DEPARTMENT OF AUDITING

AUDITING 300
YEAR TEST 1
29 APRIL 2021

Internal examiners
Mrs M Kirstein
Mrs B Beukes
Miss M Uys
Miss C Bosman

External examiners
Prof K Plant (internal)

INSTRUCTIONS
Maximum time: 2 hours (120 minutes) plus 20 minutes reading time
Maximum marks: 80

Please submit questions separately as follows:

ODTPart1 - Question 1
ODTPart2 - Questions 2 and 3
ODTPart3 - Question 4
ODTPart4 - Questions 5 and 6

Students may use the following text books during this assessment:
 SAICA student handbook – All volumes
CASE STUDY (80 marks)

Background to the auditor

You are a third-year audit trainee at Indonga Lakho Incorporated (Indonga), a newly
established medium sized audit firm located in Brooklyn. Indonga is still busy
building their client base and currently accepts any audit from any industry. Indonga
employs thirty (30) employees consisting of audit trainees, three (3) managers, two
(2) partners and administrative personnel.

Background to the audit

Indonga was appointed in September 2020 at the annual general meeting (AGM) to
perform the statutory audit of Izinwele Eziright Limited (IzEz) for the year ended
28 February 2021. The audit team consists of Fifi Themba (engagement partner),
Sipho Tholoi (manager), you and two (2) first year audit trainees. Both, Fifi and Sipho
are CA(SA)’s and registered auditors (RA).

Fifi was appointed as the engagement partner of the IzEz audit due to the major role
she played in obtaining the audit of IzEz. Fifi and Thato Mongwe, the founder and
chief executive officer (CEO) of IzEz, have been best friends since high school. They
studied together at the University of Pretoria and their families occasionally go on
holidays together. During their most recent holiday in December, Thato told Fifi that
part of the motivation to appoint Indonga was that IzEz expects a drastic reduction in
audit fees. Thato made it very clear that they will seek other audit firms if the fee is
not much lower than the audit fee of the previous auditor. As a result, Fifi promised
Thato a reduced fee.

Background to IzEz

IzEz is a leading importer and distributor of hair extensions and related products.
IzEz imports hair extensions from India, Brazil, China, America, and Nigeria. Thato
stumbled upon this business opportunity whilst she was on holiday in India in 1998.
She started off small by importing hair extensions for her close friends and family,
but as word spread on the quality of the hair extensions, within two (2) years, the
business quickly expanded across South Africa. IzEz’s head office is situated in
Pretoria from where all products are distributed to seven (7) distribution centres
located across South Africa. The distribution centres sell the hair extensions to more
than 350 salons country wide.

The previous auditor of IzEz was dismissed due to the directors’ perception that they
charged excessive fees. IzEz still owes the firm the fees from the previous year. IzEz
established an internal audit function in 2018. Mr Brazilian is the chief financial
officer (CFO) and he believes that because the external auditors can rely on the
work performed by the internal audit function, the audit fees should be much lower.
Mr Brazilian insisted that Indonga may not contact the previous auditor, but did not
provide any reason for his refusal.

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In July 2020, the Custom and Excise Unit of the South African Revenue Services
(SARS) raided the IzEz warehouse at head office, after receiving a tip off from one of
IzEz’s competitors of possible import duty fraud. During the raid, SARS identified a
substantial amount of imported hair extensions that was not declared, because it
was hidden away in special compartments at the bottom of some of the containers.
SARS confiscated all the available hair extensions, and a hefty fine was levied
against the company. This led to reputational damage to IzEz resulting in its sales
plummeting and IzEz experiencing serious cash flow problems.

IzEz applied for a long-term loan from a commercial bank. The bank requested
audited financial statements for the financial year ended 28 February 2021, before
they can approve the loan. One of the conditions for the loan is that the company
must maintain a positive current ratio and defaulting on this condition will result in
repayment of the loan with immediate effect. Thato thus requested that the audit of
the financial statements should be completed within six (6) weeks after year end and
that the audit report should be favourable. Fifi ensured Thato that they will receive a
favourable audit report within the requested time.

