Posted: June 6th, 2022

Formative Assessment 1: Procedures in Finalising an Audit

HIGHER EDUCATION PROGRAMMES
Academic Year 2022: January – June
Formative Assessment 1: Procedures in Finalising an Audit
(HAUD332-1)
NQF Level, Credits: 7, 14
Weighting: 15%
Assessment Type: Essay Questions
Examiner: M. Sass
Educator: M. Sass
Due Date: 25 March 2022
Total: 100 marks
Instructions:
• This paper consists of 3 questions.
• It is based upon units 1-4 of your study guide (Chapters 15 – 18).
• All questions are compulsory.
• The SAICA Competency Framework Reference at the end of a question is for recordkeeping and will inform you which SAICA Competency is covered.
• Where applicable, always state the section/regulation in the Act, then apply the specific section/regulation identified in the Act to the question / information / scenario.
QUESTION 1 30 MARKS
You currently working for Clarke Auditors and have been promoted to Senior Auditor at the beginning of the year (January 2022). Your first client since the promotion is
Afrisave (Pty) Ltd (“Afrisave”).
This is the first year that Clarke Auditors will perform the audit of Afrisave. Afrisave has a 28 February year-end. They are in the FMCG (Fast Moveable Consumer Goods) industry and have been in business for more than 20 years. The owners of Afrisave are involved in the day-to-day management of the company.
Afrisave has branches all over South Africa with its head office located in Gqeberha. Afrisave employs between 250-300 staff. They have a high staff turnaround, especially at a branch level.
At the beginning of the 2022 financial year (i.e. March 2021), the company started experiencing cash flow difficulties. The company’s CFO resigned as he wasn’t sure that the company would produce sufficient cash flows in the future. Before the CFO resigned, he submitted a report to the CEO which indicated that one of the reasons for the decline in sales, is that similar goods can be imported for less.
The final materiality was finalised at R 1 250 000.
The following are extracts for the financial information of Afrisave.
Actual figures Budgeted
figures Actual figures
28/02/2022 28/02/2022 28/02/2021
R m R m R m
Income
Gross profit
(Loss)/ Profit before interest paid 11 990
6 950 (2 850) 25 755
15 150
8 050 21 750
15 789
6 150
Interest paid (850) (1 980) (1 750)
Long-term liabilities
(9 456)
(8 123)
(12 789)
Current liabilities (bank overdraft included) (30 850) (19 963) (24 416)
Fixed assets 8 769 10 858 8 147
Current assets: 29 850 26 550 22 850
Inventory 15 725 13 050 9 725
Debtors 13 845 11 750 9 370
Cash 280 1 750 3 755
The overdraft facility value is R35 000 000.
1. Opening balances
Since this is the first time that your firm is performing the audit, permission was obtained from the client to contact the previous auditors to obtain more information regarding the opening balances. The previously appointed auditor simply informed you that he was pressed for time and had to rush the 2021 audit. He is, therefore, reluctant to allow you to review the 2021 audit working papers. This has immediately created concern with you on the reliability of the opening balances and why the auditor has issued an unmodified audit report.
2. Inventory
While visiting the central warehouse you established that perpetual inventory records are maintained. Goods received notes and invoices are used to capture inventory movements. While discussing the date and time to perform the physical annual inventory count, the Store Manager informed you that the previous auditor never attended the inventory count.
3. Going concern discussions held with management
During the finalisation of the audit, the following was mentioned throughout your discussion with the Financial Manager:
• During the year, Afrisave applied to extend their bank overdraft facility to R 40 000 000.
• During the year they secured a tender with the local hospital to supply goods to them on a weekly basis. However, as a result of the cash flow difficulties encountered, Afrisave were unable to keep to the agreement for a few weeks. The hospital then sued Afrisave for breach of contract for R 1 500 000. The hospital then terminated the agreement based on the above. The sales from this tender made up approximately 35% of the monthly sales.
• The local newspapers in Gqeberha published a newspaper article regarding a legal matter in November 2021. Since this article was published, sales have decreased substantially.
• Afrisave is struggling to pay their creditors on time and currently have more than half of their creditors at more than 120 days. This exceeds the agreedupon terms of 30 days.
• The Financial Manager also mentioned that Afrisave is looking to secure more products and have done some research on innovative products currently on the market.
Required
1.1 Formulate the substantive procedures to audit the opening balances and inventory. Refer to the information under notes 1 and 2.
(15 marks)
1.2 Discuss the appropriateness of the going concern assumption as per note 3 for the financial statements of Afrisave (Pty) Ltd for the financial year ended 28 February 2022.
(15 marks)
SAICA Competency No SAICA Competency Name
F2.2 Perform an audit of historic financial information
a) By applying F1, follow the stages involved in performing an audit:
(ix) Assess the evidence and results of the analysis and procedures
(x) Document the work performed and its results
F2.4 Communicate audit findings
Communicate matters to be reported to management and those charged with governance
QUESTION 2 20 MARKS
You are an Audit Trainee, currently finalising the audit of Kirkwood Citrus (Pty) Ltd “Kirkwood”. They have a 31 December financial year-end.
You have reviewed the financial statements of Kirkwood for the year ended 31 December 2021 and it is evident that they have been experiencing financial difficulties due to the severe droughts in the Eastern Cape.
In the 2018 financial year, one of the directors borrowed R1 200 000 to Kirkwood to Help with the cash flow problem. The terms stipulated that there will be no interest on the loan and it will be repayable from 2019 over 5 years in 5 equal instalments. Each instalment is due and payable by 31 December each year. Below are the accounting entries made in the financial statements.
Issue of loan November 2018
Dr: Bank R 1 200 000
Cr: Loan payable R 1 200 000
First instalment repayment December 2019
Dr: Loan payable R 240 000
Cr: Bank R 240 000
Second instalment repayment December 2020
Dr: Loan payable R 240 000
Cr: Bank R 240 000
During the finalisation of the audit, you reviewed the minutes of the board meeting and the following was decided with regards to the loan payable:
The balance of the loan payable at the end of June 2021 was R 720 000. The director who granted the loan decided to waive the loan in order to Help with the cash flow difficulties of Kirkwood. The accounting treatment of the outstanding balance was discussed during a board meeting. It was decided that no amount will be recognised as income in the financial statements of Kirkwood for the 2021 financial year, or as gross income in the tax return for the 2021 year of assessment. The board is not willing to make any adjustments to the annual financial statements and tax calculations.
The waiving of the balance of the loan was accounted for as follows:
July 2021
Dr: Loan Payable R 720 000
Cr: Other expenses R 720 000
Required:
Draft a memorandum to the Audit Partner where you discuss, with reasons, the effect that the above transaction will have on the audit report for the financial year ended 31 December 2021
(20 marks)
SAICA Competency No SAICA Competency Name
F2.2 Perform an audit of historic financial information
a) By applying F1, follow the stages involved in performing an audit:
(xi) Draw draft conclusions
b) Based on all of the above, formulate a draft audit opinion
QUESTION 3 50 MARKS
Upon completion of your Honors in Accounting, you started your articles at Wolmarans (Pty) Ltd (“Wolmarans”) three years ago. Wolmarans has been the auditor of CDE Industries for the past six years. At the beginning of the year, you were promoted to Audit Senior.
You were assigned to the audit of CDE Industries. CDE Industries is an engineering company and mainly does construction in the Western Cape.
CDE Industries imports raw materials needed to perform their work, especially when the costs are cheaper than buying them locally.
CDE Industries has a February year-end. You are currently busy with the finalisation of the 28 February 2022 audit.
You were provided with an extract of the draft financial statements of CDE Industries for the financial year ended 28 February 2022.
1. Legal claims
The draft financial statements for 2022 contain no reference to provisions for legal claims. As part of the routine audit procedures, you enquired from Mr. Henn, the Managing Director, about the existence of any pending legal claims against CDE
Industries. He answered that no legal claims have ever been instituted against CDE Industries and you recorded this in your working papers. You performed no additional audit procedures in this regard as your assessment was that the risk of material misstatement in this regard is low.
Last night, however, you were reading a newspaper journal online on problems encountered by clients of engineering companies in South Africa, specifically relating to the importing of cheaper raw material that doesn’t last as long as intended. Three clients of CDE Industries who indicated that they have already been involved in lawsuits with CDE Industries for six months were interviewed. The claims result from financial damages to clients. The total of the three claims amounts to approximately R870 000.
2. Unresolved matters picked up during the audit.
During the audit the following three audit differences were identified:
2.1 Fixed assets
CDE Industries bought another building during the year for R1 550 000. The business is growing and needs more space. The building purchased was budgeted and planned for in the 2023 capital budget. The transaction was consequently not recorded in the February 2022 draft financial statements since management rather want to include it in the 2023 annual financial statements.
2.2 Retrenchment expense
The recent Covid-19 pandemic had a great impact on CDE Industries, and it was decided that staff members had to be retrenched. The retrenchment date was set at 30 September 2021 and the employees would work until this date after reaching an agreement with the unions on 31 July 2021, which detailed the retrenchment packages. The cost of retrenchment was calculated by the nominations committee and agreed with the trade unions, however, no amount has been provided for in the 2022 annual financial statements. The total payments to be made in relation to the retrenchments will be R 4 000 000.
2.3 Accrued expenses
Your audit work indicated that accrued expenses were understated with a specific invoice for February 2022. The amount totals R 980 000.
2.4 Previous years
Your Schedule of Audit differences, before consideration of the three audit differences above, shows the following amounts that were carried over from the previous years:
• Fixed assets: Accumulated depreciation was erroneously overstated with R120 000 in 2021.
You calculated final materiality, based on equity, at R3.5 million. You regard all amounts smaller than 0.05% of income as clearly trivial which is equal to R500 000 and less.
3. Relying on information produced by a management’s expert
CDE Industries constructs various wind turbines whereby raw materials are converted into a finished product with fixed and variable overheads. It is a complex process to assemble the turbines, and the process cannot be easily understood by observing the production process.
CDE Industries employs a registered production engineer, Mr. Derrick, on a contractual basis. Mr. Derrick has been a contract worker for five years and is responsible for certifying and calculating the cost pricing of the work in progress. The auditors have set the risk of material misstatement of inventory at an acceptable level.
Required
3.1. Evaluate the materiality of each audit difference that you detected during the 2022 audit as per note 2 and reach a conclusion. This Assessment should be performed at both an individual level as well as cumulatively with the other audit differences.
Also, discuss the impact your conclusion will have on your audit opinion.
(20 marks)
3.2 Discuss and motivate the steps you as the auditor will take as well as the additional audit procedures you will perform during the 2022-year end audit in reaction to the newspaper article you read as per note 1.
(20 marks)
3.3 With reference to note 3, describe the aspects you will consider in determining the nature, timing and extent of the audit procedures when relying on the work of the engineer, Mr. Derrick.
(10 marks)
SAICA Competency No SAICA Competency Name
F2.2 Perform an audit of historic financial information
a) By applying F1, follow the stages involved in performing an audit:
(xi) Draw draft conclusions
b) Based on all of the above, formulate a draft audit opinion
F2.3 Reliance on other parties
a) Identify the possibility of, and need to, rely on other parties (internal and external auditors, and internal and external experts)
b) Describe suitable procedures to ensure audit quality is maintained when relying on the work performed by other parties
F2.4 Communicate audit findings

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