation between sales and cost of sales should be performed; in addition, the sales manager should be asked about variances noted and it should be followed-up with supporting documentation. (1) Available marks [4]; maximum marks [4] Question 4 LEVEL 2 Report [14 marks] You are the engagement partner on the independent review of Compucache (Pty) Ltd (Compucache), a company selling computer products to customers via the internet, for its nancial year ended 31 December 20X1. e board of directors of Compucache has adopted the International Financial Reporting Standards for small and mediumsized enterprises (IFRS for SMEs) as the company’s nancial reporting framework. Based on the results of this review, there was no reason to doubt the reasonableness of this basis of accounting, to modify the review report or to report on other legal and regulatory requirements. A directors’ report accompanied the annual nancial statements. At the conclusion of the engagement, the manager on the review team, after having taken the previous year’s audit report and adapting it for the purpose of the review, prepared the following report for your attention. Although the company opted for an audit last year, it undertook a review for the current year as per the requirements of the Companies Act 71 of 2008. Independent practitioner’s review report We have reviewed the accompanying nancial statements of Compucache (Pty) Ltd comprising the statement of nancial position as at 31 December 20X1; the statements of comprehensive income, of changes in equity and of cash ows for the year then ended; a summary of signi cant accounting policies, and other explanatory information. Management’s responsibility for the nancial statements The company’s nancial accountant is responsible for the preparation and fair presentation of these nancial statements in accordance with the company’s standard accounting procedures and the requirements of the Companies Act 71 of 2008. Practitioner’s responsibility Our responsibility is to express an opinion on the accompanying nancial statements. We conducted our review in accordance with the International Standard on Review Engagements (ISRE) 2400, which requires us to conclude whether the nancial statements, when taken as a whole, were prepared in all material respects in accordance with the applicable nancial reporting framework. A review of nancial statements in accordance with ISRE 2400 is a limited assurance engagement. The practitioner performs procedures, consisting primarily of making inquiries, where appropriate, of management and others within the entity, applying analytical procedures and evaluating the evidence obtained. Conclusion [To be prepared by engagement partner] Engagement partner’s signature to be furnished, together with the date and the audit rm’s address. REQUIRED 1. Identify and discuss the de ciencies (including omissions) in the above independent review report in terms of the requirement of the International Standards on Review Engagements (ISREs) and the Companies Act 71 of 2008. (10) 2. Draft a conclusion for the independent review report above. (2) 3. Without referring to the above scenario, state the different types of review conclusions applicable to independent review reports. (2) [14] QUESTIONS Question 1 LEVEL 1 Internal controls: Various cycles [10 marks] As the auditor senior at Brainstorm Corporate (Pty) Ltd (Brainstorm), you have been provided by one of the rst-year trainee accountants with a list of key controls that have not yet been matched to a relevant cycle. Internal controls: Brainstorm Access to the warehouse should be restricted to authorised personnel only. Goods may be ordered based only on a properly authorised requisition form. One person should be responsible for the payment of taxes and contributions (the isolation of responsibilities). All cash should be kept in a secure place, such as a safe. All invoices should be compared to purchase orders, delivery notes and GRNs before being posted to the purchases journal. A complete employee le containing all the required documentation for all employees should be kept. The receiving clerk should obtain the purchase order and compare the quantity and the description against the delivery note and the actual goods. Any unmatched documents should be followed up. Clock cards should be prepared by the personnel department in accordance with a valid and current employee list. REQUIRED From the list provided above, group the internal controls to the relevant cycles, as indicated below. INTERNAL CONTROL CYCLE Each internal control matched to the correct cycle (1 mark) [10] Question 2 LEVEL 1/2 Internal controls [24 marks] PART 1 Internal control activities have to be performed properly in order to be successful. As human error can occur, the possibility exists that internal controls will not function as intended. e internal control system may have weaknesses, and thus inherent limitations. REQUIRED Explain the inherent limitations of an internal control system. (6) PART 2 Internal controls are classi ed as controls that may prevent, or detect and correct, possible weaknesses. A combination of these controls is sufficient if they are functioning as intended. e following controls are those that may either prevent or detect an error or control weakness: 1 All purchase invoices are compared to payment advices after payments have been made. 2 The procurement manager conducts spot checks on a quarterly basis on the authorisation of purchase orders. 3 The system does not allow any user to exceed his/her limit with regard to an order being placed or payment being approved. 4 All cheque payments are approved by managers in the company’s nance department. 5 Security does not check products leaving the premises, as a result of the company’s belief in each person’s right to privacy. 6 Only the nancial director may transfer funds electronically, using passwords on the banking system. 7 All employees may order products by submitting an electronic purchase requisition. The system does not have any control in order to verify the validity of the purchase and the budget for the product. 8 Budgets are prepared for capital expenditure and are reviewed quarterly by the nancial director. No actions are taken, and the expenditure is accepted. 