Module 9 - Substantive Proc - Class Q - 23 July

College of Business and Economics
School of Accounting
Department of Accountancy
Substantive Procedures,
MODULE 9
Sampling & Integrated Topics
AUDIT, ASSURANCE AND GOVERNANCE
CLASS QUESTIONS: 23 July 2019
Prof. Ben Marx
2019
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CLASS QUESTIONS – 23 July 2019
Question 1 Dynamico Auditors ITC June 2013 80 marks
Question 2 Winterfell ITC June 2016 70 marks
Question 3 AIP Auditors ITC June 2018 63 marks
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QUESTION 1 (ITC JUNE 2013 ) (80 MARKS)
You are a first-year trainee accountant at Dynamico Auditors, and part of the team currently
engaged on the external audit of Hofstein Ltd (‘Hofstein’), a company listed on the Johannesburg
Securities Exchange. Hofstein holds a 51% interest in Retailers Online Ltd (‘Reton’), an online
catalogue retailer selling household appliances and furniture. Reton has a 30 September year end.
Dynamico Auditors also holds the appointment as external auditor of Reton.
Dynamico makes extensive use of general audit software.
The following are extracts from the 2016 audit file of Reton:
Work paper Reference

Overview of the group activities B–100
Extracts from separate financial statements C–100
System description: Revenue and receivables K–100
Internal control weaknesses: Revenue and receivables K–101
Inventory Q–101
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Client: Reton Year end: 30/09/2016
Prepared by: AK Date: 15/07/2016 B–100
Reviewed by: HJ Date: 29/07/2016 1/2
Subject: Overview of the group activities
1 Introduction
Reton sells household appliances and furniture for cash (± 30%) and on credit (± 70%) via
its online portal to ± 300 000 customers. The company performs internal credit-worthiness
checks on all new customers. The company procures its stock from within the Hofstein group
as well as from external suppliers. Approximately 60% of its suppliers are local and 40%
foreign. The company hedges against currency movements, but does not apply hedge
accounting.
2 Business overview
Trading conditions were challenging in 2016 as consumers faced high transport and utility
costs, which resulted in less disposable income. However, continued merchandise
innovation and focused market strategies have enabled the company to maintain its gross
profit margins. Management expects trading conditions to remain unchanged.
3 Corporate governance
Mr John Mtembu, the chief executive officer, leads a robust Board of Directors with strong
independent directors. It maintains a culture of effective corporate governance and ensures
that the company complies with the Code of and Report on Governance Principles for South
Africa (King IV) in all material respects.
4 Outsourcing of website maintenance and catalogue design

Outsourcing of website maintenance and catalogue design to CTO (Pty) Ltd (‘CTO’) was
approved during February 2015. CTO is a company formed by the previous chief information
officer of Reton, Mr Martin Benade. Mr Benade is now the chief executive officer of CTO. On
1 July 2016 Reton obtained a 51% interest in CTO in return for intellectual property rights
transferred to CTO. The key management of CTO, who are all former staff members of
Reton’s Information Technology Department, hold the remaining interest via the CTO
Management Trust. Mr Benade remains on Reton’s Board of Directors as a non-executive
director. The Board of Reton approved a three-year loan of R8 million which was advanced
to CTO on 30 September 2016 as start-up capital.
5 Strategy and risk

Areas that impact on sustainable growth are identified annually and are aligned to the
stakeholder engagement process. The following are stakeholders with an interest in the
business:
 Customers,
 Suppliers of merchandise and services,
 Shareholders and the broader investment community,
 Communities in which the group operates,
 Employees at head office and stores throughout the group, and
 Industry regulators who monitor compliance.
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Prepared by: AK Date: 15/07/2016 B–100
Subject: Overview of the group activities
The following are material matters and key risks which have been identified by the Board of
Directors:
Strategic objective Key risks Management plans

Credit management
Optimise the quality of the Inability to maintain optimal quality  Focus on increasing the number
debtors’ book by improving of debtors’ book owing to – of satisfactorily paying customers
collections, reducing debtor  high levels of unemployment  Implement customer
costs and exploring further  deteriorating economic segmentation and credit limit
sales opportunities conditions strategies
Merchandising
Maintain competitive  Suppliers and distribution  Establish reliable back-up
advantage by sourcing partners perform below standard supplier channel
exclusive, quality, value for  Lack of depth in supplier base  Further improve supply chain
money merchandise  Exchange rate fluctuations management through system
enhancements
 Manage foreign currency risk
Maintain customer focus  Poor execution of the customer-  Grow the customer base through
focused business model new customer acquisition and
 Selling goods at low or no retention initiatives
profitability  Expand the store footprint
 Insufficient experienced  Focus on stable store
operational staff management through training,
recruitment and selection
strategies
Capital management
Manage financial risks and Ineffective capital management  Ensure access to capital at all
the liquidity requirements could impact on profitability and times
of the business effectively returns to shareholders  Manage currency exposure
 Manage the investment portfolio
Human capital
 Institute ongoing Inability to attract, develop and  Run training and development
development of staff for retain suitable staff for executive programmes
management positions and operational management  Establish employee incentive
 Ensure retention of positions schemes
current management  Use focused recruitment and
 Attract competent selection practices
individuals as required  Transform the company through
broad-based black economic
empowerment
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Prepared by: PH Date: 17/11/2016 C–100
Subject: Extracts from separate financial statements
EXTRACTS FROM THE STATEMENT OF COMPREHENSIVE INCOME

2016 2015
Notes Unaudited Audited
R’000 R’000
Revenue 456 800 409 600
Merchandise sales 229 200 204 000
Finance income 91 300 90 300
Insurance premiums 75 100 61 200
Other 61 200 54 100
Cost of sales 145 000 133 000
Net profit after tax 105 000 90 000
EXTRACTS FROM THE STATEMENT OF FINANCIAL POSITION

2016 2015
Notes Unaudited Audited
R’000 R’000
Non-current assets
Property, plant and equipment 27 800 25 100
Intangible assets 9 100 7 000
Loan to CTO 1 8 000 –
Current assets
Inventory 2 97 700 47 300
Trade and other receivables 353 500 342 700
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Prepared by: PH Date: 17/11/2016 C–100
Subject: Extracts from separate financial statements
Notes to the financial statements
1 Loan to CTO
The company made a loan to CTO on 30 September 2016. The loan is unsecured, bears no
interest and is repayable on 30 September 2019. The company has not designated the loan to
be measured at fair value through profit and loss.
Further explanatory audit work paper note
1.1 A unrelated commercial bank recently offered CTO a three-year loan with a single capital
repayment at the end of the period. The loan would bear interest at a fixed rate of 11,5%
per annum.
1.2 The prime overdraft rate is 12,5% per annum.
2 Inventory
Inventory, comprising merchandise held for resale, is valued at the lower of cost and net
realisable value. Cost is determined using the weighted average basis, net of trade and
settlement discounts. Net realisable value is the estimated selling price in the ordinary course of
business, less estimated costs necessary to make the sale. Provision is made for slow-moving,
redundant and obsolete inventory, as well as sales returns.
Further explanatory audit work paper note
2.1 The company operates a periodic inventory system.
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Prepared by: NH Date: 18/07/2016 K–100
Subject: System description: Revenue and receivables
1 General system overview
Sales are either for cash or on credit and orders are placed via telephone, fax or online.
2 Ordering
New online customers need to open an account by registering on the system. Once
registered, customers log on to the system using a unique account number and password.
The credit vetting division assigns a credit limit to each new customer.
Once an order has been captured on the system, customers are notified by means of a cell
phone text message (sms). Orders can be cancelled telephonically or online. Cash orders
can be paid by electronic funds transfer or credit card. All credit card purchases are
protected by the 3D Secure Process, a credit card verification process.
3 Deliveries
Distribution to customers is done from four outlets by means of the company’s delivery
vehicles or through delivery agents. Each customer receives a sms upon despatch of goods.
Delivery notes are automatically generated from orders once the goods have been packed
and are ready for delivery. Customers sign for deliveries to acknowledge receipt of goods.
Invoices are generated once the goods have been delivered and signed delivery notes
returned to the administration department.
4 Returned items
Customers may return goods within 21 days free of charge via post or delivery to any of the
four distribution outlets. The goods need to be accompanied by an original invoice. Returned
items are inspected prior to a refund being given.
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Prepared by: NH Date: 25/07/2016 K–101
Subject: Internal control weaknesses: Revenue and receivables
The following system weaknesses were identified during the performance of tests of controls:
Weakness 1
A review of the access rights assigned to staff in the credit vetting division showed that the
debtors’ clerks have limited viewing rights, but are able to capture credit limits and make
adjustments to the limits. The access rights of the two credit managers allow them to create new
customer accounts, override system functions and process journal entries. They also have full
viewing rights.
Weakness 2
Not all delivery notes were signed by customers upon receipt of goods. Also, some invoices had
no corresponding delivery notes whatsoever. Upon further investigation, it was found that in
some instances no invoices were generated for actual shipments to customers.
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Prepared by: AK Date: 15/10/2016 Q–101
Subject: Inventory
2016 2015
Unaudited Audited
R’000 R’000
Cost of merchandise 93 300 45 400
Goods in transit 10 000 7 100
Provision for sales returns 5 100 4 400
Less: Provision for obsolescence (10 700) (9 600)
Total 97 700 47 300
The company’s merchandising strategy is based on the philosophy that customers are attracted
to its website by its products rather than by the credit which is offered. The focus is therefore on
providing customers with differentiated household ranges. This is achieved by the following
means:
 Innovative product sourcing globally, so that customers are offered distinctive and affordable
furniture and appliances;
 Value-added features on products to ensure differentiation and increase the perceived value;
and
 Six-monthly launches of new furniture and appliance ranges, ensuring that customers are
constantly offered fresh and original products.
Products are sourced locally and internationally, to ensure that Reton offers exclusive products.
Imports ensure that furniture ranges use the latest designs and are produced with the most
modern manufacturing techniques. International factories also provide a broader range of
developmental designs and offer a wider variety of raw materials, which allow for more product
differentiation than local factories. Furthermore, imports offer price and design advantages and
mitigate the risk of local supply disruption.
According to the stock controller, significant unexplained inventory losses were identified at
inventory counts during the year, but the operations director has been too busy to investigate
them.
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Marks
REQUIRED Sub-
Total
total
(a) Calculate the amount at which the loan to CTO should be measured on
initial recognition in the separate financial statements of Reton. 3 3
(b) Discuss the impact of the information provided under the heading
‘Strategy and risk’ in work paper B–100 on the risk assessment
procedures to be performed during the 2016 audit of Reton, as well as
on the risk assessment of material misstatement in the financial
statements of Reton for the year ended 30 September 2016. Detailed
audit procedures are not required. 15
Communication skills – layout and structure; clarity of expression 2 17

(c) With regard to the two weaknesses identified in work paper K–101 –
(i) propose improvements to the system of internal control over
revenue and receivables to address each weakness; and 9
(ii) describe how you would reduce the impact of each weakness on
audit risk related to the potential material misstatement of revenue
and receivables (if any) to an acceptable level. Detailed audit
procedures are not required. 6
Communication skills – clarity of expression; logical argument 2 17

(d) Formulate the substantive procedures that you would perform to audit
the loan to CTO in the financial statements as per work paper C–100. 14
Ignore the presentation and disclosure assertions and the timing and
extent of the procedures.
Communication skills – clarity of expression 1 15

(e) With regard to the company’s inventory as set out in work papers
C–100 and Q–101 –
(i) discuss the risks of material misstatement relating to inventory
(ignore the presentation and disclosure assertions); and 10
(ii) formulate the substantive procedures to audit inventory at year-
end. 17
Communication skills – layout and structure 1 28

