READ THE CASE STUDY BELOW AND ANSWER THE QUESTIONS THAT FOLLOW: You are the audit senior at NewPoint Incorporated ("New Point), a medium-sized audit firm located in the Gauteng. The firm has recently been expanding and operates in Gauteng, Kwa-Zulu Natal and has recently opened a satellite office in Cape Town. The firm has 70 trainees across all locations and currently employs 6 directors. The expansion of the firm was required due to anticipating new client wins as a result of mandatory audit firm rotation. Your firm was recently appointed as the external auditors of ChemCo Limited ("ChemCo") for the financial year ended 31 December 2020. ChemCo is a large chemical manufacturing group listed on the Johannesburg Stock Exchange which has two wholly owned subsidiaries, ChloroCo, which is a chemical manufacturing entity which has its manufacturing plant in Gauteng and various distribution and warehouses in each province across South Africa and ChemTech which is the research and development hub situated in Kwa-Zulu Natal. The appointment of NewPoint as external auditors of ChemCo came as a shock to the profession and inspired other small and medium audit firms as the previous external auditors were one of the Big 4" which had been their external auditors for numerous years. Your firm was appointed at the beginning of June 2020 by the board of directors with the approval of shareholders at a special shareholders meeting scheduled at the request of the CEO, Mr Clive Milligan. ChemCo had approved Mr KZ Gumede as the independent auditor representing NewPoint who will sign off on the group and statutory audit opinions for the group and its subsidiaries as he was part of the proposal pitch to ChemCo and was recommended by the CFO, Mrs Nabeela Amod CA (SA) as she previously did her articles internship with Mr Gumede many years ago. Mr Gumede is one of the newly appointed directors at NewPoint and became director on 1 January 2020. Mr Gumede has 10 years of audit experience and mainly specializes in family owned businesses and retail entity audits. As the other directors did not have capacity to take on the ChemCo audit, Mr Gumede was more than happy to take on ChemCo as this would be good exposure for his career as a director and will be the first audit he will sign off an audit opinion. The engagement letter for the audit was signed on 4 June 2020. The half year review deadline is 15 July 2021 and the year end financial statement audit deadline is 25 January 2021. These tight reporting deadlines are non- negotiable as ChemCo is listed and need to report to the JSE. Additionally, in the current year the CEO was assertive that the deadline needs to be met as the banks additionally require the financial statements in order to assess ChemCo for further funding and overdraft extension in the new year. . Opening balances and inquiries with management Based on inquiries with management the following was noted in relation to opening balances and other discussions in the transition for NewPoint taking over as external auditors: Mr KZ Gumede held discussions with the predecessor auditor regarding taking over the audit of ChemCo and noted that no threats or issues will prevent NewPoint from taking over as external auditors. However, no formal letter or document was signed by the predecessor auditor to attest to this fact. Mr Gumede advised you that you do not need to worry about the documentation around this as he would complete the required documents and place on file. The previous auditors were not available to perform a handover and do opening balance procedures as they had no available time however ChemCo advised that they had copies of all the predecessor auditor working papers and can provide these together with the audited trial balances and financial statements to NewPoint upon their request. The board of directors did not provide sufficient reasoning and commentary as to why the predecessor auditor was removed and whether this was done in a legal manner. The CEO just commented that the relationship had reached its end and it was about time the entity changed auditors and if he had his way they would have changed a long time ago. The CEO, Mr Clive Milligan advised you that the main reason for the appointment of NewPoint as external auditors was the audit fee R1,1 million as opposed to R4,5 million which was paid to the previous auditors for the 31 December 2019 audit During your conversations with the CFO you noted that there was a question raised from shareholders about the fact that Mr Gumede's father held shares in ChemCo however these only amounted to 0,5% of the total shares in issue on the stock exchange. The board determined that this was not material and would not affect the appointment of New Point as auditors During April 2020 there was a media article which showed that ChemTech had infringed on patents held by a competitor for their new Chemical X which is to be launched in November 2020 however this matter is still on-going and the litigation process has started but there is no conclusion on this matter yet. Media critics and industry experts have done research and do not see ChemTech winning this case however the board is adamant that there was no infringement and the case will be settled and closed in the next few weeks. The CFO advised that there is a provision raised in the books of ChemTech should this process be long and drawn out. . Group activities- current year Board and management The board of directors for ChemCo also serve as the board of directors at the ChloroCo and ChemTech. The CEO is of the belief that if there are multiple sets of directors at each level that it would cause confusion and