9 The storeman receives the products and signs as proof of delivery. The delivery note and the purchase order are led. 10 Payments for products are processed based on the invoice and the monthly statement received. 11 Assets below R10 000 are strictly controlled. A purchase requisition and a purchase order should be authorised by the responsible supervisor and approved by the department’s nance manager before the order may be placed. REQUIRED Indicate whether the controls listed above are preventative controls, or detective and corrective controls. Supply reasons for your answers, which should be presented in tabular form. (18) [24] Question 3 LEVEL 2 Key controls, control objectives, tests of controls: Receipts [25 marks] Glassnovations (Pty) Ltd (Glassnovations), a large wholesale distributor of household glass items, has been an audit client of your rm for many years. Last year, the audit team placed reliance on the internal controls in the company as part of the audit of cash receipts. e company’s nancial year for the current audit is 30 June. During the interim audit, the following updated system description based on an interview with staff members was prepared by a second-year trainee accountant responsible for the audit of cash receipts: All sales by Glassnovations are to retail customers, and on credit. Customers settle their accounts either by EFT or by paying cash in person at the company’s administration office. 1. Controls over cash receipts a) When receiving cash, the company’s cashier, Ms Bonny Blue, generates a receipt from the computerised cash register to hand to customers. e transaction is automatically posted to a pending cash receipts le on the computer system to await reconciliation with the bank deposit slip (see (e) below). b) At the end of each business day, Ms Blue counts the cash received and compares the total to the daily receipt report printed from the computerised till. She prepares a daily deposit slip indicating the total cash takings to be banked. c) Ms Blue places the cash with the deposit slip into a cash bag and places it in a drop safe located on the premises, to which only the company’s general manager, Mr Danny Goldberg, and the guards of the company’s security agent have a key. Both keys are needed in order to unlock the safe. d) Cash is banked on a daily basis by the security agent’s personnel, whereupon a copy of the bank-stamped deposit slip is returned to the company’s cash book clerk, Ms Bulelwa Mthuba. e) Ms Mthuba releases on a daily basis the batch of pending cash receipts le on the computer system (see (a) above) for recording to the cash book, after having agreed the total amount pending to the bank-returned deposit slip. e total of each day’s deposit, together with the individual receipts making up the total, is displayed on the on-screen cash book. f ) On a weekly basis, the company’s nancial manager, Ms Ruby Padayachee: prints an exception log from the system of all missing or cancelled receipts in the cash book for review and follow-up with the cashier reviews the sequence of dates in the cash book for recorded cash deposits in order to ensure that daily batches of receipts as per (e) above have been released agrees the total amount of daily deposits recorded in the cash book to the bank-stamped deposit slip. g) Ms Padayachee attaches the exception log to the deposit slip, signs both documents as evidence of the above review having taken place and les them with the daily receipt report. 2. Controls over EFT receipts a) Ms Mthuba checks the online bank statements on a daily basis in order to identify EFT deposits from individual debtors and to post these to the cash book. b) She records any unidenti ed deposits on a list of unidenti ed deposits, indicating all pertinent information relating to such deposits, such as the dates, the deposit references (if any) and the amounts. 3. Controls applicable to both cash and EFT receipts a) At the end of each month, Ms Mthuba prepares a bank reconciliation in order to reconcile the balance in the cash book to the balance on the bank statement. b) Ms Padayachee reviews the bank reconciliation by comparing all balances to supporting documentation, thereby ensuring that valid reasons exist for reconciling items. c) Ms Padayachee also agrees the total of unidenti ed deposits to the latest list of unidenti ed deposits prepared by Ms Mthuba and follows up on any differences until they have been properly resolved. d) Debtor queries are handled by the company’s credit controller, Ms abo Mabenge. REQUIRED 1. Describe the key internal controls evident from the system description that you would rely on for the purpose of auditing cash receipts in the company’s nancial statements. Ignore controls over the segregation of duties, computerised controls and logical access controls. (5) 2. State the control objective(s) achieved by each of the key controls identi ed in question 1. (5) 3. Describe the test of control procedures the audit team should conduct on each of the key controls identi ed in question 1. (10) For each of the above questions (1–3), present your answers in tabular form. 4. Comment on whether you consider the segregation of duties over cash receipts to be strong or weak in Glassnovations. Explain your answer. (5) [25] Question 4 LEVEL 2 Key controls, control objectives and tests of controls [30 marks] You are the senior on the audit of Vivaldi Trading (Pty) Ltd (Vivaldi Trading), a large distributor of self-assembly furniture (procured mostly from overseas suppliers) to numerous retailers around the country. All sales are on credit, and deliveries are made using the company’s own eet of trucks. Your audit manager has indicated that, as in the previous year, the audit team intends to rely on the company’s system of internal controls for the purpose of auditing the nancial statements. You have already obtained sufficient appropriate audit evidence of such controls over credit background checks for customers (i.e. the approval and awarding of credit limits). Other pertinent details about the company’s revenue and receipts cycle are as follows. e company’s sales office, staffed by two sales order clerks, receives customer sales orders by fax. For each order, the sales clerk on duty makes out a carbon-copied and sequentially