College of Business and Economics

School of Accounting

Department of Accountancy

MODULE 4 Engagement and Planning

AUDIT, ASSURANCE AND GOVERNANCE

Prof. Ben Marx

2025

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 [DOCUMENT TITLE]

Step 5: Self-reflection & correction: (section 6 and 7)

Reflect on your understanding of the client acceptance
and audit planning concepts relating to the external audit
as per the Class Questions

Do the Self-Assessment questions provided and reflect

on your application of the principles

Do the homework question for hand in

Step 4: Solve the problem: (Section 5)

Understanding how to apply client information practically
to evaluate new clients, do risk assessment and plan
audits

Step 3: Understand the theory: (section 2,3 and 4)

Understand and contextualize the principles underlying
Client-acceptance and Planning of audits

Step 2: Understand the problem:

Why is important to evaluate potential client before
acceptance as an audit client?
Why is it important to understand and plan a client’s audit
carefully?

Step 1: Problem discovery:

What are :
- pre-engagemnt audit activities
- risk assesment and planing audit activities

Pre-reading: Read the article and consider whether you

would have retained Salungano as an audit client

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CONTENTS PAGE

1. STUDY OBJECTIVES 3

2. STUDY MATERIAL 3

3. EXAMINATION POSSIBILITIES 3

4. STUDY APPROACH 3

5. CLASS QUESTIONS 6

5.1 Motor Makers

5.2 IQ Limited

6. SELF ASSESMENT QUESTIONS: 18

6.1 Dludlu & Scott

6.2 CFC LtD
6.3 Starnet
6.4 ACS 3.3
6.5 ACS 3.11

6. HOMEWORK QUESTION FOR SUBMISSION 25 MARCH: 58

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1. STUDY OBJECTIVES

After studying this module you should:

■ have a deep understanding of:

- the considerations and procedures that relates to the engagement activities;
- the considerations and procedures that relates to the planning of the audit and
each of the stages thereof;
- the identification of and response to business and audit risks.

■ be able to apply the knowledge to practical audit situations.

The above objectives are met by studying and understanding the principles in the
textbook and then to master the practical application thereof by doing the questions
(class, self-assessment and homework questions).

2. STUDY MATERIAL

Study Source: Dynamic Auditing, Chapter 5 and 8.

Reference: ISQM1 and ISQM21; ISA 220, ISA 200, 300, 315 (R), 320, 330.

3. EXAMINATION POSSIBILITIES

These aspects will be examined through questions where you have to apply the relevant
principles.

A thorough knowledge and understanding of the topic is thus essential.

4. STUDY APPROACH

The approach you should follow to master the topic is the following:

4.1 Underlying theory

# Study and understand Dynamic Auditing:

 Chapter 5: The audit process and audit practice matters.
 Chapter 8: Engagement and planning activities

You should know and understand the principles as explained in the textbook. This forms
the basis of this section of the work and is a prerequisite for answering an audit question
thereon.

# Refer to the ISA’s where necessary (Audit Statements): Open Book for reference
purposes.

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4.2 Practical applications

You should attend the face-to-face class where the work will be explained and
contextualized and thereafter you should study and master the concepts yourself, after
which you should:
- Revise the class questions to master your understanding of how the underlying
principles are applied practically to a real-life scenario (question).

# Self-assessment Questions

- These questions you should do in your own time and assess your answers in detail
against the suggested solutions.
-
# Homework

You should do the question for hand in in class on 25 March.

If you have any problems with the work, you should immediately contact us for help.

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5. CLASS QUESTIONS

QUESTION 5.1 (35 MARKS)

You are a partner at Raurek & Partners, a medium sized auditing firm whose head office is situated
in Johannesburg. For a number of years your firm has been acting as the auditors of Motormakers
Limited, a company which manufactures spare parts for motor vehicles for the local and export
market. The company’s year-end is 31 March.

During the audit planning meeting with management to determine the scope of the audit, you were
informed that the company’s shares had changed hands and that a foreign company which is
registered in Germany now holds 65% of the issued shares. The financial manager of Motormakers
informed you that the audited financial statements have to be with the company’s holding company
in Germany by 16 April 2025 for consolidation purposes. The holding company’s year-end is also
31 March.

The following interim financial statements for the six months ended 31 March 2024 were also made
available to you:

Statement of financial position for the 6 months ended 31 March 2024:

Land and buildings 3 000 000

Plant 4 000 000
Current assets 2 500 000
Construction costs 591
9 500 591

Shareholders’ funds 4 000 591

Long-term loan (see 1) 2 500 000
Current liabilities 3 000 000
9 500 591

The sales and profit figures were as follows:

ACTUAL: 6 MONTHS BUDGETED FOR THE

ENDED 31 MARCH 2024 6 MONTHS ENDED 31 MARCH 2024

Sales 7 500 000 7 800 000

Net profit 1 000 000 1 200 000

The company showed an assessed loss and did not pay any tax.

The financial manager also informed you that the company had large capital expansions which
drastically reduced the manufacturing costs. The expansion was financed through loans.

YOU ARE REQUIRED TO:

a) Quantify the planning materiality which you deem appropriate for the audit for the year ended
31 March 2024; (8)

b) Name the actions which can be taken to perform the engagement within the stated time
frame. You must deal with it in the context of
i) Steps which can be taken by the client (12)
ii) Steps which can be taken by the auditor. (13)

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QUESTION 1 (SUGGESTED SOLUTION)

a) Planning materiality

The planning materiality will be based on actual interim amounts because it represents actual
amounts and appears to be accurate in comparison with the budget. (1)

Criteria Boundaries based on actual

data for 6 months ended
31 March 2024

Turnover 2 - 1% R 37 500 (2) - R 75 000 (1)

Net income 5 - 10% R 50 000 (2) - R100 000 (1)
Equity 2 - 5% R 80 011 (2) - R200 029 (1)
Total assets 1 - 2% R 95 005 (2) - R190 011 (1)

Materiality amounts

Balance sheet: Between R80 011 and R200 000

Income statement: Between R37 500 and R100 000 for 6 months (1)
* Therefore for 12 months between R75 000 and R200 000
(2)
Also consider the effect of qualitative aspects such as risks,
management pressure, etc.

Planning materiality: On average R140 000 (rounded off). (1)

Precision materiality for more risky accounts: set at 75% of planning
materiality.
(Motivation e.g.: Seemed to be good control environment and
ethical management.)

Alternatively: Given the motivation materiality could vary between R75 000 (lowest margin)
and R200 000 (upper margin). (3)
MAXIMUM: 8

b) Actions to meet the reporting deadline

(This is an example of a practical question where you need to think and apply your audit
knowledge.)

i) STEPS THAT THE CLIENT CAN TAKE

1. Accounting records

1.1 Accounting records should be balanced and reconciled on a regular basis

(monthly) to prevent unnecessary delays at year end. Specifically: (1)
- Creditors' statements should be reconciled during the year and
differences must be corrected immediately - not at year end. (2)
- Debtors' accounts should be reconciled during the year as above. (2)

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1.2 Management should ensure that an effective control environment exists, and
that effective accounting and internal controls are in place (so that it is possible
for the auditor to follow a systems-based (test of controls based) approach).
(1)

1.3 Implementation of an internal audit department which: (1)

- can assist the auditor during the audit (1)
- should ensure that the accounting records are accurate and up to date,
and that the internal controls function effectively (1)

2. Confirmations

2.1 Stock counts should be done before year end and adjustments should be
made for movements between the stock count and year end. (1)

2.2 If possible large purchases of stock must be delayed until after the year end.
(1)

2.3 Asset registers should be written up and depreciation calculations completed

before year end. Any acquisition or sale of assets which occur after the
registers have been closed-off can easily be added. (1)

3. Availability of information

3.1 Information, records and source documents, particularly those which will be
examined by the auditor, should be available and should be up to date at year
end. Specifically: (1)
- Where possible arrangements should be made with creditors that the
statements relating to the last month of the financial year will be
collected or posted timeously. (1)
- arrangements should be made with the bank to obtain a bank
statement as soon as possible after year end so that the cash book
can be reconciled timeously. (1)

3.2 Consider making the month end a few days before the year end (e.g.
25 September instead of 30 September). (1)

3.3 Arrangements should be made for the timeous confirmation of overseas

balances. (1)

3.4 The outline of the annual financial statements, together with the notes,
comparative figures and reports can be prepared in advance. Year-end
figures can then be added as soon as they become available. (1)

3.5 The client must be provided with copies of the format of the trail balance and
audit schedules (working papers) so that they can be prepared for the auditor
before arrival. (1)

4. Staff

4.1 All staff members which will be needed for audit purposes, etc. should be
available and helpful. (1)

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 5. Implementation of an audit committee (2)

Which monitors the audit function and ensures that effective accounting and
internal controls are in place. (2)
MAXIMUM: 12

ii) STEPS WHICH THE AUDITOR CAN TAKE

Staff

1. Ensure through good planning that the necessary (adequate) audit staff are available
for the timeous completion of the audit. (1)
2. If possible staff who are familiar with the client's operations should be assigned to the
audit. (1)
3. Inform the client timeously of the assistance which will be required from his staff
members (preparation of schedules, reports etc. for the auditor) (1)
4. Audit staff must be informed of their duties and deadlines before the audit begins.
(1)

Audit approach

5. If permitted by the client's accounting and internal control systems a systems-based

approach should be followed so that year end procedures consists mainly of limited
substantive procedures. This will mean that a large number of the audit procedures
will be completed during the course of the year (tests of controls and early
verification). (2)

Confirmations

6. Stock, fixed assets, debtors and creditors should be verified

before year end and rolled forward. (1)
7. Analytical procedures should be performed during the year on management accounts
to identify items of importance for the audit before year end. (1)
8. Deadlines should be set for each phase of the audit and progress must be monitored
regularly. Corrective steps, if necessary, must be taken immediately. (1)
9. Certificates of balances for loans, deposits and other items should be requested
before year end. (1)
10. Prepare and request the following timeously before year end:
- Bank confirmation letters (1)
- Attorneys' letters (ensure that client requests these timeously) (1)
- Management representations letters. (1)
11. Obtain timeously before year end instructions from the group auditors in Germany
i.r.o. certain specific requirements to be met. (1)
MAXIMUM: 13

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QUESTION 5.2 (40 MARKS)

Background

IQ Inc. (‘IQ’) was appointed as the new external auditor of Furnco Ltd. (‘Furnco’) on 1 April 2021.
One of IQ’s managers in the Technical Department, Ms Bella Cohen, referred this work to the firm.
The Technical Department is responsible for assisting audit teams with queries about financial
reporting issues. Ms Cohen’s father started Furnco in 1980 as well as the Cohen family trust that
holds all the shares of Furnco. Mr Cohen and his wife are the main beneficiaries of the trust. The
company’s year-end is 31 December 2021. You are a trainee on the audit of Furnco.

Furnco’s head office and manufacturing plant are located in Cape Town, with showrooms throughout
the country. Distribution of goods takes place from Cape Town and depots in Durban, Port Elizabeth
and Johannesburg. Furnco employs more than 250 permanent staff to handle every aspect of its
business, from manufacturing or importing the latest trendy furniture to after sales service.
Approximately 40% of goods are imported from China. Furnco prides itself on its free and fast
delivery to customers using its own delivery fleet. With over 30 years’ experience in the South African
furniture industry, Furnco is considered a specialist in its field. The company currently processes
approximately 12 000 orders per annum.

Mr Cohen is the chief executive officer and acting chief financial officer. Furnco’s success lies in
selling large volumes of high quality furniture at reduced prices directly to the public. Until the current
downturn had a negative impact on revenue, this ethos had led to tremendous growth year after year
and has gained the company many loyal customers.

During the financial year ended 31 December 2021 Furnco embarked on a project to renovate its
showrooms and improve its logistics. Prior to this project, Furnco had a single storage facility at
which goods were received and dispatched. Furnco has now set up distribution centres throughout
the country which act as depots for receiving products from overseas or the manufacturing plants
and for dispatching goods to customers. Costs of R10 million relating to the implementation of this
project were incurred in the 2021 financial year. The project has resulted in significantly reduced
lead times and much faster delivery. The new showrooms have more space for in-store promotions.
Management expects a 20% increase in sales as a result of the showroom renovations and a 10%
decrease in costs due to the new distribution process.

The company had material inventory, accounts receivable, and property, plant and equipment
balances at 31 December 2021. Customers purchasing on credit have 24 months to repay amounts
owing and, as with other similar companies, credit losses are significant. Management uses a
provision matrix that specifies fixed provision rates (based on past experience and industry trends)
for the number of days a debt is overdue.

Furnco makes use of a perpetual inventory system. Inventory records are maintained on a
spreadsheet. Management performs regular cycle counts to adjust the book value of inventory to the
actual value and also performs a full inventory count once a year.

Imports are denominated in US dollar. The company uses forward exchange contracts to hedge the
risks associated with foreign currency fluctuations. The company’s policy is to hedge 50% of
anticipated cash flows.

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The following accounting policy relating to cash flow hedges is disclosed: ‘The effective portion of
changes in the fair value of derivatives that are designated and qualify as cash flow hedges is
recognised in other comprehensive income. When the forecast transaction which is hedged results
in the recognition of a non-financial asset (inventory), the gains and losses previously deferred in
equity are transferred from equity and included in the initial measurement of the cost of the asset.
The deferred amounts are ultimately recognised in cost of goods sold in the case of inventory.’

During the current year, an impairment charge of R5 million was recognised in the statement of
comprehensive income against the value of property, plant and equipment as a result of impairment
reviews performed during June 2021.

The company expects an operating loss in the current year due to the impact of exchange rates on
foreign currency transactions not hedged and the impairment of property, plant and equipment.
Management is under significant pressure from investors to minimise the impact of foreign currency
on the financial results of the entity.

Predecessor auditor

The predecessor auditor qualified her audit opinion in 2020 as follows:

‘We did not observe the counting of the physical inventories at the Johannesburg depot at the end
of the year and we were unable to satisfy ourselves by alternative means of the inventory quantities
held at 31 December 2020. As a result we were unable to determine whether any adjustments might
have been necessary in respect of recorded or unrecorded inventories.’

Inventory held at the Johannesburg depot has always been deemed to be material.
IQ has already received a letter from the predecessor auditor in which she stated that she had
resigned from this audit and there is no reason why IQ should not accept the appointment as auditor
of Furnco.

During the planning phase of the 2021 audit, the IQ audit team experienced great difficulty in
reconciling opening balances to the financial statements audited by the predecessor auditor. For
example, the carrying amount of property, plant and equipment in the fixed asset register differs from
the amount disclosed in the previous financial statements by R1 810 500. The financial manager
explained that the predecessor auditor never gave Furnco the final adjusting journal entries arising
from the 2020 audit to process to the fixed asset register. When the financial manager queried this
with the predecessor auditor, she replied: ‘Sorry, the audit file of Furnco seems to be missing, so I
unfortunately cannot assist you.’

Planning materiality

The following working paper was prepared by Tick Evans, one of the members of the audit team.
This is the only working paper in the audit file that addresses materiality in planning and performing
the audit.

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 Client: Furnco Prepared by: TE Date: 15/7/2021
Year end: 31 December 2021 Reviewed by: ID Date: 25/7/2021 C2/12
Subject: Materiality in planning and performing the audit

Source of data: The latest forecast results for the 2021 financial year were used because IQ is
performing the audit for the first time. These were approved by management and are for the full
12 months of the 2021 financial year.

2021 2020
Forecast Audited
R’000 R’000
(Loss) / Profit after tax for the year (8 589) 4 454
Revenue 58 322 51 983
Gross profit 16 950 12 950
Total assets 40 748 45 748

It was decided to use profit or loss for the year as a basis for calculating materiality as it is one
of the most important figures to users of financial statements. The company’s main focus is profit
and for this reason profit or loss was considered to be the appropriate basis for calculating
materiality.