disconnect in the decision-making process at the subsidiary level and group level. There is currently no audit committee and other decision- making board as this would affect the funds available to pay director remuneration at the executive level. Each entity in the group has its own finance department which is responsible for invoicing, processing and record keeping. Each of the entities financial managers report up to Mrs N Amod, the CFO, who then consolidates the subsidiary results each month. The financial managers at each entity are all competent and qualified chartered accountants however during the year the financial manager at ChemTech contracted COVID-19 and passed on a few weeks after. Since then, there has been no replacement and the financial manager of ChloroCo is performing both entities financial records since May 2020. The financial manager at ChloroCo has 2 years of experience as the financial manager of ChloroCo but does not have much experience relating to research and development at ChemTech. When the CFO raised the concerns to the CEO about this he was quite disappointed and questioned the CFO as to whether she wanted her bonus reduced in order to pay for the additional resource. Financial statements are prepared in accordance with the Companies Act of South Africa and International Financial Reporting Standards. As the entity is listed on the JSE they are also required to comply with the JSE rules and regulations. Operational ChemTech cyberattack Shortly after taking over from the previous financial manager at ChemTech there was a cyber attack on ChemTech's main servers and confidential information relating to current and previous projects were copied. Management also noted that the costing model and financial records for May and June were lost. This directly impacted the intangible asset data and cost capitalization modules in the ERP (SAP Hana) which is a key performance driver for management at ChemTech for performance bonuses. ChemCo has an IT department at the group level and the team has been performing disaster recovery procedures in order to secure the breach. Based on our inquiries with IT there was no formal disaster recovery plan approved and the draft was sitting with the Board for final approval. Employees at ChemTech are assisting the finance team to reconstruct the general ledger and related accounts using approved calculations and hard-copy invoices however this has been a tedious process. The CFO is not confident that the information will be ready for the half year review. Half year inventory count ChloroCo has the only inventory balance in the group as it is the operational entity which manufactures chemicals based on designs patented at ChemTech. Inventory is material and consists of both manufactured inventory and consignment inventory from its foreign supplier Chemicals LLP for which inventory is only recognized once consumed into the manufacturing process. Each month a reconciliation is performed by the inventory manager and the financial manager to determine the amount utilized in the production process. This is reviewed by the CFO on a monthly basis and confirmed by Chemicals LLP. Management at ChloroCo do not have a documented stock count process however these counts have been done every year and staff perform the count on the planning meeting held before each count. This is led by each inventory manager at the various locations who issue instructions based on their experience in the company. Audit team inventory approach Inventory count Ahead of the year end count Mr Gumede has requested the audit team to attend the half year count being held at 30 June 2020 in order to test inventory at the interim period and obtain comfort over the quantity of manufactured and consignment inventory ahead of the year end audit. Based on the group scoping performed by the manager 5 locations across the country (distribution and warehouse centres) will be counted. The audit manager has planned staff to go out for these counts however due to resource constraints at the firm only 4 locations will be attended by the audit team. Inventory costing Based on your discussions with the financial manager and inventory managers at ChloroCo you have determined that the entity uses a weighted average costing system in order to determine the cost of inventory per product. You also noted that this process includes the purchase of raw materials and cost of labour from the hours worked by the employees in the manufacturing process. Manufactured chemicals are filled in 100L containers and the ratio of raw materials consumed and labour costs required vary from product to product. You have held discussions with the audit manager and partner in order to determine the use of specialists on the audit to assist in testing the costing module to ensure that the system is calculating inventory correctly and he indicated that there was no budget. The audit manager suggested selecting a sample of products and substantively testing the costing at half year in order to reduce the extent of procedures to be performed at year end. You obtained the inventory listing on the day of the count and sampled the following two products and obtained managements costing as at 30 June 2020. 