SUGGESTED SOLUTION TO EXERCISE 15.21
1 Page only
a)
b)
1.
To avoid an audit, with a public interest score of 134, Images (Pty) Ltd is
required to have its annual financial statements compiled externally by someone
who satisfies the requirements of an “independent accounting professional” in
terms of the Companies Act 2008.
2.
The independent accounting professional must
2.1
be a registered auditor, or
2.2
be a chartered accountant (i.e. a member in good standing of SAICA), or
2.3
be qualified to be appointed as an accounting officer of a CC
2.4
not have a personal financial interest in Images (Pty) Ltd
2.5
not be currently involved in the day-to-day management of Images (Pty) Ltd
and not have been involved during the previous three years
2.6
not be a prescribed officer, or full-time executive employee of Images
(Pty) Ltd and not have been such an employee or officer during the
previous three years
2.7
not be related (as defined) to any person as in 2.4 to 2.6.
1.
In terms of Regulation 29, an independent review of a company’s annual financial
statements must not be carried out by an independent accounting professional who
was involved in the preparation of the financial statements.
2.
In addition, as we are registered auditors, we are bound by the requirements of
the Code of Professional Conduct which states that for us to “review our own work”
amounts to an unacceptable self-review threat to our independence.
3.
The fact that we were the auditors has no bearing.
During that period, there
would have been no self-review threat as the AFS were prepared by the company.
c)
Independent Reviewer’s Report
To the shareholders of Images (Pty) Ltd
We have reviewed the financial statements of Images (Pty) Ltd set out on pages 16 to 42, which
comprise the statement of financial position as at 30 April 2016 and the statement of
comprehensive income, statement of changes in equity and statement of cash flows for the year
then ended, and the notes comprising a summary of significant accounting policies and other
explanatory information.
Directors’ Responsibility for the Financial Statements
The company’s directors are responsible for the preparation and fair presentation of these
financial statements in accordance with the International Financial Reporting Standards for Small
and Medium-sized Entities and the requirements of the Companies Act of South Africa, and for such
internal control as the directors determine necessary, to enable the preparation of financial
statements that are free from material misstatement, whether due to fraud or error.
Basis for Qualified Conclusion
The company’s investments in listed companies are carried at R1.3m. The directors have stated
these investments at the value at which they were stated at the end of the previous financial
year, instead of at the fair value of the investments at 30 April 2016.
This constitutes a
departure from the requirements of the IFRS and SMEs. The company’s records indicate that had
the directors stated the listed investments at fair value, an impairment adjustment of R327 206
would have been recorded. Accordingly, listed investments would have been reduced by R327 206,
as well as net income and shareholders’ equity.
Qualified conclusion
Based on our review, except for the effects of the matter described in the Basis for Qualified
conclusion paragraph, nothing has come to our attention that causes us to believe that the
financial statements do not present fairly, in all material respects, the financial position of
Images (Pty) Ltd as at 30 April 2016, and its financial performance and cash flows for the year
then ended in accordance with the International Financial Reporting Standards for Small and
Medium-sized Entities and the requirements of the Companies Act of South Africa.
Other reports required by the Companies Act
As part of our independent review of the financial statements for the year ended 30 April 2016,
we have read the Directors’ Report for the purpose of identifying whether there are material
inconsistencies between this report and the reviewed financial statements. The Directors’ Report
is the responsibility of the directors.
Based on reading the Directors’ Report we have not
identified material inconsistencies between this report and the reviewed financial statements.
However, we have not reviewed the Directors’ Report and accordingly do not express a conclusion
thereon.
Karel Marks
Karel Marks
Registered Auditor
15 May 2016
22 Comrades Way
Johannesburg
2001
**2016**
SUGGESTED SOLUTION TO EXERCISE 15.20
1 Page only
a)
b)
1.
Kent Magura’s response is disappointing as he is the financial director of the
company.
2.
He appears to regard a review as of little value and that we as the external
reviewers should do so as well.
3.
He fails to realize that an independent review adds a measure of credibility and
assurance to the company’s AFS and that this is important from the point of view of
the stakeholders in the company.
4.
His attitude also implies that because it is a review and not an audit, we do not
have to comply with the standards of the profession regardless of the assignment i.e.
“we must do the job properly”, which will obviously not be the case if we adopt Kent
Magura’s attitude.
5.
We are obliged to comply with ISRE 2400 (revised) which, inter alia, requires that we
comply with the fundamental principles of processional competence and due care as
well as professional behaviour.
Independent Reviewer’s Report
To the shareholders of Ponzey (Pty) Ltd
We were engaged to review the annual financial statements of Ponzey (Pty) Ltd set out on
pages 4 to 25, which comprise the statement of financial position as at 31 March 2016, and
the statement of comprehensive income, statement of changes in equity and statement of cash
flows for the year then ended, and the notes comprising a summary of significant accounting
policies and other explanatory information.
Directors’ Responsibility for the Financial Statements
The company’s directors are responsible for the preparation and fair presentation of these
financial statements in accordance with the IFRS for SMEs and the requirements of the
Companies Act of South Africa, and for such internal control as the directors determine
necessary to enable the preparation of financial statements that are free from material
misstatement whether due to fraud or error.
Basis for Disclaimer of conclusion
An important part of a review engagement involves analytical procedures on the financial
data produced by the client, as well as enquiry and discussion with relevant personnel.
However, we were not able to successfully conduct these procedures due to the fact that
data produced by the financial system was found to be unreliable. Furthermore, due to
accounting breakdowns, suitable documentation which we required to gain sufficient evidence
to support information provided to us by employees, was not available.
Disclaimer of conclusion
Because of the significance of the matters described in the Basis for Disclaimer of
Conclusion paragraph, we were unable to obtain sufficient appropriate evidence as a basis
for the expression of a conclusion on the financial statements.
Accordingly we do not
express a conclusion on these financial statements.
Johnny January
John January
Registered Auditor
42 Scrum Road
Port Elizabeth
30 April 2016
**2016**
SUGGESTED SOLUTION TO EXERCISE 15.19
1 Page only
a)
1.
In terms of the Close Corporations Act there would be no problem in your
wife being a member of the CC to which you are
the accounting officer. The
Act, in fact, allows a member to be accounting officer with the permission of all
members.
2.
However as a practicing accountant, you are bound by the Code of Professional
Conduct and should consider your independence carefully. To cover yourself, you
could perhaps consider stating in your report that your wife is a member of the CC
and that you have the written permission of all members to act as accounting
officer.
b)
Report of the Accounting Officer to the members of Fleetwood CC
I have performed the duties of accounting officer of Fleetwood CC for the year ended
31 March 2016 as required by Section 62 of the Close Corporations Act 1984.
These
financial statements are the responsibility of the members.
No audit has been carried
out and accordingly I express no assurance thereon.
I have determined that the financial statements are in agreement with the accounting
records, and have done so by adopting such procedures and conducting such enquiries as I
considered necessary in the circumstances. I have also reviewed the accounting policies
which have been represented to us as having been applied in the preparation of the annual
financial statements, and I consider that they are appropriate to the business.
I further report that the Corporation has contravened Sec 46 of the Close Corporations
Act in that at a members meeting held on 15 September 2016 (assumed) at which a quorum
was not present, it was agreed by members holding less than the required 75% of members'
interests, to purchase certain immovable property.
My wife is a member of Fleetwood CC and all the members have consented in writing to my
appointment as accounting officer.
Kobus King
Kobus King & Co
Chartered Accountant (S.A.)
PORT ELIZABETH
29 April 2016
**2016**
SUGGESTED SOLUTION TO EXERCISE 15.18
Page 1 of 2 pages
a)
Independent Reviewer’s Report
To the members of Satcon (Pty) Ltd.
We have reviewed the annual financial statements of Satcon (Pty) Ltd set out on pages 6
to 36 which comprise the statement of financial position at 31 March 2016 and the
statement of comprehensive income, the statement of changes in equity, and statement of
cash flows for the year then ended, and the notes which comprise a summary of significant
policies and other explanatory information.
Basis for Qualified conclusion
Part of the company's inventory consists of imported cellular telephones. This inventory
is disclosed in the annual financial statements at cost which may be in excess of net
realisable value due to the fact that the telephones may be illegal in terms of the
cellular network regulations and therefore not saleable.
In terms of IAS 2 –
Inventories, inventory should be valued at the lower of cost or net realisable value. A
decision on the legality of the telephones is awaited but at present it is not possible
to establish the value at which this inventory should be included. This matter has not
been disclosed by the directors.
Qualified Conclusion
Except for the matter discussed in the Basis for Qualified Conclusion paragraph based on
our review, nothing came to our attention which causes us to believe that the financial
statements do
not fairly present, in all material respects, the financial position of
Satcon (Pty) Ltd as at 31 March 2016 and its financial performance and cash flows for the
year then ended in accordance with the International Financial Reporting Standard for
Small and Medium sized Entities and the requirements of the Companies Act of South
Africa.
Bakkies Botha
Bernard Botha
Registered Auditor
14 Loftus Road
Pretoria
5 May 2016
b)
Report of Factual Findings to the directors of Kwikchick (Pty) Ltd.
We have performed the procedures agreed with you and enumerated below in connection with
royalties payable by Featherfood (Pty) Ltd to yourselves in respect of the six months
ended 31 March 2016 as set out in the accompanying royalty schedule on pages 2 to 10.
Our engagement was undertaken in accordance with the International Standard on Related
Services applicable to agreed upon procedures engagements. The procedures were carried
out solely to assist you in evaluating the validity of royalties payable and are
summarised as follows:
1.
We inspected all sales invoices for the six months ended 31 March 2016 to ensure
that the value of the sales of your product reflected on the invoices had been
correctly entered on the royalties schedule.
2.
We checked on a random basis, the unit selling prices entered on the invoices to
the master pricelist.
3.
We reperformed the casts and extensions on all invoices and the royalty schedules.
4.
We scrutinized the sequence of sales invoices for completeness.
5.
We recomputed the royalty payable in terms of clause 8 of the royalty agreement.
**2016**
/continued on page 2
SUGGESTED SOLUTION TO EXERCISE 15.18
Page 2 of 2 pages
Findings:
We report our findings below
1.
A book of 100 invoices could not be found. Other than the 100 invoices which were
missing, all invoices were correctly entered on the royalty schedule. Entries for
the missing invoices were reflected on the royalty schedule, but we were not able
to confirm that the correct amounts had been entered.
2.
The random test indicated that the unit selling prices used, were in accordance
with the master pricelist.
3.
All casts and extensions were found to be correct.
4.
Other than the 100 invoices (numbered 3101 to 3200) referred to in point 1 above,
the sequence of invoices was complete.
5.
The amount payable in respect of sales recorded on the royalty schedule was
correctly calculated in terms of clause 8 of the royalty agreement.
Because the above procedures do not constitute either an audit made in accordance with
International Standards on Auditing or a review made in accordance with International
Standards on Review Engagements, we do not express any assurance on the amount payable at
31 March 2016.
Had we performed additional procedures or had we performed an audit or review of the
financial statements in accordance with the International Standards, other matters might
have come to our attention that would have been reported to you.
Our report is solely for the purpose set forth in the first paragraph of this report and
solely for your information, and is not to be used for any other purpose or distributed
to any other parties. This report relates only to the royalty schedule specified above
and does not extend to any other financial information of Featherfood (Pty) Ltd.
Bakkies Botha
Bernard Botha
Registered Auditor
14 Loftus Road
Pretoria
20 May 2016
**2016**
a)
SUGGESTED SOLUTION TO EXERCISE 15.17
Page 1 of 2 pages
The practitioner’s objectives in a compilation agreement are to
b)
c)
1.
Apply accounting and financial reporting expertise to assist management in the
preparation and presentation of financial information in accordance with an
applicable financial reporting framework based on information provided by management.
2.
Report in accordance with the required standard, i.e. ISRS 4410 (Revised).
1.
Integrity
The practitioner should be straightforward and honest in performing professional
services.
2.
Objectivity
The practitioner should be fair and should not allow prejudice or bias or influence
of others to override objectivity.
In situations where the practitioner is not
independent, the report should state that fact. Independence is not a prerequisite
for accepting a compilation engagement.
1.
Confidentiality
The practitioner should respect the confidentiality of information acquired during
the course of performing professional services and should not use or disclose any
such information without proper and specific authority or unless there is a legal or
professional right or duty to disclose information.
2.
Professional competence and due care
An engagement to compile financial information should be performed and the report
prepared with due professional care by persons who have adequate training, experience
and competence in accounting. When work is delegated to assistants, the practitioner
should carefully direct, supervise and review their work.
He must comply with the
technical standards applicable to the engagement, e.g. ISRS 4410 (Revised).
3.
Professional behaviour
The practitioner should comply with the law and behave in a manner which does not
discredit the profession.
Practitioner’s Compilation Report
To the management of Ricoh (Pty) Ltd
We have compiled the accompanying financial statements of Ricoh (Pty) Ltd, based on
information you have provided.
These financial statements comprise the statement of
financial position of Ricoh (Pty) Ltd as at 31 March 2016, the statement of comprehensive
income, statement of changes in equity and statement of cash flows for the year then
ended, and a summary of significant accounting policies and other explanatory
information.
We performed this compilation engagement in accordance with International Standards on
Related Services 4410 (Revised) – Compilation Engagements.
We have applied our expertise in accounting and financial reporting to assist you in the
preparation and presentation of these financial statements in accordance with the
International Financial Reporting Standards for small and medium-sized entities (IFRS for
SMEs). We have complied with relevant ethical requirements, including the principles of
integrity, objectivity, professional competence and due care.
These financial statements and the accuracy and completeness of the information used to
compile them, are your responsibility.
Since a compilation engagement is not an assurance engagement, we are not required to
verify the accuracy or completeness of the information you provided to us to compile
these financial statements. Accordingly, we do not express an audit opinion or a review
conclusion on whether these financial statements are prepared in accordance with IFRS for
SMEs.
Davey Done
David Done
Registered Auditor
20 April 2016
14 Boss Drive
Kingsmead
Durban 4001
**2016**
a)
1.
/continued on page 2
SUGGESTED SOLUTION TO EXERCISE 15.17
Page 2 of 2 pages
Ricoh (Pty) Ltd has a public interest score of 115 and its financial statements
have been independently (externally) compiled.
Therefore, in terms of the
Companies Act 2008, the company’s financial statements will have to be
independently reviewed.
2.
In terms of Regulation 29, as the preparer of the AFS, I am the “accounting
professional” responsible for the compilation and therefore cannot be the reviewer
or auditor, as I would not be independent.
**2016**
SUGGESTED SOLUTION TO EXERCISE 15.16
1 Page only
1.
False. This will only apply if the company’s public interest score is less than 100.
2.
True.
As an audit is not being conducted, the ISAs do not apply.
must comply with ISRE 2400 (revised).
The registered auditor
3.
True.
ISRE 2400 (revised) does not specifically require a strategy to be formulated for
a review. ISA 315 (Revised) does require that an audit strategy be formulated.
4.
False. ISRE 2400 (revised) requires that for a review engagement materiality be set for
the financial statements as a whole to be in a position to identify areas of the
financial statements where material misstatements may arise, and to be in a
position to evaluate whether financial statements are free from material
misstatement.
5.
True.
As a review engagement does not require that tests of controls are conducted, a
detailed knowledge of the client’s internal controls is not required (ISRE 2400
(revised)).
6.
True.
Risk assessment procedures are carried out to provide a basis for determining
further audit procedures i.e. tests of controls and substantive tests. A review
engagement usually consists of substantive procedures only, primarily inquiry and
analytical procedures.
7.
False. In terms of ISRE 2400 (revised) the practitioner conducting the review must
conduct procedures to address "three specific circumstances" in addition to
general inquiries and analytical review.
These are related parties, fraud and
non-compliance with regulations and going concern.
8.
False. In terms of the Companies Regulations 2011 (not the AP Act 2005), the practitioner
has a duty to report a reportable irregularity to CIPC (not IRBA).
9.
False. A review gives rise to a review conclusion. The practitioner conducting a review
does not obtain sufficient appropriate evidence to support an opinion.
(He
concludes based on the limited review procedures he has carried out.)
10.
False. The level of assurance given for a review engagement
Reasonable assurance is given for an audit engagement.
is
limited
assurance.
**2016**
Nature:
Inappropriate
Selection/application
of accounting standard
Disagreement.
SUGGESTED SOLUTION TO EXERCISE 15.15
1 Page only
1.Plant and equipment is overstated as is net profit.
2.In terms of IAS 36 – Impairment of assets, the correct treatment
would have been to write the asset down to
its recoverable amount and carry the loss to the statement
comprehensive income.
of
3.It has no “in use” value, its value at year-end is its scrap value.
4.However, if the company was “virtually certain” that the insurance
company would bear the full cost of the repair then the insurance
company should be raised as a debtor and the future income from the
insurance company taken to the statement of comprehensive income
(which would off set the impairment).
5.BUT payment by the insurance company is not virtually certain as
*they intend to investigate the possibility of sabotage and
*Billy Bragg does not seem sure that sabotage did not take place…. he
says “they can’t prove it” and there was severe labour unrest at
time.
*disabling
the
power
surge
unit
does
not
“normally
occur
accidentally”
*there are some inconsistencies in the report on the event.
6.Either way (virtually certain or not) we therefore disagree with the
company’s treatment of this matter as it does not comply with
international accounting standards.
Material/Pervasive
This matter cannot be regarded as immaterial; it is at least material as net profit after
tax is overstated by 7½%
It is, however, not material and pervasive as only a limited number of account headings
are affected, and the financial statements cannot be regarded as meaningless or
misleading.
Independent Auditor’s Report
To the shareholders of Blockz (Pty) Ltd
We have audited the financial statements of Blockz (Pty) Ltd set out on pages 16 to 34, which
comprise the statement of financial position at 31 March 2016 and the statement of comprehensive
income, statement of changes in equity and statement of cash flows for the year then ended, and
the notes, comprising a summary of significant accounting policies and other explanatory
information.
Basis of qualified opinion
Prior to the financial year end, an item of plant and equipment was extensively damaged resulting
in an impairment to the asset of R…… In terms of the International Financial Reporting Standards
IAS 36 – Impairments of Assets, the impairment to the item of plant and equipment should be
recognized in full.
However, the directors have chosen not to do so on the grounds that the
costs of repair will be borne in full by Blockz (Pty) Ltd’s insurance company. Due to various
circumstances surrounding the event, the insurance company intends to undertake a thorough
investigation as these circumstances suggest that the impairment may have resulted from a
situation not covered by the company’s insurance policy. It is therefore not virtually certain
that the insurance company will honour the claim.
If payment by the insurance company was
virtually certain as described by IAS 37 – Provisions, contingencies and post balance sheet
events, the insurance company could be raised as a debtor and the anticipated payment accrued in
the statement of comprehensive income, in effect, off-setting the impairment cost. As this is
not the case, the impairment loss must be fully recognised and cannot be ignored on the grounds
of the possibility of the insurance company settling the claim. In essence, whether the payment
from the insurance company is virtually certain or not the failure to deal with this matter in
the financial statements is, as mentioned, a contravention of IAS 36.
Qualified audit opinion
In our opinion, except for the effects of the matter described in the Basis for qualified opinion
paragraph, the financial statements present fairly, in all material respects, the financial
position of Blockz (Pty) Ltd at 31 March 2016 and its financial performance and cash flows for
the year then ended, in accordance with International Financial Reporting Standards and the
requirements of the Companies Act of South Africa.
Richard Rexal
Richard Rexal
Registered Auditor
18 May 2016
14 Drummond Hill
Kloof
3601
**2016**
SUGGESTED SOLUTION TO EXERCISE 15.14
1 Page only
a)
Independent auditor’s report
To the shareholders of Bluevision (Pty) Ltd.
Report on the financial statements
We have audited the financial statements of Bluevision (Pty) Ltd set out on pages 16 to
42, which comprise the statement of financial position at 29 February 2016, and the
statement of comprehensive income, statement of changes in equity and statement of cash
flows for the year then ended, and the notes, comprising a summary of significant
accounting policies and other explanatory information.
Opinion
In our opinion, the financial statements present fairly in all material respects the
financial position of Bluevision (Pty) Ltd as at 29 February 2016 and of its financial
performance and cash flows for the year then ended in accordance with International
Financial Reporting Standards and the requirements of the Companies Act of South Africa.
Other reports required by the Companies Act
As part of our audit of the financial statements for the year ended 29 February 2016, we
have read the Directors’ Report for the purpose of identifying whether there are material
inconsistencies between this report and the audited financial statements. The report is
the responsibility of the directors. Based on reading the report we have not identified
any material inconsistencies between the report and the audited financial statements.
However, we have not audited the report and accordingly do not express an opinion on the
report.
Report on other Legal and Regulatory Requirements
In accordance with our responsibilities in terms of Section 44(2), 44(3) and 45 of the
Auditing Profession Act, we report that we have identified certain unlawful acts
committed by the directors of Bluevision (Pty) Ltd which constitute a reportable
irregularity in terms of the Auditing Profession Act and have reported the matter to the
Independent Regulatory Board for Auditors.
The matters pertaining to the reportable
irregularity have been described in note 10.
The directors have responded to the circumstances and conduct in question to the extent
that we believe no further loss will be suffered by the parties identified in note 10 and
that all amounts including penalties have been accounted for. The unlawful act described
in note 10 is, to the best of our knowledge, no longer occurring.
Rudolf Strydom
Rudolf Strydom
Registered Auditor
13 Rooiplaat Road
Pretoria
13 May 2016
b)
1.
This situation amounts to the continuation of the reportable irregularity
and the audit report will have to reflect this.
2.
In terms of Sec 44 of the AP Act, we may not give an unqualified (unmodified)
opinion unless we are satisfied that no reportable irregularity had taken place.
We are not satisfied.
3.
The qualification will be on the basis of disagreement with the disclosure in, and
adjustment to the financial statements because as they stand, the financial
statements do not “present fairly”.
4.
A “basis for qualified (adverse) opinion” paragraph, explaining the scheme and the
lack of disclosure/adjustment will have to be added.
5.
The standard opinion paragraph will have to be amended to reflect either an
“except for” or “adverse” opinion depending on the materiality of the amounts
involved.
6.
The following paragraph will have to be added:
Report on Other Legal and Regulatory Requirements
In accordance with our responsibilities in terms of Sections 44(2), 44(3) and 45
of the AP Act, we report that we have identified certain unlawful acts committed
by the directors of Bluevision (Pty) Ltd which constitute a reportable
irregularity in terms of the AP Act and have reported the matter to the IRBA. We
have also submitted the additional report to the IRBA in terms of section 45(3)
indicating that, in our opinion the reportable irregularity is continuing.
The
matters pertaining to the reportable irregularity have been described in the
report above.
**2016**
SUGGESTED SOLUTION TO EXERCISE 15.13
Page 1 of 2 pages
a)
INDEPENDENT AUDITOR’S REPORT TO THE SHAREHOLDERS OF WORKZ (PTY) LTD
We have audited the annual financial statements of Workz (Pty) Ltd which comprise the
statement of financial position as at 31 March 2016, the statement of comprehensive
income, statement of changes in equity and statement of cash flow for the year then
ended, and the notes comprising a summary of significant accounting policies and other
explanatory information.
Directors’ Responsibility for the Financial Statements
The company’s directors are responsible for the preparation and fair presentation of
these financial statements in accordance with International Financial Reporting Standards
and the requirements of the Companies Act of South Africa and for such internal control
as the directors determine is necessary to enable the preparation of financial statements
that are free from material misstatements whether due to fraud or error.
Basis of disclaimer of opinion
These statements have been prepared on the basis of accounting practice applicable to a
going concern. This basis presumes that funds will be available to finance future
operations and that the realisation of assets and the settlement of liabilities,
contingent obligations and commitments will occur in the ordinary course of business. As
explained in note 10, certain of the company's export markets in Eastern Europe and
Africa have collapsed and as a result, the company’s ability to continue as a going
concern is dependent on the restructuring of the economies of countries in these regions.
In our capacity as auditors we believe that conditions in these economies are too
uncertain to predict when such restructuring will take place and whether it will lead to
the recovery of these markets.
As indicated in Note 11, the company has obtained a subordination agreement from one of
its major creditors undertaking to subordinate the amount owed to it until such time as
the markets are restructured. However, this subordination agreement does not remove the
significant uncertainty relating to the re-establishment of your company’s trading
partners in Eastern Europe and Africa.
Disclaimer of Opinion
Because of the significance of the matters discussed in the Basis for Disclaimer of the
Opinion paragraph, we have not been able to obtain sufficient, appropriate, audit
evidence to provide a basis for an audit opinion.
Accordingly, we do not express an
opinion on the financial statements.
Other reports required by the Companies Act
As part of our audit of the financial statements for the year ended 31 March 2016 we have
read the Directors’ Report for the purposes of identifying whether there are material
consistencies between this report and the audited financial statements. This report is
the responsibility of the directors. Based on reading this report we have not identified
material inconsistencies between this report and the audited financial statements.
However we have not audited the report and accordingly do not express an opinion on these
reports.
Sam Smitt
Samual Smitt
Registered Auditor
20 Bakkies Avenue
PRETORIA
31 May 2016
**2016**
/continued on page 2
SUGGESTED SOLUTION TO EXERCISE 15.13
Page 2 of 2 pages
b)
Audit Opinion
In our opinion the financial statements present fairly, in all material respects, the
financial position of Workz (Pty) Ltd at 31 March 2016 and its financial performance and
cash flow for the year then ended in conformity with the International Financial
Reporting Standards and the requirements of the Companies Act of South Africa.
Emphasis of Matter
Without qualifying our opinion above, we draw your attention to notes 10 and 11
respectively. As detailed in note 10, the company has entered into a subordination
agreement with one of its major creditors whereby the creditor has agreed to subordinate
the amount owed to it until such time as the company re-establishes certain of its
markets. As indicated in note 11, your company’s return to profitable trading depends on
the subordination agreement remaining in force and the restoration of the economies of
the Eastern European and African countries in which your company’s markets exist.
We
believe there is a realistic chance of this restoration taking place within a reasonable
period, and of the subordination agreement being in force until this occurs.
c)
Basis for adverse opinion
As indicated in Note 7, the directors have entered into a subordination agreement with a
major creditor which will be in force until the company returns to profitable trading.
However, central to this return to profitability, is the restructuring of the economies
of countries in Eastern Europe and Africa, in which Workz (Pty) Ltd’s trading partners
operate. This situation indicates the existence of a material uncertainty which may cast
significant doubt on the company’s ability to continue as a going concern and therefore
it may be unable to realize its assets and discharge its liabilities in the normal course
of business. The financial statements and notes thereto do not disclose the information
pertaining to the restructuring of the relevant Eastern European and African economies.
Adverse opinion
In our opinion, because of the significance of the matter discussed in the Basis for
Adverse Opinion paragraph, the financial statements do not present fairly, the financial
position of Workz (Pty) Ltd at 31 March 2016 and its financial performance and cash flows
for the year then ended in accordance with International Financial Reporting Standards
and the requirements of the Companies Act of South Africa.
**2016**
SUGGESTED SOLUTION TO EXERCISE 15.12
1 Page only
(a)
In terms of Sec 44 of the AP Act 2005, our team would be unable to:
*
Satisfy ourselves that proper accounting records have been kept.
sales, debtors, contracts, minutes, etc.
No access to
*
Satisfy ourselves that minutes of directors' meetings have been kept.
to statutory registers.
*
Satisfy ourselves that registers of shareholders, directors, company secretary
etc, are correctly kept - no access to statutory registers.
*
Obtain all vouchers and documents which the team considers necessary to carry out
our duties - access denied to full accounting records and all audits require work
to be conducted on sales/debtors.
*
Satisfy ourselves as to the existence of all assets and liabilities – no access to
relevant records, e.g. debtors.
No access
*
*
(b)
Carry out the audit free of restriction and in compliance with the applicable
auditing pronouncements e.g.
*
gather sufficient appropriate evidence
*
identity related parties
*
properly evaluate internal controls, risk of misstatement
*
assess assertions relating to disclosures.
Determine the fairness of the financial statements.
Independent Auditor’s Report
To the shareholders of Missiles (Pty) Ltd.
We were engaged to audit the annual financial statements of Missiles (Pty) Ltd set out on
pages 16 to 42, which comprise the statement of financial position at 31 March 2016, and
the statement of comprehensive income, statement of changes in equity and statement of
cash flow for the year then ended and the notes comprising a summary of significant
accounting policies and other explanatory information.
Auditor’s Responsibility
Our responsibility is to express an opinion on these financial statements based on
conducting our audit in accordance with International Standards on Auditing. Because of
the matter described in the Basis for Disclaimer of Opinion paragraph, however, we were
not able to obtain sufficient appropriate audit evidence to provide a basis for an audit
opinion.
Basis for Disclaimer of Opinion
Due to limitations placed on the scope of our audit by the directors, we were unable to
conduct audit procedures on sales and accounts receivable. Further limitations on our
access to the statutory registers also restricted our performance, and consequently we
did not obtain sufficient appropriate audit evidence to satisfy ourselves as to the
assertions relating to sales and accounts receivable or other account headings or
disclosures with which the statutory registers may have assisted us.
Disclaimer of Opinion
Because of the significance of the matters described in the Basis for Disclaimer of
Opinion paragraph, we have not been able to obtain sufficient appropriate audit evidence
to provide a basis for an audit opinion. Accordingly we do not express an opinion on the
financial statements.
Other reports required by the Companies Act
As part of our audit of the financial statements for the year ended 31 March 2016, we
have read the Directors’ Report for the purpose of identifying whether there are material
inconsistencies between this report and the audited financial statements. This report is
the responsibility of the directors.
However, as we have not been able to conduct an
audit of the financial statements and have not been able to fulfil this duty despite
having read the Directors’ Report.
Carmen Kruger
Carmen Kruger
Partner: Kruger and Lugar
Registered Auditors
Main Road
Krugersdorp
31 May 2016
**2016**
SUGGESTED SOLUTION TO EXERCISE 15.11
1 Page only
Independent Auditor’s Report
To the shareholders of Mainline Ltd
We have audited the financial statements of Mainline Ltd set out on pages 16 to 35, which
comprise the statement of financial position at 29 February 2016 and the statement of
comprehensive income, statement of changes in equity and statement of cash flows for the year
then ended, and the notes comprising a summary of significant accounting policies and other
explanatory information.
Opinion
In our opinion, the financial statements present fairly, in all material respects, the financial
position of Mainline Ltd at 29 February 2016 and its financial performance and cash flows 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
Without qualifying our opinion, we draw attention to note 26 to the financial statements.
As
explained in the note, the possibility exists that new regulations pertaining to the road
transport of
hazardous chemicals will be introduced.
As explained, these regulations could
have a material effect on the company’s operations.
Other matter
Without qualifying our opinion, we draw attention to the fact that the supplementary information
set out on pages 36 to 40, does not form part of the financial statements and is presented as
additional information. We have not audited these schedules and accordingly, we do not express
an opinion on these reports.
Other reports required by the Companies Act
As part of our audit of the financial statements for the year ended 29 February 2016, we have
read the Directors’ Report, the Audit Committee’s Report and the Company Secretary’s Certificate
for the purpose of identifying whether there are material inconsistencies between these reports
and the audited financial statements.
These reports are the responsibility of the respective
preparers.
Based on reading these reports, we have not identified material inconsistencies
between these reports and the audited financial statements. However, we have not audited these
reports and accordingly do not express an opinion on these reports.
Ryder Hejerdal
Ryder Hejerdal
Partner : Evans and Cavendish
Registered Auditors
13 Box Way
Durban
18 April 2016
**2016**
SUGGESTED SOLUTION TO EXERCISE 15.10
Page 1 of 2 pages
1.
Justification for choice of reports.
1.1
The issue here is whether the
development exceed their cost
*
net
realisable
values
of
the
plots
in
this
an informal settlement is likely to cause a decline in the value of the
plots but will the decline be to below cost? Has the asset been impaired?
1.2
As the auditor, I am uncertain as to the plots’ net realizable value and my
procedure to establish this (engaging the agent) has not settled that uncertainty.
I have thus been unable to gather sufficient appropriate evidence relating to the
value of the plots. Note that as auditors we are not in a position to say that
the property must be written down – even the experts can’t give us an answer.
1.3
The question of whether the matter is material or material and pervasive to fair
presentation is difficult to answer.
1.4
The consequences of a total writedown of R5 000 000, even taking into account that
the write down would be tax deductible, would be pervasive. Although the property
is only 30% of current assets, profits for the year and the shareholders equity
would virtually be wiped out and the company may find itself in a technically
insolvent position. However, there is absolutely no justification on the evidence
available to suggest a write down of R5 000 000 (the full amount) is necessary.
1.5
The company's going concern ability does not at this stage appear to be threatened
as
1.6
*
the company is relatively liquid
*
there are other developments progressing well
*
no money is owed by the company on the plots which may need to be written
down.
As indicated I do not believe that there is sufficient justification for
"expecting the worst" and therefore regard the matter at this stage as material.
The financial statements will not be rendered meaningless by inclusion of the
plots at cost, but the uncertainty of the matter must be brought to the attention
of the users of the financial statements by way of disclosure as it is information
which is very important to users.
1.7
If the directors are prepared to make full disclosure (report (a)), then an
unqualified opinion and emphasis of matter will be appropriate.
1.8
If the directors refuse to make full disclosure of the matter (report (b)), then
an except for opinion, based on disagreement (disclosure omitted), would be
necessary.
(a)
Independent auditors report
To the shareholders of Habitat (Pty) Ltd.
We have audited the financial statements of Habitat (Pty) Ltd set out on pages 16 to 38,
which comprise the statement of financial position as at 31 March 2016, the statement of
comprehensive income, the statement of changes in equity and statement of cash flows for
the year then ended and the notes comprising a summary of significant accounting policies
and other explanatory information.
Audit opinion
In our opinion, the financial statements present fairly in all material respects, the
financial position of Habitat (Pty) Ltd at 31 March 2016 and its financial performance
and cash flows for the year then ended in accordance with the International Financial
Reporting Standards and the requirements of the Companies Act of South Africa.
Emphasis of matter
Without qualifying our opinion above, we draw attention of note 7 to the financial
statements. As disclosed an amount of R5 000 000 has been included under current assets
as land for residential development.
During the current financial year an informal
settlement sprung up on the tract of land adjoining this proposed residential development
and as a result all interest in the purchase of plots in this residential development
ceased. Attempts to obtain expert opinion on the possibility of these plots being sold,
proved fruitless.
Due to the uncertainty of the situation we are unable to determine
whether the net realisable value of the plots exceeds the current cost and hence whether
any impairment allowance in respect of these plots is required.
Peter Bantock
Registered Auditor
25 May 2016
Brakpan
**2016**
/continued on page 2
SUGGESTED SOLUTION TO EXERCISE 15.10
Page 2 of 2 pages
(b)
If a qualified opinion (except for) was to be given (see workings), the report would read
as follows:
Basis for qualified opinion
The current assets of the company include a property development valued at a cost of
R5 000 000. During the year under audit an informal settlement sprang up on the tract of
land adjoining this development and as a result all interest in the purchase of plots
ceased. In terms of the International Financial Reporting Standards IAS 2 – Inventories,
these plots should be shown in the financial statements at the lower of cost or net
realisable value. Attempts by the directors and ourselves to establish a net realisable
value have proved impossible. Despite the fact that we are in no position to say that the
plots should be impaired and cannot be shown at cost, to achieve fair presentation the
material uncertainty relating to their valuation and possible impairment should have been
disclosed in the notes to the financial statements as this information is relevant to
users and may influence any decisions they make based on the financial statements. The
directors have declined to make these disclosures.
Qualified opinion
In our opinion, except for the effects of the matter described in the Basis for Qualified
Opinion paragraph, the financial statements present fairly, in all material respects, the
financial position of the company as at 31 March 2016 and of its financial performance
and cash flows for the year then ended in accordance with the International Financial
Reporting Standards and the requirements of the Companies Act of South Africa.
**2016**
SUGGESTED SOLUTION TO EXERCISE 15.9
Page 1 of 2 pages
1.
The title of the report should read “Independent Auditor’s Report” not “independent
report” as the latter does not convey that it is an audit report.
2.
The report should be addressed to the shareholders not the board of directors.
3.
The introductory paragraph
4.
5.
3.1
“We have evaluated” should read “we have audited”.
3.2
The components of the financial statements should be included in the paragraph
e.g. the statement of financial position, the statement of comprehensive income,
statement of changes in equity and statement of cash flow, and summary of
significant accounting policies and other explanatory information.
3.3
Date of the statement of financial position and period end (i.e. 30 June 2016)
should be included.
3.4
Reference to “evaluating for fairness” does not come into this paragraph and is in
any event, not how the auditor’s function is expressed.
3.5
The audit is not carried out in terms of the MOI of the company, it is carried out
in terms of the ISA requirements.
No reference to this is required in the
introductory paragraph.
3.6
The pages on which the annual financial statements are set out, should also be set
out in this paragraph.
Management’s responsibility
4.1
There is no heading to indicate what the paragraph is about.
4.2
Although it is positive that the “management responsibility” paragraph was
included, its content is incomplete and inaccurate and it should actually be
directors responsibility.
*
no mention that directors are also responsible for fair presentation in
terms of the IFRSs and
*
the requirements of the Companies Act
*
no mention that management is responsible for such internal controls are
needed to enable the preparation of financial statements that are “free
from material misstatement”, whether due to fraud or error
*
although there is a reference to fraud, it is mentioned in the context of
preventing fraud, not in the context of preparation of the financial
statements which are free from material misstatement.
Auditor’s responsibility
5.1
There is no heading to indicate what the paragraph is about.
5.2
The auditor’s responsibility is not to detect fraud which has not been prevented
by the directors; the auditor assesses the risk of misstatement arising from both
fraud and error and responds to the risk by devising an appropriate audit strategy
and plan.
5.3
The paragraph does not comply with the requirement of ISA 700 or 705 at all. This
paragraph is supposed to describe what the auditor’s responsibilities are, e.g.
*
express an opinion based on the audit
*
conduct the audit in terms of the ISAs
*
comply with ethical requirements
*
plan and perform the audit to obtain reasonable assurance…
*
assess risk, consider internal control (but not to express an opinion on
internal control)
*
evaluate accounting policies for appropriateness, and the reasonableness
of accounting estimates and overall presentation
*
indicate that procedures are based on the auditor’s judgement.
**2016**
/continued on page 2
SUGGESTED SOLUTION TO EXERCISE 15.9
Page 2 of 2 pages
6.
Paragraph commencing “We report…”
6.1
The opinion paragraph expresses a qualified opinion so presumably this is supposed
to be a “basis for qualified opinion” paragraph.
6.2
However, it is completely unclear what the paragraph is trying to convey.
*
it is incorrect to include the information about the expert and unclear as
to whether work-in-progress is misstated.
There is no indication that
there was any problem with WIP
*
it is also confusing (and inconclusive) for a user, for the report to
indicate that the risk assessment warranted an expert; was this risk
resolved or not?
7.
8.
*
again what is the point of including point 2? If the matter is material
to fair presentation and has not been properly disclosed then
a
qualification is required on the grounds of misstated information
(disclosure). The user is simply left wondering
*
with regard to the wage fraud, it appears to be an immaterial matter with
regard to financial reporting (small wage fraud). There is no reason to
bring it up in the audit report.
Opinion paragraph
7.1
Again no heading (whether it is supposed to be qualified or not)
7.2
The opinion paragraph is supposed to convey an opinion on whether the financial
statements “present fairly”, in all material respects the
*
financial position of Litetech (Pty) Ltd at 30 June 2016
*
its financial performance and cash flows for the period then ended in
accordance with the IFRSs and the requirements of the Companies Act of
South Africa.
7.3
The opinion paragraph does not convey this but instead gives an opinion on whether
or not there are any outstanding issues from the audit.
7.4
The auditor’s responsibility paragraph and not the opinion paragraph should state
that the audit is conducted in terms of the ISAs.
7.5
Furthermore, the audit is not conducted in terms of the IFRS (the trainee is
confusing this with the basis of presentation of the financial statements).
Emphasis of Matter
The emphasis of matter paragraph is only included where there is a matter which has been
adequately dealt with in the AFS but which requires, in the opinion of the auditor, to be
emphasized.
The paragraph is not included if there is nothing which meets this
requirement which appears to be the case.
9.
10.
The audit report should include an additional paragraph below the opinion paragraph
headed "other reports required by the Companies Act." This paragraph should
9.1
Explain that part of the audit of financial statements is for the auditor to read
the Directors’ Report for the purpose of identifying whether there are any
material inconsistencies between the directors report and the AFS.
9.2
State whether or not there are any inconsistencies as applicable.
9.3
Indicate that as the
expressed on it.
directors’ report has not been audited, no opinion is
Signing off
10.1
The date of the report cannot be the date of the financial year end.
10.2
The report should be dated in terms of when the directors “take responsibility”
for them, i.e. the directors sign the financial statements. The auditor considers
the effect of events and transactions of which he becomes aware and that occurred
up to that date, and cannot sign prior to that date.
10.3
There is no indication of who the designated auditor is.
**2016**
SUGGESTED SOLUTION TO EXERCISE 15.8
1 Page only
Independent Auditor’s Report
To the shareholders of Specfix (Pty) Ltd
We have audited the financial statements of Specfix (Pty) Ltd set out on pages 16 to 38,
which comprise the statement of financial position at 31 March 2016, and the statement of
comprehensive income, statement of changes in equity and statement of cash flows for the
year then ended, and the notes comprising a summary of significant accounting policies
and other explanatory information.
Basis for Qualified Opinion
Legal proceedings have been instituted against the company in respect of damage caused to
a customer's property whilst effecting repairs to that property and for loss of profits
expected to be suffered by the customer resulting from production disruptions.
Your
company is not insured against any loss suffered should the action for damages succeed.
The opinion of your company’s legal counsel is that it is probable that the company will
be held liable for damages but the extent of this liability cannot be estimated with any
reliability. The directors are of the opinion that as the amount of damages cannot be
reliably estimated, this matter is not material to fair presentation. Therefore no
disclosure of the existence and nature of this contingency has been made in the financial
statements, although such disclosure is required in terms of IFRS, IAS 37 – Provisions,
Contingent Liabilities and Contingent Assets.
Qualified Opinion
In our opinion except for the effects of the matter described in the Basis for Qualified Opinion
paragraph, the financial statements present fairly in all material respects the financial
position of Specfix (Pty) Ltd as at 31 March 2016 and its financial position and cash
flows for the year then ended in accordance with International Financial Reporting
Standards and the requirements of the Companies Act of South Africa.
Other reports required by the Companies Act
As part of our audit of the financial statements for the year ended 31 March 2016, we
have read the Directors’ Report for the purpose of identifying whether there are material
inconsistencies between the report and the audited financial statements. This report is
the responsibility of the directors. Based on reading this report we have not identified
any material inconsistencies between this report and the audited financial statements.
However, we have not audited this report and accordingly do not express an opinion on the
report.
Alan Dereks
Alan S. Dereks
Registered Auditor
Jones and Jonker
Registered Auditors
Pretoria
2 July 2016
**2016**
SUGGESTED SOLUTION TO EXERCISE 15.7
1 Page only
a)
1.
This amounts to a subsequent event which seriously prejudices the going
concern ability of the company.
2.
3.
Prior to this development, an unqualified opinion appears to have been fully
justified; this however is most likely to result in an adverse opinion on the
going concern ability of the company;
2.1
the question states that the importation of waste is "regarded as the only
way in which the company could continue to operate".
2.2
importation of waste has been banned indefinitely and
2.3
in the opinion of experts, is unlikely to be lifted in future years.
2.4
the directors can offer no plausible explanation as to how the company
will continue to operate.
The company is facing severe liquidity problems
3.1
their borrowing powers are extended to the limit and in the absence of
profitable trading, they will be unable to pay back this capital or
interest thereon.
3.2
it is very likely that they will face lawsuits for non-performance on the
contracts they have signed for the recycling products.
3.3
they are likely to have to pay some amount in respect of the waste which
they purchased in the Far East.
4.
The directors contention that it should not affect the 31 December financial
statements as it occurred after balance sheet date is contrary to IAS 10. IAS 10
states that an entity shall not prepare its financial statements on a going
concern basis if management determines after the reporting date, that it has no
realistic alternative but to cease trading.
5.
Their contention that there is "no point in alarming the shareholders" is equally
ridiculous, if they are not prepared to “present fairly” the position of the
company in the financial statements, they are in fact knowingly misrepresenting
the state of the company.
6.
Furthermore, as there has been coverage in the media, it is very unlikely that the
shareholders would be unaware, and would probably be awaiting the financial
statements with some anxiety.
7.
b)
As discussed above, there is no alternative but to
financials should be presented on the liquidation
significance of the matter.
cease
basis
trading and
because of
the
the
Independent Auditor’s Report to the shareholders of H-Two-Oh (Pty) Ltd.
We have audited the financial statements of H-Two-Oh (Pty) Ltd set out on pages 3 - 30
which comprise the statement of financial position at 31 December 2015 and the statement
of comprehensive income, statement of changes in equity and statement of cash flows for
the year then ended and the notes comprising a summary of significant accounting policies
and other explanatory information.
Basis
As described above in Note 10 to the financial statements, the financial statements have
been prepared on the going concern basis which assumes that the company will continue to
operate.
According to the directors, the company's future depends upon the successful
entry into the waste recycling market.
To this end, new plant and equipment was
commissioned, and contracts for the purchase of chemical waste and for the subsequent
sale of the recycled products have been signed. However, the government has placed an
indefinite ban on the import of waste products which expert opinion believes, will not be
lifted in the future due to the growing influence of environmental bodies within
government. The directors can offer no plausible explanation as to how the company will
continue to operate.
The financial statements are prepared on the going concern basis
which, in our judgement, is inappropriate in the circumstances.
Adverse Audit Opinion
In our opinion because of the significance of the matter discussed in the Basis for
Adverse Opinion paragraph, these financial statements do not fairly present the financial
position of H-Two-Oh (Pty) Ltd at 31 December 2015 and of its financial performance and
cash flows for the period then ended in accordance with International Financial Reporting
Standards and in compliance with the Companies Act 2008 of South Africa.
Kalvin K. Kline
Kalvin K Kline
Registered Auditor
Partner: Deloitte
Registered Auditors
73 Ventoux Road
Gardens
4 April 2016
**2016**
SUGGESTED SOLUTION TO EXERCISE 15.6
1 Page only
Independent Auditor’s Report
To the shareholders of Destinations (Pty) Ltd
Report on the Financial Statements
We have audited the financial statements of Destinations (Pty) Ltd, set out on pages 12 to 36,
which comprise the statement of financial position as at 29 February 2016, and the statement of
comprehensive income, statement of changes in equity and statement of cash flows for the year
then ended, and the notes, comprising a summary of significant accounting policies and other
explanatory information.
Directors’ Responsibility for the financial statements
The company’s directors are responsible for the preparation and fair presentation of these
financial statements in accordance with IFRS for SMEs and the requirements of the Companies Act
of South Africa, and for such internal control as the directors determine is necessary to enable
the preparation of financial statements that are free from material misstatement, whether due to
fraud or error.
Basis for qualified opinion
Included in accounts receivable, is an amount of R337 222 which is owed by a debtor that has been
placed in liquidation since the year end of the company.
An impairment loss has not been
recognised in accordance with International Financial Reporting Standards, IAS 39 Financial
instruments – Recognition and Measurement.
The liquidator has indicated that creditors are
unlikely to receive any payment.
In these circumstances, an impairment loss should have been
recognised in full. Had this been done, accounts receivable would have been stated at R832 003
(assume) and net profits would have been reduced to Rxxxx.
Qualified opinion
In our opinion, except for the effects of the matter described in the Basis for Qualified Opinion
paragraph, the financial statements present fairly, in all material respects, the financial
position of Destinations (Pty) Ltd as at 29 February 2016 and its financial performance and cash
flows for the year then ended, in accordance with the IFRS for SMEs and the requirements of the
Companies Act of South Africa.
Other reports required by the Companies Act
As part of our audit of the financial statements for the year ended 29 February 2016, we have
read the Directors’ Report for the purpose of identifying whether there are material
inconsistencies between this report and the audited financial statements. The Directors’ Report
is the responsibility of the directors. Based on reading the report we have not identified any
material inconsistency between the report and the audited financial statements. However, we have
not audited the report and accordingly, do not express an opinion on the report.
Report on other legal and regulatory requirements
Minutes of Directors’ meetings, as required by Sec 24 of the Companies Act of South Africa have
not been maintained.
Richard Quin
Richard Quin
Registered Auditor
30 April 2016
1 Ramron Lane
Balgowan 5001
**2016**
SUGGESTED SOLUTION TO EXERCISE 15.5
1 Page only
Independent auditor’s report
To the shareholders of Cordon (Pty) Ltd
We have audited the annual financial statements of Cordon (Pty) Ltd set out on pages 5 to 30
which comprise the statement of financial position as at 31 March 2016, and the statement of
comprehensive income, statement of changes in equity and cash flows for the year then ended, and
the notes, comprising a summary of significant accounting policies and other explanatory
information.
Basis for qualified opinion
1.
As described in note 5 to the financial statements, the company has valued its inventory at
anticipated replacement value.
International Accounting Standard IAS10 – Inventories,
requires that inventory be valued at the lower of cost or net realisable value.
This
departure from the accounting standards has resulted in inventory being overstated in the
statement of financial position by R1 750 000 and reserves by the same amount.
Total
comprehensive income for the year has been correspondingly overstated by R1 750 000.
Taxation was calculated on the correct basis and hence no adjustment to taxation payable is
required.
2.
All material transactions between the company and related parties must be disclosed in
terms of International Accounting Standards (IAS) 24 – Related Party Disclosures. During
the year under audit the company entered into material transactions with entities or
individuals which are by definition, related parties through their connection to directors
of Cordon (Pty) Ltd. Details of these transactions have not been disclosed as required by
IAS 24.
Qualified opinion
In our opinion except for the effect of the matter described in paragraph 1 and the omission of
information described in paragraph 2 of the Basis for Qualified opinion paragraph, the financial
statements present fairly, in all material respects, the financial position of Cordon (Pty) Ltd
at 31 March 2016 and financial performance and cash flows for the year then ended, in conformity
with the International financial Reporting Standards and the requirements of the Companies Act in
South Africa.
Jimmy Oats
James Oats: partner
Registered Auditor
Hall and Oats
Registered Auditors
63 Jett Way
Brakpan
1 May 2016
**2016**
SUGGESTED SOLUTION TO EXERCISE 15.4
1 Page only
No.
Nature
1.
Insufficient appropriate evidence
Scope limitation
Material and/or pervasive
-
Opinion
disclaimer
2.
Disagreement (misstatement)
Material
-
Inappropriate application of
standard
3.
Disagreement (misstatement)
-
adverse
-
unqualified
Inappropriate selection of standard
4.
Emphasis of matter
5.
Disagreement (misstatement)
Material
-
Material and pervasive
-
Material
-
Inappropriate disclosure
6.
Disagreement (misstatement)
Inappropriate selection of standard
7.
Insufficient appropriate evidence
Scope limitation
8.
Disagreement (misstatement)
Inadequate disclosure/inappropriate
application
-
except for
**2016**
SUGGESTED SOLUTION TO EXERCISE 15.3
1 Page only
a.
1.
The introductory paragraph
This paragraph
1.1
states that the financial statements have been audited
1.2
identifies the entity to which the audit relates
1.3
identifies the title of each of the components of the complete set of
financial statements which are being reported on
1.4
makes reference to the accompanying notes
1.5
states the date and period covered by the financial statements.
2.
Directors Responsibility paragraph
This paragraph states that the directors are responsible for
2.1
the preparation and fair presentation of the FS in accordance with the
IFRS/IFRS for SME’s and the Companies Act 2008
such internal control as the directors determine is necessary to enable the
preparation of financial statements that are free from material
misstatement, whether due to fraud or error.
Auditor’s responsibility paragraph
2.2
3.
This paragraph should inform the user that:
3.1
the auditors responsibility is to express an opinion of the financial
statements
3.2
the audit was conducted in accordance with the ISAs and that the standards
require
3.3
4.
compliance with ethical standards
*
planning and performing the audit to obtain reasonable assurance as to
whether the financial statements are free from material misstatement
the audit
*
involves performing procedures to obtain audit evidence about amounts
and disclosures
*
procedures depend on the auditor’s judgement including the assessment
of risks of material misstatement whether due to fraud or error
*
risk assessment includes considering internal controls, evaluating
accounting policies, reasonableness of accounting estimates and
overall presentation and disclosure
*
does not include audit procedures conducted for expressing an opinion
of the effectiveness of internal controls.
The opinion paragraph
4.1
b.
*
This paragraph conveys to the user that in the opinion of the auditor the
financial statements present fairly in all material respects the financial
position of the company at a date, and its financial performance and its
cash flow for the period ended on that date, in accordance with
International Financial Reporting Standards and the Companies Act 2008.
The standard audit report which will include the four paragraphs above plus the paragraph
dealing with other reports required by the Companies Act will be expanded under the
following circumstances
1.
where there is
disclaimer).
2.
where the auditor wishes or is required by law to convey to users, information
which does not affect fair presentation. This can be broken down further
2.1
a
need
to
modify
the
opinion
given
(qualification,
adverse
emphasis of matter; where the auditor wishes to bring the attention of the
user to a matter although the matter has been adequately dealt with in the
financial statements
2.2
where the auditor considers it necessary to communicate a matter
which is not presented or disclosed in the FS an “other matter” paragraph
may be added.
c.
2.3
where the auditor has other reporting responsibilities, in terms of an Act
or (other) Regulation, e.g. in terms of the AP Act relating to reportable
irregularities.
1.
Where there is a need to modify the audit opinion
1.1
2.
the report will be expanded by the inclusion of "a basis for
qualification" paragraph. This paragraph will explain why the opinion is
being qualified, or why an adverse opinion or a disclaimer of opinion is
being given.
Where the auditor wishes to, or is required by law to convey information
2.1
an information paragraph, or a number of information paragraphs will be
added after the opinion has been given.
2.2
no special wording is required other than that for an "Emphasis of matter"
where the paragraph is opened with the standard wording "without
qualifying our opinion above, we draw attention to...".
2.3
where the added paragraph is an “other matter” paragraph, the paragraph
will be headed “other matter”.
2.4
where the added paragraph is as a result of other legal or regulatory
duties, the additional paragraph will be headed “Report on other Legal and
Regulatory Requirements”.
**2016**
SUGGESTED SOLUTION TO EXERCISE 15.2
1 Page only
1.
The objectives of the auditor are
1.1
To form an opinion on the financial statements based on evaluation of the conclusions
drawn from the audit evidence obtained.
1.2
To express clearly that opinion through a written report that also describes the
basis for that opinion.
2.
General purpose financial statements are financial statements prepared in terms of a
reporting framework designed to meet the common financial information needs of a wide range
of users.
3.
No, Fred Dedd should not agree to this request.
Reasons:
3.1
In terms of ISA 700, the audit report must be in writing.
3.2
The wording of the audit report is specific and designed to clearly convey the
responsibilities of various parties (directors/auditors) in a standard format.
Deviating from this by giving a narrative report increases the risk of the audit
report being misunderstood (particularly the responsibility of the auditor.)
3.3
With regard to the auditor giving the shareholders a better understanding of the
audit report, this can still be achieved as Fred Dedd will be at the AGM and there is
nothing to prevent the shareholders from quizzing him.
3.4
Finally, the audit report, although primarily for the shareholders, is also important
to other stakeholders in Pottholes (Pty) Ltd who will not be at the AGM as they are
not entitled to be.
financial statements.
4.
5.
6.
7.
They require a written audit report which accompanies the
4.1
Whether the financial statements
policies selected and applied.
4.2
Whether the accounting policies selected and applied are
applicable financial reporting framework and are appropriate.
4.3
Whether the accounting estimates made by management are reasonable.
4.4
Whether the information presented in the financial statements is relevant, reliable,
comparable and understandable.
4.5
Whether the financial statements provide adequate disclosures to enable the users to
understand the effect of material transactions and events on the information conveyed
in the financial statements.
4.6
Whether the terminology used is appropriate.
4.7
Whether the financial statements achieve fair presentation.
4.8
Whether the financial
reporting framework.
5.1
The name of the entity whose financial statements have been audited.
5.2
A statement that the financial statements have been audited.
5.3
The title of each statement that comprises the financial statements.
5.4
A reference to the summary of significant accounting policies and other explanatory
information.
5.3
The date or period covered by each financial statement comprising the financial
statements.
6.1
Statements 6.1 and 6.3 are true.
6.2
This statement (6.2) is false.
An emphasis of matter is not a modification of the
auditor’s opinion, it is simply an additional paragraph to bring an important matter
to the attention of the user.
An adverse opinion is a modification of opinion.
(Note: the second part of the sentence is correct.)
statements
adequately
adequately
disclose
describe
the
or
significant
consistent
refer
to
accounting
with
the
the applicable
Misstatements which have a pervasive effect are those which
7.1
Are not confined to specific elements, accounts or items of the financial statements
but
7.2
If so confined, represent
financial statements.
7.3
In relation to disclosures, are fundamental to users understanding of the financial
statements.
or
could
represent
a
substantial
proportion
of
the
8.
8.1
The signature of the designated auditor
8.2
The name of the designated auditor
8.3
The words “registered auditor”
8.4
The date on which the report was signed
8.5
The auditor’s address.
**2016**
SUGGESTED SOLUTION TO EXERCISE 15.1
1 Page only
1.
:
1.2
2.
:
2.2
3.
:
3.3
4.
:
False (registered auditor is compulsory, chartered accountant is voluntary)
5.
:
5.3
6.
:
6.3
7.
:
7.3
8.
:
8.4
9.
:
9.2
10. :
10.4
**2016**
SUGGESTED SOLUTION TO EXERCISE 14.14
Page 1 of 2 pages
a)
1.
In terms of Sec 22 of the Companies Act 2008, a company must not carry on its business recklessly, with gross
negligence, with intent to defraud or for any fraudulent purpose.
2.
Whilst continuing to trade in a situation where liabilities exceed assets does not automatically mean that
Milectrix (Pty) Ltd is “carrying on its business recklessly … etc”, it is a situation which has the potential to give rise to
recklessness, gross negligence etc on the part of the directors of the company
2.1
this is because Milectrix (Pty) Ltd is insolvent and if the directors for example, continue to enter
into contracts with suppliers etc, knowing that the supplier will not be paid, they will be acting
negligently/committing fraud. Furthermore, if the directors are careless in spending money/paying
themselves bonuses etc, it could be construed as reckless trading.
3.
In terms of Sec 22, if the Commission has reasonable grounds to believe that Milectrix (Pty) Ltd is engaging in
reckless trading etc or is unable to pay its debts as they become due and payable, it may issue a notice to the company to
show cause why the company should be permitted to continue carrying on its business
3.1
Milectrix (Pty) Ltd would then have 20 business days to satisfy the Commission that it is not
breaching Sec 22 and can pay its debts
3.2
If Milectrix (Pty) Ltd cannot provide this evidence, the Commission may issue a compliance notice
requiring the company to cease trading.
b)
Additional audit procedures: Additional audit procedures need to be carried out because
we must be in a position to evaluate whether
*
the preparation of the financial statements on the going concern basis is
appropriate
*
1.
by continuing to trade the directors are carrying on the business recklessly, with
gross negligence etc.
If this is the case it would constitute a reportable
irregularlity which we would have to report.
Provision of finance
1.1
Obtain written confirmation from Rowlec (Pty) Ltd that it will continue to provide
finance.
Reason:
2.
*
The minute in the audit file states that Rowlec (Pty) Ltd will subordinate
its loan. It does not say that it will continue to provide finance.
*
The going concern basis of preparation is only justified if the company
will be able to pay its debts as they fall due. The audit senior believes
that this is only possible if Rowlec (Pty) Ltd "provides finance to pay
its debts."
*
The financial controller has made an oral representation but we need
written confirmation for this to be appropriate evidence on which we can
rely.
The subordination agreement
2.1
Inspect the agreement itself to ensure that
*
it is a written contract
*
signed on behalf of Rowlec (Pty) Ltd and accepted by Milectrix (Pty) Ltd
with due authority, e.g. signed by the directors.
*
all legal formalities have been complied with and,
*
it is drafted in accordance with SAICA requirements.
Reason: An offer in a directors minute does not constitute sufficient acceptable
evidence; a legally enforceable contract is required.
2.2
Evaluate whether Rowlec (Pty) Ltd's loan is of sufficient size to create a
situation where exception cannot be taken to the continuation of trading.
Reason: The subordination is intended to give the company a realistic chance to
return to profitable trading.
The loan subordinated must therefore be
sufficiently material to have a positive effect on achieving this goal.
2.3
Establish by discussion with the directors and auditors of Rowlec (Pty) Ltd and by
scrutiny of their latest financial statements, whether they are of sufficient
substance to subordinate their loan AND that they are entitled to do so.
Reason:
2.4
*
Rowlec (Pty) Ltd are in effect "disposing" of an asset. Should they in
turn go insolvent, their liquidator may be in a position to set the
subordination agreement aside as a disposition not for value.
*
the asset (Milectrix (Pty) Ltd is a debtor in Rowlec Ltd’s books) may be
encumbered in some way e.g. factored.
Discuss the entire matter with the directors of Rowlec (Pty) Ltd and Milectrix
(Pty) Ltd to establish:
*
**2016**
what value they perceive is accruing to Rowlec (Pty)Ltd by subordinating
their loan.
/continued on page 2
SUGGESTED SOLUTION TO EXERCISE 14.14
Page 2 of 2 pages
Reason:
*
This may assist in proving that the subordination was not a disposition
for no value should the need arise.
*
whether
honest.
their
intentions
in
respect
of
the
backranking
agreement
are
Reason:
*
To form an opinion on whether this agreement between a holding company and
its subsidiary is genuine or one of "convenience" to stave off
liquidation.
*
whether any creditors of Milectrix (Pty) Ltd have accepted the benefit of
the backranking agreement, particularly the bank which appears to be a
major creditor.
Reason: If any creditor has accepted the benefit of the subordination agreement,
it cannot be set aside by Rowlec (Pty) Ltd and Milectrix (Pty) Ltd without
consent of the third party (creditor).
2.5
Establish the likelihood of, and expected timing of, the abolishment of the
investment incentives by discussion with the directors, the department of trade
and industry, and the electronic industry representative body.
Reason: If the abolition is not being considered or is far into the future, we
should view the contention that Rowlec (Pty) Ltd will continue to support
Milectrix (Pty) Ltd with professional scepticism.
3.
Review the latest figures, budgets and cash projections.
3.1
Any material changes in these figures since
assertion, should be substantiated.
the audit of the going
concern
Reason:
*
The going concern assertion does not simply become appropriate because of
the existence of a valid subordination agreement. The company must
*
be able to pay its debts as they become due and
*
have a realistic chance of returning to profitable trading.
These prerequisites
information.
4.
The bank
can
be
better
established
by
obtaining
the
most
up
to
date
4.1
5.
Determine from the bank whether this arrangement will favourably affect their
relationship with Milectrix (Pty) Ltd
*
extended overdraft facilities
*
less stringent requirements for security over loans and repayments.
Reportable Irregularity
5.1
Consider whether the directors of Milectrix (Pty) Ltd would be guilty of reckless,
grossly negligent or fraudulent trading if they continue to trade.
Reason: In terms of Sec 22 of the Companies Act 2008 a company which trades
recklessly etc will be in breach of the section.
Trading whilst
technically insolvent is a situation which presents a genuine risk that
reckless trading etc may occur (see part a). In terms of Sec 44 and 45
of the Auditing Profession Act we have a duty to report reckless/grossly
negligent/fraudulent trading as it constitutes a contravention of Sec 22
(illegal act).
6.
Disclosure
6.1
The AFS must be inspected to ensure that the subordinated loan is suitably
described in the statement of financial position and fully explained in the notes.
Reason: To comply with reporting standards.
Note: this assumes that the loan is subordinated and that the financial statements are
presented on the going concern basis.
Note:
The audit report will probably have to be redrafted.
Reason: An unmodified report cannot be justified in this case, regardless of the
outcome of the above procedures.
The most likely situation is an
unqualified audit opinion with an “emphasis of matter” pertaining to the
notes on going concern and the subordination agreement.
**2016**
SUGGESTED SOLUTION TO EXERCISE 14.13
Page 1 of 2 pages
Evaluation of the appropriateness of the “going concern” basis.
General
ISA570, in terms of the going concern assumption, an entity is “viewed as continuing in business
for the foreseeable future. General purpose financial statements are prepared on a going concern
basis, unless management either intends to liquidate the entity or to cease operations, or has no
realistic option but to do so.
1.
For practical purposes the foreseeable future is deemed to be 12 months, so in essence we
must evaluate whether ShoeShuffle (Pty) Ltd is justified in recording its assets and
liabilities on the basis that assets will be realized and liabilities discharged in the
normal course of business for this period.
Adjustments to the financial information provided.
1.Although the company reflects a profit for the year before tax of R287 000, a number of
adjustments should be made to obtain a clearer picture.
1.1
Inventory appears to be overvalued by the understatement of the obsolescence
allowance.
The percentage used has dropped from 8% (R279 200) in 2015 to 5.73%
(R279 337) in 2016. This is unacceptable as

the company has simply used the rand amount of the prior year’s allowance.

there has been a marked increase in the rand value and the quantity of inventory
and

despite the order book being down, production has continued resulting in
stockpiling which must raise the question of the salability of the company’s
inventory.
1.2All of the above suggest that the allowance should be at least the same percentage as
the previous year (R390 000), an understatement of at least R110 663. Although further
work would need to be done on the allowance, the basic percentages suggest overstatement
of inventory.
1.3
The allowance for doubtful debts also appears to be understated. The company has
used the same percentage (10%) as in the prior year. This is unrealistic as

the days outstanding has gone from 65 days to 95 days.

the company has relaxed its credit limits.

many of the company’s customers are facing increased liquidity problems.
1.4All of the above suggest that the allowance should be increased. At an increase of,
say 2%, there would be an understatement of R81 467. Again, more detailed work will need
to be done on the allowance.
1.5The investment in Its Shoetime (Pty) Ltd is clearly overstated, as the company has
performed poorly to the extent that 3 of the 10 original outlets have closed. The
investment should be shown at fair value not cost.
1.6Even though there may be no direct correlation, it would appear that it would be
prudent to at least write down this investment by 30% (R360 000).
2.
In effect the company has not made a profit of R287 000 before tax but has made a
loss of at least R265 130 (287 000 – 110 663 – 81 467 – 360 000) based on the unaudited
figures.
Financial Indicators
1.
Despite the adjustments that are necessary, the company is not in a net liability
position (factually insolvent) or in a net current liability position.
2.
It may, however, be commercially insolvent (i.e. unable to pay its debts as they
fall due as a result of liquidity problems).
2.1
An amount of R2 million must be found on 1 August to repay long-term loans (see
mitigating factors below).
2.2
As production is continuing, normal operating costs including wages must be paid.
2.3
Trade creditors must be paid.
2.4
Although the company has an unused overdraft facility of R1m, this will still not be
enough to cover the above outflows (see mitigating factors below).
2.5
The problem is compounded by the fact that the company’s customers are facing
liquidity problems themselves and, as a result, paying very slowly.
**2016**
/continued on page 2
SUGGESTED SOLUTION TO EXERCISE 14.13
Page 2 of 2 pages
3.
A brief analysis of some of the company’s financial ratios confirms that the
company is in financial trouble.
(This is even the case before the likely adjustments
are made.)
3.1The
current
ratio
is
a
threatening
1.1:1
and
3.2The
quick
asset
ratio
is
a
poor
0.5:1.
3.3The net profit to turnover has declined from a low 6% to a negative return, as the
company has in fact made a loss.
4.
Despite measures to counteract it, turnover has declined by 14% (R2265/R16323)
since last year and looks set to continue as orders are down by 40% and there is a
likelihood of losing government contracts.
Operating Indicators
1.
ShoeShuffle (Pty) Ltd faces the loss in late 2016 of a major market, (R1.5
million in turnover to the Government Health Department).
2.
It is likely that the other government departments will adopt the same stance as
the Health Department which could potentially reduce ShoeShuffle (Pty) Ltd’s turnover by
a further R3 million (see mitigating factors).
3.
The company faces labour problems, which could severely disrupt production and
result in large retrenchment payouts if the labour force is to be reduced.
Mitigating factors
1.
The immediate problem of finding R2m to pay the shareholders/directors loans
could be avoided if they decide in the interests of their company, to delay/roll-over the
loans.
2.
A significant portion of the Property, Plant and Equipment is unbonded and could
be used to raise additional finance.
3.
Although the directors estimate that it would take 12 months to get the company
BEE tender compliant, if they could speed it up there is a “substantial” new market which
will become available as the Government will no longer import shoes from foreign
companies.
4.
As ShoeShuffle (Pty) Ltd has supplied the government “for many years” it suggests that,
once compliant, the company is in a good position to share in this enlarged market. This
means that they probably need to hold out for only 12 months before returning to
profitability.
**2016**
SUGGESTED SOLUTION TO EXERCISE 14.12
Page 1 of 2 pages
Workings:
Adjustments :
Retained earnings
Less : Interest accrued
1 482 031
764 220
Allowances: inventory (minimum)
461 613
debtors (minimum)
328 712
1 554 545
Accumulated loss
(72 514)
Net current assets
59 131
Less : adjustments
1 554 545
Net current liabilities
1 495 414
1.
The appropriateness of presenting the financial statements on the going concern basis,
can be assessed by analysis of the financial, operating and other conditions or events
pertaining to Skinham (Pty) Ltd at year end date and during the subsequent period.
2.
Financial
Skinham (Pty) Ltd's financial position is very poor
2.1
2.2
2.3
2.4
At 31 March 2016, the company was in a net current liability position (R1 495 414)
*
although the draft statement of financial position reflects current assets
of R7.9m, even minimum allowances for inventory obsolescence and bad debts
will reduce this total to an amount which results in a net current
liability situation (see workings above)
*
raising the current liability for the interest further increases the net
current liabilities position.
Maintaining these two allowances at the historical 10% is unrealistic under the
current trading conditions and both should be increased. This will worsen the
net current liability position
*
all but one of the company's debtors are experiencing liquidity problems
which is likely to result in increased bad debts.
*
the collection period has increased sharply.
*
inventory on hand has more than doubled, and
*
if Skinham (Pty) Ltd's traditional customers (shoe business) are unable to
purchase due to their trading difficulties, Skinham (Pty) Ltd is likely
to suffer an increased level of inventory obsolescence as 60% of the
inventory on hand at year end is treated and must be used for manufacture
within six months.
The company is also approaching a net liability position
*
based on the minimum allowance adjustments and providing for the interest
owed, the company has
an accumulated loss of R72 514 which reduces
shareholders equity to R77 486
*
the accumulated loss may be "reduced" by a
revaluation of the unlisted
investment to R500 000 which appears to be a "fair" price (and the value
at which the investment should be reflected in the AFS).
This would
increase shareholders equity as well but
*
as indicated above, the allowances are understated and increasing these to
realistic levels will decrease shareholders equity
*
further losses have been incurred during the
worsens Skinham (Pty) Ltd's position.
subsequent period which
Even without making adjustments for the allowances, a simple ratio analysis
underlines the severe difficulties which Skinham (Pty) Ltd faces in their working
capital with both the current and quick ratios worsening since the prior year
current ratio
2016
2015
7 903 255
4 802 700
7 844 124
1 979 700
=
quick ratio
**2016**
1:1
=
2.4:1
3 287 123
2 417 300
7 844 124
1 979 700
=
=
,42:1
1.22:1
/continued on page 2
SUGGESTED SOLUTION TO EXERCISE 14.12
Page 2 of 2 pages
2.5
2.6
3.
Skinham (Pty) Ltd has a severe liquidity problem
*
the overdraft (which in itself is considerable in the context of the
company) is already over its limit
*
creditors are approaching R3 000 000 and will be pressing for payment
*
an interest payment of R764 220 must be paid as it was due on 1 April 2016
and was not paid, penalties are likely to be incurred.
Non-payment may
even result in liquidation proceedings being instituted, but see (4.5).
*
the company is continuing to trade and being labour intensive, will need
to find cash to pay wages to avoid further trading difficulties, e.g.
strikes
.
The agreement whereby Doochi (Pty) Ltd pays Skinham (Pty) Ltd within 15 days of
invoice, will provide some relief as far as cashflow is concerned, but is unlikely
to solve the company's fundamental problems.
Operating
Skinham (Pty) Ltd is facing adverse trading conditions which seriously threaten its
continued existence.
3.1
The industry of the company's major customer base is currently under serious
threat due to cheap imports of shoes. As the local shoe industry cannot compete,
demand for Skinham (Pty) Ltd’s product is dwindling.
3.2
The only customer who is able to trade with Skinham (Pty) Ltd as normal (Doochi
(Pty) Ltd) could cause significant problems for Skinham (Pty) Ltd:
*
the manufacturing process of leather for Doochi (Pty) Ltd is very
expensive and the highest quality must be maintained; Skinham (Pty) Ltd
have a liquidity problem and cannot afford to cut costs for fear of
producing substandard quality leather which may be rejected.
*
in addition, to service their "best" customer, Skinham (Pty) Ltd requires
a supply of non-domestic animal hides. The company’s supplier, Slice and
Slaughter Ltd is under intense pressure from environmental groups and may
be forced to discontinue supplying to Skinham (Pty) Ltd or to raise prices
considerably. (Note : Ultimately the pressure from environmental groups
may also affect the business of Doochi (Pty) Ltd, Skinham (Pty) Ltd's
best customer).
*
Skinham (Pty) Ltd is tied into a contract to
supply a minimum
monthly quantity; both of the above points, jeopardize the company's
ability to meet this requirement which could result in Skinham (Pty) Ltd
losing the contract and incurring significant penalties.
4.
Mitigating Circumstances
4.1
The directors of Skinham (Pty) Ltd are personally liable for the bank overdraft
and will no doubt be determined to save the company from liquidation.
4.2
They have already demonstrated their intention to do so by acknowledging the
company's difficulties and planning to diversify.
4.3
The investment in Baggs (Pty) Ltd could probably be sold to generate funds or at
least be offered as security to raise additional funds, e.g. overdraft.
4.4
The fixed assets of the company, a substantial figure, are also unencumbered and
may be used to secure additional finance, e.g. sale and leaseback.
4.5
The IDC loan is not repayable until 2019 and as it is unsecured, the IDC is
probably unlikely to "liquidate" the company on account of unpaid interest as they
will rank concurrently with all other creditors.
4.6
The company has been successful in tendering for a contract for the supply of
soccer balls but:
*
they will have to invest in machinery
liquidity problem this will be difficult.
"without
delay";
with
their
*
costs will also have to be incurred in training labour and setting up what
is in effect, a new business.
*
no information is provided as to cash flows/profit forecasts, costs of
machinery etc.
it is thus premature to make a decision on whether this diversification will save
the company.
**2016**
SUGGESTED SOLUTION TO EXERCISE 14.11
1 Page only
1.
The adoption of the going concern assumption means that the entity is viewed by the
directors (and users) as being able to continue in business for the foreseeable future
and assets and liabilities are recorded on the basis that the entity will be able to
realize its assets and discharge its liabilities in the normal course of business.
2.
The objectives are
3.
2.1
To obtain sufficient appropriate audit evidence about the appropriateness of the
directors’ use of the going concern assumption in the preparation and presentation
of the financial statements.
2.2
To conclude, based on the evidence obtained, whether a material uncertainty exists
that may cast significant doubt on the entity’s ability to continue as a going
concern.
3.1
No, going concern is not an assertion as per ISA 500 – Audit Evidence; it is a
basis of preparation for financial statements.
3.2
Adoption of the going concern basis will have an affect on some of the assertions
e.g. inventory is usually valued at cost on the assumption that the company will
sell the inventory but if the company is to cease trading, then net realisable
value (in this case what the company can get for the goods in a forced sale) is
more likely to be the value at which inventory is reflected. Similarly plant and
equipment will have a “going concern” value and a “not a going concern” value.
4.
No, the auditors (and directors) cannot guarantee future events and conditions.
concern is about predicting the future and nobody can guarantee the future.
5.
5.1
No, the risk assessment stage is not the only “stage” at which going concern is
considered by the auditor.
5.2
The auditor considers going concern at all stages of the audit. Para 11 of the
going concern ISA states that the auditor shall “remain alert throughout the audit
for audit evidence of events or conditions that may cast significant doubt on the
entity’s ability to continue as a going concern”.
5.3
The auditor will consider going concern right up until the signing of the audit
report (as a subsequent event procedure).
6.1
Yes it is.
The auditor himself must obtain sufficient appropriate evidence to
express an opinion on the financial statements; it is not just a matter of taking
the directors’ word for it because they have done the assessment.
6.2
Of course, where the directors have performed an assessment, the auditor will
discuss the assessment with the directors as part of the evidence gathering
process.
6.
Going
7.
A mitigating factor is a fact or circumstance which “supports” the adoption of the going
concern assumption particularly when a significant uncertainty exists which casts doubt
on the company’s ability to continue as a going concern.
8.
Modified report – adverse opinion (the financial statements do not present fairly).
**2016**
SUGGESTED SOLUTION TO EXERCISE 14.10
Page 1 of 3 pages
1.
The statement means that in preparing the financial statements, it has been assumed that
the company “is viewed as continuing in business for the foreseeable future”.
General
purpose financial statements are prepared on a going concern basis unless management
either intends to liquidate the entity or to cease operations, or has no realistic
alternative but to do so.
2.
The auditor’s responsibility is to obtain sufficient appropriate audit evidence about the
appropriateness of management’s use of the going concern assumption in the AFS and to
conclude on whether there is a material uncertainty about the entity’s ability to
continue as a going concern.
3.
The auditor considers going concern
3.1
When performing risk assessment procedures:
In terms of ISA 315 (Revised), the
auditor must carry out procedures to identify and assess the risks of material
misstatement at the “planning” phase of the audit.
The auditor shall consider
whether there are events or conditions that may cast significant doubt on the
entity’s ability to continue as a going concern.
3.2
During the performance of the audit procedures: during this stage of the audit,
the auditor will be alert to events or conditions which provide evidence relating
to going concern e.g. declining sales, cash flow problems.
4.
5.
6.
3.3
At the evaluating and concluding stage: at this stage the auditor considers all
the evidence gathered during the audit pertaining to the company’s going concern
ability. This will be the major going concern evaluation.
3.4
During the review of subsequent events: at this stage the auditor will consider
whether any event has occurred in the subsequent period which may affect the going
concern ability of the client.
4.1
Aggravating factors are those factors which work against the adoption of the going
concern basis, e.g. loss of major markets, declining profits, competition, etc.
4.2
Mitigating factors are those factors which support the adoption of the going
concern basis when there is some doubt about the adoption of the basis e.g. a
large lucrative contract has been signed by a company which appeared to have a
going concern problem.
Mitigating factors counterbalance negative events or
conditions.
4.3
To make a proper evaluation the auditor will consider both “aggravating” and
“mitigating” factors.
5.1
Yes it can. Management (and the auditor) may justifiably believe that the company
will continue in the normal course of business despite the fact that a material
uncertainty exists.
For example, a company which is facing severe trading
difficulties may be about to win a major tender which will secure the company’s
(foreseeable) future. Indications are that the tender will be won but it has not
yet been awarded.
5.2
In this type of situation it is “fair” to adopt the going concern basis but to
achieve fair presentation, full disclosure of the material uncertainty must be
made.
Factual insolvency arises when the liabilities of an undertaking exceed its assets,
fairly valued.
Commercial insolvency arises when an undertaking is unable to pay its
debts as they fall due as a result of illiquidity even though assets exceed liabilities.
**2016**
/continued on page 2
SUGGESTED SOLUTION TO EXERCISE 14.10
Page 2 of 3 pages
7.
Financial
7.1
Net liability or net current liability position.
7.2
Fixed-term borrowings approaching maturity without realistic prospects of renewal
or repayment; or excessive reliance on short-term borrowings to finance long-term
assets.
7.3
Indication of withdrawal of financial support by creditors.
7.4
Negative operating cash flows indicated by historical or prospective financial
statements.
7.5
Adverse key financial ratios.
7.6
Substantial operating losses or significant deterioration in the value of assets
used to generate cash flows.
7.7
Discontinuance of dividends.
7.8
Inability to pay creditors on due dates.
7.9
Inability to comply with the terms of loan agreements.
7.10
Change from credit to cash-on-delivery transactions with suppliers.
7.11
Inability to obtain financing for essential new product development or other
essential investments.
Operating
7.12
Management’s intentions to liquidate the entity or to cease operations.
7.13
Loss of key management without replacement.
7.14
Loss of a major
supplier(s).
7.15
Labour difficulties.
market,
key
customer(s),
franchise,
licence,
or
principle
8.
7.16
Shortages of important supplies.
7.17
Emergence of a highly successful competitor. Other.
7.18
Non-compliance with capital or other statutory requirements.
7.19
Pending legal or regulatory proceedings against the entity that may, if
successful, result in claims that the entity is unlikely to be able to satisfy.
7.20
Changes in law, regulation or government policy expected to adversely affect the
entity.
8.1
Analysing and discussing cash flow, profit and other relevant forecasts with
management.
8.2
Analysing and
information.
8.3
Reading the terms of debentures and loan agreements and determining whether any
have been breached.
8.4
Reading minutes of the meetings of shareholders, those charged with governance and
relevant committees for reference to financing difficulties.
8.5
Inquiring of the entity’s legal counsel regarding the existence of litigation and
claims and the reasonableness of management’s assessments of their outcome and the
estimate of their financial implications.
**2016**
discussing
the
entity’s
latest
available
interim
financial
/continued on page 3
SUGGESTED SOLUTION TO EXERCISE 14.10
Page 3 of 3 pages
8.6
Confirming the existence, legality and enforceability of arrangements to provide
or maintain financial support with related and third parties and assessing the
financial ability of such parties to provide additional funds.
8.7
Evaluating the entity’s plans to deal with unfilled customer orders.
9.
8.8
Performing audit procedures regarding subsequent events to identity those that
either mitigate or otherwise affect the entity’s ability to continue as a going
concern.
8.9
Confirming the existence, terms and adequacy of borrowing facilities.
8.10
Obtaining and reviewing reports of regulatory actions.
8.11
Determining the adequacy of support for any planned disposals of assets.
The note should
9.1
Adequately describe the principal conditions which give rise to the significant
doubt about the entity’s ability to continue in operation for the foreseeable
future.
9.2
State clearly that there is a material uncertainty related to events or conditions
which may cast significant doubt about the entity’s ability to continue as a going
concern and therefore that it (the company) may be unable to realize its assets
and discharge its liabilities in the normal course of business.
9.3
Describe management’s plans to deal with the events or conditions which give rise
to the doubt about the company’s ability to continue as a going concern.
**2016**
SUGGESTED SOLUTION TO EXERCISE 14.9
1 Page only
a)
1.
Occurrence and rights and obligation - disclosed events, transactions and other
matters have occurred and pertain to the entity.
2.
Completeness – all disclosures that should have been included in the financial
statements have been included.
3.
Classification and understandability – financial information
presented and described and disclosures are clearly expressed.
is
appropriately
4.
Accuracy and valuation – financial and other information is disclosed fairly and
at appropriate amounts.
b)
1.
A description of the nature of the contingent liability.
c)
d)
2.
An estimate of its financial effect.
3.
Any uncertainties relating to either or both the amount and timing of the outflows
arising from the contingent liability.
4.
The possibility of any reimbursement.
1.
To make a provision of R5m in the financial statements at year end would be a
contravention of the financial reporting standards.
2.
There is no present obligation to pay R5m, it is only a possible obligation.
Provisions are only made for present obligations.
3.
The fact that the accident happened before year end does not determine whether a
provision or contingent liability is made; the treatment for reporting purposes is
determined by the state of the obligation (present or possible).
1.
Occurrence, completeness and obligation
1.1
by enquiry of management, scrutiny of legal correspondence (attorneys
schedule of litigation and claims), and scrutiny of minutes, confirm that
*
a possible obligation which pertains to Superfood Ltd has arisen (occurrence)
*
the obligation pertains to Superfood Ltd (obligation) and not to another entity
e.g. a supplier who may have packed the shelves with a display of its products
*
that no other similar claims for other contingent liabilities should be included
(completeness).
2.
Classification
2.1
by scrutiny of the case details (and by obtaining legal opinion if
necessary) determine whether, based on the facts, that only a possible
obligation as opposed to a present obligation existed at reporting date.
This will confirm that a contingent liability and not a provision is the
appropriate treatment (classification).
2.2
by careful evaluation of the wording of note 15, determine whether the
matter has been clearly expressed. It has, but could perhaps have been improved by the
inclusion of the company attorney’s opinion on the merits of the case and the reasons
that the company’s insurance may not cover the damages if awarded.
3.
Accuracy and completeness
3.1
e)
by inspection of the claim correspondence etc, confirm that the amount
of the claim is R5m (accuracy) and that all pertinent details have been
included (accuracy and completeness).
1.
No, the matter cannot be ignored.
The event occurred and the claim has been
lodged for a substantial amount of money.
2.
The overriding requirement is fair presentation – shareholders must be informed of
this potential loss which is (possibly) 35% of gross profit. The event is both
quantitatively and qualitatively material.
**2016**
SUGGESTED SOLUTION TO EXERCISE 14.8
Page 1 of 2 pages
a)
1.
The auditor has no
responsibility of management.
2.
responsibility
to
prevent
fraud,
this
is
the
The auditor has a responsibility to
2.1
Evaluate the risk of material misstatement in the financial statements,
whether it be unintentional or intentional (fraudulent).
2.2
If the auditor is of the opinion that there is incentive, opportunity and
an accommodating attitude to fraud, he must design an audit strategy and
plan which will reduce the risk of fraudulent material misstatement
remaining undetected to an acceptable level.
2.3
The auditor also has a duty to respond to the risk by adopting an attitude
of professional scepticism, putting experienced staff on the audit,
alerting the audit team, etc.
3.
The principle explained above (pts 1 and 2) will apply to fraud committed
by management or employees.
(The auditors’ response to who committed the fraud
will be different.)
b)
1.
An audit, although competently done, may still not reveal material fraud
because the audit function has inherent limitations.
1.1
Use of selective testing - audit tests are normally performed on samples
of client transactions.
Although careful consideration goes into
selecting items for sampling, it is possible that the sample selected will
not contain or lead to the discovery of a fraudulent transaction.
1.2
Where a fraudulent transaction has taken place the perpetrators
(management or staff) will normally make every attempt to conceal the
transaction. This makes it extremely difficult for the auditor to detect
it.
1.3
The internal control system is the first line of defence in the prevention
(and detection) of fraud.
However, internal control has inherent
limitations of its own which in turn may limit the effectiveness of the
audit function to identify fraud
*
internal control may be limited by cost.
An ideal system may
require an additional staff member to achieve division of duties
but the company cannot afford it.
This ‘lack of division of
duties’ may increase the risk of fraudulent acts.
*
most internal controls are directed at routine transactions. Nonroutine transactions, (e.g. cash sale of a fixed asset) may often
bypass
controls
resulting
in
‘hard
to
detect’
fraudulent
transactions.
1.4
*
internal controls may be circumvented by collusion between
management, employees and external parties resulting in fraudulent
transactions which are impossible to detect. Although the auditor
perceives that internal control is working; it is not.
*
similarly, management may override a control
*
internal controls may not operate as designed.
Audit evidence is, by its nature, frequently persuasive rather than
conclusive.
The evidence may ‘persuade’ the auditor that no fraud has
occurred when in fact it has.
1.5
A risk assessment process is not an exact science – not every
potential risk will necessarily be identified and where management is
determined that a risk is not identified (probably as in this case) the
chances of the auditor picking it up are significantly reduced.
c)
1.
I do have a duty in respect of this matter despite the fact that the AFS
have already been accepted at the AGM.
2.
From an audit perspective, the financial directors response is very implausible
and would be enough to satisfy me that Swetts (Pty) Ltd has been involved in
selling fake branding goods and was doing so at year end, regardless of whether
the AGM has accepted the AFS.
3.
Had I known about it at the date of my report, I would have been obliged to
consider the matter carefully because I cannot sign an audit report knowing that
the AFS may be misrepresented.
4.
In terms of ISA 560, once the AFS and audit report have been signed (and issued) I
have no duty to perform further procedures pertaining to subsequent events, but if
I become aware of a fact which existed at financial year end, I must follow it up
and consider whether
**2016**
/continued on page 2
SUGGESTED SOLUTION TO EXERCISE 14.8
Page 2 of 2 pages
4.1
The matter could have serious consequences for Swetts (Pty) Ltd, e.g.
inventory confiscation, removal of permission to sell the genuine brand
goods, penalties etc.
4.2
The financial statements did not ‘present fairly’ this (at least) material
situation and as such, a proper appreciation of the company’s affairs
would not be possible.
5.
In essence I cannot allow users to rely on my report knowing that the
report may be inappropriate.
d)
*
1.
I consider that this situation would constitute a reportable irregularity
1.1
Swetts (Pty) Ltd is an audit client, the fact that the 31 March 2016 audit
is “complete” is irrelevant.
1.2
Is there an unlawful act? (Sec 45 – Auditing Profession Act)
to knowingly sell fake products as if they were genuine, is illegal.
*
it amounts to fraud, customers are being defrauded and probably
amounts to participation by Swetts (Pty) Ltd (knowingly) in a
scheme to defraud SARS through importing illegally.
*
1.3
it is a breach of the directors fiduciary duty to the company.
Has the illegal act been committed
management of Swetts (Pty) Ltd?
by
a
person
responsible
for
the
*
it appears from the response of the financial director that the
directors are in some way involved; they have “taken steps to
protect themselves”, “won’t deny it” and will not co-operate with
us.
*
it seems very unlikely that an action such as this could be taken
by outlet managers without the knowledge of the directors.
1.4
Although the directors may argue that the company has not suffered
financial loss (by selling fake goods) and therefore there is no reportable
irregularity, this argument can be rejected on two counts
*
the company is likely to suffer loss from penalties, inventory
confiscation without compensation, etc.
*
financial loss is not a pre-requisite for a reportable irregularity
where the illegal act is fraud or a breach of fiduciary duty.
1.5
One issue may be whether we have sufficient evidence of the illegal
act to be in a position to report an RI.
*
whilst I have no conclusive evidence that Swetts (Pty) Ltd
is involved, I have sufficient “reason to believe” which is all I
require to act:



