LEARNING UNIT 7 – PLANNING AN AUDIT (OBTAINING AN

UNDERSTANDING OF THE CONTROL

ENVIRONMENT, RISK ASSESSMENT, PLANNING
ACTIVITIES AND MATERIALITY)

DURATION: 3 HOURS

7.1 INTRODUCTION

“A goal without a plan is just a wish.” – Antoine de Saint-Exupery (1900 to 1944)

“Failing to plan is planning to fail.” – Alan Lakein (1938 - present)
From the above quotes, we see that planning is a key part of the audit, as it ensures that
the audit is executed and conducted properly.
Planning an audit of the financial statements forms the second phase of the audit process.

7.2 LEARNING OUTCOME AND ASSESSMENT CRITERIA

The content of this learning unit is based on the following learning outcome and
assessment criteria:
Learning outcome Assessment criteria
Examine the internal control systems • Apply the various business cycles.
implemented by management. • Evaluate the compliance and effectiveness
of controls
(financial/operational/compliance).
• Develop solutions to improve the
effectiveness of existing controls to
manage the business risks.
• Evaluate findings and report weaknesses.
• Evaluate the impact of controls on the audit
approach.
Plan an audit of financial statements. • Plan the audit engagement, taking into
account its objectives and the criteria
governing the audit opinion.
• Formulate risk assessment procedures to
obtain the necessary understanding of the
auditee sufficient to plan and perform the
audit.
• Evaluate the materiality for the audit
engagement.
• Assess the risks of material misstatement
at the financial statement level and at the
assertion level for different classes of
transactions and events, including related
disclosures, and account balances with
their disclosures.
• Formulate a suitable overall audit strategy
and audit approach.

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Open Rubric
 7.3 LEARNING ASSUMED TO BE IN PLACE

Planning activities were covered as part of your undergraduate studies. You must revise the content
below if you are not familiar with the content:

SAICA Student Handbook (2023/2024) - Volume 2A:

• ISA 200: Overall Objectives of the Independent Auditor and the Conduct of an Audit in Accordance
with International Standards on Auditing
• ISA 260: Communication To Those Charged with Governance
• ISA 265: Communicating Deficiencies in Internal Control to Those Charged with Governance and
Management
• ISA 300: Planning an Audit of Financial Statements
• ISA 315: Identifying and Assessing the Risks of Material Misstatement through Understanding the
Entity and its Environment
• ISA 320: Materiality in Planning and Performing an Audit
• ISA 330: The Auditor’s Responses to Assessed Risks
• ISA 402: Audit Considerations Relating to an Entity Using a Service Organisation ISA 610: Using
the Work of an Auditor’s Expert
• ISA 600: Special Considerations – Audits of Group Financial Statements (Including the Work of
Component Auditors)
• ISA 610: Using the Work of Internal Auditors
• ISA 620: Using the Work of an Auditor’s Expert

7.4 OBTAINING AN UNDERSTANDING OF THE ENTITY AND ITS ENVIRONMENT

During the planning phase, the auditor should gain an understanding of the entity and its environment,
the applicable financial reporting framework and the entity’s system of internal control. The
auditor should obtain such an understanding to be able to identify and assess the risks of material
misstatement, whether due to fraud or error, at the financial statement and assertion level. The risk
assessment should then provide the auditor with a basis for designing and implementing responses to
the assessed risks of material misstatement (ISA 315R, par 11).

COMMENT

Remember that the management of the audit client is responsible for implementing the system of internal
control to ensure the entity meets its control objectives. In a sense you must wear two hats when dealing
with this section of the syllabus:
Management hat: How should the system of internal control be designed and implemented.
Audit hat: Obtain an understanding of the system of internal control and test it to determine whether is
operational.

Business cycles may be described as the process of grouping together similar types of transactions or
transaction-processing systems which contains the systems of internal control.

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Organisations typically group their accounting transactions according to the following five common
business cycles:

• the revenue and receipts cycle;

• the acquisition and payments cycle;
• the inventory and production cycle;
• the payroll and personnel cycle; and
• the finance and investment cycle.

Remember that the basic principles or elements of an effective system of internal control were
established before the systems of internal control were computerised (i.e. manual systems). These
principles apply to computerised systems as well. In a completely manual system, it is relatively easy to
trace the path of a transaction from its initiation to its inclusion in the financial statements, by following
the flow of documentation. However, in computerised system environments, it may be more difficult to
trace transaction flows through systems, as they may not be visible.