Total 80
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QUESTION 1 (SUGGESTED SOLUTION)
Part (a) Calculate the amount at which the loan to CTO should be measured on Marks
initial recognition in the separate financial statements of Reton
The PV value at 30 September: 3
n =3; i =11,5; FV = R8 million
R5 771 190
Available 3
Maximum 3
Total for part (a) 3
Part (b) Discuss the impact of the information provided under the heading ‘Strategy
and risk’ in work paper B–100 on the risk assessment procedures to be
performed during the 2016 audit of Reton, as well as on the risks of Marks
material misstatement in the financial statements of Reton for the year
ended 30 September 2016
 ISA 315 requires the auditor to obtain an understanding of the following as part of the
performance of risk assessment procedures:
 The entity’s objectives and strategies and those related business risks that may ½
result in a risk of material misstatement;
 The entity’s risk assessment process; ½
 Management’s philosophy and operating style; ½
 Human resource policies and practices; and ½
 Management’s commitment to competence (of staff). ½
 It is clear from the information provided that Reton has a risk assessment process and 1
the auditor will therefore obtain an understanding of the process and the results thereof.
 An understanding of the business risks facing Reton will increase the likelihood that 1
we will be able to identify risks of material misstatement, since many business risks
will eventually have financial consequences and therefore an impact on the financial
statements.
 However, it is a concern that the information does not provide any information 1
regarding the significance of the risks which were identified by the Board and the
likelihood of their occurrence.
 The information provided under ‘Strategy and risk’ provides the auditor with insight into 1
management’s approach to taking and managing risks. This can contribute to our
understanding of management’s philosophy and operating style as part of our
identification and assessment of the risk of material misstatement.
 The risks identified by the Board will have the following impact on the risks of material 1
misstatement at the financial statement and assertion levels:
 The risk of material misstatement at financial statement level will increase because of:
 The weakness in the risk assessment process, as it is not clear whether risks are 1
properly assessed by the Board;
 A going concern risk caused by – 1
o non-payment by debtors; ½
o non-delivery by suppliers; ½
o loss of customers; ½
o ineffective capital management; and ½
o fines and restrictions on operations imposed on the company because of the ½
fact that it operates in a regulated industry.
 The overall control environment could also be negatively affected by a shortage of 1
qualified staff.
 The risk of material misstatement at the financial statement level will be reduced by the
following:
 The fact that the entity’s management and Board has a risk assessment process in 1
place;
 The evidence from the scenario that the management of Reton has a clear 1
business strategy which positively impacts on its philosophy and operating style;
and
 The actions suggested by management in order to mitigate the going concern risk. 1
 The risk of material misstatement at the assertion level is affected as follows:
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 The possibility of non-paying customers will increase the risk of material 1
misstatement regarding the valuation and allocation of accounts receivable;
 The risk of suppliers performing below standard will increase the risk of material 1
misstatement regarding valuation and allocation of inventory.
 The complexity of accounting for currency fluctuations may increase the risk of 1
material misstatement regarding accuracy of purchases and valuation and
allocation of inventory.
 The complexity of accounting for currency fluctuations may also increase the risk of 1
material misstatement regarding accuracy of derivative financial instruments and
foreign exchange profits/losses.
 The risk of completeness of provisions for fines resulting from non-compliance with 1
industry regulations.
 The employee retention scheme may increase the risk of material misstatement 1
regarding the accuracy and presentation and disclosure of share option schemes to
employees.
 New customer acquisition and retention initiatives may increase the risk of material 1
misstatement regarding accuracy and completeness of revenue and / or expense
recognition (also risks relating to non-paying customers mentioned above).
Available 23
Maximum 15
Communication skills – layout and structure; clarity of expression 2
Total for part (b) 17
Part (c) With regard to the two weaknesses identified in work paper K–101 Marks
(i) Propose improvements to the system of internal control over revenue and
receivables to address each weakness
Weakness 1
 There should be clear segregation of duties between the function of capturing credit 1
limits, making adjustments and passing journal entries.
 All credit adjustments should also be reviewed and approved by a senior official before 1
changes are made by an independent official.
 Management should review a report of all changes to master files (credit limit changes). 1
 The access rights should be revoked, and reallocated:
 Debtors’ clerks should only have viewing functions and be able to capture payments 1
and sales transactions;
 All adjustments to credit limits should be made by the credit controller on forms 1
properly authorised by the credit manager;
 No employee should be able to override system functions; and 1
 Adjusting journal entries should be approved by the financial accountant prior to 1
being processed.
 Management should review access rights periodically to ensure individual access rights 1
are commensurate with job responsibilities. Exceptions should be investigated and
resolved on a timely basis.
Weakness 2
 A delivery note must be prepared for every sale of goods. This should checked at the 1
security gate against goods leaving the despatch outlets, and stamped as proof that it
has been checked.
 No goods should leave the premises without a delivery note. 1
 All delivery notes must be signed by the customer as proof of receipt. To facilitate this, 1
the delivery notes should have an appropriate marked area for the customer’s signature.
 Before invoices are generated from delivery notes, admin staff should check that the 1
delivery note has been signed by the customer.
 Management should review the system generated exception report indicating 1
deliveries/shipments that remain un-invoiced for a predetermined length of time.
 Management should review a system generated exception report indicating invoices 1
without corresponding delivery notes.
Available 14
Maximum 9
Total for part (c)(i) 9
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(ii) Propose improvements to the system of internal control over revenue and
Marks
receivables to address each weakness
Weakness 1
 Perform analytical procedures on recoverability of debtors. 1
 Extend substantive procedures on long outstanding debtors at year end and follow up on 1
their recoverability (against payment records, etc.)
 Verify the validity of credit adjustments, adjustments to accounts passed by debtors’ 1
clerks and journal entries by the credit controllers against supporting documentation
(such as credit notes).
 Establish whether clerks had actually made credit limit adjustments and whether credit 1
managers had actually overridden system functions or processed journal entries (e.g. by
reviewing system logs).
Weakness 2
 Perform analytical procedures on sales and debtors. 1
 Extend substantive procedures at year end on occurrence of sales in cases where 1
delivery notes were not signed by the customer or where no delivery note supporting an
invoice could be found. (This can be done by e.g. selecting sales invoices and following
these through to signed delivery notes. If delivery notes have not been signed by the
customer or no delivery note exists, the debtor’s balance could be confirmed with
customer, or subsequent cash remittances credited traced to accounts to remittance
advices or other proof of receipts (e.g. deposit slips and bank statements). The auditor
could also ascertain that payments relate to the account balances that existed at year
end.)
 Extend substantive procedures at year end on completeness of sales (by e.g. selecting 1
delivery notes as well as despatch records and following these through to sales invoices
and the sales journal to ensure they have been recorded as sales).
Available 7
Maximum 6
Total for part (c)(ii) 6
Communication skills – clarity of expression; logical argument 2
Total for part (c) 17
Part (d) Formulate the substantive procedures that you would perform
Marks
to audit the loan to CTO in the financial statements as per work paper C–100
 Agree the closing balance of the loan of R8 million to the trial balance and financial ½
statements.
 Obtain a management representation letter dealing specifically with the validity and ½
amount of the loan, as well as with the proper accounting for the related party transaction
involved.
 Audit compliance with the Companies Act as follows (sections 45 and 75):
 Discuss and enquire of the company secretary regarding compliance of all aspects of 1
the loan with the Companies Act (section 86 – as it is a public company, it should have
a company secretary).
 Section 45 applies as this is an intercompany loan – therefore there should have been 1
a special resolution on the matter: Inspect the minutes of shareholders’ meeting to
determine if such a special resolution had been passed.
o Was the correct notice period given of the meeting? ½
o Was a quorum of 25% (or other percentage as required by the MoI) of votes ½
present?
o Was the resolution accepted by 75% (or other percentage as required by the ½
MoI) of votes present?
o Were the conditions of the loan spelled out? ½
 Directors’ resolution: Inspect minutes of the directors’ meeting for the decision to grant 1
the loan, and the conditions thereof;
 Ensure the appropriateness of the following in terms of the requirements of the Act and
MOI:
o Notice period of the meeting ½
o Quorum ½
o Votes ½
o Percentage of votes obtained as required to approve the decision / resolution. ½
- 14 -
Inspect the minutes of the Board meeting for evidence that the Board acknowledged 1
that it performed a solvency and liquidity test and was satisfied with the outcome of the
test.
 Test whether the company meets the following requirements:
o Liquidity: Ensure the company will be able to pay its debts as they fall due within 1
the next 12 months by referring to cash forecasts, cash position and
relevant asset ratios.
o Solvency: Ensure the company assets exceed its liabilities, fairly valued, by 1
considering fair values of assets and liabilities and possible
impairments.
 Inspect the minutes of the Board meeting for evidence that the Board was satisfied that 1
the terms under which the financial assistance was proposed to be given were fair and
reasonable to the company.
 Confirm that notice was given to the shareholders and unions. 1
 In terms of section 75 inspect the minutes of the directors’ meeting to determine that Mr
Benade –
o disclosed his interests prior to the loan being considered; ½
o left the meeting prior to the discussion of the loan; and ½
o did not vote on the granting of the loan. ½
 Verification of transaction
 Agree the loan of R8 million to the contract and verify that it is legal and binding. 1
 Inspect the contract for the repayment conditions and interest rate and agree to ½
management’s workings.
 Inspect the cash book for the payment of the R8 million 1
 Evaluate whether (ISA 550) the business rationale (or lack thereof) of the ½
transactions suggests that they may have been entered into to engage in fraudulent
financial reporting or to conceal misappropriation of assets.
 Confirm the purpose, specific terms, conditions and amounts of the transactions 1
with CTO (related party).
 Confirm that the terms of the transactions are consistent with management’s ½
explanations.
 Confirm that the transactions have been appropriately accounted for in accordance ½
with the applicable financial reporting framework with reference to IAS 39 and IFRS
9 (refer question (a) above).
 Examine the correct use of the 'effective interest method' in calculating the 1
amortisation, i.e. (IAS 39.9): recalculate whether the calculated interest rate
discounts the estimated stream of principal cash flow (excluding any impact of
credit losses) through the expected life of the financial asset and agree the data
underlying the calculation with appropriate documentation such as contractual
agreements, invoices or bank statements.
 Discuss the recoverability of the loan with management. If the loan is identified as 1
questionable, examine financial statements or other evidence of the company’s ability
to pay or inspect collateral, if any.
Available 21½
Maximum 14
Communication skills – clarity of expression 1
Total for part (d) 15
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Part (e) With regard to the company’s inventory as set out in work
Marks
papers C-100 and Q-101
(i) Discuss the risks of material misstatement relating to inventory (ignore the
presentation and disclosure assertions)
The question did not require risks to be listed per assertion. However, this is done below for
purposes of presentation and logical layout.
Existence and ownership (rights)
 The risk that inventory in transit at year end and accounted for as stock does not exist; 1
 That ownership has not passed as goods are not shipped free on board. 1
 The risk of theft because of the nature of the inventory, as the items of household 1
equipment are often small and expensive, which means that it can be easily removed.
 The fact that stock losses exist but have not been investigated and corrected increases the 1
risk that inventory does not exist.
 The fact that test of controls of the system indicated that delivery notes do not exist for all 1
sales, or, if they do, that they are not always signed, could indicate inventory removed
from outlets but not accounted for. That is, the risk that inventory does not exist.
 The fact that days inventory on hand doubled compared to 2015, again, a risk that 1
inventory might not exist.
Valuation
 With regard to cost prices, the risk that –
 cost prices are not correctly recorded on an average basis, net of trade and 1
settlement discounts;
 the cost price of imports is not recorded at the correct spot exchange rate; 1
 the cost price of imports does not include all shipping and freight charges; and 1
 the cost price of intercompany purchases are not at arm’s length. 1
 With regard to net realisable value, the risk that –
 cost prices exceed NRV because of obsolescence or damage; and 1
 NRV is incorrectly calculated. 1
 Provisions for sales returns and obsolescence:
 The risk that it is not correctly calculated. 1
 The fact that days inventory on hand doubled compared to 2015 and provision 1
for obsolescence halved compared to 2015, which raises the risk of incomplete
provisions.
Completeness
 The risk that inventory (especially goods in transit of which ownership has passed and also 1
cases where deliveries were not timeously invoiced), has not been accounted for as stock
at year end.
Available 15
Maximum 10
Total for part (e)(i)
(ii) Formulate the substantive procedures to audit inventory at year end

