ODT300 November 2020 Exam PDF

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DEPARTMENT OF AUDITINGAUDITING 300EXAMINATION18 November 2020Internal examiners Mrs B Beukes Mrs M Kirstein Miss M Uys Mr T VardenExternal examiners Prof K Plant (internal) Mr W Kriel (UNISA)INSTRUCTIONSMaximum time: 2,5 hours (150 minutes) plus 25 minutes reading time Maximum marks: 100ANSWER EACH ...

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DEPARTMENT OF AUDITING AUDITING 300 EXAMINATION 18 November 2020 Internal examiners Mrs B Beukes Mrs M Kirstein Miss M Uys Mr T Varden External examiners Prof K Plant (internal) Mr W Kriel (UNISA) INSTRUCTIONS Maximum time: 2,5 hours (150 minutes) plus 25 minutes reading time Maximum marks: 100 ANSWER EACH QUESTION IN A SEPARATE ANSWER BOOK AS FOLLOWS: Book 1: Book 2: Book 3: Book 4: Book 5: Book 6:

Questions 1 and 2 – 4-page book Questions 3 and 4 – 4-page book Question 5 – 4-page book Question 6 – 4-page book Question 7 – 4-page book Question 8 – 4-page book

Students may use the following textbooks during this assessment: SAICA student handbook – All volumes

CASE STUDY

(100 marks)

Background Sell-U-Phone (Proprietary) Limited (SUP) is an online cellular phone (phone) reseller that specialises in the buying, selling and repairing of pre-owned phones. Current owner and chief executive officer (CEO), William Mabasa, established the company in 2018, after he identified the gap in the market for pre-owned phones. SUP aims to address the risks of private sales of pre-owned phones, by offering flexible sales options to customers. SUP also offers insured delivery, condition inspections and repairs on phones, secure transactions, and free valuations on the purchase of preowned phones. SUP has been very successful to establish itself as a competitive market player. The head office, repair centre and warehouse are in Pretoria, with satellite offices in Polokwane, Durban, Bloemfontein, and Cape Town to assist in the transfer of phones to and from the other provinces. The company operates exclusively online; it does not offer walk-in purchases or sales. SUP has a 31 October year-end. William has voluntarily included the requirement that SUP should be audited in the company’s Memorandum of Incorporation (MOI). He believes that the inclusion of this requirement will send a positive signal to potential investors. Mrs Sally Abrahams is the chief financial officer (CFO) and she assisted William to grow SUP to where it is today. The board of directors consists of William, Sally, as well as the marketing and communication director, Mrs Veronica Tebele. Finance and funding The marketing department embarked on an extensive advertising campaign to ensure that the word spreads that SUP remained operational throughout the nationwide lockdown period due to the COVID 19 pandemic. Despite the work done by the marketing department, the company’s profitability declined significantly during the 2019/20 financial year due to the weak economic conditions and South Africans having significantly less disposable income. William expressed this concern in the 2019/20 draft director’s report (see extract below) but remained positive for the economic rebound in a post-lockdown world. At incorporation, SUP was provided with start-up funding by Angel Investors Limited (Angel Investors), who provided SUP with a loan of R4 million to fund the development of its website, setup of offices and hiring of staff. One of the conditions of this loan, is that the loan will be converted to shares should the profitability of SUP decline by more than 50% year-on-year.