From the above it is evident that your knowledge of the cycles forms a basis for dealing with any question
relating to systems of internal control. It is therefore imperative that you ensure your knowledge of the
cycles are up to date. First make sure you are comfortable with the basic principles as it relates to
manual cycles. Thereafter you will find it easier to understand computerised systems of internal control,
as the manual functions were simply replaced by an automated or computerised internal controls.

Most systems of internal control will be automated, although some elements of the system could still be
manual. In this learning unit we will focus on the manual systems of internal control. For a detailed
discussion on general and application controls, refer to learning units 8 and 9.

The question below will test your understanding of a manual system of internal control.

QUESTION 7.1 – SELF ASSESSMENT QUESTION 15 marks

Estimated Time
Activity
Reading Writing Marking and review Total
ProSan Limited 5 minutes 23 minutes 9 minutes 37 minutes

Background information

You are an audit senior working for WK Auditors Incorporated (WK), an audit firm situated in
Johannesburg. WK is considered as one of the larger medium sized audit firms and has been growing
at a steady pace over the last few years. WK has been the auditors of the ProSan Limited (ProSan)
group of companies for the past 8 years due to the strong client relationship built by the audit partner
over the years. The size of the current year audit team is similar to prior years.

ProSan is a manufacturer and distributer of Personal Protective Equipment (PPE), with its head office
situated in Pretoria. Having been in operation for 20 years, ProSan has become the leading
manufacturer and distributer of PPE in South Africa. The company has a 31 December year-end and is
listed on the Johannesburg Stock Exchange (JSE). The group of companies consists of a holding
company owning the majority of shares in various subsidiaries. Subsidiaries are responsible for the
development, manufacturing and distribution of PPE throughout Southern Africa.

The COVID-19 pandemic brought about a huge demand for PPE. The dramatic rise in demand for
surgical masks, goggles, gloves, and gowns has depleted stockpiles, prompting significant price
increases. ProSan recorded record profits for the 2023 financial year. Demand and prices however did
decline towards the end of the financial year as the “first wave” of infections subsided and prospects of
effective vaccinations arose.

Included below is working paper WP100 relating to inventory.

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Client: ProSan Limited Year end: 31 December 2023
WP100
Prepared by: Yourself Date prepared: 27 January 2024
Page 1 of 2
Reviewed by: Date reviewed:
Subject: Inventory

Inventory measurement:

Due to the volatility of certain raw material prices, ProSan implements a standard costing system to
value the products in order to be able to set a stable selling price using the standard cost per product.

Raw materials:

Raw materials consist of leather, rubber(latex), various types of fabrics and plastics.

The manufacturing of a ProSan product begins with the design team designing prototypes of the
product. Products have to undergo various quality tests from external service providers in order to
ensure that products meet the rigorous regulatory requirements. Apart from standards set by local
authorities such as the Department of Labour and the South African Bureau of Standards (SABS),
ProSan also adheres to the Personal Protective Equipment (PPE) Directive that was adopted by the
European Council.

Raw materials purchasing cycle:

Once the prototypes are approved, they are sent to the factory where the production manager creates
a product specific standard (PSS) for each type of product to be manufactured using the latest
approved standards as reflected on the inventory master file. If the product requires a material that is
not on the inventory master file, the production manager contacts suppliers on the authorised supplier
list to find the supplier that can supply the required material at the best price. No formal quotations are
requested from the suppliers. The price and the supplier are then noted on the PSS. The completed
PSS is then submitted for approval by the management committee. The approved PSS’s are placed
into a ‘pending’ file.

The purchasing manager removes the PSS from the pending file and adds any materials to the
inventory master file that does not yet reflect on it. A log of any changes to the master file is generated
and reviewed against the PSS by the senior administration clerk.

The purchasing manager generates sequentially numbered purchase orders reflecting the quantities
of all raw materials to be ordered as reflected on the PSS. The purchase orders are generated on the
purchasing module of the ProSan internal computer system. These purchase orders are then
automatically emailed to the applicable suppliers using the standing data in the supplier master file.

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Client: ProSan Limited Year end: 31 December 2023
WP100
Prepared by: Yourself Date prepared: 27 January 2024
Page 2 of 2
Reviewed by: Date reviewed:

Subject: Inventory

Receiving of raw materials:

All suppliers deliver to the factory at a designated delivery bay. Raw materials are received by a
receiving clerk. The receiving clerk captures the delivery on the internal company software. The
receiving clerk captures the order number obtained from the supplier delivery note into the system. If
the system recognises the order, the details pertaining to the order is reflected on the screen. The
delivery clerk then compares the detail on the screen to the detail on the delivery note and signs the
delivery note if correct. If the system does not recognise the order number an error message reflects
on the screen and the goods are not accepted.

