MIDLANDS STATE UNIVERSITY

FACULTY OF BUSINESS SCIENCES

DEPARTMENT OF ACCOUNTING SCIENCES

MODULE NAME: AN INTRODUCTION TO PERFORMING THE

AUDIT PROCESS

CODE: ACC248/ACC234/ACC214

SESSIONAL EXAMINATIONS

JUNE 2023

DURATION: 3 HOURS

INSTRUCTIONS TO CANDIDATES

1. The paper consists of 5 questions.

2. Answer all questions in Section A and any three (3)
questions in Section B.
3. Each question in Section B carries 20 marks
4. Make and state any reasonable assumptions made in
answering the question
5. Non- programmable silent financial calculator maybe
used.

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 SECTION A COMPULSORY (40 Marks)

QUESTION 1 (40 Marks)

Chinyaz Limited, is a diversified manufacturing company, with divisions that operate

throughout the Republic of South Africa and Zimbabwe. Chinyaz Limited has historically
allowed its divisions to operate autonomously. Corporate intervention only occurred when
planned results were not obtained. Corporate management has high integrity, but the board of
p..
directors and audit committee are not very active. Chinyaz Limited has a policy of hiring
competent people. The company has a code of conduct, but there is little monitoring of

• compliance by employees. Management is fairly conservative in terms of accounting

principles and practices, but employee compensation packages are controls in each division.

Acme Udi' is the general manager of the Fabricator Division. The Fabricator Division
produces a variety of standardized parts for small appliances. Acme has been the general
manager for the last ten years, and each year he has been able to improve the profitability of
wl
the division. He is compensated based largely on the division's profitability. Much of the
. _ improvement in profitability has come through aggressive cost cutting. including a substantial
reduction in control procedures over inventory.

During the last year a new competitor has entered Fabricator's markets and has offered
substantial price reductions in order to grab market share. Acme has responded to the t.

competitor's actions by matching the price cuts in the hope of maintaining market share.

Acme is very concerned because he cannot see any other areas where costs can be reduced so
that the division's growth can be maintained. If profitability is not maintained. his salary and
bonus will be reduced.

Acme has decided that one way to make the division more profitable is to manipulate
inventory because it represents a large amount of the division's balance sheet (statement of
financial position). He also knows that controls over inventory are weak. He views this
inventory manipulation as a short run solution to-the profit decline due to the competitor's
price cutting. Acme is certain that once the competitor stops cutting prices or goes bankrupt,
the misstatements in inventory can be corrected with little impact on the bottom line.

REQUIRED

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 a) Evaluate the strengths and weakness of Chinyaz Limited's control
environment. (20 Marks)

b) Discuss factors in Chinyaz Limited's control environment that led to and

facilitated Molife's manipulation of inventory? (20 Marks)

SECTION B — Answer Any Three Questions

. QUESTION 2 (20 Marks)

(a) State and explain the situations where an auditor may disclose confidential information
about a client. (8 marks)

(b) Your longest standing audit client is Matemba Fisheries Limited, a business owned by the
Mafuromanyoro family, in which you have been involved in your professional capacity as a
statutory auditor for twelve (12) years. You recently went on an extended cruise at Lake
Kariba with the managing director on his personal yacht. Further, the managing director has
invited both you and your wife to join him for a week-long holiday, fully paid for next year in
Zanzibar. During the past six months you had spent most week-ends playing golf with the
managing director.

REQUIRED

Comment on the ethical and other professional issues raised by the above matters. Your
answer should outline the threats arising, the significant of the threats, any factors you have
considered, and, if relevant, any safeguards you could apply to eliminate or mitigate against
the threats (12 Marks)

QUESTION 3 (20 Marks)

Newtons Co provides scientific services to a wide range of clients. Typical assignments range
from testing food for illegal additives to providing forensic analysis on items used to commit
crimes to assist law enforcement officers.

The annual audit is nearly complete. As audit senior you have reported to the engagement
. partner that Newtons is having some financial difficulties. Income has fallen due to the

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 adverse effect of two high-profile court cases, where Newtons's services to assist the
prosecution were found to be in error. Not only did this provide adverse publicity for
Newtons, but a number of clients withdrew their contracts. A senior employee then left
Newtons, stating lack of investment in new analysis machines was increasing the risk of
incorrect information being provided by the company. A cash flow forecast prepared
internally shows Newtons requiring significant additional cash within the next 12 months to
maintain even the current level of services. Newtons's auditors have been asked to provide a
negative assurance report on this forecast.

