QUESTION $2$

$(20$ Marks$)$

Your firm has been appointed for the first time as auditors of Alphachem $($Pty$)$ Ltd$,$ a medium sized company which manufactures chemical products. Alphachem $($Pty$)$ Ltd and its directors are well thought of in the industry for their integrity and efficient management of the business. The previous audit firm had, after a long association with the company, resigned from the audit as the partner in charge of the audit had retired. The remaining partners were not satisfied that they could service Alphachem $($Pty$)$ Ltd adequately due to the overall complexity of the business. Your firm's appointment came about as a result of the fact that one of your firm's partners, Megan Martin, is married to Michael Martin the production director of Alphachem $($Pty$)$ Ltd$.$ You have been assigned early in February to the audit for the financial year$-$end $31$ March $2018$ to assist in the evaluation of the risk of material misstatement, and have gathered the following information.

The shares in the company are held by a number of private individuals; none of the directors own shares in the company but they each receive an annual bonus based on the after tax profit for the year.

Alphachem $($Pty$)$ Ltd is located in an industrial park near the Durban harbour. The administration block, manufacturing plant, warehouses and other storage facilities are situated on the same site.

The company imports raw materials from a number of countries as well as purchasing from local suppliers. Some of the chemicals imported by Alphachem $($Pty$)$ Ltd take a number of weeks to pass through the Durban harbour as they must be tested by the port authority for authenticity and quality before they can be cleared through customs. During the testing period they are stored at the harbour. Raw materials can be in the form of gas, paste, powder or liquid and range considerably in price. Raw materials $($and some finished goods$)$ are stored in huge tanks $($liquids$)$ or in canisters $($gasses$)$ and plastic bins $($pastes and powders$)$ in one of three bulk storage warehouses. Once manufactured, most of the products are stored in a temperature controlled warehouse.

Alphachem $($Pty$)$ Ltd manufactures a wide but standard range of products in its processing plant. Many of the manufacturing processes are complex particularly where raw material chemicals are refined or mixed and must pass through multiple processes.

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Besides manufacturing its own range of products, Alphachem $($Pty$)$ Ltd manufactures pills under licence on behalf of a number of pharmaceutical companies. These companies supply Alphachem $($Pty$)$ Ltd with the necessary refined chemical raw materials which are then processed by Alphachem $($Pty$)$ Ltd$.$ The finished goods $($pills$)$ are then stored in bulk by Alphachem $($Pty$)$ Ltd in its temperature controlled warehouse before being dispatched to the pharmaceutical companies. Alphachem $($Pty$)$ Ltd charges a processing and storage fee for this service.

It is anticipated that at $31$ March $2018,$ inventory in the statement of financial position will be reflected at approximately R$48$ million. It is also anticipated that it will make up $65\%$ of current assets and will be broken down as follows:

a$.$ Raw materials : R$16$ million

b$.$ Work$-$in$-$Progress : R$12$ million

c$.$ Finished Goods : R$20$ million

Alphachem $($Pty$)$ Ltd has agreed that you may engage a chemical engineer to assist you in your audit of inventory $($as well as any other aspects of the business$)$ should you deem it necessary. The previous auditors had engaged Frans Fredericks, an independent consultant, to assist them with the audit, but he is no longer available as he has recently joined a large international chemical company on a full$-$time basis. Your firm has decided to approach Jason Ladd, a Durban based chemical engineer to assist with the audit of inventory.

REQUIRED

$2\mathrm{.}1$ Discuss the matters your firm would have considered prior to accepting this engagement.

$(10$ marks$)$

$2\mathrm{.}2$ Explain the term significant risk and comment on whether there are any significant risks for the $31$ March $2018$ audit of Alphachem $($Pty$)$ Ltd$.$

$(5$ marks$)$

$2\mathrm{.}3$ Comment on whether the fact that this is our first audit has any effect on audit risk relating to the $2018$ audit of Alphachem $($Pty$)$ Ltd$.$

$(5$ marks$)$