Once goods are accepted, the delivery clerk captures the delivery note number and quantities of goods
per the note on the computer system. The system automatically updates the raw material levels and
prints two copies of a sequentially numbered goods received note (GRN). One copy of the note is filed
by the receiving clerk and the other is taken to the warehouse with the actual delivery. A warehouse
clerk takes custody of the goods at that point.

When the production manager wants to do a production run of a product, he completes a sequentially
numbered requisition form (containing the items identified on the PSS) and emails it to the warehouse
manager.

The warehouse manager enters the detail of the raw material items and quantities ordered on the
requisition form onto the company software in the inventory issue module. A sequentially numbered
issue note is printed and the inventory levels on the system is updated (reduced by the amount of raw
material issued). The issue note is handed to a warehouse clerk to pick the necessary items from the
warehouse floor.

The warehouse clerk picks the raw materials and emails the production manager to collect the
materials from the dispatch bay. On collection the production manager agrees the description and the
quantity of the items to the issue note. The production manager signs the note, and the warehouse
clerk files the note as proof of collection.

EXAMINATION TECHNIQUE

When reading through a scenario where a business process is described, use a

method that you are comfortable with that will assist you to simplify your
understanding of the process. Examples include mind maps, organograms etc. As
part of this process, you already have to place the “perfect system” at the back of
your mind and how it compares with the system presented in the scenario.

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REQUIRED Marks
With reference to WP100, identify the weaknesses in the inventory purchases system of
ProSan Limited. For each weakness identified, briefly describe the risk associated with the
weakness and provide any recommendations to address each of the weaknesses. Present
your answer in a tabular format. 13

Note: You can exclude any weakness, risk and/or recommendations that relate to masterfile
amendments as well as other automated controls (both general and application
controls).

Communication skills: logical argument and layout and structure 2

TOTAL 15

EXAMINATION TECHNIQUE

Internal control-related questions typically focus on weaknesses, risks and

recommendation within a system of internal control.

Weakness – The internal control does not function as designed or is not present at
all.
Risk – The potential consequence as a result of the weakness.
Recommendation – The suggested improvement in order for the system of internal
control for function effectively.

• A question can require only one of the above (e.g. only the weaknesses), a
combination of two of the above (e.g. weaknesses and risks), or even all three.

• If the question asks about more than one of the above, present your answer in
a tabular format (even if the question does not specifically require it). Doing
so will assist you to present your answer in a structured manner, which will
help the marker assess what you know about the subject.

For example:
Identify the weaknesses, the potential risks/consequences of the weaknesses
and your suggestions for the relevant improvement relating to the revenue and
receipts cycle.

Structure your answer in the form of a table, as illustrated below:

Weakness Potential risk/ Suggested improvement

consequences (recommendation)

• When you are required to identify weaknesses in an internal control system,

it is important that you remember:
− not only to discuss those internal controls that are performed incorrectly
(as indicated in the given scenario),
− but also to discuss the key internal controls that you, as an auditor,
should perform but which the scenario does not mention.

Please note: The discussions concerned should be relevant to what the scenario
presents.

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 COMMENT

Please note the following regarding the business cycles:

• When you are required to identify a weakness, you are essentially comparing
the “perfect” business cycle and system of internal control with an imperfect
system in the test or exam. Any deficiencies or gaps are a weakness.
• A recommendation should then require you to provide the “perfect” internal
control.

EXAMINATION TECHNIQUE

A question can require you to “evaluate the effectiveness of an internal control

system”. In such an instance, you will have to address both negative (weaknesses)
and positive aspects of the controls being performed. In an evaluation, you must
compare the negative and the positive elements of a certain matter and draw a
conclusion about them.

A question can also require you to identify/list/describe the internal controls (both
manually and automated) that should be present in a client's internal control system,
or that should be implemented to ensure that certain control objectives are met.
Don’t confuse this with tests of control. You should be comfortable with the various
business cycles and with the internal controls that should be performed in each
cycle. You cannot describe controls that a client should have in place if you are
unfamiliar with the controls in each cycle.