1) INV2020A1B1- ChemAZ Prepared by: Financial manager ChloroCo Date: 30 June 2020 ChemAZ Cost QTY (L) Value per (ZAR) Notes 100L 9 250 15 000 1 387 500 Opening balance 1 January 2020 Total raw materials used 750 000 Note 1 650 500 Note 2 Labour costs (including engineer overtime) Consumables used 25 000 Note 3 Closing balance 30 June 2020 8 750 22 500 2 813 000 Notes Note 1 There are two raw materials used to produce ChemAZ one is locally sourced from Direct Powder, which is measured per tonne and for the 6 month period ChloroCo purchased 15 500 tonnes at R19,80 per tonne. The second raw material is sourced from a foreign supplier AniEx GmBH which is based on the average monthly USD/ZAR rate. Management has indicated that they have used R18,95 as their 6 month average and this was applied to 3 invoices received from AniEx GmBH being ChCo2819, ChCo3342 and ChCo3786. Note 2 These costs relate to 4 plant mixers, 3 refiners, 2 supervisors and the chemical engineer costs for the 6 month period. Plant mixers and refiners are remunerated on an hourly basis and do not work more than 40 hours a week and if there is overtime required to meet production levels these are signed off by any of the 3 supervisors and the chemical engineer. Wage employees are paid via EFT however payslips are physically printed and collected by employees at the admin office. An electronic copy is maintained for each pay run and the weekly payroll run has been provided for each month from January to June 2020 as part of the reconciliation provided. The supervisor and chemical engineer are remunerated on a monthly basis based on the signed cost to company employment contract. They receive their salary via bank EFT and payslips are provided electronically via email notification after payroll processing is performed. Supervisors and chemical engineers do not get overtime unless this is special circumstances and is approved by the CFO. Part of the supporting information provided you noted management has provided you with the payroll run for each month from January to June 2020 as part of the reconciliation provided above. Management have indicated that payslips are available on request by the audit team. Note 3 Consumables used relate to packaging, labelling used to secure and identify the finished completed chemical and based on our inquiries with the financial accountant it is noted that these costs are expensed directly to the income statement on a monthly basis upon receipt of the supporting invoice. 2) INV2020A3F4- Chlobyrl Based on your discussions with the financial manager there was no final calculation kept and this could not be provided to the auditors. Management are using available resources to source out the calculation however this calculation was never sampled by the predecessor auditor so a calculation was never prepared. Based on your inspection of the general ledger and trial balance you had noted that the total value of this inventory item was R12 million and one of the more popular chemicals sold by ChloroCo. QUESTION TWO [21] Based on the case study above, identify the risk of material misstatement at the financial statement level for ChemCo Limited and its subsidiaries and recommend appropriate responses to address these financial statement risks. READ THE CASE STUDY BELOW AND ANSWER THE QUESTIONS THAT FOLLOW: You are the audit senior at NewPoint Incorporated ("New Point), a medium-sized audit firm located in the Gauteng. The firm has recently been expanding and operates in Gauteng, Kwa-Zulu Natal and has recently opened a satellite office in Cape Town. The firm has 70 trainees across all locations and currently employs 6 directors. The expansion of the firm was required due to anticipating new client wins as a result of mandatory audit firm rotation. Your firm was recently appointed as the external auditors of ChemCo Limited ("ChemCo") for the financial year ended 31 December 2020. ChemCo is a large chemical manufacturing group listed on the Johannesburg Stock Exchange which has two wholly owned subsidiaries, ChloroCo, which is a chemical manufacturing entity which has its manufacturing plant in Gauteng and various distribution and warehouses in each province across South Africa and ChemTech which is the research and development hub situated in Kwa-Zulu Natal. The appointment of NewPoint as external auditors of ChemCo came as a shock to the profession and inspired other small and medium audit firms as the previous external auditors were one of the Big 4" which had been their external auditors for numerous years. Your firm was appointed at the beginning of June 2020 by the board of directors with the approval of shareholders at a special shareholders meeting scheduled at the request of the CEO, Mr Clive Milligan. ChemCo had approved Mr KZ Gumede as the independent auditor representing NewPoint who will sign off on the group and statutory audit opinions for the group and its subsidiaries as he was part of the proposal pitch to ChemCo and was recommended by the CFO, Mrs Nabeela Amod CA (SA) as she previously did her articles internship with Mr Gumede many years ago. Mr Gumede is one of the newly appointed directors at NewPoint and became director on 1 January 2020. Mr Gumede has 10 years of audit experience and mainly specializes in family owned businesses and retail entity audits. As the other directors did not have capacity to take on the ChemCo audit, Mr Gumede was more than happy to take on ChemCo as this would be good exposure for his career as a director and will be the first audit he will sign off an audit opinion. The engagement letter for the audit was signed on 4 June 2020. The half year review deadline is 15 July 2021 and the year end financial statement audit deadline is 25 January 2021. These tight reporting deadlines are non- negotiable as ChemCo is listed and need to report to the JSE. Additionally, in the current year the CEO was assertive that the deadline needs to be met as the banks additionally require the financial statements in order to assess ChemCo for further funding and overdraft extension in the new year. . Opening balances