Revenue and receipts cycle

Khulula (Pty) Ltd (Khulula) is a South African company that is primarily involved in the manufacturing and selling of clothes. The company has a financial year ending on 28 February 2023. Khulula was previously selling only to the wholesales however, new developments came to sell clothes in retail outlets as well. At the 2022 annual general meeting of Khulula (Pty) Ltd (Khulula) your firm was appointed as the companys registered auditors. A few weeks later Mr Adidas, the majority shareholder, who up until that point, was the managing director and holder of 60% of the issued shares of Khulula (Pty) Ltd, made a surprise announcement that he would be emigrating and that he had just sold all his shares to Nxiba Sports (Pty) Ltd, a subsidiary of a company of a company listed on JSE. In March 2023 Mr. Puma was nominated by Nxiba Sports (Pty) Ltd and duly appointed as Khululas new managing director. Mr. Puma is politically well connected and played a major role in persuading the Department of Trade and Industry to introduce quotas for imports of clothing from China. He has undertaken to use his influence on lobby for expanding the scope of the quotas. Mr. Puma decided that the business model of Khulula had to be changed as a matter of urgency to focus on retail as well and not just the wholesalers. Accordingly, by the end of August 2023, Khulula had already opened nine retail stores in shopping centres in five provinces across the country to sell the Team One Bester Dr branded sportsware directly to the public. Sales are made for cash or on credit. Branch managers are given full autonomy to run the retail outlets, hence they make decisions on the nature and quantities of inventory to be ordered from the Khulula factory and the credit terms that are granted to customers. This is consistent with Mr. Pumas belief that a decentralized management style, with generous rewards and demotion for failure, is effective. All retail outlets have dedicated lines connecting their point-of-sale (POS) systems to Khulula (Pty) Ltds central server. This enables all transactions to be captured and processed on an online real-time basis. The responsibility for the design and implementation of the network, as well as for making the programme changes required, was outsourced to a small computer firm, Bits and Bytes. Mr. Puma insisted on the appointment of Bits and Bytes in preference to other companies with better skills and more experience. Further investigation revealed that Bits and Bytes is owned and operated by Mr. Pumas uncle, and that the firm urgently needed the business. Long term lease agreements have been entered into with the property administrators of shopping centres from which the retail outlets operate. All equipment used in the retail outlets is leased from Leasehold CC, a close corporation owned jointly by Khulula (Pty) Ltds financial director and operations manager. Due to cash flow difficulties experienced by Nxiba Sports (Pty) Ltd during July 2023, the board of Khulula approved an interest-bearing loan of R10 Million to Nxiba Sports (Pty) Ltd, repayable within 24 months. However, during September 2023 the board of Khulula (Pty) Ltd approved a subordination agreement in respect of this loan. The subordination agreement will be effective for a period of two years.

Khulula has the following internal controls activities.

Cash sales in the retail

The customer selects item from the shelves and the salesperson scan item, then the accounting system generates total sales. The customer makes a cash payment, and then salesperson gives a charge. The accounting system generates a receipt and salesperson gives a customer a receipt; and Then the accounting system updates the general ledger. Credit sales in the retail Khulula has the branch manager the duties to perform credit assessment and final approval of credit to the customers. The branch managers perform credit checks on a potential client by looking at the latest salary advice, three months bank statement, ID Copy, proof of residential and work address. The branch managers are not running an ITC Credit Check as part of application process per the instruction of Mr. Puma, as he believes it is a waste of time. The company is having a finance manager and the general manager, however for reviews of retail credits, all the powers given to the branch managers, as Mr. Puma instructed them to focus more on wholesale sales and their personal businesses that are also supplied by Khulula. When the debtor exceeds their payment terms, the system automatically puts a hold on the debtors account which prevents the debtor from making any further purchases. When customers reached their granted credit limit, they are allowed to increase their credit limit via the store app to up to 50% of the previous approved limit without having to submit any further documents. This happens once in every 12 months period, however if the customer is already in arrears, the system will automatically decline the increase in credit limit.

Wholesale sales

The customer places an order via website, the salesperson check credit limit, if the customer is within the limit, then the salesperson send the customer order to General Manager for approval. But if the sales order exceeds R50 000, the order is sent to finance manager for approval. If the order is approved by General Manager/Finance Manager, the sale is processed, and the system print the order details and pick list. The customer collects item/items ordered at the warehouse after the warehouse clerk has matched items per customer order to the pick list. If the customer selected the delivery option at the warehouse, then the customer signs only when the goods are arrived at the customer premises.

For auditing to you are required to:

i. Discuss the key factors that you would consider prior to your commencement of the audit as a direct result of the change in Khulula (Pty) Ltds majority shareholder.

ii. Use relevant scenario to act out how the developments during the 2023 financial year will affect your assessment of the risk of material misstatement in the 2023 financial statements of Khulula (Pty) Ltd. Your assessment should include understanding the system of internal controls and communicating deficiencies identified with recommendations.

iii. And design appropriate responses to the assessed risk pertaining to the revenue cycle of Khulula (Pty) Ltd as well as overall financial statement level .