Auditing 3A Main Exam 2017

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Solutions
Question 1
a) Governing body

1) The chairperson of the board does not appear to be an independent non-executive director as required
by principle 7 practice 31 of King IV as she was previously a CEO.
2) Ms. A Khan has a 10% shareholding in KB and will not be seen as independent as she holds shares
in the company and has the ability to control or significantly influence management or the governing
body as she is the chairperson of the board.
3) According to principle 7 practice 28 (a) & (b) a non-executive director would not be perceived to be
independent if he/she is a significant provider of financial capital (shareholder) or ongoing funding
to the organisation, or is an officer, employee or representative of such shareholder or funder.
4) In terms of principle 7 practice 32 a lead independent director (LID) should be appointed in the case
where the chairperson is not independent or is conflicted.
5) It is of concern that the board structure as stated does not indicate that the company has appointed
such an LID and did not adhere to the recommendations of KING IV.
6) In terms of principle 7 practice 32 a lead independent director (LID) should lead the performance
appraisal of the chairperson and not a member of the audit committee as suggested. Ms Kim is not
independent as she is a family relative of the chairperson.
7) It is a concern that the company did not appoint a lead independent director as such did not perform
proper appraisals of the chairperson instead they have allowed the audit committee to evaluate a
chairperson.
8) Furthermore, it is a concern that the chairperson of the board was appointed by the shareholders and
not by the board of directors in terms of principle 7 practice 31.
9) In terms of principle 7 the board should comprise a balance of the skills, experience, diversity,
independence and knowledge needed to discharge its role and responsibilities.
10) It is of concern that Ms. Selina Bessissur (Chair), and her daughter (Chief Financial Officer) are the
executive directors of the company and are in effect controlling the company as a block of individuals
(family members) and as such no diversity or independence. Principle 7 practice 7(b) recommends
that the board should comprise an appropriate mix of executive, non-executive and independent non-
executive members. The governing body is merely made out of female members and there is no
gender representation in line with principle 7 practice 11.
11) Furthermore, principle 7 practice 8 recommends that the majority of the board members should be
non-executive directors.
12) KB has 6 directors of which only 3 (Ms. S Bissessur and Ms Gopichand) are non-executive directors.
50% does not comprise a majority and consequently they do not adhere to this principle.
13) Principle 7 practice 8 further recommends that majority of these non-executive directors should be
independent which is not the case with KB.
14) With no information to conclude otherwise, it seems as if Ms Gopichand will be independent and
following the discussion in 11 Ms. S Bissessur is not independent. Therefore 50% (equal) of these
directors are independent which does not comprise a majority of the non-executive directors.
15) In terms of principle, 7 practice 12 to 13 the board should establish arrangements for periodic,
staggered rotation of its members and should establish a succession plan for its membership.

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16) Both Ms. S Bissessur and Ms Gopichand has been the non-executive directors for approximately the
last 3 years and therefore they did not rotate their directors as recommended nor is there an indication
of a succession plan in place.
17) The board should ensure that the company complies with applicable laws and considers adherence to
nonbinding rules, codes and standards (principle 13).
18) Due to various companies act laws not being adhered to (for example matters relating to the audit
committee, remuneration of directors etc.), the companies laws are not well managed and is
concerning.
19) The board should provide effective leadership based on an ethical foundation (principle 1).
20) Due to the non-adherence of King IV it is arguable whether the company is managed with an ethical
foundation that take into account all stakeholders within the firm.
21) In terms of principle 1 practice 1 to 3, the board should act in the best interest of the company
embodying ethical characteristics at all times.
22) Taken all of the above into consideration it does not seem as if the board (especially the executive
directors) are acting in the best interest of the company.