numbered internal sales order (ISO), all of which are submitted to the sales manager, Mr Mozart, who: approves each order by checking that the customer is still within his/her credit limit signs the ISO as evidence of approval checks the quantities on the ISO with the original fax order in order to ensure that the ordered quantities have been correctly included on the ISO. ereafter, a duplicate picking slip is prepared by the sales clerk. Using this slip in order to select the goods from the warehouse shelves, a storeman requests the warehouse manager, Mr Bach, to authorise the issue of the goods. Both of them sign the picking slip, if they agree that the correct goods and quantities are being transferred to the dispatch area as per the slip. e storeman then prepares a carbon-copied, fourpart and sequenced delivery note, based on the physical goods being transferred to dispatch, for submission to the dispatch section. is section, working from a separate fenced-off area in the warehouse, receives the goods from the storeman, only if the latter can produce both an authorised picking slip and the delivery note. e chief dispatch clerk, Mr Schubert, checks all goods before giving instructions for the goods to be loaded onto a delivery truck. At the exit gate, security guards perform a spot check on boxes leaving the premises. Each box clearly indicates the item number and the description of the kit inside (e.g. VT 3482 Bookcase). Upon delivery of the goods, the driver requests the customer to sign the four-part delivery note after the latter has checked the quantities and the descriptions of the goods in terms of the delivery note. e rst copy is handed to the customer for his/her records. When the driver returns to the company, the second copy is sent to the sales office as con rmation that the order has been lled, while the third copy is given to Ms Strauss, the invoicing clerk in the accounting department. e delivery book containing the rst copy of the delivery note is returned to the storeman for ling with the picking slip. Ms Strauss prepares a sales invoice based on the quantities as per the delivery note and refers to the company’s authorised price list for the sales amount of each product sold. Afterwards, Mr Chopin, the bookkeeper, casts and recalculates each invoice, and agrees the quantity on the invoice to the delivery note and each product’s sales amount to the price list. He stamps the invoice as having been checked, as proof of his having performed this duty. Ms Strauss sends the original invoice to the customer, while the rst copy is given to Mr Chopin for posting to the sales journal. Ms Strauss les the second copy with the supporting documentation in the number order of the delivery note, in the cleared delivery notes le. e assistant nancial manager, Ms Elgar, carries out weekly control procedures on sales transactions recorded in the sales journal. While doing so, she performs spot checks on sales entries in the sales journal in order to ensure that: each transaction selected is supported by an invoice, a delivery note and an ISO (referring to the second copy of the invoice kept in Ms Strauss’s office) no duplicated invoice entries exist the amount recorded agrees with the amount invoiced. At the same time, Ms Elgar carries out a sequence check on the invoice numbers in the sales journal in order to ensure that no gaps exist in the recorded sequence. She also reviews the cleared delivery notes le in order to ensure that there are no gaps in the delivery note sequence. Any discrepancies are followed up with the dispatch and the accounting staff members concerned. Ms Elgar signs a weekly control checklist as proof of having performed the control procedures, noting any exceptions on the checklist. When an exception is resolved, she indicates thus next to it. REQUIRED 1. Identify and describe the internal controls that would be relevant to the audit of the revenue gure in the nancial statements of Vivaldi Trading (Pty) Ltd evident from the above system description. 2. State the control objective for revenue that management intends to achieve with each control identi ed in the rst section. 3. State the management assertion regarding revenue being addressed by each of the controls identi ed in part A. 4. For each control identi ed, describe the test of control procedure(s) you would perform in order to obtain audit evidence of the operating effectiveness of the control. Present your answers to all four questions concurrently in tabular form. [30] SUGGESTED SOLUTION TO QUESTION 4 NO. (1) CONTROL RELEVANT TO THE AUDIT (2) CONTROL OBJECTIVE ACHIEVED (3) ASSERTION AFFECTED (4) TEST OF CONTROL PROCEDURE a. 1. Mr Mozart approves sales orders by checking that the customer is still within his/her credit limit. (1) 2. Validity of recorded sales (1) 3. Occurrence of revenue (1) 4. For a sample of sales transactions selected from the sales journal, inspect the corresponding internal sales orders for the signature of approval of Mr Mozart authorising the sale (the ISO will most likely be attached to the invoice). (1) NO. (1) CONTROL RELEVANT TO THE AUDIT (2) CONTROL OBJECTIVE ACHIEVED (3) ASSERTION AFFECTED (4) TEST OF CONTROL PROCEDURE b. 1. Security guards at the exit gates perform spot checks on the boxes leaving the premises. (1) 2. Completeness of sales transactions (1) 3. Completeness of revenue (1) 4. Observe the security guards checking the contents of a truck leaving the premises. (1) Note: By checking the goods leaving the premises, the security guards con rm that the goods have been recorded on delivery notes. If they have not been recorded, the sales will be lost (incomplete) if the customer accepts the goods without evidence of the goods having been delivered. This risk applies especially where invoice quantities have been prepared based on delivery note details. Inquire from management as to the reliability and consistency of the security checks applied throughout the nancial year, noting any problems of which they might be aware. (As observation by the auditor will be a one-off procedure, possibly only after the nancial year has ended, additional evidence as to the operating effectiveness of the control during the year is also required [see the points made above].) (1) NO. (1) CONTROL RELEVANT