SUGGESTED SOLUTION:

W = Weakness Marks
R = Risk
C = Recommendations
W: No management review or approval of the process undertaken by production
manager to get the cheapest quote from suppliers 1
R: The production manager can just record the price charged by the first supplier
who is able to supply the inventory item, resulting in higher raw material costs and
potentially the loss of contracts (due to uncompetitive pricing). 1
C: When obtaining quotes, a sequentially pre-numbered quote summary form should
be completed by the production manager containing a listing of the suppliers
contacted and their selling prices for the particular item (at least three quotes should
be obtained). Written quotes from the suppliers who can supply the item should be
attached to the quote summary. 2
C: The senior administrator should review the quote summary, and supporting
documents, and authorise the preferred supplier selected by signing the quote
summary form. 1
C: Each new inventory item on the PSS should be cross-referenced to the applicable
quote summary form number. The senior administrator should review the PSS (as
part of the authorisation process) to ensure that a quote summary number was
entered alongside each new inventory item. 2
W: No review or authorisation of the purchase order is conducted after the purchasing
has captured the details. 1

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R: Therefore, errors may result in stock shortages (with consequent production
delays) or excessive inventory being purchased (which will result in losses due to
inventory theft and/or storage costs). 1
C: When capturing an order, the number of the relevant PSS should be captured as
part of the order data. 1
C: The orders generated should be reviewed and authorised by the senior
administrator (once he has logged into the system using his username and
password). 1

W = Weakness Marks
R = Risk
C = Recommendations
C: Authorisation should only take place after the senior administrator has inspected
the PSS for the quantities of goods specified. 1
W: There is no indication that anyone follows up on PSS in the pending file or PO not
actioned by suppliers. This may lead to delays in completing new products. 1
C: The production manager should review the pending file for any PSSs that are not
completed/for which no PO have been generated. 1
C: The production manager should review a list of outstanding PO generated by the
system on a daily bias and follow up with the supplier in respect of any unduly long
outstanding orders. 1
W: The goods receiving clerk does not physically count or undertake inspections
(even superficially) of the quality of the inventory items received. 1
R: This may result in the company having to pay for goods not received or for faulty
equipment. 1
C: The goods receiving clerk should count and match the inventory physically
received to the quantity on the supplier delivery note before signing the supplier
delivery note and capturing the pertinent details onto the “inventory received”
application 1
C: Damaged / faulty inventory items should not be accepted by the goods receiving
clerk. Rather he should adjust the quantities on the supplier delivery note and
request that the supplier’s representative (delivering the items) sign as evidence
thereof. 1
W: No checks appear to be in place to ensure the accuracy of capturing of goods
received data (other than order number). 1
R: If the incorrect details of goods received are captured, this may result in delays
in filling issue requests (i.e. the inventory is recorded as being on hand, but this is
not physically the case). 1
C: When goods are handed over to the warehouse clerk responsible for custody, this
warehouse clerk should agree the goods actually handed over to the GRN, and sign
the goods receiving clerk’s copy as acknowledgement of receipt. 1
Any other valid weaknesses, risks and recommendations. 3
Communication skills: Logical argument and layout and structure 2
Available 26
Maximum 13

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7.5 IDENTIFYING AND ASSESSING THE RISK OF MATERIAL MISSTATEMENT

ISA 315R, par 28 states that the auditor shall identify the risks of material misstatement and
determine whether they exist at:

a) The financial statement level; or

b) The assertion level for classes of transactions, account balances and disclosures;

7.5.1 Assessment of risks of material misstatement at the financial statement level

Risks of material misstatement at the financial statement level refer to risks that relate
pervasively to the financial statements as a whole and that can potentially affect many assertions
(ISA 315R, par A193-194).
Refer to ISA 315R, Appendix 2 for a list of examples of events and conditions that may indicate
the existence of risks of material misstatement in the financial statements, at the financial
statement level or the assertion level.

COMMENT

It is usually the same risks at the financial statement level that are examined in tests and
exams. Your knowledge from undergraduate studies is therefore key to answering questions
on this topic.

Good exam technique is very important:

• Identify the risk indicator – it is important to note that this is just the indicator – it is not
the risk that is required!
• After the indicator was identified, you need to properly formulate the risk at the overall
financial statement level.

Example:

Risk indicator Description of risk Component

of audit risk
Operations in regions or The AFS may be materially misstated, as the entity Inherent risk
countries with strict might not comply properly with the relevant
regulations/different laws and regulations. This could result in
regulations to those in material misstatements of unrecorded
place in South Africa liabilities, expenses, and so on. Examples are
the Johannesburg Stock Exchange (JSE)
regulations, environmental laws, labour laws, and
so on.

EXAMINATION TECHNIQUE

No marks are allocated for the risk indicators unless you are required to list them. Marks
are awarded for describing the risk - refer to the description of risk column in the
table above. A scenario will mention the risk indicator, to enable you to discuss or
describe the risk.

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7.5.2 Assessing risks of material misstatement at the assertion Level

The auditor uses assertions, which are management representations that the financial
statements embody, to consider the different types of potential misstatements that might occur.
The assertions fall into the following three categories, namely assertions about:

• classes of transactions and events for the period under audit;

• account balances at the period end; and
• presentation and disclosure.

