You are the audit manager in the audit firm of M&G Partners Chartered Accountants. One of your audit clients is Fair Leather Zambia Ltd (FLZ Ltd) which specializes in the manufacture and supply of various leather products.
FLZ Ltd have been your audit client for five years and you have been audit manager for the past three years while the audit partner has remained unchanged. You are now planning the audit for the year ending 31 December 2019. Following an initial meeting with the directors of FLZ Ltd, you have obtained the following information:
(i) FLZ Ltd is attempting to obtain a listing on Lusaka Stock Exchange. Information on the listing is not yet public knowledge.
(ii) You have been asked to continue to prepare the company’s financial statements as in previous years.
(iii) As the company’s auditors, FLZ Ltd would like you and the audit partner to attend an evening reception at Intercontinental Hotel,
where FLZ Ltd will present their listing arrangements to banks and existing major shareholders.
(iv) FLZ Ltd has indicated that the fee for taxation services rendered in the year to 31 December 2017 will be paid as soon as the Zambia. Revenue
Authority have agreed the company’s taxation liability. You have been advising FLZ Ltd regarding the legality of certain items as ‘allowable’
for taxation purposes and the ZRA are disputing these items. Finally, you have just inherited about 5% of FLZ Ltd share capital as an
inheritance on the death of a distant relative.
Fair Leather Zambia Ltd (FLZ Ltd) manufactures and distributes leather shoes, coats, belts and motor vehicle leather seat covers to both wholesale and retail customers. Fair leather has been trading for over 30 years and is well known for its high quality and durable leather products. FLZ Ltd operates from one central site in Lusaka, which includes the production facility, warehouse and administration offices.
FLZ Ltd sells 60% of its goods to large home chain stores, however the company has just won a tender to be the sole supplier of working boots to Brilliant Gems Mining Group PLC.(BGMG plc). It has secured the contract through significantly reducing prices and offering a four-month credit period, from the company’s normal credit period of one month. FLZ Ltd has reduced the level of goods directly manufactured and instead started to import most of its products from China. Approximately 70% is imported and 30% manufactured. Within the production facility is a large amount of old plant and equipment that is now redundant and has minimal scrap value. Purchase orders for supplies from
China are made six months in advance and goods can be in transit for up to two months.
FLZ Ltd accounts for the inventory when it receives the goods. To avoid the disruption of a year-end inventory count at the end of financial year 2017, FLZ Ltd introduced a continuous/perpetual inventory counting system.
The warehouse has been divided into 12 areas and these are each to be counted once over the year. The counting team includes a member of the internal audit
department and a warehouse staff member.
The following procedures have been adopted;
1. The team prints the inventory quantities and descriptions from the system and these records are then compared to the inventory physically present.
2. Any discrepancies in relation to quantities are noted on the inventory sheets, including any items not listed on the sheets but present in the warehouse area.
3. Any damaged or old items are noted and they are removed from the inventory sheets.
4. The sheets are then passed to the finance department for adjustments to be made to the records when the count has finished.
5. During the counts there will continue to be inventory movements with goods arriving and leaving the warehouse.
At the year end it is proposed that the inventory will be based on the underlying records. Traditionally FLZ Ltd has maintained an inventory
provision based on 1% of the inventory value, but management feels that as inventory is being reviewed more regularly it no longer needs this provision.
In May 2018, FLZ Ltd had a dispute with its finance director (FD) and he immediately left the company. The company has temporarily asked the
financial controller to take over the role while they recruit a permanent replacement. The old FD has notified FLZ Ltd that he intends to sue for unfair dismissal. The company is not proposing to make any provision or disclosures for this, as they are confident the claim has no merit.
You are also aware that the Chief Executive Officer (CEO) chairs the Board which comprises the Chief Financial Officer (CFO) and five independent, unpaid non-executive directors who were appointed by the CEO based on past business
relationships. One of your partners from a non-audit department is a nonexecutive director of FLZ Ltd’s Board. The CEO/Chair sets the Board’s agenda, distributes Board papers in advance of meetings and briefs Board members in relation to each agenda item. At each of its quarterly meetings the Board reviews the financial reports of the company in some detail and the CFO answers questions. The Board has no separate audit committee but relies on the annual management letter from the external auditors to provide assurance that financial controls are operating effectively.
Required:
(a) Explain how FLZ Ltd are not currently complying with corporate governance requirements and describe how FLZ Ltd’s board should be
restructured to comply with the principles of good corporate governance.
(b) Explain the actions that the board of directors of FLZ Ltd must take in order to meet corporate governance requirements for the listing of FLZ
Ltd
(c) Explain how your audit firm will need to communicate with the members of FLZ Ltd, in the absence of audit committee for this and
future audits.
(d) Identify, and explain the relevance of, any ethical factors which may threaten the independence of M&G Partners Chartered Accountants’ audit
of FLZ Ltd financial statements for the year ending 31 December 2019. Briefly explain how each threat should be managed.
(e) Identify and explain the audit risks identified at the planning stage of the audit of FLZ Ltd and how you plan to address them.