Calculation of materiality: 10% of loss for the year = R858 900, rounded to R860 000.

Conclusion: R860 000 seems to be an appropriate materiality figure. This is also in line with
paragraph A4 of ISA 320, Materiality in Planning and Performing an Audit, which states that profit
before tax from continuing operations is often used for profit-oriented entities.

REQUIRED:

1. Discuss the factors IQ should have considered before accepting the appointment as external
auditor of Furnco. (17)

2. Critically evaluate work paper C2/12 on materiality. (9)

3. Discuss the risks of material misstatement at the financial statement level for Furnco for the year
ended 31 December 2021. (14)

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QUESTION 2 (SUGGESTED SOLUTION)

1. Factors IQ (auditor) should have considered before accepting Furnco as client

 CLIENT CONSIDERATIONS
1. Auditors’ independence from the client should be considered as: (identify
independence)
1.1 Family relationship exists as Cohen’s DAUGTHER (CEO/CFO) is an manager in IQ 1
technical department (why)
- Threat: Self interest, familiarity, intimidations (identify possible type of treats) 1
- Considerations: Nature of relationship/position held by family member/role of 1
auditor
- Significance of threat: significant as daughter is in a position to give technical 1
advice/review of FS and father as acting CFO/CEO is responsible for
preparation thereof (why significant)
- Conclusion: Acceptable if daughter is not involved in audit or review/give 1
advice on FS
1.2 The previous auditor did adjusting journal entries which is classified as Accounting & 1
bookkeeping services – this may be required of IQ as well
- Threat: self-review threat (identify type of treat) 1
- Companies act: possible contravention of section 90(2) – performing 1
bookkeeping services
- Considerations: not acceptable if management functions performed/alterative 1
acceptable if auditors only advise and client process (motivate)
2. Client’s integrity and business risks
2. Control environment is weak as (why):
= CEO acting as CFO might lack accounting knowledge/weak governance structures 1
= segregation of duties and review lacking/widespread locations 1
= informal recordkeeping (stock records on excel) 1
= inability to pass journal entries to prepare accounts (previous auditor did jnl’s) 1
2.1 Management’s integrity under suspicion as previous auditors qualified FS and 1
management appear to do nothing to prevent this
2.2 Risk of material misstatement as complex accounting aspects/management 1
manipulation exists
2.3 Going concern risk due to losses could result in financial misstatements 1
2.4 Risk of non-compliance with laws and regulations valid e.g. of which laws and 1
regulations
2.5 Positive factors: operation for 30 years/mngt plans to curtail losses 1
3. Consideration regarding previous auditor
3.1 Why did not attend stock count (reasons – possible scope limitations by mngt) 1
3.2 Professional competence as significant weaknesses appear to exist in audit work 1
and reliance on other aspects of the audit such as opening balances might be
affected
4. Financial responsibility (Payment of audit fee)
4.1 Whether client will/be able to pay audit fee given financial position- making Losses 1
5. Audit requirement ito companies act (section 30)
5.1 Firm providing technical assistance on accounting issues is acceptable, provided no 1
management responsibility assumed
 AUDITORS CONSIDERATIONS FOR KNOWLEDGE AND SKILLS
1. Whether IQ have enough staff to audit client with multiple locations 1
2. Whether IQ have the expertise to audit complex accounting issues (Forex; 1
impairment;) etc

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  ENGAGEMENT CONDITIONS
1. Whether client prepared to sign standard engagement letter (engagement 1
acceptance)
Other valid points: list Opening balances, No previous audit file. 1
MAX 17
(Available) 27

2. Critical evaluation of materiality in work paper C2/12

1. Figures (source of data)
1.1 Reason for using forecast not appropriate/(1st audit) – be figure that reflect state of 1
Co best
1.2. Motivation for using/not using forecast 1
- Forecast could be appropriate as take into account change in business model
- Alternative: Forecast not reliable – CEO acting as CFO/figures might be
misstated
1.3 Motivation/consideration for using prior year data – stable and audited (motivate) 1
2. Criteria (basis) used (allocate marks for discussion of most suitable criteria and why)
2.1 Consideration should have be given to most stable/suitable indicator/indicators; 1
e.g.
- Revenue or gross profit – in line with prior years 1
- Total assets – manufacturing concern/plant etc significant
- Possible combination of above
2.2 Profit before tax and not after tax should be used (or discuss why after tax 1
appropriate)
2.3 Conclusion on working paper incorrect as amount used was profit after tax but 1
conclusion refers to profit before tax.
2.4 Cannot use loss as basis 1
3. Separate materiality
3.1 No consideration given to calculate separate materiality figures for classes 1
transactions, account balances or disclosures
4. Performance materiality
4.1 No performance materiality/threshold consideration for specific accounts (precision 1
level)
5. Risk of entity
5.1 No adjustment for entity risk, e.g. 1st time audit, weak control environment, etc 1
discus/motivate) adjustment lower than R860 000 (Professional judgement,
qualitative aspects)
■ Other valid points : list 1
MAX 9
(Available) 12

3.) Risk of material misstatement at financial statement level

1. Risk of fraudulent financial reporting due to fraud (or error)
1.1 Management under pressure to show improved financial results 1
1.2 Mngt financial wealth depends on profitability and net worth of company (own all the 1
shares)
1.3 Mngt might manipulate provisions, impairments, etc (more conservative - ensure 1
future profits)
1.4 Misstatements in opening balances (weak accounting practices) 1
1.5 Incorrect accounting treatment of complex issues, e.g. impairment, hedging, 1
provisions (IFRS)
1.6 Weak control environment (segregation of duties lacking, supervision, widespread 1
locations etc.)
1.7 Competence of CFO and finance function questionable (CEO acting as CFO) 1

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2. Risk of going concern (inappropriate basis used in preparation of AFS) resulting
from:
2.1 Financial losses suffered and economic downturn 1
2.2 Large workforce with associated risk of strikes and industrial action 1
2.3 Litigation/claims and fines due to non-compliance with laws/regulations, etc. (labour, 1
safety, etc.)
2.4 Forex losses as 50% of imports not hedged 1
2.5 Poor quality products due to imports from China 1
2.6 Difficult economic conditions resulting in drop in sales as it sell trendy/luxurious 1
furniture
3. Risk of fraud due to non-compliance
3.1 Risk of fraud due to non-compliance with laws and regulations (e.g. taxes, levies, co- 1
act (examples)
■ Other valid points: list 1
MAX 14

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6. SELF ASSESMENT QUESTIONS:

QUESTION 6.1 (40 MARKS)

The professional services firm of Dludlu & Scott Chartered Accountants (SA) and Registered
Auditors has two partners, Peter Dludlu and Andrew Scott. Early in February 2024 Peter Dludlu was
approached by a new client, Bay Holdings Ltd, to conduct the audit for the financial year ended 31
January 2024. Peter Dludlu immediately accepted the engagement.

As Peter was about to take annual leave, he allocated all his duties to the audit manager.
Unfortunately, a few days after Peter’s departure the audit manager resigned with immediate effect
after being offered a better position elsewhere. Janet Hope, a third-year trainee accountant who, at
the time, was a senior-in-charge was appointed as acting audit manager.

Janet Hope allocated the audit of Bay Holdings Ltd to Themba, a second-year graduate trainee
accountant, and Riyaan, who had recently left school, but was working to earn some money before
commencing his university studies. Prior to going on leave, Peter Dludlu had scribbled some
instruction relating to the audit of Bay Holdings Ltd in a notepad and attached it to the workpaper file
obtained from the previous auditors. These instructions included:

1. I want you to do a good job, as Bay Holdings Ltd is a large and important client.
2. Shaun Steward, the financial director, is a very good friend of mine. Keep him happy!
3. Shaun is a chartered accountant. Ask him to explain any complex issues to you.

Prior to the commencement of the audit, Janet provided Themba with the firm’s standard audit
programmes and instructed him to use these, as well as the previous year’s audit workpaper files.
Due to her other work commitments, Janet was unable to visit the audit team at Bay Holdings Ltd,
but she remained in contact telephonically. For the next two weeks, Themba and Riyaan worked at
the head office of Bay Holdings Ltd. They asked Shaun Steward for guidance whenever they were
unsure about how to audit something.

By the time the audit of Bay Holdings Ltd was completed, Janet was about to go on study leave -
she was due to write an Accounting 3 examination. Accordingly, she instructed Themba to leave
the audit workpapers in Peter Dludlu’s office.

Peter, upon returning to work in March, hurriedly read through the file between two important
meetings, drafted and signed an unmodified auditor’s report. As he was not particularly happy with
the work, he also drafted a memorandum to the audit manager, instructing her to send the trainee
accountants on a course on how to prepare workpaper files.

At the weekly partners’ meeting Peter Dludlu made the following comments:

I am not in favour of quality management laws such as ISQM 1 and ISA 220R and
methods such as inspections where people from SAICA are out to criticise our work –
and we have to pay for it!

Large auditing firms are given a competitive advantage because they already have
formal structures to administer their complex organisations. Quality management
regulations do not significantly affect them. Smaller auditing forms, however, need to
incur extra costs, which is a waste of money because of the small practitioner’s close
involvement on audit engagements.

Later during the meeting the possibility of incorporating the audit partnership was tabled for
discussion. It was decided that a decision on this matter would be referred to the next partnership
meeting, when a summary would be presented of the benefits that incorporation in terms of the
Companies Act would yield.

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Robert Best, Dludlu & Scott’s business advisory consultant, upon receiving notification that he had
passed the APC examination of the SA Institute of Chartered Accountants, applied for membership
of tis professional body. As Robert was recently notified that his membership application was
successful, it was further proposed that should the firm be incorporated, Robert should be allowed
to take up shares in the incorporated audit practice.

YOU ARE REQUIRED TO:

(a) Discuss fully the comments that Peter Dludlu made at the partners’ meeting. (9)
Communication skills (logical argument) (1)

(b) explain, using only the information provided, whether Dludlu & Scott’s quality management
system has been effective in achieving the quality objectives that are required to be established
by the firm in terms of International Standard on Quality Management 1. (20)
Communication skills (layout and structure) (2)

(c) summarise the benefits that could be obtained from the incorporation of an audit practice.
(4)

(d) discuss whether it would be appropriate for Robert Best to take up shares in Dludlu & Scott
Incorporated, should the audit firm be incorporated. (4)

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QUESTION 6.1 SUGGESTED SOLUTION

Part (a)

1. Neither ISQM 1 nor ISA 220R on “quality management” are laws, they are standards that
have been developed by the International Auditing and Assurance Standards Board of
IFAC, and adopted by the Committee for Auditing Standards of the IRBA for use by registered
auditors in South Africa. (1½)
1.1 If a registered auditor fails to comply with one or more of these Standards, s/he will
not be guilty of an offence, but if s/he is sued for negligence s/he may well be required
by a court of law to demonstrate that such deviation did not result in failure to achieve
the generally accepted auditing standards, and s/he may also be subjected to
disciplinary action by the IRBA / SAICA. (1½)
2. Inspection of auditors is not the responsibility of SAICA; the Inspections Department resides
within the IRBA as regulator of the external auditing profession. (½)
3. The IRBA inspectors are not “out to criticise our work”. Their objectives are twofold:
 To monitor compliance of RA’s in public practice with appropriate professional
standards in the performance of the attest function (1)
 To provide guidance to practitioners to assist them to improve their standards as part
of a continuous improvement process. (1)
4. Peter is correct in saying that the practitioner subject to IRBA inspection has to fund the costs
– if no problems are found, inspection fees will be levied twice a year based on a percentage
of total audit and other assurance services invoiced by the firm and declared per RA per
calendar year (January to December). (1)
5. Peter appears to be assuming that the quality management procedures for large and small
firms must be the same (in other words, that small audit firms must establish the same
organisational structures as large firms). This is not correct. (1)
5.1 ISQM 1 prescribes quality objectives that should be achieved at firm level – and
requires that the risks relating to the achievement of these objectives be identified and
assessed, as a basis for the design and implementation of responses to mitigate these
risks. (1)
5.1.1 Apart from a few limited ‘specified’ responses that are required (by ISQM 1.34),
each firm is left to decide on the responses that are appropriate to their context
to mitigate the assessed quality risks. (1)
5.2 Accordingly, ISQM 1.10 duly recognises that “… the design of the firm’s quality
management system, in particular the complexity and formality of the system, will
vary”. (1)
5.3 In larger practices auditing listed companies, more formal and complex structures will
have to be in place to ensure, for example, that work delegated to lower levels of
staff are subject to appropriate direction, supervision and review. There is nothing wrong
with the partner in a small firm continuing to direct, supervise and review the work of
the audit clerk directly. (1)
6. Peter Dludlu states that he is not in favour of IRBA inspections and quality management
standards. However, they are in place to ensure that the audit work is performed in
accordance with the ISAs in the public interest. Surely he must be in favour of this! (1)
6.1 It is very difficult for outsiders to gauge the quality of an audit, and when an audit failure
becomes public the image of the entire auditing profession is tainted. (1)
6.2 Without IRBA inspections and quality management standards the profession as a whole
is put at risk as (1) there is a greater risk of non-compliance with the ISAs and (2) the
few “bad apples” in the profession cannot be identified and held accountable. (1)
Maximum (9)
Communication skills (1)

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Part (b)

Introductory comments:

 A quality management system can only provide reasonable assurance that the quality
objectives identified in ISQM 1 are being achieved – due to the inherent limitation of any
internal control system. (1)
 Accordingly, situations may arise where the quality objectives are not achieved despite the
quality management system being effective. (1)
 Situations where the quality objectives are not achieved must be carefully analysed to
determine whether they point to ‘deficiencies in the firm’s system of quality management’
(e.g. where the firm failed to assess quality risks or respond to them appropriately). (1)
 These deficiencies, including the root causes thereof, then need to be carefully evaluated
to determine their severity and pervasiveness on the quality management system. (1)

Evaluation of information in relation to the quality objectives required by ISQM 1:

Despite the introductory comments above, there is reason to believe that the quality
management system designed and implemented by Dludlu & Scott is ineffective – due to a number
of situations arising where these objectives are not achieved. (1)

These situations are analysed below in relation to each applicable quality objective.