Marks
(ignore the extent of the procedures)
Note: The focus of the substantive procedures at year end will be on valuation and the
existence of inventory, given the risks discussed in (e)(i).
General procedures relating to all assertions
1 Discuss with management the existence and valuation of inventory at year end, the ½
condition thereof, the stock controller’s comment on stock losses and possible
impairment requirements.
2 Obtain a schedule from management listing inventory and the provisions for sale returns ½
and obsolescence at year end and test the castings and calculations thereof; and
agree this to the lead schedules, trial balances and financial statements. ½
3 Obtain a management representation letter (stock certificate) from management ½
regarding the assertions affecting all categories of inventory; and
inspect that inventory has been accounted for and disclosed in accordance with IFRS ½
(IAS 2).
4 Perform analytical procedures, such as days inventory on hand, acid test ratio and 1
inventory as a percentage of total assets.
5. Existence and ownership (rights)
 Inventory count
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 Agree the inventory count records of the client to the final inventory records and 1
ensure quantities agree.
 Agree test counts done (both directions) by your staff member to the final inventory 1
records.
 Examine receiving activity to determine that recorded finished goods inventory in ½
transit was indeed received after the year end.
 Review supporting documentation for goods not included in the physical count but 1
included in the general ledger inventory control account (e.g. inventory in transit, duty
and freight, returns) and determine if the goods were properly included in inventory.
 Determine (by means of review of the terms of the purchase contracts or invoices) ½
that inventory received after year end for which title had passed as at the balance
sheet date has been reflected in inventory in transit and in accounts payable.
 Discuss with management the stock controller’s comment on significant stock losses: 1
review and investigate stock losses and inspect management approval for stock
write-offs.
 If stock losses are significant, request management to perform a cycle count 1
subsequent to year end; make independent test counts to confirm the accuracy of the
company's procedures; perform appropriate roll-back procedures.
6 Valuation at year end
 Cost price: Agree inventory items on inventory records at year end to the supplier price 1
lists and invoices.
 Ensure all transportation and other costs are included by reference to invoices. ½
 Ensure all trade and settlement discounts are included in NRV by reference to ½
supporting documentation and internal documentation.
 Agree overseas purchases to the invoices and spot rates on dates of purchase and 1
ensure all are correctly accounted for.
 Determine whether the method of inventory pricing is consistent with the prior year. ½
Check the correct application of the weighted average basis method.
 Net realisable value and provision for obsolescence
 Enquire from management about the process and methods used to determine NRV 1
and the provision for obsolescence and evaluate appropriateness in the light of
measurement objectives of IFRS.
 Test the completeness and the accuracy of the schedules of slow-moving, obsolete,
scrapped or damaged items used to determine the net realisable value of inventory
and the provision for obsolescence by performing the following:
o Obtain, using CAATs, a schedule of items that have shown little or no recent 1
movement (e.g. the last 12 months) (or re-perform the inventory age analysis
using CAATs), and consider the saleability and NRV thereof;
o Trace information obtained during the observation of the physical inventory to 1
management reports of slow-moving, obsolete, scrapped or damaged items;
o Review periodic reports to management concerning such information; and ½
o Discuss with management quantities held in the light of current production ½
requirements, sales orders received and future marketing forecasts; examine
documentation, including, where appropriate, aged listings of inventory balances,
substantiating the information obtained.
 Test to confirm that cost price does not exceed NRV, using CAATs:
o Recalculate NRV, by taking latest selling prices per price lists, sale invoices, etc., 1
and deducting selling expenses as per accounting records (e.g. 10%);
o Agree NRV to cost price, and obtain an exception report where cost exceeds 1
NRV; and
o Follow up on these items, and discuss with management. ½
 Recalculate the provision for obsolescence. 1
 Evaluate reasonableness of management’s assumptions with reference to historical 1
trends (e.g. agree the provision for stock obsolescence for 2015 to the actual write-
downs in 2016 and consider whether it was appropriate).
 If considered necessary, develop a point estimate or a range to evaluate 1
management's point estimate.
 Consider subsequent events – Consider and evaluate all available data including 1
subsequent changes in selling prices or costs to verify that in estimating the NRV,
events after the balance sheet date have been taken into account to an extent that
such events confirm conditions existing at the end of the period.
- 17 -
 Inspect minutes for management’s approval of the provision. 1
 Analytical procedure: Compare the amount provided for as a percentage of total 1
inventory to that of 2015 and follow up and substantiate significant variances.
7 Provision for sale returns
 Compare the amount provided for sale returns to the actual returns in October (21 1
days to return).
 Analytical procedure: Compare the amount provided for as a percentage of total 1
inventory to that of 2015 and follow up and substantiate significant variances.
 Test/ensure cut-offs are correct, by agreeing returns before and after year end to 1
the respective inventory records and determine whether it was accounted for in the
correct accounting period.
Available 28½
Maximum 17
Total for part (e)(ii) 17
Communication skills – layout and structure 1
Total for part (e) 28
TOTAL MARKS FOR QUESTION 80
- 18 -
QUESTION 2 (SAICA ITC – JUNE 2016) (100 MARKS)
You are a newly appointed trainee accountant at Winterfell Inc. (‘Winterfell’), a large firm that
provides accounting, advisory, external audit and taxation services to their wide range of clients.
After you completed the induction week at Winterfell, you were allocated to the audit team of
Lannister Holdings Ltd (‘Lannister’). Winterfell is the newly appointed external auditor of Lannister
for the financial year ending 30 June 2016 (‘FY2016’).
In addition to the background information, potential business contract with 2Go and the service
level agreement with Airbook set out below, the audit senior provided you with the following
workpapers:
Description
C100 Extract of the system description for the recognition of revenue of Lannister’s car rental division
F200 Fixed assets – understanding the rental car fleet
1 Background information
Lannister was established as a private company in 1984 by Mr Tyrion Lannister, who was the sole
owner of the business. As the company grew it became a public company and then in 2013 it listed
on the Johannesburg Stock Exchange. Winterfell was not involved with the listing process of
Lannister.
Lannister provides its customers with a range of integrated motor car solutions, including car fleet
rental, fleet management and used car sales, through the successful operation of complimentary
divisions and subsidiaries.
Lannister does not at present have sufficient cash reserves to fund potential growth opportunities.
Lannister requires consolidated financial statements for the year ended 30 June 2016 by 12
August 2016 in order to apply for a loan from Ironthrone Bank.
The board of directors of Lannister is as follows:
Shareholding
Name and surname Position
Mr Tyrion Lannister Chief executive officer and chairperson of the board 20%
Ms Sansa Stark Chief financial officer –
Mr Jaimie Lannister Communications and marketing director (brother of Mr
Tyrion Lannister) 5%
Mr Khal Drogo Sales director –
Ms Deanerys Targaryen Human resources director –
Mr Theon Greyjoy Non-executive director 5%
During FY2016 the board approved a bonus incentive scheme applicable to all executive directors
of Lannister. In terms of the bonus scheme, all executive directors will receive a bonus if the
budgeted profit targets for the financial year are met.
IFRS 15 Revenue from Contracts with Customers is only effective for reporting periods beginning
on or after 1 January 2018, but Lannister’s board has made the decision to early adopt IFRS 15
from 1 July 2015. This is because Ms Stark convinced the board that applying the principles based
on IFRS 15 would be easier than applying those of IAS 18 Revenue. Ms Stark is also of the
opinion that complying with the Companies Act, 2008 (Act 71 of 2008), as amended, is a waste of
time and money. Most of the personnel in the accounting division of Lannister are family members
of Mr Tyrion Lannister, with limited knowledge and experience of financial accounting standards.
- 19 -
On 1 January 2016 Lannister changed its information technology (IT) system from a number of
separate, less sophisticated application modules to a real-time integrated online application system
that combines all the previously standalone financial modules into one central application system
called SmartAccounts.
Lannister outsourced the development, testing and implementation of the new SmartAccounts IT
application system to Bravos IT (Pty) Ltd (‘BIT’). This included the migration of data, as well as
post-implementation maintenance and support. The outsource agreement further includes training
of Lannister personnel, but because the accounting division of Lannister has been understaffed
and under pressure, no such training has yet taken place.
2 Potential business contract with 2Go
Lannister’s policy is to use new rental cars for a maximum period of two years. These cars are then
replaced with new cars. The replacements are done in terms of a ten-year contract with suppliers
of new cars, which was signed five years ago by the company’s directors.
Cars that are two years old (based on the end of the month of first registration in the name of
Lannister), are sold through the company’s used car sales division. However, it is taking longer and
longer to sell the used cars due to a drop in demand for used cars, and there has also been a
decrease in the demand for rental cars. Lannister regards rental cars that have been rented out for
less than five days in a month as idle rental cars.
During a meeting of the audit team to discuss the car rental business of Lannister, the audit
manager highlighted that the directors are uncertain about the reasons for the continued increase
in idle rental car capacity of the company, partly because there is no risk committee and no
investigation had yet been undertaken by the client’s management.
The audit manager added that one of the factors that is causing strain on the car rental industry is
that international tourism to South Africa decreased by ±10% in 2015 (2014: 6%), partly because of
the stricter visa requirements imposed by the South African government on persons travelling with
minors. In addition, there has also been a decrease in local tourism over the past number of years.
The audit team has estimated that Lannister’s average lost revenue due to idle rental cars for the
first half of FY2016 had reached R10 million. The audit team is of the opinion that these losses will
materially impact on Lannister’s 2016 annual financial statements. The audit manager related that
he had asked what plans management has to mitigate these revenue losses. Ms Stark mentioned
that Lannister is considering the conclusion of an agreement with 2Go.
2Go provides innovative transport solutions, accessible by customers through a smart phone
application (app) that can be downloaded free of charge. Customers using the app register their
personal details and credit card details on 2Go’s system by means of the app. Registered
customers can then request transport of their choice by means of the app.
2Go has provided Lannister with a proposed written contract in terms of which Lannister will make
its idle rental car fleet available to 2Go for a period of four years. The contract contains the
following terms and conditions:
• If the board of Lannister enters into the proposed contract with 2Go, 1 000 idle
rental cars will be provided to 2Go on 1 July 2016.
• 2Go will partner with Lannister by providing registered drivers who will utilise the
cars provided by Lannister. These cars will be under the full control of the drivers to
whom they are allocated and be their responsibility.
• 2Go will pay Lannister an annual fixed fee for the use of the total number of idle
rental cars available plus a monthly fee for each kilometre of 2Go transport provided
by Lannister’s rental cars.
- 20 -
• Lannister will receive a fixed annual fee of R15 million on 1 July 2016 and again on
1 July of each of the next three years.
• On the fifth business day of each month, 2Go will pay Lannister R1,00 per km
travelled by each Lannister car during the previous calendar month. The fixed fee
payable to Lannister per kilometre of 2Go transport will escalate by 25% per annum
from 1 July 2017.
• 2Go’s system automatically logs details of all trips accepted and undertaken by
each driver, which will be used to account for each trip’s transaction.
• 2Go will provide Lannister with a copy of a system-generated summary of all the
2Go trips undertaken by each car to support the kilometre amount paid over.
• 2Go will return the cars to Lannister’s used car fleet at the end of June 2020. 2Go
will have the option to buy the cars from Lannister on that date for 65% of their
market value.
The directors of Lannister regard the proposed transaction with 2Go as a way to improve the
company’s profits, while also making a positive social impact in South Africa. The directors plan to
sign the contract with 2Go as soon as possible.
- 21 -
3 Service level agreement with AirBook
AirBook is a company which provides online accommodation bookings through its own website.
Lannister and AirBook signed an SLA on 1 January 2015. In terms of the SLA, Lannister receives
revenue from AirBook for advertising and referral services that Lannister provides. The revenue
from AirBook makes up about 5% of the total monthly revenue of Lannister.
The SLA includes the following terms and conditions:

• A banner to advertise AirBook must be prominently displayed on Lannister’s
website.
• The banner includes an icon (‘click here icon’) which redirects customers that visit
Lannister’s website to AirBook’s website when the customer clicks on the icon.
• A referral icon to AirBook’s website after a customer makes a reservation with
Lannister. If customers make reservations with Lannister an additional icon appears
asking the customer if they would like to book accommodation through AirBook for the
same period. If customers click on this referral icon they are directed to the AirBook
website where their information is prepopulated in a booking enquiry.
• The SLA stipulates the following fees:
▪ A quarterly fee is paid in advance by AirBook to Lannister for the
display of the banner.
▪ A fee payable by AirBook to Lannister for each customer redirection.
The amount of the fee depends on whether the customer is (1) redirected
from the banner advert or (2) redirected after having made a reservation with
Lannister (at which point additional customer-specific information is already
collected).
Each time a user of Lannister’s website is redirected to AirBook’s website through the AirBook
icons programmed on the Lannister website, it is logged on both the SmartAccounts and AirBook
systems.
- 22 -
Client: Lannister Prepared by: Date prepared: 11
Grace Musimani May 2016
Year end: 30 June 2016 Reviewed by: Date reviewed: 18 C100
Cobus Laubsher May 2016
Extract of the system description for the recognition of revenue of Lannister’s car rental division
Customers can only book rental cars via Lannister’s website, by visiting
www.lannisterrentals.co.za. All bookings take place directly on the SmartAccounts application
system of Lannister. Lannister only accepts valid credit cards for making bookings and payment
for car rentals. Lannister uses firewalls which are updated continuously by BIT. All electronic
communications between Lannister’s system and all other parties and devices are appropriately
secured and function optimally.
1 Lannister car rental services – booking of rental cars
At the time of making a booking, a customer is required to provide personal, credit card and
driver information as well as destination information and dates.
The system prepares a quote for the customer. The quote contains a message that informs the
customer that –
• no changes are allowed to bookings once they have been accepted by the
customer;
• if the car is not collected for rental on the exact booked date, the customer’s credit
card will be charged for the full amount of the quote on the day after collection
should have occurred;
• the customer receives 200 km free travel per day and any distance travelled
above this is subject to an additional charge;
• a specified amount of credit available on the credit card will be placed on hold
when collecting the rental car to ensure that the customer’s credit will be sufficient
to cover the expected car rental charges; and
• the customer is required to take full insurance on the vehicle rented.
The customer is then prompted to tick a box to indicate agreement with these terms and
conditions. Once ticked, the customer is prompted to change the booking or accept the quote.
Once the customer accepts the quote, the system generates a unique, pre-numbered
preliminary invoice. The system automatically sends a copy of the preliminary invoice, with full
details of the booking, to the customer’s email address as well as an SMS to the customer’s
contact number with a unique, system-generated security code that the customer is required to
use at the time of collection of the rental car.
2 Lannister car rental services – collection of rental cars
Once the customer arrives at the Lannister Car Rental counter at the selected office, he/she is
allocated a rental facilitator. Rental facilitators use SmartReaders to process customers’
collection of rental cars. Each SmartReader is a state-of-the-art, mobile, Wi-Fi enabled, smart
reader with a biometric key lock. All SmartReaders are fully integrated with Lannister’s
SmartAccounts application system by means of a private network. Lannister operates its car
rental business in a completely paperless environment.
- 23 -
The rental facilitator uses the SmartReader to read the magnetic strip on the customer’s credit
card and the bar code on the customer’s drivers’ licence. The system automatically matches the
information with the details provided when placing a booking. The details of the booking appear
on the SmartReader’s screen. The rental facilitator then uses the SmartReader to read the
barcode on the relevant car’s windscreen and the car’s kilometre reading on the car’s control
console.
The system and the screen of the SmartReader are updated with the details of the car as well as
the kilometre reading at the time of collection. The SmartReader then displays a message that
requires the customer to enter the unique, system-generated security code that was received via
SMS at the time of the booking into the SmartReader as confirmation of agreement with the
information of the car.
As soon as the customer enters the security code, the system charges the customer’s credit card
with the payment as per the preliminary invoice and passes journal entries for the rental income
and payment received. The system also generates a hold on the customer’s credit card (for the
amount specified at the time of the booking) and passes a journal entry to account for it.
The rental facilitator then releases the car to the customer.
3 Lannister car rental services – return of rental cars
When the customer returns the rental car, a rental facilitator takes delivery of the car. The rental
facilitator uses a SmartReader to read the barcode on the car’s windscreen and the kilometre
reading on the car’s control console.
The system is updated with the details of the car, the kilometres travelled at the time of return
and if necessary, the date. The system then calculates the excess kilometres travelled by the car
(in excess of the 200 km per day included in the preliminary invoice), records the journal entries
for the additional revenue, generates a final invoice, and processes payment against the
customer’s credit card.
The hold on the customer’s credit card is then released.
- 24 -
Client: Lannister Prepared by: Date prepared: 11
Grace Musimani May 2016
Year end: 30 June 2016 Reviewed by: Date reviewed: 18 F200
Cobus Laubsher May 2016
Fixed assets – undertanding the rental car fleet
Lannister’s car rental fleet consists of some 6 000 vehicles at any given point in time.
Rental cars are carried at cost less accumulated depreciation and impairment losses in terms of
IAS 16 Property, Plant and Equipment. Depreciation is calculated over a two-year period from
the date of purchase and all rental cars have a residual value equal to 25% of their cost.
The managers of each of Lannister’s rental outlets are responsible for safeguarding the rental
cars under the control of the outlet. Each outlet’s manager is required to send a monthly report to
Lannister’s head office that confirms the existence of each rental car under the control of the
outlet and describes any operational problems of or damage to rental cars. Evidence of damage
to rental cars is also provided by means of photographs. Mr Petyr Baelish, the asset controller at
Lannister’s head office, uses the monthly reports from outlet managers to perform the
impairment calculation. Ms Stark signs these calculations as approval and Mr Baelish passes the
necessary journal entries to update the accounting system.
The fixed asset register of Lannister is fully automated and integrated with the company’s
SmartAccounts system and its general ledger.
The following are fields contained in the fixed asset register specifically for each rental car:
• Registration number
• Vehicle identification number
• Description of vehicle
• Date of first registration in the name of Lannister
• Date of transfer to used car division
• Cost price
• Depreciation rate
• Residual value
• Carrying amount: 1 July 2015
• Opening balance, at cost
• Opening balance: Accumulated depreciation and impairment losses
• Depreciation for the current financial year
• Carrying amount: 30 June 2016
• Closing balance, at cost
• Closing balance: Accumulated depreciation and impairment losses.
- 25 -
Marks
PART I – REQUIRED Sub-
total Total
(a) Identify and discuss the risks of material misstatement at the overall
financial statement level with regard to Lannister, evident from the
section headed, ‘Background information’, for FY2016. 14

(b) Describe specific overall audit responses to the risks identified in part (a). 16
Communication skills – logical argument 1 17

(c) Based on the information provided in workpaper C100, design key
controls, in addition to those already described in the workpaper, which
should be in place to mitigate the risks of material misstatement related
to its car rental revenue. 18
(d) Based on the information provided in workpaper F200, describe the

substantive audit procedures applicable to the valuation of the rental car
fleet of Lannister for FY2016. 18
Ignore audit work relating to the following:

• Obtaining appropriate audit evidence on the opening balance of
the rental car fleet asset; and
• Evaluating the impact of the idle rental cars discussed under
‘Potential business contract with 2Go’.
Total for part I 70
- 26 -
Part (a) Identify and discuss the risks of material misstatement at the overall financial statement level with regard to
Lannister, evident from the section headed ‘Background information’, for FY2016.
1 Lannister is listed on the JSE, & the board has incentive to fraudulently manipulate financial statements to maximise 1
the share price/retain listing and shareholders support/ listing requirements not met
2 New audit & opening balances might contain misstatements affecting the FY2016 statements. 1
3 Lannister is a holding company and the risk exist that on consolidation:
 Intercompany balances & transactions not eliminated/correctly accounted for (consolidation errors). 1
 RP transactions between Lannister & subsidiaries may not be correctly accounted for and disclosed in terms 1
of IAS 24.
 Risk of errors arising from using work of others (e.g. preparers of subsidiary financial statements). 1
 Complex accounting transactions (IFRS 10 & 3) and lack of understanding thereof by accounting staff 1
4 The going concern assumption of preparing the financial statements might be at risk because:
 Cash flow difficulties experienced to fund potential growth and settle its liabilities. 1
 Dependency on loan from Ironthrone bank being granted. 1
 Used car industry slowing down/declining economy, affecting re-sale market 1
5 There is a risk that Tyrion Lannister manipulates the misstatement of the financial statements to increase his
own wealth as he owns 20% of the shares and is the CEO and chairman of the company. 1
6 Misstatement of the financials by the board in order to obtain the finance from Ironthrone bank. 1
7 The tight reporting deadline to submit the audited financials to the bank for finance could result in mistakes, 1
omissions of information in preparation thereof/fraudulent financial reporting;
- could also result in subsequent events not being disclosed 1
8 A lack of management integrity/weak corporate governance could lead to fraudulent financial reporting because
of the following (King III):
 Composition of the Board lacks independence (no independent non-exec, only one non-executive). 1
 Chairman of the Board not an independent non-executive director/no Lead Independent Director; 1
 CEO also acts as Chairman. 1
 CFO does not have a high regard for laws and regulations. 1
 Director’s remuneration not set by and independent remuneration committee. 1
9 The non-compliance with the Companies Act and other applicable laws and regulations relating to the industry in
which Lannister operates, specifically:
 Section 94 requirements for audit committees consisting of at least 3 non-executive directors. 1
 Authorisation of intercompany financial assistance and directors loans (section 45). 1
 Disclosure or individual director’s and prescribe officers remuneration (section 30). 1
 JSE listing requirements (requiring independent audit committees, remuneration committees, etc). 1
10 Executive director’s bonus incentive’s provides them with an incentive to overstate profits and assets. 1
11 Control environment weak, resulting possible errors & fraud because :
 Lack of segregation of duties/independence,as most of acc division are family of Tyron Lannister. 1
 Accounting personnel have limited knowledge and experience of financial accounting standards (understaffed 1
and under pressure accounting department). 1
 Staff have not been trained in operating the new IT system and programs (SmartAcounts). 1
 Complex accounting transactions (IFRS 15) and lack of understanding thereof by CFO Stark.
12 Integrated real-time on line system could result in unauthorized access and errors carried throughout the system
and affecting all accounts. 1
13 IT risks resulting from the weak general controls that could result in processing errors or loss of data:
 Loss of data during migration/system conversion/ (no back-up). 1
 Unauthorised access to the SmartAccounts system. 1
 Unauthorised changes to the SmartAccounts information/data. 1
 Reliance on 3rd party service providers and related risks. 1
Available 32: Maximum 14
Total for part (a)
- 27 -
Part (b) Briefly describe specific overall audit responses to the risks identified in part (a)
1. Staffing (direction, supervision and review)
1.1 Assign more experienced/senior staff to complicated accounts: 1
1.2 Emphasise to the engagement team the need to maintain professional scepticism on the audit, especially when 1
obtaining and corroborating evidence obtained from management of Lannister. 1
1.3 Plan more supervision over the high risk areas such as revenue and fixed assets. 1
1.4 Incorporate elements of unpredictability in the selection of audit procedures to be performed. 1
1.5 Plan for the use of experts: IT experts/IFRS experts etc. 1
1.6 Increase awareness with components auditors of high risk areas and responses required. 1
1.7 Involve a quality review partner (2nd partner) on the audit, especially for high risk areas 1
2. Overall approach to the audit
2.1 Decrease/lower performance materiality for high risk areas. 1
2.2 Type: place less reliance on controls & focus more on substantive procedures. 1
perform more test of details and less analytical procedures. 1
This is because:
 of the system migration during the year. 1
 weak accounting control environment (staff experience, etc). 1
2.3 Timing of testing
 Focus on year-end testing for account balances/close to year-end. 1
 Consider performing testing of transactions during the year to limit the work after year end because of time 1
restriction on completion of the audit.
2.4 Extent: increase the extent of substantive procedures performed (more location coverage) 1
2.5 Place less reliance during substantive procedures on management representations (confirmations) and focus 1
more on representations and confirmations from third parties. 1
2.6 Focus on using CAATS where possible to test the populations 1
3. Specific focus/response to areas of high audit risk: the following are high risk areas to which more
audit focus (e.g. more experienced staff) should be directed
3.1 Revenue recognition because of the early adoption of the new IFRS 15 1
3.2 Compliance with laws and regulations/governance 1
3.3 Related party transactions 1
3.4 Fixed assets (motor vehicles used as rental cars) 1
3.5 Consolidation: appropriateness of accounting policies/ workings and accuracy of consolidation journals. 1
3.6 The cut-off and occurrence of revenue because of management bonuses scheme. 1
3.7 Focusing on subsequent events testing in detail due to managements attitude towards IFRS and compliance with 1
laws and regulations
3.8 Implications and assessments of the going concern of Lannister 1
Communication skills – logical argument 1
Total for part (b)
Part (c) Based on the information provided in workpaper C100, design key controls, in addition to those already
described in the workpaper, that should be in place to mitigate the risks of material misstatement related to its
car rental revenue
1 For cars not collected the system should process the rental transaction and charge the customer’s 1
credit card according to the accepted preliminary invoice on the day after the car was booked for.
2 Programmed controls (edit checks) to test the accuracy of the information captured by the customer 1
when making the BOOKINGS such as (examples of):
 alphanumeric tests, on all fields, digit tests on telephone and credit card numbers, Max 2
 echo tests to confirm selections, dropdown menus for selection of dates & category of car booked, etc.
The system should confirm with the relevant bank the authenticity and credit status (validity) of the 1
customer’s credit card before the customer is allowed to proceed and finalise a booking.
When the system generates quotes for customers, sound programmed controls should be in operation to 1
ensure the accuracy of the quote data (reasonableness checks).
If the credit card & driver’s license read by the SmartReader do not correspond with the booking 1
information an exception message should be generated and be referred to the supervisor for resolution.
The system should not proceed to process a booking unless the customer’s accepted the terms and 1
conditions of the rental.
- 28 -
3 When the customer return vehicle, the rental facilitator to check vehicle for damages and report. 1
4 MASTERFILE AMENDMENT CONTROLS to ensure all changes to rates and charges are valid
 Changes to rates and charges should be done on pre-numbered authorized amendment forms. 1
 All changes on the system should be logged and emailed to management. 1
 Management should review the log, investigate discrepancies, and sign the log using a password as 1
evidence of its correctness/review.
 Management should regularly perform spot checks on rates and charges on the system to ensure 1
correct rates and charges used.
5 Exception reports should be produced for vehicles rented where:
 rates & charges on a customer’s invoice differ from the system approved rates and charges. 1
 Used for more than an average of 200km per day and for which no additional charge was
processed; 1
 the km reading on return of the vehicle is lower than the km reading when vehicle was collected 1
 The system should identify gaps in the invoice number sequences and report these on an exception 1
report for investigation by management.
6 Management should review all exception reports and investigate any exceptions. 2
7 IT general controls
 Strong access controls (passwords, access rights, etc.) to protect the computer system at all times 1
against unauthorised access.
 SmartReaders should be regularly serviced and tested. 1
 The manager at each rental outlet should be responsible for overseeing the maintenance and 1
protection of these items.
 Sufficient continuity controls should be in place for cases of technology failure, e.g. standby Wi-Fi 1
and additional readers that are charged and ready for use
8 The system should compare the actual date of return to the date per the booking and if the car is returned 1
on a later date than the date booked, the system should automatically raise an additional revenue
journal and claim payment against the customer’s credit card.
9 User controls such as:
 Segregation of duties between staff doing capturing, processing and making adjustments. 1
 Background and integrity checks of all staff. 1
 Complaints line whereby irregularities can be reported. 1
Total for part (c)
Part (d) Based on the information provided in workpaper F200, describe substantive procedures applicable to
valuation of rental car fleet of Lannister for FY2016. Ignore audit work relating to:
 Obtaining appropriate audit evidence on the opening balance of the rental car fleet asset; and
 Evaluating the impact of the idle rental cars discussed under ‘Potential business contract with 2Go’.
General
1 Incl ref in written mgmt rep letter on appropriateness of valuation of rental fleet asset in 2016 financials. 1
2 Agree the closing balance amounts per fixed asset register to the GL and TB. 1
3 Do ARP of the depreciation, impairments & carrying amounts for 2016 to that of 2015 & budget amounts. 1
4 Confirm by management/prior year work paper that impairment/depreciation policy same as prior year 1
Impairment
When inspecting a sample of rental vehicles for existence, inspect their condition to assess whether there 1
5
is any indication that a vehicle might need to be impaired (damage, etc.).
Select a sample of monthly reports from the rental outlets and inspect that all items on these reports 1
6 have been included in the impairment calculations for the month.
Use Data CAAT’s to extract an exception report of cars which accumulated extensive kilometers during 1
7 the current year, which can be an indication that impairment needs to be accounted for
Inspect a sample of the monthly impairment calculations performed by Mr Baelish and:
 re-perform the calculations for accuracy; 1
 discuss the process followed for write downs/impairment with the asset controller Petyr Baelish; 1
8
 evaluate whether the impairment calculations adhere to the requirements of IAS 36; 1
 inspect for the signature of Ms Stark as approval of the impairment write off; 1
 follow the impairments through to the fixed asset register; 1
- 29 -
 inspect journal entries & GL posting to verify impairment charges recorded timely & correctly 1
Residual Values
9 Consider acceptability of 25%residual if not too low by comparing to industry norms/discussions mgmt 1
Select cars transferred for 2016 to used car div & test reasonableness of residual values as follows:
 compare the price the car has been sold for to the residual value (of 25%); 1
10
 if the car not sold, compare selling price as per the AA Guidelines/industry to 25% residual value; 1
 discuss significant differences and the appropriateness of residual values with Stark & Baelish. 1
Depreciation and Useful Lives (2 year depreciation period)
11 Consider acceptability of useful life - if not too low by comparing to industry norms/discussions mgmt 1
12 Use data CAATs to re-perform the DEPRECIATION as per fixed asset register 1
13 Use data CAATs to re-perform the CARRYING AMOUNT as per the fixed asset register 1
Use data CAATs to extract the population where date of first registration is older than two years and 1
14
print an exception report to discuss with Ms Stark
Cars transferred to used car business division
15 Use data CAATs calc totals for cost, acc depr & carrying amt transferred to used car div for 2016; & 1
Compare the totals computed to the balances per the general ledger. 1
Cost price :New rental cars bought (replacement cars)
Use CAATs to identify all cars purchased in the 2016 financial year and for a sample of these items:
 agree the cost thereof to the invoice and other supporting documentation; 1
16  price as per contract signed 5 years ago; 1
 ensure that the VAT has been capitalised to the cost price of the vehicle; 1
 ensure that registration costs, etc. has been capitalised to the cost price of the vehicle 1
Inspect the rental car’s accounts in the fixed assets register to verify that repairs and maintenance costs 1
17
and annual licencing fees were not capitalised
Exception reports of a general nature
Using CAATS extract exception reports such as:
 vehicles with negative cost prices, depreciation and carrying amounts; Max
18  where the opening balances plus the current year movement does not equal the closing balances; 2
These exception reports should then be audited in detail and explained/corrected by management. 1
Total for part (d)
- 30 -
QUESTION 3 (ITC JUNE 2018) (63 MARKS)
Ignore value-added tax
You are a trainee accountant at a local audit firm, AIP Auditors, and have been assigned to the audit
of R&M Ltd (‘R&M’), a company listed on the Johannesburg Stock Exchange. R&M is the holding
company of a group of companies that specialises in the manufacture and distribution of furniture
and household appliances. While R&M has focused on South Africa as a market for several years,
the company took a strategic decision in 2017 to expand to other African countries. New markets
are typically identified by the R&M research team who ensures it is aligned with the R&M Board’s
risk appetite and strategic objectives.
R&M has owned 100% of Mxolisi (Pty) Ltd (‘Mxolisi’) since Mxolisi’s incorporation. Mxolisi is a
manufacturer and retailer of customised and unique furniture pieces. Although Mxolisi is a South
African company, with the South African rand (ZAR) as its functional currency, it exports most of its
furniture to clients in the United Kingdom (UK).
The financial year end of all entities that form part of the R&M group is 31 December. AIP Auditors
has been the auditors of the R&M group since its inception. The independent non-executive directors
of the group have raised concerns about the length of the relationship between the auditors and the
R&M group. They have requested that R&M consider changing auditors after the completion of the
audit for the financial year ended 31 December 2017 (FY2017). AIP Auditors has set a group
materiality figure of ZAR1 million for the audit of the financial statements for FY2017.
The chief financial officer (CFO) of R&M, Mrs Thandeka Lou CA(SA), requested that AIP Auditors
perform their audit of certain notes to the financial statements for FY2017 based on the information
below. She was not sure that the disclosure she had included was correct and would appreciate their
feedback on any areas they believe she should correct. She also requested that the FY2017 audit
be completed much earlier than usual as the company’s bankers require the audited financial
information to determine whether they are willing to increase the limit of the overdraft facilities
granted to the company.
You have received the following information:
Page
no.
1 Extract of draft consolidated statement of financial position of the R&M
group for FY2017 2
2 iDish 6
3 Extract of the draft 2017 audit report 8
4 Summary of discussions held with the CFO on 14 January 2018 8
5 Additional information 8
- 31 -
1 Extract of draft consolidated statement of financial position of the R&M group for
FY2017
Notes ZAR
ASSETS
Non-current assets
Property, plant and equipment 17 000 000
Deferred tax asset 1.1 5 870 000
Current assets
Forward exchange contract (balance as at 31 December 2016) 1.2 146 000
Trade and other receivables 1 054 800
Inventory 1.3 2 000 000
Non-current assets held for sale 1.4 22 146 637
TOTAL ASSETS 48 217 437
EQUITY AND LIABILITIES