the financial director is not prepared to “deny or admit it”
although admitting that the directors have taken steps to
protect themselves
he is not willing to allow me to investigate any further
this is not the response I would expect if there was no
substance to the matter, and it gives rise to significant
suspicion or reason to believe.
**2016**
SUGGESTED SOLUTION TO EXERCISE 14.7
Page 1 of 2 pages
a)
1.
Procedures commonly performed by auditors to identify post balance sheet
events.
1.1
Review of the minutes of meetings
*
shareholders
*
directors
*
audit committees and
*
other executive committees
held after balance sheet date.
b)
1.2
Review of the firm’s latest available financial information, including
budgets, cash flow forecasts and other management reports.
1.3
Consideration of relevant information that has come to the attention of
the auditor from sources outside the entity e.g. information gathered by
the audit firm’s technical department from trade journals and other
publications.
1.4
Enquiry and confirmation or extension of previous enquiries of
entity’s legal advisers concerning litigation claims and assessments.
1.5
General discussion and specific enquiries of management as to whether any
material events have occurred after the balance sheet date which affect
the financial statements being reported on.
1.6
Scrutiny of the basic accounting records after the financial year end date
for large payments, receipts, etc.
1.7
Obtaining a management representation letter on PBE's specifically.
1.8
Analytical procedures.
1.9
Discussion with management on procedures they have carried out to identify
subsequent events.
1.
Roadcarry (Pty) Ltd
1.1
The financial statements at 31 December are at present incorrect, the
insurance company cannot be raised as a debtor, as they have said they
will not pay Roadcarry (Pty) Ltd.
1.2
In terms of IAS 37, any income from the insurance company can only be
recognized if its receipt is virtually certain. In this case it is not.
1.3
The subsequent event (notification by the insurance company that no
payment would be made) gives additional information about a situation
which existed at 31 December 2015.
1.4
As the existence of the truck at balance sheet date could not be
confirmed/established, it was correct to remove it from the accounting
records (AFS).
1.5
The full loss on the theft of the truck should be recognised in the income
statement at 31 December 2015.
the
1.6
2.
**2016**
A note giving a full explanation, including the intention to take the
insurers to court, should be included in the AFS.
B M Car Manufacturers Ltd
2.1
Costs will need to be incurred in respect of modification to all vehicles
assembled up to 31 December 2015 regardless of whether they were sold
before that date, or were in stock at that date.
2.2
The costs incurred in respect of modification to vehicles assembled after
31 December should be written off in the current financial year not the
year under audit.
2.3
As the condition existed at 31 December, adjustments (change to the income
statement) must be made for the amounts in 2.1 at 31 December 2015.
2.4
The company should have already created a warrantee provision and this
should be increased by the estimated cost of the modifications to vehicles
assembled from launch date to year-end. (If the company wishes to reflect
this amount in a separate provision it may do so.)
/continued on page 2
SUGGESTED SOLUTION TO EXERCISE 14.7
Page 2 of 2 pages
3.
Ausum Trucks Ltd
3.1
As it stands, the investment in Financebond Ltd would have been shown at
fair value i.e. the quoted price on the JSE (which we would have
confirmed).
3.2
This was, according to the post balance sheet date information, an over
inflated value, by virtue of a fraud which was in existence at year-end
but which was not known.
3.3
This amounts to a contingent loss as the true value of the investment will
only be known once the liquidation of Financebond Ltd is completed.
3.4
On the basis of the information available to the directors of Ausum Trucks
Ltd, it is impossible to make an adjustment to the financial statements at
31 December 2015
3.5
4.
*
although it
impaired.
is
probable
that
the
value
*
the amount cannot be reasonably estimated.
of
the
asset
will
be
To comply with IAS37 (Contingencies) this contingency should be disclosed
in the following manner:
*
the nature of the contingency.
*
the uncertain factors (amount and timing) relating to the loss.
*
a statement to the effect that an estimate of the contingent loss
cannot be made.
Sport Fibre (Pty) Ltd
4.1
Inventories of resin and glassfibre must be shown at the lower of cost or
net realisable value in the December 2015 financial statements.
4.2
With the lifting of restrictions, the net realisable value of Sport Fibre
(Pty) Ltd's inventory is likely to decline.
4.3
However if the net realisable value does not decline to below cost, then
inventory is being correctly presented in terms of the International
Reporting Standards and no obligatory adjustment or disclosure in the 31
December 2015 financial statement is required.
4.4
If the net realisable value of inventory held at 31 December 2015 does
decline to below cost, then disclosure should be made as follows:
*
explanation of the lifting of trading restrictions.
*
an estimate of the financial effect, before and after tax, of the
lifting of trading restrictions. This estimate should include any
losses which may be incurred on purchase contracts already signed
if the NRV of the goods to be purchased is below cost price.
4.5
As the lifting of restrictions was not in existence at 31 December 2015,
adjustment to inventory would be inappropriate (where net realisable value has declined
to below cost).
**2016**
SUGGESTED SOLUTION TO EXERCISE 14.6
1 Page only
1.
Effect:
1.1
The financial statements at 29 February 2016 will require adjustment (adjusting
event) to the figures (see 1.3) and further disclosure in the notes (see 1.2).
Reasons:
1.2
In terms of Sec 30(6)(c) of the Companies Act 2008, the amount of any compensation
paid to directors or past directors in respect of loss of office must be disclosed
in the annual financial statements.
1.3
Although the payment of R1m to Clive Clover was made in the post reporting period,
it was payable at 29 February 2016 and therefore should have been accrued in the
financial statements. The company had an obligation at reporting date to pay the
R1m.
1.4
It would definitely be premature to respond to the intended legal proceedings by
adjustment to the financial statements (e.g. raising Clive Clover as a debtor) as
the outcome of the matter is far too uncertain.
1.5
A reference to the "intended legal proceedings" may be made in the note
dealing with the compensation but this would be at the discretion of the
directors. At this point it would seem that the matter is still very uncertain.
It is not even certain that the company will actually institute legal proceedings
(the minute says that they intend to.) The directors will need to be very careful
that they do not falsely accuse or falsely insinuate wrongdoing by Clive Clover in
any note they may include.
2.
Effect:
2.1
The financial statements should be adjusted by writing R320 000 off to bad debts
(adjusting entry). (It may also be prudent to adjust the allowance for doubtful
debts for the balance of R80 000).
Reasons:
3.
2.2
Although the notification came from the liquidator in the post reporting period,
it relates to a condition which existed at reporting date.
2.3
The receipt of the information indicates that the asset (debtor) was impaired at
year-end i.e. Butter (Pty) Ltd was already bankrupt at 29 February 2016.
2.4
With regard to increasing the allowance, the liquidator is not stating that 20% of
the debt will be recovered, it may be that Cream (Pty) Ltd will receive nothing.
Effect:
3.1
Adjustment to the financial statements i.e. raising a liability/provision is not
required.
3.2
Disclosure of the contingent liability should be made in the notes.
Reasons:
3.3
As there is no present obligation, no liability/provision need be raised.
3.4
The directors opinion that the matter should be ignored altogether cannot be
accepted because
3.5
4.
*
there is a reasonable possibility of a contingent liability arising.
(There has already been one "successful" claim brought against the
company).
*
directors do acknowledge the possibility of a contingent liability.
The directors opinion that the matter should be dealt with in the 2016 financial
statements cannot be accepted because, despite the fact that the claims were
received in the post reporting period, they pertain to the 2016 financial year,
during which the poisoning happened.
Effect:
4.1
No adjustment or disclosure required, but directors may choose to mention it in
their report.
Reason:
4.2
The matter has nothing to do with fair presentation, and in the context of the
company, is probably immaterial to shareholders. (If it was a major restructuring
of the company, disclosure would be required.)
**2016**
SUGGESTED SOLUTION TO EXERCISE 14.5
Page 1 of 2 pages
PART A
a)
1.
Scrutinise audit work papers relating to audit procedures conducted on
commission to determine why we failed to identify this unrecorded liability.
2.
Reassess the risk of further material misstatement relating to commissions and
respond accordingly, e.g. extend/reperform tests, get the firm’s IT department
involved.
3.
With Willie Nelson's permission (it appears he will give it), discuss the matter
fully with Speedsystems CC to establish:
3.1
the general nature and extent of their tests and
3.2
4.
specifically whether the error was restricted only to new agents and not
to others.
Scrutinise the affected agent’s contracts to satisfy ourselves that the
commissions have been incorrectly calculated and are therefore due and payable
(obligation).
Note:
If we had any doubt that the amount is legally payable, legal advice would
be sought.
5.
With Speedsystems CC's permission, test that all amounts owing to all new agents
are included on the schedule by comparing new agents contracts to the schedule
(completeness).
6.
Test casts, calculations and extensions on the schedule.
7.
Test cut-off by checking that the figure of R472 917.00 does not include amounts
owed to
7.1
agents appointed after the financial year-end
7.2
sales made by agents after the financial year end.
8.
Enquire from the financial manager whether any queries have been raised by any
agents concerning underpayment of commissions.
9.
Advise Willie Nelson that:
10.
9.1
the financial statements at 29 February 2016 will require adjusting to
reflect the amount owned to agent companies in respect of commissions
underpaid.
9.2
agent companies should be notified of the amount owed to them.
Consider whether this is a reportable irregularity in terms of Sec 45 AP Act.
Are the directors in effect stealing from agents by intentionally ignoring this
matter? Is it an unlawful act by omission?
b)
1.
This matter is a material disagreement with figures presented in the
financial statements and will therefore result in a qualified report "except for".
2.
The fact that the matter was identified in the post reporting date period is of no
consequence - at the 29 February 2016 the amount of R472 917.00 was payable to
agent companies. (A present obligation existed at reporting date).
3.
As the liability
adjusted.
existed
at
this
date,
the
financial
statements
should
be
4.
Willie Nelson's argument that the matter can be ignored because the agent
companies have not queried amounts due to them (implying that they are unaware of
the additional amounts owed to them), does not mean that the liability does not
exist. Furthermore once the new system is in place, agent companies are likely to
query the changes in their commission payments, thus bringing to light the past
errors.
5.
If this evolves into a reportable
implications for the audit report.
**2016**
irregularity
there
will
be
additional
/continued on page 2
SUGGESTED SOLUTION TO EXERCISE 14.5
Page 2 of 2 pages
PART B
MATTER 1.
1.
2.
I would not be satisfied with the adjustment to inventory at 31 December 2015.
1.1
Inventory must be presented at the lower of cost or net realisable value at
balance sheet date.
1.2
Although the fire occurred at the manufacturer within the financial year under
review (prior to 31 December 2015) it did not affect the cost of Clevacomp (Pty)
Ltd's inventory.
1.3
Clevacomp (Pty) Ltd are "recognizing" profits to which they are not yet entitled,
and are in direct contravention of IAS2 - Inventories.
The full disclosure of the matter is acceptable and possibly required in terms of IFRS as
this (dramatic rise in price) is a subsequent event which could have a material effect on
the performance of Clevacomp (Pty) Ltd's trading ability at least until 2017. Users will
want to know about this development.
MATTER 2
1.
I would not be satisfied with the directors treatment i.e. to leave
unadjusted and to make no disclosure.
2.
Inventory must be valued at the lower of cost or net realisable value (IAS2 – Inventory).
3.
the Inventory
2.1
If Clevacomp (Pty)Ltd take a formal decision to drop their selling price by, say,
60% to become competitive and still recover their cost, no adjustment would be
necessary, but the entire matter should probably be disclosed.
2.2
If Clevacomp (Pty) Ltd cannot recover their cost by dropping their price to
competitive levels, the inventory must be written down to the new realisable
value. The inventory has been impaired.
The directors refusal to write down inventory on the grounds that "their superior service
and backup will recapture the market", cannot be justified on existing evidence.
3.1
The company has only managed to sell 13% of its inventory during the year, and
sales of its package have virtually ceased since the competitor launched its
product.
3.2
In a tight economy, customers are going to purchase the cheaper package, provided
it serves its purpose.
3.3
With the court case going in its favour, sales of the local package may even
increase.
3.4
If Clevacomp (Pty) Ltd were so confident of regaining the market, would they have
taken the matter to court?
4.
The matter
adjustment.
represents
a
subsequent
event
requiring
either
disclosure
or
4.1
If the inventory on hand at 31 December 2015 cannot be realised for at
least R4.35m, it must be written down to its NRV.
4.2
MATTER 1 AND 2
If the net realisable value remains above cost, then no adjustment is required,
but mention in the directors report, including reference to the court cases,
should be made.
1.
On the evidence of these two matters it appears that the directors may be intending to
overstate inventory, or at least paint a rosier picture that actually exists...
2.
The matters are collectively material and if the financials are not amended accordingly,
an audit qualification would be necessary.
**2016**
SUGGESTED SOLUTION TO EXERCISE 14.4
1 Page only
1.
IAS 10 defines events occurring after the reporting period as events "that occur between
the balance sheet date and the date on which the financial statements are authorised for
issue" whilst ISA 560 extends this "definition" to include subsequent discovery of facts
which existed at the date of the auditors report, but before the financial statements
were issued and after the financial statements were issued.
2.
To identify matters which may require adjustment to or disclosure in the financial
statements under audit.
3.
3.1
An adjusting subsequent event is one where the event provides evidence of
conditions that existed at the end of the reporting period. In terms of IAS 10
"an entity shall adjust the amounts recognised in its financial statements to
reflect adjusting events after the reporting date".
3.2
A non-adjusting subsequent event is one where the event is indicative of
conditions that arose after the reporting period. If such an event is material,
non-disclosure could influence the economic decisions of users.
Thus the event
should be disclosed in the AFS.
4.
4.1
Consideration of relevant information that has come to his attention from
sources outside the entity.
4.2
Reading of minutes of the meetings of shareholders, board of directors, and audit
and executive committees for the period after the reporting date;
and inquiry
about matters discussed at meetings for which minutes are not available.
4.3
Reading the entity's latest available interim financial information, including
budgets, cash flow forecasts and other related management reports.
4.4
Inquiry and confirmation or extension of previous inquiries of the entity's legal
advisers concerning litigation, claims and assessments.
4.5
Inquiries of management as to whether any material subsequent events have occurred
which affect the financial statements being reported on.
4.6
Reviewing procedures which management has established to ensure that subsequent
events are identified.
5.
6.
5.1
The current status of items that were accounted for on the basis of
tentative, preliminary or inconclusive data.
5.2
Whether commitments have been made, such as by way of investments, new borrowings,
guarantees.
5.3
Whether there has been, or is planned, the sale, disposal or abandonment of assets
or operating units.
5.4
Realisation of assets for less than their carrying values.
5.5
Whether the entity has made a new share issue or has agreed to a plan of merger or
liquidation.
5.6
Whether assets of the entity have been destroyed, for example by fire or flood, or
appropriated by government.
5.7
Whether there have been any developments relative to known risk areas and
contingencies, whether inherent in the nature of the business or revealed by
previous audit experience.
5.8
Whether any unusual accounting adjustments have been made since the reporting
date.
5.9
Whether management is aware of any events which have occurred or are likely to
occur which will bring into question the appropriateness of accounting policies
used in the financial statements.
5.10
Whether management is aware of circumstances which may bring into question the
concept of going concern which underlies the financial statements.
False. IAS 10 specifically states that such a dividend shall not be recognised at
reporting date because the payment is not a "present obligation" at reporting
date.
7.
None.
8.
Exercising his right in terms of Section 93 of the Companies Act, 2008 to
attend and be heard at the annual general meeting.
-
Notifying each person whom he knows has received the original financial statements
that the auditor's report should no longer be relied upon.
-
Notifying any other person whom he knows intends relying on the
statements that the auditor's report should no longer be relied upon.
-
Announcing through the public media that the auditor's report should no longer be
relied upon.
-
Notifying any regulatory agency having jurisdiction over the entity that the
auditor's report should no longer be relied upon.
financial
**2016**
SUGGESTED SOLUTION TO EXERCISE 14.3
1 Page only
a)
A misstatement is a difference between the amount, classification, presentation or
disclosure of a reported financial statement item and the amount, classification,
presentation or disclosure that is required for the item to be in accordance with the
“applicable reporting framework”. Misstatements can arise from error or misstatement.
b)
Clearly trivial.
c)
1.
The financial statements are the responsibility of management and are in effect the
representations of the directors.
Therefore the auditor cannot insist that the
misstatement be corrected.
The only “power” the auditor has is to give a modified
audit opinion where the misstatement remains uncorrected.
2.
There are several reasons that the directors may not correct the
(remember as explained in 1 above, the financial statements are theirs.)
misstatement
2.1
The directors may disagree that there is a misstatement; there is plenty of
interpretation and estimation which goes into amounts/disclosures in the
financial statements and directors and auditors may disagree, e.g. is an asset
impaired or not? Is the classification of a lease as a financial lease, valid?
2.2
The directors may not regard the misstatement as material.
not correcting the misstatement would not influence a user.
2.3
The directors may have ulterior motives. The directors may want to present a
set of financial statements which are more favourable than they should be and
correcting a misstatement may obstruct this intention.
In their opinion,
d)
2.4
The directors may regard it as “too much hassle” to make the changes; the
correction may mean changing the income statement, notes, a consolidated set of
financials, supporting schedules, etc.
2.5
The directors may just be unconcerned about receiving a qualified audit opinion.
i.
This factor lends weight to the need for the correction to be made; it makes the
misstatement “more” material (important to users).
The fact of the matter is that
the company is reflecting a profit, when in fact a loss has been made for the first
time in 11 years.
Users may be influenced by this and should be aware of it – it
should not be covered up.
ii.
Information included in the “operating and financial review” may be reasonably
expected to influence a user and although the auditor does not form an opinion on the
“other information in documents containing audited financial statements”, he does
have a duty to insure that the other information does not contain misstatements of
fact.
Should the misstatement remain uncorrected the auditor will, inter alia,
modify his report by including an “other matter” paragraph.
Note: the AFS are
unaffected so no modification of the audit report in respect of the AFS is required
(see ISA 720).
iii. This is not a factor which in anyway lessens the materiality of the misstatement. It
is in fact the opposite, and makes it more important that the correction be made.
There is a direct consequence of allowing this misstatement to go uncorrected
(invalid bonuses paid to the very people responsible for the proper corporate
governance of the entity).
vi.
The auditor cannot be influenced by the negative affect that “doing the right thing”
(requesting the correction of the misstatement and qualifying the audit report if it
is not corrected) will have.
The fact that workers will strike is not a financial
reporting problem, it is a labour problem which management must deal with.
v.
The fact that this is a factual inaccuracy about a related party contributes to the
materiality of the misstatements.
Because of the non-independent nature of related
party relationships there is an increased risk of the occurrence of non-arms length
transactions and users are particularly interested in these relationships. Providing
factually incorrect information may be a deliberate attempt to disguise the true
nature of a transaction.
**2016**
SUGGESTED SOLUTION TO EXERCISE 14.2
1 Page only
a)
Factual misstatements:
misstatements which can be specifically identified and
substantiated with supporting evidence in respect of factual
data or amounts.
Misstatements about which there is no
doubt.
Judgemental misstatements:
b)
differences arising from the judgements of management
concerning accounting estimates that the auditor considers
unreasonable, or the selection and application of accounting
policies that the auditor considers inappropriate.
The distinction is made because the auditor must react differently to each
*
where there is a factual misstatement, the auditor is on strong ground when
requesting that adjustment to the financial statements is made, or when qualifying
the audit opinion for uncorrected factual misstatement
where the error is a judgemental misstatement, a measure of compromise may have to be
accepted by the auditor when requesting adjustment.
Careful consideration must be
given before qualifying the audit opinion on the grounds of a judgemental
misstatement.
*
c)
1. A projected misstatement is the auditor’s best estimate of misstatement in a
population and it involves projecting misstatement in a sample over the population
from which the sample was drawn.
2. A client who is told that there is misstatement in an account heading may want a
lot more evidence of the misstatement than simply a “mathematical” projection based
on a sample result especially if the sampling plan was non-statistical.
d)
*
h)
*
A significant risk will certainly have an effect on the evaluating and concluding
stage.
A significant risk is one which requires special audit attention – as the
name suggests it is an important matter.
the auditor will therefore need to evaluate very carefully whether the special audit
attention (response) given to the risk has reduced audit risk to an acceptable level.
e)
Intention:
f)
The materiality of an uncorrected misstatement is important to the auditor.
If the
auditor considers that the audit difference is immaterial to fair presentation then there
is no need for qualification of the audit opinion. The auditor may evaluate the audit
difference as material or material and pervasive. These two categorisations will result
in different reports – hence it is a very important decision.
g)
The auditor will want to ensure that the accounting policies selected and applied
1.
If an intentional “error” is made to misrepresent or hide certain facts it
is actually fraud.
*
are consistent with the financial reporting standards
*
are appropriate for the entity’s business
*
have been adequately disclosed.
The
1.1
misstatement:
affects compliance with regulatory requirements
1.2
affects compliance with debt covenants or other contractual requirements
1.3
impacts on “popular”, regularly used ratios or trends derived from the AFS
1.4
affects the calculation of management’s earnings (particularly if earnings
will be increased)
1.5
relates to transactions in the financial statements relevant to particular
parties or individuals e.g. related parties/directors
1.6
reflects a measure of dishonesty on the part of the directors.
**2016**
SUGGESTED SOLUTION TO EXERCISE 14.1
1 Page only
1.
The audit manager.
2.
2.1
Whether the accounting estimates made by management are reasonable.
2.2
Whether the information presented in the financial statements is relevant,
reliable, comparable and understandable.
Whether adequate disclosures (for a user to understand the effect of material
transactions and events) have been made.
Whether the terminology used in the financial statements, including the title of
each financial statement is appropriate.
2.3
2.4
3.
The accounting policies
3.1
are consistent with the applicable
financial reporting framework).
financial
reporting
standards
(applicable
3.2
have been applied in a manner consistent with the financial reporting standards
3.3
are appropriate for the entity’s business.
3.4
which are significant and are adequately disclosed in the financial statements.
4.
4.1
Whether sufficient appropriate evidence has been obtained to reduce audit risk to
an acceptable level.
4.2
Whether uncorrected misstatements which have been identified during the audit,
result in material misstatement of the financial information (individually or
aggregated).
4.3
Whether all material events occurring after the balance sheet date and up to the
date of the audit report have been identified and appropriately dealt with.
4.4
Whether statutory requirements and regulations have been complied with.
**2016**
SUGGESTED SOLUTION TO EXERCISE 13.24
Page 1 of 2 pages
a)
1.
The overall proposal has a major problem in that the maximum number of
members which a CC may have, is ten.
2.
If two members sell their interests there will be seven members, but if all the
individuals mentioned are to acquire a members interest there will be twelve
members (9 – 2 + Carl Prins, Arnie Arrow, the financial accountant, the admin
manager and myself). This is not permissible.
2.1
the financial accountant and administrative manager cannot hold a joint
interest so would have to acquire separate interests.
2.2
Toyjoy (Pty) Ltd has not even been considered because in the calculation
of members, a company cannot be a member of a close corporation (not a
natural person).
2.3
the calculation also assumes that the two members wishing to resign would
sell their interests to individuals already included as potential members.
3.
There is no problem with two members selling their interests, they can sell to
non-existing members, existing members or the corporation itself.
3.1
3.2
if the members wish to sell their interests to non-members or existing
members they must comply with
*
the requirements of the association agreement (if any) or
*
must obtain the consent of every other member.
if the corporation itself purchases the interests
*
the written consent of the seven remaining members must be obtained
for the specific payment
*
4.
the close corporation must satisfy the liquidity/solvency
after the payments are made. (See 4 below).
test
Providing that the number of members does not exceed 10, Arnie Arrow may become a
member but the close corporation may lend him the money to purchase his interest
only if
b)
4.1
the prior written consent of every member of the corporation is obtained
for the specific assistance
4.2
after the assistance is given the corporation assets fairly valued exceed
all its liabilities
4.3
the corporation is able to pay its debts as they become due in the
ordinary course of business
4.4
the assistance will not render the corporation unable to pay its debts as
they become due in the ordinary course of business.
5.
As I am a chartered accountant, I am eligible to be the accounting officer
5.1
however, despite the fact that the current accounting officer is a member,
it is not a requirement for the accounting officer to be a member and in
fact there is little point in offering me a members interest as I can
render all the financial services that are needed by the CC as a financial
advisor.
6.
Unfortunately this does not solve the number problem as we still have eleven
individuals.
7.
However the membership of the close corporation ends up, the individual members
interest will need to be amended to reflect an aggregate of 100%.
An argument for converting Kwikstix CC to a private company.
1.
The procedure is quick and inexpensive.
1.1
the members would pass a special resolution (a 75% majority required)
1.2
I could draw up a Memorandum of Incorporation for them (there is a
standard document).
1.3
I could submit it for them along with a certified copy of the resolution,
the prescribed fee and the notice of conversion.
2.
As a private company does not limit the number of shareholders or preclude
juristic persons
*
Toyjoy (Pty) Ltd could become a shareholder thereby securing the
distribution network and
*
3.
**2016**
all the individuals who the members would like to include, can become
shareholders (and others as the company grows).
The existing members who wish to sell their interests, can easily do so before the
conversion.
/continued on page 2
SUGGESTED SOLUTION TO EXERCISE 13.24
Page 2 of 2 pages
4.
Those proposed new members such as Arnie Arrow, who has no financial backing can
be given financial assistance by the “new company” on the same basis
(liquidity/solvency of the new company).
5.
It is not necessary for the financial accountant and administration manager to
have a joint shareholding, they can be given shares in their own capacities.
6.
The shareholding of the new company does not have to be in proportion to the
existing members interest so a revised ownership structure can be developed if
necessary.
7.
As with a close corporation, the shareholders of the new company can set up a new
management structure or continue with the existing one, e.g. they must appoint a
board of directors but members of the board do not have to be shareholders or vice
versa.
8.
The maintaining of accounting records etc remains the same. As a private company,
Kwikstix (Pty) Ltd will have to have their AFS audited or reviewed independently,
but this should be seen in the positive light of providing a level of independent
assurance to their financial statements which may assist the company in its
business dealings.
9.
The CC will only have to make a simple change to its name by replacing CC with
(Pty) Ltd.
**2016**
SUGGESTED SOLUTION TO EXERCISE 13.23
Page 1 of 2 pages
a)
1.
In respect of the disposition of Chris Cloete's interest, I will obtain written consent
from all the other members and will supply my own written consent to the disposal of
Chris Cloete's interest.
2.
In respect of the loan to be made by Baseline CC to Allan Emslie for the purchase of
Chris Cloete's interest I will:
3.
2.1
Obtain the prior written consent of every member (other than Chris Cloete) for the
specified amount and transaction.
2.2
Draw up a statement which reflects the fair value of the assets and liabilities of
the CC and the anticipated cashflow for (say) the next 12 months to satisfy myself
that the CC is sufficiently solvent and liquid to advance the money and to provide
evidence that:
*
the CC's assets fairly valued will, after the assistance is given, exceed
all its liabilities.
*
the CC is able to pay its debts as they become due in the normal course of
business.
*
the payment itself does not render the corporation unable to pay its debts
as they become due.
In respect of a number of matters raised in 1 and 2
(see question) I will submit a
signed amended founding statement (within 28 days) to the Commission incorporating the
following:
3.1
The name change.
3.2
The additional business activities to be conducted.
3.3
The disposal of Chris Cloete's interest.
3.4
Required details of Allan Emslie (including his members interest).
I will retain a copy of the amended founding statement.
4.
I will arrange for the following changes to be effected (after registration):
4.1
Name of the CC on all notices and official publications and all stationery.
4.2
Name of the CC on all vehicles and other property.
4.3
The name of the CC displayed at the registered office.
4.4
The change in membership (names and initials) on all business letterheads.
5.
I will notify all parties with whom Baseline CC has on going contracts (e.g. bankers,
suppliers) of the change in name and arrange that all legal aspects related thereto are
dealt with.
6.
I will notify SARS of the change in name.
7.
I will issue Allan Emslie with a membership certificate (signed by every member or by
myself on behalf of every member) stating the current percentage of his interest.
8.
I will obtain Allan Emslie's consent to continue to act as accounting officer. (As I am
a member, I require the consent of all other members to act as accounting officer).
b)
1.
In terms of Sec 62, the primary duty of the accounting officer is to make a report to the
members of the CC not later than three months after completion of the annual financial
statements. The financial statements must be drawn up within 6 months of the year end.
1.1
Prior to making the report, I must satisfy myself that the financial statements
are in agreement with the accounting records.
1.2
I must review the appropriateness of the accounting policies adopted. Neither of
these should present any problem as I am responsible for the accounting function
of the CC.
1.3
In my report I am obliged to
*
report in respect of 1.1 and 1.2
*
report that I am a member of the CC
*
describe the nature of any contravention of the Act which might have
occurred.
Hopefully no contravention will have occurred but the
possibility cannot be overlooked as the CC has undergone a number of
significant changes.
**2016**/continued
on
page
2
SUGGESTED SOLUTION TO EXERCISE 13.23
Page 2 of 2 pages
c)
(i)
In terms of Regulation 29 of the Companies Act and Sec 62A of the CC Act
*
With a public interest score of 83 (less than 100) no external
intervention is required for the current year annual financial statements (i.e. no
audit, no independent review.)
(ii)
In future if the public interest score increases to between 100 and 349 the AFS will have
to be externally audited if, as is the case at present, the AFS are internally compiled.
*
If with a public interest score between 100 and 349, the CC decided to
have its AFS externally compiled by an “independent professional accountant”,
there would be no audit requirement or independent review requirement.
*
If the CC expanded to the extent that its public interest score reached
350 or more, the AFS would have to be externally audited regardless of whether the
AFS were compiled internally or externally.
**2016**
SUGGESTED SOLUTION TO EXERCISE 13.22
Page 1 of 2 pages
1.
2.
Martin Orvis:
1.1
No, it is not compulsory to convert.
The existing CC may continue to operate
under the amended Close Corporations Act, 1984.
1.2
No new close corporations can be registered now that the new Companies Act 2008
has been adopted.
Clark Jackson:
2.1
2.2
3.
4.
the prescribed form will have to be submitted to the Commission, the body
which administers the registration. This is the “notice of conversion”
*
the members of Castings CC will have to pass a special resolution (75% of
members or members’ interests in favour – it is not clear) to convert and
lodge a certified copy of the resolution
*
a Memorandum of Incorporation will have to be drawn up (as required by the
Companies Act 2008) and
*
along with the prescribed fee, the resolution and MOI will be submitted with
the prescribed form.
the Commission will (if they are satisfied)
*
cancel the registration of the CC and
*
give notice in the “Gazette” of the conversion
*
enter the company in the register of companies
*
issue the company with a registration certificate
*
endorse the notice of conversion and MOI filed with it
*
assign a unique registration number to the new company.
3.1
A member is not obliged to become a shareholder in the new company.
Obviously
that member’s interest will have to be disposed of as the CC will no longer exist.
3.2
You are perfectly entitled to sell your interest in the CC to another member
before the conversion takes place.
Zane Kershner:
The CC can certainly buy back Graydon Sheridan’s
Corporations Act will have to be complied with
interest
but
the
Close
*
every member of the CC (other than Graydon Sheridan) would have to give his or
her written consent for the specific transaction
*
the CC must pass the liquidity/solvency test after the payment is made (i.e.
assets fairly valued must exceed liabilities, and the CC must be able to pay
its debts in the normal course of business)
*
the percentage interest of the other members will be adjusted accordingly (to
equal 100%).
Martin Orvis:
5.1
6.
*
Graydon Sheridan:
4.1
5.
The procedure is very straight forward
No, the new shares do not have to be in proportion. This will be a matter for the
members to decide prior to making the conversion.
It may be necessary to make
some financial contribution or compensation where a member’s interest does not
receive proportional value in terms of shares in the new company.
Jason Fiddle:
6.1
The company would be a private company.
There is nothing to prevent the CC
becoming a public company but it would be unnecessary (and very unusual!) as
presumably the members of the CC wish to retain the size and ethos of the CC when
it becomes a company
6.2
The differences between a private company and a public company are essentially
that
*
a private company restricts the transferability of its shares, e.g. existing
shareholders must be given a pre-emptive right to purchase the shares of
another shareholder wishing to sell his shares
*
a private company may not offer its shares to the public
*
a private company is not required to comply with two important aspects of
chapter 3 of the Companies Act 2008 i.e. a private company is not required to:
 appoint an audit committee
 appoint a company secretary
**2016**
/continued on page 2
SUGGESTED SOLUTION TO EXERCISE 13.22
Page 2 of 2 pages
7.
6.3
A private company is also not automatically required by the Companies Act to have
its AFS audited, whereas a public company is. The extent of external assurance to
which a private company must subject its AFS, will depend largely on its public
interest score. The public interest score is a measure of the interest the public
or society has in the private company and is based on criteria such as turnover,
size, activities.
6.4
As you can deduce, public companies are usually large “public” enterprises as
opposed to “personal” entities such as a CC or private company.
Willie Wilson:
7.1
8.
It is very unlikely that the CC will have to change its name as it does not appear
to contravene any of the requirements of the Companies Act 2008 with regard to
names e.g.
*
it is not a name which constitutes propaganda for war, incitement of violence,
or advocates hatred based on race, ethnicity, gender, etc
*
is not falsely misleading e.g. that it is associated with another person or
entity.
7.2
However, if the Commission finds that the name is the same as, or confusingly
similar to another registered (existing) company name, you will need to change it.
7.3
You will also add (Pty) Ltd to the name and drop the CC.
Mary Winston:
8.1
Not necessarily, the management structure will be as your members want it to be.
9.
8.2
In terms of the Companies Act 2008, a company must have a board of directors.
8.3
Normally the shareholders will elect the directors (the MOI can make amendments to
this) and each director will be voted onto the board individually.
8.4
It is not necessary that a director you vote onto the board even be a shareholder,
you can appoint any individual, provided he or she is not disqualified from being
a director by the Companies Act.
Gavin Gibb:
9.1
The new company will be regulated by the Companies Act 2008, this act does not
require the appointment of an accounting officer.
The very minimal assurance
which the accounting officer’s report gave to the statements of the CC, has been
replaced by the requirement that the company’s AFS be independently audited or
reviewed.
9.2
With regard to the assets and liabilities of the CC, nothing really changes.
legal status of the company remains the same
9.3
The
*
Castings CC remains a juristic person with, in effect, just a name change to
Castings (Pty) Ltd
*
assets, liabilities and obligations of the former CC will vest in the company.
It is, however, likely that documentation relating to assets which are
“registered” e.g. a motor vehicle, or a liability of the CC e.g. a mortgage bond,
will have to reflect or be endorsed with the change in status.
**2016**
SUGGESTED SOLUTION TO EXERCISE 13.21
Page 1 of 2 pages
1.
2.
1.1
No. The existing documents of the existing CC cannot be used; companies do not
have founding statements or association agreements.
1.2
The primary document for incorporating Renovations (Pty) Ltd
Memorandum of Incorporation in the name of Renovations (Pty) Ltd.
1.3
This document (which can be in the standard format or in a format unique to the
company) must be filed with a Notice of Incorporation and the prescribed fee with
the Commission.
1.4
If all is in order, the Commission will issue a registration certificate in the
name of Renovations (Pty) Ltd.
1.5
A company may also have “rules of the company” relating to the governance of the
company. The MOI and rules have similar objectives to the founding statement and
association agreement.
2.1
Whether the new company will have to be audited or not depends primarily on what
is termed the company’s public interest score and whether the company’s financial
statements will be compiled internally (completed by the company itself) or
independently (compiled by what is termed an independent accounting professional).
2.2
The company’s public interest score is calculated by allocating points to such
things as its turnover, the average number of employees, the amount of 3rd party
liability and the number of shareholders.
It is only when a company reaches a
public interest score of at least 100 that the need for an external audit must be
considered.
2.3
Renovations (Pty) Ltd, when it is formed, is most unlikely (will not) have a
public interest score of anywhere near 100 so an external audit will not be
required.
This is regardless of whether or not your financial statements are
prepared internally or independently.
2.4
However, Renovations (Pty) Ltd will have to have its AFS independently reviewed.
A review is like a “watered down” audit and does not provide users with the same
level of assurance as an audit.
The review must be carried out by either a
registered auditor or an individual who qualifies for appointment as an Accounting
Officer.
2.5
If Renovations remained as a CC there would be no audit or review requirement
(assuming
that
the
CCs
public
interest
score
remained
below
100).
2.6
Finally, you as the shareholders can include a requirement in the MOI which
requires that the company be externally audited.
will
be
the
3.
3.1
Yes.
The Companies Act 2008 does not place a restriction on the number of
shareholders of a private company, so once a CC converts to a company the
“restriction of 10 members in a CC” falls away.
4.
4.1
Yes. But the liquidity/solvency requirements must be satisfied and every member
other than the selling member must give prior written consent.
4.2
The liquidity/solvency test requires that
*
after payment for the member’s interest the assets of the CC, fairly valued,
must exceed the CC’s liabilities (solvency)
*
the CC must be able to pay its debts as they become due (liquidity).
**2016**
/continued on page 2
SUGGESTED SOLUTION TO EXERCISE 13.21
Page 2 of 2 pages
5.
Yes.
In terms of Sec 44 of the Companies Act 2008, a company may provide financial
assistance for a person to purchase shares in it. However:
5.1
Any conditions or restrictions in respect of providing financial assistance laid
out in the MOI must be adhered to
5.2
Immediately after the finance
liquidity/solvency test and
5.3
The terms under which the financial assistance is proposed are fair and reasonable
to the company
is
provided,
the
company
must
satisfy
the
6.
7.
8.
5.4
A special resolution must be obtained.
6.1
No.
The Companies Act and Close
corporations may be registered.
6.2
Existing CC’s will continue to operate under the CC Act 1984 as amended, and will
be at liberty to take on new members in the manner required by the Act.
7.1
The shareholding in the new company is most likely to reflect the members’
interests in the CC, e.g. if Joe Soap has a member’s interest of 25%, it would
appear logical that he would become a 25% shareholder in the new company.
7.2
However, there is nothing to prevent the members/future shareholders from coming
to some agreement which sets out a new ratio of shareholding. This in all
likelihood would require some flow of funds between the members/future
shareholders, e.g. if Joe Soap is to become a 40% shareholder he is likely to have
to pay for the extra 15% of shares he is acquiring.
8.1
There is nothing to prevent a company from holding shares in a company which was
formally a CC.
8.2
Of course any conditions contained in the MOI relating to the issue of shares as
well as the regulations in the Companies Act would have to be adhered to, e.g.
authority, sufficient authorized shares.
Corporations
Act
state
that
no
new
close
**2016**
SUGGESTED SOLUTION TO EXERCISE 13.20
1 Page only
1.
False. In terms of the Act a close corporation may have a maximum of ten members.
2.
Founding Statement.
3.
3.1
Full name of the CC
3.2
Principal business
3.3
Postal address
3.4
Full name of each member, his/her identity number (or date of birth) and
his/her residential address
3.5
The size of each members interest (percentage)
3.6
Particulars of the contribution made by each member
3.7
Name and address of the person who consented to the appointment as
accounting officer
3.8
Date of the corporation’s financial year-end
3.9
Signatures of each member (or representative).
4.
False.
The Companies Act 2008 states that a close corporation can no longer be
registered, it says nothing about replacing the founding statement with a MOI. If the CC
converts to a company, a MOI will need to be lodged.
5.
True (required by Act)
6.
False. The contribution does not have to be money and does not have to be equal
for all members. Contributions can be in property. Contributions will vary in value
depending on the members interest to be received by the member.
7.
No. As no new CCs may be registered, a company may not convert itself to a CC regardless
of the number of shareholders.
8.
Yes.
9.
False. Members interests must always total 100%. If the number of members
changes, the percentage held by each member will change so that the total always amounts
to 100%.
10.
11.
12.
13.
10.1
By purchasing the interest of (a portion of) an existing member(s).
10.2
By making a contribution to the CC (other members interests will be adjusted to
keep the total interest at 100%).
Yes, but only by order of the Court. The members may apply to the Court to have a
member’s interest “withdrawn” where
11.1
the said member has become permanently incapable of performing his or her part in
the business, as a result of unsound mind or any other reason.
11.2
the members conduct is likely to have a prejudicial effect on the carrying on of
the business.
11.3
it is not reasonably practicable to carry on business with that member e.g. the
member is seldom available or overseas.
11.4
circumstances have arisen that render it just and equitable that such member
should cease to be a member of the corporation.
No, this proposal is not acceptable.
12.1
Jimmy James may dispose of half his interest to a non-member but will need to
comply with the CC association agreement or obtain the consent of all members.
12.2
Members interests in a CC cannot be “joint interests”.
12.3
Tryline (Pty) Ltd, being a company cannot hold a members interest.
13.1
Previously obtained consent of all members.
13.2
After the purchase, the CC assets fairly valued exceed its liabilities.
13.3
The CC is able to pay its debts as they become due.
13.4
The payment itself does not render the corporation unable to pay its debts as they
become due.
14.
False. A company cannot hold shares in a CC, hence this situation cannot exist.
15.
15.1
75% of members’ interest consent in writing.
15.2
Consent of all members.
15.3
Any member may call a meeting.
15.4
75% of members’ interest consent in writing.
**2016**
SUGGESTED SOLUTION TO EXERCISE 13.19
Page 1 of 3 pages
Query from Sibo Zooma
Procedure 1
1.1
The purpose of this procedure is to confirm that Midfield (Pty) Ltd has right of
ownership of the asset (Blondee (Pty) Ltd is a debtor in Midfield (Pty) Ltd’s books) and
therefore the right to subordinate it.
1.2
If the debt is encumbered in any way e.g. has been offered as security, the subordination
agreement may be invalid and therefore of no use as audit evidence.
Procedure 2
2.1
It is necessary to evaluate the financial position of Midfield (Pty) Ltd for you to
satisfy yourself that the subordination agreement cannot be set aside as a “disposition
not for value”.
2.2
If Midfield (Pty) Ltd places itself in a technically insolvent position by “disposing”
of (subordinating) the amount owed to it by Blondee (Pty) Ltd, and subsequently goes
insolvent itself, there is a risk that the subordination agreement could be set aside by
the liquidator (of Midfield (Pty) Ltd) on the grounds that an asset (the amount owed by
Blondee (Pty) Ltd) was disposed of and no value was received by Midfield (Pty) Ltd.
2.3
If there is a genuine risk that the subordination agreement could be set aside, its
acceptability (value) as evidence supporting the going concern ability of Blondee (Pty)
Ltd is minimal.
Procedure 3
3.1
With regard to the size of the amount; it must be sufficiently large to
*
remove the company from a factually insolvent position
*
must be significant enough to afford Blondee (Pty) Ltd a realistic opportunity to
return to profitable trading and to create a situation where exception cannot be taken to
Blondee (Pty) Ltd continuing to trade.
3.2
With regard to the period for which it was given, you will need to consider whether
Blondee (Pty) Ltd has been given a long enough (realistic) period to return to profitable
trading by being granted the “concession” by Midfield (Pty) Ltd, e.g. if the period was
for say three to six months only, it is unlikely that it is going to make much
difference.
Queries from Len Anton
Loan from Propps (Pty) Ltd to Solidd (Pty) Ltd
1.
Your trainee is incorrect.
2.
In terms of Sec 2 of the Companies Act 2008, Propps (Pty) Ltd and Solidd (Pty) Ltd are
“related”.
2.1
3.
Also, in terms of Sec 2, Brandon Else is related to Propps (Pty) Ltd and Solidd (Pty)
Ltd.
3.1
4.
a juristic person is related to another juristic person if, inter alia, either is
a subsidiary of the other.
an individual is related to a juristic person if the individual directly or
indirectly controls the juristic person. By virtue of his shareholdings, Brandon
Else directly controls Solidd (Pty) Ltd and indirectly controls Propps (Pty) Ltd.
In terms of Sec 45 a company may make a loan directly or indirectly to a director of a
related company, or to the related company itself.
So either way, however this is
interpreted, the loan is permissible, however the following requirements must be met.
4.1
any conditions or restrictions in respect of granting the loan must be adhered to.
4.2
the board of Propps (Pty) Ltd must be satisfied that immediately after the loan is
given, the company would satisfy the solvency and liquidity test.
4.3
the terms of the loan are fair and reasonable and
4.4
a special resolution is obtained.
**2016**
/continued on page 2
SUGGESTED SOLUTION TO EXERCISE 13.19
Page 2 of 3 pages
Loan from Propps (Pty) Ltd to Agamax CC
1.
In effect this is a loan by a company to an entity (CC) which is controlled by the
controlled voting power of two of its (the CC’s) members but who are also directors of
Propps (Pty) Ltd.
The two directors are Andrea Agassay and Marie Peerce.
This means
that Propps (Pty) Ltd is making a loan of R10m to two of its directors.
The loan is
permissible provided the requirements of Sec 45 are satisfied i.e. complies with the MOI,
satisfies solvency/liquidity test, and a special resolution was obtained.
2.
The detailed audit procedures will be as follows:
Occurrence
2.1
2.2
Inspect the MOI of Propps (Pty) Ltd to
*
confirm that the company has the power to make loans
*
establish any stipulations/requirements pertaining to the making of loans
*
establish whether there
interests in contracts”
*
establish the percentage of voting rights required to pass resolutions
(normally 50% and 75% for ordinary and special respectively but MOI can
alter this)
are
any
requirements
relating
to
“directors
Inspect the minutes of directors meetings for the declaration of the directors
that after granting of the loan, Propps (Pty) Ltd would satisfy the
solvency/liquidity test and by analysis of the financial position of the company
and its cash flow immediately after the granting of the loan, confirm whether the
company was solvent and liquid.
Note: strictly speaking, there should be a minute recording the interest of
Agassay and Peerce (as directors) in the loan. With regard to directors meetings,
this is somewhat irrelevant as the two of them would be in the majority (2 of 3
directors) but could not vote on the loan contract.
Thus it is very important
that the shareholders are made aware of their interest.
2.3
2.4
2.5
Inspect the notice and minutes of the meeting of shareholders to confirm that it
was properly constituted:
*
10 business days notice was given
*
the specific purpose of meeting was given.
The notice stated the terms
and effect of granting a R10m loan to a CC controlled by two of the
directors of Propps (Pty) Ltd and which itself (Agamax CC) is a
shareholder, of Propps (Pty) Ltd.
*
an indication was given that to pass the resolution, 75% of the voting
rights entitled to vote on the proposal, was required
*
the meeting was quorate, 25% of the applicable voting rights were present
(note: Solidd (Pty) Ltd alone hold 55% so its presence makes the meeting
quorate.)
*
the resolution was passed by 75% of the voting rights present (poll) or
75% of the shareholders present (show of hands). In person or by proxy.
Inspect the loan agreement itself to confirm
*
the names of the contracting parties (Propps (Pty) Ltd and Agamax CC)
*
the amount of the loan R10 million
*
terms, conditions, penalties etc (is the loan fair?)
Inspect the register of directors’ interests in contract to confirm the details
are correctly entered.
Accuracy, classification and cut-off
*
2.6
By inspection of dates and amounts on the paid cheque/bank statement, confirm
that an authorised payment was made to Agamax CC for an amount of R2m (accuracy) and that
*
the transaction took place during the year under review (cut-off)
2.7
By inspection of the general ledger, confirm that the loan was correctly posted to
a long-term loan (non-current asset account) and is reflected as such in the AFS
(classification)
2.8
By inspection of the notes to the AFS, confirm that the details of the loan have
been disclosed, i.e. amount, particulars, balance at year end (IAS 24 Related
Party Disclosures)
**2016**
/continued on page 3
SUGGESTED SOLUTION TO EXERCISE 13.19
Page 3 of 3 pages
Query from Maneeb Norris
1.
The unrealized profit can be distributed provided :
1.1
Sidepocket (Pty) Ltd’s MOI does not prohibit it and any conditions relating to
such distributions, are adhered to
1.2
The revaluation was conducted
*
in good faith by a competent valuer
*
the appreciation is permanent in nature and
*
the company’s financial position as a whole justifies it
1.3
*
In addition, as this is a “distribution to shareholders” as defined by Sec 46 of
the Companies Act, the liquidity/solvency test must be satisfied, i.e.
Sidepocket (Pty) Ltd must have been able to pay its debts as they became due (or become
due) in the ordinary course of business after payment was made, and
*
its assets fairly valued, exceeded its liabilities after the payment was
made as they have had a good trading year, this is likely to have been the
case.
1.4
Authority will be a director’s resolution authorising the distribution.
This
minuted resolution must state that the directors applied the liquidity and
solvency test and reasonably concluded that the requirements of the test
were satisfied.
1.5
The
distribution should have taken place within 120 business days of
resolution.
If it did not, the solvency/liquidity test must be
considered.
the
re-
2.
2.1
Bryan Cox and Propps (Pty) Ltd are not related as defined.
He is indirectly a
shareholder of Propps (Pty) Ltd through Agamax CC but he does not
indirectly or directly control Propps (Pty) Ltd (or Agamax CC for that
matter)
2.2
Brandon Else controls Solidd (Pty) Ltd through his 60% holding, and Solidd (Pty)
Ltd controls 8Man (Pty) Ltd through its 60% holding.
Brandon Else in
effect, controls 8Man (Pty) Ltd and therefore, by definition, they are
related.
2.3
Solidd (Pty) Ltd, Propps (Pty) Ltd and Sidepocket (Pty) Ltd are not related by
virtue of Jimbo Blake being a director of all three. He does not control
any of them.
(The three companies are related by virtue of their inter
related shareholdings.)
2.4
Sidepocket (Pty) Ltd and 8Man (Pty) Ltd are related by virtue of the fact that
Sidepocket (Pty) Ltd is a subsidiary of 8Man (Pty) Ltd.
**2016**
SUGGESTED SOLUTION TO EXERCISE 13.18
Page 1 of 3 pages
I would advise the directors as follows
1.
Disposal
1.1
The proposed disposal would be regarded as a fundamental
transaction as it amounts to the sale of the greater part of the assets of
Cookware (Pty) Ltd.
1.2
This means that the requirements of
Companies Act 2008 would have to be satisfied.
Sec
112
and
115
of
the
*
a notice of a shareholders meeting would have to be delivered to all
shareholders 10 business days before the meeting is to begin (the MOI
may stipulate a longer period)
*
the notice of the meeting must be in writing and must include
 Date, time and place of meeting
 General purpose of the meeting
 A copy of the proposed resolution to sell the greater part of the
assets (see also 1.5)
 The voting rights required to adopt the resolution - in terms of Sec
112 a special resolution is required for this transaction (75% of
votes exercised or as stipulated in the MOI) (see also 1.4 below)
 A prominent statement that a shareholder can appoint a proxy (who need
not be a shareholder)
 A written summary of the terms of the transaction and the provisions
of Sec 115 and 164 (see 1.6 and 1.7 below).
1.3
Before a person may attend and participate in the meeting, that person must
present identification.
1.4
The meeting must be quorate in terms of Sec 115; to be quorate there must
be sufficient persons present to exercise in aggregate at least 25% of the
voting rights which are entitled to be exercised on this matter.
1.5
The resolution to be taken must be expressed with sufficient clarity and
specificity and must be accompanied by sufficient information for a
shareholder to determine whether to participate
*
in terms of Sec 112, the precise terms of the disposal transactions must
be given and the fair market value of the assets at the date of
disposal, provided.
1.6
In terms of Sec 115, if the resolution is opposed by more than 15% of the
voting rights exercised on the resolution, even though it was passed by the
required 75%, the company may not implement the resolution (i.e. dispose of
the assets) if a shareholder who voted against the resolution requires the
company to seek court approval. (The shareholder has 5 business days to
request the directors to obtain court approval).
1.7
In terms of Sec 164, a dissenting shareholder is entitled to give the
company a written notice of objection to the proposal at any time before
the resolution (proposal) is voted on.
2.
New line of business
2.1
Once a company is properly incorporated it is a juristic person and has the
legal powers and capacity to exercise those powers to the extent that its
company’s Memorandum of Incorporation does not exclude them.
2.2
The MOI does not normally stipulate the objects of the company but may
restrict the company from doing certain things – e.g. operating in a
particular line of business.
2.3
In the very unlikely event that the MOI prohibits the company from
importing and wholesaling electrical components, the MOI could be altered.
2.4
To change the MOI requires a special resolution which could be dealt with
at the meeting if the shareholders approve the disposal of the plant, etc.
New name of business
2.5
The company is perfectly entitled to change its name but would have to
*
change the MOI in the approved manner (by special resolution)
*
file a notice of amendment with the Commission (with the prescribed fee)
The directors therefore cannot change the name without the shareholders
consent.
**2016**
/continued on page 2
SUGGESTED SOLUTION TO EXERCISE 13.18
Page 2 of 3 pages
2.6
2.7
3.
The Commission will determine
requirements of Sec 11
whether
the
new
name
satisfies
the
*
not confusingly similar to another company name
*
not misleading as to association with another person, company, etc
*
not constitute propaganda for war, incitement of violence, or advocate
hatred, racism, etc which obviously it doesn’t.
If the commission is satisfied, it will issue an amended registration
certificate and alter the name in the company’s register.
Payment to Ken King
3.1
Ken King is perfectly entitled to resign from the board at any time.
3.2
There may be conditions in the MOI which must be adhered to, e.g. notice
period.
3.3
Ken King is also entitled to resign as an employee of the company (he is an
executive active in the day-to-day running of the business).
3.4
In terms of Sec 66(8) a company may pay remuneration to its directors for
their services as directors but only in accordance with a special
resolution approved by the shareholders within the previous two years.
3.5
The board cannot simply decide to pay Ken King the R500 000. This payment
would have to be approved by the shareholders by a properly obtained
special resolution (see pt 1).
3.6
As this payment is part of the “disposal”, shareholders should be fully
aware of it.
3.7
Again the board does not have the power to issue shares to Ken King, he is
a director and a special resolution is required (Sec 41)
* Cookware/Airware (Pty) Ltd is a private company and therefore its shares
have restrictions on transferability.
3.8
*
There would have to be unissued but authorized shares available.
*
Any pre-emptive rights to shares to be issued (held by other
shareholders) in terms of the MOI, would have to be addressed (Sec 39).
Furthermore, the directors themselves cannot make the decision to appoint
Ken King as a director (non-executive or otherwise); it is up to the
shareholders to elect each director. (The MOI may provide for a specific
person to appoint a director to the board – this is unlikely to be the case
in a private company such as Cookware/Airware (Pty) Ltd.)
Note: An additional problem is that this payment may be regarded as the company
providing financial assistance for the purchase of its own shares. It does not
appear to be a “loan” but is it a way of providing Ken King with funds to buy
shares with the “repayment” being his services as a non-executive director?
Financial assistance is not prohibited by the Act but if it is given, the board
must be satisfied that
*
immediately after giving the financial assistance, the company would
satisfy the liquidity/solvency test



4.
can pay its debts in the normal course of business for a period of
twelve months
assets fairly valued exceed liabilities fairly valued and
that the terms of the financial assistance are fair and reasonable
to the company? Would they be in this case?
Redeemable preference shares
4.1
The repayment of the redeemable preference shares will be regarded as a
“distribution” as defined by the Companies Act 2008 (definitions).
4.2
A distribution is defined as a direct or indirect transfer of money by the
company to or for the benefit of one or more holders of any of the shares
of that company.
4.3
In terms of Sec 46, the decision to make the distribution is a board
decision, a company must not make any distribution unless
*
the distribution



**2016**
is pursuant to an existing legal obligation (which this is) or
is pursuant to a court order (not applicable) or
the board by resolution has authorized the distribution.
/continued on page 3
SUGGESTED SOLUTION TO EXERCISE 13.18
Page 3 of 3 pages
*
it
reasonably
appears
that
the
company
will
liquidity/solvency test immediately after completing
distribution.
*
the board has acknowledged by resolution, that it has applied the
liquidity/solvency test and concluded that the company will satisfy the
test immediately after the payment is made.
4.4
If the company does not fully carry out the distribution within 120
business days from making the liquidity/solvency acknowledgement, the board
must re-assess the liquidity/solvency and make a fresh acknowledgement of
having done so (another resolution). This is possible as it could easily
take more than 120 days to sell the plant etc and receive payment.
4.5
If a director of Cookware (Pty) Ltd was present at the meeting or
participated in the decision to make a distribution which was contrary to
the requirements of Sec 46 (e.g. the company did not pass the
liquidity/solvency test, but the distribution was still made), that
director will be
*
5.
satisfy
the
the proposed
liable for any loss, damages or costs sustained by the company as a
direct or indirect consequence of that director having failed to vote
against the distribution, despite knowing it was contrary to the
section.
General
The question might arise as to whether the shareholders can authorize some parts
of the proposal and not others, e.g. authorize the disposal but reject the payment
to Ken King. This may raise some interesting legal issues but from a practical
point of view, the shareholders ultimately control the board and could request
amendment to the proposal as they deem fit, so each part could be dealt with as a
separate part. Dissenting shareholders can invoke their protection remedies.
**2016**
SUGGESTED SOLUTION TO EXERCISE 13.17
Page 1 of 2 pages
(a)
1.
It appears that Ross McKewan has been removed from the board contrary to the requirements
of the Companies Act.
2.
In terms of Sec 71, the board may remove a director but only if it is alleged by a
shareholder or a director and accepted by the board, that the said director is
2.1
Ineligible or disqualified from being a director (in terms of the Act), or
2.2
Incapacitated to the extent that the director is unable to perform the functions
of a director, or
2.3
Has neglected, or been derelict in the performance of the functions of a director.
3.
Based on the information given in the question, none of these apply to Ross McKewan,
indeed it would appear that he is fulfilling his function very well despite being unable
to prevent Barry Black from acting illegally and probably being derelict in the
performance of his duties.
4.
Even if Barry Black was intent on removing Ross McKewan from the board for any of the
above reasons, he, Barry Black, would have to call another meeting of the directors at
which Ross McKewan’s removal would be proposed. Ross McKewan would have to be provided
with
4.1
Notice of this meeting, including a copy of the proposed resolution and a
statement setting out the reasons for the resolution with sufficient specificity
to reasonably permit Ross McKewan to prepare and present a response.
4.2
A reasonable opportunity to make a presentation to the meeting before the
resolution is put to the vote.
5.
In this presentation, Ross McKewan would be fully entitled to disclose Barry Black’s
contraventions of the Act in his own defence. If the directors still vote to remove Ross
McKewan, he may apply within 20 business days to a court to review the decision of the
board.
6.
As it stands, the current resolution to remove Ross McKewan is totally invalid and he
remains a director.
He should notify Barry Black, the other directors, and the
shareholders (who would probably have appointed him in the first place) of the situation.
If Barry Black still wishes to have Ross McKewan removed, he would either have to
6.1
Proceed as outlined in 2 to 4 above.
6.2
Request the shareholders to effect the removal. However, this would require the
shareholders to pass an ordinary resolution to remove Ross McKewan after affording
him the right to make representations.
(b)
1.
This is a contract in which Barry Black has a personal financial interest by virtue of
the fact that he is “related” (by definition) to the party, Singer Designs, with whom
Saska (Pty) Ltd has contracted on the strength of a directors’ resolution. The owners of
Singer Designs are his wife and daughter.
2.
Barry Black should therefore have
2.1
Disclosed the interest and its general nature to the meeting before the contract
was discussed.
2.2
Disclosed any material information he had about the contract.
2.3
Disclosed any observations/insights he had about the contract if requested to by
the directors (no doubt Ross McKewan and the other directors would have wanted
Barry Black’s opinion on why Singer Designs contract was more expensive, had they
known of his interest!)
2.4
Left the meeting and not taken part in the deliberations on the proposal to award
the contract (he did take part, actually convincing the other directors on which
one to vote for).
3.
As it stands, this contract is invalid as it was approved without disclosure and Ross
McKewan is as a director, entitled (if not obliged in terms of Section 76) to communicate
this information to the board.
4.
Barry Black would then have the option of
4.1
Having the contract ratified by an ordinary resolution of the shareholders after
making full disclosure, or (presumably)
4.2
Reconvening a directors meeting disclosing his interest and having the directors
vote again on the contract.
5.
As it stands, Barry Black appears to be in breach of Sec 76 which deals with the standard
applicable to directors’ conduct. Barry Black has contravened this section in that
5.1
He has used his position as a director to gain an advantage for himself by having
a lucrative contract awarded to his family.
5.2
He did not communicate information to the board which he should have disclosed –
financial interest.
5.3
He has not exercised his powers and functions as a director

in good faith and for a proper purpose

in the best interests of the company.
It appears that he has made a “secret profit” at the expense of the company by getting
the directors to accept an expensive (inflated) contract from which he will benefit.
**2016**
/continued on page 2
SUGGESTED SOLUTION TO EXERCISE 13.17
Page 2 of 2 pages
(c)
1.
A company is perfectly entitled to make a loan to one of its directors provided (Sec 45)
1.1
Any conditions or restrictions in respect of making the loan contained in the MOI,
are adhered to, and
1.2
The board is satisfied that

immediately after providing the loan (financial assistance), the company would
satisfy the solvency and liquidity test – no consideration seems to have been
given to this

the terms under which the loan is proposed, are fair and reasonable (a R2m
interest-free loan is not fair and reasonable), and

a special resolution is obtained.
2.
The special resolution could be one which had been passed within the last two years,
giving authority for a loan to a specific recipient (obviously not the case here), or it
could be one giving general authority to a category of potential recipients, e.g.
directors.
2.1
However, it appears that no such authority exists. The authority for this loan is
the “personal authorisation by Barry Black in his capacity as chairman”.
2.2
In terms of the Companies Act there is no such thing as the “personal authority of
the chairman”.
3.
Barry Black’s intention to have the loan made by Calgary (Pty) Ltd because Ben Johnson is
“not a director of Calgary (Pty) Ltd” is strange as Sec 45 makes it perfectly clear that
a company can make a loan to the director of a related company (Calgary (Pty) Ltd is a
subsidiary of Saska (Pty) Ltd) and therefore is related (by definition) provided all the
same conditions as described above, are met.
4.
Either way, if by his actions, Barry Black is trying to hide the loan from the
shareholders of Saska (Pty) Ltd/Calgary (Pty) Ltd, he will not succeed as shareholders
must be notified of the granting of this loan within stipulated time periods depending on
the size of the loan.
5.
As it stands, this loan is void and in terms of Sec 77, the directors who voted in favour
of the loan, may be jointly and severally liable for any loss, damage or costs arising as
a direct or indirect consequence of approving the loan, e.g. it is not repaid in full.
6.
Barry Black’s actions appear to be in serious contravention of Sec 76 (Standards of
Conduct).
(d)
1.
Saska (Pty) Ltd, although being a private company, is not required by law to comply with
the recommendations of the King III Report. However, the report urges them to do so (in
the context of the nature, size and “public interest” in the company), as Saska (Pty) Ltd
is a large company and on the basis of the information provided, needs to improve its
corporate governance significantly.
2.
In terms of the composition of the board
2.1
The company has only one non-executive director.
King III recommends that the
board has a majority of non-executive directors, the majority of whom are
independent non-executive directors.
2.2
The idea is to give the board a “balance of power”;
it is obvious that Ross
McKewan has absolutely no power at all.
2.3
This situation will be even worse if Ross McKewan is removed.
2.4
Barry Black is occupying the role of both chairman and chief executive officer
(managing director). King III recommends that these positions should be held by
two different people, with the chairman being an independent non-executive
director.
3.
In terms of the behaviour of the board
3.1
Barry Black dominates all decisions, and instead of embracing the opinion/input of
the only non-executive director, who is there to provide independent opinion, he
has sought to remove him.
3.2
None of the directors (other than Ross McKewan) appear to embrace the ethical
values and standards of responsibility, accountability, etc. and show little of
the moral duties of conscience, care, competence or commitment. (They are either
totally incompetent, unconcerned, looking out for their own interests, or totally
dominated by Barry Black.)
**2016**
SUGGESTED SOLUTION TO EXERCISE 13.16
Page 1 of 2 pages
To Sam Mashaba
1.
Yes, there are further procedures you should conduct.
2.
Firstly, you should inspect the company’s Memorandum of Incorporation to determine
whether there are any conditions or restrictions in respect of directors having personal
financial interests in contracts into which their company enters. Obviously if there are
conditions or restrictions you would have to confirm whether they have been complied
with.
3.
This purchase appears to amount to a contract in which two of the directors of Pipes and
All (Pty) Ltd have a personal financial interest by virtue of the fact that Aeron Sibaya
and Andre Booth own ATimes2 CC.
3.1
This brings into consideration whether Aeron Sibaya and Andre Booth have breached
Section 75 which requires directors to declare any personal financial interests in
a matter to be considered at a meeting of the directors, and whether by not doing
so, they have breached Sec 76.
3.2
In terms of Sec 76, directors must communicate to the board at the earliest
opportunity, any information that comes to their attention (pertaining to the
affairs of the company).
3.3
It is also required by Sec 76 that directors must exercise their powers and
perform their functions
*
in good faith and for a proper purpose
*
in the best interests of the company.
4.
Taking point 3 into account, it would seem clear that to comply with Sec 75 and avoid any
suggestion of a breach of Sec 76, Aeron Sibaya and Andre Booth should have notified the
other directors of their personal financial interest in the contract to buy a R4.6m
machine prior to the decision taken by the board to purchase the machine.
5.
Therefore you should inspect the minutes of the meeting at which the decision was taken
to purchase the machine to confirm/determine
5.1
6.
The meeting was properly constituted e.g. quorate.
5.2
The interest and its general nature (e.g. ownership of the CC supplying the
machine) was disclosed by both directors before being considered at the meeting.
5.3
Any other disclosure by the two directors which may have significance (may be
nothing).
5.4
The two directors left the meeting after making the disclosures (this should be
recorded) and
5.5
That the two did not vote on the decision to purchase (the two may be considered
as present for quorum purposes).
5.6
The resolution to purchase was approved by the other two directors (both would
have to have voted for the resolution to be passed).
As this transaction seems to have been fair and arms length, there should be no problem.
The essence is that directors in this situation are faced with a conflict of interest,
and must not make a “secret profit” out of the transaction.
7.
If the transaction was not “authorized” as required by Sec 75, the shareholders can still
ratify it by ordinary resolution.
8.
Failure to comply with Sec 75 or to have the contract ratified by the shareholders, makes
the contract voidable at the option of the company, unless an interested party applies to
the court and the court declares the contract valid.
To Daan Greef
1.
John Sepaka is a director of a wholly owned subsidiary of the company making the loan
i.e. a related company.
2.
In terms of Sec 45, a company may make a loan to a director of a related company
(directly or indirectly).
3.
The company (board) must comply with the Companies Act and any requirements/restrictions
the MOI of C-Ramics (Pty) Ltd might contain.
4.
However, despite anything the MOI might say, the board may not authorize the loan unless
*
it is pursuant to a special resolution of the shareholders, adopted within the
previous two years which approved the specific loan (i.e. to John Sepaka), or
generally for a category of recipients e.g. directors
*
the board is satisfied that immediately after providing the financial assistance,
the company would satisfy the liquidity/solvency test
*
the board has satisfied itself that any conditions or restrictions set out in the
MOI have been complied with.
**2016**
/continued on page 2
SUGGESTED SOLUTION TO EXERCISE 13.16
Page 2 of 2 pages
5.
The board must provide written notice to the shareholders (remember that this loan could
be up to two years after the special resolution) and to any trade union representative
*
within 10 business days of adopting the resolution if the loan of R150 000 is,
combined with any other such loan resolutions during the financial year, greater than
one tenth of one percent of the company’s net worth or
*
6.
within 30 business days of the year-end in any other case.
There is of course the general rule that in making the loan, the directors must act in
good faith, in the interests of the company; therefore the terms of the loan should be
fair and reasonable to the company.
To Seb Rothman
1.
The purchase by Bathtime (Pty) Ltd of its own shares amounts to a “distribution” as
defined in the Act. It is a transfer by a company of money to the holders of shares of
that company .... as consideration for the acquisition of its shares from those
shareholders (Sec 48).
2.
The “distribution” must only be made
*
if it is pursuant to an existing legal obligation or court order.
You can
establish this by inspection of directors’ meeting minutes and enquiry of Isaak
Shaai, the company secretary, or
*
if it is authorized by the board of the company.
3.
You should inspect the minutes of the meeting of directors (obtain the relevant date from
Isaak Shaai) to determine that
*
the meeting was quorate – a majority of the directors must have been present
*
the
directors applied the
distribution, the company
liquidity/solvency
test
i.e.
that
after
the