Audit Committee
23) In terms of principle 8 practice 51, the board should establish an effective and independent audit
committee with all the members of the audit committee being independent non-executive directors
principle 8 practice 56.
24) It is of concern that the company only have 1 independent non-executive director that could be
appointed to the audit committee and consequently adherence to the recommendation is not possible
currently as there are not enough governing body members for the audit committee.
25) The audit committee should be chaired by an independent non-executive director (principle 8 practice
57) not currently chaired by CFO.
26) The chair of the governing body should not be a member of the of audit committee as per principle 7
practice 36(a).
27) Ms K Bissessur is the CFO of the company and therefore not a non-executive director.
28) According to principle 8 practice 45, the board should ensure that each committee, as a whole, has
the necessary knowledge, skills, experience and capacity to execute its duties effectively. Principle
8 practice 55 further recommends that members of the audit committee should, as a whole, have the
necessary financial literacy, skills and experience to execute their duties effectively.
29) Ms Khan is only 21 and it is arguable whether she will have sufficient competence to perform these
functions and Ms. Cherise Ganesh is a marketing specialist and it is unlikely the she will possess the
required specialised financial skill set to deal with matters concerning an audit committee.
30) The board should elect the chairperson of the audit committee principle 8 practice 57.
31) In this scenario, the committee itself elected the chairperson.
32) The chairperson of the audit committee should participate in setting and agreeing the agenda of the
committee principle 8.
33) Due to the chairperson of the committee not being appointed yet at the time of the meeting, it resulted
in non-compliance with this principle with Ms S Bissessur drafting the agenda for the meeting.
34) According to principle 8 practice 59(b) & (c) and principle 15 practice 40 the board should delegate
to the audit committee the oversight role of the external audit process.

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35) Due to the fact that the audit committee decided on the dismissal of the auditors, it does not seem that
the audit committee is overseeing this process.

36) In terms of principle, 7 practice 12 to 13 the audit committee should have establish arrangements for
periodic, staggered rotation of its members and should establish a succession plan for its membership
especially the chairperson.

AP Act
1) In terms of Sec 45 – duty to report irregularities, we (the auditors) have a statutory obligation to report
any reportable irregularities as defined, to the IRBA.
2) A reportable irregularity is defined in the Act as an unlawful act which needs to be evaluated to
determine whether one has arisen at KB Ltd, as auditors we will need to evaluate whether the actions
of STA and management satisfy the definition.
3) An unlawful act is defined as one contrary to statutory law or regulation, or common law principle.
In this situation
3.1) The changing non- deductible expenditure invoices to deductible invoices is also a statutory
tax offence on its own. The directors seem to be aware of this activity done by STA.
3.2) This negligence described above amounts to a breach of the directors’ fiduciary duty, and duty
to act with due care and skill.
4) The act must be committed by any person responsible for the management of the entity.
4.1) This requirement of the definition is satisfied, as the directors are aware at least the chair and
the CFO are aware of this, as it was further discussed in their proposal document.
5) The definition also requires that the unlawful act has or is likely to cause financial loss to the entity,
members, shareholders, creditors, etc.
5.1) There is no doubt that there has or will be financial loss e.g.
a) penalties for contravening the different acts e.g. Tax Act for incorrectly classifying
expenditure.
6) There is financial loss and the illegal act amounts to fraud or theft (the company is definitely party
to fraud as result of bribery) or represents a material breach of fiduciary duty on the part of the
directors, the act is reportable.

b) Code of Professional Conduct

1) KB is a Public Interest Entity (PIE) as defined by the SAICA CPC as it is listed on the JSE.
2) In terms of section 210, before a registered auditor may accept a client they must determine if they
can comply with the fundamental principles.
3) In terms of section 290.182 a company may not perform any taxation calculations for the preparation
of accounting entries that may be material to the entity (May be allowed in emergency situations).

