Candidate no
Marker
5
4
5i
1
2
3
4
5
6
7
8
9.1
9.2
10
10.1
11
12.1
12.2
12.3
12.4
12.5
13
13.1
13.2
14
14.1
6
5ii
Total
5iii
GENERAL
Agree opening balances of inventory to prior year’s working papers and audited AFS / Agree the totals as per
inventory schedule obtained from management with the general ledger account and trial balance.
Confirm that the inventory (including consignment stock) was valued in accordance with the accounting policy and
whether it is in line with IFRS.
Through inspection, confirm management’s statement that there is no WIP. If WIP does exist, perform substantive
procedure to test the valuation of the WIP.
Obtain an understanding of the process of inventory valuation / compare the method of dealing with inventory
obsolescence for the 2013 year to the method adopted for the 2012 year for consistency, e.g. by inspection of the
prior year audit work paper file.
ANALYTICAL PROCEDURES
Perform analytical procedures on the monthly write-off amounts during 2013 by comparing e.g. month-to-month
fluctuations and the write-off amount for a particular month to the equivalent month in the 2012 financial year (or
any other relevant A/P e.g. compare the monthly write-off amount as a % of inventory / consignment stock).
ENQUIRIES, APPROVALS & CORROBORATION OF INVENTORY VALUATIONS
For abnormal write-offs in any month during the 2013 financial year, enquire from knowledgeable staff as to the
reasons for these write-offs, corroborate the reasons and consider whether this points to deficiencies in
management’s system of determining write-offs
Inspect the minutes of the relevant management/board meetings for approval of any matters relating to inventory
valuation / where the write-off of expired/damaged inventory that was summarised on the schedule for 2013 was
approved.
Enquire from the operational /warehouse personnel whether there were any events (e.g. problems with the air
conditioners/fridges/cold rooms) in Pretoria/Durban that may have caused damage to the inventory on hand at
30 September 2013, and if so obtain a schedule / list of inventory items impacted and follow these items through to
the inventory write-off schedule agreeing the write-off amount per the schedule obtained to the amount per the writeoff schedule.
Corroborate this evidence, by inspecting reports prepared by operational staff with regard to any problems with
the temperature regulation/minutes of management meetings noting such problems.
inspecting the invoices from the air-conditioner maintenance company (for both Durban and Pretoria) (consider
any other relevant examples of evidence).
WRITE-OFF’s
Compare the inventory write-offs in October 2013 to the monthly write-offs during the 2013 financial year; and
if the October 2013 write-off is unusual, investigate by enquiry from knowledgeable staff as to the reasons for
these abnormal write-offs and corroborate the evidence.
Determine whether all slow-moving, obsolete, scrapped or damaged items have been adequately identified (and
written off) by inspecting periodic reports to management/the board concerning such information.
VALUATION AUDIT PROCEDURES USING CAAT’S
Using the firm’s generalised audit software, extract a report of inventory on hand at 30 September 2013 that has an
expiry date that is before/on 30 November 2013 (i.e. two months after year-end).
compare the inventory holdings on hand at 30 September 2013 for each inventory item to the sales levels for the
items during the previous 12 months
For a sample of inventory items, compare the expiry date reflected in the inventory database to the expiry date
reflected on the physical inventory items.
discuss with sales management whether the inventory is likely to be sold before its expiry AND inspect sales
reports after year-end to corroborate their answers.
Any other valid CAAT testing to address valuation of inventory e.g. negative values, quantities etc and
corroboration thereof.
TESTING NET REALISABLE VALUE (NRV)
For a sample of inventory items per the inventory listing, agree the selling price to the most recent sales invoice to
confirm it is correctly reflected on the inventory listing.
(Using the firm’s generalised audit software) Compare the selling prices of the inventory items on hand at 30
September 2013 to their unit cost prices, and if cost > NRV, inspect the schedule of write-offs to NRV for these
adjustments
INTERNAL AUDIT AND FOLLOW UP ON REPORTS
Reviewing the audit work papers (including those from internal audit) prepared for the attendance at the year-end
inventory count to identify damaged/expired inventory items.
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
14.2
14.3
14.4
14.5
14.6
15
15.1
16
Regarding the internal auditors report reflecting the need to write down the inventory balance by R5,54 million:
Inspect the internal audit report, evaluating the nature and extent of test counts conducted (e.g. sample sizes), and
the logic and accuracy of their projection calculations (i.e. sufficient and appropriateness of work performed by IA).
Inspect the write-off schedules for September 2013 to ascertain whether the items that are specifically referred to
in the report as being damaged /unsaleable have been written off.
Enquire from Mr Steve Roids (Head IA) whether his staff have undertaken a follow-up visit and are satisfied that
the findings of their report have been addressed and corroborate the evidence.
