Faculty of Military Science

School for Organisation and Resource Management

Department of Accounting and Auditing

Auditing 244

Assignment 3

Due date 19 October 2022

QUESTION 1 (8 marks)

Which of the following is correct? Explain why you regard the others as incorrect.

1.1 The audit report should be signed by:

a. The senior partner of the auditing firm

b. The designated auditor

c. The designated auditor and the senior partner of the firm

d. The designated auditor and the chairman of the audit committee (3)

1.2 The report provided by the auditor on a set of annual financial statements provides the user with:

a. Limited assurance

b. Moderate assurance

c. Reasonable assurance

d. Unrestricted assurance (3)

1.3 Which of the following will not result in a modification of the audit opinion:

a. The auditor is unable to obtain sufficient evidence.

b. The client made inadequate and incomplete disclosures in the notes.

c. A situation has arisen requiring an emphasis of matter.

d. The client selected an appropriate accounting policy but applied it incorrectly. (2)

QUESTION 2 (17 marks)

As the audit manager assigned to the audit of Daffy Ltd (Daffy), you are currently in the completion phase. Final materiality has been set at R900 000. The following issues were identified during the audit:

Daffys computerised wages program is backed up daily. However, for two months during the period under audit, the wages records and the backups were corrupted and could therefore not be accessed. The wages for these two months amounted to R1.1 million.

Daffys main competitor has filed a lawsuit for R5 million against the company, alleging a breach of copyright. This case is ongoing and will not be resolved prior to the audit report being signed. The matter is correctly disclosed as a contingent liability.

You are required to:

Discuss the impact that the above-mentioned issues will have on the audit opinion. (5)

2.2 Draft the opinion and basis for opinion paragraphs for the two above-mentioned issues. (12)

QUESTION 3 (15 marks)

You are the senior auditor on the audit of Mewis (Pty) Ltd (Mewis), a company selling a range of household furniture, electrical appliances and home electronics. The company, which has a December financial year-end, is owned by Jacob and Jessica October who have indicated that they do not have any additional capital to contribute towards Mewis. The following information has been made available to you:

When the chief executive officer (CEO), Mr Shabalala, resigned from the company in March, the chief financial officer, Ms. Modibane, took over as temporary CEO while the company seeks to appoint a competent individual to replace the former CEO.

Ms Modibane has indicated that this process has taken longer than anticipated, as all suitably qualified candidates asked for very high salaries. With the company making losses, they are not able to pay these high salaries. To cut costs, Ms Modibanes role has been filled temporarily by a recent university graduate.

It has been brought to the attention of Ms Modibane that the former CEO, Mr Shabalala, has set up a company in competition under the name of Fitting Furniture (Pty) Ltd (Fitting Furniture), which offers furniture and related products at competitive prices. As a result, it has gained a healthy share of the market in a short period of time.

Two key suppliers, whose contracts with Mewis lapsed at year-end and have not been renewed, have indicated that they are now supplying Fitting Furniture, as Mr Shabalala had negotiated better terms with them. In addition, the suppliers are unable to fill the orders of both Fitting Furniture and Mewis.

Mewis has been advised by legal counsel that any action against Fitting Furniture to prevent them from dealing with the two suppliers concerned would not be successful, as Mr Shabalala had not had restraint of trade and/or confidentiality clauses built into his contract with Mewis. In the meantime, although Mewis has secured two new suppliers to replace the ones that they lost, they have been unable to negotiate the same credit terms as before.

A significant loss has been recorded in the statement of financial statements for the first time in the companys history. The loss recorded arose because of:

the volatility in the rand over the course of the current financial year having had a negative impact on the financial performance of Mewis (a foreign exchange loss of R500 000 has been noted in the current years financial statements); and

the revenue target for the year not having been achieved because of a growing number of individuals opting to purchase furniture and electronics from competitors, such as Fitting Furniture.

Ms Modibane foresees the losses made in the current year as a minor setback, as a substantial tender to supply several state-owned hospitals with a variety of electronic equipment was awarded to Mewis shortly before the close of the current financial year. The financial statements have been prepared on a going concern basis, and management has provided adequate note disclosure in the financial statements (Note 22) regarding the companys current going concern problems.