Total equity 1 669 093
Non-current liabilities
Other long-term liabilities 23 547 000
Deferred tax liability 3 250 000
Current liabilities
Proceeds on the forward exchange contract suspense account 1.2 270 000
Other current liabilities 19 481 344
TOTAL EQUITY AND LIABILITIES 48 217 437
A consolidated profit before tax of the R&M group for FY2017 amounting to ZAR1 960 264 is included
in the total equity. This amount does not include any necessary adjustments in terms of the matters
listed below under notes 1.2 to 1.4 to correctly account for the items.
Notes
1.1 Deferred tax asset
The deferred tax asset represents only the tax effect of the assessed loss of S&T Furnishers (Pty)
Ltd (‘S&T’), a subsidiary of R&M. S&T operates in South Africa. On 31 December 2017 management
believed that there would be future taxable income against which the assessed loss could be utilised
and therefore correctly recognised deferred tax on the full assessed loss. There are no other
temporary differences included in the deferred tax asset.
1.2 Hedge of revenue transaction
During August 2016 R&M entered into an agreement with an entity in Ghana to sell 2 000 yellowwood
desks at USD100 per desk to it. This contract was entered into with the expectation that delivery
would take place in accordance with R&M’s normal sales terms and conditions. The desks would be
delivered on 28 February 2017. Furniture sold to Ghanaian companies is denominated in United
States dollar (USD).
R&M was concerned about the volatility of the USD : ZAR exchange rate and the potential weakening
of the USD against the ZAR. On 30 November 2016 management therefore entered into a forward
exchange contract (FEC) with Stanx Bank to sell USD200 000 at the end of three months at a fixed
USD : ZAR rate. The terms of the FEC provided that the contract would be net settled on 28 February
2017. On 30 November 2016 the FEC was designated in its entirety as a hedging instrument in
terms of a cash flow hedge relationship in respect of the highly probable forecast transaction in 2017.
- 32 -
This hedge relationship was correctly accounted for in 2016 and all requirements as indicated in
IFRS 9 Financial Instruments, par. 6.4.1, have been adhered to for the duration of the hedging
relationship.
The sale transaction of the 2 000 yellowwood desks was correctly recorded in the current year.
However, the only entry recorded in FY2017 with regard to the hedging relationship was to create
the following ‘proceeds on FEC’ suspense account upon the cash settlement of the FEC:
Dr. Cr.
ZAR ZAR
Bank 270 000
Proceeds on FEC suspense account (SOFP) 270 000
Proceeds received from settlement of FEC [(14,35
– 13,00) x 2 000 x USD100]
1.3 Inventory
The inventory includes 50 customised lounge chairs upholstered with print material of the South
African flag. The customer, Furn&U, made a deposit of GBP6 750 (GBP = Great British Pound) on
25 August 2017 (which equated to 25% of the total contract price). These customised units were a
specific order and not expected to be easily sold to any other customers. The contract would only
have been fulfilled if all 50 units were delivered. In November 2017 Furn&U was liquidated before
taking delivery of the chairs or paying the remaining 75%. As the contract was effectively breached,
Mxolisi became legally entitled to keep the deposit already received. At year end Mxolisi set off the
25% deposit received against the carrying amount of the inventory. The total cost of the inventory
amounted to ZAR366 000 before taking into account the 25% deposit. At 31 December 2017 the net
realisable value of the customised lounge chairs was ZAR7 000 per chair. The contract is
denominated in ZAR.
1.4 Disposal group classified as held for sale
On 31 December 2017 the directors of R&M and Mxolisi decided to sell off some of the assets of
Mxolisi to improve the cash flow of the R&M group. The sale was considered to be highly probable.
The assets were available for immediate sale in their current condition. The group of assets to be
sold did not represent a cash-generating unit, separate major line of business or geographical area
of operation. The assets were to be sold in a single transaction (i.e. as a group of assets) and were
correctly classified as held for sale on 31 December 2017. The CFO has assessed the group of
assets for impairment in terms of IAS 36, Impairment of Assets and has correctly concluded that no
separate impairment is required on the individual assets. The directors of R&M nevertheless decided
to sell the assets as a disposal group in view of the need to improve R&M’s liquidity.
The directors began to actively seek a South African buyer for the assets. The assets were marketed
at their total combined fair value of ZAR21 million and the sale was expected to occur within six
months after the directors made their decision. Costs to sell were deemed to be negligible. One of
the prospective buyers indicated that it would convert the head office building into an art gallery for
local work and use the lounge chairs (inventory in note 1.3 above) as furniture.
- 33 -
Schedule 1: Carrying amounts of assets of Mxolisi to be sold as a disposal group
31 December 31 December
Measurement
Notes 2017 2016
basis
ZAR ZAR
Investment property 1.4.1 Fair value 6 750 000 7 000 000
Head office in the central
business district 1.4.2 Fair value 5 500 000 5 000 000
Investment in bonds 1.4.3 Fair value 8 630 137 8 366 720
Intangible asset 1.4.4 Historical cost
(cost model) 1 000 000 ‒
Inventory (50 customised Cost less
lounge chairs) deposit 244 500 ‒
Carrying amount of disposal
group 22 124 637 20 366 720
Notes to schedule 1
1.4.1 Investment property
The investment property consists of land that was purchased on 1 May 2002 for ZAR1 500 000. The
land was held for capital appreciation and was correctly accounted for at year end in terms of IAS
40 Investment Property, as per the schedule above. The fair value of the investment property was
determined by a third-party property valuer, Mr Prop Guru.
1.4.2 Head office building
The head office building in the central business district (CBD) was purchased for ZAR2 million on
31 December 2001. No tax allowances were granted on the building. At the date of purchase, the
asset had a useful life of 50 years and the residual value of the building was estimated at ZAR0. The
depreciable amount relating to the head office building is allocated using the straight-line method.
These estimates have remained unchanged.
R&M changed its accounting policy on all buildings on 31 December 2016 to the revaluation model
in terms of IAS 16 Property, Plant and Equipment. At that date the building was correctly revalued
by ZAR3 600 000 to its fair value of ZAR5 million. It was correctly revalued to ZAR5 500 000 at
31 December 2017. The fair value of the head office building was also determined by Mr Prop Guru.
It is the accounting policy of the R&M group to revalue buildings at the end of the financial year
based on their fair value at that date and to recognise depreciation based on the revalued carrying
amount as at the beginning of the year. R&M has not recognised any depreciation relating to the
head office building for FY2017.
1.4.3 Investment in bonds
Mxolisi purchased 90 000 ZAR100 5% bonds in Angloville at their fair value of ZAR8 058 615 on
1 January 2015. The bonds mature on 31 December 2018. Interest is paid annually in arrears and
commenced on 31 December 2015. Interest has consistently been paid on the due date. At the date
of purchase, the credit quality of the bonds was not considered as ‘low credit risk’. The instrument
has been correctly classified and measured at fair value through other comprehensive income in
accordance with IFRS 9, up until the end of the prior year (31 December 2016). The only entry
processed for FY2017 was to reduce the carrying amount of the bonds by the interest of ZAR450 000
that was received in cash at year end. The fair value of the bonds was ZAR8 366 720 at 31
December 2016 and ZAR8 630 137 at 31 December 2017.
- 34 -
The following extract in terms of IFRS 7 Financial Instruments: Disclosures was presented in the
audited financial statements as at 31 December 2016:
… if the investment in Angloville bonds had been classified at amortised cost, the carrying
amount would have been ZAR8 292 418 (2015: ZAR8 117 004), determined as follows:
2016 2015
ZAR ZAR
Gross carrying amount 8 492 418 8 267 004
Expected credit loss allowance (200 000) (150 000)
Amortised cost 8 292 418 8 117 004
At 31 December 2017, the following management assumptions in respect of the bonds were
applicable:
Expected credit loss

as a percentage of
gross carrying amount
12-month 3,0%
Lifetime 3,6%
The credit quality of the bonds remained unchanged throughout the period under review. The
management assumptions represent the exposure (i.e. value) at the point of default.
1.4.4 Intangible asset
The intangible asset related to a patent developed by Mxolisi for a leather protector product. The
patent was registered on 31 January 2017. ZAR860 000 of the ZAR1 million recognised related to
the registration cost of the patent. A further ZAR140 000 was incurred during the production of initial
marketing units, when alternative designs were researched, and was capitalised. These units were
given to various customers during June 2017 to introduce and promote the product. The patent was
expected to have a useful life of three years from 30 June 2017 when it became available for use.
The South African Revenue Service permits the deduction of these costs in the same manner as
which they are expensed in terms of IFRS.
2 iDish
One of R&M’s wholly-owned subsidiaries, AppliCo (Pty) Ltd (‘AppliCo’), manufactures various large
kitchen appliances, such as dishwashers, washing machines, fridges and freezers. AppliCo is a
South African registered company with a manufacturing plant in Durban. AppliCo is considering
various strategies for selling 9 000 units of its latest product, called the iDish. iDish is an energy-
efficient dishwasher marketed under a premium luxury brand that provides high-quality after-sales
support.
AppliCo’s annual production capacity for the iDish is 9 000 units. Based on market analysis findings
of the research team, the Board is considering opportunities in the following African markets as
opposed to only pursuing growing its market share in South Africa:
- 35 -
Country South Africa (SA) Kenya Zambia
General facts and considerations
Summary of key  SA has a fairly  Kenyans typically  Zambia is a typical
market large growing have less dual currency
information middle income disposable income market due to its
group, and than South highly volatile
customers are Africans, but a currency and
generally brand strong savings inflation concerns
conscious culture. In recent  Zambians have
 Target market times the middle relatively less
consumers income group has disposable income
surveyed scored grown significantly than Kenyans and
high on  Kenya has an South Africans
environmental unorthodox and  Zambia is
awareness and developing regarded as a
indicated a high financial services commodity
preference for industry. economy with
clean, energy Traditional finance copper and other
efficient products products are not mining resources
 Given that large readily available, making up most of
urban areas have but innovative its exports and
an adequate water mobile money foreign currency
supply, it is solutions and inflows into the
expected that the micro finance country
product could be markets have  The financial
used with relative emerged to cater services industry
ease for the growing is dominated by
 Consumers have demand local branches of
access to formal  Energy and water foreign banks;
and informal credit supply is typically thus loans tend to
providers stable, but be expensive with
 There is increased increasing high interest rates
stability in the demand is and fees due to
energy supply, with expected to place observed historic
many in the middle additional defaults
to higher income pressure on both  The power and
groups moving to supply networks water supplies are
alternative sources  Target market unreliable and
of energy surveys showed unstable. The
 Increased that Kenyan government is
regulatory focus consumers have a concerned about
from credit and preference for over-reliance on
consumer clean and efficient one type of energy
protection agencies products but price (hydro power), but
has damped is a big deterrent it is unsure how to
economic growth to such purchases resolve this in the
and consumer  A well-known immediate future.
spending management  According to
 A recent article in a consulting target market
popular newspaper company report surveys Zambian
indicated that highlighted consumers
consumers are Kenyans’ appetite demand durable,
increasingly for global brands cheap and
exercising their and imported effective
rights regarding products appliances
product warranties
- 36 -
Country South Africa (SA) Kenya Zambia
Economic considerations
Gross Domestic USD5 800 USD1 700 USD1 300
Product per capita
Infrastructure
 Electricity 34 000 megawatts 2 200 megawatts 2 347 megawatts
85% fossil fuels 37% hydro power 96% hydro power
33% fossil fuels
27% geothermal
 Transport
 Road 947 000 km 161 000 km 40 000 km
 Rail 20 500 km 2 000 km 2 200 km
 Sea 4,8 million container 1 million container None
(harbours) port traffic port traffic
 Air 200 000 registered 81 000 registered 10 000 registered
carrier departures carrier departures carrier departures
Financial considerations and assumptions
Sales price per ZAR6 500 KES64 000 (Kenyan ZMK8 600 (Zambian
unit Shilling) Kwacha)
(ZAR8 500) (ZAR12 000)
Manufacturing
cost per unit ZAR3 000 ZAR3 000 ZAR3 000
Logistics cost per
unit ZAR100 ZAR1 200 ZAR1 600
Export/import
duties per unit ZAR0 ZAR200 ZAR2 500
Potential demand
for units 35 000 6 000 2 000
Unknown factors  Management does not know what the cost of insurance associated
with transportation to each sales market would be
 Management is unsure about global competitors’ strategies for
entering the African market, but does not think it will be a focus area
due to the small demand
Neutral factors Sales/value-added tax does not affect the consideration of selecting a
sales market
3 Extract of the draft 2017 audit report
Key audit matters