TO THE AUDIT (2) CONTROL OBJECTIVE ACHIEVED (3) ASSERTION AFFECTED (4) TEST OF CONTROL PROCEDURE Inquire from the security guards about their checking function in order to determine whether they understand, and are aware of, their duties. (1) c. 1. Customers are required to sign the delivery notes as acknowledgement of having taken ownership of the delivered goods. (1) 2. Validity of sales transactions (1) 3. Occurrence of revenue (1) 4. For a sample of sales transactions recorded in the sales journal (it may be the same sample as in 1 above): a) trace the entry to the supporting invoice and to the attached delivery note (1) b) inspect the delivery note for an indication of the client’s acknowledgement of receipt of the goods (either a signature or a stamp). (1) NO. (1) CONTROL RELEVANT TO THE AUDIT (2) CONTROL OBJECTIVE ACHIEVED (3) ASSERTION AFFECTED (4) TEST OF CONTROL PROCEDURE d. 1. The costs and calculations on the invoices are checked by a second person (Mr Chopin), who also agrees quantities to the delivery note and prices to the authorised price list. (1) 2. Accuracy of recorded sales transactions 3. Accuracy of revenue (1)(1) 4. For a sample of sales recorded in the sales journal (it may be same sample as in 1 above), trace the entries to the corresponding invoice and inspect the invoices for the stamp made by Mr Chopin as evidence of the checking control having been performed. (1) In order to verify the operating effectiveness of the control: a) Re-perform the costs and calculations on the invoices. (1) b) Agree the item quantities on the invoice to the quantities on the attached delivery note. (1) c) Agree the prices on the invoice to the authorised price list applicable at the time of sale. (1) NO. (1) CONTROL RELEVANT TO THE AUDIT (2) CONTROL OBJECTIVE ACHIEVED (3) ASSERTION AFFECTED (4) TEST OF CONTROL PROCEDURE e. 1. Ms Elgar reviews the sales journal on a weekly basis in order to ensure that all entries are supported by an invoice, a delivery note and an ISO, and that no duplicate entries exist. (1) 2. Validity and accuracy of recorded sales transactions (2) 3. Occurrence and accuracy of revenue (2) 4. Scrutinise the weekly control checklist obtained from Ms Elgar for any indications of weeks for which she did not sign as proof of having performed the weekly review on the sales journal. (1) When performing the above control test, note any exceptions for which ‘resolved’ has not been written next to it, and follow them up with Ms Elgar as to the reasons for the delay in action. (1) In order to con rm the operating effectiveness of the control (especially since only spot checks are performed by Ms Elgar), select a sample of sales transactions recorded in the sales journal (note the direction of the testing) and: a) re-perform the control procedure NO. (1) CONTROL RELEVANT TO THE AUDIT (2) CONTROL OBJECTIVE ACHIEVED (3) ASSERTION AFFECTED (4) TEST OF CONTROL PROCEDURE by tracing each selected transaction to its supporting documentation, and verify whether a corresponding invoice, delivery note and ISO exist (1) b) scrutinise the sales journal for duplicated sales entries (1) c) agree the amount recorded in the sales journal to the amount on the invoice. (1) NO. (1) CONTROL RELEVANT TO THE AUDIT (2) CONTROL OBJECTIVE ACHIEVED (3) ASSERTION AFFECTED (4) TEST OF CONTROL PROCEDURE f. 1. Ms Elgar, the assistant nancial manager, carries out a sequence check on the invoice numbers in the sales journal in order to ensure that there are no gaps in the recorded sequence. (1) 4. The control procedure as per (e) above will apply equally to the following completeness control test. In order to con rm the operating effectiveness of the control, re-perform Ms Elgar’s sequence checks by inspecting: She reviews the le of delivery notes in order to ensure that there are no gaps in the sequence of note numbers, and that an invoice has been attached to each of them. 2. Completeness of recorded sales (1) transactions 3. Completeness of revenue (1) (1) a) the sales journal for the sequence of invoice numbers in order to verify that there are no gaps in the recording thereof (1) b) the cleared delivery notes le for the sequence numbers of delivery notes in order to detect any missing delivery notes and thus possible unrecorded sales transactions. (1) Available marks [38]; maximum marks [30] Question 5 LEVEL 2 Control objectives and tests of controls [20 marks] You are a trainee accountant assigned to the audit of the revenue and receipts cycle of Sure Surf (Pty) Ltd (Sure Surf ) for its nancial year ended 30 November 2015. A wholesaler of swimming and sur ng gear, the company operates from an administrative complex in Durban next to a warehouse used for storing and dispatching the company’s inventory. Sure Surf sells its products to numerous retailers across the country. All sales are on credit. During an interview with the company’s nancial manager, Valerie Rizzo, you posed several questions concerning key controls in the revenue and receipts cycle: 1. Are all applications for credit approved after creditworthiness checks have been performed on the prospective customers applying for credit? Client response: Yes. I personally approve all credit applications only once the credit controller, Cara McLaren, has allocated a credit limit to the customer on the application form. Cara attaches her worksheet to the application form on which the result of the creditworthiness check appears, which I then approve by signature. 2. Are all sales orders approved in order to ensure that the customer’s account will still be within the allocated credit limit after the sale has been processed? Client response: Yes. The company takes the approval of customer orders seriously, and has assigned this duty to the sales manager, Bongani Mantewu. The sales clerk on duty has to submit a daily sales order schedule (a summary of the day’s sales orders) together with the attached pending internal sales orders (ISOs) to Bongani, who then stamps the sales schedule as approved after a careful review of each customer’s credit status. 