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4) The assistance with the income and deferred tax calculation will amount to a self-review and
advocacy threat to the auditor’s independence (objectivity) (290.179).
5) As KB is a prospective audit client of STA, the taxation services cannot be provided should the
engagement be accepted.
6) In terms of paragraph 290.131, self-interest, familiarity and intimidation threats to the auditor’s
independence (objectivity) may be created by the relationship of Mrs. Banele Thabethe and her
husband, the financial manager (Mr Samkelo Thabethe).
7) Should the engagement be accepted, the significance of the relationship in terms of the audit should
be evaluated based on the roles that the two individuals will play in the audit engagement.
8) In terms of 290.217 the relative size of the audit fees from a client may create concerns relating to
self-interest and intimidation threats to the auditor’s independence (objectivity).
9) he significance of the threat should be evaluated and will for example depend of the operating
structure of the firm etc.
10) In addition, STA Auditors is a small audit firm that wants to take on an audit of a listed company.
11) This may create a threat to professional competence and due care in terms of section 130.7.
12) Giving I-Pads to the members of the audit committee can lead to a third person making the conclusion
that the gifts were given to influence the professional judgement of the member.
13) This is not professional behavior in terms of section 150 of the CPC.
14) The code of conduct allows a Chartered Accountant to advertise their business and services offered
however, there are certain guidelines, which must be adhered to.
15) The code of conduct specifies that fees should be based on the work that is performed and a CA in
practice should not quote a fee just to secure the audit.
16) PA could be found guilty of lowballing as they know what KB’s audit fee is and have told the target
clients that they will definitely be lower than KB without doing any cost analysis.
17) In terms of section 110 of the CPC, there is an obligation on all chartered accountants to be
straightforward and honest in all professional and business relationships. STA is in breach as they
have displayed a dishonest behavior.
18) Further, section 110.2 of the CPC states that a chartered account shall not knowingly be associated
with reports, returns, communication or other information that is believed to contain false or
misleading statement. STA has contravened the code through knowingly changing the non-deductible
expenditure invoices to deductible ones.
19) The audit fee cannot just be reduced by 30% and fees should be based on :
• Skills and knowledge required
• Level of training and experience of personnel required
• Time spent on work
• Degree of responsibility which the work entails
• Investment in technology needed to perform an audit

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Solutions
Question 2
a) – Materiality Concerns
To: Audit manager
From: Audit Supervisor
Re: Previous Auditors Materiality computation
I have the following concerns regarding your materiality computation:
1. The documentation for the selection of the basis of materiality is insufficient as the risk and users of
financial statements were not considered or taken into account.
2. The audit Senior said that the actual results could not be used, as they were not for the entire financial
year. This is an invalid statement as one can use interim results; they have to be extrapolated.
3. You have documented that the budgeted figure was be used, however, there is no evidence of whether
we have assessed the budgeting process or not.
4. With regard to the benchmark selection, they did not documented why the other 2 benchmarks are
not relevant. It can be argued that, as this is a profit making entity, profit before tax/revenue could
be used, as both are acceptable benchmark.
5. You have not documented the basis for the materiality amount of R3 154 000. Discounters was
assessed as medium risk and therefore, using a middle of the range would have been correct.
However, the working paper needs to reflect their thought process as to why we went for the mid-
range.
6. The computed performance materiality for this client is set at 50% of planning. This is incorrect
because the correct range to use is 80 – 90% of materiality, unless documented as why they have
reason to believe that a lower percentage is appropriate to use.
7. Therefore, we would not follow the process used by the previous auditors as there has been new
developments at Discounters in the current financial year.
8. The following developments have resulted to the risk of the engagement from being medium to high
influenced by the following: .
8.1. Appointment of a new financial director and CEO
8.2. Different management comes with a different style of leadership (FD aiming to reduce costs)
8.3. Pressure on employees could lead to material misstatements in the financial statements.
8.4. It is our first time we are auditing the client.

Should you have any further queries or concerns, please feel free to contact me.

Kind Regards

Audit supervisor

PI Score Calculation: Score Marks

Employees at beginning of 2017 100

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Employees at the end of 2017 150

Average (100+150)/2 125

Third party liability (265 total assets – 170 Equity) 95

Revenue 275

Shareholders (new 1 shareholder – Pro-Buy (SAICA’s second view) and 2

John Duckling )

TOTAL PI SCORE 497

Therefore Discounters is required to be audited as the PI Score is more than

350 and it doesn’t matter if financial statements are internally/externally
prepared and if owner managed/not owner managed

If a student did not calculate the number of employees, saying that they were only given only the
number of employees at the beginning of the year and not the end of the year number.
c) – Pre-engagement activities