*
*
4.
will be able to pay its debts (and has been able to do so) in the normal
course of business for the 12 months after the distribution and

the company’s assets fairly valued, exceeded its liabilities
the
directors
acknowledged
in
the
minute
that
they
had
applied
the
liquidity/solvency test and had concluded that the test was satisfied
the majority of the votes cast were in favour of the resolution.
Obtain the working schedules used by the directors to conduct the liquidity/solvency test
and confirm by inspection, recalculation, analytical review etc that the test was
conducted based on
4.1
Accurate and complete accounting records.
4.2
Financial statements which comply with the financial reporting standards as to
form and content.
(As we are conducting the audit this should not be difficult to do).
5.
You
should
also
inspect
the
MOI
to
conditions/restrictions to be complied with.
6.
Obtain a summary from Isaak Shaai detailing the buyback and confirm by inspection that
7.
determine
whether
there
are
any
6.1
The number of shares purchased was 50 000 Bathtime (Pty) Ltd shares.
6.2
The purchase price was R7 and that
6.3
The transaction took place within the financial year and that these details all
agree with the directors’ minute.
6.4
The buyback price of R7 was fair and reasonable.
Inspect the paid cheques/bank transfers/bank statement to confirm that
7.1
The buyback took place within 120 business days of the resolution, in full (note:
if it did not, the directors must reperform the liquidity/solvency/acknowledgement
exercise).
7.2
The amount paid out was R350 000.
8.
Inspect the share register to confirm that the shareholders details/holding have been
correctly amended.
9.
Confirm by inspection of the financial statements that
9.1
The buyback has been accurately and completely disclosed.
9.2
Issued share capital has been reduced by 50 000 shares.
9.3
Stated capital reduced by R250 000 and reserves by R100 000.
**2016**
SUGGESTED SOLUTION TO EXERCISE 13.15
1 Page only
1.
The company has 350 000 shares already in issue, and wishes to issue a further 250 000
shares. However the company has only 400 000 authorised shares.
2.
The authorized share capital will therefore have to be increased to (at least) 600 000
shares.
2.1
The board can increase the number of authorized shares.
2.2
This in turn will require an amendment to the Memorandum of Incorporation.
3.
To amend the MOI, the board (or shareholders entitled to exercise at least 10% of the
voting rights) must propose a special resolution to authorize the amendment. (This will
present no problem in this case as the board wishes to make the amendment).
4.
As Kwin (Pty) Ltd is a private company, all the existing shareholders have a pre-emptive
right before any person who is not a shareholder, to be offered to subscribe for a
percentage of the shares to be issued.
4.1
The percentage offered must be equal to the voting power of those shareholders
general voting rights immediately before the offer was made.
4.2
This may present a problem for Kwin (Pty) Ltd because the intention is not to
offer BioMed (Pty) Ltd and the share scheme trust, any of the new shares but it is
intended
4.3
To offer shares to the two directors who are not existing shareholders.
5.
As it is intended to offer shares to the directors, the issue must be approved by a
special resolution.
As the issue is not in proportion to existing holdings, the
exemption for obtaining a special resolution does not come into play. (There are other
exemptions which are not relevant).
6.
It will also have to be determinable that the issue price of R40 was “adequate”.
The
board of directors must decide whether the “consideration” of R40 is adequate, and if
they have done so, the R40 cannot be challenged on any basis other than the directors
having not acted in good faith, in the best interests of the company and with the degree
of skill and diligence reasonably expected of a director.
7.
As can be seen from the above, two special resolutions are needed for this issue (even
after resolving the pre-emptive rights issue).
Thus a meeting of shareholders must be
called.
7.1
Notice: 10 business days prior to the meeting (assuming MOI is silent).
7.2
Notice must include:
*
date, time and location of meeting
7.3
*
general purpose of the meeting
*
copies of the proposed resolutions (special in this case)
*
voting percentages required to pass the resolutions (75%)
*
a reasonably prominent statement that a shareholder may appoint a proxy and
the proxy need not be a shareholder
*
a reasonably prominent statement that personal identification is required to
attend the meeting
Quorum : “votes” quorum - the meeting may not begin until persons holding 25% of
voting rights for at least one matter to be resolved, are present (the
attendance of only the three shareholders/directors would satisfy this)
and
: “person” quorum - at lease three shareholders are present
7.4
8.
If the board makes the issue without increasing the authorized share capital, the issue
can be retroactively ratified by special resolution.
8.1
9.
Resolution voting: as these are special resolutions, 75% of the voting rights
exercised on the resolution must be in favour.
(In this case the three
shareholders/directors would require the help of other shareholders if all
shareholders attended the meeting).
If this resolution is not passed, the issue is null and void (money repaid, share
certificates and entries in the share register nullified).
Only once the full consideration (R40 per share) has been received, will the shares be
fully paid.
At this point the shareholders details must be entered in the share
register.
**2016**
SUGGESTED SOLUTION TO EXERCISE 13.14
Page 1 of 2 pages
a)
1.
In terms of Sec 93 of the Companies Act 2008, as auditors of the holding company of
Nutsenbolts (Pty) Ltd, my firm will have access:
1.1 to all current and former financial statements of Nutsenbolts (Pty) Ltd.
1.2 by enquiry, from the directors (officers) of Nutsenbolts (Pty) Ltd, Metalmatch
(Pty) Ltd and Teknifast Ltd, all such information and explanations in connection
with any such statements and with the accounting records, books and documents of
the subsidiary, as we may consider necessary to perform our duties.
2.
As we do not hold the appointment of auditor of Nutsenbolts (Pty) Ltd, we do not have
the right at any time to audit the financial records or demand access thereto. (Note:
in practice we would work closely with the other audit firm.)
3.
If any person in the group attempts to frustrate the auditor in carrying out his
duties, the auditor can apply to the court to have his rights enforced.
b)
1. In terms of Sec 86
1.1 residency: Alex Fergoosen must be permanently resident in the Republic of South
Africa and must remain so while serving as company secretary.
1.2 professional qualification : The Companies Act 2008 does not stipulate any
professional qualification (or academic) for a company secretary. However, as a
company secretary plays a pivotal role in corporate governance the Companies Act
requires that this individual has the requisite knowledge of and experience in
relevant laws.
c)
1. Transactions with statutory implications can be complex in respect of their legality
and validity.
2. This in effect increases audit risk which is best reduced to an acceptable level by
ensuring that such transactions are referred to experienced audit personnel.
3. In addition, this requirement is an effective quality control procedure.
ISA 220
requires that work be “assigned” to personnel with the requisite “skills and
competence”.
d)(i)
Metalmatch (Pty) Ltd to Donovan
1.
Donovan is a director of the company making the loan, and a director of two “related”
companies (holding and fellow subsidiary).
2.
Being a director of “related” companies does not exclude him from being granted the
loan.
3.
The board of Metalmatch (Pty) Ltd may authorize the company to make the loan provided
3.1
the particular provision of the loan is pursuant to a special resolution of the
shareholders, adopted in the previous two years which approved such assistance
to
* Donovan himself
*
3.2
a category of recipient into which Donovan falls, e.g. directors
the board is satisfied that immediately after providing the financial
assistance (loan), the company would satisfy the liquidity/solvency test
*
the company’s total assets equal or exceed its total liabilities (no problem
Metalmatch (Pty) Ltd has high net worth)
*
it appears the company will be able to pay its debts as they become due in
the course of business for a period of 12 months after the test is
considered.
4.
In addition to 3 above, the terms of the loan must be fair and reasonable to the
company (the directors must act in the interests of the company and with care and
skill and in good faith (Sec 76).
5.
Metalmatch (Pty) Ltd must provide written notice of the resolution to the
shareholders (and to any trade union representing its employees) within 30 business
days.
**2015**
/continued on page 2
SUGGESTED SOLUTION TO EXERCISE 13.14
Page 2 of 2 pages
6.
The resolution will be void if it is inconsistent with Sec 45 (and any prohibition,
condition or requirement of the MOI – none in this case)
6.1
if the resolution is declared void a director of Metalmatch (Pty) Ltd who was
present at the meeting or participated in the decision, may be liable if he
failed to vote against the resolution knowing the provision of financial
assistance to be contrary to Sec 45 (or the MOI)
d)(ii) Metalmatch (Pty) Ltd to Bouncers (Pty) Ltd
1.
In effect this is a loan by Metalmatch (Pty) Ltd to a director of a fellow
subsidiary, Stikky Stuff (Pty) Ltd. Metalmatch (Pty) Ltd and Stikky Stuff (Pty) Ltd
are related as they are controlled by the same juristic person, Teknifast Ltd.
2.
Although the loan is to Bouncers (Pty) Ltd, Bouncers (Pty) Ltd is controlled by
Ambrose (he owns 76% of the shares/voting rights). Ambrose is an “individual related
to a juristic person” in terms of Sec 2(1)(b).
3.
The board of Metalmatch (Pty) Ltd may therefore authorize the company to make the
loan in compliance with Sec 45 as explained in the answer to loan (i) above.
4.
No mention is made of the terms of the loan.
fair and reasonable to the company.
As indicated above, the terms must be
d)(iii) Gloochem (Pty) Ltd to Juries.
e)
1.
In terms of Sec 45, financial assistance does not include providing a director with
an “accountable advance” to meet anticipated expenses to be incurred by the director
on behalf of the company. It could perhaps be argued that Juries is being advanced
the money to meet the expense of living in Detroit, one week a month. The counter
argument is that he is borrowing money to purchase an asset in his own name.
2.
If the expense interpretation is correct, then there is no need to have a special
resolution from the directors or specifically apply the liquidity/solvency test.
3.
However, to protect themselves (and ensure they are meeting the standards of conduct
required by directors), the directors should comply with Sec 45 (it is not onerous
and is in the best interests of the company/shareholders to be fully aware of, and
approving of the advance/loan to its director).
4.
The fact that Juries has a house in Jhb has no bearing.
Removal of Campo as director
1.
The board of Teknifast Ltd cannot remove Campo as a director of Nutsenbolts (Pty) Ltd
as they are not shareholders of Nutsenbolts (Pty) Ltd.
2.
However, Teknifast Ltd controls Metalmatch (Pty) Ltd which in turn controls
Nutsenbolts (Pty) Ltd, and can therefore vote its shares (58%) in favour of removing
him.
3.
In terms of Sec 71, a director can be removed by an ordinary resolution at a
shareholders meeting.
4.
However, before the shareholders of Nutsenbolts (Pty) Ltd may consider such a
resolution
*
Campo must be given notice of the meeting and the resolution at least equivalent
to that which a shareholder would be given i.e. 10 business days before the
meeting
*
5.
Campo or his representative must be afforded a reasonable opportunity to make a
presentation at the meeting before a vote is taken.
If Campo is removed from office, there is nothing in Sec 71 which deprives him in
common law or otherwise, to apply to a court for damages, or other compensation for
5.1
loss of office as a director
5.2
loss of any other office as a consequence of being removed as a director.
As the grounds for his removal seem somewhat tenuous and his performance as a director is
very satisfactory, Campo may well have a case.
**2015**
SUGGESTED SOLUTION TO EXERCISE 13.13
Page 1 of 2 pages
a)
1.
If John Wayne is to have the audit requirement included in the company’s MOI, the
MOI will have to be amended in terms of the Act.
2.
A special resolution to amend the MOI is required.
3.
A meeting of shareholders can be called by the board (or by shareholders who
exercise 10% of the votes) so John Wayne will need to get this approval from his
board or the relevant shareholders, to call the meeting.
(The MOI may also
stipulate that the CEO can call a meeting of shareholders.)
4.
As Canyon (Pty) Ltd is a private company, the following will apply with regard to
the meeting
5.
4.1
notice period of 10 business days before the meeting is to begin.
4.2
notice must include date, time and location.
4.3
specific purpose for which the meeting has been called (amend MOI) must be
stated and
4.4
a copy of the proposed resolution and the percentage of voting rights
needed to pass the resolution must be included i.e. resolution to amend
MOI for an annual audit requirement, and 75% voting rights.
The notice must also include a reasonably prominent statement that
5.1
a shareholder may appoint a proxy (who does not have to be a shareholder).
5.2
6.
b)
personal identification will be needed to attend the meeting.
To be quorate, the meeting
6.1
must have at least three shareholders present.
6.2
must have shareholders holding 25% of the voting rights which can be
exercised on the amendment, in attendance before the meeting can begin or
the matter be discussed.
7.
Voting of the matter may be done by show of hands or polling those present and
entitled to vote.
8.
If the resolution is passed, a Notice of Amendment (with the prescribed fee) must
be filed with CIPC.
1.
To comply with the requirements of the Companies Act 2008
2.
1.1
shareholders
meeting.
must
appoint
the
audit
committee
at
each
annual
general
1.2
it must consist of at least three members.
1.3
each member must be a director of the company.
1.4
each member must satisfy the minimum qualifications prescribed by the
minister to ensure that the audit committee taken as a whole, comprises
persons with adequate financial knowledge and experience.
Regulation 42
requires that at least one third of the members of the audit committee
have academic qualifications or experience in economics, law, accounting,
corporate governance, etc.
1.5
a member of the audit committee must not be
*
involved in the day to day running of the company or have been so
involved at any time during the previous financial year or
*
a prescribed officer, or full time executive employee of Canyon
(Pty) Ltd (or any related or inter-related company) or have held
such post at any time during the previous three financial years or
*
a material supplier or customer of the company, such that a
reasonable and informed third party would conclude that, in the
circumstances, the integrity, impartiality or objectivity of that
member of the audit committee would be compromised or
*
a “related person” to any person subject to these prohibitions e.g.
the wife of a full time executive employee of Canyon (Pty) Ltd.
The duties of the audit committee are to
2.1
nominate a registered auditor for appointment as auditor by the
shareholders (must be satisfied nominated person/firm is independent of
Canyon (Pty) Ltd).
2.2
determine the auditors’ fees and terms of engagement.
2.3
ensure the appointment of the auditor complies with the Companies Act,
Auditing Profession Act.
2.4
determine the nature and extent of any non-audit services the auditor may
provide to Canyon (Pty) Ltd and pre-approve any agreement with the auditor
for the provision of these services.
2.5
prepare a report to be included in the AFS which
*
describes how the audit committee carried out its function
*
states whether the auditor was independent of the company
**2016**
/continued on page 2
SUGGESTED SOLUTION TO EXERCISE 13.13
Page 2 of 2 pages
*
2.6
c)
comments in any way the committee considers appropriate on the
financial statements, the accounting practices and internal
controls of the company.
receive and deal with appropriately, any concerns or complaints relating
to
*
the accounting practices and internal audit of the company
*
the content or audit of the AFS
*
internal financial controls or
*
any related matters
2.7
make submissions to the board on any matters dealt with in (2.6) above.
2.8
perform other functions determined by the board.
1.
If the MOI contained a clause which designated an individual e.g. John Wayne in
his capacity as CEO, the power to remove Doc Hudson from the board, that power
could be exercised.
2.
Doc Hudson can also be removed by an ordinary resolution of the shareholders at
any general meeting (notice, quorums, voting, etc would be described as in part
(a)) regardless of what may be contained in the MOI.
3.
Doc Hudson may also be removed if a shareholder or fellow director (e.g. John
Wayne) alleges, inter alia, that he has been negligent or derelict in his duties
as a director. The board must consider the allegation and vote on his removal.
Doc Hudson will not vote on the resolution but see (4) below.
4.
Whatever “method” of removing Doc Hudson is attempted, he must be afforded the
chance to defend himself;
5.
4.1
he must be given notice of the meeting (10 business days) and a copy of
the resolution to remove him.
4.2
he must be afforded a reasonable opportunity to make a presentation (in
person or through a representative) before voting takes place.
Where Doc Hudson is to be removed by the board, he may not vote on his removal.
For the removal resolution to be accepted, the majority of directors voting would
need to vote in favour.
d)
6.
If Doc Hudson is removed by the board, he has 20 business days to go to court for
a review of the board’s decision. Any director who votes against the resolution
can also apply to the count to have the decision by the board reviewed.
7.
If Doc Hudson is not removed, (i.e. removal resolution not passed) any director or
shareholder who voted to have him removed, may go to court for a review of the
decision (20 business days).
1.
Clint Westwood: not suitable for appointment as he is in terms of the COPC, not
independent as he is the brother of one of the shareholders of the company.
This relationship is likely to be a threat to his independence, (primarily
familiarity) and would certainly be seen to impinge upon the independence of the
opinion given by Clint Westwood in his capacity of auditor.
2.
Financial Advisors Incorporated: not suitable for appointment as the company could
not be registered with the IRBA and therefore cannot conduct audits.
The reason that the company could not be registered with the IRBA is that for any
incorporated practice to register as an audit company, all shareholders must be
registered auditors; Siya Nomvete is a lawyer and obviously not qualified for
registration with the IRBA.
3.
Jacqueline Selebi: although she is a CA(SA) it is not clear whether she is a
registered auditor. Furthermore in terms of the Companies Act, any person who has
been the company secretary (prescribed officer) at any time during the preceding
five years, is disqualified from appointment as auditor.
4.
Aeron Colt: he qualifies for appointment as he is a registered auditor. However,
whether he is suitable for appointment depends on whether in his professional
assessment, he has the necessary time, skill and resources to audit a company of
Canyon (Pty) Ltd’s size. Note: he is a sole practitioner.
5.
Karloss, Kwirosh and Co: this firm is likely to be the most suitable; it is
international and will have the necessary resources.
The fact that the firm
conducted a successful investigation at Canyon (Pty) Ltd is also a positive factor
and in no way disqualifies them from appointment.
Furthermore they would be
suitable as a long term appointment if the shareholders vote to have an annual
audit.
**2016**
SUGGESTED SOLUTION TO EXERCISE 13.12
1 Page only
a)
1.
In terms of the Companies Act 2008 (Sec 76).
1.1
Tony Teak, as a director of Marine (Pty) Ltd, should not have used his
position of director or any information obtained whilst acting as a
director, to gain advantage for himself or for another party (his brother
Terry). He must act for the company e.g. he should not pass confidential
information on to Terry about the price Marine (Pty) Ltd are prepared to
pay for the radar systems.
1.2
1.3
Tony Teak should have communicated to the board of Craft (Pty) Ltd at the
earliest practicable opportunity, any information which was material to
Marine (Pty) Ltd e.g. it would be important for the board to know that Tony
and Terry are related as a R10 million deal could be influenced by the
relationship.
Tony Teak must at all times perform his function and exercise his powers as
a director.
1.3.1
in good faith
1.3.2
in the best interests of the company.
2.
In effect Tony Teak had a conflict of interest – the company or his brother?
3.
In terms of the Companies Act 2008 (Sec 75), if Tony Teak had a personal financial
interest in the matter to be considered at a meeting of the board (sale of the
radar systems) or had known that a related person had a personal financial
interest, he should have:
3.1
disclosed the interest and
considered at the meeting.
its
general
3.2
disclosed to the meeting any material information relating to the sale
which was known to him.
3.3
disclosed any observations or pertinent insights into the matter if he had
been requested to do so by the other directors.
3.4
left the meeting (if he was
disclosures to the meeting and
3.5
have taken no further part in the meeting and
3.6
would not have voted on the decision.
present)
nature
before
immediately
the
after
matter
making
was
the
4.
As Tony and Terry Teak are brothers, they are regarded as related for the purposes
of the Companies Act 2008, as they are within two degrees of consanguinity.
5.
The information need only be disclosed if it is material (Sec 76(2)(b)).
R10 million contract would be regarded as material.
A
1.
The meeting of shareholders
electronic communication provided
by
b)
1.1
2.
ratify
the
contract
can
be
held
the company is not prohibited by its MOI from conducting the meeting by
electronic communication.
In terms of Sec 63, one or more shareholders (or their proxies) may participate in
an electronic meeting, provided
2.1
3.
to
the electronic communication employed ordinarily enables all persons
participating in that meeting, to communicate concurrently with each other
without an intermediary and to participate reasonably effectively in the
meeting.
The notice of the meeting must inform shareholders of the availability of that
form of participation and provide the necessary information to enable shareholders
(proxies) to access the available medium (cost to be borne by shareholder).
c)
Show of hands each
shareholder
(proxy)
has
one
irrespective of number of shares held by the shareholder.
By poll
vote
shareholder (proxy) must be allowed to exercise all
the voting rights attached to the shares held by the shareholder.
**2016**
SUGGESTED SOLUTION TO EXERCISE 13.11
Page 1 of 3 pages
Faber and Mkhize
P O Box 1
Durban
3000
20 May 2016
Ms Tracy Good
P O Box 8512
Randlink
2039
Dear Ms Good
Re: Formation of new business entity
Thank you for your enquiry regarding advice as to the launch of your intended new business
entity. I hope that the information which follows will resolve any uncertainties you may have.
a)
Best form of business entity
1.
A private company does appear to be most suitable for the needs of the new
business which you are planning, because
1.1
a private company would provide the benefit of limited liability to a
degree


2.
this means that creditors of the company would not have recourse
against you in your private capacity for the debts of the company.
This would achieve your aim that personal assets of potential
investors cannot be attached to settle debts owing by the company,
i.e. investors losses would be limited to the amount they had
personally invested.
however, many providers of credit (e.g. banks and major suppliers)
insist that shareholders in private companies, particularly smaller
and newly formed companies provide personal guarantees for company
debts.
Limited liability would therefore not apply in respect of
such debts, as shareholders would in effect become jointly and
severally liable with the company.
1.2
the Companies Act 2008 does not place a restriction on the number of
shareholders in a private company thus, your requirement of fifteen
shareholders excluding yourself and Emily Park, is acceptable.
1.3
the transfer of shares is restricted in a private company which has the
benefit of allowing you (shareholders) to select and approve any changes
in shareholders, and to ensure that any shares which come available for
sale, for example, an existing shareholder wants to sell her shares, are
offered to existing shareholders first.
1.4
the fifteen shareholders do not have to involve themselves in any major
way in the business so will be able to continue with their sporting
commitments.
1.5
a company is a juristic person and continues
whether the shareholders or directors change.
to
exist
regardless
of
Other possible forms of business enterprise appear to be less suitable than the
private company, as explained below.
2.1
Partnerships
Partnerships have three major disadvantages
*
members are normally jointly and severally liable
*
the partnership has to be dissolved and reconstituted every time its membership
changes which is inconvenient and can result in difficulties when a partner leaves e.g.
is there goodwill?
*
partnerships are often viewed as less formal and thus less secure
in the business world; with 17 potential “partners” this could be a
real problem.
The intention of a partnership is really for the partners to work together
for the good of the partnership as a whole.
As I understand it, the 15
investors will not be involved in the day-to-day running of the business.
2.2
Close Corporations
In terms of the Companies Act 2008, new Close Corporations can no longer
be registered so this is no longer an option.
It is possible to take over an existing CC but with the ease with which a
private company can be formed, this is unnecessary. Furthermore, as a CC
can only have a maximum of ten members, 17 of you could not be
accommodated as “owners”.
**2016**
/continued on page 2
SUGGESTED SOLUTION TO EXERCISE 13.11
Page 2 of 3 pages
2.3
Public Companies
There are many features which are common to both public and private companies, however:

public companies are more strictly regulated, and statutory
requirements are more onerous (may even make this option
unattainable in your case).

normally public companies are for large business undertakings
requiring extensive investment from the public.

as the transfer of shares is unrestricted in a public company,
you would have no control over who your fellow shareholders would
be.

a public company is totally unsuitable for your needs.
b)
Incorporation of the private company is a simple procedure.
1.
In terms of Sec 13 of the Companies Act 2008, one or more persons can
incorporate a private company. This could be you and/or Emily Park.
2.
A Memorandum of Incorporation must be compiled.
There are standard
MOIs or one unique to the company to be formed, can be drawn up.
(I would
recommend using the standard MOI for a private company.
It can be modified
before incorporation, or amended after incorporation if necessary.)
3.
The persons forming the company (or their proxies) must sign the MOI
and file it with the Companies and Intellectual Property Commission with a
Notice of Incorporation which is a standard document.
We can help you with
this process. You will need to pay the prescribed incorporation fee.
4.
The Notice of Incorporation will require that you identify the
individuals who are incorporating the company as the incorporators will become
the first directors of the company. I assume that this will be you and Emily
Park. Once the company has been incorporated, you can change the directors as
you wish provided your actions are consistent with the MOI and the Act.
5.
On receipt of an acceptable MOI and Notice, the commissioner will
5.1
assign a unique registration number to the company.
5.2
enter the company’s information in the Companies Register.
5.3
endorse by official stamp/signature the MOI and NOI.
5.4
issue and deliver to the company a registration certificate.
This certificate is conclusive evidence that all the requirements of
incorporation have been met, and the company is incorporated from the
date stated on the certificate.
6.
The MOI deals with numerous matters which are necessary to give the
company an identity and to operate including:
6.1
details of the incorporation of the company, e.g. type, name,
date of incorporation.
6.2
directors,
composition
of
the
board,
meetings,
committees,
6.3
authorised shares : number and class.
6.4
shareholders rights.
6.5
shareholders meetings e.g. notice, location, quorums, resolutions.
6.6
procedure for altering the MOI.
6.7
authority for certain acts, e.g. giving loans, financial assistance.
compensation.
7.
The MOI can deal with virtually any relevant company matter but may not
include provisions which are inconsistent with the Act.
c)
Acting as tax advisor and auditor
1.
We would be pleased to act in these capacities for your company.
2.
However, I must point out that it is very unlikely that initially you
will have to have your annual financial statements audited. In terms of the
Companies Act whether or not a company has to have its financial statements
audited is determined by what is termed the company’s public interest score and
whether the company compiles its own financial statements. Without going into
detail, your public interest score is almost certainly going to be less than
100 points.
Points are allocated for such things as turnover (1 point for
every million!) and number of employees, so as a “starting out” company you are
unlikely to reach 100 points for some time.
**2016**
/continued on page 2
SUGGESTED SOLUTION TO EXERCISE 13.11
Page 3 of 3 pages
3.
As a company with a public interest score of less than 100, you do not
need an audit.
This is regardless of whether you compile your financial
statements or not. However, instead of an audit, your annual financial statements
will have to be independently reviewed by a registered auditor or an individual
who is a member of one of the specified accounting bodies.
4.
A review of your financial statements is less intense and detailed than an
audit and consequently a lower level of assurance is provided pertaining to the
fair presentation of the financial statements.
5.
If you or your proposed investors feel that the financial statements
should be audited (as opposed to reviewed) the two of you as the directors, can
request an audit at any time or we can insert a clause in the MOI which requires
that the AFS be audited. Sometimes investors who are not involved in the company
do prefer the extra assurance which they get from an audit, but having said that,
I don’t believe that an audit is necessary at this stage.
6.
If you do decide that you require an audit and appoint us, we would be
obliged to carry out the audit in terms of our professional practice standards,
and we would have to consider whether there would be any ethical reasons why we
could not accept the appointment. For example, we would need to be sure that we
are independent of your company and shareholders/directors. As these individuals
are not known to us as yet we cannot judge this.
7.
Acting as your tax advisors whether or not we provide audit or review
services will not present any problems that we are aware of.
Please do not hesitate to contact me should you have any further queries.
Yours faithfully
Mitchell Mkhize
**2016**
SUGGESTED SOLUTION TO EXERCISE 13.10
Page 1 of 2 pages
a)
I would respond as follows:
1.
1.1
Yes, you can be removed from the board.
1.2
However, this does not mean that you will be dismissed from the company – being on
the board is a role that you are elected to over and above your employment by the
company for your skills in the electronics field.
As you are regarded as an
important person with regard to research and development at Tracshion Ltd, it is
very unlikely that they will dismiss you.
1.3
There are Companies Act requirements which must be satisfied as well before you
can be removed as a director
2.
3.
1.3.1
if the shareholders wish to remove you, they must pass an ordinary
resolution to do so. This basically means that a majority of the voting
rights held by the shareholders who had the right to vote on your
appointment, must support your removal.
1.3.2
however, if the shareholders intend to remove you they must give at least
10 business days notice of the meeting and that they intend to remove you.
You must receive a copy of this notice.
1.3.3
before the meeting votes on your removal, the shareholders are required to
give you a reasonable opportunity to make a presentation on your removal.
You may also have a representative do this for you. This enables you to
put your “side of the story” to the shareholders.
1.4
The shareholders will not take a decision to remove you lightly, remember that
they appointed you.
1.5
You should perhaps also be aware that if you are negligent or derelict in your
duties, the board may resolve to remove you. Negligence or dereliction of your
duties is serious, but if you comply with standards of director conduct (which is
not difficult to do) there is no chance of this happening. Even in this situation
you would still be allowed to make representations and a majority of the directors
would have to support your removal.
2.1
Yes, as I have explained, your appointment as a director is separate from your
employment contract.
2.2
You may resign at any time by giving written notice to the board.
2.3
Your company’s Memorandum of Incorporation may have other requirements for
resignation of a director but these are unlikely to be very onerous, e.g. minimum
notice periods.
2.4
Within 10 business days of your resignation, the company (not you) will need to
notify the Commission (CIPR) of your resignation.
The standards are laid out in Sec 76 and are quite clear:
3.1
Firstly, you must not use the position of director, or any information obtained
while acting in the capacity of director to
*
gain an advantage for yourself or any other person or
*
to knowingly cause harm to the company,
e.g. you may hear at a board meeting that the company is going to call for tenders
for a large contract; you cannot pass confidential information about the tender to
a friend who is tendering for that contract.
3.2
Secondly, you must communicate to the board at the earliest practicable
opportunity, any information that comes to your attention (about the company)
unless you
*
believe the information is immaterial to the company
*
generally known to the public or other directors
*
would be breaching a legal or ethical obligation of confidentiality,
e.g. you may have information about technical developments in your field which
might affect Tracshion Ltd’s business strategy.
You must disclose this
information. This is very logical if you understand that as a director you must
look after the interests of the company.
3.3
Thirdly, you are required to exercise the powers and perform the duties of a
director
*
in good faith and for proper purpose
*
in the best interests of the company and
*
with the degree, skill and diligence that may be reasonably expected of a
person carrying out the functions of a director and
*
having a general knowledge, skill and experience of that director.
**2016**
/continued on page 2
SUGGESTED SOLUTION TO EXERCISE 13.10
Page 2 of 2 pages
3.4
Essentially this will require you to:
*
take reasonably diligent steps to become informed about matters coming
before the board and
*
have a rational basis for supporting a board decision and believing it was
in the best interests of the company. In other words, you must be able to
justify your decision when voting on a matter before the board.
3.5
You are not expected to be “experienced”, you are a new director but you will need
to be conscientious, diligent, enquiring and willing to learn.
3.6
A particularly important aspect of 3.3 is that if you or anyone related to you (as
defined) e.g. your husband, has any personal financial interest in any matter
brought to the board, or which you think the company should know about anyway, you
should notify the board of the nature of the interest. For example, if Tracshion
Ltd was proposing to enter into a contract with a company in which your husband
has a shareholding, the board must be informed. If you are not sure what needs to
be disclosed, err on the side of caution, it is wiser to disclose than to keep
quiet.
3.7
As a director, in making decisions, you are entitled to rely on other people who
provide information, reports, opinions to the board, e.g. employees, accountants,
legal counsel,
competent.
4.
5.
b)
unless
you
have
reason
to
believe
they
are
not
reliable
or
4.1
No, it is only the court that can declare a director under probation, the chairman
cannot make this decision.
4.2
However, the company, a shareholder, a director, company secretary, a trade union
representative (or similar representative) can apply to the court to have a
director declared “on probation”.
4.3
Certain company regulatory bodies can also make application to the court.
4.4
Being declared “on probation” is not an everyday occurrence for directors and is
not something you need to worry about if you apply the required standards. In any
event, if things aren’t going well you can resign!
Probation is in a sense, a
last option.
5.1
You are fully entitled to seek advice from the chairman of the board, or any other
director.
5.2
You are also entitled to seek assistance from individuals not on the board, but
you must not breach confidentiality.
5.3
However, the best person to assist you in this regard will be the company
secretary of Tracshion Ltd.
One of the functions of the company secretary
stipulated in the Companies Act is to advise directors on their rights, duties and
responsibilities.
Conscience
Care
Competence
Commitment
Courage
**2016**
SUGGESTED SOLUTION TO EXERCISE 13.9
1 Page only
a)
An alterable provision is one which it is expressly contemplated that its effect may be
negated, restricted, limited, qualified, extended or otherwise altered in substance or
effect by that company’s Memorandum of Incorporation.
b)
1.
Unalterable. (Sec 94)
2.
Alterable (the 25% can be increased or decreased) (Sec 73)
3.
Unalterable. (Sec 69)
4.
Unalterable. (Sec 35)
5.
Unalterable. (Sec 64)
6.
Alterable (the 50% can be increased, but not decreased).
7.
Alterable (the 75% may be decreased, provided there is always at least a 10% point
difference between the requirements for approval of an ordinary and special
resolution).
8.
Alterable (the MOI can change this but it is unlikely that the quorum would be set
at less than the majority as decisions taken by the board should at least be
acceptable to the majority of directors. The MOI could call for a “higher than
majority” as the quorum, e.g. 60% or 75% of directors must be present.)
9.
Unalterable. (Sec 37)
10.
Unalterable. (Sec 74)
**2016**
SUGGESTED SOLUTION TO EXERCISE 13.8
1 Page only
1.
1.2
:
shorter period).
2.
True
3.
3.2
:
15 days.
(Note: the MOI can stipulate a longer or
25% of all voting rights..... Sec 64(1)(a).
4.
4.2 & 4.3
:
The
company
satisfies
test and a special resolution is obtained.
5.
False
:
The financial assistance provisions of the
Act are not “alterable provisions”.
6.
All
:
Provided
liquidity/solvency
test
satisfied and the necessary special resolutions are obtained.
7.
7.3
8.
:
liquidity/solvency
The requisite knowledge and experience...
8.1 & 8.2
:
private company.
8.1 and 8.2 are the major requirements for a
9.
True
:
Sec 15
10.
10.2
:
A special resolution is required.
11.
12.
11.1 & 11.2
:
The company
therefore 11.3 does not apply.
False
:
is
must
be
liquid
and
solvent
Sec 33 – Every company must file an annual return.
13.
13.2
14.
:
Rehabilitated insolvent.
14.1 & 14.3
:
Neither of them are disqualified by the
Companies Act(14.2 related to a director therefore disqualified).
15.
15.2
:
Special resolution (Sec 112).
**2016**
SUGGESTED SOLUTION TO EXERCISE 13.7
1 Page only
1.
False.
A private company (private companies are classified as profit companies) needs
only to be audited if it has a public interest score of 350 and above, or it has a public
interest score of 100 to 349 and its AFS are internally compiled (or it holds assets in a
fiduciary capacity for persons not related to the company. Minimum amount is R5m at any
stage during the year.
2.
A non-profit company is a company that is incorporated for a public benefit, and the
property and income are not distributable to its incorporators, members, directors,
officers or related persons, except as reasonable compensation for services rendered.
3.
This would probably not be acceptable in terms of Sec 11 as it could be construed as an
offensive term with connotations of race and ethnic hatred and violence.
4.
The addition of (“RF”) to a company’s name, signifies that the company has restrictive
condition(s) in its MOI, or that it MOI prohibits the amendment of some provision(s) in
the MOI.
The (“RF”) is attached to alert anyone who deals with the company that the
restrictions exist, e.g. the MOI may restrict the type of investments a company may make;
e.g. derivative trading may be prohibited.
5.
A personal liability company is
5.1
a private company, and
5.2
its MOI must state that it is a personal liability company and include in its MOI
a clause which provides that the directors and past directors are jointly and
severally liable, together with the company, for any debts and liabilities of the
company which were contracted during their term of office.
6.
6.1
6.2
A private company is private because its MOI

prohibits it from offering any of its shares (securities) to the public and

restricts the transferability of its shares (securities).
A public company is a public company because it is a profit company which is not a
state owned company, a personal liability company or a private company!
7.
True. An unalterable provision is supposedly one which cannot be altered by the MOI; but
in terms of Sec 15(2)(a)(iii) the MOI can “impose on the company a higher standard,
greater restriction, longer period of time or any similar more onerous requirement than
would otherwise apply to the company in terms of an unalterable provision of the Act”.
8.
A company comes into being when its incorporation is registered with the Commission and
it exists continuously until its name is removed from the Companies Register at the
Commission in terms of the Act.
9.
9.1
Related.
9.2
Not related.
9.3
Not related.
With his 65% holding (majority) Kent King controls KingKent (Pty)
Ltd.
With only 40% of the shares, Kent King does not control SupaKing
(Pty) Ltd.
Neither of the two companies controls the other directly or
indirectly.
Neither is a subsidiary of the other.
They are not controlled by the same person directly or indirectly.
10. Substantial compliance means that if a record or document, etc. is in a form or is
delivered in a manner which satisfies all the substantive requirements of the content of
delivery, the form or its delivery will be valid.
**2016**
SUGGESTED SOLUTION TO EXERCISE 13.6
Page 1 of 2 pages
1.
2.
1.1
A public interest score is the sum of the points allocated to certain attributes or a
company or close corporation e.g. one point is allocated to every one million rand or
part thereof, of turnover. The Companies Act 2008 requires that each company (and
close corporation) calculate its public interest annually.
1.2
The public interest score is used as a gauge of the interest the public at large
(society) has in the company or close corporation.
1.3
In terms of the Companies Act 2008 (and Companies Regulations 2011), the entity’s
public interest score is one of the factors which determines whether the entity must
have its annual financial statements audited or independently reviewed, e.g. all
companies and close corporations with a PIS of 350 and above must be externally
audited whilst a private company with a PIS of less than 100 need only undergo an
independent review.
2.1
Whether the company is audited or reviewed and who must carry out the independent
review.
2.2
Which financial reporting
financial statements.
2.3
The level of financial rescue practitioner who would be engaged, if the company
needed financial rescue.
2.4
Whether a private company must appoint a Social and Ethics Committee (Reg 43).
standard
the
company
must
use
to
prepare
its
annual
3.
Location, the number of directors (executive and non-executive), and number of years in
operation do not affect the public interest score.
4.
True.
5.
False. Public interest score criteria are set in Regulations 26 of the Companies Act and
are not alterable.
6.
6.1
All companies and close corporations must calculate their public interest score.
Tech (Pty) Ltd
Master (Pty) Ltd
8
136
6.2
N/A
N/A
6.3
62
201
6.4
2
20
6.5
9
22
81 points
379 points
Total
7.
Equal to or above 350 points
Equal to 100 or above, but less than 350 points
Below 100 points.
8.
False.
9.1
*
Shareholders meetings



9.2
Public interest score must be calculated annually.
The annual general meeting (A.G.M.) Sec 61(7)
General meetings Sec 61(1)
Meetings of directors (the board) Sec 73(1).
*
The A.G.M. : Once every calendar year but no more than 15 months after the date of
the previous AGM.
*
General meetings: when called by the board, or by any other person specified by the
company’s MOI or rules. Shareholders holding at least 10% of the shares entitled to
vote on the proposal for which the demand is being lodged, can demand that the board
(or specified person) call a meeting.
*
Directors' meetings: When called by a director authorized to do so, e.g. CEO, or by
3 directors on the board (25%). (Note: Spartan Ltd is a public company and has 12
directors.) (MOI may stipulate a higher or lower percentage.)
**2016*
/continued on page 2
SUGGESTED SOLUTION TO EXERCISE 13.6
Page 2 of 2 pages
9.3
*
Quorums for meetings
*
AGM and general meetings


a shareholders meeting may not begin until sufficient persons are present at the
meeting to exercise in aggregate, at least 25% of all the voting rights that are
entitled to be exercised in respect of at least one matter to be decided at the
meeting (Sec 64(1)(a)) and
a matter to be decided at the meeting may not begin to be considered unless
*
sufficient persons are present at the meeting to exercise in aggregate at least
25% of all of the voting rights that are entitled to be exercised on that matter
at the time the matter is called on the agenda (Sec 64(1)(b)).
 as Spartan Ltd has more than two shareholders, a meeting of shareholders may not
begin, or a matter be debated, unless at least three shareholders are present and
the requirements of Sec 64(1)(a) and (b) are met.
 the MOI may stipulate higher or lower percentages than the 25% provided by the
Act.
Directors meetings

9.4
*
The quorum will be a majority of the directors.
A meeting of the board may be conducted by electronic communication, or one or more
directors may participate in a meeting by electronic communication, provided

*
10.1
10.2
10.3
10.4
10.5
the electronic communication facility employed ordinarily enables all persons
participating in the meeting to communicate concurrently with each other without
an intermediary and
 to participate effectively in the meeting.
The MOI may stipulate that conducting the meeting by electronic communication is not
permitted.
Name
*
A private company must include the words
abbreviations in its name i.e. (Pty) Ltd.
proprietary
and
limited
or
their
*
A public company must not include the word proprietary or its abbreviation, but must
include "Limited" or its abbreviation in its name.
Directors
*
A private company must have a minimum of 1 director, no maximum stipulated in the Act.
*
A public company must have a minimum of 3 directors, no maximum stipulated.
*
The company’s MOI may stipulate a higher number.
Offer of shares
*
A private company may not offer its shares for sale to
circumstances and restricts the transferability of its shares.
the
public
under
any
*
A public company may offer its shares to the public under the conditions stipulated in
the Cosact and its MOI.
Company secretary
*
A private company is not required to have a company secretary but may appoint one.
*
A public company must appoint a company secretary.
Audit committees
*
A private company is not required to appoint an audit committee unless its MOI
stipulates that the company elects to comply voluntarily with the provisions of
Chapter 3 of the Companies Act 2008 which deals inter alia with, the appointment of an
audit committee.
*
A public company must appoint an audit committee annually.
**2016*
SUGGESTED SOLUTION TO EXERCISE 13.5
Page 1 of 2 pages
a)
1.
There is no merit in Franco Steyn’s statement
1.1
We have every right to “concern ourselves” with this matter. In fact, in terms
of the Auditing Profession Act, our firm, and particularly myself as the
designated auditor, could be in serious trouble if we do not report a material
irregularity (which this is)
*
1.2
if found guilty of failing to report this irregularity to the IRBA, in terms
of Sec 52, I could be liable to a fine or to imprisonment (for up to 10
years!) or both. Not a risk I would consider taking!
What Franco Steyn appears to be missing is that the CC is defrauding the SARS by
claiming personal expenses as business expenses.
This means the entity is
paying less tax
*
normal tax (by illegally reducing its profits)
*
VAT (by claiming the VAT back on these “business” expenses).
1.3
The only reasons that there has been no comeback is because there has been no
external intervention of the CC affairs (none required) and that the members
have colluded amongst themselves; because they have all agreed to an illegal
activity doesn’t make it a legal activity. The fact that “no member is favoured
over another” is not the point, SARS are being prejudiced!
1.4
He is correct in saying that the new legislation does not change the requirement
that CC members work together, but it doesn’t say they can work together to
break the law.
1.5
There are no such things as “company audit rules” and “CC audit rules”.
Our
duties and procedures as auditors are laid out in the Auditing Profession Act
and the auditing statements. Once we are appointed as auditors, we must abide
by the relevant rules, therefore
b)
*
he is correct in stating
Corporations Act but
that
*
reporting a reportable irregularity is one of our duties in terms of the AP
Act 2005 and as “officially” appointed auditors, we must comply with this
duty.
This will constitute a reportable irregularity.
must be satisfied:
1.
in
the
Close
To qualify as a RI, the following criteria
The act of claiming personal expenses through the CC was carried out by all the
members of the CC who are responsible for the management of the CC.
This act amounts to defrauding SARS by
*
reducing normal taxation of the CC by claiming non-business expenditures
*
claiming VAT on expenses which were not valid BuilderBoy CC expenses.
This is satisfied, as all members are charging personal expenses and have been
for years.
SARS is likely to have suffered financial loss which is material
either in respect of normal tax or VAT but probably both.
Is the act theft, fraud or a breach of fiduciary duty?
4.1
5.
mentioned
Does the act result in material financial loss?
3.1
4.
not
The act must be an unlawful act
2.1
3.
are
Committed by a person(s) responsible for management of the CC
1.1
2.
RI’s
This act is fraud and does amount to a breach of fiduciary duty by the members
to the CC itself (as a legal entity).
Are we satisfied (or do
(actually) taking place?
5.1
we
have
sufficient
reason
to
believe)
that
the
RI
is
Our audit evidence suggests this and Franco Steyn had admitted it, so we can be
satisfied that it is occurring.
**2016*
/continued on page 2
SUGGESTED SOLUTION TO EXERCISE 13.5
Page 2 of 2 pages
c)
d)
An unqualified opinion cannot be given unless
1.
The audit has been carried out free of restriction.
2.
The designated auditor has satisfied himself of the existence of all assets and
liabilities shown in the financial statements.
3.
Proper accounting records have been kept (in at least one of the official languages)
and all information, vouchers and other documents, which in the auditor’s opinion,
were necessary for the proper performance of his duties, were obtained.
4.
The auditor has not had occasion to report a reportable irregularity to the IRBA.
5.
The auditor has complied with all laws relating to the audit of that entity.
6.
The auditor is satisfied as to the fairness of the financial statements.
1.
This would
compiled
2.
depend
on
whether
its
AFS
were
internally
compiled
or
independently
1.1
If they were internally compiled, the AFS would have to be audited.
1.2
If they were independently compiled, the AFS would not have to be audited
provided the compiler was an “independent accounting professional”.
An independent review of a CC’s AFS is not a requirement under any legislative
situation (Association Agreement could require it).
This is because a close
corporation is considered to be “owner/managed” and thus subject to the review
exemption of Sec 30(2)A of the Companies Act 2008.
**2016**
SUGGESTED SOLUTION TO EXERCISE 13.4
Page 1 of 2 pages
a.
I would enquire of the costing clerk as to whether he had any concrete evidence
e.g. locations at which such houses were built, and if possible I would follow up
with the senior employees and may even attempt to inspect title deeds etc at the
Deeds Office. (It is probably unlikely that the costing clerk will be prepared to
say too much.)
2.
I would discuss the matter with the contracts manager and the other
director Jay Reddy, and attempt to get their response in writing (as they appear
to be colluding it is unlikely that they will admit to anything but the step
should still be carried out and documented for my own protection).
b.
3.
I would further examine a sample of contract costing records with the specific
intention of identifying excess orders of building materials which are unlikely to
be broken or stolen e.g. bricks, bathroom sets, geysers.
4.
I would examine the allocation of labour expenses to the various contracts and
reconcile to the total wage bill. Any allocation to a particular contract which
appears excessive, and any unallocated amounts would be followed up.
5.
I would examine delivery addresses on a sample of supplier delivery notes and
compare these to the site addresses of building contracts.
Any addresses which
did not correspond would be noted and followed up.
6.
I would request correspondence pertaining to insurance claims made for theft or
breakage as well as details of any reports of theft made to the police.
7.
If possible I would question the site foreman with regard to on site security, and
handling of excess building materials, and would request to inspect any "excess"
building materials which have not been stolen!
1.
In terms of Sec 45 and Sec 1 of the Auditing Profession Act 2005, this
situation appears to satisfy the requirements of a reportable irregularity.
2.
Section 45 stipulates that a "registered auditor" who ….
Is satisfied or has reason to believe.
2.1
The allegation by the costing clerk alone would not "satisfy" an
auditor or give an auditor "reason to believe".
2.2
The outcome of the procedures carried out in (a) would be vital in
this regard.
*
if reasonable evidence was found to support the allegation then the
requirement is met.
*
if reasonable evidence to support the allegation is not found the word
of the financial director would have to be accepted despite the fact
that his response and reaction were very suspicious.
A reportable irregularity has taken place.
3.1
A reportable irregularity is defined in Sec 1 as an unlawful act or
omission committed by a person responsible for the management of the entity
which caused or is likely to cause financial loss to the entity,
shareholders, creditors, etc.
3.2
**2016**
*
the alleged irregularity has been committed by "persons responsible
for the management of the entity. The two directors and the contracts
manager are directly involved and are "operating" the irregularity.
*
the situation is unlawful because it is theft from the company or the
clients, particularly if they are using other company resources.
*
it may also amount to fraudulent misrepresentation by the directors to
the customers (the directors have intentionally misrepresented the
quantity of materials which the customer is receiving and paying for).
*
it also represents a material breach of the directors’ fiduciary duty
to the other shareholders, the company itself, as it is theft and
abuse of the directors’ power.
*
whilst on the face of it, there does not appear to be financial loss
to the company itself; all purchases of excess building materials are
recouped (unknowingly) from the client.
*
however, if anything the extra amounts paid by the customer or the
excess materials should belong or be refunded to the customer or
should be kept by the company. This scheme is in fact enriching the
directors at the expense of the client.
*
the likelihood of clients discovering that they have been overcharged
cannot be overlooked. If a client discovers what is going on, lawsuits
and financial loss may well follow.
Section 1 does not make financial loss a pre-requisite. The section states
that the irregularity must have caused (be likely to cause) financial loss
or the irregularity must be fraudulent or amount to theft or must represent
a breach of fiduciary duty.
/continued on page 2
SUGGESTED SOLUTION TO EXERCISE 13.4
Page 1 of 2 pages
c.
1.
Clive Jones' threat to remove the firm as auditors would not stop me from
pursuing the allegation, and would not achieve Clive Jones' apparent objective of
keeping the matter secret.
2.
The auditor is appointed by the shareholders and Clive Jones does not have
the power in his capacity as financial director or as a minor shareholder to
remove our firm.
3.
The Companies Act 2008 does not "permit" the removal of the auditor.
3.1
Te auditor is appointed from one annual general meeting to the next.
3.2
If the shareholders wish to "remove" the auditor they will simply
no re-appoint him.
3.3
Clive Jones could certainly propose another auditor for appointment
but not before the AGM which will only be after the completion of the
current audit.
3.4
As a new appointment would require a 50% approval vote, Jay Reddy
and Clive Jones do not have enough shares to approve the proposal on their
own.
3.5
Furthermore, the Companies Act Sec 93 gives us as auditors the
right to be heard at the AGM on any matter which concern us as auditors
whilst we would not necessarily attempt to retain the appointment (a client
has the right to appoint whoever they wish as auditors) we would, in all
likelihood, raise our concerns about why the proposal not to re-appoint us
has been made.
4.
If a reportable irregularity has occurred, Clive Jones cannot make it "go
away" by “removing” our firm or keep it from the other shareholders, which is
probably his major intention.
**2016**
SUGGESTED SOLUTION TO EXERCISE 13.3
1 Page only
a.
b.
I would have satisfied myself that
1.
An unlawful act had taken place – the company has breached the Income Tax Act by
claiming (intentionally) VAT to which it was not entitled. This is also fraud.
2.
It was committed by persons responsible for the management of Franschoek (Pty) Ltd
– fraud was perpetrated by the financial director and managing director, the only
two executives on the Board and who effectively manage the company.
3.
It has caused or is likely to cause financial loss – SARS will suffer loss as will
the company (penalties).
4.
The above 3 points are sufficient to satisfy me, but further justification would
be that
*
this unlawful act is fraud and
*
the financial director and managing director have breached their fiduciary
duty to the company, shareholders, etc.
I would have
1.
“Without delay” sent a written report to the IRBA, giving particulars of the
reportable irregularities.
2.
Within 3 days of this report, notified the Board of Franschoek (Pty) Ltd in
writing of the sending of the report to the IRBA.
3.
As soon as reasonably possible but within 30 days of sending the first report
3.1
3.2
Have taken all reasonable measures to discuss the report with the Board of
Franschoek (Pty) Ltd and
Sent another report to the IRBA which included a statement that I am of
the opinion that
*
no reportable irregularity is taking or has taken place
*
the reportable irregularity is no longer taking place and that
adequate steps have taken place for the prevention or recovery of
any loss or
*
the reportable irregularity is continuing.
c.
(i)
It would make no difference, the Section applies to unlawful acts
conducted by persons responsible for the management of the company. The fact that they
are also shareholders is not a factor.
(ii)
I would still submit my first report.
If within 30 days thereof I am
satisfied that the directors have in fact taken adequate steps to “make good”; I would
notify the IRBA accordingly i.e. the process must still be followed.
(iii)
If Franschoek (Pty) Ltd is an audit client it does not matter that the unlawful
act was identified whilst conducting other work.
(iv)
It would probably not be a reportable irregularity but this would depend
on the interpretation of a “person responsible” for the management of the entity.
The
financial director is partially responsible but does not make up the “management board”.
The matter could possibly be dealt with as an employee type fraud which could be
reported to the Board.
If the Board does not take appropriate action then it
would definitely become a reportable irregularity.
d.
1.
The fact that this is not an audit required by the Companies Act 2008 makes no
difference.
2.
The loan agreement requires that the company be audited by a “registered auditor”.
3.
As a firm of registered auditors we are required to comply with the Auditing
Profession Act 2005 including Sec 45 (reportable irregularities).
**2016**
SUGGESTED SOLUTION TO EXERCISE 13.2
Page 1 of 2 pages
1.
False: The Act applies to any individual who is registered with the IRBA (i.e. registered
auditor). To conduct an audit of any company the individual must be a registered auditor
in terms of the AP Act 2005.
2.
False.
3.
4.
5.
2.1
Such a clause in the MOI would have no affect whatsoever. The auditor’s duty to
report a RI to the IRBA is laid down in the AP Act 2005, and a MOI cannot simply
disregard this duty created by the law.
2.2
Obviously the auditor cannot agree to such a clause as he/she is duty bound to
follow the procedure for RIs stipulated in the Act.
3.1
This is not correct. The designation CA(SA) is the designation of (and restricted
to) those individuals registered with SAICA. The designation “registered auditor”
is applicable and restricted to those registered with the IRBA.
3.2
To be registered with the IRBA it is not a requirement that the individual be
registered with SAICA (i.e. CA(SA)).
The opposite also applies; a chartered
accountant who does not offer audit services does not register with IRBA.
The essence of Section 41 of the AP Act 2005 is that a person may not pretend to be a
registered auditor (mislead the public) or use any description which creates the
impression that they are registered with the IRBA.
4.1
The description in 4.1 of the question would be unlikely to be a contravention as
Sec 41 allows the use of the description “internal auditor”. Presumably Mohammed
Mubarak is registered with the Institute of Internal Auditors and he doesn’t
appear to be “pretending” to be registered with IRBA.
4.2
The description in 4.2 of the question is likely to be unacceptable, whilst the
financial advisor part is no problem, the description creates the impression that
his consultancy carries out audits i.e. that they are registered auditors (Note:
only a registered auditor in public practice may perform audits).
4.3
The description in 4.3 is perfectly acceptable. In terms of Sec 41, both internal
auditor and accountant are acceptable descriptions.
5.1
5.1 of the question is not an acceptable reason. The AP Act states clearly that
where a registered auditor conducts an audit, he or she will have an obligation to
report a RI. The fact that BuildwithBricks (Pty) Ltd is a private company is not
relevant; once the company has engaged a registered auditor to perform an audit,
the registered auditor must adhere to the AP Act.
5.2
5.2 of the question is not an acceptable reason. Whilst it is possible that there
will be negative consequences for the company as a result of the RI, the auditor
(Mildred Tiles) must carry out her duties in terms of the AP Act.
It is as a
result of the directors’ actions that employees may lose their jobs, it is not the
fault of Mildred Tiles.
5.3
5.3 is not an acceptable reason.
It is true that the RI may result in Mildred
Tiles’ having to put in more hours than she wishes. However
*
she has a duty to comply with the AP Act
*
she is facing a serious threat to compliance with the fundamental principles
of integrity, objectivity, professional competence and due care, and the only
realistic safeguard would be to comply with her duty.
In respect of 5.1, 5.2 and 5.3, Section 52 of the AP Act, Mildred Tiles could be heavily
fined and/or go to prison for up to 10 years if she intentionally fails to report a RI.
6.
6.1
6.2
In terms of the AP Act, Hendrik Hertz cannot be registered with IRBA (not
qualified) and could therefore not become a partner of Freeloites and Co but the
fact that he is not specifically qualified as an auditor, does not mean he cannot
be employed by Freeloites and Co.
*
the requirement is that the audit be conducted by or under the direction of a
registered auditor
*
thus it would appear that in terms of the AP Act, there is nothing to prevent
Freeloites from employing Hendrik Hertz to work on the audit.
Whether it
would be a wise employment/business decision would be for the partners to
decide.
Again the fact that Jabu Motaung is not registered with the IRBA means that he
could not be made a partner at this point but he could be employed by Freeloites.
*
**2016**
as he has previously been registered with the IRBA he must have the basic
education and training requirements but he would have to show that he has the
necessary competency requirements as he has not practiced for some time (10
years).
/continued on page 2
SUGGESTED SOLUTION TO EXERCISE 13.2
Page 2 of 2 pages
7.
7.1
Archie Angel: currently a partner in an audit firm therefore must be registered
with the IRBA, can become a shareholder, must be a director (Sec 38).
7.2
Syd Sithole: does not appear to be registered with the IRBA.
He is registered
with SAICA, and provided he is registered (with SAICA) with the audit specialism
and a TIPP training contract, he will be able to register with IRBA but may have
to prove his competency for public practice; must also be appointed a director.
7.3
Monty Maggs: may become a shareholder and executive director,
qualifications and requirements as he is currently practicing.
7.4
Aravinda Silva: as he is currently in public practice he satisfies all the
requirements to become a shareholder but he must be appointed a director as well.
7.5
Stix Martin: may not become a shareholder or a director. Section 38 limits these
appointments to registered auditors.
As Stix Martin is a lawyer he cannot
register with the IRBA as his qualifications do not meet the requirements.
7.6
the three other existing partners may all be appointed shareholders and must be
appointed directors as well.
7.7
Finance (Pty) Ltd may not be shareholders; the company is not an individual,
cannot be registered with the IRBA and cannot be a director.
has
all
**2016**
SUGGESTED SOLUTION TO EXERCISE 13.1
1 Page only
1.
Auditing Profession Act 2005.
2.
The Independent Regulatory Board for Auditors (IRBA).
3.
3.1
The company must be incorporated and registered in terms of the Companies Act 2008
*
with a share capital and
*
its MOI must provide that its directors and past directors shall be
jointly and severally liable with the company for its debts and
liabilities contracted during their periods of office
3.2
Only individuals who are registered auditors may be shareholders
3.3
Every shareholder must be a director and every director must be a shareholder
3.4
The MOI provides that the company may, without the confirmation of the court,
purchase any shares held in it and allot these in terms of the MOI
3.5
Only a shareholder may act as a proxy for another shareholder.
4.
The designated auditor is the individual auditor who is “designated” as being responsible
for the audit. This person’s name is conveyed to the client.
5.
Improper conduct means any non-compliance with the AP Act or any rules prescribed in
terms of the Act or any conduct prescribed as constituting improper conduct.
6.
Not possible. Sec 38 of the AP Act 2008 restricts registration with IRBA to auditors.
lawyer cannot register in any form with the IRBA.
7.
7.1
False
7.2
7.3
7.4
False (must have trained in public practice)
True
False (the Board may register an unrehabilitated insolvent and a rehabilitated
insolvent may be registered).
8.
The IRBA may not register an individual who
8.1
8.2
8.3
8.4
9.
A
has at any time been removed from an office of trust because of misconduct
relating to that office of trust
has been convicted of theft, fraud, forgery, uttering a forged document, perjury,
corruption and has been sentenced to imprisonment without the option of a fine, or
to a fine (as prescribed)
has been declared (by court) to be of unsound mind or unable to manage his or her
own affairs
is disqualified from registration in terms of the AP Act e.g. permanently
deregistered for improper conduct.
A reportable irregularity is
*
an unlawful act
*
committed by any person responsible for the management of the entity which
*
has caused or is likely to
parties including the entity itself or
*
is fraudulent or amounts to theft or
cause
material
financial
loss
to
various
*
represents a material breach of any fiduciary duty owed by such person to
the entity, partner, member, creditor etc.
10.
10.1
A registered auditor has the professional qualification to perform the role (in
terms of the requirements of the Regulations to the Companies Act)
10.2
Whether or not the registered auditor is independent will depend on his
relationship with the client, e.g. no personal financial interest, no day-to-day
involvement with the client.
**2016**
SUGGESTED SOLUTION TO EXERCISE 12.19
Page 1 of 2 pages
PART A. AUDIT OF INVESTMENTS SCHEDULE
Rights and Existence
1.
Inspect in the presence of Paavo Nurmi, the share certificates for Sandfontein Goldmine Ltd
to confirm that
1.1
they are in the name of JSS Wholesalers (Pty) Ltd
1.2
the number of shares is 2000
1.3
their class (e.g. ordinary) agrees with the description of the shares in JSS
Wholesalers (Pty) Ltd’s records
1.4
certificates appear to be authentic.
2. Enquire of Paavo Nurmi as to why these shares have not been converted to electronic
ownership (dematerialised). Is there a problem which may affect ownership?
3. With the permission of JSS Wholesalers (Pty) Ltd, contact Computer Share Services to obtain
written confirmation that
3.1
JSS Wholesalers (Pty) Ltd are the registered owners of the number and description of
shares on the summary e.g. Engin Ltd, Oryan Ltd
3.2
No pledge of the shares has been registered against the ownership.
4.
Inspect minutes of directors' meetings for evidence of authority for the purchase of the
investments, during the year under audit, i.e. in Fame Group Ltd and Oryan Ltd, and inspect
the Memorandum of Incorporation or prior year workpapers to determine the authority and
conditions if any, for the purchase of shares by the directors.
5.
Inspect prior year audit records, current year directors minutes, correspondence and bank
confirmations for evidence of encumbrances on investments e.g. pledges as security for
loans.
Valuation
Opening balance
1.
Inspect prior year audit documentation/opening balances to verify that the value of the
investments in Engin Ltd and Sandfontein Goldmine Ltd is correctly reflected in the current
year schedule supplied to us, i.e. R24 219 and R22 338.
Note: These investments were both bought prior to the current financial year, and should
have been valued at fair value at the end of the prior year (2014).
Current year movement - purchase
2.
In respect of the investments in Fame Group Ltd and Oryan Ltd, inspect brokers notes and
returned paid cheques/bank transfers to verify:
2.1
that the capitalised cost of these investments, per the schedule supplied includes
transaction costs
2.2
that date of purchase is correctly reflected on the schedule.
3.
Confirm by enquiry (and include in the representation letter) of Paavo Nurmi an inspection
of a directors minute that the company’s policy with regard to these investments is to hold
for long term growth (not for trading) and that the shares have not been designated as fair
value through profit and loss.
Fair Value
4.
Inspect J.S.E. price listings at year-end to verify market values for each share as per the
schedule of investments, using "Last Sale" price (unless only "Buyers" and "Sellers" prices
are available and these are not significantly different from the most recent "Last Sale"
price).
5.
Reperform the calculations to arrive at the revaluation surplus/loss (closing balance –
opening balance or cost) and by inspection of the journal entry/general ledger confirm that
5.1
all fluctuations have been recognised in other comprehensive income and
5.2
that the policy is consistent with prior years.
Accuracy
6.
Reperform calculations on the investment schedule i.e. share price x number of shares =
total valuation of holding.
7.
Reperform casts on the schedule of investments and in relevant general ledger accounts.
**2016**
/continued on page 2
SUGGESTED SOLUTION TO EXERCISE 12.19
Page 2 of 2 pages
Completeness
1.
Through enquiry of Paavo Nurmi and review of directors meetings (and the CSS return for
listed shares), confirm that no other shares, listed or unlisted, were purchased during
the year
*
2.
at the same time confirm that no sale of shares, including the purchase and sale
of the same share was made in the same year.
Obtain confirmation from the company's broker’s
investment dealings by JSS Wholesalers(Pty) Ltd.
Sharevest
Inc,
as
to
current
year
Dividends
3.
By inspection and reperformance, ensure that all dividends declared, which were due to
the company in the current year have been raised correctly:
3.1
inspect J.S.E. bulletins to ascertain amounts declared in dividends per share for
each of the investments held,
3.2
reperform calculations (dividends per share X number of shares held),
3.3
inspect cash receipts records and bank statements to verify that dividends already
paid have been banked,
3.4
inspect the “dividends accrued” account in the general ledger to verify that
dividends declared but not yet paid, have been raised as a current asset.
PART B. AUDITING THE FAIR VALUE OF UNLISTED INVESTMENTS
1.
Fair values of unlisted investments have to be “estimated” by the directors of the
company holding such investments, as unlisted investments are not traded publicly and
hence have no reliable “quoted” price per share (readily available market value).
2.
We would therefore have to assess the reasonableness of directors valuations of unlisted
investments by:
3.
2.1
ascertaining the appropriateness of the valuation method and assumptions used by
the directors, through inspection of documentation and enquiry of relevant client
personnel (e.g. Paavo Nurmi),
2.2
reperformance of valuation calculations,
2.3
inspection of financial statements of the unlisted investments and any other
evidence supporting the valuations,
2.4
comparison of the valuation of the directors to valuations arrived at by ourselves
using alternative valuation methods which may be appropriate.
We would also obtain management representations relating to the valuation e.g.
reasonableness of the assumptions, confirmation of the intentions of the directors with
regard to the investment (speculative, held long term).
**2016**
SUGGESTED SOLUTION TO EXERCISE 12.18
Page 1 of 2 pages
a)
Validity
: All investments made by the company are genuine (i.e. they are not
fictitious) and
: All investments are authorised by an appropriate level of management and
in terms of the company’s policies and procedures.
Accuracy
: All investments are recorded at the correct amount in the correct accounts
in the correct period.
Completeness : All investments owned by the company are actually recorded in the books of
account.
b)
1.
The major risk associated with the account heading will be overstatement of the
amount owed to the company. This can occur by,
1.1
The inclusion of fictitious loans (existence) which seems unlikely as the
number of loans is small and easily verifiable.
1.2
The underprovision for loans which may not be repaid (valuation). This
presents a greater risk as
*
the loan scheme is new and neither the client nor we will have any
prior year information or “history” by which the repayment
performance of the long term debtors can be assessed.
*
one debt has already been written off suggesting that there is a real
risk of debts going bad.
*
loans are granted without security to “small businesses” which is an
inherently risky sector.
*
the first repayments are only due in 4 years time, so in effect, we
are having to make a decision now about a far off future event.
2.
The risk of misstatement associated
completeness) appears to be low.
with
the
other
assertions,
(rights,
c)
d)
Internal controls - I would expect to find
1.
A formal loan application procedure in place e.g. the submission of a pre-printed
application form, references, a business plan, details of ownership etc.
2.
A thorough investigation of the application by an individual (or committee) e.g.
owners interviewed, references followed up, visits to business premises, with the
major objective of determining the financial viability of the applicant, and the
likelihood of The Office (Pty) Ltd continuing to use the applicant as a supplier.
3.
The submission of a formal written report and recommendation by the investigating
employee (committee) to the Board of Directors for their approval.
4.
That no loans are granted without the consent of the Board after they have given
due consideration to
4.1
The report
4.2
Other stipulations in the original minute relating to the scheme e.g. no
directors of The Office (Pty) Ltd with a financial interest involved in the
applicant, loan does not exceed R250 000.
5.
All loans are supported by a legally binding written contract.
6.
That before the money is actually transferred to the loan applicant, the cheque
signatories (or equivalent) confirm the amount payable is correct and that the
loan has been authorized by reference to the directors’ minute/supporting
documentation.
General
1.
Inspect the Memorandum of Incorporation to determine
clauses/requirements relating to the making of loans
prohibited from making loans!
2.
whether there are any
e.g. directors may be
Obtain written confirmation from each of the directors that neither they nor their
families have any financial interest in any of the loans.
**2016**
/continued on page 2
SUGGESTED SOLUTION TO EXERCISE 12.18
Page 2 of 2 pages
Occurrence, accuracy, cut-off and classification – loan transactions
1.
Obtain the loan agreement for each of the ten loans and by inspection
1.1
Confirm that the names of the borrowers agree with the schedule.
1.2
Confirm the term of each loan (5 years) and the interest rate (5%).
1.3
Confirm that the amount of each loan agrees with the schedule (and does not exceed
R250 000).
1.4
Confirm that no security has been given for the loans.
1.5
Determine whether there are any other important clauses e.g. what happens in the
event of non-payment of the annual interest.
2.
Inspect the minutes of directors’ meetings to confirm that authority was given for each
loan.
3.
Inspect payment records e.g. paid cheque, EFT payment advice, bank statements for proof
that payments were made to the entity listed on the schedule.
4.
By inspection of the dates on the supporting documentation, confirm that the loans were
granted, and recorded in the correct accounting period.
5.
Trace the postings of the loans from the cash payment journal to the general ledger to
confirm that they have been allocated to the correct accounts.
Accrued Interest – accuracy
1.
By inspection of the loan agreement, confirm the dates on which the loans were granted,
agree with the schedule.
2.
Recompute the accrued interest using the stipulated 5% rate.
3.
Agree the total accrued interest (R45 519) per the schedule to the general ledger.
Closing balance – valuation, completeness, rights
1.
Cast the “Loans made to external entities” schedule provided by Lewis Figo and the ledger
account.
2.
Agree the loan total on the schedule to the general ledger.
3.
Obtain confirmation of the amount of the loan directly from the borrower (particularly
for the R250 000 loans).
4.
Inspect the correspondence from the liquidator of Savuka Enterprises to confirm that no
liquidation dividend will be paid.
5.
By discussion with Lewis Figo, establish whether there is any need to provide for the
non-repayment of any of the loans e.g. notification that the entity is in financial
trouble, non-performance by the entity or in respect of its role as a supplier to The
Office (Pty) Ltd.
6.
Obtain written confirmation/representation from the directors that
6.1
The company has not ceded its right to the long term debt (rights).
6.2
No loans other than those appearing on the schedule have been made (completeness).
7.
Inspect bank confirmation to confirm that long term debtors (loans) have not been ceded
(rights).
**2016**
SUGGESTED SOLUTION TO EXERCISE 12.17
Page 1 of 2 pages
a)
Audit procedures to identify specific provisions and contingent losses and gains and
commitments
1.
Inspection of the minutes of shareholders and directors meetings for
resolutions authorising transactions such as the guarantee and the capital
commitment.
b) 1.
2.
Inspection of correspondence for evidence of communications from lawyers, bankers
or other involved parties concerning matters such as the guarantee and the court
case.
3.
Enquiry of the financial director specifically about matters which could give rise
to provisions, contingent liabilities/assets and commitments.
4.
Inspection of capital budgets and forecasts for evidence of intentions to acquire
capital items such as these machines.
5.
Obtaining a management representation letter which specifically refers to the
existence and completeness of provisions etc.
Guarantee of overdraft
1.
As Microjoy (Pty) Ltd has guaranteed the overdraft of Oven (Pty) Ltd, a legal
obligation exists at balance sheet date. (The obligating event being the written
agreement to provide the guarantee).
2.
It is, however, a possible obligation which will only be confirmed by the
occurrence of uncertain future events. In this case Oven (Pty) Ltd failing to pay
back the overdraft and the bank calling on Microjoy (Pty) Ltd to make good its
guarantee.
3.
This therefore amounts to a contingent liability and should be disclosed (unless
the possibility of there being any outflow of resources, i.e. the guarantee being
called up, is remote/not probable).
4.
Assuming the outflow is not remote, Microjoy (Pty) Ltd must disclose this
contingent liability at balance sheet date and include a brief description of it,
including an indication of the uncertainties relating to the amount or timing of
any outflow. Note: this is an unlimited guarantee – this should be disclosed, and
possibly the current amount of the overdraft and projected maximum exposure if
possible.
5.
In addition to the above this
“transaction” which must be disclosed.
2.
guarantee
would
also
be
a
related
party
Court action
1.
On the basis of the evidence provided by Microjoy (Pty) Ltd’s legal advisors,
there is a present obligation at balance sheet date.
2.
There is also a probable outflow of resources according to the legal advisors.
3.
Therefore a
recognized.
4.
In this case it will be R1m, the legal advisors best estimate.
provision
(liability
of
uncertain
timing
or
amount)
should
be
Note:
Could this be regarded as a contingent liability?
Probably not.
The
lawyers believe the company cannot defend against the claim (therefore there is a
probable outflow) and it can be reliably measured (R1 million). The company has
no realistic alternative but to settle the amount.
3.
Capital Expenditure
1.
This is neither a provision (no liability/obligation) nor a contingent liability.
2.
The directors have taken a decision but have not involved a 3rd party or
signed a contract. They can easily change their minds.
3.
However, the aggregate amount of capital expenditure authorised by the directors
(R18m) but which has not been contracted for, must be disclosed.
4.
The source from which the funds to meet the expenditure should also be
provided.
**2016**
/continued on page 2
SUGGESTED SOLUTION TO EXERCISE 12.17
Page 2 of 2 pages
4.
5.
Closure
1.
There is a present (constructive) obligation arising out of the communication with
staff and retailers that there will be a closure of a division and there is a
formal plan in place.
2.
There is a probable outflow of resources and the best estimate of this cost is
R1 500 000.
3.
A provision for this amount should be recognized (supported by disclosure in the
directors’ report).
Court case 2
1.
This is potentially a contingent asset. A contingent asset is a possible asset
that arises from past events and whose existence will be confirmed by the occurrence or
non-occurrence of a future event (in this case the court case).
2.
In terms of IAS 37, Microjoy (Pty) Ltd may not recognise this contingent gain as
to do so may result in the recognition of income that may never be realized.
3.
If the realization was virtually certain, the asset would no longer be contingent
and could be recognized.
3.1
4.
In view of the legal advisors opinion, no recognition should take place.
A contingent asset is disclosed where an inflow of economic benefits is probable.
4.1
In this case it is impossible to regard the income as probable, however,
the directors may choose to disclose this matter. If they do, the wording
must not be misleading with regard to the likelihood of income arising.
**2016**
SUGGESTED SOLUTION TO EXERCISE 12.16
Page 1 of 2 pages
1.
Control environment
Concern
Management, including the financial director (who should know better!), have shown a
distinct lack of control awareness by failing to recognise the risks of the new business
activity and allowing the activity to be set up without proper organisational structure,
and proper lines of reporting and levels of authority. The lack of control consciousness
has opened up the company to the risk of significant abuse.
Recommendation
All trading be temporarily suspended, previous trades and current holdings be reviewed
and investigated.
2.
Risk assessment process
Concern
2.1 There appears to be a totally inadequate risk assessment conducted before investments
are made. Material amounts of money are being spent with no proper consideration of
risk
2.2 Inadequate skills on the “two man investment committee” to conduct appropriate risk
assessment.
Investment in shares successfully can be very difficult and poor
decisions can be costly.
Recommendation

An expanded investment committee should be formed and designated as a committee of
the Board of Directors

a suitable investment consultant/stockbroker should be appointed as a member of
the committee to advise accordingly

risk assessment pertaining to the investment activity should become an automatic
function of the company’s normal risk assessment process.
Concern
2.3 There is no defined strategy for making investments;
time” or when “cash at bank is healthy”.
meetings are held “from time to
Recommendation
Although there should be flexibility which allows the committee to meet to enable it to
take advantage of favourable investment opportunities, the general rule should be that
(as indicated)