Accuracy and recoverability of deferred tax asset
A deferred tax asset has been recognised on the income tax loss of S&T, a subsidiary of the
R&M group, to the extent that it is probable that future taxable income will be available against
which the unused tax loss can be utilised.
We focused on the accuracy and recoverability of this deferred tax asset because of its
materiality and the level of estimation that is required when assessing S&T’s expected future
taxable income and whether it will result in the utilisation of the tax loss in the future.
- 37 -
Fair value of Mxolisi properties included in assets held for sale
On 31 December 2017 the directors of the R&M group decided to sell some of the assets of
Mxolisi. The directors accounted for the transaction in accordance with IFRS 5 Non-current
Assets Held for Sale and Discontinued Operations. The R&M group was required to
determine the fair value of the assets included in the sale. This included the valuation of an
investment property (fair value: ZAR6 750 000) and a head office building (fair value:
ZAR5 500 000) in the CBD.
Due to the materiality of the fair values of the properties, they were considered to be key
audit matters.
4 Summary of discussions held with the CFO on 14 January 2018
 R&M was almost placed in provisional business rescue on 15 August 2017, although this was
ultimately unsuccessful when challenged in court. Due to the unsuccessful business rescue
challenge and the going concern assessment performed by management, the Board of Directors
believes that the preparation of the financial statements on a going concern basis is appropriate.
 Thandeka re-iterated the importance of completing the FY2017 audit much earlier than usual as
the company’s bankers are insisting on receiving the audited financial information to determine
whether they are willing to increase the overdraft facilities granted to the company. The present
overdraft facilities are secured by means of a notarial bond over debtors and inventory.
 R&M experienced significant losses in FY2015 and generated a small profit in FY2016.
Thandeka suspects this was due to a drop in local demand for its furniture and related products
and the economic downturn, which affected the sales of their luxury furniture products.
5 Additional information
 Assume a current tax rate of 28% and a capital gains tax inclusion rate of 80% for all periods
under review.
 All companies within the R&M group prepare their financial statements in accordance with
International Financial Reporting Standards (IFRS).
 The R&M group has early adopted IFRS 9, including section 6 on hedge accounting.
 Round all amounts to the nearest ZAR.
 The following exchange rates may be applicable to the above-mentioned issues:
3 month FEC 2 month FEC

Spot rate
rates rates
GBP : ZAR USD : ZAR USD : ZAR USD : ZAR
30 November 2016 1 : 14,10 1 : 14,35 1 : 14,25
31 December 2016 1 : 13,50 1 : 13,70 1 : 13,62
28 February 2017 1 : 13,00 1 : 13,30 1 : 13,20
25 August 2017 1 : 18,00 1 : 13,00
31 December 2017 1 : 15,00 1 : 11,00
- 38 -
REQUIRED:
Marks
PART II Sub-
Total
total
(c) Identify and discuss the key factors that the management of AppliCo
should consider in evaluating in which African market(s) (South Africa,
Kenya, Zambia) it should sell its iDish product. 14
Communication skills ‒ clarity of expression 1 15

(d) Prepare a memorandum addressed to the Risk Committee of the R&M
group setting out the key business risks for the group arising from its
strategy to operate in greater Africa. 13
Communication skills ‒ presentation 1 14

(e) Discuss the alternative courses of action that could be taken by the Board
of Directors to address the liquidity issues that the R&M group is facing. 6
Communication skills ‒ logical argument 1 7

(f) Discuss the advantages to the quality of the external audit that should be
considered if it is decided to change auditors as requested by the non-
executive directors of the R&M group. 7 7
(g) List the substantive audit procedures that AIP Auditors should perform to
address the following key audit matters:
(i) Accuracy, valuation and allocation of the deferred tax asset on the
tax loss of S&T; and 9
(ii) The fair value of Mxolisi’s properties included in assets held for sale. 9
Communication skills ‒ layout and structure; presentation 2 20