Inspect the findings of the investigation initiated by Mr Payne (CFO) in response to the internal audit report, and
compare these to the findings of the internal audit report / consider the objectivity and competence of the person(s)
who undertook the investigation.
Consider and discuss the impact of IA findings at the Durban plant on inventory carried at the Pretoria plant and
determine if same problems did not occur which could also have an impact on the valuation of inventory at the
Pretoria plant.
CONSIGNMENT STOCK
Obtain a confirmation from Chemsave on consignment stock held and agree the quantities and condition as per
confirmation to the inventory lists.
Appropriate formulation of audit procedures
1
1
1
1
1
1
1
Available 28 maximum 14
Part (5)Sub-part (i)
1.1
1.2
2.1
2.2
3.1
Costing – General observation
IAS2 para 25 requires inventories to be costed on a FIFO or weighted average basis.
Medimade makes use of a FIFO system that is appropriate.
Allocation of manufacturing overheads
In terms of IAS2 para 12, fixed and variable production overheads are to be systematically allocated to
inventory.
Para 13 further indicates that fixed production overheads are to be allocated on normal capacity of the production
facilities, while variable production overheads are allocated to each unit of production on the basis of actual use of
the production facilities.
In the case of Medimade, manufacturing overheads do not appear to have been split into their variable and fixed
components
3.2
Variable manufacturing overheads are therefore incorrectly allocated to production on the basis of normal
capacity.
4
The inclusion of electricity expense (which likely has a significant variable component) in manufacturing
overheads supports the above comment.
Note: This is an error of principle and does not result in the incorrect costing of inventory (unless variances are
allocated back to inventory, as this will result in incorrect variable and fixed manufacturing overhead variances).
Standard costing – Acceptability
In terms of IAS2 para 21, the standard-cost method may be used for convenience if the results approximate cost.
Standard costs take into account normal levels of materials and supplies, labour, efficiency and capacity utilisation.
They should be regularly reviewed and, if necessary, revised in the light of current conditions.
In the case of Medimade, the use of the standard-cost method is acceptable as the standards are updated
regularly
and appear to approximate actual costs, except for some of the adjustments proposed below.
Standard costing – Disposing of variances
When variances are insignificant or where variances are costs of inefficiency, they should be included entirely in
cost of sales (per IAS2 para 16), as standard cost will then approximate actual cost.
When variances are significant and not due to inefficiency (i.e. a normal part of business or permanent change in
circumstances), consideration should be given to allocating the variances to inventory to ensure that standard cost
approximates actual cost.
In the case of Medimade, variances (e.g. raw material variances) have correctly been included in cost of sales (other
than those identified in part (ii) below).
With respect to Medimade, certain variances are significant and not due to inefficiency and therefore need to be
allocated to the cost of inventory (finished goods) so as to approximate actual cost.
5
6
7.1
7.2
8
9
10
11.
1
Total marks for 5(i)
Sub-part (ii)
Direct labour rate variance
1
1
1
1
1
1
1
1
1
1
1
1
1
2
2
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
29
DR Finished goods (direct labour) / Inventory R3,2 million
CR Cost of sales (labour rate variance) R3,2 million
Correct amounts
Under-recovery of labour costs due to the rate increase of 9,2% per month from the original estimate of 5,5% (for
each month in the quarter), but only two months’ inventory on hand. As the labour variance has been included in
‘cost of sales’, the R1,6 million under-recovery will automatically have been corrected for July 2013 – as the goods
have been sold.(i.e. adequate explanation of journal entry given)
Direct labour efficiency variance
The variance that remains after excluding the labour rate variance for the last quarter results in a material variance
that needs to be considered.
There is insufficient information to determine when the efficiency arose and how much of this relates to finished
goods on hand at 30 September 2013. However, if that amount can be determined and is material, then an appropriate
journal debiting labour variance and crediting finished goods should be recorded.
Allocated manufacturing overheads
It is not appropriate to allocate the cost of a material refurbishment of equipment to manufacturing overheads
and consequently inventory – it should have been capitalised in terms of IAS16 (para 13) to the fixed asset –
packaging equipment,
and only depreciation should have been allocated to manufacturing overheads (insufficient information provided
to quantify depreciation adjustment).
DR Packaging equipment (property, plant & equipment) R4,3 million
CR Cost of sales (manufacturing overheads)
R1,43 million
CR Finished goods (manufacturing overheads) / Inventory
R2,87 million
Correct amounts used
August overheads that were overstated by R4,3 million, with two-thirds of this allocated to finished goods during
August and September – the remaining third is to be corrected through an adjustment to cost of sales for overheads
allocated in July in respect of inventory already sold.(i.e. adequate explanation of journal entry given)
The difference between the actual electricity reading and the estimate used to set the standard rate should be
adjusted to finished goods so that inventory is not stated at an amount greater than cost, as R2,2 million can be
considered significant for the two months’ production on hand.