Regular meetings should be held at which

detailed cash flow information should be available to ensure that only surplus
funds are invested

the success (or otherwise) of the portfolio is evaluated

proposed investments are carefully considered.
3.
Information system and business process for investing
Concern
3.1 No record of decisions of the existing subcommittee is made
3.2 No written instruction is given to Buller Sharp to initiate the transactions agreed
upon
3.3 Either of the two members of the committee can instruct Buller Sharp (it is therefore
possible that the instruction is never given as one party thinks the other has done
so)
3.4 Buller Sharp could also forget and claim he was never told (thus missing good
investment opportunities), or could initiate unauthorised transactions
3.5 Instructions are given to the brokers over the phone and a rough diary is kept
3.6 The company deals with several different brokers
**2016**
/continued on page 2
SUGGESTED SOLUTION TO EXERCISE 12.16
Page 2 of 2 pages
Recommendation
*
The decisions taken by the committee should be minuted
*
an official “instruction to transact” document should be implemented.
This
document should be

pre-printed and sequenced

completed at the conclusion of the meeting, and

signed and dated by the chairman and one other
*
the document number should be recorded against the relevant minute and the
“instruction to transact” document, listed in a register, sequentially
*
the company should decide on one firm to deal with, so as to build up a sound
working relationship between itself and the firm
*
although the practice of giving phone instructions to the broker is common, it is
probably as well to fax or email a copy of the instruction to transact to the
broker, or if the broker attends the investment committee meetings, to send a copy
with the broker.
4.
Control activities
Concern
4.1 Segregation of duties and comparison and reconciliation
*
Buller Sharp plays too great a role in the entire operation. He

places instructions

retains the broker notes

keeps the monthly transfer secretary statement, and

authorises payment to the broker
*
This problem is compounded by the fact that there is no independent reconciliation
of the share transactions to confirm whether they took place and that only valid
transactions took place.
Thus Buller Sharp has access and authority to every
aspect of the transaction which makes it far easier for him to perpetrate fraud.
Recommendation
*
Buller Sharp should continue to receive the broker’s notes and should reconcile
them with the register of “instructions to transact” to confirm that the purchase
or sale was authorised
*
Once satisfied that the brokers note represents an authorised trade, he should
prepare a pre-printed, etc. EFT document, sign it, cross-reference it to the
instruction to transmit register, and enter the share details in a share
investment register
*
the monthly broker’s statement should be sent directly to the financial accountant
(or similar senior person) who should reconcile the company’s investment holdings
to the investment ledger and the broker’s notes.
Concern
4.2 Custody (over the bank account)
*
The controls over EFT payments are totally inadequate. Access to the bank account
should be granted only to senior personnel not to an administration clerk and
assistant company accountant.
Of more concern, is the fact that the first
authorising person is not shown the supporting documentation, but is simply used
to facilitate the EFT. As a junior member of staff, she is unlikely to be able to
refuse to enter her password and will have little idea about what she is
authorising. This could easily result in her being implicated in fraud. It also
renders the second authority principle, absolutely meaningless.
Recommendation
*
The two “authorising employees” must be senior employees (not Buller Sharp)
*
neither of them should enter their passwords without reference to full back-up
documentation. Once they have scrutinised the back-up documentation including the
“instruction to transact” and the broker’s notes, they should each sign (initial)
and date the documentation so it cannot be presented again for fictitious payment.
Note : a full range of EFT controls should be in place.
5.
Monitoring
Concern
There is currently no monitoring
activity” or the control over it.
by
anyone
of
the
performance
of
the
“investment
Recommendation
The Board of Directors collectively, should review the investment performance and compare
it to the performance of independent investment funds and indexes.
**2016**
SUGGESTED SOLUTION TO EXERCISE 12.15
Page 1 of 2 pages
a.
The auditor is concerned about related parties because there is
material misstatement arising from transactions with such parties.
increased
risk
of
By definition a related party is not independent of the client company and the client may
be in a position to influence the transaction to the extent that it is no longer “arms
length” or is presented in a misrepresented manner for the purposes of manipulating the
financial statements.
b.
An arms length transaction is a transaction conducted on such terms and conditions as
between a willing buyer and a willing seller who are unrelated and are acting
independently of each other and pursuing their own best interests.
c.
d.
1.
Review prior year working papers for names of known related parties.
2.
Review the entity's procedures for identification of related parties.
3.
Enquire as to the affiliation of directors and officers with other entities.
4.
Review shareholders records to determine the names of principal shareholders or,
if appropriate, obtain a listing of principal shareholders from the share
register.
5.
Review minutes of the meetings of shareholders and the board of directors and
other relevant statutory records, such as the register of directors' interests.
6.
Enquire of other auditors currently involved in the audit (say a group audit) as
to their knowledge of additional related parties.
7.
Review the entity's income
regulatory authorities.
tax
returns
and
other
information
supplied
to
1.
Transactions that have abnormal terms of trade, such as unusual prices,
interest rates, guarantees and repayment terms.
2.
Transactions that lack an apparent logical business reason for their occurrence.
3.
Transactions in which substance differs from form.
4.
Transactions processed in an unusual manner.
5.
High volume or significant transactions with certain customers or suppliers as
compared with others.
6.
Unrecorded transactions, such as the receipt or provision of management services
at no charge.
7.
Transactions which appear to be overly complex.
e.
I will
1.
Promptly communicate the relevant information to the other members of the
engagement team (this will enable them to determine whether the information
affects the procedures they have conducted or plan to conduct based on the risk
assessment).
2.
Request management to identify all transactions with the newly identified
third party.
3.
Inquire as to why the entity’s controls over related party relationships
and transactions failed to identify/disclose this one.
4.
Perform
appropriate
substantive
procedures
relating
to
the
newly
identified relationships or transactions e.g. making enquiries regarding the
nature of the relationship, verifying the terms and conditions of the transaction
to determine whether appropriate accounting and disclosure requirements have been
applied.
5.
Reconsider the risk that other undisclosed related parties or significant
related party transactions may exist, and perform additional identification
procedures as necessary.
6.
Evaluate whether the non-disclosure by the directors was intentional (an
attempt to hide the fact) and if so, I will evaluate the implications for the
audit as a whole as it would suggest that the risk of material misstatement and
the presence of significant risk may have increased.
**2016**
/continued on page 2
SUGGESTED SOLUTION TO EXERCISE 12.15
Page 2 of 2 pages
f.
g.
1.
The completeness of information provided regarding the identification of
related parties and all the related party relationships and transactions of which
they are aware.
2.
The adequacy of related party disclosures in the AFS, i.e. appropriately accounted
for and disclosed.
1.
In terms of the Act, an individual is related to another individual if they are:
1.1
h.
married or live together in a similar relationship or are separated by no
more than two degrees of natural or adopted consanguinity (blood) or
affinity (marriage).
2.
From an audit perspective, a related person per the Act would be considered as a
related party
2.1
IAS 24 – Related party disclosures, states clearly that a person who is a
family member of certain related parties as defined e.g. a member of key
management, will be a related party.
2.2
More important is the fact that a transaction with a related person
attracts the same risk as explained in (a) above.
i
Yes
ii
Yes
iii
Yes
If Baggdad Ltd entered into a transaction with any of (i) (ii) or (iii) it would be a
related party transaction.
**2016**
SUGGESTED SOLUTION TO EXERCISE 12.14
1 Page only
a)
1.
Occurrence and rights and obligation - disclosed events, transactions and other
matters have occurred and pertain to the entity.
2.
Completeness – all disclosures that should have been included in the financial
statements, have been included.
3.
Classification and understandability – financial information
presented and described and disclosures are clearly expressed.
is
appropriately
4.
Accuracy and valuation – financial and other information is disclosed fairly and
at appropriate amounts.
b)
1.
A contingent liability is a possible obligation that arises from past events and
whose existence will be confirmed only by the occurrence or non-occurrence of one or more
uncertain future events not wholly within the control of the entity, or
2.
A present obligation that arises from past events but is not recognized (as a
liability) because
*
it is not probable that an outflow of resources will be required to settle
the obligation
*
the amount of the obligation cannot be measured with sufficient
reliability.
c)
A provision is a liability of uncertain timing or amount, and a liability is a present
obligation arising from a past event, whereas a contingent liability is a possible (it
will only be confirmed by the occurrence or non-occurrence of a future event) obligation
that arises from a past event. The essential difference is the level of certainty of the
event.
d)
1.
Occurrence, completeness and obligation
1.1
By enquiry of management, scrutiny of legal correspondence (attorneys
schedule of litigation and claims), and scrutiny of minutes, confirm that
*
a possible obligation which pertains to Backstop (Pty) Ltd has arisen (occurrence)
*
the obligation pertains to Backstop (Pty) Ltd (obligation) and not to another
entity
*
no other similar claims for other contingent liabilities should be included
(completeness).
2.
Classification
2.1
By scrutiny of the case details (and by obtaining legal opinion if
necessary) determine whether, based on the facts, that only a possible
obligation as opposed to a present obligation existed at balance sheet
date. This will confirm that a contingent liability and not a provision
is the appropriate treatment (classification).
2.2
By careful evaluation of the wording of note 20, determine whether the
matter has been clearly expressed. (It has, but could perhaps have been improved by the
inclusion of the company attorneys opinion on the merits of the case and whether the
company may be able to claim on insurance should they lose the case).
3.
Accuracy and completeness
3.1
By inspection of the claim correspondence etc, confirm that the amount
of the claim is R800 000 (accuracy) and that all pertinent details have
been included (accuracy and completeness).
**2016**
SUGGESTED SOLUTION TO EXERCISE 12.13
Page 1 of 6 pages
a)
The risk of material
misstatement should be regarded as medium .
Reasons:
1.
Motor Vehicles is the most material balance in the statement of financial
position, therefore material misstatement could be present in the balance (all
assertions).
2.
Motor Vehicles are mobile and spread over 30 branches around the country.
Vehicles that in fact have been written off or are impaired may be included or overstated
in the financial statements (existence and valuation).
b)
3.
The incorrect treatment of the Isuzu which was hit by the cement truck raises
concerns about the company’s technical accounting understanding or alternatively
that there is some reason that they do not wish to account for this event
according to the reporting standards.
This raises the question as to whether
there may be other problems in the account e.g. have impairments been properly
identified and accounted for?
4.
In mitigation of the above risks (particularly the directors integrity) the
company has sound management and renders quality service and has operated for many
years. There seems to be little incentive for the directors to misstate the motor
vehicles balance.
No, this treatment is not appropriate.
Reason
1.
This event occurred in the financial year under audit and must therefore
be dealt with in the financial statements at 31 July 2016.
The Isuzu
2.
As it stands the motor vehicles account includes a vehicle which does not exist
and the balance is thus overstated.
3.
Similarly a loss which the company has suffered prior to year-end has not been
accounted for; profits are therefore overstated.
4.
The question now arises as to whether it is appropriate to raise the insurance
company as a debtor (for the insured amount) and offset the loss (3 above) at
reporting date.
4.1 In terms of IAS 37 “where as a result of past events there is a possible asset
(the debtor) whose existence will be confirmed only by the occurrence of one
or more uncertain future events (the court case) not wholly within the control
of the entity, an asset may only be recognised if the inflow of economic
benefit is virtually certain.
4.2 Even if the inflow of economic benefit is probable, the asset cannot be
recognised but disclosure is required (description and financial effect).
4.3 If the inflow is not probable then no asset can be raised and no disclosure is
required (the loss is simply treated as any other loss, see 3 above).
5.
As the lawyers will not comment on the likelihood of the case succeeding, the best
course of action would be to recognise the loss (3 above) and include some disclosure
which fully and accurately explains the situation.
**2016**
/continued on page 2
SUGGESTED SOLUTION TO EXERCISE 12.13
Page 2 of 6 pages
The cement truck
6.
Glassguard (Pty) Ltd acknowledge that the company is responsible for (has an
obligation) the damage to the cement truck and the amount is known -R300 000.
6.1 Therefore this obligation must be accounted for in the financial statements at
31 July 2016.
7.
The question again arises as to whether the insurance company can be raised as a
debtor (asset) for any portion of this loss which it will reimburse Glassguard (Pty) Ltd.
c)
8.
IAS 37 states again that for an asset to be raised the expected reimbursement must
be virtually certain.
9.
In this case it is not virtually certain so an asset cannot be raised.
10.
Based on the available evidence, no decision can be taken on whether reimbursement
will take place so the loss should be recognised and (as there appears to be an
expectation of reimbursement) the matter should be disclosed, see 5 above.
Existence
1.
Using the audit software, I will search the vehicle masterfile for
duplicate registration numbers and duplicate engine numbers (none should be
found). If there are, follow up.
2.
Using the audit software I will extract a sample of vehicles from the
vehicle masterfile which includes vehicles from all branches (registration number,
engine number, description, location, book value.)
2.1 for those locations (branches) which are accessible to Durban, I will arrange
to inspect the vehicles (after hours, Saturday) and agree the registration
number, engine number, description to the sample.
2.2 for those locations (branches) which are accessible to our firm’s offices in
Cape Town and Johannesburg, I will communicate in writing with these offices,
providing them with details of the vehicles to be inspected and request that a
physical verification be conducted.
2.3 for any locations not covered by 1.1 and 1.2, I will
*
seek corroborating evidence from the monthly operating cost returns
submitted to the head office e.g. petrol invoices, repairs invoices etc,
around year-end.
*
send a confirmation letter to the branch manager requesting him to confirm
the existence of the vehicles listed as being at that location.
3.
I will analyse any sundry revenue accounts for evidence of any vehicles
sold and if any vehicles have been sold I will confirm that they have been
included as a disposal.
4.
I will review correspondence with the insurance company, inspect the schedule of vehicles
and discuss with Shatterprufe Shabalala as to whether any vehicles have been removed from
the schedule of insured vehicles. I will establish whether any such vehicles have been
disposed of and if so confirm that they have been accounted for as a disposal.
Completeness
1.
When physically inspecting vehicles I will identify a few vehicles at the
branches and will trace their details to the vehicle masterfile to confirm that
they are included. (Trainees carrying out the physical inspection on our behalf
will be asked to do the same).
2.
In the confirmation letter to the branch manager I will request him to include
details of any vehicles at the branch which do not appear on the letter sent to
him to sign.
**2016**
/continued on page 3
SUGGESTED SOLUTION TO EXERCISE 12.13
Page 3 of 6 pages
3.
I will confirm with Shatterprufe Shabalala that there are no vehicles on financial
lease.
4.
I will compare the engine number fields on the current year masterfile with the
prior year masterfile. Any prior year engine number not reflected in the current
year masterfile should be agreed to the list of vehicles disposed of (auctioneers
list).
Rights
1.
For the sample of vehicles selected, I will inspect the registration
document (log book) and licence renewal receipt to confirm that
1.1 the engine numbers agree
1.2 the documents are in the name of Glassguard (Pty) Ltd.
2.
by enquiry of management and inspection of
2.1 prior year workpapers
2.2 bank confirmations
2.3 directors minutes of meetings
I will determine whether there are any encumbrances on the motor vehicles e.g.
offered as security.
Valuation – cost
1.
I will agree the opening balances on the summary schedules to the prior
year work papers/general ledger accounts.
2.
Using the audit software, I will
2.1 extract a list reflecting the cost of all vehicles purchased during the year
(use date of purchase field) and agree the total on the list to the vehicle
cost schedule.
2.2 extract a list of the cost and accumulated depreciation of all vehicles
disposed of during the year (use date of disposal field) and agree the totals
on the list to the cost and accumulated depreciation schedules.
2.3 reperform the “depreciation for the year” calculation and agree the total to
the accumulated depreciation schedule.
2.4 reperform the calculations and extensions in the vehicle masterfile, e.g. cost
less accumulated depreciation = book value.
3.
Confirm by inspection of the journal entry and ledger accounts that the
correcting entry for the Isuzu written off (Cost and Accumulated Depreciation) has
been effected (and the supporting schedules amended).
Assuming the directors
agree to writing off the Isuzu.
Valuation – additions
Occurrence
4.
Using the audit software, I will select a sample of additions for the year
(date of purchase field) from the vehicle masterfile (registration number, engine
number, description, location, cost) and
4.1
trace each vehicle to its purchase documentation i.e. invoice from Tekwini Motors,
and confirm that the invoice was made out to Glassguard (Pty) Ltd.
5.
I will inspect the cash payment records to confirm that payment was made
for each vehicle in the sample.
Accuracy, classification, cut-off
6.
I will inspect the Tekwini Motors invoice for each vehicle to confirm that
the cost entered in the vehicle masterfile
6.1 agrees with the invoice
6.2 excludes VAT and licence costs (if paid by the garage)
6.3 includes the costs of adapting the vehicle to transport glass.
7.
I will inspect the dates on all invoices to confirm that the transaction took place in
the financial year under audit (cut off)
8.
I will trace the postings for the transaction (from the cash payment records) to the
general ledger accounts to confirm that the cost, VAT and licence fee have been correctly
posted to the appropriate accounts (classification).
**2016**
/continued on page 4
SUGGESTED SOLUTION TO EXERCISE 12.13
Page 4 of 6 pages
Disposals
Occurrence
9.
Using the audit software I will extract from the vehicle masterfile a list* of all
vehicles disposed of during the year (date of disposal field) and
9.1
will trace each vehicle on the list to the “Auctioneer’s Sale List”
confirming all details of the vehicle (registration, engine number etc).
*Note: The only vehicles on this list should be the 20 Corsa bakkies.
10.
I will inspect the sundry records/deposit slips for confirmation that the
proceeds of the auction less auctioneers’ fees were received.
Accuracy, classification, cut-off
11.
Using the audit software, I will reperform the accumulated depreciation
calculation to date of disposal for each vehicle.
12.
I will then evaluate whether the method of allocating the selling price of
R1 400 000 to the 20 sold vehicles is appropriate (note: vehicles were sold as a
single lot).
13.
I will then reperform the profit or loss on the sale of each vehicle and agree the total
to the overall loss of R212 800 (R2 520 000 – R907 200 = 1 612 800 – 1 400 000 =
R212 800) and the Vehicle masterfile.
14.
I will inspect the date on the auctioneer’s documentation to confirm that the disposal
took place in the year under audit (cut-off).
15.
I will confirm by inspection that the Vehicle and Accumulated Depreciation Accounts and
Loss on Disposal Accounts have been correctly amended (classification).
Valuation – allowance for depreciation and impairment
1.
I will confirm with Shatterprufe Shabalala that the accounting policy for depreciation
has not changed and that the depreciation rate and method are 20% per annum reducing
balance.
2.
Using the audit software, I will reperform the depreciation calculations
for the year in the vehicle masterfile to confirm that the depreciation policy has
been complied with and that the depreciation for the year agrees with the summary
schedule (adjusted for the written off Isuzu).
3.
I will request the trainees from our other offices performing the physical
verification to inspect for and enquire of the branch managers about any damaged
or “not in use” vehicles which may need to be written down (I will do the same on
my physical inspection).
4.
I will include in my confirmation letter to branches not visited by our firm, a
request that the branch manager provides details of any damaged, or “not in use”
vehicles which may need to be written down.
5.
I will inspect the branch monthly operating costs returns to head office for
evidence of vehicles that have been in accidents, are at panel beaters etc and if
any are identified, discuss the need to write them down with Shatterprufe
Shabalala.
6.
Bearing in mind that the company lost R212 800 on the sale of 20 vehicles,
I will discuss with the company whether the depreciation rate remains appropriate.
(profit/loss in prior years will need to be considered, and will determine whether
management reviewed the useful life and residual values of the assets.)
6.1
I will enguire of the directors as to whether they have reevaluated the useful life and residual values of the vehicles.
**2016**
/continued on page 5
SUGGESTED SOLUTION TO EXERCISE 12.13
Page 5 of 6 pages
7.
I will perform a simple analytical review on the allowance for the year, e.g.
7.1 comparison to prior years
7.2 comparison by location to other locations/prior year.
8.
d)
I will discuss the reasonableness of the allowance with the company and evaluate
the appropriateness of the approval process.
Occurrence : I will
1.
inspect the Memorandum of Incorporation to
1.1 confirm that the company is authorised to issue debentures.
1.2 ascertain whether there are any specific requirements for such issues e.g.
authorised by shareholders, loan covenants which must be adhered to.
2.
inspect the minutes of the meeting of directors at which the decision to issue the
debentures was taken and confirm that the meeting was quorate and the motion was duly
authorised.
(Note: if the Memorandum provide for other authorisation procedures it will be
necessary to inspect relevant documentation.
Shareholder approval is not normally
required for a non-convertible debenture issue).
3.
inspect the debenture agreement (and minutes) to confirm
3.1 the details of the private investors to whom the debentures were issued.
3.2 that the issue was for ten, 9% non-convertible debentures redeemable at a
premium of 10% after 5 years.
3.3 whether any security has been granted to the debenture holders.
4.
inspect the register of debenture holders to confirm that the register of details
of the debenture holders per the debenture agreement and minutes agree.
5.
inspect the cash receipts journal, deposit slips/bank transfers for evidence that
the payments were received and deposited.
Accuracy, cut-off, classification: I will
1.
reperform the casts to confirm that R1 million was received.
2.
trace the receipts of cash from the cash receipts journal to the general ledger to
confirm that it was posted to the correct account (debenture liability).
3.
confirm that the cost of the debenture has been correctly adjusted to its fair
value taking into account the premium by
3.1 reperforming the effective rate of interest calculation and its application.
3.2 inspecting the journal entry raising the adjusted finance cost and tracing it
to the ledger accounts.
4.
inspect the dates on all documentation to confirm that they fall within the
accounting period under audit (cut-off).
Completeness: I will
1.
confirm by inspection of the directors minutes and enquiry of the directors as to
whether any other debenture issues took place.
**2016**
/continued on page 6
SUGGESTED SOLUTION TO EXERCISE 12.13
Page 6 of 6 pages
e)
To comply with the recommendations of King III, Glassguard (Pty) Ltd will, in due
course have to
1.
restructure the Board so that its composition reflects a majority of non-executive
directors, i.e. appoint five non-executive directors, (Glassguard (Pty) Ltd currently has
4 executive directors only).
2.
appoint at least three independent non-executive directors out of the five new
appointments.
King III requires that the majority of the non-executive directors be
independent, e.g.
*
not a representative of a shareholder who has the ability to
significantly influence management or the board
*
does not have a direct or indirect interest in the company
*
has not been employed by the company in an executive capacity for the
preceding three financial years
*
not a professional advisor.
(This list is not exhaustive.)
3.
In appointing non-executive directors, attempt to ensure that a balance of power
(which prevents an individual or group of individuals from controlling the board) is
achieved.
4. appoint one of the independent non-executive directors as the Chairperson
(Dave Dean will remain as Managing Director, operationally the more important
role).
5.
consider whether, with the new appointments, the size of the board, its diversity
and demographics make it effective, i.e. it contains the necessary academic
qualifications, technical expertise, industry knowledge, experience, nationality, age,
race and gender.
**2016**
SUGGESTED SOLUTION TO EXERCISE 12.12
Page 1 of 3 pages
a)
b)
1.
Completeness and valuation of long term liabilities: The dominant risk is that
liabilities will be understated to improve the appearance of the company’s
financial position by the omission of liabilities altogether or by incorrect
valuation of the loan (e.g. finance leases are not capitalised or are under
capitalised).
2.
Existence and valuation of investments made: The dominant risk is that the asset
(investment) will be overstated, again to improve the appearance of the company’s
financial position by the inclusion of fictitious assets or by incorrect valuation
of the asset e.g. a decline in the fair value of the investment may not be
accounted for.
Planning


transactions, e.g. acquisition of a major asset, should be carefully planned
by an experienced committee and should only be entered into after thorough
evaluation of alternatives, cashflows, best methods of raising finance etc,
legal implications.
a formal budget should be compiled.
Authorisation


this should only be given at the highest level and
consideration of the relevant committee recommendations.
including consultation with the committee.
only
after
careful
Implementation

these “transactions” should be implemented by competent staff; whether they
be negotiations about financing, or the installation of a physical asset.
Review and approval

transactions should be subjected to ongoing review and approval e.g. progress
reporting on financing negotiations, independent scrutiny by internal audit.
c)
Opening balance
1.
By inspection of the prior year audit working papers and audited AFS at
30 June 2015, confirm that the opening balance (R4 615 000) on the schedule (and
in the general ledger) agrees with the prior year closing balance.
In respect of the loans raised during the year
Obligation/existence/occurrence
1.
Inspect the minutes of the meetings of the Capital Committee for authority to
enter into the contracts with CapVest and Lease Credit.
2.
By inspection of the Memorandum of Incorporation, confirm that the company has
 complied with any requirements thereof in respect of raising loans.
 and (specifically) not breached the borrowing powers of the company.
3.
Inspect the loan agreement/lease agreement with CapVest and Lease Credit
for pertinent details to confirm or determine
 that the agreements are entered into with Trashcan Ltd
 amounts and interest rates
 repayment terms/conditions
 security for loans
 that the agreements are duly signed and dated with due authority (e.g.
representatives of Capital Committee/Board of Directors)
 other salient conditions e.g. penalties for non-performance.
**2016**
/continued on page 2
SUGGESTED SOLUTION TO EXERCISE 12.12
Page 2 of 3 pages
4.
In respect of the lease with Lease Credit, inspect the lease agreement for
specific conditions (and where applicable discuss with the capital committee e.g. useful
life and specialised nature of the incinerator) which would justify the capitalisation of
the lease, i.e. the lease transfers substantially all the risks and rewards of ownership
of the incinerator to Trashcan Ltd.
 does ownership of the incinerator transfer to Trashcan Ltd by the end of the
lease term?
 is there a bargain purchase option which is likely to be exercised?
 is the lease term equal to the major part of the asset’s economic life?
 is the present value of the future minimum lease payments equal to
substantially all of the incinerator’s fair value?
 is the incinerator of a specialised nature such that only Trashcan Ltd can use
it without major modification?
 is there an opportunity for Trashcan Ltd to continue the lease at a rent
substantially lower than the market rent?
5.
In respect of the R1.4m raised from CapVest, inspect the deposit slip/bank
transfer slip/cashbook/bank statement for evidence of the receipt of the loan.
Completeness
1.
Review minutes of meetings of the Capital Committee and directors for evidence of
any unrecorded liabilities e.g. off- balance sheet financing which should be
recorded as a liability.
2.
Enquire as to the source of funding for any major acquisitions identified during
the audit of property, plant and equipment, and confirm that where applicable such
funding has been recorded as a long term liability.
3.
Reconcile “interest paid” for the year to the capital sums to which the interest
relates to ensure that all capital sums have been included.
4.
Inspect the financial records and enquire of Siya Nomvet to determine whether any
other leases have been entered into.
If so, confirm by inspection of the
agreement that they are all operating leases.
5.
Obtain specific representation from the directors that all long term liabilities
have been included.
Valuation/accuracy, cut-off, classification
1.
Obtain confirmation of balances at 30 June 2016 direct
(including Dev Cor Finance despite their nil balance).
2.
By inspection of cash payments journal/EFT, bank transfer slips, confirm that the
amount of R630 000 was repaid to Dev Cor Finance.
Note: actual payment will probably be increased by final interest charge.
3.
By inspection of the dates on the supporting documentation, confirm that the
repayment relates to the period under audit.
4.
Reperform the calculation in respect of the present value of minimum lease costs
and compare this capitalised value to the fair (open market) value of the
incinerator (effective rate is 15.9%).
Incinerator must be capitalized at the
lower of the two amounts. (Discussion with the Capital Committee and scrutiny of
relevant documentation may be necessary here).
5.
Reperform casts and cross-casts on long term loan schedule.
6.
Trace the amount of R630 000 from the cash payments journal to the general ledger
to confirm that it has been posted to the proper accounts.
**2016**
from
loan
providers
/continued on page 3
SUGGESTED SOLUTION TO EXERCISE 12.12
Page 3 of 3 pages
Current portion of long term loans.
1.
In respect of the loan from Industrial Investments:
1.1
by calculating the debt: equity and current ratios in the draft
financial statements of Trashcan Ltd at 30 June 2016 and comparing them to
the predetermined ratios stipulated in the agreement with Industrial
Investments, confirm that the company has not breached its obligations to
Industrial Investments, to the extent that the loan becomes due and payable
immediately.
Note: This should be confirmed once the audited figures are available.
1.2
obtain written confirmation from the directors that they have no intention
of taking up the option to repay the loan within the next 12 months.
2.
In respect of the CapVest loan confirm, by inspection of the loan agreement and by
recomputation, that the correct amount has been apportioned as the “current
portion” (e.g. R200 000 if repayment is in seven equal instalments).
3.
In respect of the lease from Lease Credit, reperform the calculation splitting the
R300 000 instalment due during the next 12 months into capital and interest and
confirm that the portion allocated to “current portion” is the capital amount i.e.
interest is not included.
Closing balance
1.
Confirm by inspection that the general ledger/financial
agreement with the closing balance on the schedule.
statements
are
in
d)
1.In terms of IAS 39, debentures must be held at amortised cost using the effective
interest rate.
2.
Because this debenture is redeemed at a premium the company is effectively paying
more “financing costs” than the annual 10% interest; it is paying an effective
interest of 15.72% (financial calculator) so we must calculate the true finance
cost and spread it over the life of the debenture by compiling an amortisation
table.
3.
Effective Interest
Interest paid
Capital
R
R
R
1 July 2015
(Initial recognition)
30 June 2016
150 200
(100 000)
1 057 200
30 June 2016
166 192
(100 000)
1 123 392
30 June 2017
176 597
(100 000)
*1 200 000
* rounded up.
1 000 000
This will be the capital sum repaid the following day.
**2016**
SUGGESTED SOLUTION TO EXERCISE 12.11
Page 1 of 2 pages
a)
1.
General.
1.2
2.
3.
1.1
Inspect the prior year audit documentation/audited financial statements to
verify the opening balance of R15 200 000.
Agree the draft statement of financial position balances to the land and buildings
account in the general ledger and the appropriate section in the fixed asset
register.
1.3
By inspection of the prior year work papers, agree the description and cost of the
three properties held at the start of the year to the schedule prepared by Norton
Chipping.
1.4
Confirm with the directors that the company continues to adopt the cost model.
Rights
2.1
By inspection of directors minutes, correspondence with the bank, reference to the
year-end bank confirmation and by enquiry of Norton Chipping, confirm that no
encumbrances over the three original properties have come into force during the
current year.
2.2
When inspecting the sale documents/contract/title deed etc, for the apartment,
note encumbrances, mortgages, servitudes if any, on the property (particularly as
this is likely to be in a sectional title building).
Occurrence (of the purchase transaction) existence (of the apartment)
3.1
Inspect the director’s minute approving the purchase of the apartment.
3.2
Inspect the capital expenditure budget and minutes of the budgeting committee for
authority for the purchase.
3.3
Inspect the title deed to the property and confirm that the description of the
property is Apartment 214, The Drive, Umshlali and that the registered owner is
Woodrock (Pty) Ltd.
3.4
Inspect the sale documentation to confirm that it is signed by directors with the
necessary authority to do so.
3.5
Scrutinise the Memorandum of Incorporation to determine whether there are any
clauses which must be adhered to when the company purchases property of this
nature, e.g. shareholders resolution. (Note: the directors could be buying this
property for their own private use.)
3.6
Inspect the apartment to confirm its physical existence and to confirm that it is
complete e.g. not in progress. (If not practical, corroborating evidence will be
gathered e.g. levy or rates payments, utility bills.)
Note: If the property is mortgaged, the title deed will be held by the company financing
the deal.
4.
Valuation (of property) cut-off, accuracy and classification (property purchase).
4.1
Obtain a breakdown of the cost of R3 220 000 and confirm the amounts to
*
the original contract of sale (signed offer)
*
invoices for legal fees and transfer costs.
4.2 By inspection, confirm that expenses which do not qualify as part of the cost,
have been excluded, e.g. painting of apartment after acquisition.
4.3 Inspect the cash payment records/bank transfer/EFT for evidence of the payment
to the seller of the amounts recorded in the cost breakdown.
4.4 Trace the posting to the general ledger account – Land & Buildings.
4.5 Confirm by inspection of the dates on all documentation inspected that the
purchase took place in the financial year under audit (cut-off).
4.6 Confirm with the directors that the company’s policy of not depreciating
buildings is still in force.
4.7 Discuss with the directors whether, due to the downturn in the property
market, there is any need to impair the apartment building.
5.
Completeness
5.1 Confirm by enquiry of Norton Chipping
disposals) of land and buildings took place.
6.
**2016**
that
no
other
purchases
(or
any
Valuation – Impairment of vacant land
6.1 Scrutinise the minutes of directors meetings and shareholders meetings (and
possibly the investment committee) for any reference to or decisions taken
relating to the vacant land which has been occupied.
6.2 Scrutinise any correspondence with the developers to determine whether
*
there is any plan of action
*
any compensation will be forthcoming (as they have not been able to
deliver in terms of their development obligations).
6.3 Review any correspondence with Woodrock (Pty) Ltd’s legal advisors pertaining
to this matter.
6.4 Discuss the matter with Norton Chipping and the financial director to
establish their reasoning for not impairing the asset (there seems to be no future
for this property, and it clearly cannot be sold).
/continued on page 2
SUGGESTED SOLUTION TO EXERCISE 12.11
Page 2 of 2 pages
b)
1.
General
1.1
Inspect the prior year workpapers/annual financial statement to confirm
the balance of R6 200 000.
1.2
Agree the balance from the draft financial statements to the general
ledger and fixed asset register.
1.3
By inspection of the prior year workpapers, confirm that the description
of the shares held at the start of the year, agrees with the schedule produced by
Norton Chipping.
1.4
Confirm by enquiry of the financial director, and obtain a written
representation (in the management representation letter) that the intention
remains to hold all shares long-term (not held for trade). This is a requirement
for the categorization of the investments as “fair value through other
comprehensive income.”
2.
Completeness
2.1 By inspection of the minutes of meetings of the investment committee and by
enquiry of Norton Chipping, confirm that no additional investments in shares were
made during the financial year.
2.2 Match any dividends received to the list of investments held, to confirm that
any dividends received are in respect of shares listed.
3.
Existence/Rights
3.1 Obtain a certificate from the transfer secretaries/brokers which reflects the
names of the companies and, the number of shares, i.e. Amapropprop Ltd (15 000)
shares and Comwaste Ltd (5 000 shares) owned by Woodrock (Pty) Ltd at 31 March
2016.
3.2 Obtain a similar certificate from the transfer secretaries/brokers responsible
for maintaining the electronic records of shares held on the London Stock
Exchange.
3.3 Obtain confirmation from the investment committee that no shares had been
disposed of during the year.
4.
Valuation
4.1
Obtain a list of share
institution or the JSE.
prices
at
31 March
2016
from
a
reputable
financial
4.2
Confirm by inspection that the share price was R213.33, for Amapropprop Ltd, and
R130 for Comwaste Ltd.
4.3
Obtain the same information pertaining to the shares held on the London
Stock Exchange (Anglomutual Ltd) and obtain the pound/rand exchange rate ruling on the
31 March 2016.
4.4
Reperform the calculation (no of shares x price in pounds x exchange rate) to
confirm that the value of the shares is R2 550 000.
4.5
By enquiry and inspection, confirm that the increase in the value of the shares
(net fair value gain) is treated in a manner consistent with the prior years, i.e.
recognized in other comprehensive income not in profit or loss).
**2016**
SUGGESTED SOLUTION TO EXERCISE 12.10
Page 1 of 2 pages
Existence
1.
As I will not be visiting the mine, physical verification will not be possible. However,
sufficient appropriate evidence of the Supatruck’s existence must still be gathered.
2.
There is plenty of corroborating evidence to support the existence of the truck when it was
purchased and moved to the Northern Cape so the only material risk we face is that at
balance sheet date the Supatruck had been destroyed or stolen (most unlikely!).
3.
I would therefore seek some corroborating evidence that the truck was in existence at
balance sheet date by
3.1
obtaining direct written confirmation from management at the mine that the truck was
in existence at 30 June 2016 (see also valuation). This confirmation would need to
specifically state the chassis number, engine number, description etc of the truck.
3.2
inspection of relevant insurance documentation to confirm that no claims had been
lodged in respect of the theft or destruction of the vehicle.
3.3
inspection of revenue and receipts records around June and July (near the financial
year end) for evidence of inflows of lease payments from the mine.
Rights
1.
2.
I will inspect the Supatruck’s registration papers to confirm that
1.1
they are in the name of Megaloads Ltd.
1.2
the make, description engine/chassis number agree with the entry in the fixed asset
register.
1.3
registration document is stamped or signed by the relevant registration authority and
is an original document.
I will also enquire of management as to whether the Supatruck is encumbered in any way,
e.g. offered as security. This is unlikely but should still be confirmed.
Valuation – cost
1.
To verify the cost of the Supatruck it will be necessary to verify the purchase price as
well as the costs added to the purchase price.
It will also be necessary to consider
whether the added costs are valid, attributable costs.
2.
The following costs are not directly attributable costs
2.1
driver and mechanic training costs (R40 000) are not costs attributable to bringing
the asset to a location and condition that enables it to be used.
2.2
the abnormal load transport costs of getting the Supatruck to the company’s head
office can be added to the cost of the truck as they are costs which are incurred in
bringing the asset to a location and condition that enables it to be used (final
assembly).
However, in terms of IAS 16, the cost of moving the Supatruck to the
Northern Cape cannot be added to the cost as it is a cost not attributable to the
asset but rather a cost attributable to the contract in the Northern Cape.
The
R198 500 should be reversed.
2.3
the costs of unveiling the truck (R78 450) are not attributable to the truck. They
are general expenses (accommodation, travel costs etc) which in no way relate to the
truck itself or add any value to it.
2.4
3.
I will therefore request the financial accountant (after discussion with him) to reverse
the amount of R316 950 (40 000 + 198 500 + 78 450) out of the Supatruck (vehicles) account,
and to amend the cost of the Supatruck reflected in the fixed asset register.
3.1
4.
this incorrect treatment relates to the classification assertion of the transactions
i.e. the transactions have been classified as capital expenditure instead of
expenses.
before finalising the audit of my section I will confirm by inspection of the
journal, that the entry was authorised, accurately recorded and properly posted.
To verify the purchase price and attributable costs, I will regard the acquisition of the
Supatruck as a collection of transactions; the relevant assertions will be accuracy, cutoff, classification and occurrence. I will
4.1
inspect the purchase invoice/contract from Fiatrucks Inc to confirm that it is made
out to Megaloads Ltd for an amount of Euros 851 810 after any discounts (accuracy and
occurrence).
4.2
obtain from a reputable financial institution, the exchange rate (spot rate) for the
Rand/Euro on transaction date (1 July 2015) and confirm that it was R8.73 as this is
the amount at which the purchase price has been converted from euros to rands
(accuracy/valuation).
**2016**
/continued on page 2
SUGGESTED SOLUTION TO EXERCISE 12.10
Page 2 of 2 pages
5.
4.3
inspect the bank records/bank statements and cash payments journal to confirm the
payment of R7 440 250 (851 810 euros) to Fiatruck Inc (occurrence).
4.4
confirm by inspection of the transaction documentation that the purchase took place
in the financial year end 30 June 2016 (cut-off).
For all other attributable costs i.e. payments to Fiatrucks (South Africa) (Pty) Ltd,
Seacarriage (Pty) Ltd and Outsize Flatbeds (Pty) Ltd, I will
5.1
inspect the respective invoices to confirm that
*
they are made out to Megaloads Ltd for the respective amounts before VAT (VAT
cannot be capitalised) (occurrence and accuracy).
*
the services rendered were in respect of the Supatruck and
*
by inspection of the dates that the services were rendered in the financial year
end 30 June 2016 (cut-off).
Note: only the first of the two payments to Outsize Flatbeds (Pty) Ltd qualifies.
5.2
6.
inspect the bank statements and cash payments journal to confirm each of the payments
(adjusted for VAT).
Trace all postings (4 and 5) to the general ledger and fixed asset register.
Valuation – depreciation and impairment
1.
The depreciation calculation provided by the financial accountant is incorrect on two
counts.
1.1
a number of non-attributable costs have been added to the cost and depreciated.
1.2
the Supatruck only commenced work on 2 January 2016 (half way through the financial
year) but has been depreciated for a full year.
1.3
depreciation should be (8 085 45 – 500 000) x 12.5% x 6/12 = R474 090 is therefore
overstated by (987 800 – 474 090) = R513 710.
I will therefore discuss this with the financial accountant and request that the
amount of R513 710 is reversed out of depreciation and accumulated depreciation. At
a later date I will confirm by inspection of the journal that the adjustment was
authorised, accurately recorded and posted to the correct accounts in the general
ledger and fixed asset register.
2.
By discussion with the operations director, senior financial personnel and inspection of
any client and Supatruck manufacturer documentation as well as scrutiny of client costings,
I will evaluate the reasonableness of the “useful life” and “residual value” estimates, and
the adoption of the straight line depreciation policy (this policy suggests that the future
economic benefits of the Supatruck will flow evenly through its useful life).
3.
I will also discuss with the same personnel whether the Supatruck should have been
capitalised as two or more significant parts. This will be necessary where the significant
parts have different useful lives or residual values.
(The directors may well have
considered and rejected this but it should still be raised with them).
4.
I will also enquire of the directors as to whether they reviewed the “useful life” of the
truck at the financial year end, and whether anything took place during the financial year
which may affect the useful life.
5.
As the vehicle is in the Northern Cape and as I am not physically inspecting it, I will not
have the opportunity of assessing the truck’s condition. Therefore I will request written
confirmation direct from the mine management (not Megaloads Ltd’s directors) that the
Supatruck is in complete working order and that it has not suffered any damage which may
have impaired its value.
6.
I will discuss with the directors of Megaloads Ltd whether at year end, they went through
the process of considering impairment of the Supatruck, and whether any impairment
adjustment is required.
Completeness
1.
In effect this assertion will relate more to whether all vehicles have been included in the
“vehicles” account heading and less to the “completeness” of the Supatruck.
2.
In view of the fact that the completeness of asset accounts is generally low risk,
particularly as the company has included “costs” rather than excluded them, I would limit
my procedures relating to this assertion to
2.1
enquiry of the financial
attributable costs.
accountant
as
to
whether
there
were
any
other
2.2
review of the repairs and maintenance account for any evidence of large amounts
which have been written off as an expense but which should have been capitalised.
**2016**
SUGGESTED SOLUTION TO EXERCISE 12.9
Page 1 of 2 pages
a)
I would consider the following factors
1.
The department’s organisational status.
1.1
To give
the department the necessary levels of objectivity, independence and authority, the
department should report to the Board of Directors (or the audit committee).
1.2
In the
case of Blockbuster (Pty) Ltd internal audit, independence is compromised as they report
to the financial manager, and do not appear to have free access to those charged with
governance e.g. the financial director.
“scope” of their
judgements).
work
(undue
influence
Internal audit should be an “internal
information to the Board (Audit Committee).
of
control”
others
designed
to
to
override
2.
The
professional
provide
2.1
independent
2.2
In this case Rudolf Adams and his team have their work schedules defined by Daniel Mudow,
which considerably reduces their usefulness to us as external auditors.
2.3
Daniel Mudow is domineering, uncompromising and intolerant of criticism which suggests
that the young and newly qualified Rudolf Adams is unlikely to be sufficiently objective
for our needs.
Competence
3.1
Internal control should be staffed by employees who have the necessary
qualifications and professional qualities e.g. experience, integrity.
3.
technical
3.2
As the
department is staffed by a qualified chartered accountant, supported by two assistants
who are completing their studies, it would appear that the technical qualifications are
satisfactory BUT
3.3
It is a
very young and inexperienced team which may not yet have developed the necessary
professional qualities e.g. the strength of character to stand up to Daniel Mudow, a very
demanding and domineering individual.
3.4
Their
due professional care. This requires that the internal audit team conduct its
assignments with the level of care that can be expected from a competent auditor in all
aspects of their work.
systematic and disciplined approach.
4.
A
4.1
For us
to consider relying on internal audit our firm will need to assess whether the internal
audit team applies a systematic and disciplined approach to its work. This will include
evidence of

the existence, adequacy and use of documented internal audit
procedures

sound supervision of his team by Rudolf Adams, and review by him of
their work

the production of good audit documentation which reflects the
sufficiency and appropriateness of the evidence gathered and


the suitability of conclusions drawn (consistent with the evidence
gathered)
appropriate quality control procedures over the work conducted.
b)
1.
Rudolf Adams and his team could
Perform a physical inspection of a sample of plant and equipment (selected by
myself using the location digit in the masterfile) to confirm the existence of the
asset (existence).
2.
Randomly select a sample of plant and equipment, including recently purchased
plant and equipment, at the production yard and trace them to the asset register
(completeness).
3.
Enquire of the production manager (and observe when performing the physical
inspection) as to any items of plant and equipment which appear to be impaired or
“not in use” so that they can be considered for write down (valuation).
*2016**
/continued on page 2
SUGGESTED SOLUTION TO EXERCISE 12.9
Page 2 of 2 pages
4.
c)
Conduct a search for unrecorded disposals of plant and equipment by
4.1Enquiry of the production manager as to whether any plant or equipment
has been replaced, and
4.2Identifying, during the inspection of assets, any assets which have
obviously been removed.
and tracing to the asset register to confirm that a disposal has been recorded
(existence).
Occurrence: I would
1.
Using the audit software, extract a list of all plant and equipment which
reflects:
1.1
Asset number, description, date of purchase, supplier and cost, (only) for
1.2
1.3
Assets purchased between 1 March 2015 and 29 February 2016, and
Which has an “F” in the source field.
2.
Trace the selected items to the supplier documentation e.g. invoice/sales contract
to confirm:
2.1
That the documentation is made out to Blockbusters (Pty) Ltd and that
2.2
The description, serial numbers etc on the documentation agree with the
list.
2.3
The invoice is not for repairs and maintenance.
3.
Physically inspect
numbers etc.
the piece
of
equipment
confirming
its
description, serial
4.
determine whether the necessary authority has been obtained, inspect
The capital budget to confirm that the purchased asset was included.
The signed minutes of the meetings of the capital committee and the directors.
To
4.1
4.2
5.
Inspect the payment records (bank statement, bank transfer) to confirm
payment was made to the supplier (or that a creditor has been raised).
that
6.
Inspect the insurance company’s “schedule of assets
inclusion of each addition (description and cost).
the
insured”
to
confirm
Accuracy, cut-off, classification : I would
7.
By reperformance confirm that
7.1
The addition has been raised in the fixed assets register at the spot rate
on transaction date. I would confirm the exchange rate with a financial
institution and the cost of the equipment from the purchase documentation.
7.2
8.
All relevant shipping costs and import charges have been included in
arriving at the cost (and where applicable have been converted at the
correct foreign exchange rate).
For any addition for which installation charges have been recorded, obtain the
schedule of installation costs prepared by Blockbuster (Pty) Ltd and
8.1
Confirm by reference to the purchase documentation, that installation
charges for that specific item are to be borne by Blockbuster (Pty) Ltd.
8.2
Inspect the supporting documentation for expenses charged to the
installation e.g.