1. Determine whether there are any other factors, which may threaten the team’s independence or cause
a conflict of interest.
2. Determine the reasons for the change of auditors.
3. Risk assessment procedures have to be performed by a senior member of the team and the audit team
should exercise professional skepticism during the audit.
4. Assess whether this may be because of any limitations imposed by the client on the audit. What was
the reason for the change of auditors
5. Determine if FBI has the required personnel at the required levels of knowledge for undertaking this
client’s audit. For this, the following should be considered:
a. Determine if the firm is able to verify assets at all branches and is the firm going to use other
auditors.
b. Discounters accounting systems are fully computerized. Is the firm’s (FBI) computer
department competent enough to assist in the audit?
c. Will we be able to use Computer Assisted Auditing Technology (CAATs)
6. Assess whether we have the necessary technical skills and competence or will have access to other
auditors or experts, as they also have some pressures from the group or holding company auditors.
7. Consider whether the firm possess the knowledge of the industry the clients operates in.
8. Consider the reason for the removal of the previous auditors or why they resigned to establish if a
vacancy exist or not
9. Consider whether there is a vacancy as per Companies Act No 71 of 2008
10. Consider whether Discounters are able and willing to pay audit fees
11. The terms and conditions of engagement should be finalized and reflected in an engagement
letter, signed by both client and auditor.
12. The audit manager’s friendship with Hope, the FD, may threaten independence. What safeguards
could be adopted to address any threat of independence. A possible safeguard may be to remove the
audit manager from the audit.

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13. The directors may be putting pressure on employees with the increase profitability strategy, which
may provide an incentive for the employees in wanting to present the most favorable picture as
opposed to current profit levels.
14. The group auditors require further audit work to be performed, over and above what the audit team
of Discounters had planned to perform at a company or subsidiary level.
- Additional reporting to be submitted
- Whether the audit deadline will be met considering the fact that it has been pushed
forward by 11 days.

b) – Audit Strategy
Scope
The company has multiple locations for the audit and that might affect the strategy in following way:
1. We will need to consider the expected audit coverage including the number and locations of the
braches (all as per group instructions) and outlets to be included in the audit samples.
There may be a need to use an expert as:
2. We will need to consider using CAAT’s as the company uses a highly complex computerized
system.
3. As this is our first year auditing Discounters, we will need to conduct procedures on opening
balances.
4. Pro-Buy (Holding company with inventory at the subsidiary) operates in the fashion industry as a
result, the engagement team (FBI) would need to have the requisite skills to perform audit
procedures as required by the group
Timing
5. Due to the tight deadline, and the size of the client, we may need to consider doing an interim audit
and performing roll forward procedures after year-end.
6. We will need to prepare a schedule of meetings with management and the audit committee and to
discuss the nature, timing and extent of the audit work to be done, and to discuss the audit findings.
7. The size, complexity and the number of locations will affect the timing of the visits to the client.
I.e. all branches are to be visited, for the stock counts (as per group instructions).
8. We would need to consider the timing of our communications with other auditors (Group audit
team), experts, internal audit etc. i.e. reporting deadlines, meetings etc.
9. We would need to consider the extent and complexity of computerization at the client. Will the
data be available and will the appropriate personnel be available to assist us with CAATs.
10. The timing of the work that is expected to be performed and received from the experts will need to
be detailed in the audit strategy based on our reporting deadlines (per the group instructions), e.g. 5
days after year-end.

Direction
11. A combined approach (test of controls and substantive procedures) audit will be conducted for the
following reasons:

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12. Some reliance on controls, as controls appear to be effective over inventory, computer
environment.
13. Due to the presence of possible fraudulent activities and increased risks at a financial statement
level, we need to ensure that we have more experienced staff on the audit and that they perform the
audit with the necessary professional skepticism.
14. The planning and performance materiality limits should be set at a conservative level due to the
increased level of risk.
15. The supervision and review of the audit file will need to be more intense due to the increased risk
profile of the company.
16. Consider the directors retirement and resignation (John and Andrew respectively), who will be able
to assist us and who are the new key personnel going to be.
17. More emphasis should be given to inventory being a significant account (due to group auditors
requiring that all of inventory be counted and consignment stock held, reliance is to be placed on
the inventory account balance).

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