1 Relevant Ethical requirements

1.1 Quality objective: The firm and its personnel (incl. partners) should understand the
relevant ethical requirements and fulfill these responsibilities (ISQM 1.29(a)). However,
this quality objective has not been achieved, as evidenced by the number of
breaches of the ethical requirements (as contained in the SAICA / IRBA Code of
Professional Conduct. (1)
1.1.1 Peter Dludlu accepted the engagement even though his ability to act
independently and objectively in relation to Bay Holdings Ltd is questionable,
as he is a “very good friend” of the financial director. (1)
1.1.2 Peter also instructed the staff to keep the client’s financial director happy. This
may further threaten the independence of staff in the performance of their work.
(1)
1.1.3 This instruction also creates the impression that the staff do not always act
with courtesy and consideration with all with whom they come into contact –
therefore that they do not adhere to the fundamental principle of professional
behaviour. (1)
1.1.4 A further instruction given to staff was to “do a good job”. This implies that
certain engagements are considered inferior and are neglected. Should this be
the case, the staff are not adhering to the fundamental principle of professional
behaviour (acting with due professional care). (1)
1.1.5 Another example of Peter Dludlu failing to adhere to the requirement of
professional behaviour is that he signed the auditor’s report without reviewing
the work adequately, and without being “particularly happy with the work” –
he appears to be acting without exercising integrity and due professional care.
(1)

- 19 -
2 Human resources

2.1 Quality objective: Personnel (incl. partners) develop and maintain the appropriate
competence to perform their roles (ISQM 1.32 (b)) and are recognized through timely
evaluations, compensation, promotion and other incentives. However: (1)
2.1.1 Questions arise about whether Peter Dludlu has attained and maintains the
technical standards and professional competence to perform his duties as a
partner: (½)
(a) he incorrectly calls ISQM 1 and ISA 220R “laws”; (½)
(b) he is under the false impression that the Inspections Department still
resides with SAICA; (½)
(c) he does not appear to be familiar with the sections in the Auditing Profession
Act, as the proposal for Robert to take up shares in the audit company,
tabled at partnership meeting will breach a number of provisions in this Act;
and (½)
(d) he instructs his staff to ask the client’s staff for assistance. (½)
2.1.2 Janet was appointed to the position of acting audit manager. However, with
her limited academic qualifications (she is currently only commencing her
Accounting 3 studies), it is doubtful that she has attained the standards and
competence required to carry out the duties required by this position. (1)
2.1.3 The sudden resignation of the audit manager with immediate effect may be
a reflection of an inability of the firm’s quality management system to support
the retention of competent employees. (1)
2.2 Quality objective: Engagement team members, including engagement partners, are
assigned to each engagement who have appropriate competence and capabilities
to consistently perform quality engagements (ISQM 1.32 (d)). However, this objective
is not achieved as evidenced by the following: (1)
2.2.1 Peter, a partner, allocated all his duties to the audit manager – it is
questionable whether the audit manager would have the required technical
training and proficiency to perform all of the partner’s duties. (1)
2.2.2 The audit of Bay Holdings Ltd, “a large and important client”, was assigned
to two junior staff members, who have little practical experience and/or
limited training. For example, Riyaan just left school, so he would have no
auditing knowledge or experience. (1)
2.2.3 The responsibility for directing, supervising and reviewing the audit work was
assigned to Janet, a third year trainee accountant, whose academic knowledge
is rather limited – she has just commenced her Accounting 3 studies. (1)

3 Engagement performance

3.1 Quality objective: The nature, timing and extent of direction and supervision of
engagement teams and review of the work performed is appropriate (ISQM 1.31(b)).
However, the direction, supervision and review on the audit of Bay Holdings Ltd
was severely lacking, as evidenced by the following: (1)
3.1.1 Janet was required to oversee the audit. Despite this being the first time that
she is involved in the audit of Bay Holdings Ltd, she received very little
direction from Peter (all she received were a few vague instructions scribbled
on a notepad). This in turn would have made it very difficult for Janet to direct
and supervise the staff assigned to the audit. (1)
3.1.2 The extent of direction given to the inexperienced staff was insufficient – they
were just handed the standard audit programmes and another audit firm’s
prior year work paper file. No audit plan was prepared nor was there any
tailoring of the standard audit programmes to the specific client’s situation. (1)
3.1.3 Because of the inadequate direction, the staff could possibly have
misunderstood Peter’s instruction with regard to the nature of the queries that
should be made to Shaun. (1)
- 20 -
 3.1.4 The extent of supervision was inadequate, particularly in view of the limited
training and experience of the audit staff – Janet did not visit the audit team
to monitor their progress – she merely remained in contact telephonically. (1)
3.1.5 It is not appropriate to ask the client’s staff “how to audit something”. These
queries should have been directed to the audit manager or one of the
partners. The person supervising the audit work (Janet) should have been
available to solve problems. (1)
3.1.6 The review of the audit work was totally inadequate – Janet carried out no review;
Peter hurriedly read through the file between meetings. (1)

3.2 Quality objective: Consultation on difficult or contentious matters is undertaken and

conclusions reached are implemented. (1)
3.2.1 The risks relating to the achievement of this objective appear not to have
been appropriately identified, assessed and/or responded to – why else would
Peter Dludlu instruct the engagement team to ask the client’s financial director
about complex (presumably accounting) issues. (1)

4 Acceptance and continuation of client relationships

4.1 Quality objective: Judgements by the firm about whether to accept or continue a client
relationship or specific engagement are appropriate based on information obtained
about, amongst others, the nature and circumstances of the engagement and the
integrity and ethical values of the client and the firm’s ability to perform the engagement
in accordance with professional standards (ISQM 1.30). However, this objective has
not been achieved in relation to the audit of Bay Holdings Ltd evidenced by the
following: (1)
4.1.1 Peter Dludlu accepted the audit of Bay Holdings immediately, without gathering
any of the required information. (1)
4.1.2 The lack of appropriate judgement appears to be confirmed by:
 the apparent lack of further consideration being given to the familiarity
threats to Peter’s independence in relation to the client (with him being
a “very good friend” of the financial director); and (1)
 the inadequacy of the staffing resources to perform the engagement
(the firm being short-staffed). (1)

5 Governance and Leadership

5.1 Quality objective: Leadership demonstrates a commitment to quality through their

actions and roles (ISQM 1.28 (c)). This is clearly not being achieved. (1)
5.1.1 While Peter Dludlu is one of only two partners, and as such forms a key part
of the leadership of the firm, he directly was party to many actions which
undermined the quality of the engagement performed. (1)
5.1.2 This concern is reinforced by the derogatory statements made regarding
quality management at the partners meeting. (1)

6 Monitoring and Remediation

6.1 Quality objective: The firm shall establish a monitoring and remediation process to
provide information about its quality management system and to take appropriate
actions to respond to identified deficiencies. (1)
6.1.1 Because of the numerous examples that have been identified indicating that
a range of quality objectives are not being achieved, and with no remedial
action being taken, it would be safe to say that the responses to address the
risks of this quality objective not being achieved are either absent or ineffective.
(1)
Maximum: (20)

- 21 -
Add to the solution
1. Objective 1: Firms risk assessment process:
The firm should implement a risk assessment process with policies and
procedures to identify and assess risks to audit quality, the Root Causes
thereof, and responses to address or mitigate the risks – none of this is in place.
2. Objective 7: Information and communication
The firms should have a system in place to capture and communicate
information on the system of QM to relevant parties in a timely manner
Communication skills (layout and structure) (2)

Part (c)

1 Changes in partners (directors) due to retirements or appointments are more easily

administered. No new partnership agreements need to be signed by all partners. (1)
2 As the company is a separate legal entity, an employee-employer relationship can be
established. This may have advantages from an income tax perspective: (1)
2.1 For example, away from home and other allowances that are granted to employees
would not be available otherwise. (1)
3 Income tax savings may accrue, as the corporate tax rate of 28% plus the dividends tax rate
of 20% on dividends paid may result in a lower effective tax rate being paid by a company
compared to a partnership - where each partner may be taxed at a marginal tax rate of up
to 45%. (1)
Maximum: (4)
Part (d)

1 Even though Robert has passed his SAICA qualifying examinations, and is a Chartered
Accountant (SA), he will not yet be able to register with the IRBA as a Registered Auditor.
(1)
1.1 This is as he does not have the appropriate training as a registered auditor (e.g.
there is no evidence that he has completed the audit development programme
prescribed by the IRBA). (1)
2 In terms of section 38 (3)(b) of the Auditing Profession Act, only individuals who are registered
auditors (RAs) may be shareholders of an incorporated audit practice – therefore Robert
does not qualify. (1)
3 Robert’s taking up share in the company, means that he will be entitled to dividends, in other
words, a share of the professional audit fees. (1)
3.1 In terms of section 41 (6)(e) of the Auditing Profession Act, it is an offence to share profits
derived from an audit practice with a non-RA. (1)
4 In light of the above, it would not be appropriate for Robert to take up shares in Dludlu
& Scott Inc. (1)
Maximum: (5)

- 22 -
QUESTION 6.2 (36 MARKS)

You are an audit trainee at Dimco Auditors Inc. and part of the team on the external audit of Cement-
for-Construction Group Ltd (‘CFC’). Your firm has been the auditors of CFC and all its subsidiaries
for the past five years, and is currently busy with the year-end audit of the group for the financial year
ended 30 September 2024.

Overall materiality for the audit of the consolidated financial statements has been set at R20 million
with a performance materiality of R14 500 000 for the account balance of inventory. The audit is
currently in progress and the following completed programme steps and work papers are available.

Obtain an understanding of the group and its environment:

B100 -> Understanding the group and its environment
B200 -> Extracts of notes to the consolidated financial statements
X600 -> Days of Business article, 14 October 2021

Obtain and review the minutes of meetings of shareholders and those charged with
governance:
X201 -> Extracts of minutes of CFC board meeting, 25 September 2021

Obtain an understanding of the group’s internal control activities:

N110 -> System description for the sale of cement

Obtain an understanding of the group and its environment

B100 ->Understanding the group and its environment

Prepared by: A Clerk 15/08/2024

Reviewed by:

1 Background

CFC was established in 2006 by a group of entrepreneurs to explore opportunities in construction

during the boom in the property market prior to South Africa’s hosting of the FIFA Soccer World Cup.
CFC Cement (Pty) Ltd (‘CFC Cement’), a company within the group, acquired a cement plant and
started operations in 2006, and the group has since expanded its activities to include the production
of aggregates, metallurgical grade lime, burnt dolomite and limestone. CFC and its subsidiaries
currently operate throughout South Africa and in a number of African countries.

Following the acquisition of a 26% stake in CFC by the Public Investment Corporation in 2008, the
company’s shares were listed on the Johannesburg Stock Exchange in 2009.

2 Governance

The board of CFC consists of five directors, being the managing director, the financial director and
three non-executive directors, of whom two are classified by the board as being independent. The
chairman of the board, Mr Gerling, is an industry expert and spends 50% of his time on the business
of CFC. The board has accordingly classified him as nonexecutive but not independent.

The remuneration of the executive directors and key management is determined by the company’s
Remuneration Committee and a substantial element of performance-related pay is linked to profit
and sales targets, and share price movements. The Remuneration Committee also determines the
remuneration of non-executive directors, which consists of a fixed monthly fee and fees for attending
board and committee meetings.

3 Group structure

CFC

91% 80% 85%

CFC Cement (Pty) Ltd CFC Lime (Pty) Ltd CFC Aggregates (Pty) Ltd

Company produces and Company produces Company produces

supplies cement and metallurgical grade lime, aggregates and sands
cement blending products burnt dolomite and
related products

4 Business processing and IT

The group’s accounting and IT functions are centralised at a service centre at CFC’s head office in
Midrand. To reduce the cost of data warehousing, certain data are stored utilising cloud technology.

5 Developments during the year

5.1 CFC Cement is subject to an investigation by the Competition Commission into price fixing and
cartel behaviour by the main cement producers. In its application for leniency to the
Commission, CFC Cement confirmed the existence of a cartel to divide the market amongst
the four big cement producers. CFC Cement has stated that as it is a small ‘player’ in the
industry, its involvement should be considered separately. CFC Cement further confirmed to
the Commission that the company properly sanctioned its financial director, Mr Batting CA(SA),
who was apparently aware of these practices. CFC Cement continues to cooperate with the
Commission’s investigation.

5.2 CFC acquired one million of its own shares from the general public and certain directors on
1 August 2024. The total amount paid to acquire the shares was R28 million and this amount
has been deducted from retained earnings within shareholders’ equity. This was authorised by
the board at its July 2024 meeting.

5.3 A quarry in Botswana was acquired by CFC Cement from Quarries Ltd in October 2020. The
transaction value amounted to R38 million, of which R18 million was paid during the 2020
financial year. The outstanding purchase consideration is payable in equal instalments on the
first and second anniversaries of the transaction.

5.4 The CFC group of companies experienced severe financial difficulties during the year as a
result of an extended slowdown in infrastructure expenditure in South Africa. Serious labour
problems and strikes experienced at various operations further contributed to the financial
difficulties, resulting in a significant expected loss for the group for the 2024 financial year.

6 Other matters

The group’s accounting policies conform to International Financial Reporting Standards (IFRS) and
subsidiaries conform to IFRS for Small and Medium Entities.

- 37 -
 Obtain an understanding of the group and its environment
B200 -> Extracts of notes to the consolidated financial statements

Prepared by: B Clerk 08/10/2024

Reviewed by:

Note 3: Property, plant and equipment and intangible assets

The following methods and estimated useful lives were used to calculate depreciation/ amortisation
during the year:

Item Method Estimated useful life

Buildings Straight line 30 years
Plant Straight line Up to 35 years
Vehicles Straight line Up to 10 years
Furniture and equipment Straight line Up to 6 years
Mineral rights Straight line Estimated life of reserve

At 30 September 2024 the following were reflected as property, plant and equipment:
Factory Plant,
Freehold and
decommissioning vehicles, Capitalised
leasehold land,
and quarry furniture leased
buildings and Total
rehabilitation and plant
mineral rights
assets equipment
R million R million R million R million R million
Net carrying value at 3 594
beginning of the year 455 98 28 4 175
Additions 44 2 439 – 485
To enhance existing
operations 12 2 379 – 393
To expand operations 32 – 60 – 92
Disposals (1) – (2) – (3)
Depreciation (22) (3) (381) (11) (417)
Other movements – 4 – – 4
Re-allocation to
inventory – – (38) – (38)
Translation 20 7 54 – 81
differences
Net carrying value at
end of the year 496 108 3 666 17 4 287

- 38 -
 Marks
REQUIRED Sub-
Total
total
(a) With reference to work paper B100 –
(i) identify and describe the risk of material misstatement in the 2024
consolidated financial statements of CFC at the overall financial
statement level; and 15
(ii) briefly describe the audit response which would respond appropriately to
the risks identified in part (i). 10

Communication skills – language and structure; clarity of expression 2 27

(b) With reference to work paper B200 –

identify the risks of material misstatement related to property, plant and

equipment and intangibles reflected in CFC’s consolidated statement of 9 9
financial position at 30 September 2024; and

Communication skills – clarity of expression

- 39 -
QUESTION 6.2 (SUGGESTED SOLUTION)

Note to markers: The solution is very comprehensive and thus marks for other valid points would be
rare and should only be awarded in exceptional instances.