(a) State the audit procedures that may be carried out to try to determine whether or not
Newtons Co is a going concern (8 marks)

(b) Explain the audit procedures the auditor may take where the auditor has decided that
Newtons Co is unlikely to be a going concern (8 marks)

(c) In the context of the cash flow forecast, define the term 'negative assurance' and explain
how this differs from the assurance provided by an audit report on statutory financial
statements (4 marks)

QUESTION 4 (20 Marks)

You are a manager in Geneca & Co, a firm of Chartered Certified Accountants, with specific
responsibility for the quality of audits. Geneca was appointed auditor of Etene Co, a provider
- of waste management services, in July 2021. You have just visited the audit team at Etene's
head office. The audit team is comprised of an accountant in charge (AIC), an audit senior
and two trainees. Etene's draft accounts for the year ended 30 June 2021 show revenue of
$11.6 million (2020 — $8.1 million) and total assets of $3.6 million (2020 — $2.5 million).
- During your visit, a review of the audit working papers revealed the following:

(a) On the audit planning checklist, the audit senior has crossed through the analytical
procedures section and written 'not applicable — new client'. The audit planning checklist has
not been signed off as having been reviewed.

(b) The AIC last visited Etene's office when the final audit commenced two weeks ago. The
senior has since completed the audit of tangible non-current assets (including property and
service equipment) which amount to $0.6 million as at 30 June 2021 (2020 — $0.6 million).

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 The AIC spends most of his time working from Geneca's office and is currently allocated to
three other assignments as well as Etene's audit.

(c) At 30 June 2021 trade receivables amounted to $2.1 million (2020 — $0.9 million). One

of the trainees has just finished sending out first requests for direct confirmation of
customers' balances as at the balance sheet date.

(d) The other trainee has been assigned to the audit of the consumable supplies that

comprise inventory amounting to $88,000 (2020 — $53,000). The trainee has carried

out tests of controls over the perpetual inventory records and confirmed the 'roll-back'

of a sample of current quantities to book quantities as at the year end.

Required:

Identify and comment on the implications of these findings for Geneca & Co's quality

control policies and procedures. (20 Marks)

QUESTION 5 (20 Marks)

You are the audit manager in the audit firm of Sonny and Co. One of your audit clients is
Edmunds Co, a company specialising in the manufacture and supply of sporting equipment.
Edmunds have been an audit client for five years and you have been audit manager for the
past three years while the audit partner has remained unchanged. You are now planning the
audit for the year ending 31 December 2013.

Following an initial meeting with the directors of Edmunds, you have obtained the following
information:

(i) Edmunds is attempting to obtain a listing on a recognised stock exchange. The directors
have established an audit committee, as required by corporate governance regulations,
although no further action has been taken in this respect. Information on the listing is not yet
- public knowledge.

(ii) You have been asked to continue to prepare the company's financial statements as in
previous years.

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 (iii) As the company's auditors, Edmunds would like you and the audit partner to attend an
evening reception in a hotel, where Edmunds will present their listing arrangements to banks
and existing major shareholders.

(iv) Edmunds has indicated that the fee for taxation services rendered in the year to 31
December 2011 will be paid as soon as the taxation authorities have agreed the company's
.. taxation liability. You have been advising Edmunds regarding the legality of certain items as
`allowable' for taxation purposes and the taxation authority is disputing these items.

Finally, you have just inherited about 5% of Edmunds's share capital as an inheritance on the
death of a distant relative.

REQUIRED:

(a) Identify, and explain the relevance of, any factors which may threaten the independence
of Sonny and Co's audit of Edmunds Co's financial statements for the year ending 31
December 2013. Briefly explain how each threat should be managed. (8 Marks)

(b) Explain the actions that the board of directors of Edmunds Co must take in order to meet
corporate governance requirements for the listing of Edmunds Co. (8 Marks)

(c) Explain why your audit firm will need to communicate with Edmunds Co's audit
committee for this and future audits. (4 Marks)

END OF QUESTION PAPER!

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