Please refer to ISA 315R, par A188-A191 for more detail on the different assertions.

EXAMINATION TECHNIQUE

1. Present your answer using assertions, even when you are not specifically asked
to do so. Doing so will generate marks and will show the marker that you are able
to link risk and assertion.

2. Use ISA 315R when answering a question on risks at the assertion level. Doing
so will enable you to address the correct assertion that is at risk for a class of
transaction, account balance and/or disclosure.

3. When required to describe the risk at the assertion level, use the information
provided in the scenario. For instance, if you were to write “there is a risk that trade
receivables might be valued incorrectly”, your answer would be incomplete, as you
did not link the risk to the information supplied in the scenario. You would have to
link your answer to forex valuation and to the impact of the provision for credit
losses, when discussing the valuation assertion.

4. When you are required to describe the risks at the assertion level, do not confuse
the question with one on audit procedures. Audit procedures will be covered in
learning unit 8-10.

QUESTION 7.2 – SELF ASSESSMENT QUESTION 33 marks

Estimated Time
Activity
Reading Writing Marking and review Total
FastCom Ltd 10 minutes 50 minutes 20 minutes 80 minutes

INTRODUCTION

You are a first-year trainee accountant at Game of Coms Inc (Game of Coms), a medium-sized audit
firm. Game of Coms, with its head office situated in Pretoria, has offices across South Africa. You are
currently involved in the 31 December 2023 year-end audit of FastCom Ltd (FastCom).

BACKGROUND INFORMATION OF FASTCOM

Understanding of the entity

FastCom, which was established in 2000, is listed on the Johannesburg Stock Exchange (JSE). The
company deals exclusively with providing internet telecommunication services to their customers across
South Africa.

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The directors of FastCom have a shareholding of 75% on 31 December 2023, and they receive share
options annually that are driven by profits for the year. Other stakeholders own the remaining 25% of
FastCom’s shareholding.

During the July 2023 financial year end, FastCom was able to gain control of three South African
companies that are also in the internet telecommunications industry. The three companies have a
31 December year end, resulting in FastCom changing its previous year end from 31 July to
31 December, so that all the companies in the FastCom Group have the same year end.

During August 2023, FastCom changed its operating software from ADSL X100 to Fibre X900, so as to
provide more efficient and reliable internet telecommunication services. However, the implementation
of the new Fibre X900 resulted in serious repercussions, because, in October 2023, millions of
households and businesses across South Africa were disconnected from the internet telecommunication
services provided by FastCom. According to media reports, there were numerous complaints from
customers, including of inaccurate and hugely inflated bills. The customers in various provinces marched
in protest, demanding that their internet telecommunication services be reconnected and for their bills
to be corrected. The CEO of the Department: Telecommunications & Postal Services, Khal Drogor,
deemed the situation to be a national crisis and contacted the CEO of FastCom, Zamwell Tarly, to help
deal with the situation. Tarly knew about the issues concerned, since he had received numerous
complaints from customers, following the implementation of the new Fibre X900 software system.
However, he deliberately provided incorrect information to Khal Drogor, indicating that there was no
crisis regarding the billing of the customers.

On independently investigating the matter to confirm FastCom’s compliance with the

telecommunications billing regulations, the Department: Telecommunications & Postal Services found
that there were irregularities and problems within the billing system of FastCom. Accordingly, the
Department decided to terminate the accreditation of FastCom by 31 December 2024, so as to provide
a reasonable amount of time for all parties concerned to make any amendments that they deemed to
be appropriate. The Department also lodged a lawsuit against FastCom for its non-compliance with
billing regulations. The lawsuit is set to cost FastCom R300 million, and the legal team considers that
the ruling will be in favour of the Department. FastCom has no insurance to cover such lawsuits.

Zamwell Tarly has informed the audit partner that the audited consolidated financial statements for the
year ended 31 December 2023 are required a week after year end, so as to enable the group to apply
for a loan to cover the lawsuit instituted by the Department. FastCom is experiencing going concern
problems, as a result of the penalties and lawsuit against them.

The following working papers are available for the audit of FastCom:

Working paper Working paper description

reference
WP100 Internet telecommunication services fee income
WP200 Accounting for the new Fibre X900 system

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Entity name: FastCom Ltd Year end: 31 December 2023
WP-100
Prepared by: S Stark Date: 20 January 2024
Page 1 of 2
Reviewed by: D Targarian
Audit section: Internet telecommunication services fee income
Purpose

The purpose of this working paper is to describe the details of the internet telecommunication services
fee income that is received by FastCom.