Total for part II 63
- 39 -
Part (c) Identify and discuss the key factors that the management of AppliCo should
consider in evaluating to which African markets (South Africa, Kenya, Zambia) it
should sell its iDish product.
1 Management of AppliCo need to consider both financial and non-financial
factors in deciding whether to invest in accessing the greater Africa market, 1
such as:
Financial factors: market demand, profitability and other cost implications of 1
each region.
Non-financial factors:: product perception, (the iDish is seen as a luxury item), 1
market sustainability (small markets may fade quickly) and the impact of laws
and regulations (credit, consumer protection laws) on the business.
2 Management’s risk appetite: relates to balancing the trade-off between risk
and return, e.g. does the estimated initial excess profitability in the Zambian 1
warrants taking the additional risks such as poor infrastructure, reliability of
delivery, etc
3 Profitability for each alternative is critical in the decision-making process. 1
3.1 Zambia is the most profitable per product per unit R4900, Kenya R4100 1
whereas South Africa R3400 is the least profitable per unit (profit per unit).
As production capacity is limited to 9000 units, profit should be maximized if sale 1
preference is given to Zambia 12 000 units, Kenya 6000 and SA 1000
- resulting in a maximum available profit of R29,9 million. 1
3.2 Insurance cost for each alternative should be considered as well: 1
Should insurance and other related cost be marginal for South Africa, and more
than R1 500pu for Zambia and R200 for Kenya, South Africa would be the better 1
option. (SA cost marginal vs other countries)
4 Logistical (transport) considerations and implications by country, 1
considering the information provided by the research team
4.1 Zambia:
The transport options available to deliver to Zambia are limited as it has no
access to sea transport or low cost air carrier numbers. 1
- The most viable options would be via road and/or rail which are
expected to be higher risk and lead to higher insurance costs, 1
operating losses and damaged goods costs
4.2 Kenya:
Transport to Kenya has a sea transport option, which appears to be relatively 1
better developed than its road and rail networks,
- Sea carriage poses risks of pirates along the East African coastline and 1
could result in high maritime insurance costs.
- Air transport appears a viable option with a comparatively high 1
number of registered carrier departures.
4.3 South Africa:
Have well-developed road, rail, sea and air network 1
- Access and transport related cost such as insurance and other costs
are expected to be low and delivery more reliable. 1
5 Consumer market and sustainability of demand
product’s affordability and its ability to meet consumer needs in each of the 1
assessed markets:
5.1 South Africa.
Consumer market demand in South Africa is more than five times that of the 1
other markets.
Consumers have on average more than three times the GDP per capita, 1
access to finance/credit making them more likely to invest in convenience items. 1
- 40 -
This is further supported by the product’s focus on energy efficiency and
after-sales support, which should result in a stable ongoing market across the
country.
This is however offset by strong and active competitive forces in the market, 1
the increased consumer activism and apparent rise in warranty claims.
These factors could result in increased compliance, legal and warranty costs. 1
5.2 Kenya
Kenyan customers prefer buying cash rather than credit, aligned to their
culture of savings and limited access to formal credit markets. 1
This may indicate a need for a different marketing approach to target cash
consumers opposed to using credit as a lure. 1
The growing middle income bracket aligns with AppliCo’s need to find new
growth markets and Kenya could open opportunities for other AppliCo products 1
as its brand becomes more recognised.
The consumers’ price sensitivity could result in lower than expected sales
depending on alternatives and local competitor actions in the market. 1
Consumer and government desire for sustainable and efficient energy
support the iDish which meets these demands and could support the initial 1
product launch.
Kenyans ‘appetite for global brands’, works in AppliCo’s favour. 1
5.3 Zambia
Consumers are comprised largely of persons in the lower income bracket and 1
the product might appear expensive.
The appetite for the product is likely to be subdued with an expected demand of 1
only 2 000 units.
The products status as a leading brand is missed on the Zambian consumer,
who demands low-cost, durable products. 1
The lack of formal credit markets and high interest rates make cash sales 1
critical and at current levels it is hard to see the iDish achieving even its low
demand expectation.
The currency volatility could erode any profits made in Zambia due to the 1
depreciation in the currency, resulting in reduced profitability or potentially losses
being incurred.
6 Energy and water supply as the product requires a stable supply of water and 1
electricity, which is a scare resource.
The risk of unstable supply could damage the iDish, it also affects the usability 1
of the product.
6.1 South Africa and Kenya both have extensive water supplies to homes and
stable electricity supplies, which means that the consumers would benefit from 1
use of the product.
6.2 Zambia’s have inconsistent power supply, resulting in consumers having less
desire for the product as they might not continuously benefit from its use. 1
7. Market focus: AppliCo is able to deliver 9 000 units to the market. It should 1
consider whether it wants to pursue a single market or a mix of markets
7.1 Zambia:
Small market, high margins: If it wants to pursue a single market, Zambia, 1
which only has a potential demand of 2 000 units, may not be best alternative.
However, the potential excess profit per product could justify the immediate 1
investment.
7.2 Kenya and South Africa:
appear to have a strong demand for the product, but demand is offset by lower 1
margins.
7.3 AppliCo should consider its competition within each of the markets against other
global and local brands (e.g. Samsung, LG, Bosch) and consider its offering and 1
support services relative to its competitors.
- 41 -
7 General
7.1 AppliCo is not known in the Kenyan and Zambian markets, and might have to
spend considerable amounts of money on marketing to create awareness of 1
the company and its products.
7.2 AppliCo has not traded in the Kenyan and Zambian markets and does not know 1
the markets – it might get its strategy very wrong if it do not understand its
customers’ needs.
7.3 Kenya and Zambia might not have the same electric current as South Africa,
which might mean that additional costs need to be incurred for conversion plugs. 1
7.4 R&M is suffering from liquidity issues which begs the question of where
AppliCo will get the funding for its growth strategy. 1
7.5 Political environment and business stability in Kenya and Zambia which could 1
affect exports and demand.
7.6 Local laws and regulations affecting imports and sale of foreign goods in 1
Kenya and Zambia.
7.7 Cost of providing after sale support: will be much higher for Kenya and 1
Zambia than SA.
Available 51
Communication skills ‒ clarity of expression 1
Maximum part (c) 15
Part (d) Prepare a memorandum addressed to the Risk Committee of the R&M group setting
out the key business risks for the group arising from its strategy to operate in greater
Africa.
Memorandum format
1 Political/economic risk ½
1.1 Operating in a volatile and politically unstable economy holds the risk for the group
of the recoverability of investment/profits derived from African countries due to
1
repatriation restrictions.
1.2 The long-term sustainability of the business can be compromised as a result of 1
government policy changes, protectionism and populist politics.
1.3 Resource dependent economies, such as Zambia and most other African states, are
vulnerable to commodity price movements, making market demand less 1
predictable and increasing earnings volatility.
1.4 There is an increased exposure to bribery and corruption given that the group is
considering entering new countries where corrupt officials may target new entrants to
1
the market.
Increased legal, and reputational risk resulting from the risk of bribery and the risk of
1
employees succumbing to the pressure to give bribes to achieve profitability and sales
targets.
2 Forex risk ½
2.1 Currency volatility is a constant concern. The group is exposed to foreign currency
risk (USD vs ZAR) which could lead to foreign exchange gains and losses distorting
1
performance.
3 Forecast/model risk ½
3.1 Estimating consumer demand in foreign markets requires significant assumptions
1
and estimations
3.2 Due to the limited knowledge of the different consumer needs it is likely that
under/over estimation could arise, resulting in realised margins differing significantly 1
from the forecasts.
4 Regulatory risk ½
4.1 Cross border regulatory risk such as taxation, VAT, transfer pricing and double 1
taxation agreement issues.
This could include exchange control issues. 1
- 42 -
4.2 These issues can exercise a material drag on realised margins/payments delayed.
1
Non-compliance with laws and regulations could result in fines and penalties 1
(legal risks).
5 Control risk ½
5.1 There is a business risk that the entity is expanding rapidly beyond SA borders and
the internal controls may not be adequate, resulting in operational failures and 1
ultimately losses being realised.
6 Skills risk ½
6.1 There may be a lack of skills for the integration and daily operations of the new
businesses in Africa, resulting in slow market penetration, poor customer service and 1
product delivery.
7 Quality risk ½
7.1 The iDish is known for its high-quality after-sales support. This may be difficult to
1
achieve in foreign countries.
8 Logistical risk ½
8.1 There is a business risk that deliveries are not scheduled correctly or that deliveries
1
are incorrect (both quantity and type).
9 Opportunity cost ½
9.1 The risk is that expansion will not be profitable and other more profitable
investments may be overlooked or cannot be taken up because the group’s capital 1
is tied up in this iDish venture.
10 Hedging risk ½
10.1 The cost of hedging certain illiquid currencies may also reduce expected profit
1
margins, making risk management less economical.
10.2 Hedging costs may also be uneconomical, resulting in the business not managing risk
1
appropriately.
11 Other risks
11.1 There is a risk of operational failure as AppliCo neither knows the African market,
1
nor is known in the African market (possible culture differences as well).
11.2 Water supply issues and different electric currents in the other African countries
may damage the product, with a resultant high repair costs as the company is not
1
based in those countries.
11.3 Currently the company have liquidity problems, and expanding into Africa will
1
require significant cash flows increasing the risk of business failure.
11.4 Any other valid point (Specify) 1
Available 27
Communication skills ‒ presentation 1
Maximum for part (d) 14
Part (e) Discuss the alternative courses of action that could be taken by the Board of
Directors to address the liquidity issues that the R&M group is facing
1 Funding sources
1.1 Consider the possibility of a new substantial share issue. The Debt: Equity
1
ratio is very high and issuing shares will restore some balance.
The question is, however, whether shareholders would be willing to take up
1
shares in a struggling company?
1.2 Is there any possibility of loans from shareholders/guarantees by interested
1
parties?
1.3 Consider a possible subordination agreement with present shareholders in
1
respect of long-term loans..
- 43 -
1.4 The company may be able to negotiate overdraft facilities 1
1.5 It may be able to convert some long-term loans to equity if a viable recovery 1
plan can be put to the bank.
However, the limited security that is available may be an obstacle. 1
1.6 Possible discounting / factoring of debtors 1
1.7 Possible compromise with creditors may be attractive given that underlying
assets are unlikely to realise values reflected in the draft annual financial 1
statements if the African operations are not a success in the future.
1.8 Sale and leaseback of any viable assets could be considered. 1
2 New business
2.1 Given market information, the chances in this regard seem slim, but it may be
worth exploring the possibility of negotiating with other agencies / joint 1
ventures to gain access to overseas markets.
3 Contain / reduce costs
3.1 An analysis of operational areas making losses should be undertaken to
1
consider the possibility of closure or automation.
3.2 Staff could be retrenched to reduce costs over the long term.
1
However, severance payments may reduce the immediate cost saving
1
benefits.
3.3 Assets could be sold off, although this may also be difficult in the present
1
economic climate.
3.4 Could other cost areas be limited by for example investigating / preventing
1
frauds?
3.5 The company should consider additional closure costs that may arise and
1
determine how to provide for these.
3.6 Long term product change: change focus from ‘luxury’ furniture to easy-to-put-
together, inexpensive products (perhaps more viable in SA market?) 1
3.7 The company should consider halting the expansion into Africa and rather
concentrate on its South African business until liquidity issues have been
1
addressed.
3.8 Consider selling household appliances on assignment, rather than
producing the products (e.g. the iDish). 1
Available 20
Communication skills – logical argument 1
Maximum for part (e) 7
Part (f) Discuss the advantages to the quality of the external audit that should be
considered if it is decided to change auditors as requested by the non-
executive directors of the R&M group
1 New team on the audit:
 It could result in the introduction of new expertise available in the new 1
auditing firm to which R&M have not previously been exposed; 1
 It could better service the client’s needs and unique risks faced by the client; 1
and 1
 It could provide an opportunity to strengthen the exercise of professional 1
scepticism. 1
 Better/new look and understanding of the clients business risks 1
 Better/new look and understanding of the audit risks
 Better / fresh look and understanding of the control environment 1
 Understanding and documenting the clients systems and controls will 1
result in a fresh look and reduce the possibility of fraud, error and
misstatement
- 44 -
 New firm might follow different audit approaches which are more risk
effective given a fresh look.
 New methods of sampling and substantive testing could reduce risk of
material misstatement
2 It will reduce familiarity and self-interest threats to auditor independence that 1
could lead to auditor bias or complacency.
3 The existing auditors are likely to perform their audit testing and
documentation more thoroughly as the new audit firm will be assessing the 1
present firm’s work.
4 This helps prevent over-reliance on fees by an audit firm. The audit firms will
be forced to rotate clients and therefore not compromise quality to service a key 1
client.
5 As tendering audit firms will need to submit tenders and proposal documents to
secure new audits, it will allow audit committees to ensure that firms 1
selected have the risk level of skill and expertise to perform the audit.
6 Auditors will remain professionally sceptical and will not overly trust the
1
client’s assertions.
7 It will have a positive impact on the appearance of auditor independence
1
from the perspective of the user of the financial statements.
8 Could improve the clients governance as the audit committee does not become
1
over familiar with the audit firm and partners
Available 16
Maximum for part (f) 7
Part (g) List the substantive audit procedures that AIP Auditors should perform to
address the following key audit matters for the deferred tax asset and the
two properties
(i) List the substantive audit procedures that AIP Auditors should perform to
address the following key audit matters for the deferred tax asset and the two
properties
Accuracy, valuation and allocation
1. Request a schedule reflecting the computation of the deferred tax asset as 1
at 31 December 2017 and perform the calculations
2. For the deferred tax schedule: 1
 agree the schedule amount to the total of the deferred tax balance in the 1
general ledger, trial balance and AFS
 agree the tax loss per schedule to that of the tax loss as per the clients tax 1
workings 1
 inspect the schedule to ensure that the deferred tax amount was computed
by applying the tax rate of 28% to the total estimated tax loss.
3. Audit the assessed tax loss for 2017 by::
 agreeing the amounts as per the client tax computation 1
 inspect their workings for any errors with the client’s tax computation. 1
 agree to the tax loss to the audit work performed on the income tax 1
computations 1
 discuss the tax work and assess loss with the audit firm’s tax specialists
4. Inspect S&T’s latest SARS income tax assessment to assure that the tax loss
brought forward from FY2016 and used in the computation of deferred tax 1
asset, is accurate.
Valuation (relating to recoverability of the deferred tax asset)
5. Inspect S&T’s budget for 31 December 2018 and future years to determine the 1
estimated taxable income to be generated against which the accumulated tax
losses could be utilised.
- 45 -
6. By enquiry and discussion with management obtain an understanding of 1
management’s budgetary process to ensure the process results in a robust
and realistic budget. 1
Consider the qualification and competence of persons preparing the budget
7. Perform analytical procedures on the amounts in the budgets, as follows:
 Compare the figures in the budget from 2017 to that of 2018 and 2019
(month to month / year to year etc.). 1
 Obtain an understanding of any unusual changes by enquiry from
management, and inspection of supporting documentation. 1
8. Evaluate the assumptions made by management in preparing the budgets by
enquiry from management and inspection of supporting documentation. 1
9. Re-perform calculations to verify the clerical accuracy of the budgets. 1
10. To establish management’s budgetary ability, compare management’s 1
budgeted profits for prior years and 2017 to the actual historical performance
to audit the reasonability thereof.
11. Inspect the minutes of the meeting of the Board of Directors, where the 1
budget was approved as being reasonable.
12. Inspected the notes to the annual financial statements for the disclosure 1
made by the directors regarding their expectation of the recoverability of the
deferred tax asset to ensure adequate disclosure of the level of uncertainty was
provided.
13. Request that management include reference in their written management 1
representation letter to the ability of S&T to generate future taxable income.
Available 20
Maximum for part (g) (i) 9
(ii) List of substantive audit procedures to address the fair value of Mxolisi’s two
properties included in assets held for sale
1. Request the reports prepared by Prop Guru, and re-perform all calculations 1
in the reports (and supporting workings).
2. Agree the figures used in Prop Guru’s valuation reports to the relevant account 1
balances in the general ledger, trial balance and annual financial
statements.
3. Evaluate whether reliance can be placed on management’s expert (Prop
Guru) through enquiry of Prop Guru, R&M staff, inspection of relevant
documents, etc and assess 1
 His membership of accredited professional bodies 1
 His experience in doing fair value work on these kind of properties 1
 Their independence / objectivity from the R&M group from Mxolisi,
4. Obtain an understanding of the process followed by Prop Guru in computing
the fair values by: 1
 inspecting the engagement letter setting out the nature, scope and 1
objectives of Guru’s work ; 1
 inspecting the valuation report and enquiry from Prop Guru.
 assessing their understanding of the requirements of the accounting
reporting frameworks (IAS 40/ IAS 16)
5. Agree the property details (such as erf numbers and locations) in the property 1
valuation reports to the title deeds of the properties to ensure the correct
properties were valued.
6. Perform procedures to assess the reasonableness of the expert (Prop Guru) by:
 Comparing the fair value to other recent disposals of properties in the 1
market.
 Assessing the reasonability of the discounted cash flows and discount 1
rates used in the fair value determination. 1
 Agreeing the discounted cash flows to budgets, contracts/market rates.
- 46 -
7. Should there be a significant disagreement between the auditors fair value
findings and that of Prop Guru’s, obtain permission from management 1
to appoint an “auditors own expert”. 1
8. Request that management include reference in their written management
representation letter to the appropriateness of the fair values attributed to these 1
properties in the annual financial statements.
Available 15
Maximum for part (g)(ii) 9
Communication skills ‒ layout and structure; presentation 2
Total for part (g) 20
- 47 -

Module 9 - Substantive Proc - Class Q - 23 July

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College of Business and Economics

AUDIT, ASSURANCE AND GOVERNANCE

CLASS QUESTIONS: 23 July 2019

Prof. Ben Marx

© All rights reserved.

Question 1 Dynamico Auditors ITC June 2013 80 marks

Question 2 Winterfell ITC June 2016 70 marks

Question 3 AIP Auditors ITC June 2018 63 marks

Dynamico makes extensive use of general audit software.

Work paper Reference

4 Outsourcing of website maintenance and catalogue design

5 Strategy and risk

Strategic objective Key risks Management plans

EXTRACTS FROM THE STATEMENT OF COMPREHENSIVE INCOME

Cost of sales 145 000 133 000

Net profit after tax 105 000 90 000

EXTRACTS FROM THE STATEMENT OF FINANCIAL POSITION

Notes to the financial statements

Further explanatory audit work paper note

Further explanatory audit work paper note

2.1 The company operates a periodic inventory system.

1 General system overview

Communication skills – layout and structure; clarity of expression 2 17

Communication skills – clarity of expression; logical argument 2 17

Communication skills – clarity of expression 1 15

Communication skills – layout and structure 1 28

(ii) Formulate the substantive procedures to audit inventory at year end

F200 Fixed assets – understanding the rental car fleet

The board of directors of Lannister is as follows:

2 Potential business contract with 2Go

The SLA includes the following terms and conditions:

1 Lannister car rental services – booking of rental cars

2 Lannister car rental services – collection of rental cars

The rental facilitator then releases the car to the customer.

3 Lannister car rental services – return of rental cars

The hold on the customer’s credit card is then released.

Communication skills – clarity of expression 1 15

Communication skills – logical argument 1 17

Communication skills – clarity of expression 1 19

(d) Based on the information provided in workpaper F200, describe the

Ignore audit work relating to the following:

Communication skills – clarity of expression 1 19

Total for part I 70

You have received the following information:

EQUITY AND LIABILITIES

1.1 Deferred tax asset

1.2 Hedge of revenue transaction

1.4 Disposal group classified as held for sale

1.4.1 Investment property

1.4.2 Head office building

1.4.3 Investment in bonds

Expected credit loss

1.4.4 Intangible asset

3 Extract of the draft 2017 audit report

Key audit matters

4 Summary of discussions held with the CFO on 14 January 2018

3 month FEC 2 month FEC

Communication skills ‒ clarity of expression 1 15

Communication skills ‒ presentation 1 14

Communication skills ‒ logical argument 1 7