You and other members of the audit team visited IzEz in December 2020 and
gathered the following information:

 You had a discussion with the information technology (IT) manager of IzEz
and he informed you that they purchased and implemented a new
procurement module. The process followed in purchasing and implementing
the procurement module is documented in part A.
 The audit manager had a meeting with the CEO of IzEz to gather information
regarding statutory events that took place during the financial year. An extract
of the transcribed conversation is documented in part B.
 As part of the planning phase of the audit, one of the audit trainees performed
a preliminary calculation of the planning materiality amount for the 2021 audit
of IzEz. This calculation is documented in working paper C1.
 As part of obtaining an understanding of IzEz’s business, the audit team
started to document the internal controls of IzEz. An extract from the system
description of the sales function by the distribution centres are documented in
working paper D1.

PART A

During a discussion with the information technology (IT) manager, Mr Gigabyte, it

was noted that IzEz purchased and implemented a new procurement module.

The following process was followed in purchasing and implementing the system:
In May 2020, IzEz decided to purchase and implement a new procurement module.
The reason behind this decision was that they experienced problems with the old
module due to the volume of procurement transactions.

Mr Gigabyte took the responsibility of sourcing the new software for the procurement
module. Mr Gigabyte visited the software distributer located closest to IzEz’s head

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office and spoke to the sales person about the needs that IzEz has for procurement
software. The sales person told Mr Gigabyte that most of their retail clients are using
a very complex and expensive software package called the HPP procurement
module. Mr Gigabyte decided there and then to purchase the HPP procurement
module to ensure IzEz keeps up with its competitors.

Mr Gigabyte took the decision to install the HPP procurement module, which
includes an integrated ordering, receiving, purchases and payments function, as
quickly as possible. Mr Gigabyte himself installed the new procurement module on
Friday night, 31 May 2020. Mr Gigabyte converted the entire module at once. He did
not want to spend the whole weekend at work, so he just copied all the files from the
old system to the HPP procurement module. The employees were very surprised on
their arrival on Monday to find the newly installed procurement module on their
computers and the old module deleted. This led to numerous errors and a backlog of
transactions not being processed, because of missing files, lack of system
documentation and lack of training as the employees struggled tremendously to work
and understand the new procurement module.

Mr Gigabyte has been so busy addressing all the implementation problems that he
has not had time to document anything relating to the new procurement module and
the process followed.

PART B

The audit manager had a meeting with Thato Mongwe, CEO of IzEz, in November
2020, to obtain information regarding the statutory events that took place during the
financial year as well as the company’s plans for the future. The meeting was
recorded and transcribed and you were provided with the following extract of the
transcription:

Question asked by the audit

Response from IzEz CEO
manager
1 What are the company’s We want to grow our business at a fast pace. We
future plans? want to open subsidiaries across Africa, but we
need funding for expanding the business. Most of
the banks and external financers require companies
to comply with the King IV Code. Therefore, we tried
our best to ensure that for the financial year ending
28 February 2021, we are in full compliance with the
King IV Code.
2 As required by the We are very excited to mention that we have
King IV code, the board of appointed four (4) board committees to assist the
directors may delegate board in its day-to-day activities. We made every
certain functions to board effort to ensure that the composition of these
committees. committees is in adherence with the King IV Code.
What is the progress made Our committees are as follows:
by the company in terms of 1 The audit committee meets on a monthly basis
these committees? with management and evaluates the
effectiveness of the internal audit and the
finance functions.
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 2 The nomination committee assesses the quality
of the external audit function, as well as
nominates, elects, and appoints members of
the audit committee.
3 The risk committee provides oversight on all
management functions. To ensure that this
committee functions effectively and
independently, the members of this committee
are not allowed to serve on any of the other
supporting committees.
4 The remuneration committee is of such a high
calibre that we have full confidence in their
ability to monitor and adjust all the
remuneration practices of our company.
3 Are these all the committees Yes.
that you have appointed?
4 How do you ensure that the We have the utmost respect for our board
board of directors is members. They would not have been appointed to
performing its duty effectively the board, if they did not have the company’s best
and in the best interests of interests at heart.
the company? To answer your question more directly, no specific
individual(s) have been assigned to perform any
formal performance evaluation of the board, as we
believe in its abilities.
5 When was the last time that If I remember correctly, there was an informal
your own performance was evaluation process about two (2) years ago. Since
evaluated? then I have not been evaluated, as I do what I am
supposed to, when I am supposed to do it.
6 You have indicated to us that The board delegated the oversight of the Internal
you have an internal audit Audit (IA) function to the audit committee.
(IA) function and that you are The audit committee’s chairman approved the
expecting your audit fees to appointment, employment contract and
reduce as you feel that we remuneration of the chief audit executive (CAE).
can rely on their work. The CAE was selected, due to her recent
Please elaborate on your successful completion of her BCom Financial
current internal audit Sciences degree at the University of Pretoria. She
function. knows all the “ins and outs” of internal auditing, as it
is still fresh in her mind from her recent studies.
7 Is there anything else you IzEz has a standard Memorandum of Incorporation
want to share with us? (MOI), except for the modification with regard to the
financial assistance to the directors, which is
restricted. As per the MOI, IzEz has 1,000,000
authorised ordinary shares of which 920,000 was
issued.
During a directors meeting on 31 March 2020 an
interest free loan of R3,500,000 was awarded to a
director, Mr Jill, to enable him to buy 100,000
ordinary shares in IzEz on 5 April 2020. Only Mr Jill
was given the option to purchase ordinary shares in
IzEz and no amendments to the MOI was made.
No other considerations were identified, or
resolutions were taken on the matter.
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 Client: IzEz Ltd Year-end: 28 February 2021
Preparer: T Trainee Date: 3 December 2020 C-1
Reviewer: A Manager Date: 5 December 2020 1 of 2
Subject: Planning materiality of IzEz