Note 22

STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 2020

Notes

Current year

Rand

Prior year

Rand

ASSETS

NON-CURRENT ASSETS

Land and buildings

1

13 000 000

14 000 000

Investment (10 000 shares at R30 per share)

2

300 000

300 000

CURRENT ASSETS

Accounts Receivable

2 700 000

4 300 000

Inventory

1 400 000

3 100 000

Computers

390 000

640 000

TOTAL ASSETS

17 790 000

22 340 000

EQUITY

Ordinary share capital

8 000 000

8 000 000

Retained earnings

1 600 000

4 000 000

CURRENT LIABILITIES

Loan

3

3 3 640 000

4 760 000

Accounts Payable

4 4 410 000

3 000 000

NON-CURRENT LIABILITIES

Provisions and accruals

2 400 000

1 150 000

Bank overdraft

4

940 000

1 430 000

17 790 000

22 340 000

Notes:

1. Included in land and buildings is a building located in Sunninghill, Sandton. Purchased in the previous financial year for R6.9 million, it has been standing vacant since the date of purchase. The senior management at Mewis had intended to relocate the companys administration office to Sunninghill after a full renovation of the building had been undertaken, but has indicated that, because of the financial position in which the company now finds itself, it is more feasible for them to remain in their current premises. The market value of the building has increased to R8.5 million because of improvements that have already been made. Several willing and able buyers have indicated an interest in buying the property at the current market value.

2. The investment, which is recorded at cost in the financial statements at year-end, relates to shares held in Zimba Ltd, a highly profitable company listed on the JSE. These shares are actively traded and may be sold at R45 per share after all trading costs have been considered.

3. The loan from Finance Bank needs to be settled on 31 January of the next financial year. An extension on the settlement of the loan has been requested, and Mewis should get feedback on the application once Finance Bank receives a copy of the audited financial statements.

4. The bank has indicated that they will not increase the overdraft limit beyond the agreed amount of R1 500 000.

You are required to:

3.1 Discuss whether Mewis is going to be able to continue to operate as a going concern. (15)

QUESTION 4 (10 marks)

You are the manager on the 28 February 2021 audit, currently in its finalising phase, of Vibe (Pty) Ltd (Vibe), a national retailer of music CDs and DVDs. The following misstatements in the financial statements have not been corrected by management:

1. Vibe purchased a large number of CDs featuring the music of an international artist, DJ Kite, who was due for a concert tour in South Africa in March 2021. However, the tour was cancelled after DJ Kite was part of a scandal involving him abusing his girlfriend. A public outcry followed with fans protesting and boycotting his music. Audit evidence suggests that Vibes inventory consisting of DJ Kites CDs at 28 February 2021 should be valued at R500 000 at year-end, instead of the recorded value of R750 000. This is based on the calculation by Vibes sales departments which show that the CDs will not sell if they are not sold below cost.

2. In February 2021, Vibe was sued by a customer for R500 000 in damages when the facility that allows customers to preview music malfunctioned: the volume of the music automatically rose so high that the customer experienced a degree of hearing loss. The companys legal representative indicated to the audit team that at year-end it was highly likely that the aggrieved customer would be successful in his lawsuit. The management of Vibe has not recorded any provision or made any disclosure in the 2021 financial statements regarding the lawsuit.

3. Inspection of the bank statement for April 2021 revealed a payment of R150 000 was made by Vibe to a supplier for inventory recorded as assets (and a creditor was raised) at 28 February 2021. Further investigation showed that the GRN generated for the inventory was signed and dated 3 March 2021.

The final materiality for Vibes 2021 audit is R350 000.

You are required to:

4.1 Discuss the materiality and the nature of the above misstatements, both separately and on aggregate. (8)

4.2 Assuming that management will correct misstatements 1 and 3, but not misstatement 2, discuss the effect that misstatement 2 will have on the audit report to be issued for the 2021 financial statements of Vibe. (2)

QUESTION 5 (15 marks)

You are an audit manager at KUZ Auditors. The information below relates to two unrelated audit clients of KUZ. The audit senior asked you to assist.

Company 1 Saldanha Pest Control (Pty) Ltd

Saldanha Pest Control (Pty) Ltd (Saldanha Pest Control) is currently involved in discussion to have its controlling interest acquired by Western Cape Pest Control (Pty) Ltd (Western Cape Pest Control). Saldanha Pest Control is one of the largest pest control companies in the West Coast and has a year-end at 31 December 2020. Western Cape Pest Control indicated that it would be relying on the financial statements when making its decision. Ms Mmola, the chief operating officer of Saldanha Pest Control has indicated she would like to submit the financial statements to Western Cape Pest Control on 28 January 2021 so that they can finalise the acquisition by middle February 2021.

As another matter, Mr Shabangu, the chief executive officer resigned on 29 January 2021. He indicated his decision was based on him wanting to spend more quality time with his family. Mr Shabangu is entitled to receive two months worth of untaken leave, that equals R200 000, when he officially leaved the company. You were informed about Mr Shabangus resignation on 30 January 2021.

The final materiality figure for the audit is R150 000.

Company 2 Spec Frames (Pty) Ltd

Spec Frames (Pty) Ltd (Spec Frames) assembles and distributes digital photo frames from the warehouse located in Observatory and has a December year-end.