Part a) Work paper B100 (Risk of material misstatement and audit response)
The following are risks of material misstatement at the overall financial statement level:
The company is listed and the risk exists: ½
 management might overstate profits & assets to inflate the share price 1
 the company does not comply with the listing requirements resulting in incomplete 1
disclosures, (also PIC own 26% - very active SH) etc.
Group of companies and the risk exist that on consolidation: ½
 inter-company balances and transactions not eliminated (complex consolidation/error 1
on consolidation)
 related party transactions not treated at fair value and arm’s length/correctly 1
disclosed;
 correct disclosure not made for transactions of subsidiaries (e.g. remuneration of 1
directors and prescribed officers);
 incorrect conversion of subsidiaries on IFRS for SMEs to IFRS; 1
 incorrect translation of foreign operations (i.e. quarry in Botswana)/Accounting 1
policies in Botswana;
 non-compliance with foreign regulation as result of foreign operations; 1
Complex accounting transactions and the risk exist of misstatement: ½
 due to complexity of application (business combinations, IFRS 10; 12, etc.) 1
Directors & key management remuneration largely based on performance & share price ½
growth and the risk exists:
 That they have incentives to overstate profits & assets 1
Non-compliance with laws and regulations could point to a lack of management integrity ½
and/or competence increasing risks of:
 Non companies act compliance (Audit Committee composition, non-executive fee 1
approval, share buy-back);
 anti-competitive behaviour and price fixing (reason); and 1
 JSE listing requirements (reason). 1
Governance concerns/ weak control environment increasing the risks of manipulation ½
because:
 Chairman not independent as he works 50% of his time for the company 1
 Practices of remuneration committee and how they set remuneration 1
Going concern risk due to: (marks below only awarded if linked to going concern) ½
 the company making significant losses at year end (liquidity & solvency, cash flow 1
problem);
 extended slowdown in infrastructure expenditure in South Africa/African operations; 1
 pending fine from the Competition Commission (reason); 1
 labour problems and strikes which disruption operations 1
Operations are widespread/decentralized, which makes management oversight and 1
control difficult and which could result in possible fraud, etc.
Risk resulting from IT operations ½
 unauthorised access via WAN/ corruption of data (reason) 1
 unauthorised amendment of data stored in the clouds – integrity of data 1
 loss of data stored in the clouds, resulting in incomplete financial records 1
Centralized accounting & IT create opportunity for group management to manipulate 1
records of subsidiaries/(management override of controls)
Fraud risk (CFO involved in price fixing, trading in African countries (bribes, etc.) 1

- 40 -
(iii) (a)(ii) Describe the audit response which would respond appropriately to the risks identified in
part (i) (work paper B100)
The risk of material misstatement at the overall financial statement level can be assessed as 1
high based on (i). I would therefore suggest the following audit response:
■ IDENTIFIFY SIGNIFICANT CLASSES OF TRANSACTIONS, ACCOUNT BALANCES
AND DISCLOSURES
This is done based on: 1
- the nature and inherent risk of the accounts and disclosure as well as
- accounts that is quantitively material and exceed the planning materiality figure
This will include:
- directors remunerations which is qualitatively material due to the nature thereof and the 1
various disclosure required
In terms of IFRS and the Companies Act; 1
- Share capital and reserves which is qualitatively material due to the nature thereof,
various companies act requirements that should be met for the buyback, as well as the 1
disclosure required in terms of the share buyback,
- Property, Plant and Equipment which will be quantitively material due the amount
thereof, the complexity of the Accounts involved and accounting treatment and disclosure
required ito IFRS;
■ OVERALL RESPONSE
Formulate a general audit approach for the audit as a whole
Generally a more substantive-based audit approach with less reliance on controls. 1
More detailed substantive testing and less reliance on analytics. 1
Specific focus on management overrides (year-end journal/control accounts, etc.). 1
Focus on year-end balances and less on early verification (going concern risk) 1
More work will need to be done to reduce the risk, bigger samples, more testing/ Set overall 1
materiality lower given risk (listed company, going concern) –more accounts becomes
significant that will require detail testing
Increase the number and locations of components to be included (all subsidiaries and foreign 1
operations) (increased audit coverage)
Identify areas of specific risks and focus requiring specific audit attention
More work/focus on the going concern problems and assumptions. 1
More work/focus on legal compliance (given price fixing, companies act issues, etc.) 1
More work on specific consolidation adjustments & IFRS disclosure (related party 1
disclosures, transactions with directors)
Tests of detail focused on overstatement of revenue/assets and understatement of 1
expenses / liabilities/ Set lower performance materiality for risky classes of transactions,
account balances or disclosures (provisions, PPE).
More focus on subsequent events procedures . 1
Test general IT controls for shared services/cloud service provider (ISAE 3402 reports) 1
Direction and control of the audit
Decrease/less reliance on management representations (letter). 1
More professional scepticism in testing (corroborate explanations with supporting 1
documentation).
More unpredictability in selecting items for testing 1
More senior and experienced staff on audit. 1
Increased extent of supervision of staff and the review work to be undertaken. 1
Involvement of quality review partner (listed entity/ISQC 1). 1
Given nature of the systems, we would also need IT experts and CAATS. 1
Consider involvement of fraud specialist (given unethical behaviour of management)/ 1
Consider auditor expert and /or specialists (valuations, IFRS2, etc.)
Other valid risks and responses (list ..........................................................) Max 1 1
Communication skills for part (a): language and clarity of expression 1
: structure and layout 1
Total for part (a): Max 27
- 41 -
Part (c) With reference to Work Paper B200 (Risk at assertion level and procedures)
Identify the risks of material misstatement related to property, plant and equipment
and intangibles
Note: Risk are stated by assertion for presentation purposes only (not asked by assertion &
marks should be awarded irrespective)

The risk of material misstatement will consist of the combination of:

- significant inherent risks; and
- the controls that is present/not present to address such risks
The following risks are significant based on the spectrum of risks given the magnitude
and likelihood of the risks relating to PPE as stated
Existence
The risk that repairs and maintenance may be recorded as PPE and not expensed (going 1
concern problems, etc.).
The risk that certain property, plant and equipment do not exist given the possible numbers 1
and widespread use (vehicles, furniture equipment).
Rights
The risk that assets are recognised for which the client has no rights, such as freehold land, 1
buildings and mineral rights (subject to legislation, uncertainty, etc.).
The risk that capitalised leased plant ASSETS do not qualify for capitalisation (rights have 1
not/will not transfer)
Completeness
The risk exists that not all qualifying cost and assets were capitalised for leased assets and 1
decommissioning assets,
Valuation< Accuracy and allocation
Land & Mineral rights: risk of incorrect valuation if renewal not granted by government 1
- risk of incorrect calculation of amortization. 1
Factory decommissioning assets: The risk that –
- the costs and calculations are not correctly calculated; 1
- the life of assets and amortisation periods are not correctly estimated; 1
- certain costs do not meet/qualify for capitalisation criteria. 1

Plant, vehicles, etc.: The risk that the accounting treatment is not correct/complex calculation
for –
- estimating the residual values and useful lives; 1
- component depreciation / identification of components 1
- the depreciation method. 1
The risk that translation of the PPE of foreign operations into rand may not be done in 1
accordance with the requirements of IAS 21.
Impairment: as a result of: 1
Difficult trading environment, and the likely increased competition in future, gives rise to
an increased risk that the carrying amount of PPE should be impaired (Going concern)
Difficulty of calculating the value with regard to the value in use of these assets 1
Capitalised leased plant – the risk of
- incorrect accounting treatment in terms of IAS 17: 1
- COSTS capitalised that not qualify for capitalisation 1
- the plant is capitalised at incorrect amounts, etc. 1
Disclosure
Risk of incorrect disclosure, (IAS 16 and IFRS 16 - detailed and complex disclosure) 1
Other valid marks (.............................................................................................) Max 1 1
Total for part (c)(i) Max 9

- 42 -
QUESTION 6.3 (60 MARKS)

You are a senior-in-charge employed by Dynamix Auditors Inc, a firm of Registered Auditors with
offices in Johannesburg, Durban and Cape Town and you have been assigned to the audit of StarNet
Limited (“StarNet”), a group of companies listed on the JSE, for the financial year ended
30 September 2024.

Your firm was appointed as auditors of StarNet at the Annual General Meeting in February, following
the resignation of the previous auditors after a disagreement with management regarding the tight
reporting deadlines. At the initial planning meeting with the engagement partner it was agreed that
the audit strategy for the 2023 audit of the StarNet group of companies would be control-based with
early verification used as far as possible in order to meet the 2024 reporting deadline of 18 October.
Dynamix Auditors Inc is also currently considering whether or not to accept the audit of Telemaster
PLC (“Telemaster”), a company listed on the London Stock Exchange, in which StarNet acquired
80% of the issued shares on 30 June 2024.

The Dynamix Auditors Inc audit manual provides the following guidelines for determining materiality:

Revenue ½% to 1%
Nett income after tax 5-10%

The following working papers are available:

WORK PAPER Reference

number
Telemaster PLC: Client Acceptance
Minutes of a meeting with financial manager A210
Correspondence with partner responsible for 2020 audit A220
Starnet Limited Group
Extract of 2021 management accounts B200
Understanding the entity and its environment B220

- 43 -
 Prospective client: Telemaster PLC Year End: 31/12/2024 A210
Prepared by: Trainee Date: 18/08/2024
Reviewed by: M Tsala Date: 25/08/2024
SUBJECT: MINUTES OF MEETING WITH FINANCIAL MANAGER 1/2
Date: 18/08/2024
Time: 08:00
Place: Boardroom: StarNet Limited, Johannesburg

Attendees: J Madiba (Financial Manager: StarNet)

M Tsala (Audit Manager: Dynamix Auditors)
Trainee (Senior in Charge: Dynamix Auditors)

Minutes of meeting

1. Purpose of meeting

To gather information in order to make the client acceptance decision.

2. Nature of business

Telemaster PLC is a listed company in the United Kingdom that specialises in telematics,
servicing small and medium type companies as well as large corporate and utility
organisations. The company is regarded as one of the market leaders in the UK in terms of
product range and offers unsurpassed fleet management services. An average of 2 000
tracking and monitoring systems are installed per month, through a network of 60 fitment
centres throughout the country.

3. Financial Position

Although Telemaster has a history of strong financial results, the credit crisis and worldwide
recession has affected the company badly. This, together with a number of large capital
intensive projects and bad acquisitions, has resulted in the company incurring huge losses
in the last two years and wiping out virtually its entire capital and reserves. Creditors have
also not been paid regularly recently and the company’s bankers have threatened closure on
the company’s overdraft facilities.

4. Acquisition of 80% shareholding by StarNet

StarNet management identified Telemaster PLC’s market potential and made a public offer
to shareholders to acquire their shares at four pence per share. This resulted in StarNet
acquiring 80% of the issued share capital of Telemaster PLC, effective from 30 June 2024.
Immediately thereafter, StarNet injected £4 million into the business, replaced the board of
directors and put a new management team in place.

- 44 -
 Prospective client: Telemaster PLC Year End: 31/12/2024 A210
Prepared by: Trainee Date: 18/08/2024
Reviewed by: M Tsala Date: 25/08/2024
SUBJECT: MINUTES OF MEETING WITH FINANCIAL MANAGER 2/2
5. Financial reporting and regulatory compliance

The listing of Telemaster was suspended by the London Stock Exchange in May 2024
following an investigation into certain breaches of listing requirements by management.
Rumours also surfaced that management have manipulated the financial statements in
recent years and overstated asset values. The new board is currently working hard to resolve
all of these issues.

6. Reason for change in auditors

Mr Madiba explained that, after the takeover, StarNet management made significant progress
in cleaning up the business and its management. He also was adamant that StarNet
management have lost all confidence in the current auditors, Brambee & Partners, whom
they feel should have uncovered the unscrupulous management practices and dubious
financial reporting practices of the previous management.

The new board of directors of StarNet accordingly decided to replace Brambee & Partners
as auditors. They requested us to accept the engagement as auditors of Telemaster PIC
and gave us permission to liaise with Brambee & Partners in this regard.

- 45 -
 Prospective client: Telemaster PLC Year End: 31/12/2024 A220
Prepared by: Trainee Date: 30/08/2024
SUBJECT: CORRESPONDENCE: CLIENT ACCEPTANCE 1/1
From: J Wilabee (Partner in charge of Telemaster’s audit)
Date: 29/8/2024
To: M Tsala : Dynamix Auditors Inc

Dear Mr Tsala

Following your correspondence by email (dated 26/8/2024), that your firm has been approached to
accept the appointment as auditors of Telemaster PLC with immediate effect, I would wish to advise
you as follows:

- Our firm has no intention of resigning as auditors of Telemaster PLC. We have been actively
involved with the client since our appointment as auditors 10 years ago and I myself acted as
engagement partner for the last nine years. Nobody knows their businesses as well as I do.
- We have been actively involved in assisting management in the past in preparing the financial
statements. I doubt whether they will cope without our assistance.
- The fee from Telemaster’s audit also comprises a significant part of our firm’s total audit fees
and we have no intention of giving this up.
- I also still own a significant number of Telemaster shares (“I have not sold out to the
“scavengers” StarNet) and intend to do everything possible to protect my shares’ value.

I trust that this correspondence make it clear that we have no intention of resigning as auditors. If
the board wants to get rid of us they will have to fire us.

Kind regards

J Wilabee
Brumbee & Partners
Registered Auditors
London

- 46 -
Client: StarNet Limited Year End: 31/12/2024 B200
Prepared by: Trainee Date: 30/08/2024
SUBJECT: EXTRACTS FROM THE AUGUST 2024 MANAGEMENT 1/2
ACCOUNTS

StarNet Limited
Draft (excluding results from subsidiaries)

2024 2023
R’000 R’000
(11 months) (12 months)

Extract from profit & loss statement for the period ended
31 August 2024

Revenue 280 613 240 419

Cost of sales 240 652 198 768
Gross profit 39 961 41 651

Profit for the year to date after tax 6 382 9 712

2024 2023
R’000 R’000
Extract from statement of financial position
at 31 August 2024

Share capital and share premium 51 975 51 975

Retained earnings 30 600 34 012

Long term liabilities 133 533 112 087

Current liabilities 53 631 33 590

Capitalised development 38 176 20 163

Property, plant and equipment 135 989 123 987
Inventory 48 765 24 890

- 47 -
 Client: StarNet Limited Year End: 30/09/2024 B220
Prepared by: Trainee Date: 12/09/2024
SUBJECT: UNDERSTANDING THE ENTITY AND ITS ENVIRONMENT 1/3
1. Overview of operations

StarNet is South Africa’s leading vehicle monitoring, tracking and stolen vehicle recovery
company. The company employs over 900 people, based at the head office in Midrand,
Gauteng and at regional offices in Durban, Cape Town, Bloemfontein, Port Elizabeth,
Witbank, Nelspruit and Polokwane. The offices are linked via dedicated Wide Area Networks
running on the client’s HP servers. Over 6 000 tracking systems are installed per month
through a network of self-owned and franchised fitment centres.

All tracking devices are manufactured in-house at the company’s factory situated in Isando.
The company also strives to be at the cutting edge of technology and, accordingly, has
established a fulltime research and development unit consisting of over 20 full-time electronic
engineering staff at its head office.

2. Governance and management structure

StarNet Limited’s Board of Directors consists of 13 directors, of whom 8 are independent and
non-executive. The executive directors include the managers of the three divisions as well
as the CEO and CFO. All executive directors and key management staff receive an annual
performance bonus of up to 100% of their annual salary based on profit targets achieved.
They also participate in the staff share incentive trust.

StarNet’s Board subscribe fully to the principles of good corporate governance of King IV.

3. Company and Group Structure

StarNet

Divisions Companie

Manufacturing Vehicle Research and

monitoring & development
recovery
60% 80% 50%

Rapid Transport TeleMaster PLC Star Finance

Billing (Pty) Ltd (Pty) Ltd

- 48 -
 Client: StarNet Limited Year End: 30/09/2024 B220
Prepared by: Trainee Date: 12/09/2024
SUBJECT: UNDERSTANDING THE ENTITY AND ITS ENVIRONMENT 2/3
4. Subsidiaries (excluding Telemaster)

Star Finance (Pty) Ltd is a joint venture company, established between StarNet Limited and
a local bank and is accounted for as such in the StarNet Group Financial Statements.

Rapid Transport Billing (Pty) Ltd (RTB) is a company established together with the
Johannesburg Metropolitan Council with the aim of developing a Smart Card billing system
for the council’s bus services. We are not the auditors of Star Finance (Pty) Limited.

5. Nature of the business

StarNet provides vehicle monitoring, tracking and recovery services in respect of passenger,
commercial and specialised vehicles (such as police vehicles, ambulances and refrigerator
trucks). Clients are individuals as well as corporate clients from both the private and public
sector.

The number of vehicles under surveillance has increased from 10 000 in 1999 to over 2
million in 2024.

6. Standard Contracts

All vehicles are fitted with StarNet surveillance units. These units vary in price based on
functionality.

Units: Customers have the option either to buy the monitoring unit upfront or to lease the
unit over the term of the contract. Contracts vary between three and five years after which
the customer is required to either buy the unit or return it to StarNet.