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Financial statements Management included the following introductory paragraph in the draft Directors Report that will be included in the financial statements, which they presented to the auditors: Voluntary application of Chapter 3, parts A to C of the Companies Act, No. 71 of 2008 SUP voluntarily elected to apply Chapter 3, parts A to C of the Companies Act in order to demonstrate its commitment to accountability and transparency. TWT Incorporated (TWT) was re-appointed as auditors for the financial year ending 31 October 2020 in line with the MOI requirement. SUP’s public interest score does not exceed the threshold for an annual audit to be mandatory. Management has appointed Mr Mabasa’s personal secretary, Ms Daisy Wilkens, as the company secretary. Ms Wilkens noted that SUP does not have any subcommittees other than the remuneration committee, which means she will only be responsible for taking minutes at the board meetings, apart from managing the CEO’s diary. She concluded that these responsibilities will not interfere too much with her current daily duties and she accepted the appointment. Following the qualified audit opinion SUP received in the prior year, management decided to restructure the entire finance division during January 2020. Management also replaced Mr Ernest Letaba (senior accountant), because he agreed with the auditor’s interpretation that lead to the qualified audit opinion (see below). Current year audit You are a third-year trainee accountant at a small audit firm, TWT Incorporated (TWT) and have been assigned to the audit team of SUP. This is the second year TWT will audit SUP and therefore SUP’s management requested that TWT should consider relying on the prior year’s pre-engagement assessment to save on the audit fee. Furthermore, SUP’s management also requested that a new engagement partner be assigned to the 2020 audit, because the partner responsible for the audit in the previous year, “failed to see eye to eye” with SUP’s management on certain audit issues that arose during the audit. Those audit issues included, amongst others, the misstatement of the intangible asset raised for the website design which SUP use as a platform to conduct its business. The previous audit partner believed that management failed to derecognise old components of the website when developing and implementing new components, which management did not agree with. This led to a qualified audit opinion in the prior year. TWT wanted to retain the SUP audit and assigned a new audit team, including a new audit partner, to the current year audit. Ms Thandi Letaba (CA(SA) and RA), was appointed as the partner, upon her request, as she understands SUP’s business, due to her father, Mr Ernest Letaba, being responsible for developing SUP’s accounting policies since the company’s incorporation. At a recent audit team meeting, Thandi mentioned that the SUP audit team is smaller than the previous year; they are less experienced since they all recently graduated from university however, and she knows that they are dedicated in the work they perform. She requested you to assist in identifying risks and developing appropriate Page 3 of 13

audit responses to the risks identified. You will also be responsible for the audit of inventory held by SUP and overseeing completion and reporting. The audit team prepared the following documentation and working papers: Annexure 1 Working paper O-11

Description Business process: Sales, purchases and repairs of phones

Uncorrected misstatements

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ANNEXURE 1 Business process: Sales, purchases and repairs of phones Website SUP operates exclusively on the www.SUP.com website. The interface for the website was designed to provide customers with a clean and easy experience in buying and selling of used phones. The website is continuously updated and improved to enhance the user experience, but these updates sometimes led to downtime on the website. All customers are required to register on the website prior to selling, buying or repairing a phone. SUP has an in-house courier service that is responsible for the collection and delivery of all phones. Selling options Customers have two options when they want to sell their phones. Option 1: SUP acts as agent between buyer and seller Potential sellers may choose to list their phones as “for sale” on the SUP platform but keep using the phone until it is sold. SUP charges a listing fee that is included in the listing price of the phone (see more detail below in examples of electronic documentation layout). A SUP courier will collect the phone once it is “sold” on the platform. “Sold” means that the buyer pays the full price per the listing, but a “hold” is placed on the transaction as the sale is still subjected to the damage inspection upon collection of the phone. Upon arrival at the seller, the courier completes a detailed electronic damage inspection form (DIF) on a tablet. Should the damage inspection agree with that indicated on the listing of the phone, the courier and the seller sign the DIF on the tablet. The courier submits the DIF to the finance department at head office and this automatically activates a payment instruction to the seller and records the phone as consignment inventory in SUP’s records. Any significant damages not indicated in the original listing will automatically null and void the transaction and the buyer is fully refunded. Phones that passed the damage inspection are taken to the nearest satellite office, for distribution to the buyer. Control of these phones are transferred to the buyers upon delivery of the phones. Once delivered, SUP does not have any further obligations to either the buyer or seller and recognises the listing fee. Option 2: SUP purchases phone at discount price Seller Potential sellers may choose to sell their phone directly to SUP to receive immediate payment, rather than wait for a buyer to show interest. The price is usually 15% lower compared to the recommended selling price calculated when the seller would have listed the phone. The courier follows the same process as for option 1, except that the phone is recorded as SUP’s inventory. Should repairs be required, the phone is sent to the repairs centre, where after it is stored in the warehouse until sold. Once repaired, the phone is listed as “for sale” on the SUP platform. The cost of the phone is updated to include all the relevant expenditure to get the phone to its current condition. Page 5 of 13