The company sold a large portion of its inventory at a value below the cost of the inventory during the month of January. A second-year audit trainee enquired of the chief financial officer (CFO) on 1 February if this was an indication that the inventory was valued at an amount above the net realisable value (over evaluation) at year-end. The CFO responded by saying that such a question was a clear indication that the auditors did not know what they were doing and that he would make sure they are not re-appointed for future audits. The audit trainee has indicated that she believes inventory is overstated by R650 000 at year-end.

The final materiality figure for the audit is R600 000.

You are required to:

5.1 Discuss the impact of the information noted above on the financial statements of each of your clients for the respective financial years under review and the appropriate audit responses in reaction to the relevant information provided. (15)

QUESTION 6 (20 marks)

You are the audit manager on the 31 December 2020 statutory audit of Excel Education (Ltd) (Excel Education), an unlisted national company providing private schooling services. Based on the conclusions reached from the audit evidence obtained, an unqualified audit opinion is to be expressed on the financial statements. A reportable irregularity did exist, in that the directors knowingly held back returns from SARS relating to VAT on account of cash flow constraints.

The reportable irregularity was reported to the Independent Regulatory Board for Auditors. No material misstatement to the financial statements resulted.

A junior trainee accountant on the audit, who requested an opportunity to draft the audit report to expand the understanding of the reporting phase of the audit, has submitted the following audit report set out below:

You are required to:

6.1 With reference to the report of the External Auditor set out below, indicate the errors in, and omissions from, the draft 2020 audit report of Excel Education Ltd submitted by the junior trainee accountant. For each error/omission identified describe the appropriate treatment. A rewrite of any particular paragraph is not required. (20)

REPORT OF THE EXTERNAL AUDITOR

To the board of directors of Excel Education Ltd

We have audited the financial statements of Excel Education Ltd as set out in the annual report, which statements comprise the statement of financial position as at 31 December 2020, the statement of comprehensive income, the statement of changes in equity and the statement of cash flows for the year then ended.

Directors responsibility for the financial statements

The companys 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

such internal control as the directors deems necessary in order to enable the preparation of financial statements free from material misstatement, whether as a result of fraud or error.

The auditor hereby does not accept any responsibility for either the fair presentation of the financial statements or the effectiveness of internal controls.

Basis for unqualified opinion

As a result of the sufficient appropriate audit evidence obtained, there was no reason to modify the audit opinion. A clean audit report is therefore issued.

Unqualified opinion

In our opinion, the financial statements present, fairly, in all material respects, the financial position of Excel Education Ltd as at 31 December 2020, as well as its financial performance and cash flows for the year ended in accordance with International Financial Reporting Standards and the requirements of the Companies Act of South Africa.

Emphasis of matter

The International Standards on Auditing require to us to alert users of the financial statements where any form of non-compliance with laws and regulations have occurred. We hereby emphasise the fact that a reportable irregularity took place, in that the board of directors did knowingly hold back returns from the South African Revenue Service relating to value-added tax in contravention of the Value Added Tax 89 of 1991.

Auditors signature

ABC Incorporated

Registered Auditors

Per: S Dlamini CA(SA) RA: Director

31 Main Street

Observatory

QUESTION 7 (15 marks)

You are a trainee accountant assigned to the audit of Baldwin City College Ltd (BCC). The financial year being audited ends 31 October 2021 and you have been allocated the task of auditing the balance relating to vehicle assets as disclosed in BCCs financial statements.

BCC is a large private institution that offers tertiary education to several thousand students across three campuses. BCC has a fleet of vehicles it owns, used for transport of staff, students, security officers and for office travel.

The balance for vehicle assets is reflected in the trial balance as follows:

2021

2020

Vehicles

R9 500 000

R11 250 000

During the 2021 financial year, the company acquired three new minibuses, each at a cost of R450 000. At year-end BCC owned 40 vehicles in total that are recorded in the fixed asset register. Details in the fixed asset register include:

Registration and Licensing numbers

Descriptions

Acquisition and disposal dates

Accounting values

BCC insured the assets at Sambam, an insurance company.

Each campus has a facilities management division where vehicles are cleaned and kept and where staff authorised to use the vehicles can sign the use of vehicles in and out. At any point some vehicles might not be on the campus for example if they have been signed out to use for a period.

Some vehicles may also be off-campus at vehicle servicing and repair shop, undergoing routine maintenance, or having faults that have been discovered, or being repaired after an accident.

According to a report by the main campuss facilities manager, one vehicle sustained severe damage in an accident during the 2021 financial year but is still listed on the fixed asset register. The manager confirmed the accident was reported to Sanbam and that a response from the insurer was sent to the finance department.

According to BCCs accounting policy disclosed in its prior year audited financial statements, its accounts for all its assets on the cost model. Carrying value is arrived by subtracting amortisation (at 20% straight-line per year) and any impairment losses.

You are required to:

7.1 Describe the substantive audit procedures that should be performed to verify the fair presentation of the balance relating to vehicle assets included in the financial statement of BCC Ltd. (15)