and inquiries with management Based on inquiries with management the following was noted in relation to opening balances and other discussions in the transition for NewPoint taking over as external auditors: Mr KZ Gumede held discussions with the predecessor auditor regarding taking over the audit of ChemCo and noted that no threats or issues will prevent NewPoint from taking over as external auditors. However, no formal letter or document was signed by the predecessor auditor to attest to this fact. Mr Gumede advised you that you do not need to worry about the documentation around this as he would complete the required documents and place on file. The previous auditors were not available to perform a handover and do opening balance procedures as they had no available time however ChemCo advised that they had copies of all the predecessor auditor working papers and can provide these together with the audited trial balances and financial statements to NewPoint upon their request. The board of directors did not provide sufficient reasoning and commentary as to why the predecessor auditor was removed and whether this was done in a legal manner. The CEO just commented that the relationship had reached its end and it was about time the entity changed auditors and if he had his way they would have changed a long time ago. The CEO, Mr Clive Milligan advised you that the main reason for the appointment of NewPoint as external auditors was the audit fee R1,1 million as opposed to R4,5 million which was paid to the previous auditors for the 31 December 2019 audit During your conversations with the CFO you noted that there was a question raised from shareholders about the fact that Mr Gumede's father held shares in ChemCo however these only amounted to 0,5% of the total shares in issue on the stock exchange. The board determined that this was not material and would not affect the appointment of New Point as auditors During April 2020 there was a media article which showed that ChemTech had infringed on patents held by a competitor for their new Chemical X which is to be launched in November 2020 however this matter is still on-going and the litigation process has started but there is no conclusion on this matter yet. Media critics and industry experts have done research and do not see ChemTech winning this case however the board is adamant that there was no infringement and the case will be settled and closed in the next few weeks. The CFO advised that there is a provision raised in the books of ChemTech should this process be long and drawn out. . Group activities- current year Board and management The board of directors for ChemCo also serve as the board of directors at the ChloroCo and ChemTech. The CEO is of the belief that if there are multiple sets of directors at each level that it would cause confusion and disconnect in the decision-making process at the subsidiary level and group level. There is currently no audit committee and other decision- making board as this would affect the funds available to pay director remuneration at the executive level. Each entity in the group has its own finance department which is responsible for invoicing, processing and record keeping. Each of the entities financial managers report up to Mrs N Amod, the CFO, who then consolidates the subsidiary results each month. The financial managers at each entity are all competent and qualified chartered accountants however during the year the financial manager at ChemTech contracted COVID-19 and passed on a few weeks after. Since then, there has been no replacement and the financial manager of ChloroCo is performing both entities financial records since May 2020. The financial manager at ChloroCo has 2 years of experience as the financial manager of ChloroCo but does not have much experience relating to research and development at ChemTech. When the CFO raised the concerns to the CEO about this he was quite disappointed and questioned the CFO as to whether she wanted her bonus reduced in order to pay for the additional resource. Financial statements are prepared in accordance with the Companies Act of South Africa and International Financial Reporting Standards. As the entity is listed on the JSE they are also required to comply with the JSE rules and regulations. Operational ChemTech cyberattack Shortly after taking over from the previous financial manager at ChemTech there was a cyber attack on ChemTech's main servers and confidential information relating to current and previous projects were copied. Management also noted that the costing model and financial records for May and June were lost. This directly impacted the intangible asset data and cost capitalization modules in the ERP (SAP Hana) which is a key performance driver for management at ChemTech for performance bonuses. ChemCo has an IT department at the group level and the team has been performing disaster recovery procedures in order to secure the breach. Based on our inquiries with IT there was no formal disaster recovery plan approved and the draft was sitting with the Board for final approval. Employees at ChemTech are assisting the finance team to reconstruct the general ledger and related accounts using approved calculations and hard-copy invoices however this has been a tedious process. The CFO is not confident that the information will be ready for the half year review. Half year inventory count ChloroCo has the only inventory balance in the group as it is the operational entity which manufactures chemicals based on designs patented at ChemTech. Inventory is material and consists of both manufactured inventory and consignment inventory from its foreign supplier