Phone inventory When the phones, as per option 2, arrive at the SUP warehouse, a phone inventory form (PIF) is issued. Upon creation, the system retrieves the listing information of the phone and automatically updates the inventory list with the relevant information. Copies of all inventory list change logs and exception reports are kept and are reviewed by the senior accountant on a monthly basis. The values of the phones are linked to a database of phone values (selling prices) kept by SUP. The database uses an algorithm to determine what the appropriate value of each phone is, based on recent sales of phones on SUP’s and other phone retailer’s websites. The algorithm was designed and is maintained by Mr Pillay, an independent web designer. Buyer Upon selecting a phone to purchase, the buyer pays the full listing price via electronic funds transfer (EFT) payment for both options 1 and 2 transactions. Should the buyer buy a phone owned by SUP (option 2 phone) the buyer also gets a free screen replacement offer valid for 12 months after purchase. The normal price for this service by the repair centre is R900 for repair customers (see information below). Control of the phone is transferred to the buyer upon delivery of the phone. Information provided by the seller Upon selecting a selling option (1 or 2 above), sellers are required to select the make, model, colour and storage capacity of the phone they want to sell from a pre-populated list of phones and must upload a photo of the phone (refer to listing example below). Sellers are then required to indicate the condition of their phones based on the following available selections: Rating # 1 2 3

Rating Excellent Good Damaged

Description Like new. No scratches or dents. Has scratches and dents. Switches on and works, but either screen is cracked, speaker is broken, or battery needs replacement.

Sellers are presented with a suggested maximum listing price. For option 1 the seller can adjust the price downwards at will (refer to example below) and for option 2, the system automatically displays the maximum amount that SUP is willing to pay for the phone. This amount is calculated based on the suggested listing price less the 15% reduction. The listing price is determined based on historic selling data from a database of phones, which is constantly updated as phones are sold on the SUP platform. Once the listing price is selected, the system will calculate and display the amount the seller will receive, after all costs are deducted. For option 1 the SUP listing fee is calculated at 15% of the listing price and will adjust automatically based on the selected listing price.

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Examples of electronic documentation layout Example of a completed listing of phone: Inventory code:

#20-09-05-1355-CONSIGN

Client name:

Jun Li

Client ID number:

9703240042089

Phone model and capacity:

iCell 7 32GB – Black

Selling option selected:

1

Phone condition indicated:

3

Photo uploaded by seller: I agree to the SUP terms and conditions

An example of the listing price breakdown displayed to the seller: Phone:

iCell 7 32GB – Black

Condition of phone:

3 - Damaged condition

Listing price

R3 900

Listing fee

-R585

You will receive

R3 315*

Attached photo:

Image 102

*Subject to damage assessment

The following input validation controls are applied to the fields included in the listing of the phone and acceptance of the listing price by the seller (Per the two examples included above): Inventory code field: Automatic allocation by the system Client name field: Field size limit to 255 characters Client ID number, phone condition field, listing price field and listing fee field: Numeric test to ensure only numbers are provided as input Phone model and capacity field: Validation test against phone database Selling option field: Selection of 1 or 2 from a drop-down list Terms and conditions field: No controls implemented Page 7 of 13

Repairing The repair centre is responsible for all repairs requested by customers or performed by SUP on purchased phones (per option 2). This service is not limited to phones listed for sale or sold on the SUP platform, and anyone can request a repair on the SUP platform. Customers can select the repair option on the platform and enter the make, model, colour of the phone they want repaired; next, the customer selects the repair job required from a list of repairs offered by SUP. Repair services include screen-, battery- and speaker replacements, repair of buttons and charge ports as well as fixing of dents and scratches. Once the customer selects the required repairs, a preliminary quote, based on standard prices determined by SUP, is generated and displayed on the screen. The quote sets out that a minimum non-refundable, but deductible 50% deposit is payable upon acceptance of the quote, before a detailed assessment of damages on the phone will be performed. When the minimum amount was paid and the customer accepted the preliminary quote, the courier will collect the phone from the customer. The courier completes a Phone Repair Form (PRF) on the tablet and takes a photo of the phone to confirm the condition and both the courier and the client signs the PRF. The PRF is submitted to the repairs centre. Upon arrival at the repair centre, a detailed damage assessment is performed, and an e-mail of the final quotation is sent to the customer. Should a customer choose not to accept the final repair quotation, the customer will forfeit the non-refundable deposit and the phone will be returned to the customer. However, if a customer accepts the quotation, the non-refundable deposit will be deducted from the amount due. When a customer accepts the updated quote, the repair is actioned as soon as the repair centre receives proof of full payment via electronic funds transfer (EFT).