Planning materiality

As it is the first time that Indonga performs the audit of IzEz, the partner asked the
first-year audit trainee to calculate a preliminary planning materiality amount for the
audit of IzEz. Management of IzEz was very evasive in answering questions on
certain matters.

The use of benchmarks in determining the planning materiality

Determining materiality involves the exercise of professional judgement. One of the

important parts of determining materiality is to determine an appropriate benchmark.
The factors that were considered in the identification of an appropriate benchmark
included the following:
1 Only revenue and expenses disclosed in the financial statements will be used;
2 Items the users of the financial statements tend to focus on; and
3 The nature of the entity as well as where the entity is in its life cycle.

The following information was obtained:

Audited financial Management Budget for 12

statements accounts months
(29 February 2020) (31 July 2020) (28 February 2021)
R R R
Turnover 7,000,000 6,680,250 9,300,000
Cost of sales (4,000,000) (5,812,500) (7,750,000)
Gross profit 3,000,000 867,750 1,550,000
Other income 400,000 460,000 480,000
Other expenses (700,000) (711,000) (750,000)
Profit before tax 2,700,000 616,750 1,280,000

It is Indonga’s policy to use the following benchmarks when calculating materiality:

Turnover ½% - 1%
Gross profit 1% - 2%
Operating profit before tax 5% - 10%
Total assets 1% - 2%
Net assets 2% - 5%

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 Client: IzEz Ltd Year-end: 28 February 2021
Preparer: T Trainee Date: 3 December 2020 C-1
Reviewer: A Manager Date: 5 December 2020 2 of 2
Subject: Planning materiality of IzEz
 
Calculation of materiality

4 IzEz is profit orientated and will be aiming to increase its profits. Users of the
financial statements will tend to focus on the Statement of Profit and Loss and
Other Comprehensive Income (SPLOCI) of the entity.

5 The SPLOCI indicators, being turnover, gross profit and operating profit before
tax was used as benchmarks.

6 The budgeted figures for 2021 were used in order to calculate planning
materiality as these are the latest figures available for IzEz.

7 The audit firm’s policy will be used to guide the benchmarks to be used in
determining materiality. The following ranges were calculated:
0,5% to 1% of turnover – R51,250 – R93,000
1% to 2% of gross profit – R15,500 – R28,200
5% to 10% of profit before tax – R55,500 – R120,000

8 The company has a low risk of material misstatement, because there is an

internal audit function that ensures that the internal controls are functioning
effectively.

9 It is the first time that Indonga is auditing IzEz, and therefore the higher ranges
will be used as there is a time constraint on the audit.

10 The overall planning materiality amount would therefore be between R93,000

and R120,000.