Monitoring (Surveillance) charges: Customers pay a fixed monthly fee to StarNet for the
monitoring and tracking services provided.

7. Accounting policies

Unit lease agreements are treated as operating leases. The agreements provide that StarNet
retains the residual risk related to each unit.

Revenue comprises the net invoiced value for lease rental units and surveillance services,
net of discounts and VAT. Revenue is recognised over the period of the agreement.

Lease rental units are stated at cost less accumulated depreciation and impairment losses.
Monitoring units are depreciated to residual values over the period of the underlying lease
agreements.

- 49 -
 Client: StarNet Limited Year End: 30/09/2024 B220
Prepared by: Trainee Date: 12/09/2024
SUBJECT: UNDERSTANDING THE ENTITY AND ITS ENVIRONMENT 3/3
8. Accounting systems

StarNet has outsourced the operation of its IT billing system for lease invoicing and monthly
monitoring contracts to Unico, a service bureau specialising in Information Technology
companies. Unico is responsible for the monthly invoicing for all StarNet clients, and
produces monthly reports of various revenue income streams. These reports are then used
monthly by StarNet staff to record the results of unit invoicing and monthly monitoring
(surveillance) charges into the general ledger.

9. Significant new contracts

In February 2021 StarNet won the contract from the South African Police Services (SAPS)
to install tracking devices in all their vehicles and to provide 24 hour monitoring of these
vehicles. The contract provides that all SAPS vehicles (old and new) be fitted with StarNet
tracking devices.

10. Collection of customer monthly premiums

StarNet entered into a joint venture agreement with a local bank for the collection of
customers’ monthly payments. A company was formed (Star Finance) in which the bank and
StarNet each own 50%. The shareholders’ agreement stipulates that the bank will collect all
customer payments and will pay the amounts collected over to StarNet within 30 days of
collection, less a 10% collection fee. The agreement further provides that StarNet may
cancel the agreement by giving 60 days’ notice to the bank, and that instalments not collected
will not be the responsibility of the bank, but will be treated as bad debts in StarNet’s books.

- 50 -
REQUIRED:

a) The audit director of Dynamix Auditors Inc, Mr Mathee, has indicated that he is eager that the
firm accept Telemaster PLC as an audit client as this will simplify the audit of the group’s annual
financial statements. Based on the information you have gathered as per working paper A210
and A220, prepare a confidential memorandum to Mr Mathee explaining your considerations
and concerns regarding accepting the appointment as auditors of Telemaster PLC. (15)

b) Based on the background information and the information contained in working papers B200
and B220, identify possible risks of material misstatement at the overall financial statement level
for for StarNet and StarNet Group Limited. For each of the risks identified, discuss possible
responses to reduce the risk to acceptable levels. (Note that detailed audit procedures are not
required). (45)

- 51 -
QUESTION 6.3 (SUGGESTED SOLUTION)

a) Considerations and concerns regarding accepting Telemaster PLC as audit client (client
acceptance)

Memorandum format: (Properly addressed, body, signed and dated) (1)

 Considerations regarding the need to accept Telemaster PLC as audit client

1. Telemaster PLC could be a significant component of the group in the foreseeable future, after
management’s interventions to return the company to profitability. (1)

2. ISA 600 also requires active audit involvement of the group auditors in the
components/companies – accordingly if we accept the engagement, this will simplify our
procedures in this regard as group auditors. (1)

3. If we do not accept appointment as auditors, it would probably not be possible to rely on the
work of Brumbee and Partners and their audit opinion: (1)
- resulting in extra work and cost on our behalf, regarding the audit of Telemaster PLC,
and (1)
- Possible qualification of the audit report and the financial statements of StarNet Group
Limited, if we cannot rely on the work of the subsidiary auditors. (1)

 This is because there are serious concerns regarding the independence of the auditors
and their work (SAICA Code and ISQM1) (1)
- the audit fee appears to be a significant part of their firm’s total fees/they are
dependent thereon (1)
- they have been actively involved in preparing the financial statements, which are
management’s responsibility (1)
- they appear to have been actively involved with the client and its management in the
past (1)
- Mr Wilabee also owns a significant number of shares which indicates a financial
involvement of the client (1)

 There is also a serious concern regarding the competence and quality of Brumbee and
Partners’ work:
- They appear not to have qualified their audit opinion, non-regarding the going concern
problems, and the financial misstatements by management in the past. (1)
- The rumours and possibility of misstatement of the financial statements by
management. (1)

 They also appear not to comply with the quality control policies and procedures (ISA 220
and ISQM1) as Mr Wilabee has been the engagement partner for the last 9 years –
(SAICA CPC and ISQM1) requires partner rotation after 7 years, and the companies Act
after 5 years. (1)

 Their integrity is also under suspicion, given their refusal to resign, when required to do
so by management. (1)

- 52 -
 Factors concerning whether we can or should accept the engagement

- Client acceptance

Independence

Our independence might be jeopardised if Telemaster management requires of us

to provide them with significant management advice, strategies and preparation of
financial statements as was the case with the previous auditors. (1)

Management integrity/risk

Management’s integrity might be under suspicion/high engagement risk:

* new management might have an aggressive approach to growing the business
and making profits which might indicate a high risk of material misstatement of
the financial statements; (1)
* possible non-compliance with IRFS/accounting treatment issues of the past; (1)
* possible going concern issues; (1)
* non-compliance with laws, listing requirements, etc. (1)

Vacancy and payment of audit fee

* There appears not to be a vacancy in the position of auditors as Brumbee &

Partners have not resigned as such. (1)
* Given the problems of the past and the risk of the client, we will need to do a lot
more audit work which will increase the fee – consider whether client will be
prepared to pay the fee. (1)

- Auditors’ ability to service the client (auditor screening)

* We do not have offices in London and should consider whether we have enough
staff etc. to do the audit. (1)
* We should also consider our knowledge of UK legislation, GAAP, regulatory
requirements etc. (1)

- Engagement letter
If we are to accept the engagement, an engagement letter will need to be issued in
accordance with ISA 210. (1)

Maximum: (14)
Memorandum: (1)
Total: (15)

- 53 -
b) (i) Risk of material misstatement in the financial statements, and group financial
statements of StarNet Limited and (ii) the auditors procedures/response in this
regard

Risk of material misstatement (ii) Response as auditor to each of the

risks identified. (Note: Detailed audit
procedures not required)
1. StarNet’s listing raises the risks:  Ensure the engagement partner has
- Of over-statement of results to experience of listed company audits,
inflate the share price, given especially companies in the telematics
shareholders expectations, industry (1)
especially given the situation at (1) and is registered with the JSE to do
Telemaster PLC. listed audits. (1)
- there is also a risk of non-  Have the firm’s IFRS specialist review
compliance with listing (1) all accounting treatments/ issues and (1)
requirements (and possible disclosure.
suspension and penalties), given  Greater involvement by engagement
possible non-compliance with partner and senior staff throughout the (1)
IFRS, etc. audit to ensure significant risks are
detected and responded to.
2. Opening balances may be materially  Obtain detailed knowledge of StarNet’s
misstated. This risk is significant as, (1) business, control environment and
Based on the information provided it accounting practises. (1)
would appear that errors are present  Inspect prior year working papers of
in the 2023 group financial previous auditor and evaluate the
statements, such as the SPE (Star reasons/evidence documented to
Finance) which has been incorrectly support the manner in which the group (1)
accounted for as a joint venture. (1) financial statements were prepared.
 If little or no reliance can be placed on
the work of the previous auditor (due to
his/her lack of competence), perform
audit procedures on opening balance (1)
to verify the accuracy thereof (ISA 510)
3. The tight reporting deadline will  We will need to follow a system/test or
increase the risk of material control-based audit approach, placing
misstatement of the financial as much reliance as possible on
statements due to management and controls to identify possible (1)
auditors being under pressure to misstatements early.
prepare and audit the financial (1)  Perform early verification procedures
statements in time. where possible to verify assets and (1)
liabilities.
Also the risk that subsequent events
and contingencies will not be
properly/timely identified and (1)
accounted for.
4. Group of companies with divisions/  Test the consolidation workings in
complex issues related to detail, placing emphasis on areas of
consolidation (IAS 27) and business (1) complexity such as inter-company
combinations (IFRS3): balances, related party disclosures etc. (1)
The group consists of a holding  Review the financial statements of
company and three subsidiaries which Telemaster for consistency with group
makes the consolidation process (1) accounting policies. (1)
complex.  Pay careful attention to the
- Risk of inter-company balances, determination of the fair values of
related party transactions etc. not (1) assets, liabilities, contingencies and (1)
correctly accounted for. commitments of Telemaster at
- 54 -
 - Accounting for the new acquisition (1) acquisition, any goodwill factor, and
of Telemaster. possible impairment of goodwill or, very
- Reliance on the work of other likely, any bargain purchase gain. (1)
auditors Star Finance and (1)  Adhere/comply in detail with the ISA
Telemaster PLC. statements for Group audits (ISA 600)
- Issues relating to the consolidation and related party transactions (ISA (1)
of Telemaster: 550).
- The fact that the year-end of
Telemaster PLC is different
(31/12/2021) to that of the
holding company and the
group creates a risk of error on
consol-idation.
- Accounting for foreign
currency on consolidation.
- Telemaster management in-
tegrity/allegations of manipu-
lation of financial information.
- Conflict between UK GAAP
and IFRS. (3)
(Limit on marks re Telemaster)
5. The company’s operations are widely  Plan the audit carefully with the
spread, which may make effective emphasis on testing decentralised
control more difficult for the client and (1) operations with high risk of (1)
pose logistical problems for us as misstatements.
auditors with aspects such as stock (1)  Liaise with client staff and internal audit
takes at year end. to test regional offices and attend stock (1)
counts.
6. A WAN links the various geographical  Tests, using IT specialist, the controls
divisions/areas to each other, raising over the WAN and data transmission/
risks of unauthorised access, security. (1)
unauthorised transactions, or
amendments to data transmitted. (1)
7. Management remuneration policy/  Test management bonuses/share
practises create an incentive to options in detail, especially for (1)
overstate profits and assets. Thus overstatement.
there is a high risk of fraudulent  Place emphasis on testing income for
financial reporting due to overstatement, expenses for under
management: (1) statements. (1)
 Overstating profits to earn
bonuses.
- Overstating assets and
understating liabilities to increase
the value of their shareholding. (1)
- Specific fraud risk related to
revenue and manipulation of (1)
profits (ISA240)

- 55 -
8. Risk of incorrect accounting treatment  Actively involve the firm’s IFRS experts
 The company generates revenue and technical department to audit the
from a number of different correctness of the accounting
agreements which could result in treatment, and (1)
incorrect revenue recognition  subsequent disclosure in the financial
policies (sale of units, rental of statement (1)
units, monitoring and surveillance (1)
income).  Ensure a second partner quality review (1)
is performed of the audit.
 There may be a lack of IFRS
knowledge by management given
the incorrect accounting treatment
of Star Finance. There is a risk (1)
that other items will be incorrectly
accounted for.
 The fact that Star Finance is a
SPE which must be consolidated (1)
and not accounted for as a joint
venture (IAS 31).
- This also indicates that the (1)
previous financial statements are
incorrect and should be restated. (1)
 The accounting treatment of the
rental units as operating leases.
- The rental income is (1)
recognised over the lease
term and not straight lined.
- The possibility that the rental
agreements are in fact finance
leases and not operating
leases.
9. Reliance on the work of others  Comply with the ISA standards (ISA
 Legal advisors in terms of the 600, ISA 620, SAAPS 4)
environmental issues and claims. (1) - Consider the 3rd parties’
independence, experience and
qualifications. (1)
- Test their work where possible. (1)
10. Risk of non-compliance with laws and  Comply with section 45 of the AP-Act
regulations at StarNet Limited and on the consideration and reporting of
Starnet Group level, because Reportable Irregularities. (1)
 StarNet’s non-compliance with  Involve the firm’s technical department
IFRS and Company’s Act. (1) in the consideration of these issues.
 Possible reportable irregularities (1)
at Telemaster PLC which impact
on the group. (1)

- 56 -
11. Arrangement with Unico  Review the service level agreement
11.1 Outsourcing of billing to Unico between StarNet and Unico. (1)
 reliance on service  Comply with ISA 402 and request a
provider for IT functions report from Unico’s system auditors
and billing of clients (1) regarding the effectiveness of the
 loss of confidentiality/ general controls and processing of
availability of services (1) StarNet’s transactions by Unico’s
 difficulty for us as auditors systems (application controls). (1)
to audit the IT general and - Consider/review the system
application controls and auditor’s independence,
transaction processing a (1) qualifications, experience. (1)
Unico  If possible, involve our firms IT auditors
 integration of to test operating effectiveness of the
billing/invoicing of Unico general and application controls over
with that of StarNet’s the transactions processed by Unico. (1)
accounting systems might - And the interface thereof with
lead to errors/loss of data (1) StarNet’s systems. (1)

11.2 There are a significant volume  Follow a combined audit approach and
of transactions being place as much reliance as possible on
processed monthly (over the testing of controls (reliance on the
6 000 new units installed per system). (1)
month), which will increase
significantly with the SAPS
contract. This increases the
risk of input and processing
errors and omissions both at
Unico and at StarNet. (1)
12. The increase in volumes of  Discuss at start of the audit with
transactions increases the risk that management the risk of fraud and
unscrupulous staff may use the actions taken to address this. (1)
opportunity to engage in (1)  Ensure appropriate procedures are
misappropriation of units. performed to detect fraud for areas
where controls are considered
inadequate. (1)
13. Risk of increased accounting  Conduct additional audit procedures to
treatment: (1) ensure the correct accounting (1)
 Research and development costs. (1) treatment.
 Property, plant and equipment.
14. Possibility of going concern problems,  Discuss the going concern issues with
given the economy (credit crunch), the management and the directors/test
poor current and prior year results and (1) budgets, forecasts, cash projections (1)
the financial position of Telemaster. (1) etc.
Maximum: (22 Maximum: (21)

- 57 -
QUESTION 6.4 ACS 3.3

QUESTION 6.5 ACS 3.11

- 58 -
CASE 3 : 3 SUGGESTED SOLUTION
Page 1 of 4 pages

Workings (to compute a performance materiality figure to be used in the risk

assessment):

Both the statement of profit or loss and statement of financial position indicators should be used
in determining materiality as the decision-making of users of the financial statements will be
influenced by both. (1)

Due to the actual figures for the 2019 financial year being available, they will be used in
computing materiality. (1)

Computation of planning materiality:

½-1% of revenue (R23.131 million): R115,655 to R231,310
1-2% of gross profit (R4.189 million): R41,890 to R83,780
1-2% of total assets (R14.216 million): R142,159 to R284,318
2-5% of shareholders’ equity (R4.95 million): R99,000 to R247,500 ½ X 4 = (2)

Due to a prudent approach being followed in computing performance materiality, and due to this
being a new audit (i.e. increased risk of material misstatement): (1)

Performance materiality will be set at a conservative level of R120,000.