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Client: Sell-U-Phone (Proprietary) Limited Prepared by: T Wolff Reviewed by: C Horner

Period end: 31 October 2020 Date: 12 November 2020 Date: 13 November 2020

O-11 1 of 2

Subject: Uncorrected misstatements Materiality Planning R 450 000

Overall materiality

Final R 450 000

Uncorrected misstatements The following disagreements with management are still outstanding at the evaluation and conclusion stage of the audit: Disagreement 1 – disposal of inventory to Mr William Mabasa at cost The auditors has identified that Mr William Mabasa took ownership of the following phones, which were held as inventory by SUP: Cost price (R) iCell X 64GB – Gold iCell 7 32GB – Gold Wahway P31 128GB – Blue Wahway P9 Plus 128GB – Pink Sungsam 8 Plus 128 GB- Rose

Net Realisable Value (R)

7 400 5 400 5 000 9 800 7 500

7 000 5 000 4 500 9 200 7 100

The following journal entry was processed to account for the transaction: Dr Salary & Wages expense

R 35 100

Cr Inventory – Phones

R 35 100

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Client: Sell-U-Phone (Proprietary) Limited Prepared by: T Wolff Reviewed by: C Horner

Period end: 31 October 2020 Date: 12 November 2020 Date: 13 November 2020

O-11 2 of 2

Subject: Uncorrected misstatements Disagreement 2 – understatement of salaries and wages relating to the marketing department Management has agreed to compensate all employees within the marketing department who was involved in the advertising campaign regarding SUP staying operational throughout the nationwide lockdown period. Such payments would only be made in the following financial year and management therefore argued that the overtime to be paid to these employees should only be accounted for as an expense in the following financial year. The overtime payment amounts to R623 480.

Disagreement 3 – Failure to disclose non-adjusting events after reporting date The auditors have identified that equipment used for repairs to the value of R465 000 was stolen during a burglary at the repair centre. The burglary took place on 4 November 2020. Management argued that the loss of the equipment would only be accounted for as an expense in the following accounting period, due to the timing of the incident and the fact that they are awaiting a response from the insurance company regarding the cover on the equipment.

Disagreement 4 – Inappropriate application of going concern principle The auditors are of the view that material uncertainty exists regarding the use of the going concern principle, even though the auditors have assessed that the use of the going concern principle is still appropriate in preparing the financial statements for the year ended 31 October 2020. Management is of the view that the decline in profitability only affects the company over the short term and that it is unnecessary to include harmful and distressing disclosures and adjustments in the financial statements.

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SUB TOTAL TOTAL Please answer Questions 1 and 2 in a separate 4-page book and submit these questions together 1. With reference to the information included in the CASE STUDY (excluding the annexure and working paper): REQUIRED:

a. Discuss the appropriateness of relying on the prior year pre-engagement assessment for the 2019/20 audit as requested by Sell-U-Phone (Proprietary) Limited’s management. b. If a pre-engagement assessment was performed for the current year audit, discuss the additional considerations which TWT would have considered before accepting the 31 October 2020 audit of SellU-Phone (Proprietary) Limited. Also indicate whether the engagement should have been accepted again.

3

5

8

NOTE: DO NOT address any ethical considerations in either the questions. 2.

With reference to the information included in the CASE STUDY (excluding the annexure and working paper): Draft a memorandum to the Chief Financial Officer of Sell-U-Phone (Proprietary) Limited in which you discuss the concerns you may have with regard to Sell-U-Phone (Proprietary) Limited ’s...