wages to wage reports/payroll analysis

materials to invoices, to confirm that
the charges are valid installation charges (eg not repairs) and that
they have been accurately recorded.
8.3Evaluate the inclusion of any other expenses included on the
installation schedule for reasonableness by discussion with Daniel Mudow, the financial
manager.
9. Inspect dates on all purchase documentation
purchase was made during the financial year ended 2016.
to
confirm
that
the
**2016**
SUGGESTED SOLUTION TO EXERCISE 12.8
Page 1 of 2 pages
a)
b)
1.
Zane Jubb’s contention
completely incorrect.
that
the
upcoming
audit
is
not
a
“proper”
audit
is
2.
The shareholders have taken the decision that the company will be externally
audited and have appointed our firm as the official auditors.
This decision by
the shareholders does not contravene the requirements of the Companies Act 2008
and is fully enforceable.
3.
We are still required to give an opinion on the annual financial statements and in
doing so must comply with the ISAs and the Auditing Profession Act 2005.
4.
Should we be prevented from performing a “proper” audit by Zane Jubb, e.g. denied
access to evidence we require, we will be obliged to qualify our audit report.
1.
Zane Jubb’s change of attitude. For the prior review engagements Zane Jubb was
co-operative. He is now dissatisfied with having to have an audit, regards our
audit as a waste of time and money and something the company can do without. This
is a bit suspicious and perhaps suggests that there are “things going on” which an
audit (but not a review) might uncover.
2.
His intention to deny us access.
This suggests that there may be
documents/matters which he does not want us to be exposed to. Perhaps he is less
concerned about costs and more concerned about hiding manipulation.
3.
The company is facing liquidity problems and will probably need to seek some form
of financing from the bank, e.g. extended overdraft facilities. This provides the
directors with some incentive to improve the financial statements by manipulation.
4.
Clearly directors bonuses are based on reported profits (audit costs and expenses
directly affect his bonus). Again this provides some incentive to manipulate the
financial statements.
5.
The directors are not shareholders, and the directors may be overly anxious to
present favourable financial statements to the shareholders so as to retain their
positions.
6.
As the company is already independently reviewed, the directors’ reaction is an
overreaction.
c)
The ways in which the directors could manipulate the account headings in the finance and
investment cycle are as follows:
1.
Creating unjustified (fictitious) reserves with a corresponding increase in a noncurrent asset, e.g. revaluing either the office block or manufacturing facility to
above its fair value (valuation).
2.
Omitting (understating) long term loan liabilities, i.e. either existing or new
loans raised (completeness).
3.
Understanding finance lease liabilities e.g. by unjustifiably reversing existing
capitalized leases or treating new finance leases as operating leases
(completeness, classification).
4.
Overstating non-current assets by including fictitious assets or assets which do
not belong to the company (existence, rights).
5.
Overstating non-current assets by understanding depreciation allowances and
impairments, e.g. not writing down plant and equipment that has been significantly
damaged or is no longer in use (valuation).
6.
Overstating the value of foreign listed investments by the inclusion of fictitious
share holdings and the use of inappropriate conversion rates (existence and
valuation) or failing to write down any listed investment to its fair value
(valuation).
**2016**
/continued on page 2
SUGGESTED SOLUTION TO EXERCISE 12.8
Page 2 of 2 pages
7.
Overstating the fair value of unlisted investments by the use of unreasonable
assumptions in the directors’ valuation thereof (valuation).
8.
Understating or omitting
(valuation, completeness).
9.
Omitting or inadequately disclosing contingent liabilities (completeness, accuracy
of P and D).
provisions,
e.g.
on
long
term
product
warrantees
d)
The engagement partner should
1.
2.
Ensure that the audit personnel assigned to the audit are
1.1
competent and sufficiently technically skilled in detecting manipulation.
1.2
independent and able to stand up to Zane Jubb who has stated that he will
not be as “accommodating with giving your team access”.
1.3
able to adopt the necessary level of professional skepticism.
Hold a meeting with the audit team at which
2.1
the potential
discussed.
risk
of
manipulation
of
the
financial
statements
is
2.2
advice on what to be alert to, is shared amongst the team.
2.3
advice on how to deal with Zane Jubb is discussed (professional behaviour
is very important).
2.4
the need for professional skepticism is emphasized in the context of the
audit.
3.
Ensure that the supervision and review of the audit team’s work is comprehensive.
4.
Ensure that an element of unpredictability is introduced into the audit, i.e.
gathering evidence and carrying out tests that the client (and Zane Jubb) may not
be anticipating.
5.
Hold discussions with Zane Jubb in an attempt to convince him of the “validity”
and importance of the audit i.e. that it is a proper audit.
**2016**
SUGGESTED SOLUTION TO EXERCISE 12.7
1 Page only
a)
Procedure 2:
Observing the manufacturing process gives the auditor a better
understanding of the role played by the plant and equipment and will
enable the auditor to better identify and assess the risks of material
misstatement relating to plant and equipment, e.g. assessing useful life
and impairment, identification of equipment to test existence.
Procedure 5.
This is general information about the company’s plant and equipment which
will provide some indication as to the further audit procedures necessary
for existence testing, completeness testing to a lesser extent and
valuation (depreciation and impairment) as plant and equipment may be
geographically widely spread (locally and in other countries) and/or very
inaccessible.
Procedure 8.
The question states that this procedure was carried out so as to
"determine further audit procedures".
Further audit procedures are
determined by the risk relating to the relevant account headings. Thus,
this procedure is part of risk assessment.
Procedure 10.
This procedure is designed to assess the risk of material misstatement
arising from the incorrect accounting treatment/valuation/disclosure
relating to plant and equipment. Different methods of acquiring assets
gives rise to different complications e.g. an asset acquired on finance
lease is more complicated to account for fairly, than an asset purchased
outright for cash. Obtaining this knowledge allows the auditor to plan
further audit procedures.
Procedure 12.
This procedure is essentially to gain a better understanding of the
entity and its environment and may indicate to the auditor that certain
risks may arise e.g. valuation of project work-in-progress.
b) and c)
Procedure
Objective
1.
Test of controls
accuracy and completeness
3.
Substantive
4.
Test of controls
6.
Substantive
-
valuation
7.
Substantive
-
valuation
9.
Test of controls or
substantive
-
Assertion
-
valuation (impairment/scrapping?)
validity (authority)
validity (authority)
-
occurrence (of a specific disposal)
11.
substantive
-
rights
13.
substantive
-
completeness
**2016**
SUGGESTED SOLUTION TO EXERCISE 12.6
1 Page only
1.
Property, plant and equipment are
*
tangible items
*
held by the company for use in the production or supply of goods and services, in
renting to others or for the purposes of administration and
*
which it is expected, will be used during more than one period (financial year).
2.
Rights, existence, completeness and valuation.
3.
Cost model and revaluation model.
4.
False. The assertions relating to property, plant and equipment are not affected by the
measurement model. The company is still asserting that it owns the PPE (rights), the PPE
exists and that all PPE has been disclosed (completeness). They are also asserting that
PPE is included in the accounts at appropriate amounts (valuation) i.e. appropriate in
terms of the model the company has chosen.
5.
6.
5.1
A part of an asset is considered to be significant when its cost is significant in
relation to the total cost of the asset. (This assumes that the cost of the parts can
be separately established.)
5.2
The reason for identifying parts as significant is to take account of the fact that
the significant parts may have different useful lives and different residual values.
By recognizing these differences, the parts of the asset can be separately
depreciated to give a more accurate total depreciation expense for the asset as a
whole.
5.3
Yes.
5.4
No.
Although R200 000 is a substantial amount, it is probably not significant in
relation to R4 000 000. But perhaps more importantly the tyres, as a separate “part”
cannot be recognized as an asset primarily because they will be totally consumed
(depreciated) within 5 months (i.e. not used in more than the financial year).
Therefore the replacement tyres should be written off as a consumable/period cost.
Looked at another way, the tyres are fully depreciated within the year.
6.1
A large company would be a VAT vendor and would therefore be able to claim a VAT
refund. The VAT cannot be added to the cost.
6.2
This would be a valid installation cost directly attributable to the cost of bringing
the machine to its final location. The cost can be added.
6.3
In terms of IAS 16, this is not directly attributable to bringing the machine to a
location and condition which enables it to be used as intended. It is in effect a
staff training cost. The cost cannot be added.
6.4
This is a general overhead and in terms of IAS 16 not directly attributable to the
cost of the machine. The cost cannot be added.
IAS 16 requires that this be done.
7.
The depreciable amount is the cost of the (fixed) asset less its residual value.
The
residual value is the estimated amount the company would currently obtain from the disposal
of the asset (less costs of disposal) assuming the asset was already of the age and in the
condition at the end of its useful life.
8.
The depreciable amount is systematically allocated over the useful life of the asset.
**2016**
SUGGESTED SOLUTION TO EXERCISE 12.5
1 Page only
1.
No, my trainee does not have an adequate understanding of the assertions.
2.
He does not appear to understand that there are assertions applicable to transactions and
assertions applicable to account balances.
3.
In addition he has included three “assertions”
“validity” and “transparency”. See below.
4.
Interest Received
Rights: is an asset
transaction account.
interest.
which
are
not
assertions
“accrual”,
account balance assertion and is not applicable to an income
It has nothing to do with Records (Pty) Ltd’s right to receive
Accrual: this is not an assertion it is a basis of accounting.
it with completeness and (a little) with cut-off.
He is perhaps confusing
Obligation: this is an assertion which applies to liability account balances not to
transactions, (in this case interest received). The obligation assertion represents that
the liabilities reflected in an entity’s financial statements are the obligations of the
entity, not any other entity.
Valuation: valuation is an assertion applicable to an account balance not transactions.
He appears to be confusing this assertion with “accuracy” which asserts that the
transactions making up interest received (R143 021) have been recorded at appropriate
amounts.
5.
Long-term liabilities
Occurrence: this assertion applies to transactions (i.e. the transaction has occurred, it
is genuine, not fictitious) and not to an account balance. (The trainee’s description is
not that far off).
Validity: this is not an assertion, it is an internal control objective; it has nothing
to do with the legality of the source of the loan.
Accuracy: whilst accuracy is an assertion applicable to transactions (not balances) there
is a presentation and disclosure assertion (also termed accuracy) which asserts that
disclosures in the AFS are accurate, so the trainee is not that far off – but probably
for the wrong reasons.
Transparency: this is not an assertion at all.
Its closest relevance would be as a
requirement of good corporate governance.
His explanation however, suggests he has a
slight understanding of the completeness assertion i.e. all long-term liabilities are
included in the balance of R3 200 000.
6.
It is clear that the trainee does not understand that
6.1
6.2
the assertions relating to transactions (interest received in this case) are
*
occurrence
*
completeness
*
accuracy
*
cut-off
*
classification
the assertions relating to balances (current liabilities in this case) are
*
obligation (for current liabilities) rights (for current assets)
*
existence
*
completeness
*
valuation.
**2016**
SUGGESTED SOLUTION TO EXERCISE 12.4
1 Page only
1.
Existence and completeness of contingent liabilities.
2.
Valuation of plant and equipment (impairment).
3.
Completeness of long-term loans and completeness of interest paid.
4.
Valuation of plant and equipment (depreciation).
5.
Occurrence of new loan made (has a valid loan occurred?).
6.
Valuation of intangible assets (amortization).
7.
Valuation of unlisted investments (fair value).
8.
Presentation and disclosure of contingent liabilities – accuracy and understandability.
9.
Completeness of liabilities.
10.
Occurrence of a disposal transaction (which in turn affects the valuation of property,
plant and equipment.)
11.
Accuracy and classification (of interest transaction).
12.
Occurrence of share issue transaction (valid issue).
13.
Cut-off of share issue transaction.
14.
Rights to property.
15.
15.1
Completeness of loans made by the company.
15.2
Occurrence of loans advanced during the year (and possibly some information about
the valuation of the loan).
**2016**
SUGGESTED SOLUTION TO EXERCISE 12.3
1 Page only
1.
existence and valuation (plant and equipment)
2.
completeness (plant and equipment)
3.
occurrence of purchase transaction (addition)
4.
rights (if payment is in arrears, ownership (rights) could be in jeopardy),
5.
rights (does DeadC Ltd have the rights to the asset).
6.
valuation (impairments reduce the value of the asset).
7.
valuation (listed investments must be shown at fair value).
8.
valuation (intangible assets are amortised over their useful life).
9.
accuracy and cut-off (of the purchase transaction).
10.
rights (registration documentation) existence (physical inspection).
11.
existence (share investments)
12.
valuation (plant and equipment: cost and depreciation)
13.
valuation (plant and equipment)
14.
most likely the existence and valuation assertions (this evaluation would have taken
place as part of the risk assessment process undertaken during the planning of the
audit).
15.
existence and rights (investments).
**2016**
SUGGESTED SOLUTION TO EXERCISE 12.2
1 Page only
1.
1.1 A downturn in the sales of the company’s product which has resulted in equipment
lying idle.
1.2 Recent damage to the equipment resulting from a fire.
1.3 A significant lack of knowledge in the accounting section relating to accounting
standards pertaining to plant and equipment.
1.4 There is a risk that the directors will manipulate the financial statements by,
inter alia, overstating assets.
1.5 Plant and equipment is widely distributed and inaccessible.
1.6 Many of the individual items of plant and equipment are made up of "significant
parts".
2.
Partially true but needs clarity: The company can choose between the cost and revaluation
methods, but once a method is chosen for a class of asset, say, property, all assets in
that class must be accounted for on the basis chosen, i.e. if property is at “cost” then
all properties are shown at cost. The company cannot decide to report some at cost and
others at a revaluation amount.
3.
3.1
Yes:
3.2
Yes: A cost directly attributable to bringing the plant to a condition necessary
for it to operate.
3.3
Yes: A cost attributable to bringing the plant to a condition necessary for it to
operate.
3.4
No: Cost which
operational.
In effect part of the purchase price.
will
be
incurred
in
the
future
after
the
machine
is
fully
4.
Example: Laselite Ltd uses robots to cut heavy steel panels into patterns for
construction. The cutting is carried out by huge robots which essentially consist of two
components, the computerised motor which controls the robot and the robotic arms.
The
unit is purchased as a single unit but the robotic arms are replaced every four years
whilst the motor will last at least 10 years with proper maintenance. The cost of the
unit is approximately R6 million whilst the replacement of the robotic arms will be R3
million.
In terms of IAS 16 the unit is not depreciated as a single unit but each
component is depreciated in terms of its own useful life etc.
5.
The existence assertion (If the asset has been disposed of, it doesn’t exist from the
perspective of the company).
6.
In terms of IAS 32 shares in other companies must be valued at fair value
6.1
The value of the shares listed on the JSE should be the market value on the local
exchange at the date of the financial year-end.
6.2
The same principle will apply to the shares on the London Stock Exchange. The
value quoted in sterling will then be converted at the rand conversion rate at
balance sheet date.
6.3
The shares in the private companies should be valued at fair value
*
7.
this valuation should be done by the directors or an expert
7.1
Missing or duplicated asset numbers.
7.2
Blank fields
description)
7.3
anomalies e.g. current depreciation exceeds accumulated depreciation.
7.4
negative book values
7.5
current depreciation but no accumulated depreciation.
(where
there
should
not
be
a
blank
field,
e.g.
asset
number
8.
False, (financial leases are included not operating leases).
**2016**
SUGGESTED SOLUTION TO EXERCISE 12.1
1 Page only
1.
1.1
1.2
Frequency - the number of transactions in the cycle is usually
smaller than for other cycles.
Size - transactions in this cycle are usually (relatively) material.
considerably
1.3
Legal and regulatory requirements - transactions in this cycle are often
governed by statute or the company’s Memorandum of Incorporation, for example,
issuing shares, declaring a dividend, making capital investments.
1.4
Non-standard documentation - transactions in this cycle often have their
own specific documentation, e.g. the purchase of an item of plant will require
more documentation than a simple purchase order, goods received note, etc.
2.
Compensating controls are controls put in place to make up for the fact that
transactions in this cycle are frequently not subjected to routine internal controls and
to address their other unique characteristics.
3.
3.1
Careful planning by senior management – e.g. investment committee, risk committee,
capital budgets.
3.2
Authorisation of transactions at the highest level e.g. Board.
3.3
Implementation (where applicable) by qualified staff only, using sound project
controls.
3.4
Review (monitoring) and approval of all aspects of the cycle by independent staff
e.g. internal audit.
4.
4.1
This is too much of a generalisation. The 2nd and 3rd characteristics of the cycle
(see 1 above) in themselves present increased risk.
4.2
The cycle does present the opportunity to both overstate assets (valuation and
existence of assets) and understate liabilities (completeness), so to generalise the risk
as low is not acceptable.
4.3
There are many circumstances which can result in high risk in this cycle, it will
simply depend on the circumstances at each client; plant and equipment may be
significantly impaired, it may be located in inaccessible places, etc.
5.
Impairment means that the amount which can be recovered by the use or sale of the
asset, is exceeded by its carrying value reflected in the general ledger.
6.
Occurrence, accuracy, cut-off, classification and completeness (same as any transaction).
7.
An intangible asset is an asset which has no physical substance.
franchise, trademark.
8.
Defined as tangible items that (IAS 16)
9.
10.
Examples. copyright,
8.1
Are held for use in the production or supply of goods or services, for rental to
others or for administration purposes.
8.2
Are expected to be used during more than one period.
9.1
Future economic benefits associated with the item will flow to the entity and
9.2
The cost of the item can be measured reliably.
10.1
Yes:
cost directly attributable to bringing the warehouse to the condition
necessary to operate as a warehouse.
10.2
Yes:
as above, direct attributable cost.
10.3
No:
not a direct cost, as it does not satisfy the requirements (10.1).
a “promotional” expense to be written off.
10.4
Yes:
direct attributable cost (professional fees).
10.5
No:
VAT must be excluded.
It is
**2016**
SUGGESTED SOLUTION TO EXERCISE 11.17
Page 1 of 3 pages
a)
Completeness of inventory
1.
1.1
1.2
1.3
At the inventory count
Whilst attending the year-end inventory count, I will select a sample of books (title,
author, ISBN number and quantity) from all categories of books stored in the warehouse.
I will then trace each title selected in the sample, to the inventory sheets (agreeing
details and quantity) to confirm that the title has been correctly included in the
count.
Inspect the inventory sheets to ensure
*
all inventory listed was counted, e.g. an amount in the quantity field and
*
confirm, by for example sequence testing, that all inventory sheets were included in
the valuation of inventory.
Note: if inventory is valued using the inventory masterfile (which is likely) a small
completeness test of “inventory sheet to masterfile” should be carried out.
2.
2.1
2.2
3.
3.1
b)
Cut-off
In the period following the inventory count, I will obtain all the goods received notes
for deliveries made to Bookbox (Pty) Ltd on Thursday 29 and Friday 30 July 2016 and
prepare a schedule of titles and quantities received on these days.
Once the final inventory sheets are available, I will confirm by inspection, that these
deliveries have been included in the inventory at 31 July 2016 (Note : a similar
exercise will be conducted on books sold on 29, 30, 31 July, but this is not a
completeness test).
Imported books
By inquiry of Barry Potter, and inspection of orders/import documentation, I will
confirm that any orders for which the risks and rewards of ownership have passed to
Bookbox (Pty) Ltd at 31 July 2016, but which have not yet been received, e.g. are in
transit, or are in a clearing warehouse, are included in the year-end inventory figure.
Valuation
Masterfile
accuracy : I will
1.
Compare the quantities of a sample of titles on our (auditor’s) copy of the inventory
sheets/workpapers to the final masterfile.
2.
2.1
2.2
2.3
2.4
Using the audit software, scan the entire inventory masterfile for
Any missing fields.
Any negative quantities.
Any titles with negative quantities and negative unit costs.
Duplicate records/ISBNs.
3.
Using the audit software, reperform the quantity x unit cost calculation (for each
title) and compare the result to the amount in the value field of the masterfile to
identify differences (none should be found but errors must be followed up).
4.
Confirm that all damaged inventory identified at the inventory count (by the audit
team) is included in the authorized masterfile amendments passed to correct the
inventory quantities at year end.
Pricing:
I will
5.
Using the audit software, select a sample of titles from publishers, both local and
foreign.
6.
For local purchases, trace the titles selected to the relevant publisher’s invoice, to
confirm that the correct unit price has been used in the inventory masterfile
6.1
As the company uses FIFO as its cost formula, where the quantity on hand exceeds the
quantity purchased per the most recent invoice, the invoice(s) prior to the most recent
invoice will be inspected to confirm unit prices used.
**2016**
/continued on page 2
SUGGESTED SOLUTION TO EXERCISE 11.17
Page 2 of 3 pages
6.2
Where carriage inward costs have been included in the unit cost, agree amounts to
transport invoices and evaluate the method of allocation of the total carriage inward
cost to the various titles, for accuracy and reasonableness.
7.
7.1
For purchases from foreign publishers
Trace the titles selected to the relevant suppliers invoice to obtain the unit cost in
the foreign currency.
By enquiry of Barry Potter and scrutiny of the purchase agreement/shipping documents,
determine the date of transaction and obtain (from a financial institution) the relevant
foreign exchange rate at date of transaction.
7.2
7.3
Reperform the conversion calculation and agree it to the amount used in costing the
title.
7.4
By inspection of the shipping agent’s invoices, confirm that import duties, custom duties
and shipping charges used in arriving at the cost of the title, are correct.
7.5
By inspection and reperformance of the company’s costing of imported inventory, confirm
that the allocation of 7.4 costs are appropriately allocated (accurate and reasonable) to
the titles imported.
Lower of cost or net realizable value: I will
8.
Using the audit software, compare the unit cost field to the selling price field for all
titles, to identify any instances where cost exceeds selling price (none should be found
but any instances should be followed up).
9.
For a sample of titles, verify the selling price reflected in the inventory masterfile by
reference to :
9.1
Sales price lists.
9.2
The most recent sales invoice for the title.
10.
Compare the selling price of a sample of invoices in the post-balance sheet period, to
the unit cost in the masterfile of the titles sold, to confirm that the net realizable
value exceeds the unit cost.
11.
Perform an overall analytical review of inventory comparing the value of inventory at
31 July 2016, to inventory at 31 July 2015, e.g.
11.1 Total inventory.
11.2 Inventory by category (audit software can be used to determine value by category).
11.3 Inventory as a percentage of total assets, current assets.
c) 1.
1.1
By reference to the prior year workpapers and discussion of the process for determining
the writedown, I will evaluate whether it is
Consistent with prior years.
1.2
Appropriate for the business.
2.
I will enquire of management as to whether any specific events have occurred
which might have a direct effect on the writedown, e.g. the banning of a particular
title; sales suspended due to copyright infringements.
3.
Using our audit software, I will extract from our audit copy of the inventory
masterfile, a listing of all titles for which the date of last sale is prior to 1
November 2015 (9 months), and for which a number appears in the “quantity on hand field”.
4.
For these titles, I will
4.1
Calculate the total quantity of units (books) to be placed on the clearance sale by
totalling the quantity on hand field.
4.2
Calculate the total writedown prior to adjustment for unsold books by multiplying the
unit cost price reduced by R50, by the quantity of units on hand for each title, and
totalling the result (unit cost – R50) x quantity.
**2016**
/continued on page 3
SUGGESTED SOLUTION TO EXERCISE 11.17
Page 3 of 3 pages
5.
To confirm that the writedown has been correctly increased for the donation of the unsold
books, I will
5.1
Extract the total number of books sold on the clearance sale from the inventory clearance
invoices, and deduct it from the total number of books initially written down (see 4.1
above), and multiply the result by R50. This will give the amount by which the original
writedown must be increased.
The total writedown thus calculated should be compared to the client’s writedown and any
difference resolved.
6.
Using the audit software, I will extract a list of all titles with a high “quantity on
hand” : “quantity sold year to date” ratio, e.g. there are say 200 copies in the
inventory and only 30 have been sold during the year.
I would discuss each of these
titles with management to establish whether they should be written down.
7.
I will perform an analytical review on the writedown, e.g.
7.1
By comparison to prior year writedowns.
7.2
The current year writedown per category (easily done using the audit software), to prior
years.
7.3
The writedown as a percentage of inventory, compared to prior years.
8.
I will discuss with Barry Potter the approval process for the write down, e.g. is the
writedown reviewed independently and authorized at a high level.
9.
In the management representation letter, I will include a specific reference to the
adequacy of the writedown for slow moving inventory.
**2016**
SUGGESTED SOLUTION TO EXERCISE 11.16
Page 1 of 3 pages
a)
b)
c)
1.
Write access to the “discontinued item field” should be restricted, say, to the
warehouse manager.
2.
All entries to this field should be supported by a standard masterfile amendment
form.
3.
Standard masterfile amendments should be
3.1
Cross-referenced
to
supporting
pre-numbered documentation
(supplier’s
notification).
3.2
Authorised by independent senior official (say financial controller) after
scrutiny of supporting documentation.
3.3
Logged by computer sequentially.
4.
There
should
be
regular
reconciliation
controller/warehouse manager.
4.1
Inventory masterfile to MAFs.
4.2
Logs (sequence and validity).
and
review
by
the
financial
The following reports could have been generated:
1.
A report of any missing fields e.g. a missing frame number on a (H)category line
item with a quantity on hand of 1 (for follow up at the inventory count).
2.
A report breaking down the entire masterfile by category, total number of units
and value per category (to assist in planning where audit emphasis should be
placed).
3.
A report detailing any anomalies in the quantity field
3.1
Negative quantities.
3.2
(H) category line items with greater than 1 in the quantity field.
3.3
Line items where quantity field is zero but date of last purchase is after
date of last sale. (This report should be “nil”).
3.4
Duplicate item codes.
4.
A report of items randomly
emphasising high value items.
5.
A report of line items where the date of last sale is, say, more than 12 months
prior to 31 March 2016 (these items should be checked for condition to confirm
their saleability).
6.
A report of all line items (including quantity and date of last sale details)
where a date appears in the “discontinued item field” (these items, particularly
where there are large quantities, should be examined for saleability).
selected from the masterfile
(This could be by category).
for
test
counting,
Total inventory value
1.
Using the audit software, interrogate the entire inventory masterfile for errors
which may affect total inventory value e.g. negative unit costs (none should be
found).
2.
Using the audit software, test the accuracy of the inventory masterfile by
2.1
Reperforming all extentions (quantity field x cost field) and
2.2
Casting the extension column (total inventory value).
3.
Compare the
balance.
Cost – local
total
inventory
per
our
calculation
to
the
general
ledger/trial
1.
Using the audit software, select a sample of local purchases and using the
“supplier” and “date of last receipt GRN” fields
1.1
Trace to supplier to confirm that correct purchase price has been used and
1.2
1.3
**2016**
(where necessary) reperform the weighted average cost calculation.
By examination of cost schedules, transport invoices, confirm
carriage inwards costs have been included in unit costs.
that
/continued on page 2
SUGGESTED SOLUTION TO EXERCISE 11.16
Page 2 of 3 pages
Cost – imported inventory items
1.
Using the audit software, select a sample of high-end bicycles and trace to
specific invoice for that bicycle
1.1
By matching the frame serial number to the invoice, confirm that the
correct unit price has been used.
2.
Using the audit software, select a sample of all other imported goods and trace to
supplier documentation to confirm correct purchase price has been used
2.1
Where necessary reperform weighted average calculation.
3.
For all imported inventory items, obtain the relevant costing schedules and
shipping documents
3.1
By reference to information obtained from the bank, confirm that the
correct exchange rate (date of transaction) was used to translate from
foreign currencies.
3.2
The appropriate import/customs and shipping charges were included in
arriving at cost.
3.3
The allocation of these charges to inventory items, was reasonable.
Lower of cost or net realisable value
1.
Using the audit software, extract a report comparing the “unit cost” field to the
“selling price” field; for any instances where cost exceeds selling price, follow
up with the warehouse manager and determine whether the necessary write down has
been effected.
2.
Using the samples already extracted, compare the selling prices listed in the
masterfile to
2.1
Price lists, catalogues etc.
2.2
The selling price on the invoice for the last unit sold (can use data of
last sale/invoice field).
3.
Select a sample of sales invoices from the post balance sheet period and compare
selling prices on the invoices to those listed on the masterfile.
Impairment of high end bicycle inventory
1.
Obtain the warehouse manager’s schedule
1.1
By inquiry of the warehouse manager and scrutiny of supporting
documentation (e.g. suppliers invoice) confirm that the cost of parts
stolen had been correctly entered on the schedule.
1.2
Reperform all extensions and casts to obtain the total cost of the
impairment.
1.3
By enquiry of the financial controller and inspection of the journal,
confirm that the necessary writedown was effected.
Allowance for obsolete inventory
1.
Discuss with management the process used to develop the obsolescence allowance and
evaluate the process for reasonableness and consistency with the prior year
(reference to working papers).
2.
Using the audit software, extract a list of all inventory items (excluding
discontinued items) where the date of last sale is, say, 12 months prior to
31 March 2016
2.1
For each high-end bicycle on the list, discuss with sales personnel the
possibility of the bicycle being sold at above cost (note new models come
out each year).
2.2
For all other items, discuss the need for writedown with the financial
controller.
3.
Using the audit software, extract a list of all discontinued items
3.1
Inspect most recent invoices for sales of these items (including sales
made during the post balance sheet period) to establish realistic selling
prices and
3.2
Discuss the need for possible write down with the financial controller and
sales personnel.
4.
Review the working papers from your audit team’s attendance at the year end
inventory count for any references to/identification of obsolete or slow moving
inventory.
**2016**
/continued on page 3
SUGGESTED SOLUTION TO EXERCISE 11.16
Page 3 of 3 pages
5.
Compare allowances in prior years to actual write offs in the subsequent years (to
assess management’s ability to establish reasonable allowances).
6.
Analyse the allowance and related accounts to provide evidence of
reasonableness of the allowance e.g.
6.1
Comparison of allowance to prior years as a percentage of inventory.
6.2
Inventory turnover ratio (is inventory turnover slowing?)
6.3
Days inventory on hand.
7.
Reperform any calculations used in determining the allowance.
8.
Discuss with management
8.1
The reasonableness of the allowance in the light of the evidence gathered.
8.2
9.
the
The approval procedure for the allowance.
Obtain management representation letter specifically confirming the adequacy of
the allowance.
General procedure for valuation
1.
Perform analytical review on inventory by comparing current year figures/ratios to
prior years.e.g.
1.1
Total inventory.
1.2
Total inventory by category (H, L, P and A).
1.3
Inventory as a percentage of current assets, total assets.
**2016**
SUGGESTED SOLUTION TO EXERCISE 11.15
Page 1 of 2 pages
a)
At the year-end inventory count I would have
1.
Inspected each of the six units “in progress” to confirm their physical
existence.
b)
2.
Matched each of the units to the job card and sequenced checked the job cards
(3276 to 3281).
3.
Noted the stage of completion recorded on the job card and, by inspection and
enquiry of factory personnel, evaluated whether it was reasonable.
4.
Where possible I would have noted whether the physical unit corresponded with the
job card, e.g. serial number of pumps charged to job cards actually matched the
pumps installed in the units.
5.
By enquiry of factory personnel and observation, I would have confirmed that no
other jobs were in progress at year-end (completeness).
Labour.
I will
1.
Obtain the payroll records for wage weeks 49 to 52 and by inspection
confirm that the 4 permanent employees
*
worked the hours recorded on the job cards
*
that the rate of pay for each of them was recorded, e.g. Preston R80.
2.
Compare the labour hours worked to the “materials and labour schedule” to confirm
that for a 80% complete unit, the hours are reasonable.
3.
Inspect any records available to support the payment of the casual employee and
enquire as to why he was required.
Materials
The imported Speck pumps
1.
2.
Obtain the Speck Pump Inc invoice, and all important documentation (shipping
wharfage, customs duty etc) and reperform the cost calculation for the pump and
1.1
Verify that the exchange rate used to convert the German currency to Rand
was the rate ruling at the date of the purchase transaction (not year-end).
1.2
Confirm the rate used
financial publication.
1.3
Confirm that the appropriate import and customs duties were included by
inspection of supporting documentation.
by
enquiry
from
a
financial
institution/reliable
As the pumps were imported as a batch of 20, confirm that the total cost of the
batch was accurately and equally allocated over the 20 pumps, to arrive at a unit
cost of R54 292.
Locally purchased materials
3.
Obtain a copy of the stores requisitions for the pivot arm, the piping and joints
and the consumables
3.1
Confirm by reference to the “materials and labour schedule” that the items
described on the SR are used in the manufacture and not duplicated.
3.2
Confirm by inspection that the dates on the requisitions are prior to the
31 March and (probably) dated during March.
**2016**
/continued on page 2
SUGGESTED SOLUTION TO EXERCISE 11.15
Page 2 of 2 pages
4.
By enquiry of the warehouse foreman (or similar), determine the suppliers of the
goods and trace the goods to the supplier’s invoices
4.1
Confirm that the items requisitioned have been charged to the job card at
the correct price and that in terms of company policy.
4.2
The correct cost formula has been applied i.e. FIFO.
4.3
If any charges have been added to the purchase price, confirm that they
qualify for inclusion (e.g. carriage inwards) and agree the detail to the
supporting invoices.
Overheads
5.
Request a break down of the overheads of R14 200 allocated to the job
5.1
By
enquiry
of
the
cost
accountant
and
inspection
of
supporting
documentation, confirm that only fixed or variable production costs have
been included and
5.2
That the overheads have been
*
based on normal capacity and
*
allocated on a systematic basis which is reasonable.
Additional cost
6.
Request that the amount of R18 610 for the pivot arm which fell off the forklift,
be reversed out of work-in-progress.
This cost does not qualify as a “cost of
conversion” as it is abnormal waste and should be written off.
Lower of cost or net releasable value
7.
Determine by
*
discussion with John Graham and the cost accountant and
*
comparison of the cost to date of the 80% complete unit to the cost of the
fully completed units and
*
the selling price of the unit (obtained from the contract with Turnerfarms
Ltd)
whether the cost has already exceeded the selling price or is likely to do so.
ensure that the necessary adjustments and/or disclosures are made.
If so,
General
8.
Reperform the casts and calculations on the job card.
9.
Confirm (at a later stage) that an amount of R139 785 (R158 395 – R18 610) is
correctly included in the total amount for work-in-progress.
**2016**
SUGGESTED SOLUTION TO EXERCISE 11.14
Page 1 of 3 pages
a) and b) THE PERFORMANCE OF DON KING
1.
CRITICISM
ACCEPTING/RETAINING THE ENGAGEMENT
1.1
Don King was too busy to undertake the engagement. In the past, the partnership
saw fit to conduct the verification of inventory at the East London branch
themselves, as inventory is considered to be crucial.
In terms of ISA 220 Quality Control for audits of financial statements, an engagement should not be
accepted if the audit firm does not have the necessary resources and time to
service the client properly.
SHOULD HAVE
1.2
Declined the (special) engagement or
1.3
Obtained the help of partners (both of whom were familiar with the client) or
1.4
Carried out procedures to determine the suitability of Henry Cooper to do the job
(simple as the engagement may seem!) See 2 below.
2.
CRITICISM
2.1
Don King conducted no procedures to decide whether Henry Cooper could be relied
upon (Note: the method of identifying Henry Cooper was satisfactory).
It is
perfectly acceptable to rely on other auditors but not without considering the
SELECTION OF HENRY COOPER (OTHER AUDITOR)
professional competence of the other auditor to provide sufficient appropriate
evidence.
SHOULD HAVE
2.2
Considered Henry Cooper’s professional competence/reputation by making appropriate
enquiries of other auditors, Henry Cooper himself, and other 3rd parties to the
extent necessary.
2.3
Satisfied himself as to Henry Cooper’s independence by discussion with Henry
Cooper and possibly by obtaining a written representation from him.
3.
CRITICISM PLANNING
3.1
It is apparent that Don King performed no planning for this audit and more
specifically for the inventory account.
SHOULD HAVE
3.2
Updated his understanding of the client by conducting risk assessment procedures.
3.3
Formulated an audit strategy and plan which clearly addressed the risk of
manipulation of the financial statements (there is incentive for the directors to
do this.)
3.4
Planned the audit of inventory carefully in view of the crucial importance
of inventory.
3.5
Conveyed details of the audit strategy and plan to Henry Cooper (see 4) to
the extent necessary to convey the importance of the inventory count.
4.
CRITICISM
4.1
Don King did not brief Henry Cooper adequately or provide him with proper
instructions.
Even if Henry Cooper had followed the instructions, sufficient
appropriate evidence would not have been obtained from the attendance at the
inventory count as Don King
*
INSTRUCTING HENRY COOPER
instructed him to test for existence only (one way).
*
made no mention of testing for rights, valuation and completeness, simply
telling him to do whatever else Henry Cooper felt was necessary (this is far too vague).
*
provided no background to the company and the potential risks relating to
a crucial account heading.
**2016**
/continued on page 2
SUGGESTED SOLUTION TO EXERCISE 11.14
Page 2 of 3 pages
SHOULD HAVE
4.2
Compiled an engagement letter which formalised the engagement and laid out:
*
the reason for the inventory count in the context of the loan application.
*
the materiality of inventory (it is “crucial to fair presentation”).
*
particular risks associated with Roadsport (Pty) Ltd inventory and this
engagement (e.g. components not visible, deliberate overstatement due to
reliance on AFS).
*
important details relating to Roadsport (Pty) Ltd, such as the names of
appropriate client personnel, important dates (inventory counts, reporting
date), inventory control and count procedures/methods.
*
the specific procedures required to comply with Kaplan and Co's audit plan
e.g. identification of obsolete/damaged goods, “cut-off” documentation
numbers, direction of count.
*
sample sizes and items for specific inclusion in test counts.
*
review procedures which
complete questionnaire.
would
be
adopted
after
the
engagement
e.g.
5.
CRITICISM
REVIEW PROCEDURES
5.1
Don King's review procedures of Henry Cooper’s work were non-existent.
The
responsibility of determining whether sufficient appropriate audit evidence has
been gathered rests with Don King.
5.2
In terms of ISA 220, in his capacity as engagement partner, Don King is required
to review the work of the audit team. In this case to determine whether
*
the count was performed in accordance with professional standards.
*
significant matters had been addressed.
*
the work performed supports the conclusions reached.
*
the audit objective was achieved.
SHOULD HAVE
5.3
Held direct discussion (over phone) with Henry Cooper and made notes once the
inventory sheets were received or
5.4
Asked Henry Cooper to submit a written summary of his procedures and findings or
to complete a questionnaire.
5.5
Considered whether the nature and extent of Henry Cooper’s procedures should have
been amended, as the quality of work produced by Henry Cooper would have raised
major concerns as to:
5.6
*
the sufficiency of audit evidence relating to inventory quantities.
*
the competence of Henry Cooper and his trainee.
Based on the poor work performed by Henry Cooper, Don King should have:
*
informed the client that there would be a delay in the audit.
*
arranged for another audit of inventory to be conducted by his own audit
firm and
*
recalculated the quantity of inventory on hand at 31 December 2015 from
details of the second count and details relating to inventory movement
between 31 December 2015 and the date of the second inventory audit
(rollback).
6.
CRITICISM
6.1
Don King should not have issued his report on this engagement, as inventory is
"crucial to fair presentation” and sufficient appropriate evidence had not been
gathered to support an opinion:
*
SUFFICIENT APPROPRIATE AUDIT EVIDENCE
he had not even seen the inventory sheets.
*
he was unaware that the inventory count had been conducted the wrong way
around (e.g. from crate to list for completeness, but not the other way for existence).
*
had no information about damaged or obsolete inventory (valuation).
SHOULD HAVE
6.2
**2016**
Withheld his report until he had arranged for a proper count to be conducted and
compiled adequate workpapers to support his conclusion.
/continued on page 3
SUGGESTED SOLUTION TO EXERCISE 11.14
Page 3 of 3 pages
THE PERFORMANCE OF HENRY COOPER
7.
CRITICISM
ACCEPTANCE OF ENGAGEMENT
7.1
Henry Cooper accepted the engagement on the basis of inadequate information and
instructions.
SHOULD HAVE
8.2
7.2
Obtained specific details of the engagement (including deadlines).
7.3
Decided on whether he had time/resources competence/independence to conduct the
inventory audit (ISA 220).
8.
CRITICISM
8.1
Henry Cooper did not assume leadership responsibilities for the engagement.
LEADERSHIP RESPONSIBILITY DIRECTION, SUPERVISION & REVIEW ISA 220
Henry Cooper delegated the work to a junior trainee and did not provide sufficient
direction, supervision or review of the trainees work as required by ISA 220.
SHOULD HAVE
*
8.3
Assigned personnel to the audit (or done it himself) who had the necessary
technical training and proficiency (obviously the trainee did not, judging by his
performance).
8.4
Provided direction to the trainee
informing him of the audit objective.
*
explaining the risks.
*
discussing potential problems e.g. what to do with sealed boxes.
outlining the nature and extent of tests to be done in respect of rights, existence,
completeness and valuation.
8.5
*
*
Provided supervision of the trainee by:
visiting the count to confirm that instructions were being carried out and to resolve
problems.
8.6
Reviewed the junior trainee’s work prior to reporting to Don King.
9.
CRITICISM
INVENTORY COUNT PROCEDURES
9.1
Henry Cooper was responsible for performing an inadequate engagement. Even though
the instructions he was given by Don King were inadequate and even though he
delegated the work, Henry Cooper should still have ensured that the work was
conducted in terms of international auditing standards.
9.2
Henry Cooper effectively becomes the "engagement partner" for the inventory count
and is required to gather sufficient appropriate evidence to support the
conclusion given on inventory quantities.
SHOULD HAVE
9.3
Made contact with the warehouse manager prior to the 31 December, as part of the
planning of the inventory audit.
9.4
Planned times, samples, procedures for the count in consultation with Don King.
9.5
Insisted on at least a sample of crates being opened for inspection.
9.6
Checked from the inventory sheets to the physical inventory on hand (as required)
as existence is a major risk.
9.7
Inspected for damaged components.
9.8
Insisted on proper work papers
evidence obtained, particularly:
documenting
all
procedures,
results
and
other
*
taken “cut-off” numbers for “inward and outward” documents for submission to
Don King.
*
copies of inventory sheets.
9.9
Followed up any count queries with the trainee and warehouse manager.
9.10
Complied with Don King’s request to submit the inventory sheets directly to Don
King.
9.11
Discussed the result of the engagement directly with Don King (not left it to
trainee).
**2016**
SUGGESTED SOLUTION TO EXERCISE 11.13
Page 1 of 2 pages
a)
1.
It may be impossible to obtain sufficient audit evidence without using
CAATs due to:
1.1
the complexity of the clients
computers and related controls.
system
1.2
the volume of transactions processed.
and
the
degree
of
reliance
on
2.
The manner in which data is stored by the client
-
3.
The length of time the client retains data
-
4.
b)
CAATs may be the best way to retrieve data necessary for audit where
minimal hard copy is kept.
a concurrent auditing technique such as SCARF may be necessary where
detail (transaction files) supporting totals and balances is not kept for
long.
The availability of suitable CAAT software to meet the particular audit objective.
-
if suitable CAAT software is not available it will take time and money to
develop suitable software.
-
client may
useful)
have
certain
software
(e.g.
report
writers)
which
may
be
5.
The cost effectiveness and efficiency of adopting the technique.
6.
The availability of competent staff within the audit team and firm to support and
use the software.
7.
The degree of reliance on clients DP staff that will be necessary and the effect
of such reliance on the auditor's independence.
8.
The willingness of the client to let you make use of CAATs on client hardware and
the level of co-operation which can be expected. This will depend upon:
8.1
the extent to which use
processing activities.
8.2
how much risk there is of corrupting client files through use of CAATs.
of
audit
of
hardware
CAATs
(e.g.
will
disrupt
laptop)
with
the
client’s
client
normal
9.
The compatibility
software.
hardware
and
10.
Client expectations – the client may be concerned about your firm’s competence if
you do not use CAATs.
1.
I would extract a report reflecting the aggregate value of inventory at
year-end by inventory category (quantity on hand x unit cost price) and in total.
Explanation:
1.
I would compare the total inventory value per the
masterfile to the inventory figure in the general ledger.
2.
I would use the breakdown by category
2.1
for analytical purposes e.g. comparison with prior
periods
2.2
to identify which categories are material so as to
focus audit tests appropriately (all assertions).
2.
I would extract a sample of all line items (over a given value as well as random)
reflecting inventory number, inventory category, inventory location, description,
quantity on hand, unit cost price and value.
Explanation:
3.
This listing would form the basis for the physical inventory count
(existence).
I would extract a listing of all line items on hand at year end which reflect
3.1
zero year to date sales quantity with a quantity on hand
3.2
zero year to date purchases quantity with a quantity on hand
3.3
year to date sales less than 30% (say) of quantity on hand at year-end
3.4
no sales during the past six months (i.e. date of last sale > 6 months
ago)
3.5
no purchases during the past six months (i.e. date of last purchase > 6
months ago) and no sales for a similar period.
Explanation:
the listing would assist me in determining the reasonableness of
the
client's
allowance
for
slow
moving/obsolete
inventory.
(valuation - obsolescence).
Note:
An indication of inventory turnover for a line item could be obtained by dividing
quantity sold to date by quantity on hand.
4.
I would extract a listing of high value items for which the
inventory count date fell outside the financial year under review.
Explanation:
last
physical
I would, by discussion with the inventory controller, establish why
they had not been counted;
and the listing would form the basis of additional test counts to
establish their existence (existence, valuation).
**2016**
/continued on page 2
SUGGESTED SOLUTION TO EXERCISE 11.13
Page 2 of 2 pages
5.
I would extract a listing of all line items adjusted in the month prior to the
financial year-end.
Explanation:
6.
I would extract a listing by line item where date of last adjustment is more
recent than date of last count.
Explanation:
7.
I would use the listing as a basis for test counting these items
and for tracing back to the authority for the adjustment.
The
intention would be to identify any attempts at manipulating the
year-end inventory figure (existence, valuation).
I would establish the reason for adjustment and trace back to
authority for the adjustment.
A listing of negative unit cost or negative quantity AND any line items where both
are negative.
Explanation:
I would investigate these line items to establish the reason for
the negative inventory balance.
Where both are negative a POSITIVE balance will result, resulting
in overstatement.
8.
I would extract a listing of all line items where the date of last sale and date
of last receipt is within 5 days of the financial year-end.
Explanation:
9.
I would extract a report of any line item where the average unit cost exceeds the
unit selling price.
Explanation:
10.
I would use these listings to test cut-off by test checking the
items on the listing to the underlying pre-numbered goods received
notes and issue slips to ensure that they were dated prior to the
balance sheet date (existence).
I would use this listing to request the write down of inventory so
as to comply with the requirement that inventory be valued at the
lower of cost or NRV (valuation).
I would extract a sample of line items by date of last receipt, supplier code,
unit cost and quantity on hand.
Explanation:
10.1
I would use this information to obtain the latest
cost price of the item.
*
10.2
11.
11.1
the sales value extracted would be compared to sales
in the general ledger for reasonableness (by category if
available).
11.2
the purchases value extracted would be compared to
purchases in the general ledger (by category if available).
I would extract a report(s) indicating duplicate inventory numbers and any missing
fields, and any anomalies e.g. zero in quantity field but date of last purchase
after date of last sale.
Explanation:
NOTE:
I would also inspect the purchase invoice to confirm that
they are addressed to Parts and Pieces (Pty) Ltd. (rights).
I would extract a listing of the value of quantity of sales and purchases to date
by category of inventory.
Explanation:
12.
this would be compared with the weighted average
cost
to
determine
whether
weighted
average
approximates actual cost (valuation).
This would assist in establishing the accuracy of the records.
material inaccuracies would be followed up (valuation
existence).
Any
and
You could also test for completeness as follows:
-
perform a sample of test counts randomly selected from the physical inventory.
The inventory details and quantity would be keyed into the computer for comparison
against the inventory master file.
A listing of any discrepancies would be
extracted.
Explanation:
This listing would provide me with evidence
inventory (i.e. is all inventory recorded).
of
the
completeness
of
This point is beyond the scope of the requirement.
**2016**
SUGGESTED SOLUTION TO EXERCISE 11.12
Page 1 of 2 pages
1.
"Books and paper which I can see and read"
1.1
I would explain to Marcus Welby that there will still be adequate "paper" in the
system for him to follow through every single transaction by virtue of the fact
that there will still be, for example
*
delivery notes (from suppliers)
*
GRN's printed by the computer
*
despatch/issue notes printed by the computer
which will record the movements of every item in and out of the warehouse.
2.
1.2
I would further explain that printouts (hardcopy) of all transactions,
adjustments, and the inventory masterfiles will be available to him for control
purposes.
1.3
I would explain that additional hardcopy will be available to assist him improving
his control over inventory, e.g. error listings, exception reports, aging of
inventory items.
1.4
I would also point out that once he has mastered the system it will be far easier
and quicker for him to access the information on the system, but that he will
still be able to print hardcopy if he so wishes.
"Employees will be able to gain unauthorised access to inventory records"
I would explain to him that unauthorised access will be controlled in a number of ways.
2.1
The system software will restrict access to the inventory records to only those
terminals which require access e.g. terminals in the payroll department will not
have access to the inventory records.
2.2
The system and application software will restrict access to inventory records only
to those employees who have been defined in the access profile as requiring access
to perform their functions (need to know basis). Access can be restricted (read
only) which prevents an employee from writing to a file, as opposed to writing
(changing) a file.
2.3
Access to the computer file containing details of 2.1 and 2.2 will be
restricted to the DP manager/system administrator.
2.4
The method by which this is achieved is by the use of user IDs, passwords
and user profiles. Before the system grants any access to the system an employee
will have to identify himself to the system (user ID), authenticate himself (entry
of a unique password) and will then only be given access to applications and
modules for which he is authorised by his user profile to have access.
2.5
I will concede that if user IDs and passwords are not kept confidential by
employees access can be gained by unathorised individuals.
There will be strict controls over passwords
*
employees will be disciplined for disclosing their passwords
*
passwords will be unique, changed regularly and not be displayed on
the screen when the terminal is in use
*
terminals and users will be logged off if correct password is not
entered within three attempts
2.6
3.
*
unauthorised attempts to access the terminal will be logged by the
computer
*
passwords will be stored in an encrypted format.
Unauthorised personnel will be barred from physical access to warehouse terminals
"Inability to pinpoint responsibility."
3.1
I would explain to Marcus Welby that responsibility can be pinpointed as the
system will record the user ID/password of the receiving clerk who made the entry.
This information would be available to him (Marcus Welby) using his enquiry
facility.
3.2
There will be a forced logoff time. This means that the terminal will shut down
if not in use for more than the specified time.
This assists in preventing a
receiving clerk from operating a terminal which has been "opened" but left
unattended by another receiving clerk.
3.3
Receiving clerks will still be required to sign delivery notes against which they
have received goods. Responsibility is thus pinpointed.
**2016**
/continued on page 2
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 227 of 3 pages
SUGGESTED SOLUTION TO EXERCISE 11.12
Page 2 of 2 pages
4.
Numerous errors in using the terminals/undetected
I would explain that errors made by receiving clerks and going undetected will be kept to
a minimum by the following control techniques:
4.1
All employees required to use computer equipment will be suitably trained.
4.2
The principle of minimum entry will apply.
This means that as far as possible
information which is already on the database will not have to be re-entered. For
example, in the case of the receiving clerk, when a supplier makes a delivery, the
receiving clerk will simply enter the Marbles (Pty) Ltd purchase order number on
his terminal and if it is a valid order, the screen will come up formatted as a
GRN which will contain all the detail of the order.
The receiving clerk will
still count and sign the supplier delivery note but will not have to capture any
detail on the system other than the quantity received and supplier delivery note
number.
4.3
Deliveries which do not comply with details shown on the enquiry e.g. short
deliveries, will be stored in a file by order number against which enquiries can
be made by Marcus Welby himself and the buying department.
4.4
To further assist receiving clerks in completing an accurate GRN there will be a
standard GRN screen format which will be an image of the purchase order with
provision for the receiving clerk to enter the actual quantity received and
supplier delivery note number.
4.5
There will be what are termed field validation checks e.g. an alphanumeric check
on the quantity field which means that a number (not a letter) must be entered and
a mandatory field check which means that the quantity received field and the
supplier delivery note number cannot be left blank.
4.6
There will be screen "prompts" for receiving clerks to interact with the computer,
e.g. before the quantity field is entered a message will appear on screen asking
the receiving clerk if he counted the goods.
4.7
A copy of the GRN will go to the warehousemen with the goods where it will be
checked to ensure that the physical quantity agrees with the recorded quantity.
(This would prevent receiving clerks from simply entering the quantity indicated
by the order (shown on screen) and not the quantity received).
4.8
Receiving clerks will not have write access to the on screen purchase
order/GRN (other than they require) e.g. they will not be able to create or change
a purchase order.
5.
Adjustments to inventory ledgers
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 228 of 3 pages
I would explain to Marcus Welby that
5.1
Amendments to the inventory masterfile will be strictly controlled
*
a (hardcopy) masterfile amendment form will be made out, supported
by appropriate evidence and will have to be authorised by Marcus Welby or
another senior employee.
*
the ability to process the masterfile amendment will be restricted
to a warehouse admin clerk (and possibly Marcus Welby).
*
the computer will log all inventory masterfile amendments. Access
to the log will be read only (so nobody can alter the log) and will be
given to a restricted number of senior personnel including Marcus Welby.
This means that Marcus Welby will be able to access the log at any time
from his terminal to ensure that only amendments which he has authorised
and which he knows about have been processed. Again access control will be
by the use of user ID, password and user profile.
6.
Inventory control
I would explain to Marcus Welby that
6.1
The inventory records will be kept right up to date.
6.2
The system will facilitate a variety of inventory reports which could be printed
out to facilitate better control.
6.3
*
a listing of x number of items for counting each day i.e. daily cycle
counting (or whenever Marcus Welby wishes to do so) for comparison of
actual inventory with theoretical inventory.
*
inventory aging to identify slow moving lines
*
suggested reorder levels.
The GRN will identify a computer generated storage location (Bin number) for all
goods to facilitate proper storage and retrieval.
**2016**
SUGGESTED SOLUTION TO EXERCISE 11.11
Page 1 of 3 pages
a)
1.
I would regard the risk of material misstatement in the inventory balance as medium.
2.
Rights
2.1
The risk of material misstatement arising from the inclusion of inventory which
Kitchenstuff (Pty) Ltd does not own appears to be low.
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 229 of 3 pages
3.
4.
5.
6.
2.2
Some inventory is held on consignment for another company, so there is a small
risk that these products which actually belong to Modernpots CC will be included
in Kitchenstuff (Pty) Ltd’s inventory.
This is unlikely as these pots are the
only pots held in inventory so cannot be mistakenly identified as Kitchenstuff
(Pty) Ltd’s pots.
2.3
As Kitchenstuff (Pty) Ltd does import its inventory there is a chance that some
inventory is included in the year end balance for which the risks and rewards of
ownership have not transferred to Kitchenstuff (Pty) Ltd i.e. stock-in-transit,
depending whether the inventory is carried FOB or CIF.
Existence
3.1
The risk of material misstatement arising from the inclusion of non-existent
inventory must be assessed as low.
3.2
It seems unlikely that the directors would be prepared to falsify the inventory
records to overstate inventory, particularly as it would require extensive
management override of a well designed perpetual inventory system.
Completeness
4.1
The risk of material misstatement arising from the understatement of inventory
seems very low.
4.2
It is possible that some imported stock-in-transit has been omitted but as
internal controls are sound and as there is no incentive to understate inventory,
this seems very unlikely.
Valuation
5.1
The risk that material misstatement could arise from the overstatement of the
value of inventory is medium.
5.2
As material quantities of inventory are held, the balance will be large enough to
contain material misstatement.
5.3
The directors of Kitchenstuff (Pty) Ltd are anxious that the financial situation
of the company be presented as favourably as possible.
5.4
Any overstatement in the balance will have the effect of improving a number of
important figures and ratios in the financial statements, e.g. profit, current
assets, current ratio and resulting in more favourable financial statements.
5.5
There is nothing to suggest that the directors will deliberately manipulate the
inventory balance (by for example including non-existent inventory) but there may
be an (almost subconscious) attempt to overstate inventory by understating the
obsolescence/impairment/slow moving allowances.
5.6
There may also be risk that some misstatement could occur in costing imported
inventory, e.g. incorrect foreign currency translations, incorrect calculations
and allocation of shipping costs, etc.
Although the rights, existence and completeness assertions are assessed as low risk, the
risks relating to the valuation assertion cannot be regarded as low and therefore the
risk of misstatement for the account heading cannot be regarded as low. At the same time
risk of material misstatement does not appear to be high so an assessment of medium
appears appropriate.
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 230 of 3 pages
b)
Prior to the inventory count, I would have
1.
Confirmed with Kitchenstuff (Pty) Ltd, that
1.1
the inventory count would take place after the close of business on 31 July 2016
at 4.00 pm
1.2
inventory to be counted is held only at one location
1.3
inventory held on consignment for Modernpots CC
identifiable and will not form part of the count.
is
separately
located
and
2.
Reviewed the copy of the count instructions given to count teams to ensure that an
efficient count will take place.
3.
Reviewed the prior year workpapers for attendance at the inventory count to determine
3.1
whether there were any problems which may affect
incompetent staff, difficulty with item identification
3.2
the audit strategy/plan adopted, e.g. sample sizes, and number of audit staff
required
**2016**
this
year’s
count,
e.g.
/continued on page 2
SUGGESTED SOLUTION TO EXERCISE 11.11
Page 2 of 3 pages
3.3
whether any packaging was opened to check contents and if so, the extent thereof
3.4
any problems with identifying inventory held on consignment.
4.
carried out the necessary administrative planning, e.g. organizing audit staff to attend,
setting up workpapers, scheduling meeting with the client and my audit manager.
5.
visited Kitchenstuff (Pty) Ltd’s premises prior to the count, to
c)
5.1
meet and discuss the count with Freddie Sithole
5.2
familiarise myself with the layout of the inventory
5.3
enquire as to whether there will be any inventory which should not be included in
the count and how this inventory should be identified, e.g. inventory sold close
to year-end but not yet delivered to customers
5.4
enquire as
identified.
to
how
damaged/obsolete/unsaleable
During the inventory count, the audit team will
(impaired)
inventory
will
be
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 231 of 3 pages
1.
Observe the method of counting to determine whether the count teams are adhering to the
count instructions.
2.
Conduct test counts in both directions in all 10 designated areas
3.
2.1
from inventory sheet to physical inventory(existence)
2.2
from physical inventory to inventory count sheets (completeness).
Identify any items which may be damaged/not saleable by
3.1
being on the lookout for damaged/dusty packaging or packaging which appears to
have been tampered with
3.2
inspecting items which the
saleable/impaired/slow moving.
3.3
discussion with Fred Sithole.
count
teams
have
identified
as
damaged/
not
4.
Record the details and inspect the condition of appliances in the showroom (these items
may well require some kind of impairment writedown)
5.
Obtain a copy of the printout of differences between the inventory masterfile and the
inventory count sheets and follow up by
5.1
recounting/checking with the client’s count teams, and
5.2
confirming that changes made on the inventory count sheets are correct and are
initialed by Freddie Sithole/count teams
6.
Go through the warehouse to identify any items which do not have a pink label
stuck on them, and follow up to establish why they have not been counted
.
7.
Inspect the count sheets to confirm that no Modernpots CC inventory held on
consignment is included.
8.
Test the numerical sequence of inventory count sheets (both before and at the end of the
count) to confirm that they are all accounted for and not duplicated.
9.
Confirm with the count teams/Freddie Sithole, that any items sold that had been invoiced
but not delivered at 31 July 2016, are not included in the count record.
10.
10.1
the number of the last of each of the documents used in the inventory cycle (cutoff number), e.g. delivery note, goods received note
10.2
the numbers of all GRNs for which invoices have not been received at 31 July 2016
(to be used at a later date for testing completeness of creditors).
11.
Create audit workpapers in respect of the attendance
11.1
take copies of all adjusted inventory count sheets
11.2
record details of test counts (2.1 and 2.2)
11.3
record details of inventory identified as damaged/not saleable/etc.
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 232 of 3 pages
**2016**
/continued on page 3
SUGGESTED SOLUTION TO EXERCISE 11.11
Page 3 of 3 pages
d)
Rights to the inventory.
I will
1.
Confirm by enquiry of management that no inventory held on consignment for Modernpots CC
or anyone else is included in the financial statements.
2.
Obtain a list of inventory included in the financial statements as inventory-in-transit
at 31 July 2016 and by inspection of orders/shipping contracts, satisfy myself that
ownership has passed to Kitchenstuff (Pty) Ltd by 31 July 2016.
3.
Establish whether inventory included in the financial statements is encumbered in any way
by
3.1
enquiry of management
3.2
inspection of bank confirmations (loan security)
3.3
review of directors’ meetings
3.4
review of correspondence/contracts with major suppliers and credit providers.
4.
When performing inventory pricing tests (or other tests on purchases), confirm by
inspection of supplier invoices, that documentation is made out to Kitchenstuff (Pty)
Ltd.
e)
Conducting cycle counts would be beneficial to Kitchenstuff (Pty) Ltd, because
1.
Comparison and reconciliation of physical and theoretical inventory on a regular basis
enhances internal control in the business, creating a stronger control environment.
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 233 of 3 pages
2.
Discrepancies between actual and theoretical inventory will be timeously identified and
can be followed up promptly.
3.
Employees will be less likely to attempt theft if they know that it will be detected
quickly.
4.
Preventive measures can be put in place to reduce the possibility of discrepancies
between theoretical and actual inventory recurring.
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 234 of 3 pages
**2016**
SUGGESTED SOLUTION TO EXERCISE 11.10
Page 1 of 2 pages
a)
1.
Preparation and planning of the
inaccurate and incomplete count.
count
was
inadequate
which
could
contribute
to
an
1.2
1.1
Holding the count over two afternoons so as to allow normal delivery and
dispatch was not sensible; a non-trading day or overtime count would have resulted
in a more efficient count (total count time only 8 hours).
The method of counting was inadequate; no tag system or double count.
1.3
No count controller appointed to direct count.
1.4
Composition of the counters totally inadequate
*
whilst knowledge of the product is important, counting should be done in
teams, one of whom should be independent of the warehouse function.
1.5
If pickers have been involved in misappropriating inventory, they are now
in a perfect position to hide any shortages by having the perpetual inventory records
amended (amendments were done without authority or investigation).
1.6
There is no evidence that the warehouse was prepared for the count;
although it is “tidy”, a number of procedures should have taken place
* marking damaged, slow moving obsolete goods.
* identifying expired (nearly expired chemicals).
* preparing a secure area for deliveries to be received during the count/making sure
goods received up to the 30th, have been unpacked.
* identifying
2.
the
location
of
Bushblaze
Inc
inventory
(consignment
inventory).
Count stationery was inadequately designed and incomplete
2.1
In this situation (single counter) it would have been better to have excluded the
quantities from the inventory sheets, to force the counters to count the inventory,
not just tick it off.
2.2
The inventory sheets should also have columns for second count and discrepancies.
2.3
There is no document (tag or similar) to identify the count details per item e.g.
quantity.
2.4
There
are
no
inventory
adjustment
forms
on
which
count
differences/adjustments/results of investigation can be entered for authorization
before the inventory records are adjusted.
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 235 of 3 pages
3.
4.
b)
No written instructions
substandard count.
were
prepared
for
the
count
which
again
will
result
in
a
3.1
No identification of who should count what – pickers decided themselves.
3.2
No method of counting conveyed to counters and count controller and auditors.
3.3
No instructions relating to matters raised in (1.6) or how problems on the count are
to be resolved.
The count itself was inadequately conducted
4.1
Inventory only counted once; no recount by another counter when a discrepancy
identified.
4.2
No identification and recording of slow moving, expired, damaged or consignment
inventory.
4.3
No count controller, so no walk through of the warehouse once the count is complete,
and no method of determining whether all inventory has been counted.
4.4
No procedures conducted to ensure that goods received or dispatched during the count
were properly accounted for, e.g. quantity reduced where the dispatch of an item
(say on 31 July) which had already been counted on the 30 July, took place.
No, I would not be satisfied.
Justification
1.
Prior to the inventory count
1.1
Ted Mitton did not determine/confirm the locations at which inventory to be counted,
was stored.
1.2
He did not request a copy of the count instructions
*
had he done so, he would have identified that there were no written
instructions and in doing so, pre-empted the poor inventory account.
1.3
He did not enquire as to whether Firezone Ltd had any inventory which should not
have been included in the count and how this would be identified.
**2016**
/continued on page 2
SUGGESTED SOLUTION TO EXERCISE 11.10
Page 2 of 2 pages
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 236 of 3 pages
2.
During the inventory count
2.1
Although the trainees did observe the pickers counting, it was for short
periods only, which in the light of the poor count planning, was insufficient, e.g.
counters could easily have just ticked off items without counting.
2.2
The trainees did not test count in both directions; as a result no items of physical
inventory were randomly selected from the warehouse, counted and quantities compared
to the perpetual inventory records (completeness).
3.
2.3
The trainees made no effort to identify obsolete, slow moving, damaged inventory.
2.5
2.4
They also failed to inspect the expiry dates on chemicals with limited
shelf lives.
The trainees did not resolve count discrepancies, either from their own test counts
or the pickers counts, by recounting with the Firezone Ltd count staff.
2.6
The trainees did not compile a workpaper which recorded the movement of inventory
during the count particularly deliveries and dispatches on the morning of the
31 July, affecting items already counted.
2.7
The trainees did not confirm (and record) with the counters which items of inventory
at the year-end belonged to Bushblaze Inc, and ensure that they had not been
included in the inventory sheets.
2.8
Ted Mitton did not test the numerical sequence of the inventory sheets either before
or after the inventory count, to confirm that they were all accounted for.
At the conclusion of the count
3.1
Ted Mitton did not take precautions to ensure that the inventory sheets could not be
amended after the count, e.g. by taking photocopies, ensuring that all alterations
were signed (by himself or Zane); initialing each sheet does not prove anything.
3.2
He also did not retain sufficient evidence e.g. get a copy of the inventory sheets
printed/photocopied after adjustments had been made.
Inventory sheets left with
factory administration clerk.
3.3
Ted Mitton did not record the “cut-off” numbers of documents used in the inventory
and production cycle or compile a list of goods received notes (number etc) which
had not been matched to supplier invoices; (particularly important in view of the
movement of inventory during the count.)
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 237 of 3 pages
**2016**
SUGGESTED SOLUTION TO EXERCISE 11.9
Page 1 of 2 pages
Celtec (Pty) Ltd
1.
There are no written instructions and minimal verbal instructions for the count.
1.1
The only instructions on what is required of them will be given to count
staff at a short (15 mins) “session” with Michael Message right before the count
starts. The information given at this session provides no instruction on how the
count is to be conducted or what to look out for.
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 238 of 3 pages
1.2
Without clearly written instructions count staff are likely to forget (or
not know) what exactly they are supposed to do and will have no “terms of
reference” to look to.
(The problem is made worse by the absence of Michael
Message during most of the count.)
2.
The inventory count will be inadequately supervised.
2.1
As pointed out above, Michael Message will be at a seminar for most of the
day.
This means that he will not be about to deal with count problems as they
arise.
2.2
Michael Message should not be a member of the “counting teams;” he should
play an overall supervisory role which includes ensuring that the count is
properly conducted.
3.
The count documentation is totally inadequate.
3.1
As the count sheets will be “created” by the count teams on blank paper
they will not be sequenced; hence there is no way of determining if, at the end of
the count all inventory sheets are accounted for.
3.2
As the inventory sheets are not preprinted with inventory numbers/codes
and descriptions, numerous errors in code/description could be made by the count
teams.
This could easily result in incorrect costing of inventory (i.e. wrong
cost price allocated to the inventory item.)
4.
No formal method of conducting the count has been identified and explained e.g. sticker,
tag, chalk mark, double count etc.
4.1
The inventory is only counted once
4.2
Only one team of two counts a section of the warehouse. One person counts
and the other one records, nobody checks.
Numerous count errors and recording
errors could take place.
5.
There is no method of identifying inventory items which have been counted as the count
progresses.
5.1
Count teams don’t identify what has been counted e.g. no sticker, tag or
chalk mark system, which means that items could easily be double counted or
omitted completely.
5.2
It will not be possible for Michael Message to go through the warehouse
(as he should) to check that everything in the warehouse has been counted.
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 239 of 3 pages
6.
Count staff have not been instructed to look out for items which appear to be damaged or
out of “fashion”, and if they do, how to record it should they identify any such
inventory.
6.1
This procedure assists in determining whether inventory has been impaired
in any way.
If a certain cell phone is out of fashion, or technologically
inferior it may need to be written down.
6.2
As a result, when pricing impaired inventory, Michael Message could easily
end up overvaluing inventory.
7.
Sixteen staff members counting inventory throughout the day is inefficient and a
waste of resources.
7.1
It appears that even with having to write out inventory sheets, each
section can be counted in an hour; therefore with properly prepared inventory
sheets and possibly fewer counters, the entire inventory count could be properly
performed in two to three hours. This could be scheduled to start at 1pm on the
30 April leaving counters to continue with their normal activities for the balance
of the day.
**2016**
/continued on page 2
SUGGESTED SOLUTION TO EXERCISE 11.9
Page 2 of 2 pages
8.
There is inadequate control over goods received on the day of the count and their
inclusion in the inventory balance at 31 March 2016.
8.1
Whilst receiving goods in the normal manner is sound (i.e. checking the
delivery, signing the supplier delivery note, creating a GRN) the goods should not
be transferred to the warehouse and placed on shelves. The goods should be kept
together in the receiving bay until the completion of the inventory count. (Note:
At the end of the day a separate inventory sheet for these items could be
compiled).
8.2
If they are transferred to the shelves there is no way of telling whether
they have been included in the count or not particularly in those sections which
have already been counted. As it is, there is no indication of what goods have
been counted (no tag, sticker and this makes the problem worse.
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 240 of 3 pages
(Note: As these goods were received prior to year end they must be accounted for
as inventory).
9.
There is a lack of control over the completed inventory sheets.
9.1
As these completed sheets are simply placed on Michael Message’s desk and
as they are not sequenced, a sheet could easily go missing.
10.
Adjustments to the perpetual inventory are made on the strength of a poorly organized,
totally inadequate inventory count without being followed up (no recount of items or
investigation of discrepancies).
10.1
Theoretically the perpetual inventory should reflect the quantities of
inventory which should be on hand and if the actual inventory differs, actual
inventory should be recounted and if there are still differences between
theoretical and actual they should be investigated before adjustments to the
perpetual inventory are made.
11.
Adjustments made to the perpetual inventory are not independently authorized and there is
a serious lack of division of duties between the custody of inventory and keeping of
inventory records.
11.1
As it stands Michael Message, the inventory controller can easily cover up
any shortages in physical inventory by simply adjusting the perpetual inventory
records.
During the year or just before the count he could misappropriate
inventory and change the perpetual inventory records to agree the records to the
quantity per the count.
11.2
As he puts through the
verification of the adjustment.
12.
adjustments
himself
there
is
no
independent
Inventory may be incorrectly priced.
12.1
When costing the inventory, Michael Message uses the cost price taken from
the latest supplier invoice. This means that all inventory will be valued at the
latest cost price.
It is highly probably that there will be inventory on hand
which was supplied prior to the latest delivery and at a different price.
12.2
It appears that nobody will be checking the costing, casts and extensions
on the “final” count sheets carried out by Michael Message.
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 241 of 3 pages
**2016**
SUGGESTED SOLUTION TO EXERCISE 11.8
Page 1 of 3 pages
a)
1.
To be in a position to make use of, or rely upon, the work of an internal
auditor, we (the external auditors) must be satisfied that the internal auditor
(department) has the necessary competence and objectivity to satisfy the external
auditor’s requirements. The same will apply in deciding whether an internal auditor can
provide direct assistance on the external audit.
2.
We also need to be satisfied that the internal audit function follows a
systematic and disciplined approach to its work.
3.
An assessment of the internal audit department (Simon Brown) suggests strongly
that this is not the case.
Objectivity: Organisational status
3.1 The internal audit “department” is unlikely to be taken seriously as an
independent body with influence over the control and governance of the
company.
*
*
*
the “department” consists of a single individual who was
formally an administration clerk in the creditors section. To get other
departments to take him seriously in an important function such as
internal audit, will be difficult.
Simon Brown reports to Krishen Vather the financial manager and not to the
Board or audit committee. From our perspective as external auditors, he
is in no way independent of the main focus of our audit.
furthermore it is intended that he also assists with operational functions
when staff are absent. This again directly affects his independence and
objectivity as an internal auditor.
He is too close to the operational
staff and in fact may be involved in activities which we as external
auditors will be auditing. In effect he has conflicting responsibilities
as an internal auditor.
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 242 of 3 pages
Objectivity: Scope of function and undue influence of others
3.2 Simon Brown will in all likelihood have very limited power in deciding what
assessments, evaluations or investigations he should conduct.
*
Krishen Vather is likely to instruct him on exactly what he does and when
he does it, including filling operational gaps as and when required.
*
with no training in auditing, Simon Brown is unlikely to understand the
importance of being independent or how and when to exercise professional
judgement. He will rely heavily on Krishen Vather’s judgement.
*
reporting to Krishen Vather also means that anything adverse which Simon
Brown does find, and which should be reported to the Board, can be blocked
by Krishen Vather if he so wishes, e.g. anything which may reflect
negatively on himself (Krishen Vather).
Competence
3.3 Simon Brown does not have the necessary technical skill and competence for us
to rely on his work.
*
he has no formal training or theoretical training in auditing and
*
has no experience as an auditor of any kind
*
although regarded as competent (and enthusiastic) with regard to
his creditors responsibilities, this is no substitute for auditing
knowledge and the capability to carry out and understand routine or
sophisticated audit techniques
*
it is also highly unlikely that Simon Brown has the necessary
knowledge of the financial reporting standards to fulfil a meaningful role
as internal auditor.
3.4 Due professional care. Whilst there is nothing to suggest that Simon Brown
will be “careless” in his work, his general lack of knowledge and experience
is likely to result in assignments which do not reflect the necessary level of
due professional care in planning and execution.
Systematic and disciplined approach
3.5 For external audit to be able “to rely” on internal audit, a systematic and
disciplined approach to its work must be evident. This includes evidence of
the existence, adequacy and use of documented internal audit procedures
covering such areas as risk assessment, work programmes, documentation and
reporting.
It is extremely unlikely that, given the nature and resources
(lack of) internal audit, these exist at all.
3.6 The overriding problem is that Simon Brown simply does not have the training
and knowledge to carry out internal audit procedures e.g. conducting a risk
assessment in a systematic and disciplined manner.
**2016**
/continued on page 2
SUGGESTED SOLUTION TO EXERCISE 11.8
Page 2 of 3 pages
General
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 243 of 3 pages
3.7 All of the above points show clearly that the Board of EagleEye (Pty) Ltd have
little understanding of the role of internal audit (no proper policies for
hiring, training etc, no status for internal audit).
In addition, internal
audit has been created for the wrong reasons and is unlikely to be a “control”
on which we can rely.
b)
Weakness
1.
Recommendation 1.1
There is a lack of suitable documentation to initiate production i.e.
no “production order”, “job card” or similar document.
Pre-printed,
introduced.
sequenced
multi-part
production
orders
should
be
1.2
Once sales/marketing have notified the production manager of what is
required, he should compile and sign a production order for each
technician to complete a specific job, e.g. manufacture 25
surveillance cameras.
1.3
The production order should list every
construct the item to be manufactured.
1.4
The production order should be distributed as follows
component
required
to
copy 1 – to the technician
copy 2 – to the component warehouse
copy 3 – to foreman/production office
(a fourth copy could be sent to the finished goods store).
Weakness
2.
There are inadequate custody controls over component inventory, e.g.
technicians enter the warehouse and select the items they require.
The responsibility for custody of inventory is not isolated to a
warehousing section; this increases the risk of all kinds of
inventory losses.
Recommendation 2.1
A component warehouse storeman should be appointed.
(If cost is a
factor, the warehouse clerk could be trained and/or issues of
components could be restricted to a specific time each morning,
supervised by the factory foreman.)
2.2
Technicians and other employees should not be given access to the
component store, and physical access techniques should be introduced
as necessary.
3.1
No isolation of responsibility for inventory movement. There is no
documentation to control the requisitioning or issue of components.
3.2
There is no documentation to control the transfer of completed units
to the finished goods store.
Recommendation 3.1
When the technician requires components he should complete and sign a
two-part, pre-printed, sequenced component requisition.
3.2
This document should be cross-referenced to the production order, for
which the components are required.
Weakness
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 244 of 3 pages
3.3
The technician should detail the components required as per the
production order and sign the requisition.
3.4
On receipt
should
of
the
requisition,
the
component
warehouse
storeman
*
confirm, by reference to his
copy of the production order that the components requisitioned are
included on the production order (valid).
* make out and sign a two-part, pre-printed, sequenced component
issue
note
detailing
what
is
being
issued
(quantity
and
description) and cross-reference it to the component requisition.
3.5
On taking the components, the technician should check what he is
accepting and sign the component issue note to acknowledge receipt
thereof.
3.6
Component requisition and component issue
together by numerical sequence (issue note).
3.7
On completion of a batch of units, the technician should complete and
sign a two-part “finished goods transfer form”,
a pre-printed
sequenced document, detailing the quantity and description of items
completed and cross-referencing it to the relevant production order.
**2016**
notes
should
be
filed
/continued on page 3
SUGGESTED SOLUTION TO EXERCISE 11.8
Page 3 of 3 pages
3.8
Both copies of the transfer document should accompany the goods to
the finished goods warehouse where the warehouse clerk should
* check what is being received against the transfer document and
* sign both copies
3.9
The technician should retain one copy and the finished goods store
should retain the second copy.
(Note: a third copy could be created to be kept in the production office
for use by the factory foreman/production manager).
Weakness
4.
No perpetual inventory records for either components or finished
goods are kept. This weakens control over inventory.
Recommendation 4.1
A perpetual inventory system should be introduced. It should be kept
up to date by recording movement of both components and finished
goods from the documents introduced into the system as above (as well
as purchase and sale documentation).
4.2
Regular cycle counts should be conducted and discrepancies followed
up timeously.
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 245 of 3 pages
4.3
The perpetual inventory records should be written up by the
accounting department, or someone independent of the custody of
inventory.
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 246 of 3 pages
**2016**
SUGGESTED SOLUTION TO EXERCISE 11.7
1 Page only
a) and b)
1.
General control
:
implemented to assist in preventing theft of inventory.
2.
Application control
:
implemented to provide a division of duties between custody
of the inventory and record keeping for inventory.
3.
Application control
:
implemented to detect discrepancies between actual and
physical inventory to assist in the prevention of theft of
inventory and to promote accuracy in inventory record
keeping.
4.
Application control
:
implemented to isolate the responsibility for the inventory
once it has been transferred from the custody of the goods
receiving bay personnel to the warehouse personnel.
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 247 of 3 pages
5.
General control
:
implemented to improve the control environment at Soundwaves
(Pty) Ltd.
Reflects
management’s commitment to the
competence of staff and a positive and pro-active philosophy
and operating style.
6.
General control
:
this is an action/policy implemented to assist in protecting
the company’s inventory from theft/deterioration etc, and to
protect the company from loss from being underinsured should
inventory be stolen/damaged etc.
This policy may also be
regarded as part of the risk assessment process.
7.
General control
:
implemented to enhance the control environment
enforcement of integrity and ethical values.
8.
Application control
:
implemented to prevent unauthorised amendments to the
inventory records being made (primarily) to conceal theft of
inventory.
by
the
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 248 of 3 pages
**2016**
SUGGESTED SOLUTION TO EXERCISE 11.6
1 Page only
1.
Applicable to all companies: All companies hold large quantities of inventory
which suggests that the account heading is material to fair presentation of the financial
statements.
This is by virtue of the fact that material error in the account heading
will affect many other accounts, e.g. profit, taxation etc. As the account balances are
material in themselves, they could contain material error.
2.
3.
Airtime Ltd – High
2.1
establishing the existence of gasses is impossible for the auditor without expert
help. Is there gas in the cylinders? Which gas is it?
2.2
establishing the value of WIP (manufacturing process) as well as “finished goods”
(the gasses) will be very difficult e.g. stage of completion costs of chemicals
used, allocation of overheads.
2.3
it will also be very difficult (for the auditor) to tell the difference between
the various gasses produced; as cost of production varies considerably, the value
could be misstated by applying an incorrect cost to the various gasses.
2.4
gasses have different shelf lives which will complicate the determination of
whether the write down for “obsolete” gasses is fair.
2.5
the chemicals from which the gasses are produced are unlikely to be readily
identifiable by the auditor or kept in an “easily countable” manner, increasing
the risk associated with the existence and valuation assertions.
Witehouse (Pty) Ltd – medium (not low –see pt 1 above)
3.1
as the company sells only one category of goods from one location and
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 249 of 3 pages
4.
3.2
as inventory items are easily identifiable for the audit team both in appearance
(description labelling etc) and by serial number, the risk associated with
existence and completeness is probably low.
3.3
in addition, as there is a perpetual inventory system in place, the risk relating
to the existence and completeness assertions would not be regarded as high.
3.4
establishing cost should be straight forward as items are easily identifiable and
can thus be traced to supporting documentation e.g. invoice.
3.5
white goods are not prone to rapid obsolescence/technical redundancy and damaged
goods will be clearly evident at the inventory count. Whilst there may be some
(hidden) defects in certain items, this is unlikely to be significant. Hence there
is unlikely to be high risk of misstatement of the obsolescence write down
(valuation).
Fishy business Ltd – high
4.1
whilst establishing the existence of harvested fish in the refrigerated warehouse
should be relatively simple, it will be very difficult to establish the existence
(quantity) of very young fish in the fish tanks and in the manmade lakes.
4.2
cultivating fish is a process; at balance sheet date there will be fish in all
stages of that process so how does one attach a fair value to “fish-in-process”
and to the harvested fish. Is the cost (value) based on the fish food on which the
fish are fed?
How are overheads allocated? Which overheads can be allocated?
Difficulties in establishing cost may lead to difficulty in establishing whether
the selling price will exceed the cost.
4.3
Should any allowance be made against the harvested fish for possible
saleability, and will the cost of the fish-in-process ultimately be recovered?
5.
non-
Secondhand Rose (Pty) Ltd - high
5.1
5.2
*
Existence and completeness should not prove particularly “risky” for the auditor
to obtain an appropriate level of evidence.
However, the risk of misstatement pertaining to the valuation assertion is high.
*
inventory must be reflected at the lower of cost or net realizable value.
*
how is cost established – purchase price + repairs?
as these are second hand items will they be sold above cost or sold at all.
*
what allowance should be made for obsolescence?
**2016**
SUGGESTED SOLUTION TO EXERCISE 11.5
1 Page only
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 250 of 3 pages
1.
My junior trainee has very little understanding of the assertions.
2.
Whilst he has correctly identified completeness, rights and existence as being applicable
to inventory
3.
*
he does not know what they mean and
*
he has omitted valuation.
He appears unaware that validity is an objective unusually associated with a control
procedure, not an assertion.
4.
The completeness assertion represents that all inventory including WIP, raw
materials and finished goods is included in the figure of R1 832 916.
The “stage of
completion” of the inventory does not determine whether it is included in the account
balance.
5.
He appears to have muddled validity and valuation, whilst he does seem to know that
inventory which has “deteriorated” (expired) should not be included, he clearly does not
understand that the valuation assertion represents that the amount of R1 832 916 is the
fair carrying value of the inventory. All forms of impairment have been accounted for.
6.
The rights assertion has nothing to do with the company’s (legal) rights to manufacture
their products.
The assertion represents that Bubbles (Pty) Ltd has ownership of the
inventory, it belongs to them, it is not the property of anyone else.
7.
He is partially correct on the existence assertion, but again he has excluded other
relevant categories of inventory believing that only manufactured inventory is included
in the amount of R1 832 916. The assertion relates to the existence of all categories of
inventory and represents that no fictitious inventory is included.
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 251 of 3 pages
**2016**
SUGGESTED SOLUTION TO EXERCISE 11.4
1 Page only
Procedure
Assertion
1.
1.
test of controls
-
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 252 of 3 pages
2.
risk assessment
2.
-
3.
risk assessment
3.
-
4.
substantive
4.
valuation
5.
substantive
5.
valuation
6.
test of controls
6.
-
7.
substantive
7.
valuation
8.
substantive
8.
completeness
9.
risk assessment
9.
-
10.
substantive (could also be risk assessment)
10.
rights
11.
risk assessment
11.
-
12.
substantive
12.
existence
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 253 of 3 pages
**2016**
SUGGESTED SOLUTION TO EXERCISE 11.3
1 Page only
1.
existence
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 254 of 3 pages
2.
completeness
3.
valuation (allowance for obsolete inventory)
4.
completeness
5.
valuation
6.
rights, completeness
7.
valuation (lower of cost or net realisable )
8.
rights
9.
valuation, valuation
10.
This procedure relates to a number of assertions pertaining to presentation and disclosure,
e.g.
understandability – is the accounting policy note clearly expressed?
completeness
included?
–
is
all
information
required
for
the
accounting
policy
note
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 255 of 3 pages
**2016**
SUGGESTED SOLUTION TO EXERCISE 11.2
1 Page only
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 256 of 3 pages
1.
True.
2.
False. A strong control environment is very important throughout the business. The control
environment is about a strong control awareness shown by management. A weak control
environment in the inventory and production cycle could lead to extensive losses,
e.g. theft, damage to inventory, inventory shortages resulting in production delays,
as employees will soon realize that management don’t take controls too seriously.
3.
Rights, Valuation, Existence and Completeness.
4.
4.1
Existence: If the theft has not been discovered, no write off of the inventory
stolen will have been made in the perpetual inventory records.
This
means that the records include inventory that does not exist.
4.2
Valuation: Products which are subject to rapid and frequent technological advances
usually become unsaleable very quickly or may have to be sold off at
below cost simply to create cash flow and get rid of the items. From a
financial reporting perspective this will have an affect on the
allowance for obsolete, slow moving inventory (impairment) which is part
of the valuation assertion.
4.3
Rights:
4.4
Valuation: The valuation of imported products can be complicated.
Certain
additional costs need to be included in the determination of the cost of
the product, e.g. freight charges, wharfage, import duties.
These
additional costs often need to be allocated over a range of products and
in addition the correct currency conversion rate must be used. All of
the above affect the cost at which inventory is recorded in the
accounts.
5.1
To show an increased profit through the manipulation of the inventory account, the
company will need to increase its inventory balance at year end.
This can be
achieved by
5.
The acquisition cycle and revenue cycle are directly linked to the inventory cycle.
The acquisition cycle controls the inventory which the company purchases (inflows
into the warehouse).
The revenue cycle controls the sales of the company’s
inventory (outflows from the warehouse). If the company does not know exactly what
is coming in and going out of the warehouse, it will not be able to control its
inventory properly.
As the company does not own the inventory, it does not have the “right”
to include the consignment inventory in its inventory account balance.
*
including fictitious inventory
*
overstating the cost of inventory
*
understating (not recognizing) impairments of inventory.
6.
True.
The basic principle is that inventory must be reflected in the financial statements
at the lower of cost or net realisable value.
IAS permits the adoption of three
cost formulae, specific identification, weighted average and FIFO, but the addition
states that a company may reflect its inventory at standard cost provided that the
standard cost approximates actual cost.
7.
7.1
The auditor will increase his substantive tests as this is the only way he can
gather sufficient appropriate evidence relating to the inventory assertions.
Controls cannot be relied upon.
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 257 of 3 pages
8.
7.2
If the internal controls have been assessed as weak there is no point in testing
them any further. If they don’t work they will not be producing valid, accurate and
complete information and no amount of testing the controls will change this.
7.3
Analytical procedures are substantive in nature, but can only be relied upon to
provide general corroborative evidence.
Analytical procedures are also only
effective where the underlying information on which the procedures are being
conducted is “valid, accurate and complete” which in this instance it is not.
The auditor is testing for completeness. He wants to gather evidence that the inventory
items in the warehouse have been included in the count and will be included in the
inventory balance at year end.
**2016**
SUGGESTED SOLUTION TO EXERCISE 11.1
1 Page only
a)
Documents used in the cycle and use
1.
picking slip
2.
inventory adjustment form
3.
transfer to finished goods note used to record the movement of manufactured items
from the manufacturing department to the finished goods store.
4.
clock cards -
as this is a manufacturing company, the items manufactured will have to be
costed. The clock cards may be used as a basis for allocating the labour
charge.
5.
job card -
a job card is used to track the stages of manufacture for specific job and
record costs, e.g. wages, materials incurred during each stage.
b)
1.
-
used to identify the goods which must be selected (picked)
from the stores to make up an order from a customer.
-
used to record adjustments which must be made to
correct the perpetual inventory records when actual
inventory and theoretical inventory do not agree.
Job costing is suitable where
*
the item(s) being manufactured are unique and have their own specifications
*
small quantities are being manufactured at a time.
If the toys were being mass produced, a process costing system would be
suitable.
more
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 258 of 3 pages
c)
d)
purchase order
-
acquisitions and payments cycle
sales invoice
-
revenue and receipts cycle
supplier delivery note
-
acquisitions and payments cycle
customer remittance advice
clock card
-
revenue and receipts cycle.
payroll and personnel cycle (see 4 above).
1.
control of physical transfer of inventory (in its various forms).
2.
protection of the inventory (in its various forms) from damage, loss or theft.
3.
proper planning, controlling and recording of the costs of manufacture.
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 259 of 3 pages
**2016**
SUGGESTED SOLUTION TO EXERCISE 10.17
Page 1 of 3 pages
Part 1 - (a)
1.
The obligation assertion in respect of trade accounts payable represents that all amounts
included in the balance are actually owed by the company, i.e. they are not the
obligations/debts of any other person or entity.
2.
The existence assertion simply represents that at 29 February 2016 the trade accounts
payable existed (they were not fictitious).
Part 1 – (b)
Yes, Out ‘n About (Pty) Ltd is obliged to have its AFS externally audited (in terms of
the Companies Act 2008 and Companies Regulations 2011) because it has a public interest
score of between 100 and 349 and it compiles its annual financial statements internally.
Part 1 - (c)
Valuation
1.
Agree the list of individual trade creditors balances at 29 February 2016 to the balance
on the trade accounts payable control account.
2.
Agree the control account to the trial balance.
3.
Reperform casts of the trade control account and the corresponding list.
4.
Identify any debit balances on the trade creditors list and establish the reason
therefore (if necessary request that any material balances be transferred to debtors.)
5.
Select a sample of trade accounts payable (including Out n’About (Pty) Ltd’s major
customers) and reperform the creditors reconciliations at 29 February 2016.
5.1
agree opening and closing balances on the reconciliation to the trade
creditors list/creditors account and creditors statement respectively.
5.2
test the logic of the reconciliation.
5.3
reperform the casts.
5.4
inspect the supporting documentation and
confirm the validity of the reconciling items.
by
enquiry
and
confirmation,
Completeness
1.
Compare the list of creditors at 29 February 2016 to the corresponding
28 February 2015, to identify
1.1
creditors on the 2015 list who do not appear on the 2016 list.
1.2
creditors balances which are significantly smaller at 29 February 2016
and by enquiry and inspection, determine the reason.
list
at
2.
For all GRN’s which appear on the “list of unmatched GRNs at year-end”, confirm that a
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 260 of 3 pages
liability has been raised at year-end by inspection of the journal entry.
2.1
confirm that the amounts raised as trade creditors are correct for
each GRN by inspection of the corresponding supplier invoice (if available) or
2.2
where no invoice is available, by inspection of price lists, the
purchase order, or by enquiry of the supplier.
3.
Select a sample of material purchases from the purchase journal for March and trace to
the goods received note for each purchase selected to confirm that
3.1
the GRN number is greater than the GRN “cut off” number.
3.2
the dates on the GRN and supplier delivery note are after the final year-end.
4.
Select a sample of large payments from the cash payments journal for March and, by
inspection of the GRN and delivery notes confirm that, if the payment relates to goods
received or services rendered prior to year-end, the corresponding amount was raised at
the financial year-end as a trade creditor.
5.
Inspect the workpapers relating to the annual inventory count to identify any instances
of physical inventory exceeding recorded inventory i.e. received prior to year-end, but
not recorded (goods received but liability not raised).
**2016**
/continued on page 2
SUGGESTED SOLUTION TO EXERCISE 10.17
Page 2 of 3 pages
6.
Inspect the trade creditors correspondence file for correspondence relating to unsettled
disputes with suppliers, and discuss the need for adjustment with senior personnel .
7.
Inspect the workpaper relating to the results of creditors reconciliation procedures to
establish how disputed amounts are treated, particularly those which appear to reduce the
amount owed.
8.
Inspect the trade accounts payable control account for any unusual debit entries and if
necessary follow up.
9.
Perform analytical procedures and obtain and evaluate reasons for material fluctuations.
10.
Enquire of the accountant as to whether suppliers of services (i.e. no delivery note or
goods received note) have been appropriately raised as trade accounts payable.
11.
Include reference to the completeness
management representation letter.
assertion
for
trade
accounts
payable
in
the
Part 2
My audit senior’s decision that the matter should be ignored, is not acceptable for the following
reasons:
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 261 of 3 pages
1.
In conducting an audit, the auditor should consider all evidence which comes to light.
Because this matter did not arise out of a “specific procedure in the audit programme” or
"from risk assessment procedures" does not mean that it is not important and can be
ignored. A good auditor should be alert to potential errors/misstatements regardless of
the specific procedure being conducted and if the further audit procedures/audit plan has
to be amended it must be amended.
2.
It is not acceptable to ignore an important audit matter on the grounds that to follow it
up may result in the budget for the audit being exceeded. An audit must be conducted in
compliance with the highest levels of independence. To allow the budget to restrict what
should be done will impair that independence, could amount to a restriction in scope and
will result in a substandard audit.
3.
In effect, the trade accounts payable includes an amount of R102 927 which is not an
obligation of Out ‘n About (Pty) Ltd.
It is an obligation of the directors in their
personal capacities and results in an overstatement of approx 6% in the balance.
4.
Even if the directors were authorised to have the company pay for their trip, it amounts
to personal expenditure and should be disclosed as directors emoluments which it hasn’t
been, thus compromising fair presentation.
5.
As auditors we are appointed by, and report to the shareholders, and as we know that the
directors are misleading the shareholders (to whom they have a fiduciary duty) we cannot
ignore the matter.
6.
This matter amounts to a reportable irregularity. (Auditing Profession Act 2005,
45).
Sec
6.1
we are the registered auditors of Out n’ About (Pty) Ltd (year-end audit)
6.2
and we are satisfied/or at least have reason to believe that a RI is taking place
6.3
*
supporting invoices are missing
*
financial director has told the audit senior that the directors went to
the Australian Tennis Open, and intend to cover up this unauthorised
expenditure.
that an illegal act has been committed by persons responsible for the management
of the company
*
it amounts to dishonesty/fraud by the directors and amounts to a breach of
their fiduciary duty to the company and its shareholders
*
in addition it amounts to VAT fraud as the company is claiming VAT on nonbusiness expenditure (personal) expenditure
*
all the directors were
derived the benefit.
**2016**
involved,
they
authorised
the
expenditure
and
/continued on page 3
SUGGESTED SOLUTION TO EXERCISE 10.17
Page 3 of 3 pages
6.4
the illegal act has caused material financial loss to the entity and a creditor
(SARS)
*
the amount cannot be regarded as immaterial as it involves an amount of
R102 927 and penalties (SARS) are also likely to be incurred
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 262 of 3 pages
*
profits have been reduced by including non-business expenditure.
*
SARS will also suffer loss as a result of the company claiming
 non business expenses (reduction of normal tax)
 VAT on non-business expenses.
7.
We cannot ignore our Sec 45 duties which we would be doing if we ignored this matter. If
we not fulfil our AP Act 2005 duties, our firm (designated partner) may suffer serious
legal consequences.
8.
Finally, we cannot ignore this matter because it reflects adversely on the integrity of
the directors. This in turn should lead us to re-consider whether our “risk assessment
procedures” carried out when planning the audit, were appropriate.
It appears that at
this planning stage the directors’ integrity was not in question, but with this matter
having arisen we would need to consider whether material misstatement may be present in
other accounts.
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 263 of 3 pages
**2016**
SUGGESTED SOLUTION TO EXERCISE 10.16
Page 1 of 3 pages
a)
1.
The 3rd party(ies) to be circularized should be selected independently by the
auditor.
2.
The confirmation should be sent by the auditor directly to the 3rd party and
should be returned directly to the auditor by the 3rd party (no client
involvement). Confirmation should be sent timeously.
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 264 of 3 pages
b)
3.
The 3rd party from whom the confirmation is obtained, should be independent of the
client.
4.
The 3rd party providing the confirmation, should be reputable and competent to
confirm the balance.
5.
Information to be confirmed is clear and unambiguous.
I would include:
1.
A selection of creditors with large balances.
Reason.
Confirming large balances provides me with
proportion of the total creditors balance.
evidence
to
support
a
greater
2.
All balances where there has been a material decrease in the size of balance
outstanding compared to prior year.
Reason: We are testing primarily for understatement (completeness).
As the company’s
“output and product range” are reasonably constant, it is reasonable to expect
suppliers balances to be reasonably constant.
3.
All nil balances (including any creditors who have been removed from the
masterfile during the financial year ended 31 March 2016).
Reason: Again we are testing for understatement (completeness).
All suppliers will be
quick to point out any understatement of amounts payable to them.
4.
Any creditor whose record on the masterfile reveals amounts in
outstanding field(s)” older than the “credit limit” field.
Reason: There is a greater likelihood that these accounts may be in dispute.
c)
5.
A (small) random selection of the entire creditors population.
Reason:
The sample should be representative
evidence is to be obtained.
of
the
entire
population
if
“the
days
meaningful
The following information may suggest that creditors are understated:
1.
A significant decline in the year-end balance on the creditors account compared to
the prior year.
2.
The company has a long term loan, one of the covenants of which is that certain
ratios which are influenced by the creditors balance must be maintained at preset
levels if the loan is not to be called up.
3.
The AFS are
application.
to
be
presented
to
a
3rd
party
(bank)
in
support
of
a
loan
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 265 of 3 pages
4.
There have been breakdowns in the acquisitions and payments system towards year
end.
Note:
Any indication that
increases the risk.
the
directors
may
**2016**
manipulate
the
financial
statements
/continued on page 2
SUGGESTED SOLUTION TO EXERCISE 10.16
Page 2 of 3 pages
d)
Valuation
1.
Using the audit software
1.1
2.
Extract and cast a list of individual creditors balances and agree
inspection, to the creditors control account in the general ledger.
it,
by
Using the audit software
2.1
Reperform the cross-cast (days outstanding) on the masterfile.
2.2
Scan the masterfile for “error” conditions e.g. missing account numbers.
2.3
Scan for debit balances, follow up reasons therefore with Lance Pantani
and consider whether the balances should be transferred to debtors.
3.
Reperform casts on the creditors control account.
4.
Scrutinise the creditors control account for unusual (particularly debit) entries and
follow up with Lance Pantani.
5.
Select a sample of creditors reconciliations at 31 March
reconciliations prepared by each of the three clerks) and
5.1
Test logic and reperform casts on the reconciliations.
5.2
5.3
6.
2016
(which
includes
Agree balances (opening and closing) on reconciliations to creditors statements
and list of creditors.
Confirm the validity of the reconciling items by reference to the supporting
documentation, taking particular note of any reconciling items which suggest
understatement of the creditor.
Obtain a list of accruals from the client
6.1
Cast the list.
6.2
Agree the total on the list to the account in the general ledger and draft
financials (where it will have been added to the trade creditors).
6.3
Agree amounts on the list to supporting documentation and reperform calculations
where applicable.
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 266 of 3 pages
7.
1.
2.
Using the audit software, extract a listing of any creditor to whom payment is
outstanding significantly beyond the credit terms granted to Wheelies (Pty) Ltd, and
follow up with Lance Pantani to establish the correct status of the amount (see also pt 5
below).
Completeness
Enquire of Lance Pantani as to any explanations for the material reduction in the
creditors balance compared to the prior year particularly in view of the fact that output
has remained “reasonably constant over the past few years.”
Using the audit software, compare the list of creditors at 31 March 2016 to the prior
year (held on memory stick) to identify
2.1
Creditors on the prior year list which do not appear on the current list.
2.2
Creditors balances which are significantly smaller at 31 March
31 March 2015.
2016 than at
and establish and evaluate the reasons therefore.
3.
Obtain the list of GRN’s awaiting invoices at 31 March 2016 obtained by Gregg Minnaar and
confirm by inspection that for each GRN, the corresponding liability has been raised
3.1
Confirm that the amount raised is correct by reference to the relevant invoice (if
received) or by recomputation of the amount owed using the price and quantity of goods
purchased.
4.
Select a sample of material (large) purchases from the purchase journal for April and
trace to the GRN to confirm that
4.1
The GRN number is greater than X7392.
4.2
The date of the GRN and suppliers delivery note is after the financial year end.
**2016**
/continued on page 3
SUGGESTED SOLUTION TO EXERCISE 10.16
Page 3 of 3 pages
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 267 of 3 pages
5.
Using the audit software, extract a listing of creditors records which have an entry in
the “query” field
5.1
Using the “correspondence reference number” trace to the correspondence and follow
up on the status of disputed accounts with Lance Pantani.
6.
Refer to the results of the positive creditors circularization to identify any creditors
who do not agree with the amount owed to them and follow up by reference to the creditors
reconciliations and Lance Pantani.
7.
Select a sample of material payments made subsequent to 31 March 2016 and by inspection
of the dates on the corresponding GRN and supplier delivery note, confirm that if receipt
of the goods or service took place prior to year end, the corresponding creditor was
raised at 31 March 2016.
8.
Inspect Gregg Minnaar’s working papers relating to the inventory count for any instances
where physical inventory materially exceeded theoretical inventory (this may indicate
purchases have been received but not raised).
9.
Determine whether all accruals have been correctly raised by
10.
9.1
Inspecting the general ledger accounts for monthly (regular) expenses e.g. power and
water, rent, insurance, for 12 entries.
9.2
Comparison
of
consistency.
Perform analytical
fluctuations e.g.
the
current
procedures
on
year
the
and
prior
creditors
year
balance
lists
and
of
follow
accruals
up
on
for
material
10.1 Comparison of “ageing” current year to prior year
10.2 Comparison of current year purchases and creditors to each other and prior years.
11.
Enquire of Lance Pantani, review prior year workpapers/minutes of management meetings to
establish whether suppliers of services which are not accounted for through the normal
purchases system, and for which there are amounts outstanding, have been raised as
creditors. (There is often no “normal” documentation for services e.g. no purchase order
or goods received note.)
12.
Include specific reference to the
Accruals” in the management letter.
completeness
assertion
for
“Trade
Creditors
and
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 268 of 3 pages
**2016**
SUGGESTED SOLUTION TO EXERCISE 10.15
Page 1 of 3 pages
PART A
a)
1.
Some risk at financial statement level exists as it is in the interests of the company to
present the financial statements at 30 April 2016 in the most favourable light. They are
applying to the bank for additional finance, and this finance is dependent on the company
achieving specified working capital ratios.
There is a risk that the financial
statements could be manipulated in various ways to produce a “favourable financial
picture” of the company.
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 269 of 3 pages
2.
As most management positions/directorships in this family owned business are held by
members of the family, if the directors wish to manipulate the financial statements they
could easily do so.
3.
However, the following factors mitigate (reduce) the risk of manipulation
3.1
the company is successful and appears unlikely to
financial statements to obtain the necessary finance.
have
to
“manipulate”
its
3.2
there is a strong control environment which suggests that the directors follow
ethical business practices and that they have integrity.
3.3
the directors have the incentive and the opportunity to (fraudulently) manipulate
the financial statements, but their integrity and success (attitude) make
manipulation unlikely.
b)
1.
Despite our assessment of “overall risk” (see (a) above) being low, we would still need
to take note of the following factors which could increase the risk of material
misstatement in trade creditors
1.1
the trade creditors balance of R9 267 914 is considered to be material in the
context of the business; it could therefore contain misstatement material enough
to affect fair presentation.
1.2
the balance at 30 April 2016 is approximately 22% lower than it was at 30 April
2015. This is an indicator that trade creditors may have been understated.
1.3
trade creditors is an account heading which directly affects the working capital
ratios so would be an account heading which might attract manipulation.
1.4
the company has (substantial it appears) foreign creditors.
This slightly
increases risk as foreign currency translation of creditors at year end may be
inappropriately applied unintentionally or intentionally.
c)
1.
2.
Once the order clerk has compiled the file of purchase orders it will be available on the
system to be accessed by Polly Clarkson for approval
1.1
on completion of the file the order clerk will select, say, “approval requested”
option and a message will appear on Polly Clarkson’s screen alerting her that the
file is ready.
1.2
the approval function will be linked to Polly Clarkson’s user profile.
1.3
the order clerk will not have approval privileges, e.g. his screen will either
have no “visible” approve option for him to select or the option will be shaded
and will not respond if clicked on.
Polly Clarkson will access the file (read only) and
2.1
check each order against supporting documentation e.g. purchase requisitions.
(The supporting documentation may be “physical” or on the system) to the extent
she considers necessary.
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 270 of 3 pages
2.2
confirm that there is an order for all items on the purchase requisition report
and that no additional items were ordered.
3.
Polly Clarkson will not have write access to the purchase order file and any changes she
might require will have to be made by the order clerk; the file will be “transferred”
back to him and the necessary changes communicated to him. Once the changes have been
made, the approval process is repeated.
4.
Once the purchase order file has been approved by Polly Clarkson, no changes can be made
to it by the order clerk.
5.
Again, once the approval option is selected by Polly Clarkson, a message will be sent to
the order clerk (on screen). He will then execute the order by phone, email or fax.
**2016**
/continued on page 2
SUGGESTED SOLUTION TO EXERCISE 10.15
Page 2 of 3 pages
d)
I would expect to find the following :
Validity
1.
All additions of suppliers are recorded on pre-printed, sequenced masterfile amended
forms (MAF)
2.
A comprehensive evaluation of the supplier, e.g. reliability pricing, quality of goods is
conducted by senior personnel, including Polly Clarkson before the supplier is approved.
3.
Independent confirmation of the suppliers banking details is obtained
4.
MAF is:
4.1
cross referenced to supporting documentation
4.2
authorised (signed) by Polly Clarkson and a second senior employee
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 271 of 3 pages
5.
6.
Logical access to the masterfile amendment module is restricted to
5.1
a limited number of personnel by the use of user Id’s, user profiles and passwords
5.2
(possibly) a single terminal on the network (by the use of terminal profiles).
All masterfile amendments are automatically logged by the computer on sequentially
numbered logs, i.e. date, time, terminal, user ID, sequential MAF number and amendment
details
6.1
only “read only” access to the logs is given (see 7 below)
7.
Logs are frequently and regularly reviewed by an independent senior employee who must
confirm that all logged amendments are supported by authorized MAFs
8.
Unused MAFs are subject to strict stationery controls
PART B
General Procedures
1.
Inspect the Racketman (Pty) Ltd statement to confirm that
1.1
the statement balance is R592 876
1.2
the statement date is 25 April 2016
2.
Inspect the Racketman (Pty) Ltd account in the creditors ledger to confirm that the
balance is R348 460
1.
Review the Racketman (Pty) Ltd account in the creditors ledger for any unusual or
unexplained entries (and if necessary, follow up with creditors personnel)
2.
Reperform
4.1
the casts of the reconciliation and the Racketman (Pty) Ltd account in the
creditors ledger
4.2
the logic of the reconciliation (i.e. amounts have been correctly added or
subtracted)
5.
Inspect the Racketman (Pty) Ltd’s May statement to confirm that the necessary adjustments
for reconciling items have been made by Racketman (Pty) Ltd e.g. correcting invoicing
error.
6.
Review Sporting Life (Pty) Ltd’s receiving records for any goods received by the company
from Racketman (Pty) Ltd between the 25 and 30 April 2016
Electronic transfer
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 272 of 3 pages
1.
Inspect Sporting Life (Pty) Ltd’s April bank statement to confirm that
1.1
an amount of R134 533 was transferred to Racketman (Pty) Ltd
1.2
the transfer was effected before 30 April 2016
**2016**
/continued on page 3
SUGGESTED SOLUTION TO EXERCISE 10.15
Page 3 of 3 pages
Invoice number 7493
1.
Confirm by inspection of Racketman (Pty) Ltd’s April statement, that invoice 7493 was
1.1
1.2
2.
included in the balance of R592 876
for an amount of R76 913.
Inspect the dates (of acceptance) on the Racketman (Pty) Ltd delivery note and
corresponding Sporting Life (Pty) Ltd goods received note to confirm that delivery only
took place on 7 May 2016 and not prior to 30 April 2016.
Goods returned note 1017
1.
Inspect correspondence from Racketman (Pty) Ltd, acknowledging that it is responsible for
the damage to the racquets and that they will pass a credit note for the full amount.
2.
Inspect Racketman (Pty) Ltd’s April statement to confirm that invoice 7216 was
3.
2.1
included in the balance owing of R592 876
2.2
for an amount of R46 290.
Inspect goods returned note 1017 to confirm that it
3.1
was signed by an official of Racketman (Pty) Ltd, acknowledging receipt of the
returned goods
3.2
was for damaged tennis racquets as supplied on invoice 7216.
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 273 of 3 pages
4.
Confirm with the audit manager that these racquets were not included in inventory at year
end.
Error invoice 7001
1.
Inspect invoice 7001 to confirm that the balls were charged at R14.80.
2.
Inspect original order for the rugby balls (or official supplier price list to confirm
that the correct price of the rugby balls is R148.00, not R248!).
3.
Reperform the calculation (100 x R133.20) to confirm the amount of the adjustment.
4.
Inspect correspondence notifying Racketman (Pty) Ltd of the mistake and requesting that
the correct invoice be submitted.
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 274 of 3 pages
**2016**
SUGGESTED SOLUTION TO EXERCISE 10.14
Page 1 of 3 pages
Opening balance
1.
Agree the opening balance on the creditors control account of R2 372 119 to the interim
audit work papers and April closing balance.
2.
Confirm by inspection of the audit work papers that there were no adjusting entries
required as a result of the April interim audit (none have been put through).
3.
Cast the account and confirm the calculation of the balance carried down.
Purchases 25 May and 25 June
1.
Trace the postings of May and June purchases from the purchase journal (PJ83 and 89) to the
creditors control account to confirm the accuracy of the amounts posted.
2.
Select a small sample of purchases for May and June from the purchase journal and for each
purchase in the sample
2.1
Inspect the order form to confirm that it is signed by Bob Bass and that it is
2.2
For goods sold by the company.
2.3
Inspect the relevant supplier’s delivery note to confirm that
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 275 of 3 pages
2.4
*
it is cross-referenced to the official order
*
it is signed by Gordon Watts acknowledging acceptance
*
the goods accepted agree with the details on the order.
Inspect the relevant GRN to confirm that
*
it is cross-referenced to the supplier’s delivery note
*
supplier, description and quantities agree with the delivery note and the order
*
it is signed by Gordon Watts to acknowledge that he has carried out the control
procedures.
2.5
Inspect the suppliers invoice to confirm that it corresponds with the details on the
GRN.
2.6
Reperform any casts, extentions and calculations on the invoice.
2.7
By inspection, confirm that the invoice amount has been correctly entered in the
purchase journal and posted to the correct account.
Purchases cut-off
1.
Compile a list of all GRNs from the file held by Gordon Watts in respect of goods received
in the period 26 June to 30 June and sequence test the list for any missing documents.
2.
With the help of Paula Yawa, and by reference to orders and any supplier invoices which may
be available, establish the amount which should be raised in the creditor’s control
account. (These purchases were made prior to year end.)
3.
For say, the last ten GRNs made out prior to 25 June, confirm by inspection of the
supporting documentation and purchase journal that the corresponding supplier invoices for
the goods received were included in the purchase journal for June.
4.
For say, the first ten GRNs made out after the 30 June, inspect the supporting
documentation, particularly the dates on the supplier delivery notes to confirm that the
goods were actually received after the 30 June.
5.
Enquire of Paula Yawa as to whether she has any GRNs (other than included in 1 and 3 above)
which have not been matched to invoices.
6.
Request Clarence Carter to raise any creditors identified above and inspect the journal
entry for accuracy once it has been passed.
Payments 31 May and 30 June
1.
Select a small sample of payments from the cashbook.
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 276 of 3 pages
2.
For each item in the sample
2.1
Obtain the supplier’s statement
prepared by Mavis March.
supporting
the
payment
**2016**
and
the
reconciliation
/continued on page 2
SUGGESTED SOLUTION TO EXERCISE 10.14
Page 2 of 3 pages
2.2
Confirm the opening and closing balances on the reconciliation to the creditors
statement and creditors ledger respectively.
2.3
Follow up on any reconciling items by tracing to the supporting documentation.
2.4
Test the logic of the reconciliation and reperform the casts.
2.5
Trace the payment to the authorised (signed by Clarence Carter) EFT listing agreeing
the amount and details of the payee to the list.
2.6
Trace the payments to the relevant bank statements to confirm that they were
processed through the bank timeously. (This can be easily achieved by on line access
to Wetfoot (Pty) Ltd’s bank account with the assistance of the client.)
Closing balance
1.
Once any adjustments required to the creditors control account have been made (e.g. journal
entry note 1), agree the balance on the account to the creditors ledger (masterfile) and
the trial balance.
General
1.
Enquire of the personnel involved in the cycle as to whether there are any breakdowns in
internal control or unusual occurrences in the cycle during May and June.
Journal entries
1.
Reversal – note 1
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 277 of 3 pages
2.
1.1
Inspect the correspondence and documentation including the goods returned note 61 to
confirm the return of the boots and the acceptance thereof by Fishfeet CC (signature
on the goods returned note).
1.2
Inspect the January purchase journal and March EFT listing (cash book) to confirm
that the purchase of and payment for the boots are included at an amount of R62 693.
1.3
If so, request Clarence Carter to reverse this entry from the creditors control
account.
Fishfeet CC is in fact a debtor for this amount.
The amount should be
included as a debtor and evaluated for recoverability.
Reversal – note 2
2.1
3.
4.
By reference to the goods
DairyBoots (Pty) Ltd and
returned
note
63,
obtain
the
original
invoice
from
*
confirm by inspection of the attached GRN and delivery note that the goods were
received by Wetfoot (Pty) Ltd prior to 25 May and
*
that the amount of the purchase of R48 460 was recorded in the purchase journal
(probably April or May)
*
confirm that the description and quantity of the goods returned (per the goods
returned note) agrees with the invoice.
2.2
Inspect the goods returned note to confirm that DairyBoots (Pty) Ltd signed the note
acknowledging acceptance of the goods returned.
2.3
Inspect any credit note or correspondence issued subsequent to 25 May acknowledging
the credit of R48 460.
Goods returned note – number 62
3.1
Enquire of Gordon Watts (or other personnel) as to the whereabouts of goods returned
note 62. 61 and 63 are accounted for and reflected in the creditors control account,
so what was note 62 used for or was it cancelled?
3.2
Confirm the explanation given by seeking substantiating evidence,
document was cancelled, inspect and record the cancelled document.
e.g.
if
the
Discounts – notes 3 and 4
4.1
**2016**
By discussion with Mavis March/reference to correspondence and the audit work papers,
determine the terms and conditions of the early settlement arrangements with these
suppliers.
/continued on page 3
SUGGESTED SOLUTION TO EXERCISE 10.14
Page 3 of 3 pages
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 278 of 3 pages
4.2
5.
By reference to the cashbook/EFT payment documentation, determine to which purchases
the payments relate, and by inspection of the supporting documentation, particularly
dates of delivery and dates of payment, confirm
*
that the payments qualified for the early settlement discount
*
the total amount of the discount is correctly calculated at R21 208 and R18 219.
4.3
Confirm by inspection of the journal entry that appropriate VAT adjustments have been
made.
4.4
Inspect any credit notes issued
supplier of the discount taken.
by
the
suppliers
to
confirm
acceptance
by
the
Reversal – note 5
5.1
By inspection of the purchase order, confirm that the price entered on the order form
was R101 906.
5.2
By inspection of the supplier invoice, confirm that the amount charged in respect of
this order was R137 125.
*
inspect the order, supplier delivery note, GRN and invoice to confirm that the
description and quantity of the boots agree and that only the price charged
differs.
5.3
By inspection of the May purchase journal, confirm that the amount of R137 125 was
included (not the lesser amount of R101 906).
5.4
Determine by discussion with Clarence Carter and inspection of any relevant
correspondence whether Mud and Manzi (Pty) Ltd have been notified that Wetfoot (Pty)
Ltd will not pay the amount and if so, what the supplier’s reaction was.
5.5
Record the details of the matter in the “overs and unders/queries” schedule for
review by the audit manager.
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 279 of 3 pages
**2016**
SUGGESTED SOLUTION TO EXERCISE 10.13
Page 1 of 2 pages
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 280 of 3 pages
a)
b)
1.
The control environment within a cycle will be determined by the attitudes, awareness
and actions of management with regard to the controls within the cycle.
Obviously
the overall “control tone” of Lighttime (Pty) Ltd will affect the cycle, because the
cycles of a business do not operate in isolation.
2.
The fact that all employees are issued with ethical guidelines specifically tailored
to their functions, is a clear indication that management takes “control” seriously.
Furthermore the fact that transgressions are dealt with appropriately and that there
have been no transgressions over (at least) the past year, suggests that employees in
the cycle understand, accept and comply.
This is positive as regards the control
environment.
3.
By implementing on-going training, management is demonstrating its commitment to
competence in the cycle.
This is likely to translate into employees understanding
and performing their functions more effectively and being more control conscious.
Being better trained means employees understand the controls they are responsible for
and the risks the controls address and are therefore more likely to be “control
aware”. To train personnel is a sound human resource practice and usually results in
a happier work environment which employees will not want to jeopardise.
4.
It would appear that managers/senior personnel set a good example in their operating
style. Pete Peters, the factory manager and Dave Parker the creditors manager, carry
out their “approval” functions “carefully and meticulously”.
This reflects strong
control awareness and will encourage those employees who report to them to apply the
same control awareness in carrying out their duties.
5.
The cycle is organised in a manner which promotes a strong control environment, with
good segregation of duties, clear lines of reporting and appropriate assignment of
authority and responsibility.
Isolation of responsibility
1.
The factory clerk signs the purchase requisition to acknowledge his responsibility
for carrying out the functions underlying the preparation of the document (manual).
2.
Pete Peters signs the purchase requisition to isolate his responsibility for
approving the purchase requisition.
This implies that he has taken responsibility
for performing the approval procedures (manual).
3.
The responsibility for on screen approval of purchase orders is isolated to Dave
Parker by restricting this privilege to his user profile.
(Provided Dave Parker
keeps his password confidential, only he can approve purchase orders.) Note: there
will be a contingency plan if he is not at work.
Segregation of duties
1.
The functions within the cycle are segregated e.g. ordering, receiving, etc (manual).
2.
Within each function, incompatible functions are segregated e.g. initiation of the
purchase order, preparing the purchase order and approval of the purchase order
(manual).
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 281 of 3 pages
3.
The use of “dongles” and passwords segregates the payment of creditors from other
functions in the cycle e.g. preparation of the payment schedule.
Note: other duties are also separated by the effective use of user IDs, passwords and
user profiles which as described above, also facilitate isolation of responsibility.
c)
1.
Access to the “prepare purchase order module” should be restricted to Clive Crawley,
the order clerk.
This is achieved by the use of user IDs, passwords and user
profiles.
2.
Access to the “approve purchase order” function will be restricted to Dave Parker
3.
2.1
this privilege will be assigned only to his user profile and what appears on his
screen will be linked to his profile, e.g. he will have an approve icon which he
will select when he wishes to approve a purchase order.
2.2
likewise Clive Crawley’s screen will either not display an approve icon or the
approve icon will be shaded and will not react when clicked.
Once Clive Crawley has compiled the file of purchase orders he will select and click
on the appropriate icon (e.g. “continue”) and a message will be sent to Dave Parker’s
terminal alerting him to the fact that the file is ready for his approval.
**2016**
/continued on page 2
SUGGESTED SOLUTION TO EXERCISE 10.13
Page 2 of 2 pages
4.
d)
Dave Parker will access the purchase order file and carry out any checks he deems
necessary
4.1
he will have access to the hardcopy requisitions and
inventory masterfile to facilitate his approval function.
read
access
to
the
4.2
he will not have write access to the purchase order file and any changes he
might wish to make will have to be referred back to Pete Peters for approval and
correction by Clive Crawley the order clerk.
4.3
if he is satisfied with the purchase order file he will select and click on the
approve icon (see 2 above).
5.
Once Dave Parker has clicked on the approve icon, no changes to the file will be able
to be made by the purchase order clerk or anyone else.
1.
In an EFT payment system as operated by Lighttime (Pty) Ltd, the information which
facilitates payment by EFT will be held on the creditors masterfile, and the schedule
of payments will be compiled from this information
1.1
if an employee wishes to make a payment to a fictitious creditor, the creditor
will have to be added to the creditors masterfile. So if controls of amendments
to the masterfile are not strictly maintained, the risk of invalid payments
being made is considerably increased.
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 282 of 3 pages
e)
1.2
the bank details of the creditor will determine the account into which the
transfer is made so again if, for example, the bank details of an existing
creditor on the masterfile can be fraudulently changed, the risk of invalid
payments is again considerably increased if strict controls over masterfile
amendments are not operating.
1.3
one of the most important and effective masterfile amendment controls is access
control particularly write access.
2.
The actual transfer of funds is instantaneous (not so with cheque payments) so
failure to control the payment “at source” i.e. the creditors masterfile can have
very serious consequences as there is no opportunity to intervene once the bank has
received the payment instruction.
1.
As described in the question, the bank’s EFT software is loaded only on a limited
number of terminals (Jake Lekota and Cyril Regis).
2.
The entry of the employees user ID and password will be sufficient to get the
employee to the bank’s webpage (but no further).
3.
The entry of an additional PIN number (provided by the bank) and unique password by
the employee will provide access to the company’s bank account
3.1
this additional PIN will only be made available to the employees who need access
to the bank account to perform their function.
4.
Once access has been gained to the bank account, a menu of the functions available
will be displayed and the access which is given to the employee will be linked to the
employees user profile.
For example, at this stage the cashbook clerk, having
identified and authenticated herself successfully may be authorised by her user
profile to download bank statements but not authorised to do anything else.
5.
To make an EFT payment, an additional authentication procedure is required and in the
case of Lighttime (Pty) Ltd this procedure is achieved by requiring the employee to
insert the “dongle” in the USB port of the employee’s terminal. This is in effect an
additional
password
which
works
in
conjunction
with
the
employees
other
identification and authentication requirements
5.1
the privilege of being able to gain access to this payment function will again
be given to only those employees who need this access.
(A limited number of
“authorising” senior employees.)
5.2
the “dongle” will be registered to the specific employee and will only operate
on a terminal which has the bank’s software loaded on it.
5.3
all PINs, and passwords must be kept confidential and the dongle must be used
solely by the employee to whom it is given and must be kept safe at all times.
6.
There should be automatic shutdown of the site after three unsuccessful attempts to
access the bank account.
7.
As a detective measure, attempts at unauthorised access to this function (and the
bank account itself) should be logged and followed up.
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 283 of 3 pages
**2016**
SUGGESTED SOLUTION TO EXERCISE 10.12
Page 1 of 3 pages
Weakness 1
There is a lack of division of duties between the initiation of the order and its execution.
1.1
Explanation 1
The buying officers decide what to order without the authority of a signed requisition
from the warehouse and they place the order.
1.2
This means that a buying officer can place an order fraudulently (e.g. order goods
for himself).
Weakness 2
There is no sound basis for the placing of orders e.g. no reorder level or quantity, no sales
projection data etc.
2.1
2.3
Explanation 2
When deciding what inventory to purchase, the buyers simply look at the quantity on hand
on the perpetual inventory. There is no guidance on which to base the quantity of toys
to be ordered or whether a particular toy should be ordered at all.
2.2
This is inefficient management of the company’s resources i.e. tying up funds in
excess inventory and potential loss from redundant/obsolete inventory.
It may also lead to the failure to order enough inventory resulting in lost sales.
2.4
As there is no reconciliation between physical inventory on hand and the
masterfile there may be no physical inventory and a quantity reflected in the masterfile.
Hence no order may be placed when an order is necessary.
Weakness 3
Orders placed are not authorised by the senior buyer Goliath Booysen.
Additions to the preferred supplier masterfile are not authorised by Goliath Booysen.
Explanation 3
As Goliath Booysen does not see the orders before they are sent, there is no check that they are
for goods for the company, from an approved supplier. This combined with weakness 2 makes it
even easier for an employee to place an invalid order.
Weakness 4
Access to the local area network at systems level is inadequate.
Explanation 4
The use of a general password to get onto the network amounts (almost) to uncontrolled access.
This weakness at systems level weakens access to applications on the network, in this case
acquisitions and payments.
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 284 of 3 pages
Weakness 5
Access at application level is inadequate which severely weakens (failure to apply need to
know/minimum entry principle)


5.2
division of duties
isolation of responsibility.
Explanation 5
5.1
All employees in the “ordering” and “receiving” functions of the acquisition cycle
have access to all the modules in the application by virtue of a common password.
In effect, this means that at least nine employees are able to

initiate an order

place an order

effect a masterfile amendment e.g. add a supplier and in the case of the receiving
clerks

gain easy access to the goods ordered and amend the records.
5.3
The above substantially increases the risk of invalid purchase transactions
occurring.
For example, a receiving clerk could easily place an order for goods for
himself, receive the goods, steal them, amend the inventory records if necessary, and
have the company pay for the goods.
**2016**
/continued on page 2
SUGGESTED SOLUTION TO EXERCISE 10.12
Page 2 of 3 pages
Weakness 6
Poor programming/application design results in the need for employees to enter extensive
information which is already in the database (failure to apply minimum entry principle).
Explanation 6
When creating a purchase order, although the format comes up on the screen, the buyer must still
enter all the details pertaining to the supplier and the goods to be ordered. In principal the
minimum amount of information e.g. quantity and product number should have to be entered.
Information already on the database should automatically be included. This enhances the accuracy
and completeness of the order being placed as fewer keying in errors will be made e.g. incorrect
descriptions, product numbers etc.
Weakness 7
The receiving clerk checks what has been delivered against the suppliers delivery note only, not
against the purchase order.
Explanation 7
7.1
Adjusting the supplier delivery note for discrepancies between the goods delivered and
the supplier delivery note but not for discrepancies with the purchase order will result
in the company accepting (and ultimately paying for) goods in excess of what they ordered
or which they did not order at all.
7.2
As the inventory masterfile is updated by what was actually received and the
“pending order field” is cleared, the buyer will not know if there has been an over or
under supply of what he actually ordered.
7.3
Short deliveries will not be addressed as no comparison is made between what was
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 285 of 3 pages
actually ordered and received.
Weakness 8
There is no checking or acknowledgement of receipt of the goods when they are moved from the
“receiving department” to the warehouse (poor isolation of responsibilities).
Explanation 8
As the boxes are placed in the cage to be dealt with by warehouse staff when they have time,
there is a period when nobody has responsibility for the goods; if discrepancies are discovered
the goods receiving clerks can simply say they put the goods in the cage and the warehouse staff
can say the goods were not put in the cage, i.e. were not in their custody.
Weakness 9
Nobody counts/checks the contents of boxes for quantities and goods actually delivered and nobody
checks for damaged goods.