Assessment of the Risk of Material Misstatement

Applicable to ALL ASSERTIONS:

• The fact that our audit firm was only appointed after year end increases the risk of
material misstatement applicable to all assertions, as management may be
attempting to improve their ability to conceal fraudulent activity by making it
more difficult for us to undertake our audit. (1)
• Also, the reason for the apparently sudden resignation of the previous auditor is
not clear – it could be due to a disagreement with management or concerns about
their integrity. Should this be the case, the overall risk of material misstatement is
increased further. (1)

Assertion: Accuracy, valuation & Assessment: High (½)

allocation of property plant
and equipment
Explanation:
• Due to the revalued property constituting approximately 39% of the total assets
there is a risk that material misstatements in the financial statements can result
from: (½)
o The revalued amount of R5.5 million not being the “fair value” of the
property as envisaged in IAS 16 para 31 (i.e. determined with reference to
market-based evidence undertaken by a suitably qualified valuer). (1)
• There is a risk that the depreciation on the property plant and equipment may be
computed incorrectly in terms of the requirements of IAS 16, by for example
failing to review (and if necessary, adjust) the useful lives and residual values of
CASE 3 : 3 SUGGESTED SOLUTION
Page 2 of 4 pages

these assets at each financial year-end, resulting in a misstatement of the carrying

amounts. (1½)
• As this is the first year that our firm will be auditing Select Books (Pty) Ltd, there
is a risk that there could be material misstatements due to errors in the opening
balance of property plant and equipment (specifically shop fittings). (1)

Assertion: Completeness of property Assessment: High (½)

plant and equipment
Explanation:
• Assuming that Select Books (Pty) Ltd has early adopted the application of IFRS
16 on Leases, misstatements are likely to exist given the company’s failure to
appropriately recognize all right-of-use assets relating to its rented premises and
other rented assets. (1)
• This understatement is likely to be material (i.e. the amount to be capitalized is
likely to be in excess of R120,000). (1)

Applicable to ALL INVENTORY ASSERTIONS:

Due to the size of the account balance and the fact that any misstatements will have a
direct impact on both the statement of profit or loss and statement of financial position,
increases the risk pertaining to all the inventory assertions. This matter has been taken
into account in the assessment of risk of material misstatement for each of the inventory
assertions. (1)

Assertion: Completeness of inventory Assessment: High (½)

Explanation:
• The decline in the gross profit percentage could be due to the understatement of
inventory due to, for example, undercounting of inventory at the year end
inventory count. (1)
• Inventory is held at four branch outlets and at the warehouse and numerous
inventory transfers take place between these locations; therefore, there is a risk of
omission of this inventory due to its not being counted at either the receiving or
dispatching location. (1)
• Due to a large number of textbooks being imported, the risk is increased that there
could be inventory in transit, to which Select Books (Pty) Ltd has the rights of
ownership, but which have not been recorded in its accounting records before
year end. (1)
• As the inventory is either purchased outright for resale or are held on
consignment, there is a risk that inventory purchased outright is incorrectly treated
as being on consignment (and hence excluded from inventory). (1)
• As Select Books (Pty) Ltd in certain instances supplies books on consignment to
bookshops in other African countries, there is a risk that certain consignment
issues are treated as being outright sales, resulting in inventory that has been
issued on consignment no longer being recorded as being on hand. (1)
• Inventory held on consignment at the bookshops in other African countries may
not be counted correctly at year end. (1)
CASE 3 : 3 SUGGESTED SOLUTION
Page 3 of 4 pages

Assertion: Accuracy, valuation & Assessment: Medium (½)

allocation of inventory
Explanation:
• The complexity of costing of imported inventory increases the risk as:
o Shipping costs, import duties, etc. may not be correctly allocated to the
cost of the inventory; and (1)
o The conversion of the foreign currency amount into Rands may not be
performed in accordance with the requirements of IAS 21. (1)
• The potential obsolescence of textbooks that have been purchased by Select
Books (Pty) Ltd and which may be replaced by newer editions or replaced on the
prescribed book lists of universities also increases risk due to the complexity of
the estimate that has to be made. (1)
• The decline in the gross profit percentage could be due to the allowance for
inventory obsolescence being overstated. (1)

Assertion: Rights of inventory Assessment: Medium (½)

Explanation:
• Due to a large number of textbooks being imported, the risk is increased that there
could be inventory in transit could be recorded as that of Select Books (Pty) Ltd
when the risk and rewards of ownership have not yet passed to the client before
year end. (1)
• As the inventory is either purchased outright for resale or are held on
consignment, there is a risk that inventory held on consignment is incorrectly
treated as being purchased outright (and hence is incorrectly recorded as being
owned inventory). (1)
• As Select Books (Pty) Ltd in certain instances supplies books on consignment to
bookshops in other African countries, there is a risk that certain outright sale
transactions are treated as being issued on consignment, resulting in inventory that
has been sold still being reflected as being on hand - however, the relatively small
balance reduces this risk. (1)

Assertion: Accuracy, valuation & Assessment: Medium (½)

allocation of trade receivables
Explanation:
• As debtors are subject to a thorough creditworthiness check, the risk that debtors
will not be recoverable is reduced. (1)
• To the extent that the sales to bookshops in other African countries is
denominated in a currency other than SA Rand, there is a risk that the amount
reflected as being outstanding may be incorrectly measured in the financial
statements (either due to errors in initial measurement or in the subsequent
restatement of the balance due). (1)
• As this is the first year that our firm will be auditing Select Books (Pty) Ltd, there
is a risk that there could be material misstatements due to errors in the opening
balance of trade receivables. (1)
CASE 3 : 3 SUGGESTED SOLUTION
Page 4 of 4 pages

Assertion: Completeness of trade Assessment: Medium (½)

receivables
Explanation:
• As Select Books (Pty) Ltd in certain instances supplies books on consignment to
bookshops in other African countries, there is a risk that certain outright sales are
incorrectly treated as being issued on consignment. (1)
• Also, sales made by consignees may not be raised as revenue/trade receivables at
the time the consignee made the sale to a third party. (1)
• However, the relatively small balance reduces both the abovementioned risks. (1)
• Increasing the risk pertaining to this assertion is the decline in the gross profit
percentage – coupled with the decline in the Rand amount of the revenue, this
could point to understated sales to the other bookshops and hence understated
accounts receivable. (1)

Communication skills:
Layout and structure (1)
Logical argument (1)

Maximum (28)
CASE 3 : 11 SUGGESTED SOLUTION
Page 1 of 6 pages

PART A (a)

1. As the planning of the audit only commenced after year-end, it will complicate the
obtaining of audit evidence that should have been gathered at year-end or before year-
end. (1)
1.1. For example, the attendance at the year-end inventory count, the verification of the
existence of property, plant and equipment, as well as the external confirmation of
trade receivables should ordinarily be conducted at year end. (1½)
1.1.1. Failure to do so will result in additional audit work having to be done – e.g.
“roll-back” procedures should be performed on the balance verified to the
balance that existed at year-end (and which is included in the annual financial
statements). (1)
1.1.2. Should the control environment be weak, or the assertions otherwise be at very
high risk of material misstatement, the possibility exists that it may not be
possible to gather sufficient appropriate audit evidence about the balance (and
the related assertions). (1)
1.2. Should the audit procedures for the matters identified in 1.1 indeed have been
performed at year-end, the failure to undertake the planning phase of the audit (at
least in relation to these areas) prior to the commencement of the audit procedures
being performed will mean that the nature and extent of the procedures performed
may be inappropriate. (1)
1.2.1. This is as the risk of material misstatement for the relevant assertions may not
have been properly assessed. (1)

Maximum (4)

PART A (b)

1. Inspect the following:

1.1. The 2018 and 2019 annual financial statements of Mystique Hospitals (Pty) Ltd to
determine the company’s accounting policies for Property Plant and Equipment
(PPE) and the details of the PPE asset; (1)
1.2. The company’s fixed assets register to determine the nature and details of the
individual PPE assets (including the residual values and useful lives of these assets);
(1)
1.3. The company’s policies and procedures manual to obtain an understanding of how
the PPE asset is safeguarded and controlled; and (1)
1.4. The 2018 audit work paper files to evaluate the nature and materiality of the
misstatements that were identified by the audit team in relation to the PPE balance.
(1)
2. Enquire from the Finance Director, Finance Manager and other staff involved in
accounting for PPE about the effectiveness of the controls to ensure the complete and
accurate accounting for the PPE-related transactions (e.g. acquisitions, disposals,
revaluations). (2)
3. Visit the locations where the PPE is located and observe the condition of these assets. (1)
4. Perform the following analytical procedures:
CASE 3 : 11 SUGGESTED SOLUTION
Page 2 of 6 pages

4.1. Compare the balances / movements for the various types of PPE in 2019 to the prior
financial year and the capital budgets; and (1)
4.2. Compare the total of the repairs and maintenance expenditure for the FY2019 to
FY2018 and the budgeted expenditure. (1)

Maximum (6)
PART A (c)

Risks at the Financial Statement Level:

1. As the accounting department appears to be well-staffed, and the Financial Director is a

Chartered Accountant (SA), this inherently reduces the risk of material misstatement at
the financial statement level. (1)
2. As the company’s hospital administration and accounting systems are based on open
source software downloaded from the internet, the risk of material misstatements in the
financial statements will be inherently increased – as no input / oversight would have
been provided during the development of this software. (1)
3. With the outsourcing of the software support and maintenance to PrimeOutsource (Pty)
Ltd, a company experienced in the health-care industry, the risks of material misstatement
should be reduced. (1)
3.1. However, “administrator” level access to the system is available from remote
locations, exposing the system to unauthorised access with the risk of the loss or
modification of data and software – increasing the risk of material misstatement. (1)
4. With the risk of retrenchment of administrative staff and likely reductions in salary
expenditure (in terms of the board resolution of 15 March 2019), employees’ reduced
morale is likely to:
4.1. have an adverse effect on their work – increasing the risks pertaining to the
completeness and integrity of the financial information used for preparing the annual
financial statements; and/or (1)
4.2. increase the risk of misstatements due to the misappropriation of assets – as these
employees are likely to have incentives and rationalisation for such fraudulent
activity. (2)
5. The control environment appears to be weak as:
5.1. the directors resolved to write off in excess of R155,458 without requiring any further
investigation or improvement in control; (1)
5.2. Dr Mimic’s query about the completeness of revenue was dismissed by the finance
director, by her stating that the “figures were correctly extracted from the
computerised system”, without evaluating whether all invoices were recorded on the
system timeously; (1)
5.3. the risk management process (one of the elements of an internal control system), and
specifically the actions taken to respond to the risks identified, are ineffective / weak
(see point 10 below); (1)
5.3.1. Specifically, the provision of hospital services to related parties without being
invoiced further weakens the control environment – given management’s
apparent willingness to apply “special rules” to related persons. (1)
The board’s attitude towards controls is likely to result in an increased risk of material
misstatement due to fraud (as staff may perceive more opportunity to engage in
CASE 3 : 11 SUGGESTED SOLUTION
Page 3 of 6 pages

fraudulent activity) or error (due to staff perceiving less management supervision /

override of controls. (2)
6. The composition of the board of directors of Mystique Hospitals (Pty) Ltd is such that
there is a majority of executive directors, with the non-executive directors not appearing
to play a particularly strong role. (1)
6.1. This will increase the risk of management override of controls / fraudulent conduct
on the part of management, given that the independent oversight of management’s
conduct is limited. (1)
7. The risk that the going concern basis of accounting has been inappropriately applied in
the preparation of the financial statements is increased by the following:
7.1 The company is experiencing serious liquidity problems as is evident from the weak
current ratio and the significant increase in short-term borrowings; (1)
7.2 Given the lax credit controls around admitting self-funding patients, part of the
accounts receivable balance may prove difficult and time-consuming to collect –
placing further pressure on the company’s liquidity situation; (1)
7.3 The company is highly geared – which will make it difficult for the company to raise
additional debt financing; (1)
7.4 There has been a significant decline in revenue and pre-tax profit - without any
effective strategy to address a turnaround; (1)
7.5 The drastic steps taken by the board to cut staffing levels and salary costs at the
hospitals is evidence of the severity of the above problems. (1)
The risk will, however, be partially reduced by the following:
7.6 The twenty doctors who practise in the area served by the hospitals will have a vested
interest in ensuring that the hospitals continue to operate – and hence may invest
further funds in subscribing for the company’s shares. (1)
7.7 The company was incorporated more than 20 years ago – and the fact that it has been
in operation for so long demonstrates that that it has the potential to “weather the
storms”. (1)
8. The previous risk factor will provide an incentive to management to misstatement the
financial statements (e.g. overstating assets / revenue and understating liabilities /
expenses). (1)
9. There is an inconsistency to the reference in the board meeting of 15 March 2019 to the
“budgeted loss for the year” and the actual reported profit of R84,000. This inconsistency
may be the result of management having fraudulently misstated the financial results in
order to generate a small profit – further increasing the risk of material misstatement. (1)
10. From the information documented on work paper M-103, it can be concluded that the risk
management process followed by Mystique Hospitals (Pty) Ltd is weak, increasing the
risk of material misstatement at the financial statement level. For example: (1)
10.1. The key risks identified and included in the risk register appear to be incomplete
(e.g. no risks relating to transactions involving medical aids have been identified); (1)
10.2. The actions taken to respond to the risks identified are often ineffective (specifically
in relation to risks 1 and 3) – leaving fairly high (and unacceptable) residual risks. (1)
10.3. Many of the “unmanaged” business risk are likely to manifest themselves as
misstatements in the financial statements. (1)
11. The failure of directors to comply with the requirements of the Companies Act increases
risks generally, as this may point to a lack of competence and/or integrity on their part. (1)
CASE 3 : 11 SUGGESTED SOLUTION
Page 4 of 6 pages

11.1. It is likely that the managing director has an interest in the cleaning contract (e.g. in
addition to the commonality of the surname, Mr Cyclops can “guarantee” the cost of
the service). (1)
11.2. However, there is no evidence that this interest had been disclosed before the board
resolution was passed or that any of the other Companies Act requirements regarding
dealing with director’s personal financial interests have been met. (1)
11.3. There is also evidence of management abuse of power, as despite the requirement
that the director with an interest should not vote on the contract, the resolution was
only passed due to the casting vote of Mr Cyclops. (1)

Maximum (18)
Risks at the Assertion Level:

1. Property, Plant and Equipment (PPE)

1.1. Given the magnitude of the balance of property, plant and equipment relative to the
performance materiality figure, there is a high risk that misstatements in this account
balance will cause material misstatements in the financial statements. (1)
1.2. The risk pertaining to the existence assertion is increased because of the sizeable
increase in the PPE balance during FY2019 – it is possible that this increase was the
result of repairs and maintenance expenditures being inappropriately capitalised. (1)
1.2.1. This risk (as well as the other risks identified relating to the overstatement of
the account balance) is increased due to fact that Mystique Hospitals (Pty) Ltd is
experiencing serious financial difficulties (high gearing, etc.), and management
will have an incentive to overstate the carrying amount of the company’s assets.
(1)
1.3. The risk pertaining to the accuracy, valuation and allocation assertion is increased as:
1.3.1. The board of directors is concerned about the profitability (going concern) of
the hospitals owned by the company and this may point to the need to impair the
carrying amounts of the non-current assets in the loss-making hospitals – which
may either not have been done at all or done incorrectly. (2)
1.3.2. The residual values of assets are fixed at acquisition or deemed to be NIL.
There is thus a risk that misstatements will arise due to the failure to comply
with the requirement of IAS 16 for residual values to be reviewed annually,
which will result in the depreciation charges / accumulated depreciation
balance to be misstated. (1)
1.4. The risk pertaining to the valuation and allocation assertion is reduced as:
1.4.1. The accounting policy adopted by Mystique Hospitals (Pty) Ltd in accounting
for PPE is in accordance with the requirements of IAS 16 (with the exception of
the manner in which residual values are accounted for). (1)
1.5. As all property, plant and equipment are owned by the company the risk of
material misstatement in respect of the rights of ownership assertion is reduced. (1)