11 An acceptable amount would be R110,000.

 
   

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Client: IzEz Ltd Year-end: 28 February 2021
Preparer: T Trainee Date: 3 December 2020
Reviewer: A Manager Date: 5 December 2020
D-1
1 of 1
Subject: Extract from the system description of the sales function at the
distribution centres

Sales to salons can either be on credit (for pre-authorised account holders) or cash.
After selecting the products, customers proceed to the sales clerks’ counters. To ring
up a sale, a sales clerk logs into the sales application on the computer system using
a generic username and password (the username and password is ‘Sales123’). All
the products have barcodes on and these are scanned with a barcode scanner. The
system has been set up in such a way that the product descriptions, price per
product as well as the total sales amount are displayed on the screen visible to the
customers.

Credit customers

Credit customers must present a store card, which contains an account number, to
the sales clerk. The sales clerk enters the customer account number to display the
customer account details on the screen. New credit applicants are referred to the
sales manager’s office before being allowed to purchase any products on credit.

In instances where the customers reached their credit limits, the sales clerk enters
an override code if the sales clerk deems the customer’s reason for exceeding the
credit limit as reasonable. Credit customers receive a printed, sequentially numbered
sales invoice.

Cash customers

Cash customers do not have to provide any form of identification. Cash customers
proceed with their products to a sales clerk and pay the amount due. A sequentially
numbered cash invoice is printed by the cashier and handed to the customer after
the invoice is stamped ‘paid’.

At the sales clerk’s discretion, he/she can enter a discount percentage for cash
sales. According to sales clerks, this function is never used. Sales clerks’
commission is based on net sales.

For both cash and credit sales

Goods are packed into shopping bags when paid.

The security guard at the door compares the physical products to the sales (or cash)
invoices before the customers exit the store.

   

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 SUB
REQUIRED:
TOTAL TOTAL
Please submit Question 1 separately – File name = ODTPart1.
1. Refer to the information included under the headings:
 Background to the auditor
 Background to the audit; and
 Background to IzEz.
Describe the matters the audit partner of Indonga
Lakho Incorporated should have considered before
accepting Izinwele Eziright Limited’s audit engagement
for the year ended 28 February 2021. 19

Communication skills – Layout and structure 1 20

Please submit Questions 2 and 3 together – File name = ODTPart2
2. Refer to the information included in:
 Part A

Identify the weaknesses in the programme change and

conversion controls of Izinwele Eziright Limited during
the purchasing and implementation of the new
procurement module. 8

Communication skills – Clarity of expression 1 9

3. Refer to the information included in:
 Part B
Discuss any non-adherence to the recommended
practices of the King IV Report on Corporate 9
Governance for South Africa 2016.

Communication skills – Layout and structure 1 10

Please submit Question 4 separately – File name = ODTPart3.
4. Refer only to the answer provided to:
 Question number 7 included in Part B
a. Discuss whether the issue of shares to Mr Jill is in
compliance with the Companies Act 71 of 2008,
b. List and discuss the remedies that IzEz could have
implemented to legalise the transaction; and
c. List and discuss the consequences if the remedies
mentioned above are not implemented
successfully. 20

Communication skills – Layout and structure 1 21

Note: Limit your answer to only question 7 of the
conversation.
Questions 5 and 6 continues on the next page.
   

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Please submit Questions 5 and 6 together – File name = ODTPart4.
5. Refer to the information included:
 Under the heading: Background to IzEz; and
 In working paper C1: Planning materiality of IzEz
For every statement (1 - 11) included in the audit
trainee’s reasoning in the calculation of planning
materiality of IzEz indicate whether the statement is
correct or incorrect. For every incorrect statement,
provide the correct or additional consideration/s.
10
Note: Present your answer in the following tabular
format
The statement is Correction/
Statement
correct or additional
number
incorrect? considerations
(½) (1)

6. Refer to the information included in:

 Working paper D1: Extract from the system
description of the sales function at the distribution
centres
Describe the weaknesses in the sales function at the
distribution centres evident from the extract of the
system description. For every weakness identified, also
explain the risk associated with the weakness and
describe the recommended control that should be put
in place to minimise the risk(s). 10
Note: Present your answer in the following tabular
format

Weakness Risk associated Control to

with the minimize the
weakness risk

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