The receiving clerk checks only to the details on the side of the box.
When the toys are unpacked from the boxes in which they are delivered, the warehouse
packers do not check what has actually been received against any documentation before
the goods are packed away on the shelves.
Explanation 9
As Toy-Toy (Pty) Ltd does not know exactly what toys they actually received they will in all
likelihood


10.2
be paying for goods they never received/are damaged.
have very poor inventory records which will result in losses through inefficient
inventory management.
Weakness 10
10.1
As in weakness 6, poor application/programme design results in the receiving clerk
having to enter data that is already on the system when they create the goods received
note.
The receiving clerk has complete control over the information that is entered onto the
system as

he does not simply update authorised information already on the system and

nobody checks that the details on the GRN agree with the supplier delivery note.
**2016**
/continued on page 3
SUGGESTED SOLUTION TO EXERCISE 10.12
Page 3 of 3 pages
10.1
Explanation 10
Again the less information that has to be entered, the less errors of accuracy and
completeness will arise. This will result in fewer problems in the functions which flow
from the GRN e.g. inventory record maintenance and payment to creditors.
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 286 of 3 pages
10.2
In respect of weakness 9, significant fraud is possible by the simple entry of
fictitious (invalid) information, e.g. the receiving clerk can make out a completely (or
partially) fictitious GRN, arrange for a fictitious invoice/statement to be sent to ToyToy (Pty) Ltd by a fictitious supplier and share the ensuing payment to the supplier.

Making this type of fraud even easier, is the lack of access controls and division of
duties as explained in weakness 5.
Weakness 11
Controls of masterfile amendments are inadequate.
Explanation 11
As

at least nine employees have access to the masterfile amendment module of this
application and as

Goliath Booysen does not authorise additions of suppliers and

there does not appear to be any documentation (MAF) to support amendments and

there is no review of logs of masterfile amendments for accuracy, completeness and
validity by an independent manager,
any number of employees could make invalid amendments to facilitate fraud.
Weakness 12
The lack of supervisory and managerial controls results in a poor control environment.
Explanation 12
As neither Goliath Booysen nor any other members of the management get involved in the activities
described, employees will before long realize that they can do precisely as they please,
including engage in fraudulent activities for their own benefit.
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 287 of 3 pages
**2016**
SUGGESTED SOLUTION EXERCISE 10.11
Page 1 of 2 pages
Weakness 1
No investigation is made into whether the parts to be purchased appearing on the printout are
actually required, or that the re-order quantity is appropriate
Explanation 1
Re-order levels and quantities are guidelines only and placing an order on the strength of a
theoretical balance (from the perpetual inventory) without checking the actual inventory
position, may result in overstocking or inventory shortages
Weakness 2
Gilbert Simoni retains no record of the “requisitions” he has generated (it is a single part
printout)
Explanation 2
The printout is the initiating document (start of the audit trail) and without a copy, Gilbert
Simoni will not be able to respond to any queries or defend himself if any problems arise, e.g.
Bob Marli mislays the only copy and never places the order (see also 9)
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 288 of 3 pages
Weakness 3
Before placing the order, Bob Marli does not confirm availability, delivery dates or prices with
the supplier (Note: prices may be checked at the invoicing stage)
Explanation 3
Despite the fact that the company uses only approved suppliers, it is still necessary to confirm
at least that the goods are available and the date on which they will be delivered. Failure to
do so could result in production delays, lost sales, etc
Weakness 4
Access to the local area network (access at systems level) is inadequate.
Explanation 4
Access can be gained by the use of a general password which in addition, is reasonably obvious,
i.e. the name of the company. Uncontrolled access at systems level weakens control over access
at application level.
The chance of unauthorized access to the acquisitions and payments
applications is thus increased
Weakness 5
Access at application level, e.g. to all modules of the acquisitions and payments, including
masterfile amendments for both the supplier masterfile and the inventory masterfile, is
inadequate
Explanation 5
5.1
Again, there is a general password which is known to a number of employees
5.2
5.3
Entry of this general password provides the employee with access to any module of the
application . Anyone, including those with incompatible functions, who has the password
could, for example

initiate an invalid order

add an unauthorized supplier to the masterfile
It appears that access can be gained from any terminal (whichever screen ….)
All of the above increase the risk of unauthorized access and hence invalid “transactions
/ amendments” being effected. Division of duties and isolation of responsibilities are
significantly weakened, e.g. Bob Marli could probably order goods for himself from a
supplier he has added to the masterfile (see also weakness 8)
Weakness 6
Bob Marli is required to key in extensive information (much of which is already on the system)
when initiating the order
Explanation 6
Having to key in data already on the system is inefficient and could lead to errors being made
(if for example, the entry of the part number automatically brought up the description of the
part, fewer errors in picking and invoicing would occur or if the supplier code brought up all
the supplier’s details, there would be fewer incorrect deliveries, invoicing errors).
Weakness 7
Pieter Tosh (or other supervisory staff members) does not check the POs against the printout
requisition
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 289 of 3 pages
**2016**
/continued on page 2
SUGGESTED SOLUTION EXERCISE 10.11
Page 2 of 2 pages
Explanation 7
As no independent check is carried out
7.1
unintentional errors on the PO will not be detected, resulting in the purchase of
incorrect items or quantities
7.2
items requisitioned may be omitted from the PO
7.3
unauthorised purchases (not on the requisition) can easily be made by Bob Marli (see
weakness 8) or anyone else with the necessary password
Weakness 8
Family members perform two important functions in the same cycle (weakens division of
duties)
Explanation 8
Collusion between family members may be more easily facilitated. In this case, Bob Marli could
provide a “valid” purchase order and Ziggi Marli could intercept the goods and prepare the GRN as
normal, resulting in the company paying for the goods stolen by the Marli’s
Weakness 9
The printout (requisition) from Gilbert Simoni is thrown away, further destroying the audit trail
Explanation 9
Once the document is thrown away, it will not be possible to follow up on any authority for a
particular purchase or resolve any “requisitioning” queries, e.g. were all items requisitioned,
actually purchased
Weakness 10
There is a lack of division of duties in the process of approving suppliers, adding them to the
supplier masterfile and adding part details to the inventory masterfile, i.e. too much authority
vested in Pieter Tosh; in addition there is insufficient documentation supporting these changes.
Explanation 10
10.1
as Pieter Tosh initiates and executes the decision to add a supplier, and the part
details and
10.2
as he retains/controls the evidence (logs) thereof, and
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 290 of 3 pages
10.3
as there is no masterfile amendment form documenting the amendment, no independent review
or authorization takes place, of
*
the decision to add a supplier (validity) or
*
the actual entry (accuracy and completeness) i.e. no independent review of the log,
he, Pieter Tosh could easily add a supplier which serves his own personal interests, to the
detriment of the company, e.g. his own company, arranging kickbacks etc, resulting in Clearcut
(Pty) Ltd paying more for parts than they should, holding excess inventory, etc
Weakness 11
A general lack of supervisory and managerial controls results in a poor control environment
Explanation 11
At no stage are any checks carried out on the functions performed by Gilbert Simoni, Bob Marli or
Pieter Tosh, resulting in virtually a total lack of involvement by senior personnel.
These
employees, as well as others who will soon notice the lack of attention to control, can do as
they please.
Note: It may be considered that the production and distribution of hard copy POs is a weakness
as all the necessary information could be accessed on the network. For example, when a delivery
is made by a supplier, Ziggi Marli could simply access the purchase order on the system rather
than retrieving the hard copy PO from the pending file.
**2016**
SUGGESTED SOLUTION TO EXERCISE 10.10
Page 1 of 3 pages
a)
1.
Our firm is not responsible for the prevention and detection of fraudulent acts by
2nd Part (Pty) Ltd.
2.
In terms of international auditing standards (ISA 240, 300, 330) the auditor has
2.1
a duty to identify and assess the risk of material misstatement as part of
planning the audit.
This includes the identification and assessment of
the risk of both intentional (fraud) and unintentional (errors)
misstatements.
2.2
a duty to develop an audit strategy (scope, timing and direction) and
audit plan (nature, timing and extent of testing) which will reduce the
risk to acceptable levels.
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 291 of 3 pages
3.
b)
1.
As 2nd Part (Pty) Ltd is in a business sector where there is trafficking in stolen
goods, our firm should probably regard this as a significant risk and would
therefore have a duty to consider special audit attention to ensure that the risk
is adequately addressed by for example:
3.1
assigning the right level of experience and technical competence to address
this difficult risk
3.2
keeping the audit team up to date and informed about the risks and what to
look for
3.3
adopting a high level of professional skepticism.
The risk of unauthorised access in a networked environment increases because
1.1
the
computer
equipment
(terminals/workstations/servers)
are
“geographically” spread out making physical access to the system far more
difficult to control, e.g. LAN’s do not make use of terminal rooms which
can be physically secured to prevent unauthorised access.
1.2
c)
in a network resources are shared by many users.
Thus there are many
“points of entry” or “links” to data and programs through which
unauthorised entry can be gained resulting in an increased risk of
manipulation, destruction or theft of data.
Validity (occurrence and authorization)
1.
Amendments should only be made
masterfile amendment forms (MAF).
on
the
strength
of
pre-printed,
sequenced
2.
Every MAF should be signed by two senior employees after
supporting documentation arising from the approval process.
scrutiny
of
the
3.
Write access to the approved supplier masterfile should be restricted to a
designated employee independent of the buying department, by means of user
profiles/password. Note: access could be restricted to a designated terminal but
is more commonly achieved through attaching privileges to the employee.
4.
The computer should record all masterfile amendments on sequenced logs (no write
access to the file).
5.
The logs should be regularly (and frequently) reviewed by the senior buyer and
Bernard Bunz. Both should only have read access.
Logs should be
5.1
sequence checked (validity and completeness) and
5.2
matched to supporting documentation for authorisation.
Accuracy and Completeness
1.
Program controls should be used to ensure the accurate and complete entry of data
from the masterfile amendment
1.1
mandatory field, e.g. MAF reference number
1.2
alphanumeric check e.g. on postal code
1.3
screen formatting and dialogue
1.4
sequence test on last MAF entered
1.5
automatic generation of new supplier account number.
2.
When logs are reviewed (see (5) above) the details of the amendment should also be
checked for accuracy against the supporting documentation.
**2016**
/continued on page 2
SUGGESTED SOLUTION TO EXERCISE 10.10
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 292 of 3 pages
Page 2 of 3 pages
d)
I would expect the following controls to be in place:
1.
2.
3.
4.
Access controls
1.1
write access to the "receiving goods module" restricted to the 3 receiving bay
clerks by user IDs, passwords linked to user profiles.
1.2
access to the receiving goods module restricted to the terminal in the receiving
bay.
1.3
receiving clerks would not have write access which would enable them to change
details on the "on screen" GRN e.g. add an item ordered.
Valid orders only
2.1
only goods for which there is a valid purchase order should be accepted.
Receiving clerk to enter the purchase order number for the delivery (taken from
the supplier delivery note). If no number is entered or an incorrect number is
entered no purchase order details will appear on the screen and the receiving
clerk will not be able to compile a goods received note. (Receiving clerks will be
under strict instructions not to accept deliveries for which there is no purchase
order.)
2.2
this is a matching/validation control; the system matches the purchase order
entered to the file of purchase orders on the system.
If there is a match the
screen will come up formatted as a GRN.
Isolation of responsibility
3.1
isolating which of the
achieved by the system
*
logging the user ID of the receiving clerk accessing the "receiving goods module"
to enter the purchase order number
*
having the receiving clerk sign the hard copy GRN he produces to accompany the
goods to Quality Check.
receiving
clerks
received
the
delivery
can
be
Accepting the correct goods (quantity and description)
4.1
5.
three
the receiving clerk will count the goods and compare what has been delivered to
the suppliers delivery note and purchase order
*
items not on the purchase order should not be accepted
*
short deliveries accepted over deliveries rejected
*
all discrepancies should be noted on the supplier delivery note and
acknowledged by both the receiving clerk and the suppliers delivery personnel.
Compiling the GRN accurately and completely
5.1
screen formatting and minimum entry.
On entering a valid PO number the screen
should come up formatted as a GRN and all fields should be populated.
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 293 of 3 pages
e)
1.
5.2
receiving clerk should have write access to only the quantity field and a field to
record the supplier delivery note number.
This will prevent alterations to the
goods ordered.
5.3
alphanumeric check on the quantity field (must be numeric), and the quantity field
would be mandatory. Supplier delivery note number could also be mandatory.
5.4
screen dialogue if say, quantity field entered differs from quantity field on the
system.
Occurrence
I would inspect the supporting documentation to confirm that
1.1
all documents are present i.e. requisition, order, goods received note, supplier
delivery note, supplier invoice and that they reflect 2nd Part (Pty) Ltd as the
customer.
1.2
all documents are correctly cross referenced and that the details agree, e.g.
goods ordered per the order agree with the requisition and the delivery note.
1.3
the order is supported by a requisition which has been signed by the warehouse
manager.
1.4
the supplier delivery note has been signed by one of the three receiving clerks
and the delivery address is that of 2nd Part (Pty) Ltd.
1.5
the internal documents (e.g. order) and external documents (e.g. delivery note).
1.5.1 relate to the same supplier and to one which
1.5.2 appears on the approved supplier masterfile.
1.6
all documents are “stamped” and signed to indicate that control checks on the
document have been carried out.
1.7
the goods purchased are of a type which is sold by 2nd Part (Pty) Ltd.
**2016**
/continued on page 3
SUGGESTED SOLUTION TO EXERCISE 10.10
Page 3 of 3 pages
Accuracy and cut-off
1.
I would, by reperformance, confirm that casts and extentions on all relevant
documents have been checked for arithmetical accuracy, and that VAT and/or
discounts have been correctly treated.
2.
By inspection of the requisition confirm that the price charged on Crash ‘n Smash
(Pty) Ltd’s invoice is as agreed with the warehouse manager.
3.
I would, by inspection of the dates on the goods received note, delivery note,
confirm that the transaction fell within the year under audit and that all dates
on the documents are reasonable in relation to each other.
4.
By inspection of the purchase journal I would confirm that the entry was for the
total amount of R17 620.14 and that VAT (if applicable) had been correctly
allocated.
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 294 of 3 pages
**2016**
a)
1.
If a company does not implement sound control procedures over its ordering
of goods function, the following risks may arise:
1.1
Incorrect goods may be ordered (quantity or type).
1.2
Goods of inferior quality, resulting in obsolescence, sales returns, etc, may be
ordered.
1.3
Unnecessary goods may be ordered resulting in wastage/ obsolescence, cash flow
problems.
1.4
Orders may be placed fraudulently by buyers or others, resulting in payment by the
company for goods never received or used by the company.
1.5
The company paying unnecessarily high prices either because competitive prices are
not sought, or because of fraud, e.g. buyers taking bribes or kickbacks.
1.6
Requisitions from stores, manufacture or sales departments not acted upon
(timeously or at all) by the ordering department resulting in production delays, lost
sales due to items being “out of stock”.
1.7
Orders placed, not timeously acted upon or not acted upon by suppliers resulting
in the same problems as in 1.6.
1.8
Order forms misused e.g. to facilitate private purchases by employees, for
which the company will ultimately pay.
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 295 of 3 pages
**2016**
/continued on page 2
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 296 of 3 pages
b)
Recommendation
Reasons
1.
1 and 2. Splitting the “receiving” and “dispatch” areas, and ensuring
they are access controlled and secure will reduce the risk of fraud and
theft in the receiving function of the cycle e.g. it will be harder to
steal goods by sending them out on a delivery vehicle instead of
transferring them to the warehouse.
The “receiving/dispatch” area should be split into separate
areas, one for “receiving” and one for “dispatch”.
2.
Both should adjoin the warehouse but should be secure and access
controlled from the warehouse and each other.
3.
Each of the seven warehouse assistants should be allocated to a
specific function, either “receiving”, “dispatch” or “custody of
inventory in the warehouse”, and should be restricted to that
function. (The allocation will have to be done once an analysis of
each functions requirement has been carried out).
3. This will enhance division of duties between these three functions
and improve isolation of responsibilities. This will in turn reduce
the risk of theft and fraud in the cycle.
4.
The purchase order documentation should be re-designed to
include an additional copy of the purchase order which is headed
“Goods Received Note” (multi-part stationery) and this copy
should be sent to the receiving department with the copy of the
purchase order which is already sent to the warehouse.
(Note: If the single copy of the purchase order is used as a GRN,
“receiving” will have no documentation to refer to at a subsequent
time, e.g. to resolve a query).
4.1
It is unacceptable that goods are received from a supplier
without being checked by the receiving staff as this facilitates
theft, acceptance of incorrect goods, damaged goods, short
deliveries etc, as it becomes impossible to isolate the point at
which theft occurred, goods were damaged or went missing.
4.2
Writing out a GRN causes the delay and providing a prepared GRN
(which will provide details of the supplier and lists the goods
ordered) will facilitate the proper checking of goods promptly
and efficiently.
4.3
Not having to write out a GRN in detail will result in more
accurate and complete receiving documentation.
5.
The warehouse assistant (now a receiving clerk) should compare
5. The intention of this control is to compare what was received to
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 297 of 3 pages
Recommendation
the goods actually received to the purchase order/GRN and
supplier delivery note not just against the supplier delivery
note, in addition to checking that the delivery is for a valid
order.
5.1 Discrepancies should be clearly marked on the purchase order/GRN
and supplier delivery note.
6.
When the goods are moved from the receiving area, one of the
custody assistants (see point 3) above must check the goods he is
taking custody of against the GRN and sign the GRN to acknowledge
the transfer.
**2016**
Reasons
what was ordered so that
5.1
invalid orders will be identified
5.2 incorrect deliveries (quantities and type) will be identified
5.3 goods on the order but not delivered at all are identified.
6. This control makes use of the division of duties created by
splitting the receiving, dispatch and custody and isolates
responsibility for the goods at all times.
/continued on page 3
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 298 of 3 pages
c)
1.
Jean Senna should present Manual Pettit with all the documentation supporting each
creditor’s payment on the list given to Manual Pettit, e.g. order, GRN, supplier
delivery note, invoice. (Note: the creditors list is in effect the cheque
requisition.)
2.Before making out the cheques, Manual Pettit should agree the creditor’s details
and amount on the list to the supporting documentation for completeness, accuracy and
validity.
3.Manual Pettit should “stamp/initial” the supporting documentation in such a
manner that it cannot be presented in support of another (fraudulent) payment.
4.
Note:
The cheques plus their supporting documentation should be passed to a second
signatory who should again validate the payment against the supporting
documentation before signing the cheque.
He or she should also “stamp/initial”
the supporting documentation.
An acceptable alternative might be for Jean Senna to prepare the cheques.
(Pts 2 to 4 would still be carried out) but this is probably outweighed by the benefit of
having the cheque book kept under tight control.
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 299 of 3 pages
**2016**
SUGGESTED SOLUTION TO EXERCISE 10.8
Page 1 of 2 pages
Weakness 1:
The control environment is poor.
As has been proved by the theft, Jody
Shektar has an almost naive approach to internal control (he would know if
“anything strange” was going on). In addition, the general lack of management
implementing controls and being control orientated (e.g. documents presented
to support payments are incomplete and not properly scutinised by
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 300 of 3 pages
signatories),
important.
conveys
to
employees
that
internal
control
is
not
that
Recommendation 1:
1.1
The company’s internal control systems should all be evaluated and
redesigned where necessary.
1.2
Management should be informed of the importance of internal
controls, the reasons for specific controls, and the specific purposes of the controls.
They should realize that they need to lead by example and should be monitored.
The
importance of control awareness should be emphasized.
1.3
Louis Hamilton should be dismissed from the company and criminally
charged. This conveys to other employees that dishonesty will not be tolerated.
Weakness 2:
2.1 Insufficient documentation is presented to Jody Shektar.
the transfer.
2.2
There is only one signatory on the Bank Transfer Form to authorise
2.3
Jody Shektar signs the transfer without properly scrutinizing the
invoice or the Bank Transfer Form especially for important details such as the payee
account number.
To accept that PMR CC is an “acceptable” name for PimpMyRide is just
naïve!
2.4
Jody Shektar does not initial/stamp/cancel the invoice so that it
cannot be presented again for payment.
Recommendation 2:
2.1
Documentation presented in support of a bank transfer
should include the invoice, supplier delivery note, goods received note and purchase
order.
*
the transfer should be made out to the full name of
the supplier as it appears on the supplier invoice.
*
all of the above should be matched and checked by
the creditors clerk before they are presented to the signatories. The
creditors clerk should use a grid stamp and acknowledge the checks she
has carried out by initialing the grid.
2.2
Another authorised signatory, either Alonso or Mokoena
should be required to sign the bank transfer form. (All payments by cheque and transfer
should have a common signatory plus a second signatory).
2.3
Before signing the bank transfer, the signatories should
scrutinize the supporting documentation carefully, agreeing the payee and amount, and
confirming (from some other source) that the payee account number is valid.
2.4
The first signatory should sign/stamp/cancel the supporting
documentation before passing the documents to the second signatory who must follow the
same procedure.
Weakness 3:
Louis Hamilton prepares the bank transfer form which is then returned to
him to effect. This gave him the opportunity to make the fraudulent changes
(additions).
Recommendation 3:
It would be better internal control for the creditors department to prepare
all payments to creditors.
In the future, once the transfer form has been
properly authorised it can be returned to the new accountant (Louis Hamilton’s
replacement), to take to the bank.
**2016**
/continued on page 2
SUGGESTED SOLUTION TO EXERCISE 10.8
Page 2 of 2 pages
Weakness 4:
4.1
Cheque payments are also inadequately supported when
presented for authorization.
4.2
Again there is only one signatory, and this signatory
performs inadequate checks (checking the cheque against the cheque requisition proves
very little).
Recommendation 4:
4.1
As with bank transfers, the full pack of supporting
documentation should be presented to the signatories after the creditors clerk has
carried out the necessary controls (see 2.1 above).
4.2
All cheques should have two signatories (see 2.2) and
signatories should carry out control procedures as indicated in 2.3 and 2.4
Weakness 5:
5.1
There is a weakness in the division of duties between
making payments and writing up the cash payments journal.
(Louis Hamilton was able to
misallocate the bank transfers to hide the theft).
5.2
There is inadequate supervisory control/review over the
cash payments journal.
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 301 of 3 pages
Recommendation 5:
5.1
As we recommend that the creditors section prepare all
payments, the new accountant should be responsible for writing up the cash payments
journal (and cash receipts journal) from all the supporting documentation.
*
account allocations should be entered on the cheque
requisition/bank transfer when they are prepared, not left up to the
accountant.
5.2
The bank reconciliation should be performed by a staff
member other than the accountant.
5.3
The cash book (CPJ and CRJ) and reconciliation should be
reviewed each month and any unusual entries followed up e.g. abnormal amounts, strange
payee names, long outstanding cheques.
5.4
Particular attention should be paid to the validity of bank
transfers.
Weakness 6:
The accountant appears to be able to open and make use of suspense
accounts in the general ledger, without supervision.
Recommendation 6:
Although suspense accounts are necessary at times, their use should be
restricted
*
any opening of a suspense account should be authorised by
the senior financial employee and
*
suspense accounts must be closely monitored i.e. posting to
suspense accounts should be authorised and amounts in the suspense account regularly
followed up until they are resolved.
**2016**
SUGGESTED SOLUTION TO EXERCISE 10.7
Page 1 of 3 pages
1.
Question 1 - sequencing
1.1
Numerical sequencing is very important as it provides each document with a
unique number which identifies the specific document.
2.
1.2
The number also enables the document to be cross-referenced to other documents in
the cycle e.g. a purchase order and a goods received note.
1.3
The numerical sequence also enables employees (and auditors) to “sequence test”
documents to identify any missing documents.
Question 4 – stationery controls
2.1
All blank documents should be kept under lock and key.
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 302 of 3 pages
2.2
staff member.
Access to the documents (the key) should be restricted to a responsible
2.3
Requests for the issue of documents should be recorded on a requisition
signed by the head (senior member) of the section/department requesting the documents.
2.4
description
register.
2.5
On issue, the number sequence of the documents being issued and a
e.g. purchase orders 1050 to 1999, should be entered in a stationery
The register should be signed by the stationery custodian and the recipient.
2.6
On a (reasonably) regular basis, blank documents
reconciled with the stationery register by an independent employee.
2.7
3.
on
hand
should
be
Orders placed with the printers of the company’s documentation should be authorised
by senior personnel (two) and the printer should be informed that no printing of
Perky Pets (Pty) Ltd’s stationery should be done without an authorised order, under
any circumstances.
Question 6 – preset levels
3.1
Preset levels are theoretical and are based on a number of factors, e.g.
lead times, demand, etc.
3.2
4.
The factors used to calculate them can change e.g. demand for a product may have
significantly reduced since the levels were set.
To avoid overstocking (or
understocking!) the most current information should be obtained. Preset levels are
only indicators.
Question 8 – purchase order
4.1
The receiving department is sent a copy of the order so that
* they can prepare to receive the delivery
* they can determine that the delivery results from an authorised order and thus can
be accepted.
* they can compare what is being delivered to what was ordered (quantity and
description), thus identifying any over/under or incorrect goods deliveries.
4.2
The creditors department is sent a copy of the order so that they can match the
supplier invoice, GRN to the original order before payment to the creditor is
authorised. This assists in preventing invalid payments.
4.3
With regard to filing the purchase order in alphabetic order, this may assist with
some queries, but it would not enable important sequence controls such as
identifying missing orders, to take place. In this instance it is far more useful
to work with a numerical sequence.
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 303 of 3 pages
4.4
Most queries will be linked to the unique document number, so it is far quicker to
locate the order documents if they are filed in numerical sequence.
**2016**
/continued on page 2
SUGGESTED SOLUTION TO EXERCISE 10.7
Page 2 of 3 pages
5.
*
*
Question 11 – senior buyer authorisation
5.1
The intention of this control is to reduce the risk of
invalid orders being placed e.g. the buying clerk purchasing goods for himself.
inaccurate or incomplete orders being placed e.g. incorrect descriptions or incorrect
item codes being used or quantities being omitted.
* incorrect prices being entered (agreed to) on the purchase order and
* orders being placed with non-approved suppliers e.g. the buying clerk placing
orders with his friend’s business (at an inflated cost).
5.2
It is partially an example of isolation of responsibility – when the
senior buyer signs the purchase order, he/she becomes accountable for the placing of the
order, and any errors or irregularities can be traced back to him.
5.3
6.
It is primarily an example of division of duties i.e. between “authorizing” the
transaction and “executing” it.
Question 13 – goods received note
6.1
Firstly, it is important to have an internally generated document to
provide an audit trail for every purchase transaction.
6.2
The goods received note records what was actually received, which is not
necessarily what is on the supplier delivery note.
6.3
The GRN enables accurate perpetual inventory records to be maintained.
6.4
It also provides the creditors department with a document to reconcile what was
actually received from the supplier, with the suppliers invoice before payment is
authorised.
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 304 of 3 pages
6.5
7.
Suppliers delivery notes obviously come from different suppliers so will have
different number sequences. Creating an internal sequenced document (GRN) provides
the benefits of sequence testing.
Question 15 – transfer to stores
7.1
Deliveries from suppliers should be moved from the receiving area (bay)
into the custody of the warehouse as promptly as possible to minimize the risk of theft
(or damage) to these goods, e.g. goods could be sent out on another supplier’s truck
(theft by collusion).
7.2
The transfer of the goods to the warehouse is in effect a transfer of the
custody of an asset.
7.3
8.
Therefore the recipient in stores should check what he is accepting before signing
the GRN, because by signing the GRN, he acknowledges the transfer of the
responsibility for the goods to the warehouse and hence that ”warehouse” is
accountable for the goods.
Question 18 – purchase invoices
8.1
The purchase invoice will be matched to the purchase order, goods received
note, supplier delivery note.
8.2
The creditors section will match
* supplier name, document numbers
* quantity and description of goods
* prices and discounts
per the purchase invoice to the supporting documentation.
**2016**
/continued on page 3
SUGGESTED SOLUTION TO EXERCISE 10.7
Page 3 of 3 pages
*
8.3
In addition, the creditors section will
confirm that the amounts on the invoice have been allocated to the correct ledger account
e.g. consumables, stationery.
* test all casts, VAT calculations etc.
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 305 of 3 pages
9.
Question 22 – signing powers
9.1
It is not really an isolation of responsibility control although the
signature does make the signee accountable.
9.2
The two signature control is primarily an access/custody control designed
to protect a company asset i.e. the company’s bank account.
9.3
It may be easier to have six authorised signatories (two to sign) but it
significantly increases the risk of cheque fraud, as access to the bank account is
given to more individuals.
9.4
In addition, where there is no common signatory, supporting documentation
could be presented to two different sets of signatories, to fraudulently have the
same amount paid twice.
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 306 of 3 pages
**2016**
SUGGESTED SOLUTION TO EXERCISE 10.6
1 Page only
1.
substantive test – valuation of creditors.
2.
risk assessment procedure – understanding the entity including internal controls.
3.
test of controls - only approved suppliers added to the masterfile.
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 307 of 3 pages
4.
test of controls – only authorised purchases for the company are made.
5.
risk assessment procedure – understanding the entity.
6.
risk assessment procedure – understanding the internal controls.
7.
test of controls – controls over validity and accuracy of payments to creditors.
8.
substantive test – valuation of creditors.
9.
test of controls – only goods in respect of and in terms of valid orders accepted.
10.
risk assessment procedure – (identifying related parties) but could also be a substantive
procedure relating to related party disclosures.
11.
risk assessment procedure.
12.
substantive test – completeness of creditors.
13.
substantive test – cut-off of purchase transactions (may also relate to completeness of
creditors).
14.
risk assessment procedure.
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 308 of 3 pages
**2016**
SUGGESTION SOLUTION TO EXERCISE 10.5
1 Page only
1.
My fellow trainee has little understanding of the assertions.
2.
He seems unaware that there are (three) different categories of assertion namely,
transactions and events, account balances and presentation and disclosure, and he doesn’t
know what the assertions are.
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 309 of 3 pages
2.1
occurrence is an assertion applicable to transactions and not to account balances.
2.2
measurement is not an assertion at all (so it is not surprising that he doesn’t
know what it means).
2.3
materiality is not an assertion.
2.4
fair presentation is not an assertion (but is linked to the presentation and
disclosure assertions in a sense).
3.
Although completeness is an assertion applicable to account balances, the trainee does
not know what it means.
It has nothing to do with “orders placed by year end” and
actually means that all trade accounts payable that should have been recorded at 31 March
2016, have been recorded.
4.
Although existence is an assertion applicable to account balances, the trainee has got
its meaning wrong.
It does not assert that the trade accounts payable are not
understated.
The assertion means that the trade accounts payable existed at 31 March
2016 (they are not fictitious).
5.
Obligation is an assertion applicable to trade accounts payable.
It asserts that the
amounts owed reflected in the trade accounts payable balance, represents obligations of
Croxley (Pty) Ltd (i.e. obligations of other persons or entities are not included). The
trainee is probably muddled between obligation and occurrence!
6.
The other assertion which the trainee has missed is valuation. This assertion means that
the trade accounts payable of R7 211 313 is included in the financial statements at an
appropriate amount.
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 310 of 3 pages
**2016*
SUGGESTED SOLUTION TO EXERCISE 10.4
1 Page only
1.
1.2
2.
2.1
3.
3.3
4.
4.4 (division of duties)
5.
5.3
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 311 of 3 pages
6.
6.4
7.
7.2
8.
8.1
9.
9.3
10.
10.3
11.
11.2
12.
12.3
13.
13.3
14.
14.4
15.
15.4
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 312 of 3 pages
**2016**
SUGGESTED SOLUTION TO EXERCISE 10.3
Page 1 of 2 pages
1.
1.1
To operate efficiently a company must have inventory available when it is needed,
e.g. to fill a sales order or to supply manufacturing. There must be a “mechanism”
or procedure which alerts the storeman to the fact that an order must be placed for
an inventory item and which guides the storeman on deciding the quantity which he
should request the ordering department to purchase.
1.2 One way of achieving these two objectives is for a company to assign a “re-order
level” and a “re-order quantity” for each inventory item and to enter these figures on
the perpetual inventory records for each item.
1.3 When the quantity field for an item in the perpetual inventory records drops to the
re-order level, the storeman will be alerted to the fact that an order must be placed.
1.4 The re-order quantity and re-order level will have been carefully worked out by
management taking into account such things as expected demand for the product,
supplier’s lead times, the needs of manufacture and possibly even quantity discounts.
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 313 of 3 pages
1.5 For re-order quantities and re-order levels to be effective, there must be some way of
alerting the storeman to the fact that the re-order level has been reached. This is
best achieved by having a computerised perpetual inventory system which can be
programmed to print out a daily (weekly) report of inventory items which have reached
their re-order levels and which also shows the re-order quantity.
2.
The reasons are :
2.1 Because the cycle deals with the payment of creditors, it is in effect, the cycle
which deals with the outflow of funds. The processes are all in place to create the
outflow so if these processes are not strictly controlled, invalid payments can
occur. For example, setting up an electronic funds transfer to pay creditors is very
common and is a quick and easy way to do business. However, if the EFT process is
not strictly controlled, invalid payments can empty the bank account very quickly!
2.2 The cycle is fertile for corruption.
Tender fraud, bribing of buyers, pricing
arrangements, are all a means of doing this.
2.3 The cycle must also deal with the transfer of goods between the purchasing company
and the supplier. This is regarded as a very weak link in the cycle as the risk of
collusion between receiving and delivery personnel, is in the real world, very high.
The most common application of collusion is for the receiving clerk to “sign”
(receive) for a full delivery, but only actually take say 80% of the goods off the
delivery truck. The remaining 20% of the items are sold by the supplier’s delivery
personnel and the proceeds split with the receiving clerk.
3.
3.1 True, but only in conjunction with user profiles.
3.2 A menu is simply a list of applications/modules/functions which are available on the
system. The access of a particular user can be controlled usually in one of two ways

Either only the applications/modules/functions to which that user needs access to
do his job and which are specified in his user profile, will appear on the screen
for him to “click on” (obviously if the module does not appear on his screen, he
can’t click on it), or

all available applications etc. will appear but the ones to which the user is to
be allowed access (in terms of his user profile), will be highlighted or will be a
different colour. If the user clicks on a non-highlighted or different coloured
module, nothing will happen.
3.3 Segregation of duties is achieved by denying the user access to the modules which are
incompatible.
For example, the buying clerk can create a purchase order by being
granted access to the “create order module” but would be denied access to the
“masterfile amendment module” which would prevent him from adding an invalid supplier
to the approved supplier (creditors) masterfile.
The menu which appears on his
screen would prevent this in the manner explained above.
**2016**
/continued on page 2
SUGGESTED SOLUTION TO EXERCISE 10.3
Page 2 of 2 pages
4.
Completeness – the risk that the trade creditors balance will be understated.
5.
5.1 This is an application control not a general control. An application control is a
control activity which takes place in a specific cycle, i.e. the acquisitions and
payment cycle. It is not an overall control relating to the system at large.
5.2 This is a detective control.
A log is a record of what the computer has already
processed.
The log is checked subsequently to see if any amendments which are
unauthorised, inaccurate, etc., have been made.
6.
6.1 Identify : Moey Banton must enter his “user ID”.
valid user ID “registered” on the system.
The system will check that it is a
6.2 Authenticate : Moey Banton must enter his unique password. The computer will again
check that it is a valid password as registered on the system, and that it matches to
Moey Banton’s user ID.
The system is “confirming” that the person who entered the
user ID is actually the person who entered it.
(Only works if password is kept
confidential.)
6.3 Authorise : Moey Banton’s user profile, which will have been carefully “constructed”
to give him access on a “need to know/least privilege” basis, will authorise the
access be granted. The user profile will be linked to the user ID and password of
Moey Banton.
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 314 of 3 pages
7.
True.
Requiring that two employees sign a cheque is a control activity implemented to
protect the company’s bank account from unauthorised withdrawal.
In a sense the
signatories are the custodians of the company’s bank account.
8.
In an EFT system the principle is applied by requiring that two employees are required to
effect an EFT payment.
8.1 One employee must authorise the payment and a second employee must
payment before the transfer is made.
release the
8.2 The ability to authorise and to release are restricted to each of those employees by
their user profiles (and use of passwords).
In other words a payment cannot be
effected before it has been authorised and released by the employees individually.
9.
Dongles and random number generators are additional physical devices which a bank will
supply to the employees of a client who are responsible for making EFT payments.
9.1 A dongle is a device which is inserted into the USB port of the terminal from which
the EFT will be effected when the payment is to be authorised and released.
9.2 The dongle communicates with the bank’s software on the terminal and acts like a
physical “password”. No dongle inserted, no transfer.
9.3 Each dongle is unique to the employee to whom it has been registered on the system
and like any password it must be kept confidential.
9.4 A random number generator is a device which operates on exactly the same principle.
Each employee (or at least one) of the employees who “authorise” or “release” EFT
payments will have a random number generator uniquely registered to him on the
system.
9.5 When activated by the employee, the device produces a once off number which the
employee must enter on the system (along with his usual unique password) to fulfil
his function in the EFT process. No “random number” password, no transfer.
9.6 The random number generator is the responsibility of the employee and must not be
lent to any other employee.
10.
Collusion. The “two signature principle” whether applied in a cheque payment system or
an EFT system relies on a division of duties (authorise and release) between the two
employees.
If, for example, the second “signatory” agrees knowingly to “release” an
invalid cheque or EFT or provides the other employee with his password etc, the principle
breaks down. (The two parties have colluded to make an invalid payment.)
**2016**
SUGGESTED SOLUTION TO EXERCISE 10.2
1 Page only
a) and b)
1.
Receiving. Reason: to confirm that the delivery is in respect of a valid order from
Plateglass (Pty) Ltd before the goods are accepted.
2.
None of the functions listed. Takes place
order.
3.
Receiving. Reason: to provide proof/evidence that a short delivery took place for which
Plateglass (Pty) Ltd cannot be charged, and to have the supplier’s
representative acknowledge the validity and accuracy of the recording
of the short delivery.
in
the
warehouse
department
to
initiate
an
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 315 of 3 pages
4.
Ordering. Reason:
to reduce the risk of the company being supplied inferior goods at
unreasonable prices and not as required (timeously) to avoid
subsequent loss of sales/reduced profits.
(Note: this control does
not prevent the order clerk from placing an order with a non-approved
supplier as it would in a computerised system which will usually be
programmed to prevent a purchase order from being made out for a
supplier not on the creditors masterfile.)
5.
Ordering. Reason:
the requisitions are filed numerically so that they can be
subsequently sequence checked for missing requisitions and crossreferenced to the purchase order so that when sequence testing takes
place the buying clerk can determine whether there are any
requisitions for which an order has not been placed.
(These
procedures could also take place in the warehousing department where
the requisition was initiated.)
6.
Recording of Purchases. Reason: to determine that the invoice is in respect of goods
which were officially ordered and received before raising
the liability.
7.
Receiving. Reason:
to create an internal document to record exactly what goods were
received from the supplier and to isolate the responsibility of the
receiving clerk for receiving the goods.
8.
Ordering. Reason:
to
notify
the
accounting
department
classification of the purchase.
9.
Actual payment and recording. Reason: to reduce the risk of unauthorised withdrawals from
the bank account (Custody).
10.
Payment preparation. Reason:
as
to
the
correct
to ensure that payments are made only to “genuine”
creditors. It is a control which contributes to the
prevention of fraud.
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 316 of 3 pages
**2016**
SUGGESTED SOLUTION TO EXERCISE 10.1
1 Page only
(a)
(b)
Department
Document
1.
Administration (warehouse)
1.
Inventory
requisition (generated)
2.
Buying/ordering
2.
(generated)
Purchase
order
Inventory requisition (used)
3.
Receiving
3.
note (generated)
Goods
Purchase order (used)
Supplier delivery note (used)
4.
Accounting
4.
Cheque
requisition (generated)
Customer invoice (used)
received
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 317 of 3 pages
Goods received note (used)
Customer delivery note (used)
Purchase order (used)
(c)
1.
Inventory requisition (generated in the warehouse to initiate the process
of purchasing inventory)
2.
Purchase order (placed by buying department in response to the inventory
requisition)
3.
Supplier Delivery Note (accompanies goods sent by supplier)
4.
Goods Received Note (made out by Steelworks (Pty) Ltd receiving personnel
on delivery of the goods ordered by the supplier)
5.
Purchase Invoice (sent by supplier indicating amount owed)
6.
Cheque Requisition (made out by the creditors clerk at Steelworks (Pty) Ltd to
initiate payment of creditor)
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 318 of 3 pages
**2016**
SUGGESTED SOLUTION TO EXERCISE 9.14
Page 1 of 2 pages
a)
Justification for adopting prior year plan
1.
The approach has been used (successfully) in prior year audits and no major changes
in the cycle have taken place. (The audit was efficiently and effectively carried
out).
2.
The combination of tests of controls and substantive tests which this strategy
adopts, is suitable in the case of Canned Heat (Pty) Ltd as it will provide
reasonable assurance that wages paid and recorded throughout the year were valid,
accurate and complete.
3.
There are a number of characteristics which support this plan
* internal controls are regarded as generally satisfactory (so they can be tested
for reliance and are likely to produce reliable data).
*
the availability of reliable data for 4 divisions and a number of cost
centres, makes analytical procedures effective for gathering substantive evidence.
* monthly production (and therefore the wage expense) is reasonably constant;
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 319 of 3 pages
fluctuations from our base period should therefore be easily identifiable and easy to
follow up making use of the period-to-period reconciliation.
4.
Selecting the base week in May means that the bulk of the work will be done prior to
year end, which contributes to the deadline being met.
5
There is nothing to suggest that the assessment of risk of misstatement in the
wage expense has increased from the previous year.
We can therefore assume that
adopting the prior year audit plan for further audit procedures will be
acceptable for the current year audit.
b)
To ensure that there are no fictitious employees on the payroll for the selected wage
period, I will
1.
select a random sample of employees from the payroll and for each employee
* inspect the documentation in the employee’s file, e.g. employment contract,
identity document, tax registration, etc, and agree the details to the payroll
* perform a physical verification of the employee by visiting his cost centre (or
similar) and confirming his existence by inspection of the staff identity tag in
conjunction with confirmation from the foreman.
* inspect (April) returns to outside entities for whom deductions have been made
from employees (e.g. medical aid, pension fund) for the inclusion of employees in
the sample.
2.
Agree the details of any employees added or removed from the selected payroll
to the corresponding masterfile amendment and other supporting documentation, to
ensure that the amendment agrees with the date of appointment or resignation.
3.
Use audit software to scan the employee masterfile for any “error” conditions which
may indicate fictitious employees, e.g.
* duplicate or missing identity numbers
* duplicate or missing tax reference numbers
* duplicated bank account numbers.
If any such “conditions” are identified, they will be followed up.
c)
For a sample of employees selected from the payroll, I will
1.
Trace the normal and overtime hours recorded for each employee on the payroll, to
the employee’s clockcard for the week
* reperform the “hours worked” calculations on the clockcard and agree them to the
payroll
* inspect the clockcard (or similar) for authorization of the overtime worked.
2.
Confirm that the hourly wage rate used for each employee is correct in terms of
his grade and is authorized in terms of a notification in the employee’s
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 320 of 3 pages
personnel file or a general agreement with the trade union if applicable.
3.
Confirm by enquiry of the personnel manager, and inspection of the company policy
document/trade union agreement (or similar) that the overtime pay rates used are
valid.
4.
Compare all deductions made, e.g. PAYE, medical aid, pension fund,
contributions
to the appropriate tables/regulations, to confirm that the correct deductions (and
company contributions where applicable) have been applied.
**2016**
/continued on page 2
SUGGESTED SOLUTION TO EXERCISE 9.14
Page 2 of 2 pages
d)
e)
5.
Confirm by inspection of approved supporting documentation, that all non-standard
deductions made from employees, e.g. loan repayments, garnishee orders, are valid.
6.
Reperform the calculations, casts and extensions of the payroll as appropriate.
7.
Trace the net amount of wages paid to the individual employee, to the list of EFT
payments made/bank statement, and agree the total of the EFT payments for wages to
the total of the net wages paid for the period. (The same would be done for the
deductions etc. paid to third parties).
1.
The analytical procedures will consist primarily of comparisons of the base period
wage amounts with the other 25 wage periods for the year.
2.
Any abnormal fluctuations will be followed up by reference to the period to period
reconciliations for evidence to support any major reconciling items will be sought.
3.
Using our audit software the wage employee masterfile will be stratified, and
summarized wherever possible to make comparison more meaningful, e.g. wages for each
two week wage period by division, cost centre, grade, etc.
Fraud
1.
We as the auditors have no responsibility to prevent fraud; this is the
responsibility of the management of Canned Heat (Pty) Ltd, (they are responsible for
internal control).
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 321 of 3 pages
2.
In terms of the detection of fraud, we have the responsibility of planning and
performing our audit in such a manner that the risk of material fraud going
undetected is acceptably low. This requires that
*
at the planning stage we conduct risk assessment procedures which will
enable us to identify and assess the risk of material misstatement of the wage expense
and that
* we respond to our assessed risk by conducting further audit procedures (audit
plan) which will reduce the risk of material misstatement going undetected to an
acceptable level
* we adopt an attitude of professional skepticism when conducting wage tests
* we ensure that all members of the audit team working on the audit, understand the
potential risk of fraud in the wage cycle.
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 322 of 3 pages
**2016**
SUGGESTED SOLUTION EXERCISE 9.13
1 Page only
As physical verification is
employees), I would select
part
of
testing
for
occurrence
of
salaries
(i.e.
fictitious
1.
All employees who have the same bank account number as another employee – abnormal so would
want to physically verify such employees (note : there may be valid account sharing e.g.
husband and wife).
2.
All employees for whom there is
2.1
no tax reference number
2.2
no identity number
all employees should have these.
3.
A sample of employees appointed during the year (using the date of employment field). This
sample could be verified by reference to the supporting documentation in the employees’
files e.g. engagement contract etc, to provide evidence supporting the existence of the
employee. (These employees could be included in the sample for physical verification.)
4.
A list of employees for whom there is both a date of employment and a date of resignation
within the financial year under audit. This list would be verified against the employee’s
records to gather evidence that a genuine appointment and resignation etc took place, e.g.
engagement contract, notice of termination.
This supplies some evidence that fictitious
employees are not being added to and taken off the masterfile for short periods as part of
a wage fraud.
5.
Any employees whose names and identity numbers or taxation numbers are identical.
been deliberately listed twice.
6.
A random sample after stratification by grade (and possibly office size) of the entire
population. This would be used to physically verify employees in the sample.
May have
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 323 of 3 pages
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 324 of 3 pages
**2016**
SUGGESTED SOLUTION TO EXERCISE 9.12
Page 1 of 3 pages
EXPECTED CONTROLS OVER THE PAYROLL SYSTEM AT HAY SIXTEEN (PTY) LTD.
MASTERFILE AMENDMENTS
Validity
1.
Pre-numbered masterfile amendment forms (MAF’s) should be completed in
respect of each proposed amendment.
2.
There should be segregation of duties and isolation of
responsibility within the Human Resources department, such that:
2.1
one of the assistants, say Ian Patty, should be responsible for custody and
completion of all MAF’s
2.2
the other assistant, say Kim Robbits, should be responsible for
entering all masterfile amendments onto the employee system.
3.
All MAF’s should be properly authorised before being entered onto the
masterfile to ensure that they are valid. Critical examples of such
authorisation include:
3.1
addition of new salaried employees/ changes to salary amounts
*
3.2
authorisation by Katherine Peear and Derek Dark
changes to bank account details of employees
*
authorisation
Peear.
by
the
employee
concerned
and
Katherine
4.
All MAFs should be cross-referenced to supporting documentation which
should be filed with the MAF in numerical sequence.
5.
There should be automatic logging of all masterfile amendments by the
system. There should be no write access to these logs.
6.
Access controls over the system should include the use of user ID’s,
passwords and access privilege tables so that the following access
restrictions are enforced:
7.
6.1
masterfile amendment programme functions are accessible only to
Kim Robbits
6.2
read-only access to the log of masterfile amendments is provided
only to Katherine Peear and Derek Dark
The log of masterfile amendments should be reviewed as follows:
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 325 of 3 pages
7.1
Katherine Peear should ensure that each logged masterfile
amendment is supported by a properly authorised MAF, and
7.2
Derek Dark should inspect the log for evidence of Katherine
Peear’s review and any suspicious or unusual amendments.
8.
When a new employee is added to the masterfile, the employee’s identity
number/passport number, and tax number should be mandatory fields.
9.
The new employee’s bank details should be supported by a supporting
document from the bank.
(Same would apply to changes in banking
details.)
Accuracy
1.
Programme checks should be carried out such as field size checks on bank
a/c no’s and limit checks/reasonableness/dependency checks on salary
amounts.
2.
Screen prompts, careful design of the MAF’s and use of codes (e.g. for
commonly used banks) could also be used to aid accuracy.
3.
While Katherine Peear is reviewing the log of masterfile amendments for
validity (see 6.1 above), she should also reconcile the accuracy of the
detail on the log to the relevant MAF’s.
Completeness
1.
MAF’s should be pre-numbered and sequentially controlled by Ian Patty.
2.
Programmed sequence checks should be carried out by the system e.g.
automatically prompting for the next MAF No. in sequence when the input
function is accessed.
**2016**
/continued on page 2
SUGGESTED SOLUTION TO EXERCISE 9.12
Page 2 of 3 pages
3.
The log of masterfile amendments should be reviewed by both Katherine
Peear and Derek Dark for:
3.1
any gaps in the sequence of MAF No’s, and
3.2
any
obvious
omissions
from
the
log.
In
this
regard,
it
is
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 326 of 3 pages
particularly
important
that
they
are
aware
resignations/dismissals
and
that
they
ensure
employees have been deleted from the payroll.
of
recent
that
these
PREPARATION OF THE SALARY PAYROLL
1.
Preparation of the payroll should be restricted to Katherine Peear’s
terminal; she should access the “prepare payroll” module on the software to
set the processing of the payroll in motion.
2.
Performing this function should be restricted to Katherine Peear (passwords
etc).
3.
Once she has gained access, each employee’s record (on the masterfile)
should appear on the screen and Katherine Peear should carefully check that
the detail on the record is correct against:
*
the prior month’s details, e.g. a change in basic salary should be
confirmed against the masterfile amendments
*
appointments and resignations supporting documentation.
4.
Once Katherine Peear is satisfied with each employees’ record, she should
“run” the application to produce the salary payroll (the software will
create the payroll file by drawing information off the masterfile and other
relevant files, e.g. PAYE deductions).
5.
Any changes to an employee’s record made by Katherine Peear should be
logged for subsequent independent review.
6.
There should be a range of programmed processing controls included in the
software, e.g. run-to-run totals.
7.
Once Katherine Peear is satisfied with the payroll, she should select the
“first confirmation” (or similar) option, and notify Derek Dark.
8.
Derek Dark should call up the payroll file (this will
protected) to enable him to conduct further control tests
be
password
8.1 once Katherine Peear has selected the “first confirmation” option, she
should no longer have write access to this file (unless Derek Dark
requires amendment, in which case other control procedures will come
into play – see pts 11 and 12).
9.
Derek Dark should review the payroll to satisfy himself of the validity,
accuracy and completeness by, for example
9.1
accessing amendment logs to confirm any salary amount
additions to, or removals from, the payroll of employees
changes,
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 327 of 3 pages
9.2
scrutinising
any
reconciliation
9.3
assessing the reasonableness of the payroll expenses
9.4
agreeing the number of EFT payments to be made to the total number of
employees.
the
reports,
payroll,
he
e.g.
should
month-to-month
10.
Once he is satisfied
confirmation” option.
11.
If Derek Dark requires amendment, he will select the “no confirmation” (or
similar) option. The software will then revert to the control of Katherine
Peear, who will make the amendment after following up and confirming the
validity of the amendment
12.
with
supporting
select
11.1
Derek Dark will not have write access to the payroll file
11.2
the amendments will be logged.
the
“second
Katherine Peear will again select the “first confirmation”; Derek Dark will
check the amendment log to ensure that only valid amendments (as requested
by himself) have been made before selecting the “second confirmation”
option.
Once the “second confirmation” has been selected, no further
amendments can be made.
**2016**
/continued on page 3
SUGGESTED SOLUTION TO EXERCISE 9.12
Page 3 of 3 pages
EFFECTING THE EFT PAYMENT
1.
Once the “second confirmation” is selected, the software should convert the
payment to a format compatible with the bank’s EFT software. The resultant
EFT schedule will contain only the name, bank account details and amount to
be paid for each employee.
2.
The ability to make an EFT payment will be restricted to Katherine Peear’s
terminal (bank software will be on her terminal) and after a final scrutiny
of the EFT schedule, she will select the “authorize” payment option.
3.
Derek Dark will then be required to select the “release” payment option to
effect the transfer of the EFT schedule to the bank.
4.
Both the “authorize” and “release” options will be protected (passwords
etc).
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 328 of 3 pages
5.
There should also be additional authentication controls required by the
bank to make an EFT payment.
This is commonly a physical device e.g. a
dongle, which is inserted into the USB port of the responsible employee’s
terminal at the time of effecting the payment, or a random number
generator, which when activated, produces a unique additional number which
must be entered with the normal passwords and PINs required to make the
transfer
5.1
6.
dongles and number generators are simply sophisticated “passwords”
and must be unique to the responsible employee and must be kept safe
and secure for confidentiality purposes at all times.
The following controls should also be in place:
6.1
the total amount of salaries to be paid should be transferred to a
salary clearing account from the main bank account and the employees’
salaries should be transferred from the clearing account to their
individual accounts (this protects the main bank account and
increases confidentiality)
6.2
as salaries are paid only on the last Friday of the month, transfers
from the main bank account to the salary account could be restricted
(by a programmed control) to the dates on which these Friday’s fall
6.3
data should be encrypted (security and confidential)
6.4
there should be an automatic shutdown of the EFT system after three
unsuccessful attempts to access the bank’s software on the company’s
system, and these attempts should be logged for follow up.
AFTER THE PAYMENT
1.
On the Monday following the payment of salaries, Derek Dark should download
a copy of the salary clearing account bank statement. Only he should have
access to this account.
2.
He should confirm the salary payments per the bank statement to the payroll
individually, and in total (and follow up on any discrepancies – shouldn’t
be any).
3.
When the payroll is confirmed (prior to the EFT), a payslip for the month
should be printed out for each employee in a “sealed envelope” format.
This enables the employee to reconcile the amount deposited into her/her
bank account with the earnings for the month.
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 329 of 3 pages
**2016**
SUGGESTED SOLUTION TO EXERCISE 9.11
Page 1 of 2 pages
a)
Validity
:
the company pays wages only in respect of genuine hours worked by genuine
(not fictitious) employees of the company.
:
all wages paid
management’s policies and procedures.
Accuracy
:
are
properly
authorized
in
accordance
with
all wage payments are correctly calculated using the correct hours, rates
and deductions.
:
all wage transactions are recorded in the accounting records at the
correct amount in the correct account in the correct period.
Completeness :
b) 1.
Ben Bigg should
1.3
1.4
1.5
2.
all wages that should be paid are paid, and recorded in the records.
1.1
agree the total number of clockcards collected from the racks to the
masterlist of employees (provided by HR).
1.2
divide the clock cards into three batches of approx 33 cards according to
the employee’s section.
calculate the number of ordinary and overtime hours worked for each employee.
agree the overtime hours per employee to the overtime schedule and confirm that they
have been authorised by Reagon Seconds (signature).
complete a (pre-printed) batch control sheet by entering
*
a batch number and batch identification e.g. section A, week 25, wages
*
control totals:

record count (number of clockcards)

hours worked, both normal and overtime

hash total e.g. total of employee number.
1.6
enter the batch identification details and control totals in a batch
register and sign it.
Each foreman should
2.1
test check (recalculate) a sample of hours worked calculations for his section.
2.2
confirm by referring to the overtime schedule that the overtime hours worked in his
section have been authorised.
2.3
confirm by inspection that batch details and control totals have been correctly
entered in the batch register.
2.4
sign the batch register.
3.
Preston Ngcobo should acknowledge receipt of the three batches from Ben Bigg by
signing the batch register after agreeing the batches he is receiving to the register.
c)
1.
Access to the LAN should be restricted to authorized terminals.
This is
achieved by the use of terminal identification controls (the system will only allow
access to terminals which have been authorised and identified to the system).
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 330 of 3 pages
2.
Access to the LAN itself should be restricted by the use of user IDs and passwords.
3.
Once access to the LAN has been granted, access to the wage application itself
and to specific modules within the wage application i.e. masterfile amendments module,
should be further restricted to only staff who need access to fulfil their functional
responsibility e.g. Preston Ngcobo would have access to the LAN itself and to those
modules he needs access to enter hours and process the payroll.
4.
Access to applications/modules within applications will be achieved by the
creation of user profiles which are linked to user IDs and passwords. The user profiles
determine the privileges which are allocated to the user on a least privilege/need to
know basis.
5.
Actually restricting access is achieved in different ways. For example, on
entering a user ID and password, the computer will confirm that both are valid. If not,
the user cannot proceed.
If the user ID and password are accepted, the
applications/modules to which that user has access will appear on the screen.
Alternatively, all modules will appear but those to which the user has access will be
highlighted.
5.1 to gain access the user will “select” and “click”. There will be no response
(other than possible screen dialogue) unless the user profile permits it.
5.2
if a read only privilege is granted, the “screen” will not respond to
attempts to write to the module.
**2016**
/continued on page 2
SUGGESTED SOLUTION TO EXERCISE 9.11
Page 2 of 2 pages
6.
There should be a full range of password controls, a very important part of
access control e.g.
6.1
unique to the individual (no group passwords).
6.2
changed regularly, not obvious.
6.3
kept secret, do not appear on screen, on printouts etc.
6.4
six digits, alphabetic, numeric, etc, mix.
7.
There should be automatic shutdown of the terminal in the event of, say, three
access violations e.g. incorrect password entered.
8.
There should be a “time out” facility which automatically logs out the user if
the module is “open” but no activity is taking place.
9.
Access violations (and access) should be logged by the computer.
The logs
should be reviewed and access violations followed up in an attempt to identify the
perpetrator.
d)
Mandatory field check:
This check prevents the process from
until “data” has been entered into a specific field.
continuing
example: Until a number has been entered into the normal hours worked field, the
programme will not allow Preston Ngcobo to proceed to the next clockcard.
Verification check: This check verifies data against the masterfile.
example:
When Preston Ngcobo enters the employee number, the programme will check
it against the masterfile to determine whether it is listed (i.e. valid employee
number) if not, no further data will be accepted until the “error” has been
corrected.
Limit check :
This check prevents a quantity or amount which is in excess
of a preset limit from being entered in a specified field.
example:
In respect of entering normal hours worked, a limit check of 45 hours
(employees work 7am to 4pm) can be programmed. An attempt to enter normal hours in
excess of this will not be accepted.
e)
1.
Requests for programme changes should be documented on prenumbered, preprinted
change control forms.
2.
These requests should be evaluated and approved by the
*
user department (in this case wage section Jerome Jantjies, and management)
*
Shakira Maharaj the IT manager.
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 331 of 3 pages
3.
The programme change should be managed as a mini-project, e.g.
responsibilities allocated, deadlines set and progress monitored.
4.
Changes should be made to a test programme (a copy of the live programme) to avoid
corruption of the live programme.
5.
The “changed” test programme should be thoroughly
independent of the programmer making the change).
6.
The programme change should then be discussed with users (wage section/management) and
they should sign the relevant change control form if they approve of the change.
7.
The amended test programme should then be placed on the LAN (made live) and the updated
“change” logged by the computer.
8.
Shakira Maharaj should regularly (frequently) review the log of programme changes and
reconcile it to the change control forms.
9.
All documentation relating to the wage application should be updated to reflect the
change.
debugged
planned
(preferably
properly,
by
someone
**2016**
SUGGESTED SOLUTION TO EXERCISE 9.10
Page 1 of 3 pages
a) and b)
Weakness 1.
The system as it stands presents a significant risk that wages and
accounts will contain a variety of errors.
related
Explanation.
As the company still performs all aspects of the wage system manually, there is a
far greater risk that errors will be made. Administration clerks are required to
write names, employee numbers hours etc onto daily time sheets, payrolls and
paypackets for 120 wage earners, select payrates, perform calculations etc.
Computerised.
Payroll software would perform all of these functions (and others) far more
efficiently and accurately, as it is designed with a whole range of programme
checks to enhance accurate and complete input and processing e.g. minimum entry,
alphanumeric checks etc, reducing manual intervention to a minimum.
Weakness 2.
There is generally a poor control environment.
Explanation.
The lack of control over most aspects of the cycle e.g. timekeeping (particularly
overtime), payroll checking etc, suggests that the management of the company is
not control focused.
Computerised.
The control environment is determined by the attitude to and awareness of control
of management. If this attitude does not change, the control environment will not
improve. There is no obvious reason why management will become more control aware
because the payroll is processed on a computer and not manually.
In fact, if
management do not understand the risks which come with computerization the control
environment could deteriorate as management may think that the “computer will
control everything!”
Weakness 3.
There is no human resource department.
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 332 of 3 pages
Explanation.
A business with an hourly paid staff of 120, warrants an HR department
which is responsible for all aspects of labour and which has the necessary expertise to
deal with labour law, unions, hiring and dismissal/resignation.
By not having an HR
department, the company lays itself open to potential costly/disruptive labour problems.
Computerised.
1. A good payroll package will not be a substitute for a human resource
section, but it will make such a section far more effective and efficient,
which probably means less employees will be required.
2. Whilst employees with human resource expertise and skills will still be
required, basic functions such as appointment/dismissal/resignation, employee
record keeping e.g. employee masterfile, will be significantly enabled or
enhanced.
Specially designed human resource management software is widely
available.
Weakness 4.
The method of recording actual hours worked is totally inadequate and the
company could end up paying wages for hours which were never worked, particularly
overtime.
Explanation.
1.
As no independent (supervised) clocking system is in place, an accurate record
of when an employee started and stopped work is not available.
2.
It is very simple for a section supervisor to “tick off” an absent employee as
being at work and subsequently sharing the extra unearned wages with the employee
(collusion).
3. Overtime is not authorised, the section supervisor is informed but no
authority is granted by the factory foreman before it is worked.
4.
Furthermore, as there is no means of actually recording the overtime worked, the
employees could easily inflate the hours worked when they inform the section supervisor
the following day.
5. As neither the foreman nor anybody else authorizes (or checks up on) the
overtime hours after they have been credited to the employee,
*
the section supervisor could easily add overtime hours to employees in his
section (in collusion with the employee) and
*
the administration clerks could do the same.
The proceeds could then be shared with the employee.
**2016**
/continued on page 2
SUGGESTED SOLUTION TO EXERCISE 9.10
Page 2 of 3 pages
Computerised.
Computerisation can greatly enhance timekeeping. The use of biometric readers and
magnetic strip card (tag) systems linked to physical access terminals and to the
“accounting system” can control who enters the workplace and can record and
download hours worked accurately and completely onto the system (no human
intervention).
Reports can be drawn off the system virtually immediately and
hours worked (both normal and overtime) can be authorized on the system before any
processing takes place.
For example the foreman and factory manager could be
required to authorize all hours worked, a control which would virtually eliminate
fictitious hours/workers fraud. (NB no control is foolproof!)
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 333 of 3 pages
Weakness 5.
There is a significant lack of division of duties in respect of the procedures
carried out by the admin clerks.
Weakness 6.
Supervision/management checks are inadequate which facilitates fraud.
Explanation (5 and 6).
The administration clerks:
1.
Make up the payroll from records which they keep.
2.
Have access to the cash (returned to them to make up the paypackets).
3.
Conduct the payout.
4.
wages.
As a result of 1 to 3, the wage clerks could easily misappropriate
5.
As neither the foreman nor the factory accountant review/check the payroll to
source documents/records, the administration clerks can
*
6.
*
add fictitious employees to the payroll.
use inflated wage rates for a particular employee and collude with that
employee to share the “extra” wages.
as the clerks prepare the paypackets (unsupervised) they have easy access to
the fictitious wages they have created.
7.
as they conduct the wage payout (again unsupervised), there is little
chance of the inclusion of fictitious employees being discovered.
Computerised.
1. Computerisation will address this problem very effectively and
efficiently.
A strong division of duties can be implemented by the use of user IDs,
passwords and profiles which will control which employees have access, and which type of
access, to which modules of the payroll system.
For example, a supervisor, foreman or
wage administration clerk will not be able to add a “fictitious” employee to the payroll
as he will have no access to the employee masterfile amendment module.
Access will be
restricted to the human resource section. In addition, if payment is made by EFT there
will be no cash to steal.
2.
With regard to the lack of supervisory/management checks, payroll
software provides for management to carry out numerous “on screen” (convenient) reviews
and authorizations.
Logs and reports produced by the computer provide independent
evidence for management of exactly what the computer has done, who did it, etc.
Weakness 7.
No period-to-period wage reconciliation is prepared by the administration clerks
(inadequate documentation).
Explanation.
This document provides an explanation as to changes in the amount of wages paid
from one week to the next and should be supported by authorised supporting
documentation e.g. an increase in the number of staff should be supported by
signed “Employee Engagement/Dismissal/Resignation Forms”.
If this document was
produced, the factory accountant and financial accountant could check the payroll
properly before signing the wage cheque.
This would reveal fictitious wages,
incorrect rates, hours, etc.
Computerised.
As indicated above, payroll software has the capacity to produce numerous reports,
one of which is likely to be a period to period reconciliation and supporting
information which makes review simple and efficient.
Weakness 8.
The second signatory does not review supporting documentation before signing the
wage cheque.
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 334 of 3 pages
**2016**
/continued on page 2
SUGGESTED SOLUTION TO EXERCISE 9.10
Page 3 of 3 pages
Explanation.
Whilst the two signature principle is good, it is no use if both signatories do
not check the supporting documentation carefully to confirm that the amount being
drawn is valid and correct.
In this situation the financial accountant simply
signs the cheques without reference to any supporting documentation, e.g. the
payroll. (In effect, access to the company’s bank account is inadequate.)
Computerised.
In a computerized payroll system payment of wages will be by EFT.
In an EFT
system the “two signature principle” is applied by requiring one employee to
“authorize” the EFT and a second employee to “release” the payment. However, if
the employees do not perform the necessary procedures to verify the payments they
are “authorizing” and “releasing”, the computer will not be any the wiser. In
other words, an invalid payment can still be authorized and released if the
employees do not carry out their responsibilities.
Weakness 9.
Wages are paid in cash.
Explanation.
Paying wages in cash to 120 employees every second week (same day) increases the
risk of armed/violent robbery and loss to the company as a result of theft.
Computerised.
The introduction of a computerized system will facilitate payment of wages by
electronic funds transfer. This will reduce the threat of armed robbery to nil,
but will introduce the risk of theft of the company’s cash resources through
fraudulent EFTs if controls are not strictly adhered to.
Weakness 10.
No risk assessment or monitoring of the system.
Explanation.
A risk assessment process (either formal or informal) is an important component of
internal control, as is the monitoring of the system over time. Management appear
not to have identified the risk of fraud, theft and personal safety which are
significant in the company’s payroll system.
Although the company is now
considering computerization, it does not appear that this is a result of having
monitored the system over time to identify the system’s weaknesses.
Computerised.
A computerized system will not “assess risk” and “monitor the system” but it will
produce information which can assist management in carrying out these activities
effectively.
SUGGESTED SOLUTION TO EXERCISE 10.9
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**2016**
SUGGESTED SOLUTION TO EXERCISE 9.9
Page 1 of 3 pages
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 336 of 3 pages
Weakness
1.
There is a poor control environment.
Explanation
1.1
By his own admission Max McCarthy does not concern himself with the wage
system. With about one hundred employees, wages is a major expense and as the
general manager he should be monitoring it closely.
1.2
Head office do not seem particularly concerned, e.g. funds are transferred to
the factory account on the strength of a phone call and without any
confirmation or reconciliation at any time of the amount requested, with the
payroll.
1.3
Controls within the system are inadequate in many respects (see below) which
suggests that the senior staff at the factory are not control focused and do
not really set a control aware example.
1.4
Employees will soon pick this up and become less control aware themselves.
This could easily lead to misappropriation of cash in the cycle.
Weakness
2.
There is no human resource department/senior member of staff at the factory
with adequate human resource skills. The factory foreman is responsible for
hiring and dismissing staff (both of which can be difficult) without input
from (even) the general manager.
Explanation
2.1
There are about 100 hourly paid employees at the factory and this warrants HR
skills sufficient to take responsibility for all aspects of labour law,
hiring/dismissal, strikes etc as well as record keeping.
2.2
By not having the necessary skills, Woodcrate (Pty) Ltd lays itself open to
potential costly/disruptive labour problems.
3.1
There is only one signatory on the bank account.
3.2
There is a lack of division of duties with regard to banking and record
keeping.
3.3
No supporting documentation is sent to head office as evidence of cheques
written.
3.1
As Max McCarthy is the only signatory, he can write a cheque for anything e.g.
personal expenditure, and have the company pay.
Weakness
Explanation
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 337 of 3 pages
3.2
Because he writes up the cash book, reconciles it and prepares the expense
summary for head office, he can easily conceal any “unauthorized” expenditure
by describing it as a legitimate factory expense or wages.
3.3
As head office do not require any supporting evidence, and do not appear to
carry out any variance analysis on actual expenditures, unauthorized
expenditure, theft at the factory will not be picked up.
3.4
From a practical perspective, if Max McCarthy is not available to sign the
wages cheque on a Thursday/Friday morning, wages may not be paid, resulting in
labour problems.
Weakness
4.
There is a lack of supervision at clocking in/out.
Explanation
4.
As the clocking in and out procedure is not supervised, there is plenty of
opportunity for employees to manipulate the clocking in/out procedure, e.g.
clocking in the card of a fellow worker who is late/not present, delaying
clocking out so as to gain overtime. These practices will result in invalid
hours being recorded.
**2016**
/continued on page 2
SUGGESTED SOLUTION TO EXERCISE 9.9
Page 2 of 3 pages
Weakness
5.
There is no authorization of overtime hours worked or review of normal time.
Explanation
5.1
With regard to overtime, all that Buzi Gumede (or anyone) does is calculate
the overtime hours worked from the clock cards before sending them through for
capture.
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 338 of 3 pages
5.2
She does not
* agree the hours to any authorized schedule of planned overtime (probably
isn’t one) or
* have the overtime authorized by Carlton Smith, the factory foreman.
5.3
Neither the foreman nor Joe Percy reviews the clock cards for inconsistencies,
mistakes in hour calculations, etc.
Buzi Gumede could send through
inaccurate or inflated hours worked (intentionally or unintentionally).
Weakness
6.
The clock cards are inadequately controlled and batched prior to entry into
the computer.
Explanation
6.1
Buzi Gumede does not
* batch the clock cards into workable batches
* take any control totals (record count, hash totals)
* ensure that there is a clock card for each employee, and
* enter the batch details in a batch register.
6.2
This makes it impossible to derive the benefits of batch controls as the wage
cards progress through the system to ensure the completeness and accuracy on
data keyed in and processed, e.g. if Buzi Gumede takes a record count and
confirms that there is a clock card for every employee, then any clock card
lost or not entered by Joe Percy will be picked up (completeness).
Weakness
7.
The control over the creation of the weekly clock cards is inadequate.
Explanation
7.1
Although the fact that a clock card can only be printed for an employee who is
on the employee masterfile is sound in principle, it has little effect here as
amendments to the masterfile are inadequately controlled (see weakness 8).
For example if Joe Percy or Buzi Gumede wanted to create a fictitious source
document (the clock card) for a fictitious employee they could easily do so as
they have write access to the masterfile.
Weakness
8.
There is inadequate control over masterfile amendments.
Explanation
8.1
Both Joe Percy and Buzi Gumede have write access to the employee masterfile.
8.2
Masterfile amendments are not entered from authorized masterfile amendment
forms.
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 339 of 3 pages
8.3
Even if a log of amendments is maintained by the computer, it does not appear
that anyone checks the log to confirm that all amendments required are made
and that only valid amendments are made.
8.4
This means that errors could occur and more importantly, wage fraud could be
perpetrated by, for example, fictitious workers being added, resigning
employees being left on the payroll, unauthorized changes being made to wage
rates etc.
**2016**
continued on page 3
SUGGESTED SOLUTION TO EXERCISE 9.9
Page 3 of 3 pages
Weakness
9.
The hiring and dismissal of employees is the responsibility of one member of
staff only with no input from the general manager or head office.
Explanation
9.
Taken in the context of weakness 2, this places too much power over employees
in the hands of the foreman. This could lead to a dissatisfied labour force,
e.g. as a result of victimization
* hiring of unnecessary employees (waste of money) and
* could contribute to wage fraud perpetrated by Carlton Smith.
Weakness
10.1 The major weakness in the system is the lack of division of duties and
supervisory checks in the system. This enables both Joe Percy and Buzi Gumede
to misappropriate cash relatively easily either individually or together.
10.2 Collusion between them and Carlton Smith would make wage fraud very simple and
virtually undetectable.
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 340 of 3 pages
Explanation
10.1 There is absolutely no confirmation, review or analysis of the wage expense by
the general manager or head office.
The employees who deal with wages are
simply not accountable.
10.2 Both Joe Percy and Buzi Gumede are involved in all aspects of the cycle
* they both have write access to the employee masterfile
fictitious employees and then remove them when necessary.
so
could
add
* any number of hours, normal or overtime could be captured onto the system as
there is no authorized or independent control total to check against.
* as nobody confirms or validates the amount of the cheque drawn for wages to
supporting documentation, Joe Percy can simply add on an extra amount to be
misappropriated.
* as both Joe Percy and Buzi Gumede have access to the actual cash it is easy
to get their hands on the “fictitious” amounts, and the theft can easily be
concealed by creating a new payroll to reflect whatever it needs to reflect,
e.g. making the genuine pay packets agree with the payroll for payout
purposes.
(In effect, singularly or collectively, the two of them can
authorize, execute and record the wage transaction and they have custody of
the cash).
10.3 The presence of various programme controls may help the accuracy and
completeness of input and processing, but validity controls can easily be
circumvented by ensuring that any “fictitious” input satisfies the programme
controls, e.g. to give an employee an official employee number is simply a
matter of making a masterfile amendment. In any event, as nobody checks up on
anything, error exception reports, override logs etc produced as a result of
programme controls, will not be followed up rendering the control ineffective.
Weakness
11.
There appears to be no risk assessment process to identify and respond to the
risks the business faces.
Explanation
11.
Both Max McCarthy and head office seem unaware of the risks the company faces
with regard to its labour force and related matters.
For example, having
large amounts of cash on the premises every week poses a danger to the safety
of the employees. Whilst the question says that employees want cash, active
steps should be carried out to open accounts for every existing employee at
FNB and to make it a condition of employment that all new employees must have
a bank account.
Furthermore, paying such limited attention to human resource management can
easily result in major unrest, disciplinary hearings, production disruption,
etc.
Weakness
12.
There is no monitoring of the payroll system.
Explanation
12.
The general lack of interest by senior management/head office in the wage
expense and the controls within the payroll cycle, suggest that there is no
monitoring of the system’s performance over time.
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 341 of 3 pages
**2016**
SUGGESTED SOLUTION TO EXERCISE 9.8
Page 1 of 2 pages
1.
Deepdiggers Ltd
1.1
1.2
1.3
1.4
1.5
1.6
Loss of production from strike action.
IT risk. An IT “disaster” which directly affects the processing and payment of wages
accurately and timeously.
Health risks which threaten the wellbeing and efficiency of the workforce.
Outbreaks in xenophobia leading to violence, death and injury to the workforce.
Lack of trained and skilled mining personnel.
Failure to comply with black economic empowerment and employment equity laws and
regulations.
2.
Magoo (Pty) Ltd
a)
Joel Jantjies should
1.1
Count and compare the actual clockcards to the list of hourly paid employees (or
similar), to confirm that there is a card for each employee.
1.2
Calculate the normal and overtime hours worked.
1.3
Initial or sign each clockcard to acknowledge that he has carried out the procedure.
b)
Once the above procedures have been successfully carried out, Joel Jantjies should
1.1
Group the clockcards into two separate batches of 50 cards.
1.2
Compute the following control totals for each batch
*
record count, i.e. number of cards in each batch
*
hash totals, e.g. total of hours worked, normal and overtime.
1.3
Prepare a batch control sheet for each batch.
This batch control sheet will contain
* a description of the batch, e.g. batch 1 and 2, wage period ending 15 Sept 0001
(transaction type should be identified)
* the control totals (for the batch).
1.4
Sign the batch control sheet to acknowledge having carried out the procedures.
3.
2.
Joel Jantjies should present the batches with the batch control sheet to the factory
foreman (or similar), who should check the calculation of hours and specifically
review any overtime hours worked. The factory foreman should sign the batch control
sheet (and possibly initial each clockcard).
3.
The details of each batch should be written into a batch register which should be
taken with the clockcards by Joel Jantjies to Brandon August. Brandon August should
confirm that the batches he is receiving, agree with the details in the batch
register and should sign the register to acknowledge the receipt of the batches.
Glasscon (Pty) Ltd
1.
1.1
1.2
Record all masterfile amendments on a source document
The details of each employee to be added to the employee masterfile, should be
recorded on a hardcopy masterfile amendment form.
The MAF should be preprinted, sequenced and properly designed.
2. Authorise the MAF
2.1
The MAF(s) should be signed by two senior employees (e.g. human resource manager and
factory manager) after having agreed the details to the supporting documentation
which should include a letter of appointment, engagement contract, etc.
3. Enter only authorised MAFs onto the system, accurately and completely
3.1
Write access to the employee masterfile should be restricted to a specific member of
the human resource section by the use of user IDs and passwords.
3.2
All masterfile amendments should be automatically logged by the system on sequenced
logs, and there should be no write access to the logs.
3.3
To enhance the accuracy and completeness of the keying in of the masterfile
amendments and to detect invalid conditions, screen aids and programme (automated)
checks will be implemented, e.g.
*
screen formatting

on accessing the masterfile amendment module, the screen will come up
formatted as the masterfile amendment form, or as an employment record.
The fields to be completed should be clearly identified, e.g. employee
name, taxation number
**2016**
/continued on page 2
SUGGESTED SOLUTION TO EXERCISE 9.8
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 342 of 3 pages
Page 2 of 2 pages


the employee number should be generated by the system
where possible, “drop down” lists should be in use, e.g. employee grade
and cost centre
*
programme (automated) checks

mandatory fields on employee identity number and income tax number as well
as full banking details

alphanumeric checks and field size checks on, for example, identity number
field and tax reference field