Description: Contract & billing

A standard contract, setting out the terms, conditions, fee structure and other related matters is entered
into for the billing of each of the customers. Both the internet telecommunication services fee income
and the penalty structures were approved by management, who were included in one of FastCom’s
policy documents.

The billing of the various customers by FastCom is based on monthly data usage. Each customer has
a unique account number, and the movement in data usage from the prior month to the current month
has to be billed.

The internet telecommunication services fee is charged according to the number of megabytes data
that a customer uses. The standard contract with customers contains the following fee structure:

Number of megabytes data used Fee per megabyte of data used per month
for the month (value-added tax [VAT]-exclusive)
1 to 100 000 R0.20
100 001 to 250 000 R0.15
250 001 to 500 000 R0.10
500 001 and more R0.05

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Entity name: FastCom Ltd Year end: 31 December 2023
WP-100
Prepared by: S Stark Date: 20 January 2024
Page 2 of 2
Reviewed by: D Targarian
Audit section: Internet telecommunication services fee income
Description: Penalties

The Department: Telecommunications & Postal Services has a stipulation in place that indicates that
a penalty is payable by FastCom to the Department: Telecommunications & Postal Services if a
reduction occurs in the internet telecommunication services provided by FastCom to its customers.
The services are identified based on customer complaints relating to incorrect billing, as a reduction in
such services would be deemed non-compliance with both the Department’s billing regulations and
with the Consumer Protection Act, No. 68 of 2008. Customer complaints, which are lodged
electronically, are received by both FastCom and by the Department. The penalty payable by FastCom
is based on the following sliding scale:

Percentage reduction of internet Number of customer complaints

telecommunication services fees (penalty) relating to incorrect billing
2% 10 to 100
4% 101 to 500
6% 501 and more

The penalty percentage is multiplied by both the internet telecommunication services fee that was
levied in the previous month (and to which the complaint relates), as well as by the valid number of
complaints received from customers. Therefore, a backdated provision is raised for any disputes that
will be lodged relating to the December 2023 internet telecommunication services fee, as the details
will become available only in January 2024.

Description: Net internet telecommunication services fee

The invoice that is prepared at the end of each month for each customer contains the internet
telecommunication services fee, a penalty deduction (if necessary), the VAT amount and the net
internet telecommunication services fee amount. The net internet telecommunication services fee is
calculated using the gross fee, less any penalties.

Description: Conversion process from the ADSL X100 system to the Fibre X900 system

During the conversion process from the ADSL X100 system to the Fibre X900 system, a power outage
occurred, at the time when the master files of the system were being transferred. The disruption
resulted in an estimated 1000 valid complaints from customers. The number of valid complaints is
derived from a list that is drawn from the “Disputes” module of the new Fibre X900 system.

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Entity name: FastCom Ltd Year end: 31 December 2023
WP-200
Prepared by: J Stark Date: 22 January 2024
Page 1 of 1
Reviewed by: D Targarian
Audit section: Accounting for the new Fibre X900 software
Purpose:

The purpose of this working paper is to provide a description of the accounting process for FastCom’s
new Fibre X900 software.

Description: Contract and international purchase

The Fibre X900 system was purchased on 10 March 2023, at an amount of €2 000 000, from an
international supplier in Japan. FastCom decided to take out an FEC on the same day, so as to cover
itself against major fluctuations in the exchange rate, as there were rumours in the market that a
weakening of the rand could be expected at the beginning of June 2023. The invoice was only payable
after the Fibre X900 system had been implemented and was fully operational.

Description: Additional costs

FastCom incurred additional costs, amounting to R400 000, that were directly attributable to the Fibre
X900 systems (e.g. the feasibility study). Training was provided to the personnel of FastCom by
Mr Podrick Pain, the Information Technology manager, to enable them to operate the system
effectively, with its cost amounting to a further R500 000.

Description: Wear and tear and impairment

After discussions with the international supplier, and based on a feasibility study, it was concluded that
the Fibre X900 system could be used, problem free, for a period of ten years. Thereafter, FastCom will
need to consider updating the system for it to continue operating effectively. However, management
decided to write the Fibre X900 system off over a period of 12 years. As the system was bought in the
current year, management did not deem it necessary to do an impairment test on the system.

EXAMINATION TECHNIQUE

As is the case with a system of internal control, when reading through a scenario
where a business process is described, use a method that you are comfortable with
that will assist you to simplify your understanding of the process. Remember that we
are auditing the annual financial statements presented by the management of the
audit client. The management of the company are marking assertions relating the
transactions and balances reflected in financial statements.