2. Accounts Receivable
2.1. The risk relating to the valuation and allocation assertion is increased as services are
rendered to self-funding (private) patients, and the controls implemented to evaluate
their creditworthiness are very poor (merely requesting the patient’s home address).
There is a high risk that many of these patients will not be able to settle the amounts
CASE 3 : 11 SUGGESTED SOLUTION
Page 5 of 6 pages

due by them, which may not be appropriately considered when determining the
allowance for credit losses. (2)
2.2. While inherently the risk pertaining to the completeness of revenue and accounts
receivable is increased due to risk 2 identified on work paper M-103, this risk is
reduced due to the sound system of internal control that has been implemented. (1½)
2.3. However, the risk for the completeness of accounts receivable due to the incomplete
recording of revenue from consumables items issued to patients remains high due to:
2.3.1. Management’s failure to identify and address this risk (through internal
controls) in the risk register; and (1)
2.3.2. The recorded inventory balance from consumables being larger than that on
hand on 28 February 2019 (prior to the write-off) – this variance could be
indicative of consumables having been issued to patients, but not being charged
to them. (1)
2.4. The expression of surprise by Dr Mimic, one of the doctors who utilise the hospitals,
at the revenue numbers being below his expectations further increases the risk
pertaining to the completeness of revenue / accounts receivable – as the occupancy
levels should closely correlate to the revenue figure. (1)
2.5. Reducing the abovementioned risks is the fact that the debtors collection period has
remained fairly stable at around 31 days (from audited 2018 figures to those in 2019).
(1)
3. Inventory
3.1. Increasing the risk pertaining to the existence of inventory is the fact that the
consumables used in the hospitals are inherently relatively easy to steal, and the
board does not appear to enforce strong controls over inventory custody (there were
no records to support the write-off for the inventory). (1)
3.2. The risk in respect of the completeness of inventory is high, due to the significant
decline in the inventory balance from 2018 to 2019 - the write-off of R154,458 may
have been done an error and would partly explain the decrease. (1)
3.3. The risk pertaining to the valuation and allocation assertion is increased as other
items (in addition to those that were written-off) may be obsolete / have past their
expiry date and may have to be destroyed. To the extent that such items are still
included in the inventory balance, these amounts may be in excess of their net
realisable values. (1)
3.4. The risk of material misstatement in respect of the existence and valuation of
inventory is relatively low as the balance is small in relation to the performance
materiality figure. (1)
Maximum (11)

Communication skills (layout and structure) (1)

PART B
1. Mrs Pryde is a chartered accountant in business and is therefore bound by parts 1 and 2 of
the SAICA Code of Professional Conduct. (1)
2. In this regard, she is bound by the fundamental principles of Professional Behaviour and
Confidentiality.
CASE 3 : 11 SUGGESTED SOLUTION
Page 6 of 6 pages

2.1. Professional Behaviour requires that a chartered accountant complies with all
relevant laws and regulations. (1)
2.2. Confidentiality requires the chartered accountant to refrain from disclosing
confidential information acquired as a result of a business relationship outside the
firm without authority to do so. (1)
3. S260 of the Code of Professional Conduct makes allowance for the conflict that may arise
between her responsibility to ensure that all relevant laws are not breached (Professional
behaviour) (e.g. Health and Safety Laws) and the responsibility to keep her employer’s
information confidential. (1)
4. In this regard, S260 deems it not to be a breach of confidentiality, if reporting such
information is appropriate in the public interest. (1)
5. As the lives of patients are potentially at risk, her responsibilities as a chartered
accountant would extend to reporting the health and safety issues appropriately and would
not be considered a breach of confidentiality. (1)
6. Firstly, however Mrs Pryde would need to get a better understanding of the matter as
there is only a suspected non-compliance with the law. This would entail determining:(1)
6.1. the nature of the act(s); (½)
6.2. the circumstances in which it has occurred; and (½)
6.3. the potential consequences to Mystique Hospitals (Pty) Ltd and its patients. (½)
7. Once the information has been gathered, it may be prudent for Mrs Pryde to consult legal
counsel – to determine whether the cut-backs complained of will give rise to breaches to
laws and regulations applicable to Mystique Hospitals (Pty) Ltd. (1)
8. Should the theatre sister’s allegations about non-compliance with laws and regulations
appear justified, Mrs Pryde would need to address the matter as follows:
8.1. Report the issue to her immediate superior, in this case probably the managing
director, Mr Cyclops. (1)
8.2. Report the issue to those charged with governance, being the company’s board of
directors. (1)
8.3. Reduce the risk of re-occurrence of non-compliance by reporting the issue to the
health and safety officer of the company and ensuring that compliance tests are
performed on the procedures followed in the operating theatres. (2)
8.4. Comply with applicable laws and regulations, including the reporting of the non-
compliance to an appropriate authority (e.g. the Department of Health). (1)
9. Mrs Pryde should consider whether there is a necessity to report the non-compliance to
the company’s registered auditors (X-Men & Co). (1)
10. Mrs Pryde should then assess the appropriateness of the response of her superiors,
including those charged with governance (i.e. does the response adequately address the
potential non-compliance in a manner that is sufficiently timely given the nature and
urgency of the matter). (1)
10.1Based on this assessment, she should then determine whether further action (e.g.
resignation from the company) is needed. (1)
11. Finally, Mrs Pryde would need to document all discussions, reports, responses and
considerations to show that she has satisfactorily fulfilled her responsibilities set out in
S260 of the Code. (1)
Maximum (10)
 Homework question

Do the following question for hand in class on

25 March 2025
QUESTION (53 MARKS)

BACKGROUND

You are an audit partner of a medium-size auditing firm, Van Dyk & Partners (hereafter VD&P). This
reputable firm has audit offices in all major cities of South Africa and has been in existence since
1995.

You are currently busy planning the 2022 audit of TeleConnect (SA) Limited (hereafter referred to
as TCL), a new client with a December 2022 year-end. Your firm was appointed as auditors in June
2024, after a successful presentation to the audit committee of TCL. The company (TCL) decided to
contact different auditing firms due to an ongoing dispute between TCL and their previous auditors;
the details of this dispute are unknown to you. The firm (VD&P) was successfully appointed as TCL’s
auditors due to quoting a low audit fee. VD&P has never audited a telecommunications company
prior to TCL. The audit must be finalised at the end of January 2025, as agreed with the audit
committee.

TCL is the third largest provider of telecommunication services in South Africa. TCL forms part of
the TCL group that operates in two countries in the Southern African region, namely South Africa
and Namibia. TCL is listed on the Johannesburg Stock Exchange (JSE) and represents TCL Group’s
cellular communication network in South Africa.

The South African mobile communications market is a highly competitive and a rapidly changing
environment. A key focus area for the company is the improvement of the quality and capacity of the
cell phone networks and computer information systems. This together with a number of innovative
and customer focused products were introduced by the company to stay competitive. As part of the
increased focus on improving capacity to support the business strategy, TCL has been restructured
into a functional organisation design. This structure has been supported by a number of senior
appointments in key specialist areas. TCL has also decided to migrate to Xero cloud accounting
software from TopDog Accounting Software due to TogDog not receiving any security or functionality
updates in over a year. Management decided that they will address any changes in 2024 to IFRS
late next year, as the primary focus at this point of time is the delivery of outstanding results.
Shareholders have high expectations of this successful company, because it operates in the cell
phone industry. The share-options of executive directors are due to expire on 15 February 2025.

The telecommunications industry is regulated by the requirements of the Independent

Communications Authority of South Africa (ICASA). Health authorities, such as the World Health
Organisation and the South African Department of Health also regulate the industry. Since 5G was
released in 2019, there have been a number of health concerns raised regarding the emitted radio
frequency. However, the consensus of the health authorities, having reviewed relevant research and
noted the findings of scientific review panels on radio frequency emissions; is that there is no
substantial evidence of adverse effects from the low levels of radio frequency emissions generated
by cell phone towers, if they comply with national and international safety guidelines. These levels
of emitted radio frequency emissions levels around cell towers are regularly monitored by TCL to
ensure that they are compliant with safety limits at all times.

The following extracts from the 2024 audit working paper file of TeleConnect are provided:

Working Paper Reference

Planning: Understanding of the entity: Sundry information A2
Planning: Understanding of the entity and its environment - Inventories B7

- 75 -
 Client: TeleConnect (SA) Limited Prepared by: Vanessa Van Dyk
Year-end: 31/12/2024 Reviewed: Ben Marx
Date: 10/05/2024 A2
Subject: Planning: Understanding of the entity: Sundry information

Board members

Several board members resigned during January 2024. The chairperson of the company
immediately appointed new board members in order to replace the board members who have
resigned.

The board of directors currently consists of the following people:

Dr A Zonke Executive chairperson

Mr K Ward Chief Executive Officer
Ms C Viljoen Chief Operating Officer
Ms Z Zanele CA(SA) Financial Director
Mr N Strydom Executive Director
Dr C Leke Executive Director

The board has established an audit committee which consists of the following people:

Dr A Zonke Executive chairperson

Mr K Ward Chief Executive Officer
Ms Z Zanele CA(SA) Financial Director
Mr N Strydom Executive Director
Dr C Leke Executive Director

The main responsibility of the audit committee is the preparation of the annual financial statements.
The audit committee considers it necessary to publish financial statements annually and integrated
reports once every 5 years.

Remuneration of directors

The Board of Directors determines a broad policy for individual director’s remuneration and benefits
to maintain a compensation policy, which is both competitive and equitable. This is done on an
annual basis. The Board views the compensation of directors as a confidential issue and although
a policy exists in this regard, it is not available to people other than the Board of directors.

A major part of the remuneration of executive directors is performance based. Performance bonuses
are paid twice a year to executives and the company has a share option scheme in place.

Non-executive directors are not awarded share-options but receive a fixed fee of R5 000 per
directors meeting that they attend.

- 76 -
SENS announcement on the 15th of January 2024:

TeleConnect (SA) Limited

(Incorporated in the Republic of South Africa)
(Registration number 1994/009584/06)
(Share code TCL)
(ISIN: ZAE000042164)
(TCL)

TCL SUCCESSFULLY AWARDED A CONTRACT

TCL was awarded the contract to provide data communication services to the Local Organising
Committee of the 2022 Premier Soccer League for the period 2022 to 2024.

Fairland
15 January 2022
Lead Sponsor
J.P. Morgan Equities South Africa Proprietary Limited
Joint Sponsor
Tamela Holdings Proprietary Limited

Market response
Immediately after the SENS announcement on 15 January 2022, the share price of TCL increased
by 20%.

The following share transactions involving the company’s directors took place in January
2024:

DATE DIRECTOR TRANSACTIONS AMOUNT

14 January 2024 Ms. Z Zanele Purchased 100 000 shares R500 000
16 January 2022 Ms. Z Zanele Sold 100 000 shares R600 000

- 77 -
 Client: TeleConnect (SA) Limited Prepared by: Vanessa Van Dyk
Year-end: 31/12/2024 Reviewed:
Date: 10/06/2024 B7
Subject: Planning: Understanding of the entity and its environment:
Inventories

Understanding of the entity and its environment – Inventories

- The company imports various cell phones, representing the most popular brands and the
newest technology over the world, from leading suppliers in the USA and Japan. Contracts
with these suppliers include details such as requirements for return in case of faulty cell
phones.

- Cell phones are distributed to outlets nationwide, but the bulk of cell phones are kept at the
main warehouse in Johannesburg.

- Each outlet has a full workshop to address all technical queries from customers in respect of
cell phones that is covered by the guarantee period of 12 months.

- Other products such as sim cards, prepaid cards and cell phone accessories are also available
at these outlets.

- Cell phones are divided in categories according to their values and sold as part of a cell phone
contract. Customers are allowed to pay an extra fee to obtain a cell phone from a higher
category.

- Cell phones are only sold after entering into a contractual agreement with a client.

- The company are obliged to keep a register of cell phone numbers, contract numbers and the
PUK code of the cell phone.

Total marks
REQUIRED: Sub-
Total
total
(a) Based on the background information and working paper A2 provided,
discuss any factors and issues that your audit firm should have considered
before accepting the appointment as auditors of TCL. 15

Communication skills: clarity of expression 1 16

(b) Identify the risk of material misstatement at the overall financial statement
level, evident from the background information and working paper A2 with
regard to the audit of TCL for the year ended 31 December 2024. 15

Communication skills: clarity of expression 1 16

(c) With reference to the information under the heading: SENS announcement
on the 15th of January 2024, discuss whether or not the share transaction
by Ms. Zanele was ethical.

Please note:
Use the ethical triangle (good, good for self, good for other) to structure
your answer. 6

- 78 -
(d) With reference to the background information, as well as the information
included in working paper B7, assess the risk of material misstatement for
each of the assertions for the account balance of inventory. 14

Communication skills: clarity of expression 1 15

53

- 79 -
 Module 4 – Engagement & Planning
Risk Identification and response
Prof. Ben Marx

1. IMPORTANCE
• VERY IMPORTANT IN PRACTICE
• Basic principles of risk based auditing
• Form basis of audit methodology of audit firms
• Basic requirement of Audit Quality and Quality Management

• VERY IMPORTANT FOR EXAMINATIONS

• Every UJ exam
• IAC exam

• EASY MARKS!!!

1
 2. CONTENT

ENGAGEMENT OVERALL DETAIL AUDIT

ACTIVITIES AUDIT PLANNING
• new clients PLANNING (for significant
• existing clients • steps and issues to accounts)
consider / address • steps and issues to
• risk assessment consider / address
and response • risk assessment
and response/audit
approach

3. STUDY SOURCES

TEXTBOOK AUDIT
QUESTIONS
(NB!) STATEMENTS
• Ch 5: Overview of • ISQM 1 & 2 • Recorded
the audit process • ISA 200 questions
• Ch 8: • ISA210 • Self-Assessment
Detail on • ISA220 questions
engagement and • Homework (hand
• ISA300
planning activities in)
• ISA315 (R)
• ISA320
• ISA330

2
 4. STUDY APPROACH
• Principles of Engagement, Planning and Risk Assessment
• Application of principles (module questions)
Class F-F • Home: Master the principles form Textbook and ISA’s and the
Recording Q Questions done in the recording

• Revise, study and understand: DA Ch 5 and 8

• Reference to ISA’s: (NB issues of DA)
Home:
• Revise class questions at home
Self work • Do self assessment questions in own time

Attend Class
• Application of principles (interactive)
Recording

• Revise the question done in class

Home: • Do self assessment questions in own time
Self work

4. STUDY APPROACH (continue)

• STUDY THE TEXTBOOK : Ch 5 and 8 (NB!)
• Study and understand the principles
• READ THE STATEMENTS
1. Statements
• Engagement: ISA 200, 210, 220, 300, ISQM 1 and 2
• Planning and response: ISA 200, 300, 315(R), 320, 330
2. Approach
• Read once
• Reference to statements when practical, e.g.
• Engagement letter (ISA 210)
• Planning considerations (ISA 300)
• Assertions (ISA 315)
• UNDERSTAND THE UNDERLYING PRINCIPLES (NB)
• STUDY THE FRAMEWORKS (AND UNDERSTAND)
• DO QUESTIONS  Application
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 5. NOTES ON AUDIT QUALITY OF AUDITORS
WORK and QUALITY MANAGEMENT
• Deals with the auditor’s:
• Quality of audit work/negligence
• Compliance with the audit statements, etc.
• Compliance with quality management (ISA 220, ISQM 1 & 2)
• Type of questions
• Criticise the auditor’s work
• Discuss negligence of the auditor/compliance with ISA’s, etc.
• Discuss compliance with Quality Management objectives (ISQM 1) and Engagement
Quality Reviewer (ISQM 2) nad Quality on Audit (ISA 220)
• Base answers on scenario/info of question and using ISQM and ISAs as guidance and
benchmark
• Examination technique
• Practical application  use the information of the question and measure this against:
• Statements
• Best practice standards
• Think!!!