Chemicals LLP for which inventory is only recognized once consumed into the manufacturing process. Each month a reconciliation is performed by the inventory manager and the financial manager to determine the amount utilized in the production process. This is reviewed by the CFO on a monthly basis and confirmed by Chemicals LLP. Management at ChloroCo do not have a documented stock count process however these counts have been done every year and staff perform the count on the planning meeting held before each count. This is led by each inventory manager at the various locations who issue instructions based on their experience in the company. Audit team inventory approach Inventory count Ahead of the year end count Mr Gumede has requested the audit team to attend the half year count being held at 30 June 2020 in order to test inventory at the interim period and obtain comfort over the quantity of manufactured and consignment inventory ahead of the year end audit. Based on the group scoping performed by the manager 5 locations across the country (distribution and warehouse centres) will be counted. The audit manager has planned staff to go out for these counts however due to resource constraints at the firm only 4 locations will be attended by the audit team. Inventory costing Based on your discussions with the financial manager and inventory managers at ChloroCo you have determined that the entity uses a weighted average costing system in order to determine the cost of inventory per product. You also noted that this process includes the purchase of raw materials and cost of labour from the hours worked by the employees in the manufacturing process. Manufactured chemicals are filled in 100L containers and the ratio of raw materials consumed and labour costs required vary from product to product. You have held discussions with the audit manager and partner in order to determine the use of specialists on the audit to assist in testing the costing module to ensure that the system is calculating inventory correctly and he indicated that there was no budget. The audit manager suggested selecting a sample of products and substantively testing the costing at half year in order to reduce the extent of procedures to be performed at year end. You obtained the inventory listing on the day of the count and sampled the following two products and obtained managements costing as at 30 June 2020. 1) INV2020A1B1- ChemAZ Prepared by: Financial manager ChloroCo Date: 30 June 2020 ChemAZ Cost QTY (L) Value per (ZAR) Notes 100L 9 250 15 000 1 387 500 Opening balance 1 January 2020 Total raw materials used 750 000 Note 1 650 500 Note 2 Labour costs (including engineer overtime) Consumables used 25 000 Note 3 Closing balance 30 June 2020 8 750 22 500 2 813 000 Notes Note 1 There are two raw materials used to produce ChemAZ one is locally sourced from Direct Powder, which is measured per tonne and for the 6 month period ChloroCo purchased 15 500 tonnes at R19,80 per tonne. The second raw material is sourced from a foreign supplier AniEx GmBH which is based on the average monthly USD/ZAR rate. Management has indicated that they have used R18,95 as their 6 month average and this was applied to 3 invoices received from AniEx GmBH being ChCo2819, ChCo3342 and ChCo3786. Note 2 These costs relate to 4 plant mixers, 3 refiners, 2 supervisors and the chemical engineer costs for the 6 month period. Plant mixers and refiners are remunerated on an hourly basis and do not work more than 40 hours a week and if there is overtime required to meet production levels these are signed off by any of the 3 supervisors and the chemical engineer. Wage employees are paid via EFT however payslips are physically printed and collected by employees at the admin office. An electronic copy is maintained for each pay run and the weekly payroll run has been provided for each month from January to June 2020 as part of the reconciliation provided. The supervisor and chemical engineer are remunerated on a monthly basis based on the signed cost to company employment contract. They receive their salary via bank EFT and payslips are provided electronically via email notification after payroll processing is performed. Supervisors and chemical engineers do not get overtime unless this is special circumstances and is approved by the CFO. Part of the supporting information provided you noted management has provided you with the payroll run for each month from January to June 2020 as part of the reconciliation provided above. Management have indicated that payslips are available on request by the audit team. Note 3 Consumables used relate to packaging, labelling used to secure and identify the finished completed chemical and based on our inquiries with the financial accountant it is noted that these costs are expensed directly to the income statement on a monthly basis upon receipt of the supporting invoice. 2) INV2020A3F4- Chlobyrl Based on your discussions with the financial manager there was no final calculation kept and this could not be provided to the auditors. Management are using available resources to source out the calculation however this calculation was never sampled by the predecessor auditor so a calculation was never prepared. Based on your inspection of the general ledger and trial balance you had noted that the total value of this inventory item was R12 million and one of the more popular chemicals sold by ChloroCo. QUESTION TWO [21] Based on the case study above, identify the risk of material misstatement at the financial statement level for ChemCo Limited and its subsidiaries and recommend appropriate responses to address these financial statement risks