Integration of your accounting knowledge therefore is also key in identifying risks at

the assertion level. As explained above, simplify the transaction flow from where it
originates, through processing by the accounting system and then where it is
eventually reflected in the financial statements. A method you can use as an
example is to draw op T-accounts which reflects the debits and credits of that specific
balance. Throughout this process you have to keep the accounting requirements in
terms of the applicable accounting standard at the back of your mind.

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REQUIRED Marks
(a) With reference to the BACKGROUND INFORMATION OF FASTCOM: Understanding
of the entity and Auditors, identify the risk indicator and describe the risk of material
misstatement at the overall financial statement level, in the financial statements of
FastCom Ltd, and at the group level for the year ended 31 December 2023.
20
Your answer should be structured in the following table

Risk indicator Description of risk

Communication skills: logical flow and tabular format

1
(b) With reference to working paper WP-100 and to working paper WP-200, discuss the
risk of material misstatement at the assertion level for the internet telecommunication
services fee income and accounting for the new Fibre X900 software. 11

Communication skills: proper formulation of risks 1

Total 33

EXAMINATION TECHNIQUE

Probably the most important exam technique in auditing that you have to master, is
to make sure that you read and interpret the required accurately.

Keep the following in mind:

• Read the required once to get a general feeling and thereafter read it again in
more detail.
• Analyse the required by breaking up the sentence in smaller sections that would
include the following:
1. The scope of the required – is it a certain working paper or a certain section
of the scenario?
2. The verbs – list/describe/analyse etc.
3. In what format should you present your answer – table/memorandum/email
response etc.

HJB
SUGGESTED SOLUTION:

(a) With reference to the BACKGROUND INFORMATION OF FASTCOM: Understanding of the

entity and Auditors, identify the risk indicator and describe the risk of material
misstatement at the overall financial statement level, in the financial statements of
FastCom and at the group level for the year ended 31 December 2023.

Your answer should be structured in the following table

Risk indicator Description of risk

1. FastCom Ltd is listed on the JSE. • The AFS may be materially misstated, in order for
(1) FastCom to meet the JSE listing requirements. (1)
• The AFS may be materially misstated in order to meet the
shareholders expectation. (1)
• The AFS may be materially misstated on order to
manipulate the share price. (1)
2. CEO, Zamwell Tarly deliberately • The AFS may be materially misstated as the control
provided incorrect information to environment might be compromised by the lack of
the Department of integrity of the CEO/management. (1)
Telecommunications & Postal
Services. (1)
3. Directors receive share options • The AFS may be materially misstated by overstating
driven by the profit for the year and revenue/ income and understating expenses,
directors have a significant manipulation of profits, to increase the directors’ benefits.
shareholding in the company. (1) (1)

Risk indicator Description of risk

4. Change in the financial year end. • The AFS may be materially misstated, as the items in the
(1) financial statements might not be properly accounted for
in the correct period. (1)
• The AFS may be materially misstated as the change in
year end might not be done in compliance with the
Companies Act requirements. (1)
5. Going concern (1) The financial statement may be inappropriately presented on
the going concern basis due to: (1)
• Losing their accreditation to operate which would result in
loss of revenue. (1)
• Not having enough cash to settle the lawsuit of R300
million. (1)
• Going concern problems may give management the
opportunity to manipulate the financial statements to show
a favourable position. (1)
6. Loan depends on the audited • The AFS may be materially misstated, as the assets/
financial statements. (1) revenue might be overstated, and liabilities/expenses
understated in order to obtain the loan (fraudulent
financial reporting). (1)
7. FastCom operates within a group. • The AFS may be materially misstated, as the related
(1) party/inter group relationships and transactions might not
be properly accounted and disclosed in FastCom ’s
financial statements. (1)

HJB
 • The AFS may be materially misstated as this is the first
year consolidated financial statements will be prepared.
(1)
• The AFS may be materially misstated as the controls
might not be operating consistently throughout all the
companies within the group. (1)
8. FastCom acquired three entities • The AFS might be materially misstated as the acquisition
during the year. (1) of the three entities might not be accounted for in terms of
IFRS3. (1)
9. Consolidations required. (1) • There is a risk that the inter-group party transactions might
not be eliminated on consolidation. (1)
• Inconsistent accounting policies may be used by the
different companies in the group. (1)
10. Reliance on the component • There is a risk that the components auditor might not
auditors. (1) possess the required independence, skills and expertise
to audit the component resulting in material
misstatements in the group AFS. (1)
11. Financial statements are required a • The tight audit timeframe on the audit team creates an
week after year end and the opportunity for fraudulent reporting by management on
decrease in the members of the the financial statements. (1)
audit team. (1)
12. Change in operating software. (1) • Data could be incorrectly transferred from the old to the
new system, leading to misstatements (1)
Communication skills: logical flow and tabular format (1)
Available 34
Maximum 21

EXAMINATION TECHNIQUE

Students often get confused with the difference between risks of material
misstatement at the assertion level and the financial statement level. A general test
that you should perform to distinguish between the two is to determine whether the
risk relates to only certain transactions or balances. If the answer is yes then you
are dealing with a risk at the assertion level.