3. Are spot checks performed on dispatched goods at the exit gate before delivery vehicles leave the company’s premises? Client response: We employ an external courier to deliver goods to customers. After the trucks have been loaded at the warehouse, they do not get checked at the exit gate. However, our inventory supervisor, Ron Deacons, is present when boxes are loaded in order to ensure that the contents of the boxes agree with the delivery notes. He stamps each delivery note as evidence of the check. 4. Are customers requested to sign delivery notes as proof of having received ordered goods? Client response: We regularly remind the courier company’s delivery personnel to request customers to sign the delivery notes, owing to the fact that we experienced instances in the last nancial year where customers did not always sign them. 5. Does management review the nancial records for evidence of missing sales entries (sales that have not been recorded)? Client response: In order to check for evidence of missing sales entries: I review the sales journal on a weekly basis to check for any missing invoice numbers by referring to their number sequence. The journal has a space for a reviewer to sign, which I duly do. I also go through the le of unmatched delivery notes in order to follow up on any missing delivery notes for which no invoice, and thus no entry in the sales journal, exists. However, I do not sign as evidence of this check. REQUIRED 1. State the control objective(s) for each of the controls listed above in the internal control questionnaire, explaining the purpose of each. (8) 2. Assuming each control in the questionnaire is relevant to the audit, describe the tests of controls you would perform in order to obtain evidence of the operation of the controls. (12) Assume that the company does not make use of computerisation in its business and accounting processes. [20] Question 6 LEVEL 2 Control objectives and purpose: Computerised systems [18 marks] You are the senior in charge of the audit of Cutting Edge (Pty) Ltd (Cutting Edge), a company that provides weekly gardening services to private residences. You have prepared the following system description relating to sales: Interested new customers open a credit account with the company by completing a credit application form and supplying a copy of their ID document. Cutting Edge has requested a credit bureau, Credit Investigations CC, to perform credit background checks on all potential customers. Based on the results, a credit limit is awarded to each customer by Cutting Edge’s senior sales agent. New customers are added to the service module on the company’s computerised system. On a weekly basis, the company’s nancial manager requests the computer system to print a report of all new additions to the service module in order to compare them to the credit bureau’s credit report and the customer application forms. e service fees for garden services charged to each customer, which are determined by the senior sales agent, are entered by him onto the service module. e nancial manager prints a report of customers who have exceeded their credit limits in order to ag such customers on the system. However, this does not limit the processing of sales should a sale lead to a customer’s credit limit being exceeded. Flagged customers are not eligible to receive any further garden services until they have settled their outstanding accounts. At the start of each week, the chief gardener prints a service register from the service module containing a listing of all those customers eligible to receive garden services that particular week. e register is completed by the gardening supervisors at the end of each day in order to indicate which customers received a service (it does occasionally happen that entry cannot be gained to a residence). e chief gardener reviews the register on a daily basis, following up with the gardeners as to why certain gardens were not serviced. At the end of a week, the company’s data capturer captures the details of the services provided to customers from the service register onto the service module. She can select from an on-screen drop-down list only those customers who are already on the service module, as the system does not allow her user ID to add new customers. Afterwards, the company’s debtors clerk compares the service register with the data-capturing results. At the end of each month, Cutting Edge’s debtors clerk prepares from the service module electronic invoices for emailing to all customers. After completion thereof, an invoice report is generated indicating the number of weeks the customer received services and the weekly rate at which he/she was invoiced (e.g. four weeks of services at R75 per week = R300). e nancial manager compares the service register with the invoice report in order to check for any customers who received services but for whom no invoice has been prepared. REQUIRED By stating the control, as well as the control objective(s), identify the internal controls from the above scenario that affect the recording of sales transactions. In addition, describe the purpose of each control. [18] SUGGESTED SOLUTION TO QUESTION 6 1. a) Control: A credit bureau performs a credit background check on all potential customers, to each of whom a credit limit is awarded. b) Control objective: Validity of sales transactions (1) (1) c) Purpose of the control: In order to prevent credit sales to customers who are unlikely to pay their debts, thereby curbing or mitigating possible nancial losses. (1) 2. a) Control: e nancial manager compares all new additions on the service module to the credit bureaux credit reports and the customer application forms. (1) b) Control objective: Validity of sales transactions (1) c) Purpose of the control: In order to ensure that only valid and approved customers, with whom the company can transact without excessive risk being taken as to the collectability of debt, are added to the service module. (1) 3. a) Control: e nancial manager prints a report of customers who have exceeded their credit limits and ags the customers on the system. (1) b) Control objective: Validity of sales transactions (1) c) Purpose of the control: In order to prevent future services (sales) to the customer for which he/she will not be able to pay, which could result in nancial losses for the company. (1) 4. a) Control: e chief gardener reviews the service register on a daily basis and follows up with the gardening supervisors as to