DR Cost of sales (manufacturing overheads expenditure variance) R2,2 million
CR Finished goods / Inventory (manufacturing overheads)
R2,2 million
Amounts correct
Electricity expense significantly over-estimated, resulting in a misstatement of the allocation of manufacturing
overheads to finished goods for August and September. The remaining R1,1 million over-estimation relating to
July does not need to be adjusted as the manufacturing overheads expenditure variance has been included in
cost of sales, which includes July’s finished goods sold, which is also misstated (i.e. automatic correction). (i.e.
adequate explanation of journal entry given)
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
Total marks for 5ii
30
31
32
33
Sub-part (iii)
The total adjustment to finished goods is therefore:
Direct labour
R3,20 million
Manufacturing overheads (2,87 m + 2,2 m)
(R5,07 million)
Net adjustment
(R1,87 million)
In evaluating the effect of this misstatement on the audit opinion, it must first be determined (e.g. through discussion
with management) whether there is any intention to correct any of these items before the financial statements are
authorised for issue. (If adjusted, there will be no effect on the audit opinion.)
If not adjusted, the net misstatement is below the materiality amount (of R4 million) and is therefore not considered
to be quantitatively material in isolation – and as such will have no effect on the audit opinion.
However, the net adjustment will have to be included in the summary of differences and will be considered together
with other uncorrected misstatements to determine whether material misstatement(s) in the financial statements have
arisen – if the misstatements are material in aggregate, a modification of the audit opinion will be required.
Total marks for 5iii
Available 38 / max 17
Part (6)
1
1
1
1
1.1
1.1.1
1.2
1.2.1
2.1.
2.2
3
4
4.1
5.1
5.2
6
6.1
7
7.1
7.2
7.2.1
8
Unresolved matter 1:
Uncorrected misstatements arise in respect of these notes for the following reasons:
In terms of IFRS 5.6 an entity shall classify a non-current asset as held for sale if its carrying amount will be
recovered principally through a sale transaction rather than through continuing use.
However, the plant and equipment classified as ‘held for sale’ in the note will be used by Medimade until at least
30 June 2014 – and therefore is not available for immediate sale in its present condition (as required by IFRS
5.7)
Moreover, in terms of IFRS 5.32, a component of an entity should only be reflected as a discontinued operation
(for which the financial effects should be disclosed separately) should it be classified as held for sale and
represent a separate line of business or geographical area of operations.
As the classification of ‘held for sale’ is inappropriate (as explained above), and the disposal of a ‘few’ cold and
flu remedy product lines will not represent a separate line of business, it is inappropriate to disclose the
financial effects of a discontinued operation in the note.
The uncorrected misstatements are material:
Quantitatively – as the amount of the plant and equipment misclassified (R14 million) is well in excess of the
materiality figure of R4 million.
Qualitatively – as this incorrect disclosure enables the company to report a steady increasing trend in profits from
‘continuing’ operations – whereas this would not have been the case had the IFRS requirements been correctly
applied.
The uncorrected misstatements are unlikely to be pervasive, as they are not fundamental to the users’
understanding of the financial statements
As such, a qualified audit opinion should be expressed, and
A ‘basis for qualified opinion’ / “Except for” paragraph added to the audit report to explain how the disclosures
are misstated.
If the matter gives rise to a reportable irregularity [the departure from the requirements of IFRS (which the CEO is
party to) may be the result of an attempt to fraudulently present the financial performance of the company in a
more favourable light than is actually the case]:
Should the criteria for a reportable irregularity be satisfied, and a paragraph included in the audit report under the
heading ‘Report on other legal and regulatory requirements’ dealing with the matter.
Unresolved matter 2
As the sustainability report is cross-referenced to the annual financial statements, the page numbers covered by the
audit report should be clearly specified in the introductory paragraph and the sustainability report must be
excluded.
Moreover, should it be considered that the sustainability report is not clearly differentiated from the audited
financial statements, the auditor shall explain in an ‘other matters’ paragraph in the audit report that the content
of the sustainability report has not been audited (ISA 700.46).
The fact that the race and gender staff representation is incorrectly presented in the sustainability report constitutes
a ‘material misstatement of fact’.
Should management refuse to correct the matter, the auditor can consult with a qualified third party (eg
lawyers/ IRBA / SAICA).
If the matter gives rise to a reportable irregularity (which appears likely given that management is fraudulently
conveying information to stakeholders of the company):
it should be dealt with as explained in point 1 above (i.e. in the section of the audit report headed ‘Report on
other legal and regulatory requirements’
Communication skills (logic of answer)
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
Available 18 max 13