(possibly) range check, limit check and dependency check on wage rate
field (programmed controls which make use of the relationship between
grade of employee and the wage rate).
On-screen checking/approval of the MAF could be carried out by a second employee in
the human resource department (no write access).
3.4
4.
Review masterfile amendments to ensure they occurred, were authorised and were accurately
and completely processed
4.1
The logs of masterfile amendments should be reviewed by someone independent of the
employees who authorised the amendment, e.g. the financial accountant.
4.2
The sequence of logs themselves should be checked and any missing logs followed up
(shouldn’t happen).
4.3
Each additional employee amendment on the log should be checked to confirm that it
is supported by a properly authorised MAF and that the details entered, are correct.
4.4
The MAFs themselves should be checked against the log to confirm that all MAFs were
entered.
4. Bingo (Pty) Ltd
1.
Screen formatting :
Screen designed to facilitate accurate and complete entry.
2.
Minimum entry :
Wage clerk only required to enter employee number to bring up other details of employee.
3.
Validation clerk :
System will compare employee number entered to employee masterfile.
match, wage clerk cannot continue.
If there is no
4.
Alphanumeric check :
Example, entry of an alphanumeric character in the hours worked field will be rejected.
5.
Limit check :
Example, normal hours entered in excess of 40 hours, will be rejected.
6.
Mandatory field :
Process will not continue if normal hours field is not entered.
7.
Batch control totals :
The entry of batch control totals prior to keying in, and the comparison by the system of
these control totals after keying in, will identify inaccurate or incomplete entry.
8.
Access control :
Restricting access to the “enter hours module” to the wage clerk will contribute in a
general sense to control in this function.
**2016**
SUGGESTED SOLUTION TO EXERCISE 9.7
1 Page only
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 343 of 3 pages
1.
My trainee’s understanding of the assertions is very poor.
2.
Accuracy:
Although
accuracy
is
an
assertion
applicable
to
wages
(transactions) it does not mean that all wages have been included in the amount (this is
the completeness assertion).
3.
Valuation:
This assertion relates to balances not transactions, and is
therefore not applicable to wages (transactions). In any event the valuation assertion
has nothing to do with the value of an employee!
4.
Rights: Again this is an assertion which relates to balances and not transactions
and pertains to the rights of Diggers (Pty) Ltd to the ownership of its assets. It has
nothing to do with the rights of employees to be paid.
5.
Obligation:
The obligation assertion applies to Diggers (Pty) Ltd’s liabilities
(account balance) and does not apply to the payment of wages (transactions).
6.
Validity:
This is not an assertion it is an internal control objective. The
trainee’s description is close to the occurrence assertion i.e. amounts included in the
R7 321 421 were paid to genuine employees for genuine work carried out (i.e. no
fictitious wages).
7.
The trainee does not appear to know that the assertions relating to wages (transactions)
are cut-off, accuracy (he probably guessed this one!) classification, occurrence and
completeness.
7.1
7.2
7.3
7.4
7.5
Cut-off – asserts (represents) that the amounts included in the R7 321 421 have
been accounted for in the correct accounting period.
Classification – asserts that the wages paid have been recorded in the proper
accounts.
Accuracy – asserts that amounts pertaining to wages and the related deductions
have been recorded appropriately.
Occurrence – asserts that the wage expense of R7 321 421 was incurred in terms of
valid hours worked by valid employees.
Completeness – asserts that all wage transactions which should have been included
in the wage expense, have been included.
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 344 of 3 pages
**2016**
SUGGESTED SOLUTION TO EXERCISE 9.6
1 Page only
a) and b)
1. a.
Application control.
1. b.
This procedure is designed to contribute towards preventing losses due to employees
being remunerated for “clocking” unnecessary overtime hours. It could also be argued
that it is a detective control because it provides a means of detecting unauthorised
overtime hours, if overtime hours actually clocked are compared to the schedule which
they should be.
2. a.
General control
2. b.
This policy is implemented to detect unauthorised individuals who may be on the
company’s premises and would be part of a combination of controls to prevent security
problems.
3. a.
This is primarily an application control (recording valid hours worked) but is also a
general control in the sense that the biometric reader is an overall security measure
(access/custody control).
3. b.
This is a preventive control. It assists in preventing the company from remunerating
employees for hours not worked.
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 345 of 3 pages
4. a.
Application control
4. b.
Preventive. This control is implemented to prevent employees from being remunerated for
unauthorised overtime hours and overtime hours not actually worked.
5. a.
Application control in the context of the payroll cycle, but also a general control in
the context of the company’s overall access/custody control.
5. b.
Preventive. This control is implemented to prevent invalid withdrawals e.g. theft, from
the company’s bank account.
6. a.
Application control (output control)
6. b.
Preventive. The control (sealed salary advice) is designed to prevent unauthorised
access to confidential information.
(The salary advice itself also enables the
employee to detect any errors in the amounts paid to them.)
7. a.
General control
7. b.
Preventive control.
This activity/policy is designed to prevent the company from
suffering adverse consequences from non-compliance with the law, e.g. penalties,
enquiries/law-suits from unfair labour practice, etc, strikes.
8. a.
Application control
8. b.
Preventive control. This control will be implemented to contribute to the prevention
of the inclusion of “fictitious” employees to the payroll.
9. a.
Application control
9. b.
Detective control. This control is implemented to determine whether any unauthorised
amendments to the employee masterfile have been made.
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 346 of 3 pages
10. a.
Application control
10. b.
Detective control. This control is implemented in the programme to detect processing
errors (or input errors depending on the software.) The control is only effective if
the exception report is carefully reviewed and followed up by an appropriate employee
in the cycle.
**2016**
SUGGESTED SOLUTION TO EXERCISE 9.5
1 Page only
1.
Control environment: Demonstrates management’s commitment to competence and is a sound
personnel practice.
2.
Segregation of duties: one employee checking the work of another and
isolation of responsibilities:
3.
foreman sign to acknowledge their responsibility.
Custody control: protection of the company’s physical cash and
segregation of duties: between payroll preparation and payout.
4.
Segregation of duties and isolation of responsibility achieved by restricting access.
5.
Comparison and reconciliation.
6.
Segregation of duties, authorisation/approval, isolation of responsibility.
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 347 of 3 pages
7.
Access control/custody control: restricts access to the company’s bank account and in
doing so contributes to the protection of the company’s cash in the bank.
8.
Control environment: senior management displaying a management style which sets a good
example and promotes control awareness.
9.
comparison and reconciliation, isolation of responsibility segregation of duties and
custody (cash)
10.
Authorisation/approval. (It is also a sound personnel policy which is part of a sound
control environment.)
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 348 of 3 pages
**2016**
SUGGESTED SOLUTION TO EXERCISE 9.4
Page 1 of 2 pages
1.
False: The major difference between wages and salaries is that the amount of the wages to
be paid is based on hours worked (and may include overtime hours worked) and
salaries are paid at a fixed monthly amount regardless of hours worked, whether
the hours worked are normal or overtime. Furthermore, the method of payment for
either a wage or a salary could be cash, cheque or EFT. Cash payment of salaries
is possible but very rare, and cash payment of wages is becoming less and less
common and is rapidly being replaced by EFT.
2.
Personnel (Human Resources)
Timekeeping
Payroll Preparation
Payment Preparation and Payout
Deductions : Payment and Recording.
3.
completeness :
all valid hours worked for which payment must be
made by the employer are included in the calculation of wages paid.
accuracy :
the net wage to be paid has been correctly calculated using
the correct hours, pay rates and deductions.
validity :
all wages paid have been paid in respect of hours (validly)
worked (i.e. not fictitious) to employees who exist and who worked the
hours i.e. no fictitious or dummy workmen.
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 349 of 3 pages
4.
completeness
:
there are no unrecorded wages i.e. no wages have
been omitted from the financial records.
cut-off :
period.
wages have been recorded in the correct accounting
accuracy:
the amount
recorded appropriately.
of
wages
and
related
deductions
have
been
classification: wages and related deductions have been posted to the proper
(correct) accounts.
occurrence
:
all wages transactions are genuine (not fictitious
or fraudulent) expenses of the company which actually took place.
5.
5.1
Clock cards: A card unique to the employee, is passed through a time
clocking device by the employee on entering or exiting the factory.
The clock
records the times of entry and exit on the card.
Hours are then manually
calculated. New cards are prepared for each wage week.
5.2
Swipe/magnetic strip cards: Each employee has a magnetic strip card (like a
credit card) which has his details on the magnetic strip.
The card is swiped
through a reader/clocking device on entry to or exit from the factory and the time
is recorded.
The device reads the magnetic strip to obtain the details of the employee
and automatically transfers the information to the wage department for payroll
preparation. Hours are automatically calculated by the software.
5.3
Biometric reader: This machine reads some form of biometric data from the
employee e.g. a fingerprint.
Before allowing access, the software compares the
fingerprint of the employee wishing to enter or exit the factory, to the
fingerprint database and if there is a match, the employee is allowed access
(usually through a turnstile). Entry and exit times are recorded and transferred
to the wage department for payroll preparation.
Hours are automatically
calculated by the software. The major advantage of biometric scanners is that one
employee cannot record entry/exit times for another employee who is absent (as can
be done with a clock card or swipe card).
**2016**
/continued on page 2
SUGGESTED SOLUTION TO EXERCISE 9.4
Page 2 of 2 pages
6.
A cashless wage system is one in which the wages due to the employee are paid directly
into the bank account of the employee by electronic funds transfer.
No pay packet
containing cash is necessary.
7.
A payroll cycle which is not subject to strong internal control will be susceptible to
fraud because:
7.1
The cycle is designed to facilitate an outflow of funds from the business,
therefore if internal controls are weak, the system can be exploited.
7.2
In a large organization there will usually be a large number of employees
and the payroll expense will be considerable.
Combined with the weak controls,
this may be a very tempting prospect for certain employees to defraud the company
in a way which will not be noticed. For example, if 10 fictitious workers could
be added to an EFT payroll of 1000 employees, the wage expense would not look
“unusual”.
7.3
A fraud such as this would require
control, collusion becomes far more likely.
collusion
but
with
weak
internal
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 350 of 3 pages
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 351 of 3 pages
**2016**
SUGGESTED SOLUTIUON TO EXERCISE 9.3
1 Page only
1.
-
1.4
2.
-
2.3
3.
-
3.2
4.
-
4.4
5.
-
5.2
6.
-
6.1
7.
-
7.3
8.
-
8.3
9.
-
9.3
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 352 of 3 pages
10.
-
10.2
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 353 of 3 pages
**2016**
SUGGESTED SOLUTION TO EXERCISE 9.2
1 Page only
a) and b)
1.
Timekeeping:
implemented to address the risk of fictitious hours being recorded by, for
example, an employee clocking the card of an absent employee.
2.
Personnel:
implemented to minimize the risk of employing individuals
underqualified, not competent or ethically unsuitable.
3.
Payroll Preparation:
who
are
implemented as one of a number of controls to address the risk of
invalid, or inaccurate wages being paid or the omission of wages
which should be paid (completeness).
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 354 of 3 pages
4.
Payment preparation and payment (by EFT):
implemented to address the risk of invalid,
inaccurate
or
incomplete
EFTs
being
effected.
5.
Deductions, Payment and Recording:
6.
Payroll Preparation:
7.
Timekeeping:
implemented to address the risk of employees being
unauthorised or incorrectly calculated overtime hours.
8.
Personnel:
implemented to address the risk of negative consequences arising from noncompliance with labour legislation.
9.
Personnel:
implemented (with other controls) to reduce the risk of fictitious hours
being recorded for a fictitious worker and the recording of inaccurate or
incomplete hours.
10.
Timekeeping:
implemented to reduce the risk of hours worked being incompletely or
inaccurately entered (keyed in). Used in conjunction with other controls.
implemented to address the risk of Hastings (Pty)
Ltd having to pay penalties for late submission of
amounts owed or payment of incorrect amounts.
implemented to address the risk of fictitious employees being added
to the payroll by the wage clerk. The entry of the employee number
validates (verifies) that the employee is on the masterfile.
remunerated
for
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 355 of 3 pages
**2016**
SUGGESTED SOLUTION TO EXERCISE 9.1
1 Page only
a)
The following documents will be used in the payroll cycle:
1.
Tax rate tables:
These are tables which are provided by SARS to indicate the
amount of tax which must be deducted from an employee’s
earnings, e.g. PAYE.
2.
Clock card:
A card which is passed through a clocking device each day by
an employee when the employee enters or exits the workplace.
The time of entry/exit is stamped on the card so that the
hours worked by hourly paid employees can be calculated.
3.
Deduction return:
This is a document which is compiled by the company and sent
as supporting evidence for payments to the trade unions
administration office. It reflects the union fees deducted
from each employee’s earnings which are being paid to the
union.
4.
Employment contract:
This is a document which formalizes the terms and conditions
of employment and is signed by the company and the employee
on appointment.
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 356 of 3 pages
5.
b)
Masterfile amendment
form:
This is a document which details and authorizes changes to
the employee masterfile, e.g. addition of a new employee, or
a change in salary amount.
6.
Cheque requisition:
Where wages are paid in cash, a cheque requisition will be
completed to request a cheque for the amount of the wages to
be paid.
If deductions e.g. medical aid, union fees are
paid over by cheque, requisitions would be required for
each.
7.
Batch control sheet:
In a clockcard wage system, clock cards could be divided
into workable batches before being transferred to data
capture for keying in of hours worked by individual
employees.
The order and function(s) in which the documents/records are most likely to be used:
1.
Employment contract
-
Personnel (Human resources).
2.
Masterfile amendment
-
Personnel (Human resources).
3.
Clock card
-
Timekeeping and payroll preparation.
4.
Batch control sheet
-
Timekeeping and payroll preparation.
5.
Tax rate tables
-
Payroll preparation.
6.
Cheque requisition
-
Payroll preparation (and Deductions and recording).
7.
Deduction Return
-
Deduction: payment and recording.
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 357 of 3 pages
**2016**
SUGGESTED SOLUTION TO EXERCISE 8.25
Page 1 of 3 pages
a.
2.
1.
Overall – risk of material misstatement
1.1
The trade debtors figure is material (R7m and a significant portion of
current assets) which increases risk as it is large enough to contain
material misstatement.
1.2
The dominant risk would be overstatement (existence and valuation) but the
attitude (strong ethical business principles) of management and financial
state of the company suggest that there is little risk of deliberate
overstatement. This reduces risk.
1.3
An increase in control risk may arise by virtue of the new system, but it
appears that the development and implementation of the system has been
very well controlled and therefore it is unlikely that material
misstatement would have gone undetected and uncorrected.
Account heading assertions
Existence
2.1
There seems to be little risk of non-existent debtors (intentional or
unintentional) being included, due to the involvement of internal audit
and our computer audit division in the conversion and the post
implementation debtors confirmations.
Valuation
2.2
The only potential risk here is the understatement of the allowance for
bad debts (or the failure to write off specific debts).
The
recoverability of amounts owed to Style Council (Pty) Ltd may be difficult
to determine as
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 358 of 3 pages
*
it is subjective
*
the clothing industry, particularly fashion goods is volatile which
may result in some of the smaller Style Council (Pty) Ltd's debtors
having difficulty in paying.
Rights, Completeness, Presentation
2.3
There appear to be no specific risks relating to these assertions.
Based on the above particularly due to the materiality of the figure and the allowance for bad
debts, I would regard audit risk to be medium.
b.
1.
Audit risk is defined as the risk that the auditor will express an
inappropriate opinion when the financial statements are materially misstated, and
its components are inherent, control, and detection risk. Detection risk is the
risk that the auditors procedures will not detect material misstatement and is
controllable by the auditor.
2.
The fact that the audit team is not under pressure and has the time to
carry out audit procedures which produce strong evidence (e.g. subsequent receipt
testing) reduces detection risk and thus audit risk.
c.
The conversion controls adopted would have been as follows:
1.
2.
The conversion would have been treated as a project within itself which would have
required
1.1
Forming a steering committee to manage the project
1.2
Planning stages and defining tasks
1.3
Allocating responsibility
1.4
Setting deadlines
1.5
Obtaining necessary skills
1.6
Monitoring progress.
Extensive “clean up” of the old debtors data would have taken place PRIOR to
conversion by
2.1
Positive circularisations
2.2
Correction of debtors details e.g. names, addresses, blank fields
2.3
Removal/resolution of credit balances and other problems in debtors.
3.
The most suitable conversion method would have been decided upon, e.g. run old and
new in parallel, immediate shut down of old.
4.
A data control group would have been formed to
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 359 of 3 pages
**2016**
4.1
Provide conversion approval for each file before the process of conversion
was undertaken.
4.2
Compare selected portions of the old file with the new e.g. details of all
debtors beginning with the letters C and R.
4.3
Reconciling whole files by record count, hash totals and amount totals.
4.4
Co-ordinate the obtaining of 3rd party confirmations of data on the new
files (in this case the debtors circularisations which were conducted.)
4.5
Overseeing the follow up including correction of problems and errors.
/continued on page 2
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 360 of 3 pages
SUGGESTED SOLUTION TO EXERCISE 8.25
Page 2 of 3 pages
d.
1.
Existence
1.1
Review and discuss with internal audit, results of the debtors
conversion as well as the positive circularisations carried out by
internal audit.
1.2
Conduct subsequent receipts testing on a small sample of debtors
*
select the sample from the debtors list at 31 March 2016
*
identify payments
31 March 2016
*
trace the payments to the debtors remittance advice supporting
the payment
*
from the remittance advice identify which invoices are being
paid and inspect the invoice and supporting delivery note to
confirm that


1.3
1.4
received
from
the
selected
debtors
after
they are dated prior to year end
and were included in the sales journal and debtors ledger at
year end.
Using audit software, search the debtors masterfile for
*
any duplicate account numbers, names
*
any “no name/no account numbers” where there is an amount in the
total amount owed column.
Using audit software, extract a listing of “status query Code 1"
debtors and determine whether dispute relates to existence of debtor,
e.g. debtor claims never to have received goods/made the purchase and:
*
follow up with accounting personnel, and if still dissatisfied
*
inspect delivery notes for evidence of customers' signatures
acknowledging receipt of goods.
(Note: Tests of controls have satisfied you that documentation such as
delivery notes, orders, picking slips etc, are satisfactory.)
2.
Rights
2.1
Determine whether any debtors have been ceded, factored or in any other
way encumbered by inspection of
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 361 of 3 pages
*
minutes of directors meetings
*
loan agreements
*
bank confirmations
and by discussion with management.
3.
Completeness
3.1
Obtain the results of sales “cut-off” tests conducted by the audit
team.
4.
5.
Valuation – ‘gross’ amount
4.1
Using audit software, cast the “total amount owed” column and compare
it to the amount reflected in the debtors control account and the trial
balance.
4.2
Review the debtors control account at 31 March and follow up on any
material or unusual amounts.
4.3
Discuss the tests of controls carried out by the audit team in January,
February and March for any matters relating to your year-end procedures
in particular, the results of the cut-off and roll-forward tests
performed.
4.4
Using audit software, extract a listing of negative (credit balances)
from the masterfile and follow up to establish reason.
Consider
whether these should be transferred to creditors and make appropriate
recommendations/record on “Overs & Unders” schedule.
Valuation - allowance for bad debts
5.1
Enquire of management/inspect prior year workpapers to determine the
method and procedures adopted to estimate the allowance for bad debts.
5.2
Enquire as to, and evaluate, the authorisation procedure for the
allowance e.g. is it “authorised” by the credit controller or by the
financial director.
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 362 of 3 pages
**2016**
/continued on page 3
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 363 of 3 pages
SUGGESTED SOLUTION TO EXERCISE 8.25
Page 3 of 3 pages
5.3
Assess whether the basis of calculating the allowance is reasonable and
consistent with the prior year.
5.4
Refer to the results of the debtors circularisations carried out by
internal audit for evidence of disputed/irrecoverable amounts which are
still included in the debtors listing.
5.5
Using audit software, extract a random sample of individual debtors which
reflects the aging of the debtor and test the aging by tracing the amounts
owed back to the source documents e.g. sales invoices and receipts to
determine whether they have been allocated to the correct time period (say
60 days).
5.6
Using the audit software, select a complete list of
*
debtors who have exceeded their credit limit, and
*
debtors who have exceeded both their credit limit and their credit
terms.
5.7
Discuss each of the debtors identified in (5.5) and (5.6) above with the
financial manager and credit controller to obtain an opinion on their
recoverability (see also pt 5.9).
5.8
Using the audit software, extract a listing of “status query” code 1, 2
and 3 and by discussion with legal advisors and Style Council (Pty) Ltd
personnel as well as inspection of correspondence, evaluate the
recoverability of the amounts (i.e. the need to write off the debt or
include it in the allowance) (see also pt 5.9).
5.9
For all “status query” debtors obtain latest information by inspection of
financial records (particularly records of receipts) in the subsequent
period and by discussion with credit controller.
5.10
Perform analytical reviews (using audit software where possible)
*
compare bad debts allowance as a % of sales and debtors to prior
year
*
compare age analysis at 31 March 2016 with prior year to determine
whether debt is getting older, e.g. more than 120 days and over
accounts.
*
similarly calculate “days outstanding debtors”
prior years.
and compare to
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 364 of 3 pages
5.11
6.
Compare the actual bad debts written off during the year under audit to
the allowance made at the end of the previous year to obtain an idea of
the reasonableness of the directors allowance setting procedures.
General
6.1
Perform an overall analytical review of debtors for reasonableness
*
comparison with debtors at conversion date and prior years.
*
debtors as a percentage of sales.
*
debtors as a % of total assets and of current assets compared to
prior years.
*
overall number of debtors compared with prior years.
*
stratification of debtors compared with prior years by amount owed.
**2016**
UGGESTED SOLUTION TO EXERCISE 8.24
Page 1 of 3 pages
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 365 of 3 pages
a)
1.
The bank’s software should be loaded onto only the terminals of those employees who
need access to the bank facilities, e.g. financial director, debtors manager.
2.
Initial access to the company’s LAN should be controlled by the use of user IDs
and passwords given only to employees who use the LAN to fulfil their functions (this is
simply a basic control to restrict access to the LAN).
3.
Once access has been gained to the Stanwest Bank site, the various functions
available to users will be displayed (in some systems to get to this section of the site
may require an additional password).
4.
The employee will click on the “download bank statement” function and be requested
by the system to enter a PIN or password which is linked to the employees user profile.
If the user has not been granted the privilege an “access denied” message will appear.
5.
A full range of password controls should be in place
e.g.
*
unique to each employee, frequently changed
*
six characters, random, not obvious, etc
*
confidentiality enforced and disciplinary action taken if passwords
are shared.
6.
The system should shut down in the event of access violation e.g. three unsuccessful
attempts at entering a password/PIN.
7.
There would be a “time out” facility which would automatically logout the user
after say, 3 minutes, of inactivity.
8.
There would be automatic logging, review and follow up of access and access
violations.
Note: more rigorous controls are required to make EFT payments.
b)
1.
The accounts receivable balance is material in itself (R7,9m) and makes up 55% of
the current assets.
The balance therefore is large enough to contain material
misstatement and hence risk is present.
2.
The underlying systems pertaining to the accounts receivable balance have been
audited by our firm during the year and have been found to be well designed and
effective. Thus the probability of the accounts receivable balance containing (material)
invalid, inaccurate or incomplete information, is reduced.
Hence risk of material
misstatement is reduced.
3.
As Monty Zuma (directly responsible for accounts receivable) and the other
financial staff are assessed as hardworking, honest and competent, the risk of material
misstatement (intentional or unintentional) being present, is reduced.
4.
As the company is financially sound with a strong customer base there seems little
incentive to overstate accounts receivable. Risk is reduced.
5.
One factor which would increase the risk of misstatement for the current audit is
the change in credit limits and payment terms.
There is a (slight) increase in risk
relating to the valuation assertion in that as more credit has been extended and payment
terms relaxed, the allowance for bad debts may be understated, i.e. it may not adequately
reflect the effect of the change in policy.
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 366 of 3 pages
**2016* *
/continued on page 2
SUGGESTED SOLUTION TO EXERCISE 8.24
Page 2 of 3 pages
c)
Existence
1.
Subsequent receipts testing
1.1
Using our audit software, I would select a small sample of debtors from the
debtors masterfile at 31 May 2016.
1.2
Using the enquiry facility, I would print out the account record for the
debtors selected at the end of June and July 2016 to identify payments
received from these debtors after May 2016.
1.3
Using the document references on the account as well as any remittance
advices available, I would inspect dates on the sales invoices and
matching customer signed delivery notes to confirm that the payment is in
respect of a sale made prior to year end 31 May (i.e. the debtor existed
at year end).
2.
Cut off
I would obtain the signed customer delivery notes for, say, the last 20 sales
invoices prior to 31 May (and any material sales entered in May) to confirm that
delivery took place prior to 31 May i.e. the debt existed at that date.
3.
New debtors
Using the audit software, I would identify new account holders by comparing the
list of debtors at 31 May 2016 with the list of debtors at 31 May 2015. I would
then trace these debtors to their initial credit applications etc to substantiate
their existence.
4.
Error conditions
Using the audit software, I would scan the masterfile for any “error” conditions
which might indicate existence problems e.g. duplicate account numbers, figures in
the amount column but no name, account details, etc.
5.
Proof of delivery
For any debtors for which there is no subsequent receipt, trace amount owed to the
debtor signed delivery note to confirm delivery took place to correct address
prior to 31 May.
Valuation – gross amount
1.
Using the audit software, I would cast the individual balances on the debtors
masterfile and compare it to the debtors control account/trial balance.
2.
Using the audit software, I would extract any negative balances (credit balances)
from the masterfile, follow up, and if necessary, request that they be reversed.
3.
I would review the debtors control account for any unusual items and would cast
the account.
Valuation – allowance for bad debts
1.
By enquiry of Monty Zuma and/or Marcel Roux, I would
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 367 of 3 pages
1.1
1.2
1.3
Confirm whether the “percentage of aged amounts” method of establishing
the allowance was still being used AND
That the percentages (current 0%, 90 days 15% etc) were still the same as
used in prior years.
Determine whether they had considered the need to make changes to the
policy or percentages in view of the new policy on credit limits and
payment terms.
2.
However, as it is not acceptable from an accounting perspective to use this
general percentage method unless the percentages correlate very strongly with prior years
and other relevant evidence, I would seek evidence that this is the case by analyzing the
trend of actual bad debts write off for the prior three years against the allowances
made, I would assess whether the company’s allowance was reasonable. (Essentially we as
auditors need to be satisfied that the value at which accounts receivable is reflected in
the AFS is fair and any “impairments” have been accounted for.)
3.
By inspection of the minutes of the monthly directors meetings (June or July) I
would confirm that the current allowance was authorised.
**2016**
/continued on page 3
SUGGESTED SOLUTION TO EXERCISE 8.24
Page 3 of 3 pages
4.
Using a (small) randomly selected sample from the masterfile, I would test the
ageing of debtors by tracing the amounts owed, to the source documents to determine
whether they had been allocated to the correct time period. (I would use the enquiry
facility to print out detailed accounts of each debtor to assist in this procedure).
5.
5.2
5.3
Using the audit software, I would extract a list of debtors who had
5.1
Exceeded their credit terms (e.g. debtors with a 30 day limit and amounts
in the 60 day and/or 90 day and over field).
Total amounts owing which exceed their credit limit.
A hold on their account.
I would then discuss the recoverability of each of these debts with Monty Zuma, inspect
any relevant correspondence/documentation to assess the need to specifically write off
additional amounts, I would also relate this evidence (specific debtors) to the blanket
percentages used for the allowance.
6.
I would reperform all calculations in respect of the allowance.
7.
I would perform an analytical review of the allowance

comparison to prior years

comparison of ageing to prior year (what is the effect on this of the changed
credit policy)

calculation of ratios (e.g. allowance as a % of sales, days outstanding
debtors) and comparison to prior years.
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 368 of 3 pages
**2016**
SUGGESTED SOLUTION TO EXERCISE 8.23
Page 1 of 3 pages
a.
1.
Material:
accounts receivable is a material amount on the
statement of financial position which suggests that the account balance is
large enough to contain material misstatement.
2.
Existence:
as the consequences of failing to reach monthly
revenue targets can be serious, there is a risk that the directors may
manipulate the sales/accounts receivable figures by the introduction of
“fictitious” sales or by indulging in practices to inflate the
sales/debtors figures such as pre-invoicing.
3.
Completeness: on the other hand there is a risk that sales actually made in March
may be held over to April for recording if March targets have been met so as to ease
pressure on reaching April targets.
4.
4.2
Valuation:
4.1
as credit policies have been relaxed,
it is likely that the risk of bad debts will increase but that
as the directors are required to meet profit targets
4.2.1 there is an increase in the risk that sales
will have been made to bad credit risks, and that the
accounts receivable balance will contain debtors who should
have been written off as bad, (overstating profit) and that
the allowance for bad debts will be understated for the same
reason.
5.
Due to the above, and particularly because senior employees of Talking Heads
(Pty) Ltd have a direct interest (continued employment) in the financial statements,
there will be an increase in the risk of material misstatement associated with accounts
receivable.
b.
1.
Enquire of the financial manager/director of Talking Heads (Pty) Ltd as to:
the methods and procedures adopted in setting the allowance for bad debts.
1.2
whether any specific procedures were carried out or considerations
taken into account due to the change in credit control policy.
1.3
the authorisation procedure for the allowance e.g. is it approved at
board level (financial director) or by the credit controller.
1.1
2.
Assess by reference to the prior year workpapers whether the basis of determining the
allowance is consistent.
2.1
and, particularly if the basis has changed to accommodate the
relaxation of the credit policy, that it is reasonable.
2.2
and if group policy for allowances has been imposed on the company,
that it is also reasonable in the context of Talking Heads (Pty) Ltd.
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 369 of 3 pages
3.
Reperform all calculations used in arriving at the allowance.
4.
Using audit software, extract a (small) random sample of debtors and reperform the
ageing of the debt by tracing the amounts owed (per the age column) to source documents
(invoices and receipts) to confirm that allocation to the correct time period has
occurred.
5.
Using audit software, extract listing of all debtors
5.1
whose “amount owed” field exceeds the credit limit field
5.2
in the 120 days and over 120 days
and discuss the recoverability of each debtor on these listings with the
financial controller/credit manager.
**2016**
/continued on page 2
SUGGESTED SOLUTION TO EXERCISE 8.23
Page 2 of 3 pages
6.
and
Using the audit software, extract a listing of all debtors who have been handed over
6.1
inspect correspondence from the attorneys in respect of each of these
debtors and discuss their recoverability with management.
7.
Inspect the debtors correspondence file to identify any disputed debtors.
8.
Record potential bad debts out of (5) (6) and (7) above and review the allowance in
the light of information obtained.
9.
Compare actual debtors written off during the year under audit to the prior years
allowance to obtain an indication of management ability to set realistic allowances.
10. Perform some analytical procedures
reasonableness of the allowance.
e.g.
c.
to
obtain
additional
assurance
as
to
the
10.1 compare the bad debt allowance as a percentage of sales to prior
years and follow up on any unexpected results e.g. in view of the new
credit policy, I would expect an increase in this allowance as a
percentage of sales.
10.2
compare the number of debtors handed over to prior years.
I would expect to find the following controls.
Access controls
1.
The “telesales” operators should be located in a separate terminal room which is
physically secured to prevent unauthorised access i.e. entry only by swipe card or keypad
code.
2.
Access to the system and to the “telesales” order module of the sales application
should be restricted to the telesales operators and Andy Capp, by the use of user
identification, user profiles and passwords.
3.
Access to the telesales application should be restricted to authorised terminals by
the use of terminal identification (e.g. terminals in telesales departments only).
Customer identification and sales authorisation
1.
On placing a telesales order, the customer should first supply an account number.
This should be immediately validated against the debtors masterfile on being keyed in by
the operator.
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 370 of 3 pages
2.
The entry of a valid customer order should bring the customer’s details onto the
screen and the operator should confirm the details (sufficient to confirm the identity of
the customer) by asking the customer to provide information e.g. name of company,
delivery details, e-mail address etc.
Note: operators should not provide details and ask the customer to confirm.
3.
Where a valid account number is entered, the customer’s credit status should appear
i.e. available credit, and whether the account is overdue. If the account is in default,
the software should prevent the order from being written to the “sales order file”. See
pt 5 below.
4.
If, in placing an order, the customer’s credit limit is exceeded, the operator should
be alerted by screen dialogue.
Again the software should prevent the order from being
written to the “sales order file”. See pt 5 below.
5.
In the case of 3 or 4 occurring
5.1
the customer should be informed, and if the customer wishes to continue with
the order and
5.2
the order should be recorded on a “pending sales order” file
5.3
Andy Cap should be notified (preferably on the system).
**2016**
/continued on page 3
SUGGESTED SOLUTION TO EXERCISE 8.23
Page 3 of 3 pages
6.
Andy Capp should have the ability to authorise the sale and transfer it to the
“sales order file” should he wish to, after discussion with the customer.
7.
All “overrides” must be logged by the computer and reviewed regularly by the
sales director of Talking Heads (Pty) Ltd.
Note: Andy Capp should not have write access to the log of overrides.
Accuracy and Completeness
1.
Programme controls and software design which require the minimum amount of details to
be captured by the operator e.g. when the inventory code number is entered, the
description of the goods, price etc is automatically brought to screen from the database.
2.
Mandatory fields :
to confirm that all information necessary
order, is taken. In this case the following fields would be relevant:
2.1
order quantities
2.2
customer’s order number/references
to
fill
the
3.
alphanumeric checks particularly on the quantity and item code fields.
4.
Screen aids:
4.1 screen formatting : the terminal screen should be formatted in the form of a
sales order.
4.2 screen dialogue: messages to prompt the operator should appear, e.g. have you
confirmed delivery address?
5.
Once an order has been placed, the operator should read back the details to the
customer for confirmation.
6.
All telesales orders taken should:
6.1 be numerically sequenced by the computer to facilitate follow ups to confirm
that all orders have been filled and invoiced. (This reference to be given to the
customer.)
6.2
be written to a daily sales order file for review by Andy Capp.
7.
The responsibility for taking the order should be isolated by the automatic recording
of the operator’s code/user ID against the order.
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 371 of 3 pages
**2016**
SUGGESTED SOLUTION TO EXERCISE 8.22
Page 1 of 2 pages
1.
Agree/reconcile the opening balance at 1 February to the closing balance at 31 January 2016
in the working papers from the interim audit.
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 372 of 3 pages
2.
Cast the debtors control account.
3.
Reperform the posting from the cash receipts journal (CRJ), sales journal (SJ), credit note
journal (CNJ) and the general journal (J) for Feb and March.
4.
Inspect the CNJ for March and the general journal for Feb and March to confirm that there
were no other entries which should have been posted to the debtors control account.
5.
Enquire of the financial accountant and James Jett as to whether there were any problems
during Feb and March with the underlying systems pertaining to the debtors control account
(revenue and receipts).
6.
6.1
Confirm by inspection of the sales journal and Mightyflow CC’s account in the debtors
ledger, that a sale of R92 150 was not included in the Feb or March sales figures.
6.2
Inspect correspondence (possible official order) from Mightyflow CC confirming that
the loan of the pump should be converted to a sale;
6.3
7.
8.
*
agree the description of the pump invoiced per J44 to the details on the pump loan
documentation
*
confirm (by inspection of this agreement) that the selling price would be R92 150
including VAT
*
inspect the date of the confirmation of the sale. (Note: even if the confirmation
was shortly after the year end, the substance of the transaction was a sale made
prior to the year end and thus the sale can be raised.)
Confirm with the trainee responsible for the inventory audit that the cost price of
this pump has not been included in the inventory balance at year end.
Obtain the sales invoices making up the sales raised for the period between 25 March and
31 March;
7.1
Cast the invoices to confirm the total of R352 214.
7.2
By inspection of the invoices, confirm that all invoice numbers are after X3792 (last
invoice at 25 March), and that the sequence of numbers is complete (no missing
invoices).
7.3
Inspect the dates on the invoices and delivery notes to confirm that the delivery
took place prior to the financial year end.
Inspect the dates on a small sample of material invoices and corresponding delivery notes
for sales raised shortly after year end to confirm that the sales were (correctly) excluded
at year end.
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 373 of 3 pages
9.
Confirm by inspection of the CRJ and enquiry of the financial accountant that the cashbook
was not also closed off on 25 March. If the bank reconciliation at 31 March 2016 includes
any outstanding deposits from debtors, request that these be processed as an adjustment to
the year end.
10.
10.1 Inspect copies of the credit notes making up the amount of R104 145 for authorizing
signature.
10.2 Obtain an explanation for each credit note and inspect supporting documentation e.g.
goods returned note for damaged goods returned by customer.
10.3 Inspect the invoice to which each credit note relates and confirm by inspection of
the sales journal, that the original invoice had been raised as a sale.
11.
11.1 Inspect the journal entry (J45) and by inspection of the interim workpapers, confirm
that the entry is correct in terms of the amount and allocation.
11.2 Trace the journal entry postings to
debtors account in the debtors ledger.
the
other
account
affected
**2016**
e.g.
individual
/continued on page 2
SUGGESTED SOLUTION TO EXERCISE 8.22
Page 2 of 2 pages
12.
12.1 Inspect the correspondence relating to this special discount looking specifically for
authority for the granting of the discount.
12.2 Obtain the original invoice made out to Maxipressure (Pty) Ltd
*
confirm by inspection of the sales journal that the invoice was included in sales
and at the full amount (i.e. the discount has not been taken twice).
*
reperform the discount calculation
“before VAT” unit sale price.
confirming
that
it
was
calculated
on
the
12.3 By inspection of the journal entry, confirm that the adjustment to VAT has been
correctly calculated and accounted for.
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 374 of 3 pages
13.
13.1 Inspect correspondence with the liquidator of Waterworx (Pty) Ltd to confirm that the
company has been placed in liquidation and the maximum which could be expected as the
liquidation dividend.
13.2 Discuss with James Jett and the financial director, any evidence justifying the write
off of the entire amount.
13.3 Confirm by inspection of the Waterworx (Pty) Ltd account in the debtors ledger that
the total amount owed is R225 413.
Note: even if the evidence supporting the financial director’s opinion is not convincing,
it is unlikely that we (as auditors) would request a partial reversal.
It is
subjective, the amount is not material in the context of debtors, and the dominant
risk for debtors is overstatement and this amounts to understatement.
14.
By reference to the workpapers on collectability of debtors at year end, confirm that no
other amounts should be written off as bad debts.
15.
Obtain a list of individual debtors balances at 31 March 2016 and agree it to the balance
on the debtors control account (R5 000 306).
16.
Assuming no further adjustments to the control account are required, agree the balance of
R5 000 306 to the trial balance at 31 March 2016.
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 375 of 3 pages
**2016**
SUGGESTED SOLUTION TO EXERCISE 8.21
Page 1 of 3 pages
a)
i.
The fact that this is an audit required by the MOI and not by virtue of the company’s
public interest score, will have no effect on our assessment of risk. The MOI simply
sets the requirement for the audit and whether the audit is required by the PIS or
the MOI does not change the conditions at the client.
ii.
(1) Audit strategy is determined, inter alia, by the scope of the audit (timing and
direction also affect strategy). There is nothing to indicate in the MOI that the
scope of the audit should be anything other than a conventional audit in terms of the
International Standards on Auditing (same as a Companies Act required, PIS based
audit).
(2) The audit plan is the detail of the nature, timing and extent of testing which is
to be carried out on the audit and is determined by the assessment of risk,
materiality levels set etc. None of the determinants of the audit plan are affected
by the fact that this is an MOI audit as opposed to an audit required by virtue of
the PIS.
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 376 of 3 pages
iii. The objective of any audit of financial statements is for the auditor to gather
sufficient appropriate evidence to be able to express an opinion on the fair
presentation of the financial statements. This objective does not change.
b)
1.
I would assess the risk of misstatement at 31 March as high.
2.
The debtors figure is material in the
therefore could contain material error.
contain material error).
3.
The underlying systems relating to the account heading have “not been maintained and
were generally poor” for a significant part of the year.
This suggests that there
may be errors which directly affect the assertions relating to the account heading
(valuation (gross amount) existence, completeness). This is control risk.
4.
The newly appointed debtors manager has found that Adam Brown “had done things his
way” and there were numerous unexplained adjustments, no regular reconciliations etc.
This suggests that Adam Brown was either
context of the financial statements and
(The account heading is large enough to
4.1
incompetent or
4.2
perpetrating fraud (misappropriating funds).
5.
The fact he left suddenly shortly after the announcement that an internal auditor was
joining the company, suggests (when combined with 4 above), that he was
misappropriating funds. In addition, Adam Brown had sole responsibility for debtors
enabling him to misappropriate funds and conceal the theft.
This suggests a
significant risk which we will need to address.
6.
The fact that Cherry Checkitt has been appointed as internal auditor is very
positive. However, in the context of the 2016 year-end audit, it does not reduce the
risk of misstatement in the debtors accounts heading at year end as
6.1
she has not yet been able to spend much time on the cycle and
6.2
she has only been at the company for a month, so will have had little effect
on the 2016 financial year-end figures.
7.
Risk of misstatement is also present due to the fact that this is a first audit of
the company’s (as opposed to the CC) financial statements. The company may not know
quite what to do in complying with accounting standards, company regulations and
producing evidence for audit purposes.
8.
More specifically, the financial figures for the 2016 financial year-end will be
directly affected by the opening balances taken up when the former CC was
incorporated (1 April 2015).
These opening balances were produced by poor systems
and are unaudited.
9.
Although there is no suggestion that the directors will want to manipulate the
financial statements, the bank has indicated that they would like to see a “healthy
set of figures” in support of continuation of the bank overdraft.
This may filter
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 377 of 3 pages
down into the directors attitude in setting allowances. In this cycle there may be a
tendency to understate the allowance for bad debts and a reluctance to write off
debtors.
**2016**
/continued on page 2
SUGGESTED SOLUTION TO EXERCISE 8.21
Page 2 of 3 pages
c)
Nature of testing
1.
I will concentrate on substantive testing of the year-end balance for the following
reasons
1.1
The underlying systems in the cycle cannot be relied upon to produce valid,
accurate and complete information, e.g. there was a distinct lack of division
of duties in the cycle with Adam Brown having sole responsibility for many
incompatible functions.
1.2
There is a lack of audit trail (underlying records)
unexplained adjusting entries.
The opening balance is unaudited and possibly unreliable.
1.3
reconciliation
and
The most effective approach would therefore be to attempt to substantiate what is actually
reflected at year-end.
2.
The major risks are that the balance is overstated by
2.1
The inclusion of fictitious debtors created by Adam Brown to conceal
misappropriation/fraud (existence) and
2.2
That the allowance for bad debts is understated or that debtors which have
actually gone bad, are not written off (valuation).
3.
Existence of debtors is best addressed by conducting
3.1
An extensive debtors circ (positive only).
3.2
Subsequent receipt testing (there is no specific audit deadline).
Some evidence of fictitious debtors may also come to light when anaylsing long outstanding
debtors balances.
4.
Valuation (allowances and write offs) is best addressed by age analysis, analytical
review, and detailed debtor investigation e.g. payment history.
Both 3 and 4 above amount to substantive testing.
5.
Wherever possible I will plan to work with
controller, and the “temporary” debtors manager.
Cherry
Checkitt,
the
new
credit
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 378 of 3 pages
6.
There are two thousand four hundred debtors and although the computerized accounting
records have not been properly maintained, I would still attempt to use CAATs
whenever possible e.g. extraction of samples for the debtors circulation.
7.
The possibility that there has been misappropriation (theft) in the cycle by Adam
Brown has been identified as a significant risk (one that requires a specific
response by the auditors).
7.1
By testing for existence we will be responding to the risk of the creation of
fictitious debtors (created to conceal fraud) but we have not addressed the
question of completeness of debtors, i.e. are there debtors which have been
invalidly reduced (by an unauthorized credit note or other adjustment) or
perhaps removed completely or never raised?
7.2
To address this, some tests of detail should be carried out on the validity of
credit notes passed and other adjusting entries. (It must be borne in mind
that if a debtor has paid but Adam Brown has stolen the payment and passed an
adjusting entry, the debtors balance will be correctly stated.)
Note: If this becomes a fraud investigation (perhaps with the intention of prosecuting Adam
Brown) it will move beyond the scope of the audit.
d)
1.
Completeness testing in general can be difficult for the auditors because we are
looking for evidence of transactions which are not recorded.
2.
If we conclude that the internal control system produces valid, accurate and complete
information, our task is made easier as we can take some comfort that the system has
picked up all sales. At Wallandall (Pty) Ltd the systems are not well maintained and
internal controls were poor.
3.
Some tests of detail may be possible e.g. sequence testing dispatch notes and
matching dispatch notes to invoices to identify any dispatches (sales) not raised as
debtors, but this is unlikely to render reliable results.
**2016**
/continued on page 3
SUGGESTED SOLUTION TO EXERCISE 8.21
Page 3 of 3 pages
e)
4.
Essentially
that
leaves
conducting
extensive
analytical
procedures
as
our
alternative, e.g. comparison of sales to prior years, analysis of recorded sales by
category to prior years.
However, as this is the first audit of Wallandall (Pty)
Ltd, neither our firm nor the client is likely to have much reliable information on
this. (Also bear in mind that the “information systems” are poor).
1.
Subsequent receipts testing
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 379 of 3 pages
1.1
1.2
1.3
1.4
1.5
1.6
f)
I would select a (large) sample of debtors included in the list of debtors at
year end.
(Note: the debtors list would have to have been agreed to the
debtors ledger which would have been agreed to the debtors control.)
I would then identify payments received from these selected debtors from the
cash receipts journal.
These would then be traced to the debtors remittance advice to identify which
invoices the payment is in respect of.
The invoices and matching delivery notes would then be inspected to confirm
that they were dated prior to the year end and included at year end in the
sales journal and debtors ledger.
This test proves that a genuine debtor was appropriately included at year end.
It does not identify fictitious debtors because fictitious debtors won’t be
making payments (there is no subsequent receipt).
Of course the auditor may choose to follow up on any debtor selected for
subsequent receipts testing for which there is no payment received in the post
financial year end period.
However, this does not mean the debtor is
fictitious, e.g. it may just be a valid, long outstanding debt.
1.
Enquire as to the method and procedures adopted by management to set the allowance.
2.
Evaluate whether these are appropriate for the circumstances in which Wallandall
(Pty) Ltd finds itself with regard to the problems in the debtors department.
3.
Confirm (or establish whether) the authorization of the allowance was given at a
sufficiently senior level after due consideration, e.g. authorizing the allowance was
not left to Gunston Smith, and was authorized by the financial director.
4.
Reperform the aging of the debtors list (Gunston Smith presented an aged list) by
selecting a sample of debtors and tracing the amounts owed back to the source
documents, e.g. sales invoices and receipts to determine whether they have been
allocated to the correct time period.
5.
Each and every long outstanding debtor should be discussed and evaluated for
recoverability. The opinion of the new credit controller, Gunston Smith and Cherry
Checkitt should be sought.
6.
Reference to the workpapers from:
6.1
The debtors circularization and other.
6.2
The audit procedures carried out on identifying fictitious debtors,
adjustments to debtors and reconciliations should be evaluated for evidence of
debtors who should be written down or off.
7.
Any correspondence with debtors and the company’s legal advisors should be reviewed
for matters pertaining to recoverability.
8.
Despite the fact that the prior year figures are unaudited, some comparison to the
prior year debtors and allowances should be made and material or unusual variances
discussed with Wallandall (Pty) Ltd’s management, e.g. if the aging profile of
debtors has changed, it may have an effect on the allowance.
9.
All casts and calculations pertaining to the allowance should be reperformed.
10.
Enquiry should be made of management as to whether there are any specific matters
known to them with respect to the recoverability of debtors amounts.
11.
The evidence gathered should be collectively evaluated for reasonableness (bearing in
mind that there may be a tendency to understate the allowance for financial statement
purposes).
Note: any use of amounts or other information for the period for which Adam Brown was in
charge, should be addressed with some caution.
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 380 of 3 pages
**2016**
SUGGESTED SOLUTION TO EXERCISE 8.20
Page 1 of 2 pages
1.
Agree the opening balance at 1 May to the closing balance at 30 April reflected in the
interim work papers.
2.
Cast the Debtors Control Account.
3.
Refer to responses to the positive debtors circularisation to confirm that no adjustments
to the control account arising out of the responses to the circularisation were required
(none have been made).
4.
Reperform the postings from the cash receipts journal, sales journal, goods returned
journal and the general journal for the months of May and June.
4.1
Confirm by enquiry of the warehouse manager and goods returned documentation that
no goods were returned in May.
4.2
Review the (general) journal for the months of May and June to confirm that there
are no further entries which should be posted to the control account.
5.
Enquire of the financial accountant as to whether there were any problems with internal
control for the underlying systems (e.g. revenue and receipts cycle) during the months of
May and June.
6.
Discuss the reversal of discount
controller/financial accountant
7.
given
by
Violet
Violins
CC
with
the
credit
6.1
Confirm that the discount was granted in the first place by reference to the sales
invoice and the amount received as well as by reference to the journal entry.
6.2
By inspection of the date of receipt/deposit of the payment, confirm that the
amount was paid outside the discount period of 30 days.
6.3
Inspect (if available) correspondence with Violet Violins CC to determine whether
they accept the reversal.
6.4
Enquire of the financial accountant as to whether this situation has occurred with
any other debtors (i.e. discount incorrectly granted).
Obtain the sales invoices making up the sales raised for the period 25 June to 30 June.
7.1
Cast the invoices.
7.2
By inspection of the dates on the invoice and delivery notes, confirm that the
sales were made during the period and not subsequent.
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 381 of 3 pages
8.
Inspect the dates on a small sample of material invoices and delivery notes after the
cut-off number for the financial year-end 30 June 2015 to confirm that the sale was made
after the year-end (and therefore have correctly been excluded).
9.
By scrutiny of the June bank statement, confirm that no deposits (receipts) from debtors
took place between 24 June and 30 June.
10.
Request that the amount of R72 400 raised as a sale to Wonder Pianos (Pty) Ltd be
reversed.
10.1
No sale has been made, an order has not yet been received.
contravention of the revenue recognition standard.
This amounts to a
10.2
The matter should be recorded in the workpapers and the adjusting journal entry
vouched once it is passed.
11.
Select a small sample of the debtors who make up the R100 000 (May and June) of
discount allowed.
11.1
Confirm by enquiry of the financial manager that they are entitled to discount and
11.2
By inspection of dates of invoice and date of payment, confirm that the conditions
have been filled.
11.3
Reperform the discount calculation.
**2016**
/continued on page 2
SUGGESTED SOLUTION TO EXERCISE 8.20
Page 2 of 2 pages
12.
Inspect correspondence with the liquidator of Chellos (Pty) Ltd to confirm that the
company has been placed in liquidation.
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 382 of 3 pages
12.1
If the full amount owed by Chellos (Pty) Ltd prior to the write off was greater
than R15 200, request and verify evidence that a liquidation dividend is expected
(e.g. notification from the liquidator).
13.
By reference to workpapers on collectibility of debtors at year-end, confirm that no
other amounts should be written off.
14.
Obtain a list of debtors at 30 June 2016 per the debtors ledger/masterfile and agree the
control account balance to the list.
15.
Agree the balance of R1 957 819 to the trial balance at 30 June 2016.
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 383 of 3 pages
**2016**
SUGGESTED SOLUTION TO EXERCISE 8.19
Page 1 of 3 pages
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 384 of 3 pages
a)
Existence:
evidence to support this assertion is provided. In effect, confirmation
of the company’s representation (assertion) that the debtor does exist
is being given by the debtor itself.
Completeness:
no evidence is provided in respect of this assertion.
The sample for
circularization is drawn from the debtors masterfile so if a debtor has
been omitted (i.e. the masterfile is incomplete) the debtor cannot be
selected for circularization.
Valuation:
some evidence is provided in that by confirming the amount owed, or by
pointing out errors in the amount owed, evidence pertaining to the gross
amount of the debt is provided. However, no evidence is provided as to
the carrying value of the debt i.e. whether or not an allowance for nonpayment of the debt should be made.
Rights:
this assertion represents that the company has not given up its right of
ownership of the debt.
A debtors circularization will not reveal any
evidence relating thereto.
Generally a debtor will be unaware of any
“rights” issues believing simply that the amount is owed to the company
who supplied the goods or services.
b)
c)
1.
A negative circularization provides very little evidence primarily
because the debtor is only required to respond if there is a problem. However, the
auditor cannot assume that a non-response means that the debtor confirms the
balance as there are a number of reasons that a debtor may not respond. e.g.
*
debtor never received the confirmation or
*
couldn’t be bothered to respond.
*
error is in favour of the debtor
I would include:
1.
The 9 debtors with balances over R75 999: This will give confirmation of
the existence of debtors making up at least 39% of the total balance.
2.
A random sample of
2.1 new accounts:
overstatement of accounts receivable can be achieved by
adding (new) fictitious accounts.
2.2 accounts under R5 000: although these account balances are relatively low the
sample should be representative of the total population (all debtors) and we
are primarily testing existence.
2.3 accounts between R5 000 and R75 000 – same reason as in (2.2) above.
3.
All debtors in the “120 days and over” aged column. It appears that these may be
disputed accounts, judging by the large percentage of debtors in the 30 and 60 day
column.
d)
Towards the end of June
1.
Enquire of the financial controller/other relevant personnel as to whether there
have been any internal control breakdowns in the accounting systems underlying the
accounts receivable balance e.g. sales, receipts, sales returns.
2.
Inspect a small sample of sales invoices, receipts, credit notes etc for the
months of May and June for evidence supporting the occurrence, accuracy, cut-off,
classification and completeness assertions relating to these transactions.
3.
Inspect the debtors control account at the end of May and June for any unusual
(size or nature) entries made during the two months.
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 385 of 3 pages
**2016**
/continued on page 2
SUGGESTED SOLUTION TO EXERCISE 8.19
Page 2 of 3 pages
4.
Reperform casts, and calculations, of control accounts and subsidiary journals for
the two months.
5.
Reperform entries from subsidiary journals to the control account.
6.
Compare the balance on the debtors control account at 30 June 2016 to the balance
at 30 April 2016 and follow up if there appears to be any unusual fluctuation.
7.
Inspect documentation (particularly the authority) for any adjustments made to the
debtors control account during May and June including any adjustments arising out of the
debtors circularization.
8.
Reperform the reconciliation of the total on the debtors masterfile to the general
ledger at 30 June 2016 and follow up on any reconciling items.
9.
Perform analytical procedures
debtors/turnover ratios against prior
fluctuations etc.
e)
(e.g. comparison of sales per month and
years), including thorough investigation of
Boekwurms CC
1.
Obtain and review the correspondence between Boekwurms CC and Mutterworths (Pty)
Ltd to gain a clearer understanding of the dispute.
2.
If available, inspect the original order picking slip and dispatch documentation
for the order in dispute to confirm that the incorrect edition of the book was in fact
dispatched.
3.
Discuss the matter with Ukay Zedden to establish why the books have not been
collected and a credit note issued to Boekwurms CC or whether there is any justifiable
reason for not doing so.
4.
If there is no justifiable reason for not reducing the debtor/reversing the sale,
inspect the debtors control account/debtors account/credit notes/ journal entry to
confirm that the debt has been written off by year-end, (if not written off, request
management to effect the necessary entry) or
5.
If the matter is in genuine dispute, request that the debt, at least be included
in the allowance for bad debts.
6.
By scrutiny of correspondence with debtors and discussion
establish whether any other debtors have a similar dispute.
with
Ukay
Zedden,
7.
Inspect inventory records at year-end to establish whether any second edition
copies of this textbook have been included in inventory at year-end, if so request that
the value be written down as they are out of date.
Printables (Pty) Ltd
1.
Inspect the cash receipts records/bank deposit for the period, say, 7 to 9 February for
evidence of the deposit of R45 511.
2.
If the amount was received, trace the account to which the amount was posted. It could
have been posted to
*
the incorrect debtors account
*
a suspense account for EFT receipts which are not clearly referenced by
the sender
*
some other incorrect account in error.
If this is the case, request that the misallocation be corrected.
3.
If no evidence of the receipt can be found, request Ukay Zedden to contact Printables
(Pty) Ltd immediately to confirm that the bank details for Mutterworths (Pty) Ltd on its
system are correct and have not been fraudulently changed at any time.
4.
If the banking details are correct, Ukay Zedden should request Printables (Pty) Ltd to
confirm with its bank exactly to which account number etc the R45 511 was transferred.
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 386 of 3 pages
**2016**
/continued on page 3
SUGGESTED SOLUTION TO EXERCISE 8.19
Page 3 of 3 pages
5.
If it is not a misallocation and the matter is not resolved by the financial year end,
how it is treated must be discussed with the audit manager and Ukay Zedden.
From
Mutterworths (Pty) Ltd’s perspective, the amount was never received, and from Printables
(Pty) Ltd’s perspective they paid it.
If Printables (Pty) Ltd acknowledges that the
fault was theirs they will probably be prepared to pay the R45 511 to Mutterworths (Pty)
Ltd. However if they dispute that it was their fault (fraud or error) the collectability
of the R45 511 becomes uncertain and may have to be acknowledged in the allowance for bad
debts.
Bookreview (Pty) Ltd
1.
Inspect the goods returned note RN 2471, to confirm that the goods were actually returned
and signed for as claimed on the 18th April.
2.
Trace the details on the goods returned note RN 2471 to the original orders to confirm
there was a duplication and that it was actually for the goods returned.
3.
Confirm with Ukay Zedden that he did agree that the books could be returned for a full
credit of R22 000 and enquire as why a credit note was not passed prior to 30 April 2016.
4.
Confirm by inspection that a credit note was passed prior to the 30 June 2016.
5.
At the financial year-end confirm, by inspection that credit notes have been processed
for all goods returned notes for goods returned prior to 30 June 2016. There appears to
be a potential weakness in the internal controls over passing credit notes.
6.
Inspect inventory records to determine whether
included in the inventory balance at year-end.
the
books
returned
have
been
**2016**
SUGGESTED SOLUTION TO EXERCISE 8.18
1 Page only
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 387 of 3 pages
1.
This could be a test of controls or a substantive test (dual purpose)
1.1 test of controls if we are testing that all masterfile amendments are approved by the
designated officials
1.2 substantive test if it is part of testing the existence of the debtor particularly if
there is a risk of fictitious debtors on the masterfile.
2.
Risk assessment procedure.
3.
Substantive test – existence of debtors.
4.
4.1 test of controls if we are testing that all credit notes are authorised
4.2 could also be part of the substantive tests of detail conducted on a debtors account
balance.
5.
Risk assessment procedure.
6.
Test of controls (not a very effective one!)
Could also be a risk assessment procedure if the procedure was carried out to gain an
understanding of the internal control system.
7.
Risk assessment procedure.
8.
Test of controls.
9.
Substantive test – existence and valuation (to a lesser extent).
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 388 of 3 pages
10.
Substantive test – valuation (bad debt allowance).
**2016**
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 389 of 3 pages
SUGGESTION SOLUTION TO EXERCISE 8.17
1 Page only
1.
2.
The junior trainee’s understanding is weak (very weak!).
Accounts Receivable
2.1
As accounts receivable is a balance, the assertions relating thereto are: rights,
existence, valuation and allocation, and completeness. The trainee does not seem to
know this.
2.2 Accuracy is an assertion which relates to transactions.
Although he has identified
sales as the underlying transaction for this balance, accuracy does not apply to the
accounts receivable balance, it relates to the accuracy of recorded sales.
2.3 The existence assertion simply means that the debtors included in the list at year end
existed (are not fictitious), it has nothing to do with whether they will pay or not.
2.4 The obligation assertion relates to liability balances not to asset balances.
2.5 Validity is not an assertion (in the context of auditing it is an internal control
objective). The trainee is confusing validity with existence.
2.6 The trainee has omitted the following assertions:
3.
*
valuation and allocation: i.e. the balance of R2 631 981 is an appropriate carrying
value for accounts receivable, adequate allowance having been made for bad debt write
offs.
*
rights: i.e. Safe-T (Pty) Ltd has or controls the right of ownership to the accounts
receivable (they have not, for example, factored them).
*
completeness: i.e. all accounts receivable that should have been recorded at year-end
have been included in the balance of R2 631 981.
Sales
3.1 “Sales” represents transactions and the assertions relating to transactions are
accuracy, cut-off, classification, completeness and occurrence. The trainee does not
seem to know this.
3.2
Recognition is not an assertion and he appears to muddle the assertions
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 390 of 3 pages
with the accounting
recognized.
standard
which
deals
with
when
revenue
can
be
appropriately
3.3
Collectability is not an assertion. The “collectability” of credit sales
is reflected in the valuation assertion relating to accounts receivable (an assertion he
was not aware of).
3.4
Valuation the valuation assertion applies to balances not to transactions,
a distinction he clearly does not understand.
3.5
Rights: Again rights is an assertion relating to the balance reflected on
an asset account (e.g. accounts receivable). The likelihood of non-payment is reflected
in the valuation assertion applicable to accounts receivable.
3.6
The trainee has omitted the following assertions relating to sales
*
occurrence: the sales recorded of 9 246 124 have occurred and pertain to
Safe-T (Pty) Ltd.
*
completeness: all sales that should have been recorded have been recorded
*
accuracy: the amounts of the sales have been recorded appropriately
*
cut-off: sales have been recorded in the correct accounting period
*
classification: sales have been recorded in the proper account.
**2016**
SUGGESTED SOLUTION TO EXERCISE 8.16
Page 1 of 3 pages
1.
Recording cheques received through the post
1.1
Each day mail should be directed to Clarissa Chetty.
1.2
At a pre-determined time each day she and Samual Kramer should open the post together
and record details of all cheques received in a remittance register, including the
date, name of the business paying the cheque, cheque number and amount
*
the remittance advice/document sent by the debtor identifying the invoices which
are being paid, should be attached to the cheque
*
all other post, e.g. orders, should be recorded and sent to the appropriate
section.
1.3
Samual Kramer should then take the cheques and supporting documentation to Loverboy
Zumah who should agree the cheques to the register and sign the register to
acknowledge receipt.
1.4
Loverboy Zumah will then complete a pre-printed, sequenced, dated “cheque receipts
input sheet” which lists the
*
name of the debtor whose account is being paid
*
the account number
*
the total amount of the cheque and the numbers of the invoices which are being
paid. These will be taken from the remittance advice if available.
If not, Loverboy Zumah will phone the debtor to find out.
Note: this could easily be drawn up on the computer.
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 391 of 3 pages
2.
1.5
Before listing a cheque, Loverboy Zumah should carefully scrutinise the cheque to
ensure it is properly made out and crossed to minimise the chances of it being
rejected by the bank.
1.6
Loverboy Zumah will then make out a deposit slip for the total amount of cheques to
be deposited
*
the cheques and deposit slip will then be passed to Samual Kramer who will deposit
the cheques in the bank the same day
*
the copy of the bank stamped deposit slip will be attached to the “cheque receipts
input sheet”, or if the deposit slip is a fast copy (in a book) it will be crossreferenced to the input sheet.
Recording EFTs and direct (cash) deposits into the bank account
2.1
Millicent Scott the credit controller should access the company’s bank account via
the internet each morning and download a bank statement
*
2.2
Loverboy Zumah should not have the bank software on his computer as he does not
need access to the company’s bank account.
Millicent Scott’s access to the company’s bank account should be strictly controlled
*
she will have the bank’s software on her computer
*
access to the bank’s site will be gained in the normal manner (user IDs, password)
*
access to the company’s bank account will require that Millicent Scott enter a PIN
and password
*
if this identification and authentication procedure is successful, a menu of the
functions will appear including a “download bank statement” function
*
this function will be linked to Millicent Scott’s user profile, allowing her to
download the bank statement.
Note: access of any kind to the company’s bank account will be limited to only a few
senior employees and the functions to which each employee is given access, will be
strictly controlled.
2.3
Millicent Scott will then print out a copy of the daily bank statement and pass it to
Loverboy Zumah
*
2.4
Loverboy Zumah will check the date/document sequence of the bank statement to the
previous bank statement he received.
Loverboy Zumah will then prepare an electronic “receipts input sheet” in the same
manner as he did for the cheque receipts.
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 392 of 3 pages
**2016**
/continued on page 2
SUGGESTED SOLUTION TO EXERCISE 8.16
Page 2 of 3 pages
2.5
At regular intervals Millicent Scott should arrange for a communication to be sent to
all account holders which
*
provides the company’s banking details and fax and email address for proof of
payments
*
urges debtors to pay by EFT where possible (efficiency and less potential cheque
fraud)
*
reminds debtors to reference their EFTs (and direct cash deposits) properly e.g.
use their account number as a reference
*
send proof of payment and remittance advice (showing which invoices are being
paid) by email or fax.
2.6
As proof of payments arrive at Supplyline (Pty) Ltd (by post, email or fax) they
should be directed to Loverboy Zumah who should file them alphabetically by date.
2.7
When compiling the electronic receipts input sheet, Loverboy Zumah should tie up each
EFT payment and cash deposit on the bank statement to a supporting proof of payment
to
*
confirm the debtors account to which the EFT must be credited
*
identify the invoices which are being paid.
2.8
If an EFT (cash deposit) cannot be tied to a debtor (inadequate referencing and no
proof of payment) the payment should be posted (allocated) to a debtors suspense
account (i.e. all EFTs and cash deposits reflected on the bank statement should be
dealt with, and subsequently investigated and cleared from the suspense account).
2.9
Loverboy Zumah should total the amounts he has entered on the electronic receipts
input sheet and the EFT receipts on the daily bank statement to confirm they are the
same
*
he should sign the sheet and pass it to Millicent Scott.
2.10 She should review it and sign it once she is satisfied
completeness. She should return it to Loverboy Zumah.
3.
Entering the receipts onto the system
with
its
accuracy
and
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 393 of 3 pages
3.1
Loverboy Zumah will be responsible for entry of the cheque and electronic input
sheets.
3.2
Access to the “process receipts” module of the revenue and receipts module should be
restricted to Loverboy Zumah in the normal manner (user IDs, profiles and passwords).
3.3
Precisely how the system works will depend on the features of the application, but in
principle the following should occur
3.4
**2016**
*
once Loverboy Zumah has entered a debtors account number (taken from the input
sheet) the screen will come up with the debtors account including a list of unpaid
invoices making up the balance owed
*
any invalid account number entered will be rejected by the system
*
the suspense account will have its own unique account number
*
the system will be set up and the screen will be formatted for Loverboy Zumah to
select the invoice(s) for which the payment has been received and to enter the
actual amount received from the debtor for that invoice in the designated field
*
if the amount entered differs from the amount of the invoice on the system, a
screen message will ask Loverboy Zumah to confirm the amount entered (see 3.5).
When Loverboy Zumah has entered the total amount received from the debtor (broken
down by invoice) he will move to the next debtor on the input sheet
*
when all amounts have been processed, Loverboy Zumah will extract a report which
shows the total of all amounts entered
*
Loverboy Zumah will agree this total to the total on the two receipt input sheets.
Any discrepancies will be followed up
*
a copy of the report will be printed out, signed and attached to the input sheets
once it has been reconciled by Loverboy Zumah.
/continued on page 3
SUGGESTED SOLUTION TO EXERCISE 8.16
Page 3 of 3 pages
3.5
Debtors do not always pay the exact amount of the invoice (the debtor may make a
mistake or deduct a discount to which the debtor may or may not be entitled)
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 394 of 3 pages
*
3.6
If there is no invoice on the system against which the receipt can be matched, the
amount is posted to the suspense account not to the debtors account. The same will
apply to any receipt on either of the input sheets which has not been tied to a
specific debtor. (This is more likely to be the case with EFTs and cash deposits)
*
4.
where a difference has been identified (see 3.3 above) and Loverboy Zumah has
confirmed the amount he keyed in against the invoice as correct, the detail of the
difference will be written to a report.
the system will produce a report of all available details of amounts written to
the suspense account.
Independent reconciliation
4.1
At the end of each week, Moses Mabida should extract from the system, a report of
daily receipts processed, to the masterfile for the preceding week and reconcile it
to the remittance register, the receipt input sheets, the deposit slips and the bank
statements.
4.2
He and Millicent Scott should also extract a report of all amounts in the suspense
account and a report of all invoices in respect of which the amount received did not
agree with the invoice.
These reports should be discussed by the two of them and
followed up.
4.3
Any journal entry required to adjust a debtors account, e.g. grant a discount, should
be authorised by Moses Mabida and Millicent Scott. The same principle should apply
where an amount is to be transferred out of the suspense account.
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 395 of 3 pages
**2016**
SUGGESTED SOLUTION TO EXERCISE 8.15
Page 1 of 2 pages
a)
1.
All the sales personnel have write access to the debtors masterfile.
1.1
The ability to make amendments to the masterfile should be strictly
controlled by restricting access, particularly write access, to a limited number of
people.
This reduces the risk of unauthorized changes, e.g. changes of standing
data, removal of debtor from the debtor’s masterfile.
2.
Amendments
evidence.
are
made
to
the
masterfile
without
authorisation
and
without
supporting
2.1 The salesperson adding the new customer does not do so on the strength of a document
(see also pt 3 below) which has been authorised by a senior employee. A salesperson
could easily add a fictitious debtor to “hide” the theft of clothing either by
himself/herself or in collusion with a “customer”.
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 396 of 3 pages
3.
Information provided by customers is not verified and inadequate.
3.1 Before credit is granted to the customer,
*
far more information about the customer should be obtained
e.g. banking details, trade references, income etc.
*
all information provided should be followed up and verified
wherever possible e.g. ID document inspected, debt bureaus contacted.
4.
There is no reasonable basis used for setting a credit limit.
4.1
Even though the company’s policy is to grant credit freely, some basis of
setting a limit should be used. It is not acceptable to ask the customer how much
they would like – a realistic limit should be set based on what the customer can
afford (see pt 3).
4.2
In addition no terms are set e.g. 30 days, 60 days and no follow up on
payments (see pt 8).
5.
There is no check on the identity of existing customers when they make further
purchases.
5.1
A purchase can be charged to an account by simply providing a valid
account number.
No attempt is made to confirm that the customer providing the
account number is the account holder.
6.
There is no acknowledgement by the customer that he or she has made a purchase.
(The plastic card is totally superfluous as it does not contain the signature of the
customer so having the customer sign the sales invoice would be pointless.)
7.
Coupled with pt 5 above
7.1 A customer could easily dispute an amount charged to his account and refuse to pay
for a purchase which he or she actually made.
7.2 Anyone, including sales personnel can make a purchase and charge it to any account
holder.
8.
There appears to be no limit to the amount a customer can spend on his/her account
e.g. is the customer paying? Has the “credit limit” been exceeded?
8.1
Even though a “limit” is set, there is no check to determine the status of
the account before further purchases can be made, e.g. is the customer a regular
payer, has he exceeded his or her credit limit.
b)
Validity
1.
Access to the “masterfile amendments” module should be restricted to a (limited
number of) terminals in the debtors department.
2.
Write access to the masterfile should be restricted to a (limited number of) single
employees in the debtors department (user ID, passwords). No access should be given to
any sales personnel.
3.
All masterfile amendments for additions of new customers should be recorded on preprinted
sequenced masterfile amendment forms and cross referenced to the relevant credit
application form.
4.
Every new customer must complete a standard pre-printed sequenced credit application form
by providing all personal details, banking details, trade references, details of
disposable income, etc.
4.1 All details must be followed up. If satisfactory, credit terms should be granted in
terms of company policy or by the credit controller and financial manager (or
similar).
4.2 The credit application and MAF should be signed by both the credit controller and
financial manager (or similar).
**2016**
/continued on page 2
SUGGESTED SOLUTION TO EXERCISE 8.15
Page 2 of 2 pages
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 397 of 3 pages
5.
All blank credit applications and MAFs should be subject to sound control over custody
and issue.
6.
All masterfile amendments should be automatically logged by the computer.
6.1 write access to the log should not be given to anyone and read access to only senior
financial management, say, credit controller and Vikram Pather.
c)
7.
On a regular and frequent basis the employees in (6.1) should agree the log of masterfile
amendments to confirm that all amendments are supported by an authorised MAF.
1.
The entry (conversion) of the data onto the new system should be managed as a mini
project.
1.1 project team
1.2 planned
1.3 deadlines
1.4 allocation of responsibilities
1.5 progress monitoring.
2.
There should be a comprehensive clean up of debtor information before conversion. Data
should be thoroughly checked e.g. missing detail identified, bad debts written off, etc.
This is particularly important in this case as the debtors masterfile is likely to
contain numerous bad debts, fictitious accounts, etc.
3.
The appropriate conversion method should be chosen
3.1 parallel processing
3.2 immediate shut down on implementation of the new system
3.3 phased conversion.
d)
The data control group should:
1.
Perform comparisons between old and new files and resolve discrepancies.
2.
Reconcile from original to new files using record counts and control totals.
3.
Follow up exception reports produced through the use of program checks.
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 398 of 3 pages
4.
Obtain user approval for data converted e.g. from credit controller.
5.
Obtain direct confirmation from customers of balances reflected on the new system.
**2016**
SUGGESTED SOLUTION TO EXERCISE 8.14
Page 1 of 2 pages
a)
A sales order may be placed on the pending order file because the programme controls have
indicated that
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 399 of 3 pages
*
*
b)
1.
Access to the file of pending sales orders would be restricted
*
nobody would have write access to the file once it has been created
*
Ben Bolt and Clarence de Wet would have read access as they need to carry out
their functions, e.g. Ben Bolt as the sales order clerk may need to respond to a
query from a customer relating to a pending order, and Clarence de Wet obviously
needs to be able to read the details of pending orders before giving/denying
approval
*
access to the system and the pending sales order file would be controlled in the
normal manner by user ID, password and user profile.
2.
The privileges which Ben Bolt and Clarence de Wet have, would be reflected on their
screens which would be linked to their user profiles.
For example, when Ben Bolt
accesses the file, there will be no “approve” option on his screen which he can
select, or the approve option will be shaded and will not react if clicked on.
Clarence de Wet’s screen will also reflect his privileges, and will include an
approve option.
However, he will not be able to add or change any fields in the
file. On selecting the approve option, the pending sales order will be transferred
to the sales order file.
3.
For the approval to be successfully carried out, Clarence de Wet must have access to
all information pertaining to the debtor’s dealings with Jobfixers (Pty) Ltd, e.g.
lists of previous sales to the customer, any previous issues with non-payment,
payment record, etc. He will also contact the debtor to discuss the situation. In
effect, before approving or rejecting the sale, Clarence de Wet is evaluating the
risk that Jobfixers (Pty) Ltd will not be paid for the order if it is filled.
4.
Until the pending sales order is approved, the system will prevent the process from
proceeding, i.e. the warehouse will not be able to obtain a picking slip in any form.
5.
If the matter is not resolved by the customer and he wishes to cancel his order, the
ability to do this will be restricted to the credit controller.
6.
If the pending sales order is to be amended to bring the total amount owed below the
credit limit, Clarence de Wet will select an option which transfers the pending sales
order back to Ben Bolt for amendment.
7.
Approvals and rejections should be logged for review by the financial manager/sales
director.
**2016**
c)
(i)
processing the order will result in the total amount owed by the customer (debtor)
exceeding that customer’s credit limit, i.e. the total amount of credit that can be
granted to the debtor, or
processing the order will not result in the customer exceeding his credit limit, but
the programme control has identified that the customer has exceeded his credit terms,
i.e. there is an amount owed which has been outstanding for a longer period than the
customer was granted, e.g. R10 000 outstanding for 90 days, credit terms granted for
60 days.
/continued on page 2
SUGGESTED SOLUTION TO EXERCISE 8.14
Page 2 of 2 pages
Foster Grove : He requires read access only.
Reason : Part of his function is to select and print out a picking slip. He has no
need and should not be able to make any alterations to the sales order file (the
sales order “becomes” the picking slip).
If he was able to write to the “sales
order” file (amend the picking slip), it would be a breach of segregation of duties
and isolation of responsibility.
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 400 of 3 pages
(ii)
The picking control clerks : The two of them will require write access to the sales
order file (which is also the picking slip file as sales orders remain on this file
but have a status code attached to them to signify that they have been selected for
picking) but the write access will be to only the quantity field.
Reason : The picking control clerks function includes checking the physical goods
picked and altering the picking slip to reflect the actual quantity picked for
delivery if it is necessary to do so. The intention is to select exactly the correct
type and quantity of tools ordered. If the wrong tools or an incorrect quantity are
physically picked, the picking control clerk will (with the picker), replace the
incorrectly picked tools on the shelves and select the correct ones.
The picking
slip cannot be changed to accommodate what was picked other than where a lesser
quantity than was ordered, has been picked. This will occur if there is an
insufficient quantity of inventory on hand when the goods are picked. Therefore, the
picking control clerks only need to write to the quantity field.
(The programme
control may even prevent the picking control clerks from increasing the quantity
field on the on-screen picking slip).
Each of the two picking control clerks would
have unique user IDs and passwords.
(iii)
The pickers : They do not require any access.
Reason : They perform a manual procedure and are supplied with a hardcopy picking
slip.
This is given to them by the picking control clerk so they have everything
they need to carry out their functions without needing access (need to know/least
privilege).
(iv)
Joe Hart : He will require read access only.
Reason : Joe Hart is required to perform a final check of the tools to be despatched
to the picking slip on the system.
He therefore needs read access to the picking
slip.
If there are any errors either in the goods picked or on the picking slip,
they must be resolved by the picking control clerk. Joe Hart should not be able to
alter the picking slip as this is a breach of segregation of duties and would enable
Joe Hart to steal a tool and amend the picking slip to agree with the physical goods
despatched.
(v)
Loyiso Gwala : He will be given read access only.
Reason : His role as the warehouse manager is managerial and supervisory.
Because
the sales order file will reflect the stage at which each sales order is (real-time
processing), he will be able to

track the sales order as it passes through the warehouse to measure the
performance of the warehouse employees, e.g. picking control clerk, pickers

respond to queries about the status of an order from a customer, and

schedule the picking and despatch functions more efficiently, e.g. prioritise
any sales orders urgently required by customers. In terms of good segregation
of duties, he is a custodian/manager of the warehouse not part of initiating
or executing sales orders and has no need for write access to fulfil his
duties.
**2016**
SUGGESTED SOLUTION TO EXERCISE 8.13
Page 1 of 3 pages
a)
The intention of management should be to introduce internal controls over sales
which will ensure that
1.
All sales which are entered onto the system are genuine sales (not fictitious)
which pertain to the company (validity). (They have occurred and are authorised.)
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 401 of 3 pages
b)
2.
The details of the sale, e.g. selling price, discounts, VAT etc are correctly
calculated and recorded (accuracy).
3.
Each and every sale made by the company is recorded (completeness).
The directors are representing (asserting) that
1.
All debtors included in the balance do exist, they are genuine and not fictitious
(existence).
c)
2.
Debtors have been reflected at an appropriate carrying value i.e. the correct
amounts have been charged and a suitable allowance has been made for nonrecoverable debts (valuation).
3.
All debtors of the company have been included in the balance (completeness).
4.
Tapp Tapp (Pty) Ltd “owns” the debtors, i.e. they have not encumbered the debtors
or given up their ownership thereof. (The debtors belong to the company).
The two assertions are existence and valuation.
Reason: Under normal circumstances there is greater risk that a company will
overstate its asset accounts, rather than understate them. This can be achieved
by:


including fictitious debtors in the accounts receivable balance or
making an inadequate (understated) allowance for bad debts.
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 402 of 3 pages
**2016* *
/continued on page 2
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 403 of 3 pages
SUGGESTED SOLUTION TO EXERCISE 8.13
Page 2 of 3 pages
d)
Explanation of weakness
Weakness Identified
1.
There
is
inadequate
validation
of
the
contractor.
1.1 The
salesman
should
not ask the contractor
to confirm his details
but
should
ask
the
contractor to supply
his details.
(Once
the customer’s account
number
has
been
entered, and the other
details, e.g. address,
name are presented on
the
screen,
the
contractor should be
asked to supply them
for the salesman to
confirm
against
the
screen).
1.2 There
is
no
indication/acknowledge
ment by the contractor
to authorize the sale
e.g.
a
customer’s
order
reference,
identity document or a
contractors
signature
(see also 5.3 below).
2. There
is
inadequate
authorization of the sale
2.1 It
appears
that
no
credit limits are set
(see 3.3 below)
2.2 The salesmen do not
even
consider
the
status
e.g.
large
balance,
long
outstanding,
of
the
contractors
account
before
making
the
sale.
3.
The procedure for opening
a new customer’s account,
(extending
credit),
is
inadequate
3.1 No trade references,
income and expenditure
details etc are given
by
the
prospective
account holder.
3.2 Hence no follow up on
the
customer’s
creditworthiness
(ability to pay) is
made
before
the
customer is supplied
with goods.
3.3 No credit limit is set
and new customers are
immediately
supplied
with
“whatever
they
require”.
1.1 A contractor needs only the name of
another customer of Tapp Tapp (Pty) Ltd
to be able to (invalidly) purchase goods
on that customer’s account.
1.2 As the contractor does not have to
provide identification, give an order
reference
number
or
sign
any
documentation, Tapp Tapp (Pty) Ltd will
have great difficulty in following up on
any disputes or problems or proving that
charges to a debtors account are valid.
1.3 Any
of
the
six
salesmen
could
be
misappropriating
inventory
by
making
“sales” to (non-customers) accomplices,
but charging the sale to a genuine
customer.
2. Because credit limits are not set, and
the status of the contractors’ accounts
is not checked prior to the sale, the
risk that sales for which no payment will
be received increases i.e. bad debts will
be incurred.
3.1 As there is no follow up on trade
references etc, customers who are not
creditworthy will be supplied with goods
for which they may not be able to pay.
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 404 of 3 pages
4.
There
is
inadequate
control
over
the
debtors
masterfile
(masterfile
amendments)
4.1 Salesmen
have
write
access to the debtor’s
masterfile.
4.2 Masterfile
amendments
are not

supported
by
adequate
documentation
(MAFS)

reviewed
and
authorized
by
a
senior independent
employee prior to
entry.
**2016**
4.1 The present system enables any one of the
six salesmen (and possibly others) to add
an invalid account to the debtor’s
masterfile thus providing a means of
defrauding the company.
If the ability
to
make
masterfile
amendments
was
restricted to senior personnel, and they
were adequately supported, reviewed and
authorized, this risk is significantly
reduced.
/continued on page 3
SUGGESTED SOLUTION TO EXERCISE 8.13
Page 3 of 3 pages
4.3 There is no log of
masterfile
amendments
which is reviewed by a
senior
official
to
confirm their validity
and
completeness
(after entry).
5.
The controls over despatch
of goods are inadequate
5.1 There is a lack of
division
of
duties
between “picking” and
“despatch”.
5.2 The
despatch
clerk
does
not
sign
any
document to indicate
“picking”
or
“despatching”,
but
simply
uses
an
ink
stamp to indicate that
the
order
has
been
“filled”.
5.3 Contractors
do
not
sign any documentation
to indicate that they
have taken the goods
(see 1.2 above).
5.4 There
is
no
independent check on
goods
leaving
Tapp
Tapp
(Pty)
Ltd’s
premises
(gate
control).
5.1 As despatch clerks “pick” and “despatch”
there is no double check on whether the
goods picked and despatched are correct
or authorized (e.g. a despatch clerk
could make a mistake or deliberately
include
extra
items
i.e.
steal
inventory).
5.2 As the despatch clerks do not isolate
their
responsibility
by
signing
the
document it will be impossible to follow
up on any incorrect despatches/invoicing
problems at a later stage.
5.3 As contractors do not sign for accepting
the goods, they could, at a later stage,
deny having received the goods and refuse
to pay if a dispute arises.
5.4 As there is no independent check (e.g.
gate control) on what actually leaves the
warehouse, despatch clerks (and others)
could easily remove inventory from the
premises e.g. send out goods that have
not been invoiced, with an accomplice
(theft).
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 405 of 3 pages
**2016**
SUGGESTED SOLUTION TO EXERCISE 8.12
Page 1 of 2 pages
1.
The risk is increased but it can be controlled as follows:
Physical controls over the telesales
1.1
The three order clerks and their terminals will be located in a
“telesales” room, access to which will be restricted by the installation of physical
access controls, e.g. magnetic card, key pad code, etc.
1.2
Access cards/codes will be given only to the order clerks and your sales manager.
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 406 of 3 pages
1.3
Depending on the terminals used, terminal locks or keys could be used to prevent
unauthorised use.
Terminal identification and authorization
1.4
In layman’s terms the telesales terminals could be “linked” only to those
applications/modules in which it needs access, i.e. those applications relating to
the taking of orders. This means that even if someone manages to gain access to the
system through the telesales terminals, they will not be able to get into other
applications, e.g. salaries, wages, etc.
Logical access
2.
1.5
The sales applications/sales order module will also be user ID and password
protected.
This means that anyone other than the 3 order clerks will have to
identify themselves to the system and authenticate themselves by entering their
password.
1.6
The computer will look at the user profile (which is stored on the computer) and if
the profile does not permit access to the sales application for that ID and
password, the person will not be able to create an ISO.
1.7
In addition, access violations will be logged (recorded) by the computer and can be
followed up at a later date to try and identify who was trying to gain access.
1.8
If your system is set up properly, access to all the applications e.g. wages,
salaries, sales etc, can be very effectively controlled by the use of user IDs and
passwords.
Inventory availability and creditworthiness
2.1
If the system is set up properly, the three order clerks can be given access to the
inventory masterfile and the debtors masterfile.
2.2
This will be read access only (which means that the order clerks will not be able to
make any alterations to these files).
2.3
The system should also be set up so that the sales clerks are only given
access to the information they need on the masterfile, not the full record on the
masterfile. For example, all the order clerk requires from the debtors masterfile
is an indication that the customer on the phone has (or will) exceed his credit
limit if the order is accepted.
3.
Terminology
3.1
“Least privilege” – this is a computer security term which means that the user
(employee) is given only the access privileges he needs to
perform his function e.g. where an employee needs to read a
file, but does not need to write to the file he will be given
only read access on his user profile.
3.2 “minimum entry”
this is a control technique which
aims to limit the amount of information a user has to capture.
For example, instead of having to type in all the details about
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 407 of 3 pages
the customer when the customer phones, such as name, delivery
address, contact details, the user (order clerk) would just
type in the customer’s account number and the computer would
automatically provide all this detail.
This cuts down on
capture time and the occurrence of errors.
3.3
“mandatory field” this is a control technique which demands that a piece of
information be inserted before the next step in the process can commence, for example, in
a telesales system, a customer order number/reference must be entered before an order
clerk can continue with taking the order.
**2016**
/continued on page 2
SUGGESTED SOLUTION TO EXERCISE 8.12
Page 2 of 2 pages
4.
Capturing
*
4.2
4.1
*
There is no chance of orders being taken from customers not
approved.
The order process can only continue if the order clerk keys in an
approved debtor account number. (The system will immediately verify the account
number against the debtors masterfile and if the account number is not on the
masterfile, the order taking process cannot continue).
If, of course, an invalid “debtor” could be added to the debtors masterfile, an
order could be taken from a non-approved customer, but as pointed out, the sales
clerk does not have write access to the debtors masterfile and masterfiles are
subject to extensive controls where amendments are made.
Errors in capturing e.g. quantities, product codes and descriptions will be kept to
a minimum by the following physical and programmed controls
*
before terminating the phone call, the sales order clerk should confirm all the
pertinent details with the customer by reading what has been captured back to
the customer.
*
the minimum entry principle will also be applied; when typing in a product code
(given over the phone by the customer who reads it off the catalogue)
 the code will be verified against the inventory masterfile and
 if it is valid, the description of the goods will appear on the screen
(invalid product codes will be rejected)
*
there will also be programmed checks such as limit/reasonableness checks and
alphanumeric checks for example,
 an alphabetic digit cannot be entered in the quantity field
 a limit/reasonableness check may be set on the quantity ordered to cut down on
errors in the quantity e.g. a max limit of 50 items; an entry of 55 would send
a message to the order clerk on the screen, alerting him
 mandatory fields (as explained earlier) on the quantity field – no quantity
entered, the procedure cannot continue.
*
there will also be screen aids to enhance the accuracy and completeness of
capture.
 the screen will be formatted like an ISO
 there will be screen aids and screen dialogue to guide the order clerk e.g. an
on screen prompt reminding the clerk to confirm the details recorded.
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 408 of 3 pages
**2016**
SUGGESTED SOLUTION TO EXERCISE 8.11
Page 1 of 2 pages
a)
Weakness 1
1.1
There is inadequate identification of customers when they arrive to purchase
seedlings.
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 409 of 3 pages
Explanation 1
1.1
The seed salesman does not check against the debtors listing/masterfile or any
form of customer identification (card) that the customer or the account number
given are valid. This could result in
*
sales being made to non-customers and which will never be paid for
*
sales being charged to the wrong account, or to no account if the wrong
account number is given, resulting in lost sales revenue.
This could be
deliberate or simply a mistake.
Weakness 2
2.1
Credit (account) sales are made to customers without the status of the customer’s
account being checked before the sale is made (i.e. before further credit is
extended).
Explanation 2
2.1
The seed salesman writes up further invoices without establishing whether the
customer has exceeded his credit terms (amount and/or payment terms).
This is
likely to result in an increase in bad debt write-offs.
Weakness 3
3.1
There is a totally inadequate division of duties
recording” function and the “dispatch” function.
3.2
There is no form of gate control.
between
the
“picking
and
Explanation 3
3.1
The seed salesman has control of the seed trays, writes up the invoice and
authorizes the “dispatch” of the seed trays, i.e. loading onto the customer’s
vehicle, without any independent checks being carried out by a second employee, or
gate security.
As a result:
*
the quantity, code or price of seed trays recorded on the invoice could differ
from the quantity, code and price of seed trays actually taken, resulting in
under/over charges and other errors in inventory, the accounting records, etc.
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 410 of 3 pages
*
the seed salesman could easily collude with a customer by allowing seed trays
to be removed without entering them on the invoice in return for a bribe,
resulting in lost sales, and stolen inventory.
Weakness 4
4.1
Invoices are compiled manually.
Explanation 4
4.1
As the invoice is compiled (details entered, extensions, casts, VAT calculations)
by the seed salesman it is inevitable that errors will occur i.e. no use is made
of scanning machines or similar electronic devices.
(Although addressing this weakness may be expensive it is still a weakness.)
**2016**
/continued on page 2
SUGGESTED SOLUTION TO EXERCISE 8.11
Page 2 of 2 pages
b)
1.
Each morning Petunia Park should retrieve all the invoices from the wire basket
and
1.1
Sort them by salesman.
1.2
Confirm that the name and account number of the customer are correct against
the debtors listing/masterfile.
1.3
Reperform the extensions, casts and VAT calculation on each invoice.
1.4
Sequence test the invoices for completeness for each salesman (for the day,
and to the last invoice of the previous day).
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 411 of 3 pages
All errors, missing documents should be followed up and resolved.
Note: a secure pigeon hole would be better than a wire basket.
2.
Petunia Park should then group each salesman’s invoices into a separate batch and
prepare a (pre-printed sequenced) batch control sheet for each batch. The batch
control sheet should include
2.1
A unique batch number and date.
2.2
Identification of the transaction type: invoices/Joe Salesman.
2.3
Control totals, e.g.
2.4
3.