the reasons for certain gardens not having being serviced. (1) b) Control objective: Completeness of sales transactions (1) c) Purpose of the control: In order to ensure that all services rendered have been indicated on the register. Owing to the fact that sales are captured from the service register, they will not be complete if a service was rendered but not recorded on the register. (1) (Note: is control has an operational objective, in the sense that customers could accidentally be overlooked and not have their gardens serviced. e chief gardener’s review might pick up such instances, which would avoid making such customers dissatis ed.) 5. a) Control: e data capturer may select only those customers already on the service module; the system does not allow her to use her user ID in order to add new customers. (1) b) Control objective: Validity of sales transactions (1) c) Purpose of the control: In order to prevent the data capturer from creating ctitious debtors or debtors who are not creditworthy (i.e. credit customers who might not pay their debts). (1) 6. a) Control: e debtors clerk compares the service register with the results of the data capturing in terms of services rendered. (1) b) Control objective: Accuracy and completeness of sales transactions c) Purpose of the control: In order to ensure that the number of (2) services per customer has been accurately captured, and captured in full (i.e. no input data are missed): if a service has not been captured, it will not be invoiced, as the data on the service module are used for invoicing purposes. (1) 7. a) Control: e nancial manager compares the service register with the invoice report. (1) b) Control objective: Completeness of sales transactions (1) c) Purpose of control: In order to ensure that all revenue transactions have been recorded that should have been recorded (based on actual services rendered). (1) Available marks [22]; maximum marks [18] Question 7 LEVEL 2 Control objectives and purpose: Computerised systems [20 marks] Kim Kleyn is an internal auditor at Techpoint (Pty) Ltd (Techpoint), a company that distributes computer hardware to retailers from a large store on the East Rand. e company, whose system is computerised, records its sales only after a customer-signed delivery note has been returned. During a particularly busy day, Kim observed the following controls in place: 1. After performing a credit background check, the company’s credit controller denied a request for an increase to a customer’s credit limit. 2. e senior bookkeeping clerk scrutinised the le of unmatched delivery notes in the invoicing section in order to identify any delivery notes for which no invoices had as yet been prepared by the invoicing clerk. 3. e security guards at the gate compared the physical goods in a delivery truck leaving the premises to the delivery note dispatched with the consignment. 4. e invoicing clerk was prompted by the sales system on the computer to supply an internal sales order number before she could proceed with preparing an invoice on the system. 5. While the invoices were prepared by the invoicing clerk on the computer, the computer automatically assigned a number to each invoice in numerical sequence. 6. e invoicing clerk did not have to input sales prices manually on the on-screen sales invoice while the item numbers were being input by the clerk. Rather, the computer automatically allocated to items prices sourced from the approved price list master le stored on the computer system. 7. e cash takings for the day were stored in a secure reproof safe overnight while awaiting deposit the next day. 8. e senior bookkeeping clerk compared the deposit slip returned from the bank with the cash recorded in the cash receipts journal. 9. e nancial manager reviewed the most recent bank reconciliation for any unusual entries and signed the reconciliation as proof of review. 10. When the sales clerk tried to create a credit note on the sales system, the system denied her access to the sales adjustments module. REQUIRED State the control objective(s) of the internal controls listed above, explaining the purpose of each. [20] Question 8 LEVEL 2 Risks and substantive procedures [24 marks] Your audit rm is conducting the year-end audit of ADACO (Pty) Ltd (ADACO), a leading South African healthcare company that manufactures, markets and distributes a range of branded and generic prescription and over-the-counter medicines, as well as personal care products. e following transaction took place during the nancial year ended 31 July 20X1. PHARMA (Pty) Ltd (PHARMA), a medium-sized pharmaceutical sales and marketing business in South Africa, was acquired on 1 February 20X1. Both parties agreed to the purchase price of R782.4 million. e fair value of the identi able assets as at the date of acquisition is outlined below: ASSETS R’000 Property, plant and equipment 32 000 Marketing-related intangible assets 618 748 Customer-related intangible assets 55 498 Contract-related intangible assets 13 040 Manufacturing-related intangible assets 1 630 Total identi able net assets at fair value 720 916 Goodwill arising from acquisition 61 484 Purchase consideration 782 400 e major factor contributing to the recognition of goodwill of approximately R61.5 million was related mainly to the fact that PHARMA has an established presence in the human immunode ciency virus (HIV) and acquired immunode ciency syndrome (Aids) pharmaceutical markets in South Africa. PHARMA plays a vital role in the continuous battle against both the virus and the syndrome in South Africa through the manufacture of antiretroviral drugs and HIV testing kits for supply to such stakeholders as the South African government. Included in the property, plant and equipment balance of ADACO as at 31 July 20X1 are the following items (including the PPE items obtained through the acquisition of PHARMA): e land and the buildings on which the production plant and the four distribution centres are situated Production plant equipment and machinery Delivery vehicles Office equipment and furniture (including computers, servers, etc.) REQUIRED 1. Provide the factors that you, as the auditor, would consider in assessing the control risk of intangible assets and goodwill of ADACO. 