NOTES ON AUDIT QUALITY MANAGEMENT

• Deals with Audit Quality
• Firm level (ISQM 1 & DA page 5-32 -5.41)
• Engagement Quality Controller (ISQM 2 & DA page 5.40 – 5.42)
• Audit level (ISA 220 & 5.42 – 5.46)
• Focus
• Relate to Firm responsibility to implement a system of QM
• Applies to Audits & Reviews of FS, other Assurance E or Related services
• Must operate on an interactive and continual manner responsive to changes in
circumstance and risks
• Follow a risk base approach
• Consist of:
• Establishing quality objectives : 8 objectives for the system of QM
• Identifying and assessing risks
• Identifying responses to address the risks (procedures/actions/controls)
• Annual statement by Head of AQ on compliance

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 NOTES ON AUDIT QUALITY MANAGEMENT
• ISQM 1 AT FIRM LEVEL (DA Page 5.30 – 5.40):.
• Responsibility: Firm and CEO
• Objectives (components) of QM system

1. The firm’s risk assessment process;

2. Governance and leadership;
3. Relevant ethical requirements;
4. Acceptance and continuance of client relationships and engagements;
5. Engagement performance; 6. Resources;
7. Information and communication; 8. Monitoring and remediation process.

• ISQM 2 : ENGAGEMENT QULITY REVIEWER (DA Page 5:40 to 5:42)

• Required for all Listed and PIE and that required by firms own policies (Firm responsibility)
• EQC reviewer responsibility: Avoid self review, familiarity , independence threaths
• Procedures: Focus on significant – judgements, matters, EP ethical & independence
• Consider whether proper consultation done on significant matters
• Consider involvement throughout the audit of partner

NOTES ON AUDIT QUALITY MANAGEMENT

• ISA 220: QAULITY MANAGEMENT ENGAMENT – AUDIT LEVEL (DA Page 5.42 – 5.46):.
• RESPONSIBILITY: Engagement partner
• OBJECTIVES (components) of QM at Audit level

1. Leadership responsibility for quality on audits

2. Ethical requirements;
3. Acceptance and continuance of client relationships and engagements;
4. Engagement resources (human; technological; intellectual)
6. Engagement performance (direction; supervision; review)
7. Monitoring and remediation process.
8. Documentation
• EXAM TECHNIQUE on QULITY MANAGEMENT
- Identify what is required : Firm; Audit, EQR
- Address quality from: Firm responsibility level
: Audit level
- Use ISQM 1 and ISA 220 as guidance
- Focus on information of scenario/question
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 THE AUDIT PROCESS (cont)
Steps in the audit process

Engagement Planning Audit procedures

( ISQM 1 & ISA 220) (ISA 300, 315(R), (Assertions)
330) Evaluating
• New clients • Tests of controls and
• Continuous clients • Overall financial • Substantive
statement level
concluding,
procedures
• Assertion level Reporting

REFER TEXTBOOK: CH 5 : PAGE 5.15 - 5.17

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6. METHOD OF OBTAINING ENGAGEMENT AND

PLANNING INFORMATION (RAP)
• Why
To identify and assess risks:
• At overall Financial statement level
• At assertion level for significant accounts
• Significant due to nature and inherent risk
• Quantitatively material (> planning materiality)
• When?
• Engagement
• Planning
• Overall audit planning
• Detail audit planning (significant accounts assertion level
• How? Risk assessment procedures (ISA 200/300/315/330)
• enquiries: inside and outside of organisation
• inspection of documentation
• analytical review

REFER TEXTBOOK: CH 7: PAGE 7.4 12

CH 8: PAGES 8-4 – 8.5; 8-11

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 7. NOTES ON ENGAGEMENT ACTIVITIES
• Deals with the engagement considerations as auditor for:
• accepting a new client
• evaluating an existing client to determine if you can continue as auditor
• Why?
• to evaluate the acceptability of clients (to limit the risk to the firm)
• legal liability/litigation
• reputational risk
• to consider whether we can offer a quality audit
• to consider compliance with regulatory, statutory, ethical requirements (ISQM1 & ISA 220)
• Documentation
• Document considerations and procedures
• Responsibility for client acceptance and continuance
• Partner (engagement partner)
• Examination technique
• Framework  headings
• Practical application  use the information in the question and apply this to the
framework
REFER TEXTBOOK: Ch 5: page 7.17 – 5.18;
Ch 8 : page 8.3 – 8.9
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FRAMEWORK: Considerations and

actions/procedures regarding engagement activities
1. Client investigation/evaluation (Client) (Page 8.5- 8.6)

• Independence of the auditor: actual and perceivable (threats to independence

• personal/family relationships/financial involvement, etc. (CPC)
• Integrity of the client (management integrity & risks of the client (business risk)
• Integrity and business reputation: Directors, Key Management, Related parties, owners
• Corporate governance practices & commitment to Ethical Business practices
• Involvement in litigation/legality of operations/money laundering history, etc
• Financial position  going concern/ plans for future developments such as retrenchments, cutbacks, etc
• History of lawsuits/
• Attitude towards the audit/ limitation of scope of audit work/ agresivly limiting audit fees,
• etc.
• Changes in the entity (existing clients): impact on
• Independence: changes in management/ownership
• Special knowledge required
• Performance of the audit work
• Communication with the previous/existing auditor (CPC)
• Communication as per CPC
• Also consider:
• The legal procedures in respect of engagement (existence of a vacancy in the position of the auditor)
• the client’s ability/willingness to pay (Financial Responsibility of the client)

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 FRAMEWORK (continue)
2. Skill and competence (Auditor) (Page 8.7)
• Industry knowledge and expertise
• Staff with knowledge or regulatory and financial reporting requirement, or can obtain
this
• Firm have the IT skills and experiemce required for the audit
• Firm have suffient staff with the right skills to do the audit
• Experts are available if needed
• Deadlines can be met;
• etc

3. Conditions of engagement: engagement letter (ISA 210 and page 8.7 to 8.9)
• For a new engagement/changes in circumstances of existing clients

• Engagement letters (ISA 220)

• Purpose
• Issue
• Content
• Accepting a change in the terms of the engagement

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8. NOTES ON PLANNING ACTIVITIES

• Statements: ISA 200, 300, 315 (R), 320, 330

• Planning consist of:
• Overall planning: Financial statement level
• Detail planning: Assertion level for significant accounts
• Extent of planning: Page 8.9
• Benefits of planning: Page 8.9
• Persons responsible for planning: Page 8.10
• Professional scepticism: Page 8.10 (NB) ; detail from textbook
• Obtaining information do plan the audit (Risk Assessment Procedures): Page 8:11
• Planning discussion (Page 8.11)
• Engagement team discussion
• With the client

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 PLANNING FRAMEWORK (OVERVIEW)
A. OVERALL: FINANCIAL STATEMENT LEVEL (Page 8.13 – 8.43)
1. Obtain understanding of entity and environment
• Internal factors: structure, governance, business model, financial aspects, PMngt
External factors: Industry, regulatory, economic
• Financial reporting framework
2. Obtain understanding of entity system of internal control (& IT systems)
• Control environment,
• Risk management system
• IT environment & Information systems; Internal controls, etc
3. Risk of Material Misstatement: Identify and assess
4. Planning Materiality
• Set planning materiality & performance materiality
5. Overall Response
5.1 Identify significant accounts based on: Inherent risk, Materiality (R)
5.2 Formulate overall response (audit strategy/overall audit plan)
• General audit approach to audit as a whole
• Identify areas of specific risk : that require special attention.
• Direction & control: : Professional scientism, unpredictability, staff, experts,, etc.

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PLANNING FRAMEWORK (OVERVIEW) CONTINUE

B. ASSERTION (detail level) : SIGNIFICANT INDIVIDUAL CLASSES OF
TRANSACTIONS, ACCOUNTS BALANCES AND DISCLOSURES
For individual significant classes of transactions, account balances and disclosures:

1. Perform risk assessment procedures to identify and assess the risk at assertion level
of material misstatement
R • Identify inherent risks and assess them for scalability (risk ranking between low and
O
high) in terms of magnitude (impact) and likelihood (of occurrence)
M
M • identify controls that will address the significant assessed risks above (control risk)

2. Design and perform further audit procedures( audit approach) whose nature, timing
and extent are based on and are responsive to the assessed risks of material
misstatement above at the assertion level, consisting of:
- Tests of controls only,
- Substantive procedures only; or
- Combination thereof (test of controls and substantive procedures).

3 Allocation of resources and coordination and control of the audit (staff, level of
supervision and review, use of experts, use of CAATs, time and cost budgets, etc.)

4. Perform audit procedures (test of control and/or substantive tests) in response to the
assessed risk.
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 ASSESMENT OF RISK AT ASSERTION LEVEL

Quantitative ? Observe
Vs. How? Inquire
ISA 315:12 (j)
Qualitative Inspect
ISA 315:
Risk assessment
procedures

Account balance/ Class of

Transaction or Disclosure has
Risk of Material Misstatement ISA 315:12 (k)
(RoMM)
(Inherent risk) Significant account:
One or more relevant
Is it material?
assertion has risk
N
O YES

Design and perform further audit

Perform analytical procedures:
procedures • Test of Controls
• Substantive Procedures
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• Combination

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PLANNING FRAMEWORK
 AT FINANCIAL STATEMENT LEVEL (OVERALL)
1. Obtain an understanding of the entity and its environment:
(ISA 315 (R); Pages 8.13- 8.16)
• Internal factors
• Entity’s organizational structure and ownership
• Entity’s governance
• Entity’s business model and strategy
• Entity’s activities: operations, investments financial results etc
• Performance measures and criteria
• External Factors
• Industry factors
• Regulatory factors
• Economical factors
• Financial Reporting framework
• Accounting principles, revenue recognition, SPE, etc

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 PLANNING FRAMEWORK
 AT FINANCIAL STATEMENT LEVEL (OVERALL)
2. Obtain an understanding of the entity’s system of internal control:
ISA 315 (R) (R) (Pages 8.17 – 8.21)
• Control environment
• Risk management process
• System to monitor internal controls and internal audit
• The Accounting information system
• Internal controls
• IT environment
• General IT controls (IT Environment controls)

3. Identify and assess risk of material misstatement at the overall FS level

[“significant risks”] ISA 315 (Pages 8.22 – 8.33)
• Identify the risks
• Assess the risks : Overall assessment of High, Medium, Low

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 AT FINANCIAL STATEMENT LEVEL CONTINUE

4. Set planning materiality and identify significant accounts (ISA330;
Pages
8.25 – 8.29)
• Calculate planning materiality (ISA 320)
• Set performance materiality for individual accounts
• Adjust materiality for risk of the entity

5. Overall audit response (ISA330; Pages 8.37 – 8.43)

5.1 Identify significant accounts based on:
- Nature & Inherent risk
- Amount (Planning materiality)
- Significance of disclosure
5.2 Formulate overall response
• General audit approach: audit as a whole: combined vs substantive
• Identify areas of specific risk : that require special attention.
• Direction & control: Professional scientism, unpredictability, staff,
experts, etc 22

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 PLANNING FRAMEWORK (OVERVIEW) CONTINUE
B. ASSERTION LEVEL (detail): SIGNIFICANT INDIVIDUAL CLASSES OF
TRANSACTIONS, ACCOUNTS BALANCES AND DISCLOSURES
(Pages 8.43 -8.44)
1. Perform risk assessment procedures to identify and assess the risk at assertion level
of material misstatement
R • Identify inherent risks and assess them for scalability (risk ranking between low and
O high) in terms of magnitude (impact) and likelihood. (of occurrence)
M
• identify controls that will address the significant assessed risks above (control risk)
M

2. Design and perform further audit procedures( audit approach) whose nature, timing
and extent are based on and are responsive to the assessed risks of material
misstatement above at the assertion level, consisting of:
- Tests of controls only,
- Substantive procedures only; or
- Combination thereof (test of controls and substantive procedures).

3 Allocation of resources and coordination and control of the audit (staff, level of
supervision and review, use of experts, use of CAATs, time and cost budgets, etc.)

4. Perform audit procedures (test of control and/or substantive tests) in response to the
assessed risk.
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9. NOTES ON RISK
RISK OF MATERIAL MISSTATEMENT vs AUDIT RISK
- Risk of MM – Management
- Audit risk : External auditor

BUSINESS RISK (BR) (management)

• The risk the business and management are exposed to
• Management should address BR through:
• Internal controls
• Risk management processes, etc.

• BR is an indication of risk of material misstatement at the overall financial

statement level (inherent risk)

THE AUDITOR SHOULD IDENTIFY BUSINESS RISK AS IT IMPACTS ON THE

RISK OF MATERIAL MISSTATEMENT

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 INHERENT RISK OF MATERIAL MISSTATEMENT
1. Overall financial statement • Response to risk at the Financial
level statement-level
Affects:
• Materiality
• all accounts and balances
• Overall response (planning memorandum)
• the audit as a whole
• General audit approach audit as a whole
• Types of risks (examples)
• Identify areas of specific Risk and Focus
• going concern problems
• management’s integrity • Direction and control
• corporate governance compliance • Professional scepticism
procedures • Unpredictability
• legal liability risks (3rd party reliance)
• Use of Data software and CAATS
• tough audit deadlines
• Experts
• listing requirements and IFRS compliance
• IT: environment, type of • Staff, etc.
systems/conversion, general controls etc.
• nature of industry
• Financial statements (both)
• reliance on others: auditors and experts
• outsourcing of services (IT, IA) - overall level
• general computer controls, etc - assertion level

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INHERENT RISK OF MATERIAL MISSTATEMENT

(cont)

2. Assertion level for significant accounts (audit plan)

• At the assertion level: think assertions: ISA 315 Para 186 -190
• Identify/describe the risk for the assertions
• Use info in the question

NB! Understand assertions and link risks to assertions

3. Response to risk at assertion level

Risk of MM
Assertion Significant Significant Test of Substantive
Risks Controls Controls procedures
(IR of MM)

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 10. NOTES ON MATERIALITY

Performance
Materiality
• Planning phase (ISA 320) • Evaluating and
• Affected by risk • Materiality for a specific concluding phase
class of transaction, • To measure audit
disclosure or account differences against
balance
• Affects sample size
Planning • Represents: Maximum
potential error (Sample Final materiality
materiality size) (ISA 450)
(ISA 320)

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MATERIALITY (cont)
• Setting of materiality • Group set-up: based on:
• subsidiaries: subsidiary’s own statements
Indicators: • group: groups statements
• quantitative • branches: company’s statements
• Turnover ½ - 1%
• Gross profit 1 - 2%
• Relationship between risk and
• NI 5 - 10%
materiality
• high audit risk  lower materiality and vice
• Total assets 1 - 2% versa
• Equity 2 - 5%
• qualitative • Examination technique
• Type of question: calculate materiality/
• control environment/ evaluate audit differences
effectiveness of IC • Approach:
• integrity of management 1. % and calculations
• irregularities, etc. 2. Motivate the figures used/risks, etc.
3. Conclusion

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 11. EARLY VERIFICATION
• PREREQUISITE: Strong control environment, and internal controls
• Income statement
• Balance sheet

• MEANING: Performance of audit procedures before year end, because of:

• Time limitation on the completion of the audit
• To reduce pressure on firm’s staff (practice management)

• STAGES:
• Early verification
• Roll forward
• Year-end

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HOMEWORK

1. Read Dynamic Auditing Ch 5 & 8: Understand

2. Reference to ISA’s where needed;
- ISA 210, 300, 315, 320, ISQM 1, 2 and ISA 220
3. PP slides – understand own notes – reference for future
4. Class questions - understand and absorb !!
5. Self assessment questions : do physically and mark ! (now
and over time)
6. Homework for hand in on 25 March in class

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