Your firm, Baraka & Musa Certified Accountants, recently responded to a tender for the provision of audit services to Lukanga Ltd a large car assembly company. Your partner has written to inform you that your firm has been appointed auditors of Lukanga Ltd for the year ended 31st December 2016.

He wants you to prepare detailed notes which will be used by your firm in deciding whether or not to accept the appointment. The following information has been provided to you to help you prepare the notes requested.

Management of Lukanga plc Lukanga Ltd is a private owned company with five major shareholders. Two of the shareholders are based abroad and they come to Tanzania four times a year to attend quarterly board meetings. The other three shareholders are the Chief Executive, the Production Director and the Finance Director.

Matters arising in a meeting your partner had with the CEO of Lukanga Ltd Chintu, the Chief Executive, has been at the helm of the company since its inception ten years ago. He makes all the major decisions and he has indicated to your partner that all serious audit finding should be referred to him. He has indicated that the company terminated the services of the previous auditors on grounds of not consulting him on matters of concern they had.

In response to a request for authority from your firm to communicate with Manda & Co Certified Accountants, the outgoing auditors, the Chief Executive Officer indicated that this will delay your appointment as auditors and he is reluctant to let your firm communicate with them.

Other issues noted by your partner:

Mr. Tembo, the only person who can be the audit manager on this audit, is a nephew of the Finance Director of Lukanga Ltd. He feels that because of this relationship your firm will not face any problems with this engagement.

There is a very tight timetable for the audit and the CEO emphasized that the audit should be complete within one month of the year. The overseas shareholders can only come to Tanzania at this time for the AGM.

The CEO has recommended that if your firm will need to engage an expert to value work in progress at the year end it should be company that Lukanga Ltd has used in the past. This is a company in which the Production Director of Lukanga Ltd has a controlling interest.

Nature of company The company imports more than 60% of its components from the Far East. The balance of 40% of components is imported from a subsidiary company that was established in a neighbouring country. The justification of setting up a manufacturing company in the neighbouring country is the low labour costs compared to those in Tanzania.

The subsidiary in the neighbouring company imports most of its raw materials from the west. A new law has just been passed in this country restricting the amount of foreign exchange that can be externalized per month. This has resulted in operational problems for the subsidiary resulting in lower production.

The company sells its motor vehicles through car dealers spread in the country on a consignment basis. A significant drop in sales has been experienced in the last two years and this is attributed to a high increase in cheap imported second hand vehicles.

Lukanga Ltd exports some of its vehicles to car dealers abroad based in the country where the subsidiary is located. The car dealers are given one month in which to pay for the vehicles. There has been a notable increase in old outstanding debts from export sales.

Matters raised in an informal meeting with the outgoing auditors Manda & Co has been auditors of Lukanga Ltd for the last three years. There were disagreements between the auditors and Lukanga Ltd in the treatment of research and development expenditure. This led to Lukanga Ltd terminating the services of Manda & Co Certified Accountants.

Manda & Co Certified Accountants are aware that Lukanga Ltd will not allow them to communicate with the incoming auditors. The angagement partner who was assigned this audit is a friend of the Chief Internal Auditor of Lukanga Ltd who informally told him who the incoming auditors are. Phiri the partner incharge of Manda & Co called your partner for an informal meeting at which a number of issues were discussed.

Phiri told your partner that this meeting should be regarded as informal and the CEO of Lukanga Ltd should not come to learn about it. He stated that the integrity of the management of Lukanga Ltd is questionable and the internal controls in place are weak.

Over a period of time the same control weakness have been highlighted to management through letters of weakness. When the CEO was handing the letter terminating the services of Manda & Co Certified Accountants, he indicated that he does not expect them to communicate anything bad about the company in the event that the incoming auditors insist on communicating with them.

The outgoing auditors have informed your partner that Lukanga Ltd has been sued by a number of motor vehicle buyers because of brake failure. This has arisen because of a component imported from the Far East, which is substandard. The company has underplayed this and is trying to settle these claims outside the court for fear of bad publicity.

An understanding of the entity from press reports It has been established from press reports that Lukanga Ltd runs a garage at which it conducts repairs and servicing of motor vehicles. The garage accumulates large quantities of used oil which it disposes off into the council drainage which flows into a stream. There are people who live close to the stream and they use this water for domestic use.

You have read in one of the daily newspaper that a number of companies emitting effluent in the council drains are being prosecuted by the Environmental Management Agency. The report states that there are heavy penalties against those found to be in breach of the legislation regarding disposal of hazardous materials. Your own investigations have revealed that one of these companies being prosecuted is Lukanga Ltd.

During 2015, twenty employees left and the entity estimates that a total of 20% of the 500 employees will leave during the three year period.

During the current year, a further 20 employees left and the entity now estimates that only a total of 15% of its 500 employees will leave during the three year period.

REQUIRED:

(a) Describe the professional and ethical matters that your audit firm should consider in making the decision whether or not to accept appointment as auditors of Lukanga Ltd.

(b) Identify and explain the risk of material misstatement that may occur as a result of Lukanga Ltd not complying with the environmental regulations.

(c) Identify and explain the business risk that Lukanga Ltd faces.