2. Describe the substantive audit procedures that you would (7) perform in order to address the rights and obligations assertion pertaining to intangible assets and goodwill acquired in the acquisition of PHARMA (Pty) Ltd. (4) 3. Provide examples of substantive analytical procedures that you would perform in the audit of property, plant and equipment of ADACO as at 31 July 20X1. (7) 4. Describe the substantive procedures that you would perform in order to verify the existence of PPE items, as well as the rights of ADACO relating to these as at 31 July 20X1. You need not discuss those procedures relating to disposals or unrecorded disposals. (6) [24] Question 9 LEVEL 3 King IV™ report [17 marks] As audit senior working at FZ Auditors (FZ), a rm of registered auditors, you have been assigned to the audit of Bestfurn Ltd (Bestfurn), a JSE-listed furniture retailer. e following information pertains to the company: Board of directors James Kirk (69): chairperson It is to the leadership of James Kirk, who founded Bestfurn in 1996, that much of the company’s growth and success may be attributed. Although he holds some 22% of the issued shares in the company, these are loaded with voting rights, which enable him to control the company. James Kirk is involved in the day-to-day operations of the company. James Kirk is also the chairperson of the remuneration committee, the social and ethics committee, and the risk committee. Gary Porter (67): chief executive officer Gary Porter is a close friend and a long-time colleague of James Kirk. Last year, his total remuneration package of some R28 million attracted considerable media attention in the light of Bestfurn’s relatively poor performance and the low salaries of other employees of Bestfurn that year. Gary Porter is a member of the nomination committee as well as the remuneration committee. Reginald Khumalo (67): chief operating officer Jenny Parbhoo (36): marketing director Arnie Becker (43): non-executive director Arnie Becker is a director of Secretariat (Pty) Ltd, the company that provides secretarial services to Bestfurn, and attends Bestfurn’s board and board committee meetings in order to ensure that members are kept informed of regulatory requirements. Secretariat (Pty) Ltd is deemed to be a signi cant service provider of Bestfurn. Samuel Bloomberg (61): non-independent, non-executive director Samuel Bloomberg, who holds an MBA from a highly regarded US business school, serves on the boards of numerous large companies and non-pro t organisations. He is a close friend of James Kirk, who approached him to join Bestfurn’s board. Other information about staff Pat Johnson is Bestfurn’s chief nancial officer. She is a CA(SA), and has been with Bestfurn for eight years. Audit committee Bestfurn has an audit committee that oversees the effectiveness of Bestfurn’s assurance function and ensures that it results in: an effective internal control environment integrity of internal reports for decision making. e audit committee members are: James Kirk Reginald Khumalo Samuel Bloomberg. External auditors FZ Auditors has been Bestfurn’s auditors since the company’s incorporation, with Ms Helen Harper, the engagement partner, responsible for the audit since 2015. FZ Auditors audits only Bestfurn’s annual nancial statements. REQUIRED With reference to the information provided, discuss any concerns that you may have about Bestfurn’s corporate governance practices in the light of relevant guidance in the King IV Report on Corporate Governance for South Africa 2016™ (King IV™). e involvement of the chairperson of the board as well as the chief executive officer on the various board committees should be included in your answer. However, you do not have to address the composition of the nomination committee, risk committee, remuneration committee, and social and ethics committee in your answer. [17] Question 10 LEVEL 2 Integrated question [30 marks] PART A You are the senior on the year-end audit of Fusion Ltd (Fusion), a company that manufactures a range of organic cleaning products. e manufacturing manager, Mr Maker, has explained to you that Fusion’s products are very popular owing to their being environmentally friendly and obtaining excellent cleaning results. In the complex manufacturing process, chemicals are mixed at the company’s plant situated in Gauteng using machinery imported from Germany. Times when the machines lie unused could lead to material losses for the company. Mr Maker added that, because the chemicals are so expensive, Fusion carries as little inventory as possible. He also indicated that the staff in the chemical warehouse consists of one manager, Mr Stocks, and four clerks. Fusion’s internal audit department provided the following system description: Orders The inventory control department orders chemicals weekly, as requested verbally by Mr Maker. Orders are placed telephonically with one supplier only, Joy Chemicals, it being the sole supplier of organic chemicals. After delivery notes have been compared to orders placed, the orders are marked off as received as soon as delivery notes have been obtained from the chemical warehouse (see Received in chemical warehouse below). The delivery notes are then sent to the administration department. Received in chemical warehouse Any available staff member in the manufacturing department at that speci c time receives inventory at the back of the plant in the goods receiving area. He/she receives the goods, counts them and signs the supplier’s delivery note. This note is then handed to Mr Maker, who sends it to the ordering department at the end of the day. The receiving department has two security doors: One to the outside, through which chemicals are delivered The second to the plant, through which chemicals move to the rest of the plant All manufacturing staff members have keys for both these doors, since they should be able to receive chemicals at any given time, or remove chemicals so that the manufacturing process does not come to a halt. Cost department The costing department calculates the unit costs for the manufactured products as follows: The materials, labour and factory overhead cost speci cations are obtained from each product’s formula (prepared by the chemical engineer), the plant’s capacity (as per the plant’s manual received