Number of invoices in the batch (record count)

Financial total (total of sales value for batch)

Total of say, the quantity fields (hash total).
Spaces for employees who deal with the batch, to sign, e.g. Petunia Park
will sign as preparer.
Petunia Park should enter the days batches in a batch register and take the
register to the data entry clerk.
3.1
The data entry clerk should inspect the batches he is receiving i.e. 10
batches and sign the register.
4.
The details of each batch should be entered onto the system by Eddie Key to create
a header label.
5.
The necessary information off each invoice should then be keyed in (batch by
batch) and subjected to
5.1
5.2
5.3
5.4
5.5
Validation checks, e.g. account number is valid.
Minimum entry should apply.
Mandatory field checks e.g. on quantity field.
Screen formatting/prompts.
Limit checks, alpha-numeric checks, etc.
6.
When the invoices for each batch have been entered, the computer will compute its
own control totals and compare them to the control totals on the header label. If
the control totals agree, the batch is accepted for processing.
7.
Entered batches should be signed off by Eddie Key and filed in date order by
salesman.
Note: One of the basic principles of data processing is that the data should be as error free as
possible before it is keyed in. Once data has been keyed in it can be subjected to various tests
depending on the software. For example, in this system the software could duplicate many of the
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 412 of 3 pages
checks carried out manually by Petunia Park, e.g. prices could be checked against the product
code.
In addition changes implemented to
subsequent controls in the system.
address
the
weaknesses
identified
in
(a)
could
change
**2016**
SUGGESTED SOLUTION TO EXERCISE 8.10
Page 1 of 3 pages
Weakness Identification
Explanation
Weakness 1.
Explanation 1.
1.
1. As the receptionist (and the senior
warehouse clerk) is not required to record
all incoming orders (mailed or faxed) in a
register, the risk that orders are lost
(and therefore never filled) is increased.
2. As the senior warehouse clerk does not
acknowledge receipt of the orders (e.g. by
signing the mail register) he cannot be
held responsible if orders are lost/not
filled e.g. he can simply deny having
received the order in the first place.
There is a lack of basic division of duties
as there is no separate order department to
receive and authorise customer orders.
1.1 There is inadequate control over the
receipt of customer orders
* a mail register is not written up to
record all orders received.
* there is no record of faxed orders
received by the senior warehouse clerk.
*
1.
there is no acknowledgement of receipt of
orders from the receptionist by the
senior warehouse clerk.
Weakness 2.
The internal documentation initiating sales
transactions is inadequate
1.1 No pre-printed, properly designed
sequenced internal sales order/picking
slip is used to record customer orders
and initiate picking of goods ordered.
1.2 there is a lack of audit trail.
Explanation 2
1. If customer’s orders are not recorded on a
sequenced internal document, the risk of
orders not being filled/lost is
significantly increased, as there is no
method of sequence testing orders to
determine whether they have all been
executed or accounted for.
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 413 of 3 pages
2. the lack of a properly designed ISO/picking
slip e.g. with specific blocks for the
picker to sign and enter details of “out of
stock” or short picked items will increase
the occurrence of incorrectly picked items
(quantity or description).
3. the lack of audit trail makes it more
difficult to follow up on customer queries.
Weakness 3
Explanation 3
1. No (initial) credit management controls are
in place
1. All orders that are received are filled
before checking whether the order is from
an existing customer; if the customer does
not have an account Carmen Chetty simply
opens one without any evaluation of the
client’s creditworthiness.
2. This significantly increases the risk of
losses from bad debts as the company will
inevitably make sales to companies that
cannot pay.
1.1 credit is extended to new customers
without a credit application being
completed by the customer and evaluated
by Cold Front (Pty) Ltd’s management.
1.2 no credit terms and limits are set or
authorised by management.
3. The failure to “authenticate” its customers
before providing them with goods also
facilitates fraud being perpetrated e.g.
anybody (including an employee) could fax
through an order from a fictitious company
to obtain goods with no intention of paying
for them. This will result in losses for
the company.
**2016**
/continued on page 2
SUGGESTED SOLUTION TO EXERCISE 8.10
Page 2 of 3 pages
Weakness 4
Explanation 4
1. Sales authorization procedures are
inadequate
1. The failure to carry out checks on existing
customers credit standing, considerably
increases the risk of losses from bad debts
(this problem is compounded by the fact that
no credit terms/limits are set)
1.1 no check is carried out on the credit
standing of existing debtors before
their orders are filled e.g. long
outstanding balance or balance too
high.
Weakness 5
Explanation 5
1.
1. If orders that have been faxed and sent
through the post are not identified, the
same order will be filled twice, resulting
in problems later on in the cycle e.g. goods
being returned, customer dissatisfaction.
There appears to be no method of
identifying orders which have been both
faxed and sent through the post.
Weakness 6
Explanation 6
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 414 of 3 pages
1. Controls over the picking of goods are
inadequate
1.1 photocopies of customers orders are not
suitable for picking items.
1.2 pickers do not sign the photocopy order
they have picked (or initial changes
they make to the quantities).
1.3 there is no supervisory checks carried
out by the senior warehouse clerk on
the picking of the junior warehouse
clerks.
1. Customers orders are not suitably designed
for use as picking slips; this increases the
risk of producing inaccurate “picking slips”
which in turn will result in the generation
of incorrect delivery notes and invoices.
2. as pickers do not sign the picking slip it
is more difficult to isolate responsibility
for errors in picking and recording.
3. this lack of accountability, combined with
the fact that the senior warehouse clerk
does not check what has been picked, will
result in a failure to identify
*
quantities or items which have been
incorrectly picked (by mistake or as
theft)
*
orders that have not been picked at all.
Weakness 7
Explanation 7
1.
1. Customers will only be aware that they are
not receiving the goods they ordered once
the delivery is made (or, where their entire
order cannot be filled, when they phone to
enquire). This may cause serious disruption
in their business and lead to Coldfront
(Pty) Ltd losing future sales.
Customers are not promptly informed of
orders that cannot be filled at all or can
only be partially filled.
1.1 no inventory availability check is
carried out when the order is received
(no order department!)
1.2 no comparison between what the customer
ordered (per the customer order) and
what was dispatched (per the delivery
note) is made.
2. Customers may receive goods they have not
ordered resulting in customer
dissatisfaction.
Weakness 8
Explanation 8
1.
1. Although the pickers (partially) identify
“out of stock” items on the photocopy order,
nothing is done about it; this means that
items will remain “out of stock” until
normal re-ordering takes place. Customers
will be dissatisfied, and further sales will
be lost.
There appears to be no back order system in
place whereby the buying department is
notified about inventory shortages.
**2016**
/continued on page 3
SUGGESTED SOLUTION TO EXERCISE 8.10
Page 3 of 3 pages
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 415 of 3 pages
Weakness 9
Explanation 9
1.
1. Items can go missing or be
stolen and the point at which
they went missing cannot be
isolated to a specific section,
e.g. a picker may claim to have
sent an item to dispatch when in
fact he has stolen it.
The dispatch section
1.1 does not acknowledge the transfer of the picking
baskets from the warehouse to dispatch (checking
contents before signing for the baskets) and
1.2 does not check the items for which it is making out
the delivery note (details are taken from the
photocopy order)
2. Dispatch does not ensure that
the delivery note is made out
correctly in respect of the
description and quantity of
goods actually dispatched
2.1 mistakes in picking will
not be identified
2.2
discrepancies between what
is on the delivery note
and what is delivered will
occur.
Weakness 10
Explanation 10
1.
1.
There is a serious lack of division of duties with
regard to the functions performed by Carmen Chetty. She
1.1 opens new debtors accounts
1.2 receipts payments/raises invoices
1.3 passes credit notes etc
Carmen Chetty carries out
incompatible functions. For
example she could easily
defraud the company by
1.1 writing off amounts owed
by friends or family
1.2 steal receipts from
debtors and pass a
fictitious credit note to
cover the loss.
Weakness 11
Explanation 11
1.
1.
There is a poor control environment, management do not
appear to be control conscious or to lead by example
*
junior staff are not supervised and checked
*
Carmen Chetty is left to her own devises.
The lack of supervisory
controls will result in all
staff cutting corners, making
errors (and possibly
defrauding the company) which
will ultimately cause losses
to the company.
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 416 of 3 pages
**2016**
SUGGESTED SOLUTION TO EXERCISE 8.9
Page 1 of 2 pages
a.
Weakness 1
:
Internal
Sales
Orders
are
not
made
out
for
all
orders
Explanation 1
:
There should be an internal (sequenced) document which initiates all
transactions. This provides the order department with “authority” to
process, and provides a means of following up queries.
Weakness 2
:
Internal Sales Orders are not sequenced.
Explanation 2
:
As ISOs are not sequentially numbered, it makes
sequence test the documents for the purposes of
it
1.
identifying missing ISOs
2.
confirming that all orders have been processed and
3.
following up on queries.
received.
impossible
to
Weakness 3
:
There are inadequate controls to prevent sales being made to nonaccount holders e.g. no second staff member or supervisory check.
Explanation 3
:
The order clerk has a list of account holders but there are no second
or supervisory checks to ensure that this control is carried out prior
to the sale being processed.
:
even though it is picked up “later”, the sale has already been made
to a customer for whom no creditworthiness checks have been carried out, thus increasing
the risk of losses from bad debts (Note, the amount of the sale could be substantial as
there are no limits).
Weakness 4
:
Inadequate credit management controls are in place;
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 417 of 3 pages
2.
Explanation 4
:
1.
inadequate
information
is
gathered
when
application for credit is made by a prospective customer.
credit terms and limits are not set.
an
The decision to grant credit is made on the strength of two trade
references given by the prospective customer.
The prospective
customer is unlikely to give poor trade references, so further
information (preferably from an independent source e.g. credit bureau)
must be gathered before credit is extended so as to establish the
likelihood that the prospective customer will pay.
:
even though a prospective customer appears creditworthy,
the granting of unlimited credit terms will result in abuse by customers (they are
getting free financing) and significantly increase the risk of losses from bad debts.
Weakness 5
:
There is inadequate documentation for the picking of goods.
Explanation 5
:
Customers’ orders, original and faxed, as well as ISOs are used for
picking; to assist in goods being accurately picked both in terms of
quantity and description, a standardized, preprinted, properly
designed, sequenced document should be used (can be an adapted copy of
the ISO).
:
Inaccurate picking can result in increased returns of goods, incorrect
invoicing and customer dissatisfaction.
Weakness 6
:
No documentation remains in the order department.
Explanation 6
:
As the order clerk sends all ISOs, customer orders (original and
faxed) to the warehouse department, she has no means of following up
queries or
:
determining whether orders have been duplicated e.g. a phone order
also sent through the post.
This will result in duplicated picking
and invoicing (and customer dissatisfaction).
**2016**
/continued on page 2
SUGGESTED SOLUTION TO EXERCISE 8.9
Page 2 of 2 pages
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 418 of 3 pages
b.
Weakness 7
:
There is no supervisory check on goods picked.
Explanation 7
:
As no supervisory check is carried out, the risk that items ordered
will be picked incorrectly (quantity and description) resulting in
incorrect invoices etc, is increased and
:
an increased opportunity for theft by pickers is presented. (Note:
simply instructing pickers to pick carefully does not mean that they
will do so!)
Weakness 8
:
The control environment at Gone Fishing (Pty) Ltd is weak.
Explanation 8
:
It is evident from the responses (taken collectively) that there is a
lack of management control e.g. supervisory checks. Management do not
seem to be “control orientated” and employees will soon pick this up.
1.1
Inquire of the order clerk whether ISOs are made out for all orders received.
1.2
Inquire of the warehouse staff as to whether goods are only picked against ISOs
(or rather what documents are used to pick goods).
1.3
Inspect supporting documentation for sales
evidence of an ISO supporting the sale.
1.4
Observe the “picking” activity to determine whether goods are picked against an
ISO.
2.1
Inquire of the order clerk as to the procedure she follows when receiving an
order.
2.2
Inquire of the debtors/accounting staff as to whether there are instances when
they receive a signed delivery note from a customer who is not included in the
debtors ledger.
2.3
Inspect order clerk’s signature on a sample of ISOs indicating that this check has
been carried out.
3.1
Point 2.1 above is relevant.
3.2
Inspect the debtor ledger accounts to determine whether there are instances of
debtors being beyond their credit limits (will need to determine what limits are).
3.3
Inspect order clerks signature on a sample of ISOs indicating that this check has
been carried out.
entered
in
the
sales
journal
for
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 419 of 3 pages
**2016**
SUGGESTED SOLUTION TO EXERCISE 8.8
Page 1 of 3 pages
PART A
a)
1.
I agree
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 420 of 3 pages
b)
c)
d)
1.1
The control environment is the control consciousness of the entity.
It
sets the tone of the entity towards internal control and creates the
atmosphere in which employees go about their duties. One of the effective
control activities relating to internal control is frequent and timeous
reconciliation of physical assets (cash) with the accounting records
(theoretical).
1.2
Knowing that they will be regularly and randomly checked, custodians of
cash
are
far
more
likely
to
ensure
that
they
fulfil
their
responsibilities, for example, by ensuring that they only provide cash
from their float on the strength of properly authorised vouchers, or in
the case of a raw material sale, that proper documentation is made out to
support the cash he holds.
1.3
The fact that the counts are carried out by an independent person (a
person not involved in any aspect of the cash floats) makes the control
more effective.
1.4
If this kind of control activity is not conducted, employees are likely to
become less control aware, e.g. the raw material foreman may see an
opportunity to steal cash and the control environment will be weakened.
1.
The imprest system for cash floats requires that a fixed amount is set to meet the
needs of the float, i.e., enough to not have to reimburse the float too
frequently, but not to have too much cash on hand lying about.
2.
The float is then given to the responsible cashier.
3.
The cashier must obtain an authorised voucher (supporting document) for each and
every amount paid out of the float.
4.
This means that at any given time, the cash on hand plus the value of the
authorised vouchers, should equal the amount of the original float.
5.
When the float needs to be re-imbursed (topped up) a cheque (or other means of
obtaining cash from the bank) for an amount equal to the value of vouchers will be
cashed and given to the cashier, bringing the total cash on hand back to the
original fixed amount.
1.
The counts should be conducted on a surprise basis.
2.
If the custodians of the cash know when their cash is to be counted, they will
have the opportunity of covering/concealing any shortages, and the internal
auditor will gain little insight into whether the controls over cash are
effective.
1.
The custodian of each float must be present for the duration of the count (so that
the internal auditor cannot be accused of having stolen the cash if there is a
shortage).
2.
On completion of the cash count, the custodian should sign the workpaper
(reconciliation) to acknowledge that he/she accepts the reconciliation and that
the cash was returned by the internal auditor intact.
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 421 of 3 pages
e)
1.
2.
**2016**
There should be a three-part multi-coloured, pre-printed, sequenced cash sales
invoice/receipt made out for every cash sale.
Copy one
:
given to the employee making the purchase
Copy two
:
sent to cashier/accounting (recording)
Copy three
:
remains in the invoice/receipt book (fast copy)
Both the employee making the purchase and the materials storeman should sign the
sales invoice/receipt to confirm the amount paid is correctly stated, and
acknowledge the sale and transfer of cash.
Note: there should be a sign alerting employees to the fact that they must get a
cash sales invoice/receipt as this is their proof of payment. This will also make
it a little more difficult for the cash storeman to steal cash by not recording
the sale.
/continued on page 2
SUGGESTED SOLUTION TO EXERCISE 8.8
Page 2 of 3 pages
3.
The employee making the purchase should not be allowed to leave the factory
premises with the scrap metal without a copy of the sales invoice/receipt, e.g.
the scrap and sales invoice/receipt must be presented when the employee goes
through the security gate control.
4.
Gate control should stamp and date the sales invoice/receipt (so that it cannot be
used as a supporting document again) after checking the scrap and the signatures
on the document.
5.
At regular intervals, say every Friday, (depending on the amount of cash
generated), the material raw storeman should compile a schedule
(two part) of
cash sales made, and attach all the 2nd copies (numerically listed) to the
schedule.
6.
After agreeing the total of the invoices/receipts to the schedule and cash on
hand, he should sign the schedule.
7.
The cash and supporting schedule should be taken by the raw material storeman to
the cashier who should
7.1
agree the cash handed over to the schedule in the presence of the
storeman.
7.2
sign to acknowledge receiving the cash (both copies of the schedule) once
it has been agreed to the schedule.
7.3
sequence check the invoice/receipts including the continuity of sequence
from the previous schedule to the present schedule.
7.4
make out a deposit slip and cross reference it (date) to the schedule
7.5
ensure that the cash is banked promptly.
7.6
File one copy of the schedule with the deposit slip.
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 422 of 3 pages
8.
The second copy of the schedule should be filed in date order in the raw material
storeman’s office.
The production manager should review the schedules on a
regular basis for anything out of the ordinary.
9.
On a monthly basis the financial accountant should review the cash receipts
journal and scrap sales schedule (including sequencing) to satisfy himself that
all cash handed over has been banked.
Note:
If the company considers it necessary to introduce more control over scrap and
scrap sales, a simple scrap inventory system should be introduced.
PART B
1.
2.
Reperform the bank reconciliation
1.1
Clear all reconciling items e.g. outstanding cheques on the 30 November 2015
reconciliation to the post November bank statements. (Note: cheque no 49378 is
still outstanding.)
1.2
Trace all entries (deposits and cheques) from the cash book for December, January
and February to the bank statements for Dec, Jan, Feb to identify reconciling items,
e.g. outstanding cheques.
1.3
Inspect the bank statements and cash book for any unmatched
inspection, confirm that they appear in the reconciliation.
1.4
Total bank charges reflected on the bank statements and confirm their correct entry
in the cash book, and in the case of February charges of R163.00, in the
reconciliation (see below pt 5).
1.5
Cast the cash book and the reconciliation.
1.6
Confirm the balance per cash book at R127 261.30.
1.7
Confirm the balance per bank statement at R222 873.60.
1.8
Test the logic of the reconciliation.
items;
and
by
Obtain directly from the bank:
2.1
A certificate confirming the balance at 29 February 2016 of R222 873.60
2.2
A cut-off bank statement showing
29 February and the current date.
all
movements
on
the
account
between
the
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 423 of 3 pages
**2016**
/continued on page 3
SUGGESTED SOLUTION TO EXERCISE 8.8
Page 3 of 3 pages
3.
Outstanding cheques
3.1
Long outstanding cheques
 Trace cheque no 49378 to prior months (Jan, Dec, Nov) bank reconciliations to
confirm that it was reflected as outstanding.
 Agree the cheque amount to invoices/statements and confirm by enquiry of Otis
Redding, that the amount represents a bona fide payment.
 Enquire of Otis Redding as to whether
* the payee has been contacted
* the cheque has been stopped
* a new cheque has been issued.
 Request that the cheque be written back in the cash book (it is stale).
amount should be reflected as owing at the year end.)
3.2
(The
Cheque no 52133
 Trace cheque 52133 to the cut-off bank statement, and if the cheque has not been
presented by enquiry of Otis Redding (and the payee, if Otis Redding agrees)
establish why it has not been presented (it is long outstanding and for a material
amount).
3.3
Cheque no 53193
 Obtain the supporting documentation for this payment and confirm that it was for a
valid expense for Beachbreak (Pty) Ltd and that it was authorised.
 Explain and evaluate an explanation from Otis Redding as to why this payment was
not made by EFT as it was over R20 000 (consider whether it could be fraudulent in
any way, as cheque payments may be subject to less stringent controls).
3.4
Other cheques
 Agree the other cheques outstanding to the cut-off bank statement.
If not yet
presented, agree to invoices/statements and confirm that the amounts represent
bona fide payments.
3.5 Inspect the cut-off bank statement to establish whether any cheques with numbers
lower than the last cheque number for the financial year, other than those in the
reconciliation, appear. (None should be found).
4.
EFT Deposit
4.1
Inspect the cut-off bank statement to confirm that the bank has reversed the
incorrect deposit.
4.2
5.
If not, enquire of Otis Redding or inspect correspondence with the bank to confirm
that the bank has been notified of the incorrect deposit.
Bank charges and fees for February 2016
5.1 Although not material, request Otis Redding to record the bank charges of R163.00 in
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 424 of 3 pages
the February 2016 cash book.
**2016**
SUGGESTED SOLUTIO
Weakness
1. There
are
insufficient
access controls,
physical
1.1 between the finished goods store
Explanation
1. As an additional uncontrolled “entry/exit”
point has been created to the finished
goods store, the increase in the risk of
theft (unauthorized dispatches) from the
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 425 of 3 pages
and the outlet – inventory is
“conveniently transferred” from
finished goods stores to the
outlet, and employees can “come
and go as they wish”
1.2 between
the
outlet
and
the
street – customers (i.e. anyone)
have
“easy
access”
to
the
outlet.
factory (and the outlet itself) has been
increased significantly.
2.
The physical layout and lack of
security checks increases the risk
of theft by the general public.
2. “Customers” can walk in off the street,
steal goods and exit the outlet without
having to pass through any security.
3.
There is no check (division of
duties) in respect of the effecting
and recording of a sale by Greta
Garbo,
3. Because Greta Garbo is (normally) the only
person involved in a sale, she is able to
3.1 undercharge on a particular item
3.2 not charge at all (friends etc),
thereby allowing goods (in effect) to
be stolen.
i.e. no security or “gate control”
on whether goods leaving the outlet
are supported by a receipt.
4.
Finished goods stores clerks assists
on an “ad hoc” basis.
4. This reduces isolation of responsibilities
and gives the clerks the opportunity to
sell goods (fraudulently) from the finished
goods store.
5.
The receipt made out to record a
sale is inadequate as it is not
5.1 a
standardized
pre-printed
multicopy document
5.2 not pre-sequenced
5.3 not checked for correctness of
prices, extentions casts and
VAT.
5.1 A standardized pre-printed document would
enhance the accuracy and completeness of
recording the sale.
There
is
inadequate
physical
protection over cash on hand at the
outlet.
6.1 To keep the day’s sales in a moveable
cashbox under the counter in an area which
has direct uncontrolled entry/exit to the
street, significantly increases the risk
of theft of the box/injury to employees
(armed robbery).
6.2 A second key to the cashbox is available,
which provides the opportunity for cash to
be stolen when Greta Garbo is not present.
6.
5.2 Because the receipts are not sequenced,
there
is
no
possibility
of
properly
reconciling receipts with cash sales made.
Despite the fact that an “official” receipt
has been made out and signed by the
customer Greta Garbo can simply destroy her
copy of the “receipt” and steal the
equivalent amount of cash. (If a sequenced
receipt is made out a completeness of cash
on hand can be carried out).
/continued on page 2
SOLUTION TO EXERCISE 8.7
SUGGESTED
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 426 of 3 pages
Page 2 of 2 pages
**2016**
7 & 8
7.
No independent reconciliation of the
sales recorded for the day to the
cash on hand takes place.
8.
When the cash is transferred between
different parties (e.g. Greta Garbo
and
Vish
Naidoo
there
is
no
acknowledgement
of
transfer
isolation of responsibility).
9.
Excessive amounts of cash are held
at
the
company
(not
banked
timeously).
10. Cash from cash sales is used to pay
wages.
Because of these weaknesses
7.1 There is no source total for cash
sales
to
which
subsequent
reconciliations can be made e.g.
postings to the cash sales account
in the ledger, cash banked.
7.2 Cash can be stolen by a number of
parties
e.g.
Vish
Naidoo,
the
stores clerk who sometimes drops
off the cash (would need the key –
easily obtained),
Joe Ryder, or
anyone
who
has
access
to
the
company safe.
Any amount stolen
cannot be quantified (no source
total) or pinpointed (isolated) to
a particular individual.
9. This increases the risk of armed robbery
and endangers staff.
10. This
weakens
the
misappropriation of cash by
control
over
10.1 unnecessarily
complicating
the
reconciliation and audit trail of
cash receipts and wages, by combining
a cash generating system and a cash
expense system.
11. There is inadequate control over the
authorisation and accuracy of the
journal
entry
passed
by
Otis
Redding.
11.1 He
does
not
independently
verify
or
reconcile
the
figures presented to him.
11.1
Greta Garbo can report any
figure she likes for cash sales, and
hence
could
easily
cover
up
any
misappropriations
(she
could
also
easily collude with Joe Ryder to
perpetrate larger fraud).
11.2
Because
there
is
no
reconciliation of actual cash on hand
to theoretical cash on hand before the
entry is passed, any theft of cash by
Joe Ryder will not be detected.
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 427 of 3 pages
12. Management do
created
a
environment.
not appear
strong
to have
control
12.
The
failure
to
implement
suitable
controls,
e.g.
division
of
duties,
isolation of responsibilities, lack of
supervision, particularly in respect of
cash
and
the
physical
control
of
inventory
and
cash
will
result
in
misappropriation
of
company
assets.
Management appear not to be particularly
control orientated.
**2016**
SUGGESTED SOLUTION TO EXERCISE 8.6
Page 1 of 2 pages
1.
Personnel
1.1
As the assistants will be dealing with cash and will be unsupervised most
of the time, careful consideration should be given to their appointment,
*
background checks should be carried out in respect of their honesty,
reliability and competence (computer literate).
1.2
Similar recruitment procedures should be adopted when appointing the caretakers.
(Note: there will be 100 caretakers).
2.
Documentation
2.1
All documentation used should be carefully designed to ensure accurate
completion see below.
2.2
It should be multi-part, preprinted and sequenced.
3.
Collection schedule
3.1
The fifty Laundromats should be broken down into two regions and each
assistant should be allocated 25 laundromats for which he is responsible.
3.2
The collection of cash must take place bearing in mind the following
*
each laundromat must be visited within 7 days of the previous visit (to ensure
machine does not switch off as a result of being full of money).
*
a fixed pattern of visits should not be established due to the risk of attack when
the cash is collected
*
caretakers should not be informed when cash will be collected for the same reason.
3.3
As time passes, “sales” should be analysed to identify patterns of use,
e.g. some locations may be very busy over weekends and should be emptied prior to the
weekend and shortly after the weekend.
3.4
At regular intervals (not too frequently) the region for which the
assistant is responsible should be alternated.
4.
Bank Account
4.1
It is preferable that an account be opened at a bank which has branches
close to all Laundromat locations so that banking can be done promptly and with the least
risk to the assistant. (To satisfy these requirements, accounts may need to be opened at
different banks but a single bank would be preferable).
5.
Procedure
5.1
On arrival at the Laundromat, the assistant should access each machine’s
memory using his laptop and download the details of the machine’s activity since the
previous download,
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 428 of 3 pages
*
both the assistant’s laptop and the machine’s computer should be password
protected (all machines for which the assistant is responsible could have the
same password, known only to him and Clinton Clean and wife),
*
the assistant should have no write access to this information.
5.2
The cash (the strongbox will be key or code protected) should then be
removed and counted,
*
the caretaker should assist in this exercise as a control and to hasten
the process.
5.3
The details of the cash counted should be entered by the assistant on a
“Cash Collection Schedule”. This document should
*
indicate the date of the count and the Laundromat location
*
list the machine number and the total of the cash taken from the machine.
*
reflect the total cash for the location.
*
be signed by the assistant and the caretaker.
5.4
The assistant should compare the cash counted and recorded to the totals
downloaded from the machines and follow up on any discrepancies. All problems should be
noted on the cash collection schedule.
5.5
The assistant should then bank the money before proceeding to the next
location,
*
the deposit slip should be made out to agree with the “cash collection
schedule” and referenced to the Laundromat location.
*
the assistant should attach a copy of the deposit slip to the cash
collection schedule.
**2016**
1.
/continued on page 2
SUGGESTED SOLUTION TO EXERCISE 8.6
Page 2 of 2 pages
Reconciling
At the end of the working week the assistants should return to the head office and pass
all cash collection schedules to Clinton Clean (or wife). He should
1.1
confirm that there are 25 per assistant, one for each location.
1.2
sequence check the documents.
2.
He should then download the machine readings from the assistant’s laptop onto his
computer and print out the details for each location. He should then
2.1
agree each cash collection schedule to the corresponding printout and the
deposit slip.
2.2
agree the deposit slip to the bank statement confirming that the deposit
was made on the day of collection. (Clinton Clean should have a facility with his bank
which enables him to download the bank statement on a daily basis).
3.
Clinton Clean should initial the cash collection schedules to evidence the control, and
the schedule, printout and deposit slip should be filed together numerically by week.
4.
Clinton Clean should set up a spreadsheet onto which he can enter the “sales” per machine
per location per day; this will
4.1
assist in ensuring that all machines are cleared as scheduled.
4.2
provide data for analysis of sales by machine, location, day and date, to
assist in streamlining and/or expanding the business.
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 429 of 3 pages
**2016**
SUGGESTED SOLUTION TO EXERCISE 8.5
Page 1 of 2 pages
a)
1.
Order department
Employees honest, but careless and not control aware.
1.1
Not all customer orders may be acted upon, or orders may not be acted upon timeously
leading to customer dissatisfaction and loss of business.
1.2
Orders may be accepted from customers (non-account holders) who have not been subjected
to credit worthiness testing.
1.3
Inadequate sales authorization may take place.
*
orders taken from account holders who have exceeded their credit terms (increased
risk that goods will never be paid for).
1.4
Inaccurate or incomplete order details may be recorded.
2.
Warehouse
2.1
Goods may be incorrectly picked or not picked at all due to
*
errors in compiling the ISO (picking slip)
*
errors in actual picking (omissions, incorrect goods picked)
*
no picking slip from the ordering department
*
picking slip lost, mislaid or just forgotten about
leading to incorrect invoicing, customer dissatisfaction, returns, etc.
2.2
“Out of stock” items may not be
*
identified on the picking slip
*
communicated to the customer or
*
placed on backorder.
3.
Despatch
3.1
Despatch errors may occur
*
incorrect goods/quantities dispatched although correctly picked
*
goods picked may not be dispatched at all
*
goods delivered to the wrong customer.
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 430 of 3 pages
3.2
Proof of delivery may not be obtained from customer and as
a
result,
delivered may be invoiced or customer may deny receiving the goods.
not
all
goods
4.
Invoicing and recording of sales
4.1
Invoices may be inaccurately prepared, e.g. incorrect prices, quantities, casts and
extensions, invalid discounts given, VAT incorrectly calculated.
4.2
Goods dispatched to customers may never be invoiced.
4.3
Invoices may not be entered, (or may be inaccurately entered) in the sales journal
resulting in incorrect postings to debtors accounts (which will lead to queries, delayed
payment from debtors, etc).
4.4
Invoices may not be timeously sent or not sent at all (resulting in same problems as in
4.3).
5.
Receipts and recording of receipts from debtors
5.1
Cheque payments received from debtors may not be banked due to carelessness (mislaid,
lost).
5.2
EFT payments and cheque payments received may not be properly and accurately entered in
the cash receipts journal (resulting in incorrect debtor records).
6.
Goods returned by customers
6.1
The description and quantity of goods returned by customers may not be recorded correctly
and incorrect credit notes may be passed.
6.2
Credit notes may be passed for goods not yet returned.
6.3
Credit notes may be inaccurately recorded and credited to the incorrect debtor.
7.
Credit management
7.1
Inadequate credit management may be occurring
*
inadequate information about a prospective debtor obtained before credit terms
extended
*
over generous credit terms extended to debtors
*
slow invoicing of debtors, no statements sent
*
inadequate follow up of slow payers
*
non-paying debtors not handed over for collection
*
debtors written off as bad prematurely.
8.
General
8.1
Inadequate reconciliations of the bank account, debtors control etc, will result in
errors going undetected and corrected.
**2016**
/continued on page 2
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 431 of 3 pages
SUGGESTED SOLUTION TO EXERCISE 8.5
Page 2 of 2 pages
b)
Theft and defrauding the company
1.
The cycle offers a fair number of opportunities for both ordinary employees and managers
to steal from or defraud the company.
2.
The problem is increased because dishonest employees are likely to collude with each
other and managers may do the same (employees and managers may also collude with each
other).
3.
Dishonest managers have even more opportunity to steal/defraud the company because they
can override internal controls.
4.
Because of management override and collusion, thefts and fraud can often be easily
covered up.
5.
Theft or fraud in the cycle can be perpetrated in various ways
5.1
Cheque payments from debtors can be diverted to a second bank account for the
company opened by a dishonest manager. The theft could be covered up by recording
a fictitious credit to the debtors account, e.g. credit note, or bad debt write
off journal entry.
5.2
An employee could steal a cheque and attempt some form of cheque fraud but this is
difficult to do with the banks clamping down on such fraud.
5.3
With a little bit of collusion, all employees in the cycle could set up a false
business entity which sends an official order which is filled.
The goods are
delivered and either never “invoiced’ or they are invoiced and the debt is written
off or a credit note is passed.
5.4
The other business entity may be a genuine business belonging to an employee or
manager (or friend or family) at Crazytimes (Pty) Ltd
*
extra items may be picked and dispatched to the other business along with a
genuine order and never charged
*
goods may be invoiced at very low prices
*
an order may be filled and dispatched but the invoice deliberately not raised
*
invalid adjustments can be made to the debtors account so that the debtor does
not pay for goods purchased in the correct manner, i.e. proper order, correct
goods picked and delivered, etc. To settle or reduce the amount owed, invalid
discounts may be given, false credit notes passed etc, in return for some
"favour" from the debtor to the Crazytimes employee.
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 432 of 3 pages
**2016**
SUGGESTED SOLUTION TO EXERCISE 8.4
1 Page only
1.
Application control.
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 433 of 3 pages
2.
General control – control environment (commitment to competence/human resource policies).
3.
Application control.
4.
General control (overall access) - access control.
5.
Application control (specific to the cycle).
6.
Application control.
7.
General control – systems development.
8.
General control – control environment – human resource policies and practice.
9.
Application control.
10.
General control – access/custody control.
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 434 of 3 pages
**2016**
SUGGESTED SOLUTION TO EXERCISE 8.3
1 Page only
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 435 of 3 pages
1.
Risk assessment process - such a committee would be considering the risk that the company
may be subject to penalties etc for non-compliance with the law and the risk of users
injuring themselves and suing the company.
2.
Control environment - this reflects a commitment to competence on the part of management.
3.
The information system etc - this is part of the process of initiating a sale.
4.
Control activities
-
in effect the clerk in the credit control section is approving
(authorising) the sales order.
This is a control measure to
address the risk of making a credit sale for which the company
will be paid.
-
this also amounts to segregation of duties as it is a split
(segregation) of initiation and approval of the sale transaction.
5.
Control activities – Isolation of responsibility.
The picker is acknowledging that he
was responsible for picking the goods and can be held accountable for any inaccurate or
incomplete picks.
6.
Control activity – custody control.
Mary Muggins’ function is to minimise
deterioration in value of the debtors, a “non-physical” asset in the business.
7.
Information system etc – lays down the process or procedure which must be followed to
amend the masterfile. It also identifies the document to be used to “support the action”
and addresses the requirements of good document design.
the
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 436 of 3 pages
8.
Monitoring of controls – this procedure enables management and the board to monitor, over
time, whether risks that threaten the company’s objectives are being adequately responded
to by the internal controls.
For example, if bad debts are increasing over time, the
credit application controls and Mary Muggins may not be effective controls.
**2016**
SUGGESTED SOLUTION TO EXERCISE 8.2
1 Page only
1.
Credit management.
2.
Order Department (receiving customer orders and sales authorization).
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 437 of 3 pages
3.
Warehousing.
4.
Despatch.
5.
Despatch.
6.
Credit management.
7.
Despatch.
8.
Recording of Sales.
9.
Invoicing.
10.
Mailroom receipting/cashier.
11.
Goods returned function.
12.
Ordering department (or warehousing).
13.
Credit management.
14.
Invoicing.
15.
Warehousing.
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 438 of 3 pages
\
**2016**
SUGGESTED SOLUTION TO EXERCISE 8.1
1 Page only
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 439 of 3 pages
a)
Note:
b)
1.
customer order
6.
credit note (note 1)
2.
internal sales order
7.
statement
3.
picking slip
8.
customer remittance advice
4.
delivery note
9.
receipt
5.
sales invoice
10.
deposit slip
A credit note is not part of a normal transaction, but if a sale is made and the goods
returned shortly thereafter, the order given above is the most likely.
1.
delivery note
1.2
2.
receipt
:
1.1
records date, description and quantity of goods
dispatched to the customer and is signed by the customer to
acknowledge the receipt of the goods.
used to initiate the invoice.
:
2.1
records details of payments from customers.
picking slip
:
3.1
lists items ordered by customer and is used to
inform the warehouse as to which goods must be picked to fill the order.
customer order
:
4.1
external document sent by the customer which details
the goods the customer wishes to purchase.
5.
credit note
:
5.1
an internal document sent to the customer to
acknowledge that the customer’s account has been reduced
(credited) for some reason other than for a payment
received e.g. goods have been returned by the customer.
6.
sales invoice
:
6.1
internal document sent to the customer
detailing the quantity, price, discounts, VAT, total amount
of the sale.
7. internal sales order
7.2
:
7.1
internal document prepared by the company’s
order clerk which records the goods ordered by the
customer.
used to authorise the sale (creditworthiness) and as a
basis of creating the picking slip.
8. deposit slip
:
8.1
bank document made out by the company’s
staff to record the deposit of payments received from the
customer, into the bank.
9.
:
9.1
a summary of all the transactions with a
customer for a period (usually a calendar month) sent by
the company to the customer.
9.2
usually reflects the total amount owed
broken down into days outstanding e.g. 30 days, 60 days,
etc.
statement
10. customer remittance
advice
: 10.1 document sent by the customer to the company with their
payment to identify exactly which invoices are being paid.
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 440 of 3 pages
c)
d)
1.
so completeness testing can take place to identify missing documents.
2.
to provide each document within a document type e.g. each invoice, with a unique
identity.
3.
to facilitate cross-referencing.
The document numbers are useful as they provide each document, say, a customer order, with
a unique identity which Backwoods (Pty) Ltd can use to
1.
cross reference to its own documents, e.g. the ISO
2.
provide an easy reference when following up queries with the customer.
**2016**
SUGGESTED SOLUTION TO EXERCISE 7.11
Page 1 of 2 pages
a)
Existence of inventory.
b)
1.
A sample of thirty boxes from a population of fifteen thousand units may
appear to be very small.
2.
As it is a non-statistical sample, the number was arrived at judgmentally
and would have been based primarily on our assessment of the risk of material
misstatement in the inventory balance arising from the inclusion of non-existent
inventory.
3.
Based on the evidence available at the time of making the assessment, this
particular risk was probably assessed as low
3.1
strong control environment
3.2
sound controls over the receiving and issuing of inventory
3.3
sound physical controls over inventory
3.4
in prior years no instances of empty boxes were found and there is no indication
that there has been a weakening of controls during the year.
The fact that play stations are attractive items to steal would also have been
considered.
4.
Had a statistically based sample been selected, it would probably not have been
much bigger.
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 441 of 3 pages
c)
Peter Dean
Roy Sidhu
1.
He is making the basic mistake of drawing a conclusion on the
population without extrapolating the results of the sample over the
population.
Even a simple proportional extrapolation would come
out at 500 (potentially) empty boxes.
2.
It is not one empty box in fifteen thousand, it is one empty box in
thirty as only thirty boxes were selected.
3.
His conclusion is completely invalid.
1.
The principle of extending the sample is sound on the grounds that
this may just be a “one-off” error which happened to be identified
in our initial sample but is not indicative of the population as a
whole.
2.
However, it is not as simple as just selecting another thirty boxes
2.1
the underlying risk assessment should be re-examined and
2.2
the “cause” of the empty box should be followed up, e.g. was
it used as a demonstration model perhaps?
3.
Furthermore, the empty box can never be ignored, it must be
followed up, recorded and reported to the warehouse manager.
Bob Boon and Creedence Ndlovu
1.
Bob Boon has no basis for deciding that one out of thirty (3.3%) is
a “tolerable error rate” (tolerable misstatement).
2.
If he agrees with Peter Dean he has no understanding of sampling
and the conclusions which can be drawn about the population.
3.
Creedence Ndlovu has a better understanding of the situation. The
most obvious and likely explanation is that the contents of the box
have been stolen and we would, as auditors, be in trouble if we did
not recognise this as a potential theft (misappropriation of
assets).
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 442 of 3 pages
**2016**
/continued on page 2
SUGGESTED SOLUTION TO EXERCISE 7.11
Page 2 of 2 pages
4.
Peter Dean
d)
1.
4.1
theft is “unacceptable” but even if there has been some
undetected theft, inventory can still be fairly presented
(i.e. contain only immaterial misstatement)
4.2
In essence there are two issues here, fair presentation and
the misappropriation of assets.
The former may be achieved
even if there has been an occurrence of the latter.
1.
Again a real lack of understanding on his part.
If additional
testing is required, it must be carried out. We cannot voluntarily
limit our scope to suit the warehouse manager.
2.
The warehouse manager has a legitimate concern about opening boxes
and it is reasonable for us to be careful, but we need to satisfy
the requirements of an independent audit by gathering sufficient
appropriate evidence.
The discovery of the empty box should be reported to the warehouse manager and an
explanation sought. Although the most likely explanation is theft (the box has
been resealed) there may be a perfectly valid explanation, e.g. the play station
was taken out and is being used as a demo model.
2.
confirmed.
e)
Her suggestion that every box will have to be checked is
impractical and unnecessary. Her argument that you cannot have an
“tolerable error rate” for theft is not quite correct
If the warehouse manager supplies an explanation, its validity should be
1.
I would treat each of the four types of play station as a separate population.
Reason. Each type of play station is already stored in its location and the play
stations vary in value; this is, in effect, a form of stratification.
2.
I would randomly select a judgmentally based sample for each population, selecting
a larger sample for the Nintendo and Sony play stations. Reason. No real need
for a statistically based sample, but some emphasis should be placed on the high
value play stations which are likely to be more susceptible to theft.
3.
I would, with the warehouse manager, determine whether there were any factors
(other than value) which may make a particular type of play station susceptible to
theft, e.g. less effective custody controls in that location of the warehouse.
Reason. To determine whether the sample size for that type should be increased.
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4.
I would carry out the procedure of opening the boxes with the help of the
warehouse manager and his team. Reason. It would be far more cost efficient to
incorporate the client’s staff and in addition, the responsibility for following up on
the suspected theft lies with management as it is their responsibility.
5.
Another possibility may be to actually use a statistical sampling plan
(setting parameters which take into account the “updated” risk assessment which we should
have carried out) to establish a “statistical” sample size and random selection of
sampling units for testing. Reason. We suspect fraud (misappropriation of assets) and
thus we may be well advised to obtain “best quality” evidence. Should we need to defend
our actions at a future date it will be easier to defend a “statistical sample” than a
“judgemental sample”.
**2016**
SUGGESTED SOLUTION TO EXERCISE 7.10
Page 1 of 2 pages
a.
1.
Yes, I would agree with my senior.
2.
Justification
2.1
The authorization
signatories.
process
is
inadequate,
should
be
two
authorizing
*
as only one of three authorised signatories is
required, it would be a reasonably simply matter for an employee to have
the same journal entry passed twice by presenting the genuine JER to one
signatory and then later presenting the false JER to another signatory.
*
this weakness is compounded by the fact that the
signatory does not indicate in any way that he or she has reviewed the
supporting documentation; it should be signed or stamped accordingly
otherwise it can be presented a second time, to support a false JER.
2.2
Returning the JER to the requester provides the opportunity for the
requester to alter the JER before passing it on for capture.
2.3
It appears that the clerical assistant does not check the JER for
authorization but simply captures what s/he is given.
2.4
There is only one copy of the JER which weakens audit trail and
makes it much easier for evidence of an unauthorized journal entry to be
destroyed.
(Compounded by the fact that it is filed in the accounting
department’s general space).
2.5
There is no reconciliation of the computerised log of journal
entries to the JER by a senior staff member.
*
the clerical assistant could be passing journal
entries e.g. writing off a debtor’s account in collusion with other
members of staff or
*
members of staff could be bypassing the authorizing
step and simply sending the JER through for processing (see 2.3. above).
b.
Step 1 :
Define the objective of the test.
:
We wish to gather evidence on whether all journal entries are
authorized, i.e. that they are signed and supported by appropriate original
documentation.
Step 2 :
Decide on the procedure to be performed.
:
We must specify the “error (deviation) condition”, in this case
unauthorized JERs.
The procedure will be to select a sample of journal
entries from the computerised log (or transaction file if it is available)
SUGGESTED SOLUTION TO EXERCISE 10.9
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of journal entries and trace them to the JERs which will be inspected for
the signature of one of the approved signatories, and traced to original
supporting documentation.
Step 3 :
Step 4 :
:
Define the population (appropriate and complete).
:
The population will be all journal entries passed for the year
under audit, listed (numerically) on the computerised log of journal
entries. Note: the start and end points of the population can be established
as the JERs are sequenced.
Define the sampling unit.
The sampling unit will be a (each) journal entry.
Step 5 :
Determine the sample size.
:
If we are to use a statistical package (as requested) we will need
to define the following
*
confidence level
*
precision
*
tolerable rate of deviation rate
*
expected rate of deviation rate
*
population size
These parameters can then be applied to the appropriate formulae tables to give
sample size.
Note: If a non-statistical package is used, the sample size will be made
judgementally.
**2016**
/continued on page 2
SUGGESTED SOLUTION TO EXERCISE 7.10
Page 2 of 2 pages
Step 6 :
Decide on the sample selection method. (Select the sample).
:
As we require a statistical sample, the selection must be done on a
random basis to afford every journal entry an equal chance of selection.
:
As we have software available we would use a “random number
generator” and select by JER number.
Step 7
:
Perform the audit procedures
:
We will extract the journal entries whose numbers appear on the
random selection.
:
We will then obtain the JER and inspect it to determine whether it
was authorized and supported.
Step 8
:
Analyse the nature and cause of errors (deviation).
:
We will analyse the sample results and consider the cause of the
deviations including whether the deviations are anomalous or not.
Step 9
:
Project the sample results over the population.
:
We will then calculate the number of deviations (see step 2) in the
sample and using the formula/tables and parameters set in step 5, calculate
the estimated rate of deviation for the population.
Step 10 :
Conclude
:
Compare projected deviation rate to tolerable deviation rate and
conclude on whether our results fall within acceptable (pre-set) parameters.
:
Decide on the need for further audit procedures.
c.
1.
No, we cannot assume that fraud has occurred.
2.
We did not test for fraud, we tested whether journal entries were
authorized.
Even though we discovered an unacceptable level of unauthorized
journal entries, we cannot conclude that they were fraudulent/that there was any
intent to misrepresent. It may simply be that an employee forgot to have the JER
signed (perhaps in a hurry) and the weak internal controls did not pick it up.
3.
Of course the results have to be carefully followed up because we have
been alerted to potential fraud.
SUGGESTED SOLUTION TO EXERCISE 10.9
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**2016**
SUGGESTED SOLUTION TO EXERCISE 7.9
Page 1 of 2 pages
Audit 1
a)
b)
1.
Sampling risk. This is the risk that the auditors conclusion based on a sample
may be different from the conclusion if the entire population was subject to the
same audit procedure.
2.
It is risk that is “inherent” in sampling. There is always the chance that the
sample we extract, despite being done technically correctly, is not representative
of the population.
3.
Non-sampling risk is the risk that the auditor reaches an erroneous conclusion for
a reason not related to sampling risk, e.g. drawing invalid conclusions, selecting
the wrong items.
In other words it is to do with the person carrying out the
sampling exercise and not the “inherent” risk of sampling.
1.
This is an example of non-sampling risk.
2.
When setting up the sampling exercise, the trainee did not confirm that the
population from which the sample was drawn, was complete.
3.
Although he used random number tables, the correct selection of JEAs could not be
made as not all JEAs had been resequenced.
SUGGESTED SOLUTION TO EXERCISE 10.9
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c)
4.
Due to the trainees carelessness/negligence, a positive conclusion was drawn about
the controls over JEA authorization.
Had the sample been drawn from the full
population, a different conclusion may have been drawn.
1.
No, the trainee’s conclusion cannot be accepted.
2.
Statistical sampling requires strict adherence to the “laws”, one of which is that
*
each sampling unit in the population has a known probability of being
selected. In this case the sampling units are the JEAs and as a number of
JEAs have been excluded, they have no chance of being selected.
3.
Furthermore, as the trainee did not have the correct size of population when
setting his parameters, he is likely to have ended up with an incorrect sample
size (too small).
4.
The fact that the deviations were “well within” the tolerable rate of deviation
makes no difference; firstly, “well within” is a judgemental and not a statistical
assessment, and secondly, rate of deviation in the sample cannot be extrapolated
over a “defective” population to produce a statistically acceptable conclusion.
Audit 2
a)
A subsequent receipt testing is carried out as follows:
1.
Sample of debtors on the list of debtors at year end is selected.
2.
Payments from these debtors are then identified in the cash receipts journal for
say, the month after year end.
3.
By tracing the remittance advice applicable to these receipts, the invoices and
matching delivery notes to which the receipt relates, are identified and inspected
to confirm that
3.1
the documents were dated prior to year-end (i.e. the sale took place
before year end) and
3.2
that the sale was included at year-end and in the sales journal and
debtors ledger.
(Note: the obvious assumption is that if the debtor has paid, the debt existed at
year end provided the sale was made prior to year end.)
b)
1.
This is an example of sampling risk.
2.
The audit team carried out all aspects of the sampling exercise properly so it is
not non-sampling risk.
3.
Sampling risk is the risk that the auditors conclusion may be different to what it
would have been had the entire population been tested using the same procedure
SUGGESTED SOLUTION TO EXERCISE 10.9
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(subsequent receipt testing). There is always a risk that the sample will not be
truly representative of the population, this is just “how it is” with sampling.
**2016**
/continued on page 2
SUGGESTED SOLUTION TO EXERCISE 7.9
Page 2 of 2 pages
c)
1.
Essentially we are testing the debtors balance for overstatement by, for example,
the inclusion of sales which were made after year end in the debtors year end
balance, and gathering reliable evidence that the debt existed at year end.
A stratification of the debtors into amounts would have allowed us to direct our
audit effort at satisfying ourselves that the larger debtors balances at year end
consisted of sales made prior to year end, and that the larger debtors actually
existed.
d)
e)
2.
By stratifying we could probably have selected smaller samples and obtained good
evidence about a larger percentage of the value of the debtors account (improved
audit efficiency.)
1.
The trainee would be looking for evidence that debtors are understated.
(This
test would be part of “cut-off” testing and is likely to supplement sales “cut
off” tests.
This, plus the fact that understatement is usually a low risk for
debtors, would result in a small sample.) He would therefore
1.1
Trace the receipts selected from the post year end cash receipts journal
to their supporting remittance advice, and corresponding invoice and
matching delivery note.
1.2
Inspect the dates on the invoice and delivery note to determine whether
the sale was made prior to year end.
1.3
For those sales made prior to year end, trace the invoice to the sales
journal prior to year end and confirm by inspection of the debtors account
that the sale was included in the balance at year end.
1.
I do not agree with the trainee’s conclusion.
2.
He has omitted the important step of extrapolating the sample result over the
entire population he is testing.
3.
If there are say, 400 receipts in the population then even a simple extrapolation
would suggest that there are around 53 instances of sales made prior to year end
that have not been included in the year end debtors balance.
Even though the
SUGGESTED SOLUTION TO EXERCISE 10.9
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sample plan was not statistical, the extrapolation must take place to get an idea
of the possible misstatement in the entire population.
4.
An extrapolation by value could also be done (monetary value of the two invoices
divided by the monetary value of the sample, multiplied by the entire population).
5.
Either way, it is most unlikely that this would be within tolerable misstatement.
**2016**
SUGGESTED SOLUTION TO EXERCISE 7.8
Page 1 of 2 pages
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 449 of 3 pages
1.
INVENTORY COUNT
1.1
There is no reference to any risk assessment pointing to a particular risk of
overstatement.
1.2
There is usually risk associated with the existence of inventory (overstatement)
but the level of testing being suggested does not seem warranted unless there is very
material and specific risk to existence.
2.
1.3
In a general sense, emphasis can be placed on higher value items provided there is
also some coverage of low and nil value inventory items.
A sample should be
representative of the population but can be stratified.
1.4
No rationale is given for aiming at 50% of the total value - this seems to be a
particularly poorly considered approach with no indication of how many test counts
will be needed!
1.5
By testing only from the records to the physical inventory, no evidence will be
gathered about the completeness of inventory.
A small sample for testing the
other way should be selected. In addition, the trainee’s method and reasoning do
not make it absolutely clear whether he will be selecting from the records or from
the physical inventory!
PURCHASES
2.1
There seems to have been no evaluation of the risk of misstatement in “purchases”.
2.2
There is no indication of what testing the junior trainee will be carrying out –
is he conducting tests of controls or tests of detail?
2.3
Haphazard selection is not a totally random method of selection so this
immediately negates the possibility of introducing statistical evaluation “should
we want to”.
2.4
Furthermore, statistical analysis requires that a proper statistical sampling plan
be used. This requires setting out objectives, setting parameters, defining the
population etc. None of this has been done.
2.5
There is no indication of the population size or what document(s) is actually
being tested.
Even without this information, 200 items selected is a very big
sample.
*
boredom is very likely to set in resulting in non-sampling error
*
a proper statistical sample is likely to be smaller and by using random
tables, a far more representative sample will be obtained
*
audit efficiency and effectiveness is improved if statistical sampling is
used on large populations.
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 450 of 3 pages
2.6
There is no indication of how the audit senior arrived at R5 000 as a cut-off.
Again, whilst stratification is perfectly acceptable, there must be some
justification for setting the different strata.
As it stands, every purchase
under R5 000 will be ignored and when combined, could make up a large percentage
of purchases.
Note:
2.2 above is a very important point, the sampling plan must match the objective of
the test.
**2016**
/continued on page 2
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SUGGESTED SOLUTION TO EXERCISE 7.8
Page 2 of 2 pages
3.
COMPLETENESS OF CREDITORS
3.1
Completeness is the assertion relating to creditors which tends to attract
the greatest audit risk so the senior is correct with regard to its importance.
3.2
However, MUS (monetary unit sampling) is not a sampling plan which matches
to the objective of testing completeness.
3.3
MUS tends to “hook out” the larger creditors balance from the list of
creditors. In testing for completeness we are more interested in creditors which
are not on the list at all or which are understated.
Therefore MUS is not a
suitable sampling plan.
3.4
The audit team should be concentrating on all the other completeness of
creditors tests, e.g. comparison with prior year balances, nil balances, cut-off
testing for purchases, etc.
3.5
The results of purchases testing will usually have a bearing on
completeness of creditors testing (e.g. purchases cut-off). The senior does not
consider this but that is probably because he has not decided on, or defined, what
tests he is conducting on purchases (see 2.2).
3.6
Successful statistical sampling (including MUS) is not just a matter of
following step-by-step instructions in the audit manual. It is essential that the
audit team in the field has a good understanding of the technique. Steven Denham
clearly lacks the understanding to make the sound professional judgement calls
which are also required when applying MUS.
4.
DIRECTORS MINUTES
4.1
The reason that all directors minutes are reviewed is that important
decisions which the auditor may not discover any other way, may be contained in
the minutes.
4.2
Although 24 sets of minutes may seem excessive (it is not really) it is
not possible to extract any meaningful samples, statistical or otherwise because
*
directors meetings do not necessarily deal with the same matters from
meeting to meeting, i.e. the sampling units are too dissimilar and their
characteristics are too varied
SUGGESTED SOLUTION TO EXERCISE 10.9
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5.
*
the population is far too small to perform a suitable sample
*
furthermore before the auditor reviews minutes, he does not know exactly
what he is looking for.
Of course he has an idea of matters which may
arise, but there could be any number of matters which the auditor did not
expect.
COST OF PLANT AND EQUIPMENT
5.1
Again no mention of any risk evaluation in respect of plant and equipment.
5.2
It is not necessary to do such extensive verification of additions unless
there is serious risk of overstatement.
5.3
It appears as if only substantive work will be done on fixed assets. Is
there any rationale for this decision?
Why will there be no tests of controls
over the acquisition of fixed assets including plant and equipment. For example,
if the authorising controls over additions (and disposals) of fixed assets are
good and strictly applied, substantive work can be significantly reduced.
5.4
Whatever the amount of testing is decided upon, there should be some
physical inspection of a sample of all assets, not just additions, for existence
(and physical condition/impairment purposes).
Assets included in the opening
balance may no longer exist or be owned by the company.
The cost of any such
assets should be removed from the plant and equipment accounts.
5.5
Furthermore a sample of disposals will need to be verified to ensure that
costs are properly removed from the records where necessary.
**2016**
SUGGESTED SOLUTION TO EXERCISE 7.7
1 Page only
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 453 of 3 pages
1.
Decrease:
1.1
If we are able to tolerate (accept) a greater number of deviations
(instances where a control has not been applied as prescribed) then
we can do less testing; thus sample size is reduced.
This
situation suggests that the risk associated with the internal
control procedure not being applied, has reduced.
2.
Increase:
2.1
The higher the expected rate of deviation, the larger the sample
size needs to be for the auditor to be in a position to make a
reasonable estimate of the actual rate of deviation. In effect, we
consider that there may be an increased risk of unauthorized/valid
overtime payments.
3.
Increase:
3.1
The risk surrounding the material misstatement of inventory by the
inclusion of non-existent inventory has increased substantially.
We must therefore increase our testing to make sure we do not let
material misstatement go undetected.
4.
Decrease:
4.1
As we expect to be in a position to conduct successful subsequent
receipt tests, we will be going some way to gathering sufficient
appropriate evidence about the existence of debtors.
This will
reduce the amount of evidence we need to gather from the
circularization. Hence a smaller sample size.
5.
Increase:
5.1
If the auditor wishes to be in a position to rely to a greater
extent on the internal control system to identify, prevent, detect
material misstatement, it will be necessary to increase the tests
of controls on the system.
This should provide the level of
assurance required by the manager.
6.
Various:
6.1
There are two considerations here.
Firstly, the fact that there
are three thousand more inventory items will have little effect on
the sample size. (This is part of probability theory.)
6.2
However, with the introduction of new products and the associated
spare parts, there could be increased risk of material misstatement
in inventory.
For example, physical storage of the new inventory
lines may be chaotic, not all new lines may have been entered
correctly on the database (existence or completeness) etc.
Increased risk would lead to larger samples as more evidence
relating to existence would have to be gathered.
7.1
In general and with all other things being equal, the aggregate of
the sample sizes from the strata will be less than the sample size
that would have been required if the total population was sampled.
As we are stratifying in terms of monetary value, better coverage
of the population is obtained by selecting say, five high value
items from the top stratum, than from selecting fifteen or more
items from the bottom stratum.
7.
Decrease:
SUGGESTED SOLUTION TO EXERCISE 10.9
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**2016**
SUGGESTED SOLUTION TO EXERCISE 7.6
1 Page only
1.
Higher risk of material misstatement- Increase.
The higher the auditor’s assessment of risk, the larger the sample size needs to be. My
assessment that the risk of the inclusion of fictitious debtors has increased suggest
controls in the cycle are not as affective as they were last year. I need to ensure that
audit risk is reduced to an acceptably low level and as I can’t rely on the controls, I
will have to do more substantive work.
In this case, increase my sample size for
positive circulation.
2.
Introducing subsequent receipts testing – Decrease.
The more I can rely on other substantive procedures (tests of detail or analytical
procedures) to obtain evidence pertaining to the existence assertion, the less assurance
I will require from my circularisation and, therefore, the smaller the sample size can
be. Subsequent receipt testing and positive circs both provide existence evidence, and
subsequent receipt testing produces good quality evidence.
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 455 of 3 pages
3.
Level of assurance – Increase.
The greater the degree of “confidence” that I require, that the results of the sample are
in fact representative of the total population of debtors (indicative of the actual
fictitious debtors in the population), the larger the sample size needs to be.
4.
Increase in tolerable misstatement - Decrease.
The more misstatement that can be “tolerated” the less we have to test – I will be less
concerned about missing a greater amount of fictitious debt than the previous year. If
more misstatement can be tolerated it probably means that the materiality limit has
increased, i.e. fair presentation will still be achieved despite a (possible) greater
amount of misstatement in the accounts receivable balance.
5.
Expected increase in rate of deviation - Increase.
The greater the rate of deviation I expect to find in the population, the larger the
sample size needs to be in order to make a reasonable estimate of the actual rate of
deviation.
6.
Stratification – Decrease.
When a population can be appropriately stratified, the aggregate of the sample sizes from
the strata generally will be less than the sample size that would have been required to
attain a given level of sampling risk, had one sample been drawn from the whole
population. For example, if I stratify debtors by amounts, selecting a few accounts from
the high value debtors, it is likely to give a better coverage of the total population
(by amount) than selecting randomly from an unstratified population.
7.
Increase in the number of debtors – Negligible effect.
For large populations, the actual size of the population has little, if any, effect on
sample size. (Theory of probability.)
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**2016**
SUGGESTED SOLUTION EXERCISE 7.5
1 Page only
a)
Sampling risk
1.
The intention behind sampling is to be able to draw a conclusion about the
population from which the sample is drawn once the procedures have been conducted
on the sample units.
2.
In selecting the sample, certain parameters are set with the intention of
providing the auditor with a sample which will provide the auditor with a level of
assurance at which the conclusion can be expressed e.g. 90% assurance that …
3.
However, there is always the risk that the sample selected, despite the auditor
doing everything correctly, will not be representative of the population from
which it is selected.
4.
This is termed sampling risk which may lead to the auditor drawing an incorrect
conclusion on the population sampled. It is a risk which is inherent in sampling.
Non-sampling risk
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 457 of 3 pages
b)
1.
With any auditing procedure, there is the possibility that the person carrying out
the procedure will make some kind of error which could lead to an incorrect
conclusion being drawn on the population being sampled.
2.
This is termed non-sampling risk, and in effect means that the erroneous
conclusion reached is caused by reasons other than the non-representivity of the
sample (sampling risk). For example the auditor may:
1.
2.
3.
2.1
Make mistakes in calculating sample size.
2.2
Select the wrong sampling units.
2.3
Apply an inappropriate procedure for the assertion for which evidence is
being gathered.
2.4
Misinterpreted the results.
Non-sampling risk
1.1
The sampling plan, if applied properly, would have detected the problem.
1.2
The trainee erred in failing to select precisely the cheques indicated by
the sampling plan.
Non-sampling risk
2.1
The trainee erred in his choice of procedures - he omitted a procedure
essential when testing to the completeness of sales assertion.
2.2
There was nothing wrong with the sampling plan. The failure to identify
the unrecorded sales was due to the incompetence of the trainee.
Sampling risk
3.1
The trainee has not done anything wrong : he chose, and applied, his
procedures correctly and implemented the sampling plan correctly.
3.2
The undetected non-existent inventory items clearly were not selected in
the sample of items from the masterfile as identified by the sampling plan
i.e. their omission was strictly by chance - a risk inherent in any
procedure involving sampling.
SUGGESTED SOLUTION TO EXERCISE 10.9
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4.
Non-sampling risk (most likely)
4.1
The senior made an error of judgement in choosing his tolerable rate of
deviation.
4.2
Presumably setting the tolerable rate too high was a result of the senior
underestimating the risk of the controls not operating (control risk).
This resulted in the selection of a sample which was too small.
4.3
The sampling plan would quite possibly have detected the breakdown in
controls if the sample size had been bigger, which it would have been had
a lower tolerable rate of deviation been applied.
**2016**
SUGGESTED SOLUTION TO EXERCISE 7.4
1 Page only
1.
1.1
A substantial amount of judgement and knowledge of the client is required
when using statistical sampling, and the better the auditor is at exercising this
judgement the better the statistical sample will be.
1.2
In fact, the auditor is forced to exercise judgement where he might
otherwise not have e.g. deciding on:
*
the degree of assurance required.
*
tolerable rates of deviation or misstatement.
*
the expected rates of deviation or misstatement.
1.3
The auditor’s assessment of the risk of misstatement is an important part of
setting parameters and the assessment of risk depends largely on professional
judgement.
1.4
The only two instances where the auditor does not exercise judgement when using
statistical sampling are the two where the auditor is least equipped to exercise
judgement, i.e.
*
deciding on the sample size, having set the initial parameters.
*
extrapolating the sample results to the population on completion of
the procedures.
Both of the above are determined for the auditor by the statistical
package used.
2.
2.1
On the contrary, in a court-of-law a judge might not understand the
decision of an auditor to examine, say, only 1% of a population consisting of thousands
of transactions.
It may, in fact, be harder to explain how justifiable decisions were
made using professional judgement only.
2.2
At least if statistical sampling has been used, the auditor has a sound
theoretical basis to explain his actions and decisions.
SUGGESTED SOLUTION TO EXERCISE 10.9
Page 459 of 3 pages
2.3
In addition the auditor can call a statistician as an expert witness to
vindicate his decisions.
It is, of course, possible to call other auditors to
vindicate a professional judgement call but it may not be that easy.
2.4
As indicated in 1 above, judgement is used, and the assistance of
statistics is not mathematical trickery, it is an accepted and constantly used
scientific discipline.
3.
3.1
It is indeed more cost effective (and less tedious) to obtain evidence
from analytical procedures. One must, of course, be satisfied that analytical procedures
give the required level of assurance.
3.2
If an auditor wants to de-emphasise his tests of controls he can change
his sample size parameters for these tests of controls accordingly.
*
the new parameters will reduce the sample size in a statistical
sample BUT the lack of assurance about controls tested must be made up by
increased substantive testing.
3.3
It is not realistic to compare the “value” of statistical tests of
controls with non-statistical substantive tests as they have different objectives,
and one is not a substitute for the other.
3.4
If sample sizes are too large, resulting in an inefficient and non-cost
effective audit, an alternative audit plan must be considered without compromising
the quality of the audit. Properly considered and applied statistical samples may
actually reduce sample sizes, e.g. by using stratification.
4.
4.1
It is not necessary for every trainee accountant to fully understand the
theory and application of statistics.
Clearly the audit seniors/managers must have a
thorough working knowledge of the particular sampling methods used by a firm to fulfil
their supervisory and review functions.
4.2
Provided the technical partner has access to a statistician and
understands the theory and application of the audit sampling techniques used by
the firm, there should be no problem. It is the audit team which must have the
required skills.
4.3
Sampling in an audit environment has been made "user-friendly" and a
detailed knowledge of statistics and statistical theory is no longer necessary for
the routine application of the technique.
4.4
We are also duty bound to ”train” our trainees and if statistical sampling
is the most efficient and effective manner of obtaining particular evidence, our
trainees must be able to apply the technique.
5.
5.1
Certainly, statistical sampling in auditing does present practical
problems in its application, but non-statistical methods of testing also present
practical problems.
5.2
However, statistical packages/methods have been developed which meet the
needs of the problems auditors face in using statistical sampling techniques.
5.3
In answer to the specific problem raised, the systematic method where
items using a constant interval and starting at a random point would solve this
specific problem with the selection of journal entries, or journal entries could
be temporarily numbered for selection especially in a computerised environment
where audit software can easily do this.
5.4
With the progress in audit software, random number tables are easily
generated.
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SUGGESTED SOLUTION TO EXERCISE 10.9
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SUGGESTED SOLUTION TO EXERCISE 7.3
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1.
1.2
2.
2.3
3.
3.4
4.
4.1
5.
5.3
6.
6.4
7.
7.2
8.
8.3
SUGGESTED SOLUTION TO EXERCISE 10.9
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SUGGESTED SOLUTION TO EXERCISE 10.9
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SUGGESTED SOLUTION TO EXERCISE 7.2
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1.
2.
3.
4.
The population being sampled.
1.1
The intention of the company appears to be to draw a conclusion about the use of its
software by home computer users.
1.2
To draw conclusions about this population it would be necessary to select a sample
from the entire “home computer user” population.
1.3
The population Interphace (Pty) Ltd has chosen to select its sample is the company’s
own debtors masterfile.
Therefore conclusions can only be drawn about that
population and not about the “home computer user” population.
The sample size and sample itself.
2.1
To be of any value, the sample should be representative of the population itself.
2.2
In an attempt to get a “good response” Joe David has picked out those customers whom
he thinks will respond. This introduces bias (Joe David’s opinion) and negates the
representivity of the sample.
2.3
It appears that no parameters or thought was given to the sample size – this was
determined by an opinion of which customers might or might not reply.
“Statistically pretty conclusive”
3.1
For a result to be “statistically pretty conclusive”, a statistical sampling approach
would need to have been carried out.
3.2
As a minimum this would require that sample items (home computer user) be randomly
selected and the use of the probability theory be used to evaluate sample results.
As can be seen from the above, this has not happened.
3.3
To be able to effect a statistical sampling approach, careful consideration must be
given to setting parameters, e.g. confidence levels, extrapolating results, etc.
None of this was done and at best this could only be described as a non-statistical
sample. Thus the conclusion that the result is statistically conclusive is totally
invalid.
The conclusion drawn.
SUGGESTED SOLUTION TO EXERCISE 10.9
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5.
4.1
The conclusion drawn (Interphace software is the most commonly used software …) does
not in anyway relate to the questions asked and responded to.
4.2
Asking a wholesaler of the company’s products whether the product meets user
requirements and if they outsold other brands, is a long way from concluding that
Interphace software is the most commonly used software by home computer users.
Overall.
5.1
This sampling exercise was very poor in all aspects.
for meaningful sampling were met, e.g.
None of the basic requirements
*
minimal planning: clear objectives, defining the population, etc
*
inappropriate selection of sample units
*
proper evaluation of the results.
SUGGESTED SOLUTION TO EXERCISE 10.9
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