from the German suppliers) and historical results and costs as per the yearly budget. The standard variances are calculated using the actual chemicals purchased, the price lists and the actual wage rates. Finished goods warehouse As soon as one hundred items of a product have been completed, they are packed into a crate and moved to the nished goods warehouse. Throughout the year, Mr Stocks makes use of a perpetual inventory system in order to determine inventory on hand. Fusion performs an inventory count at the end of the nancial year only. REQUIRED 1. Under the headings ‘Orders’, ‘Received in Chemical Warehouse’ and ‘Finished Goods Warehouse’, describe the weaknesses evident from the information. (15) 2. Draw up an audit programme for auditing the standard costs of the completed inventory at year-end. (10) PART B You are of the opinion that inventory forms a material part of the entity’s assets. As a result, when you contacted Mr Stocks during the last week of February with a view to your attending the year-end inventory count, he informed you that Fusion had performed the inventory count three days before, since the company’s staff has a team-building event on 28 February, the date originally planned for the year-end inventory count. REQUIRED 1. Describe the procedures you should perform in order to con rm both the existence and the condition of Fusion’s inventory at yearend. (2) 2. Discuss the effects on the audit opinion if you cannot perform sufficient procedures on the existence and the condition of inventory. (3) [30] SUGGESTED SOLUTION TO QUESTION 10 PART A 1. a) Orders i) Orders are placed without an authorised requisition. (1) ii) No order forms are issued for orders placed. (1) iii) e entity does not follow up on long outstanding orders. iv) e entity does not make use of re-ordering levels. (1) (1) v) Before goods are ordered, there is no check in order to con rm that the goods are needed. (1) vi) e person placing the order does not check with the supplier as to the availability of the goods. (1) vii) Orders are not checked and authorised before they are placed. (1) b) Received in chemical warehouse i) ii) ere is no designated goods receiving area. (1) Access is not controlled, as all staff members have keys to the security doors. (1) iii) e delivery truck driver is not required to sign delivery notes. iv) ere are no dedicated goods receiving personnel, as (1) any staff member receives orders. (1) v) On receipt of the goods, the description of such goods is not checked. (1) vi) No super cial quality tests are performed on goods received. vii) No goods received notes are issued. (1) (1) viii) e movement of delivery notes is not controlled. (1) ix) ere is no control over the movement of inventory from the manufacturing plant to the nished goods warehouse. (1) c) Finished goods warehouse Inventory counts take place only once a year, and physical inventory is not compared regularly to the perpetual inventory system. (1) d) General No management supervision controls are in place. (1) Available marks [18]; maximum marks [15] 2. a) Quantity i) Attend the inventory count and perform test counts. (1) ii) For the items selected during the inventory count, compare the quantity counted against the perpetual inventory records. iii) Discuss with management any differences found. (1) (1) iv) Perform analytical procedures for the reasonability of the inventory quantity (e.g. compare the quantity on hand (per item) for the current year to that of the previous year). (1) b) Unit cost i) Con rm the speci cations by inspecting: product recipes (½) the capacity of the plant (½) historical results (½) management projections. (½) ii) Con rm the cost per unit through inspecting: the price lists or the invoices (½) the contracts with suppliers (½) wage rates or agreements (½) the trade unions (½) the effect of in ation. (½) iii) With reference to variances: recalculate them (½) discuss with management the reasons for them (½) consider whether standards are still appropriate, or whether variances are: material (½) permanent (½) uncontrollable. (½) iv) Other: Compare the information with that contained in the previous year’s working papers. (1) and select a sample of inventory items on hand at year-end in order to recalculate the standard cost calculation. (1) Available marks [13]; maximum marks [10] PART B 1. e auditor should: a) undertake a physical count on an alternative date, if unable to attend the physical inventory count on the date planned as a result of unforeseen circumstances (1) b) when necessary, perform audit procedures on intervening transactions. (1) Available marks [2] 2. e effects will be that: a) the fair presentation of the nancial statements will be compromised (1) b) sufficient and appropriate audit evidence will not be able to be obtained, which constitutes a limitation of scope (1) c) the audit report would be quali ed, since inventory is material d) the audit report opinion would be a disclaimer, if the auditor (1) determines the inventory gure to be material and pervasive. (1) Available marks [4] maximum marks [3] [30] List of references BOOKS Prinsloo, F & Von Wielligh, P (eds) (2018) Auditing Fundamentals in a South African Context (second edition), Cape Town: Oxford University Press. REPORTS Institute of Directors Southern Africa (2009) King Report on Governance for South Africa 2009, King Code of Governance Principles for South Africa, Cape Town: Juta Law, 2010. Institute of Directors Southern Africa (2016) King IV Report on Corporate Governance™ for South Africa 2016. LEGISLATION Auditing Profession Act 26 of 2005 Companies Act 71 of 2008 Companies Regulations 2011 (Companies Act 71 of 2008) INTERNET SOURCES Independent Regulatory Board for Auditors (IRBA) (2014) (Revised) Rules Regarding Improper Conduct and Code of Professional Conduct for Registered Auditors. [Online] Available: https://www.irba.co.za/upload/Rules%20and%20IRBA%20Code%20(Revised %202014)%20Issued%2017%20March%202014.pdf South African Institute of Chartered Accountants (January 2014) Code of Professional Conduct for Chartered Accountants. [Online] Available: https://www.saica.co.za/Technical/Discipline/CodeofProfessionalConduct/tabi d/701/language/en-ZA/Default.aspx

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