(b) With reference to working paper WP-100 and working paper WP-200, discuss the risk of
material misstatement at the assertion level for the net internet telecommunication
services fee income and accounting for the new Fibre X900 software.

Internet telecommunication services fee income

1. There is a risk that the net internet telecommunication services fee income fee income of
the next period might be accounted for in the current period to inflate profits due to
the fact that management have share options based on profits and there is going concern
issues. (Occurrence, cut-off). (1)

2. There is a risk that FastCom might charge customers incorrect rates, as the rates are
driven by the number of data megabytes used for the month that are based on different
rates (Occurrence, Accuracy, Completeness). (1)

3. There is a risk that all the complaints and resulting penalties are not taken into account
for calculation of the net internet telecommunication services fee (Completeness). (1)

HJB
 4. There is a risk that the VAT subtracted is not on the net fee income (excluding the penalty
charged) but full fee income (inclusive of the penalty charged) (Accuracy). (1)

5. The internet telecommunication services fee income could be calculated using the
incorrect penalty percentage (1)/original fee (1)/number of customer complaints (1)
(Accuracy). Max (3)

6. The provision for the December 2023 penalties may be incorrectly calculated due to
the many problems that occurred during the year (Accuracy). (1)

7. The provision for the December 2023 penalties may not be included in the net fee
income (cut-off). (1)

8. There is a risk that the net internet telecommunication services fee accounted for in the
general ledger might be inclusive of VAT and penalties charged (Accuracy). (1)

Accounting for the new Fibre X900 software

1. There is a risk that the costs may not be properly treated. (1)
1.1 Costs capitalised to the intangible assets are not qualifying costs (e.g. training
costs) (Accuracy). (1)
1.2 The costs qualifying to be capitalised (e.g. feasibility study costs) might not be
capitalised (Existence, Completeness). (1)

2. There is a risk that the foreign invoice with regards to the purchase of Fibre X900 might
not be translated at the correct exchange rate when the risks and rewards pass to
FastCom (Valuation, Accuracy). (1)

3. There is a risk that the translation of the FEC asset or liability might not be properly
calculated (Accuracy). (1)

4. There is a risk that FEC gains or losses might be incorrectly accounted for in the cost
of the Fibre X900 (Valuation, Accuracy). (1)

5. There is a risk that the Fibre X900 might be amortised over the incorrect useful life
(Valuation). (1)

6. There is a risk that the intangible asset is not assessed for impairment as required by
IAS 36, as management did not deem it necessary to do an impairment test especially in
light of the complaints received which might be software related (Valuation). (1)
Available 18
Maximum 12
Total 40
7.5.3 ANNOUNCEMENTS
Please refer to the Announcements on Learning Unit 7 for live discussion classes where we
will look at more examples on the content of this Learning Unit.

7.6 Planning activities

As per ISA 300, par 7, the auditor shall establish an overall audit strategy that sets the scope,
timing and direction of the audit, and which guides the development of the audit plan.

7.6.1 Overall audit strategy

In establishing the overall audit strategy, the auditor shall do the following:

(a) Identify the characteristics of the engagement that define its scope.
(b) Ascertain the reporting objectives of the engagement to plan the timing of the audit and
the nature of communication required.
(c) Consider significant factors in directing the engagement team.
HJB
(d) Consider the results of the preliminary engagement activities and, where applicable,
whether the knowledge gained from other engagements performed by the engagement
partner for the entity is relevant.
(e) Ascertain the nature, the timing and the extent of resources that are necessary to perform
the engagement.

7.6.2 Audit plan

The completion of the overall audit strategy guides the development of the audit plan.

IMPORTANT PRINCIPLE

Risks at the overall financial statement level are dealt with by the overall
responses (ISA 330, par 5 and A1 to A3). The risks at the assertion level are
dealt with by further audit procedures that respond to the assessed risk of
material misstatement at the assertion level (ISA 330, par 6 and A4 to A8).

The audit plan is more detailed than the overall audit strategy, as it includes a description of
(ISA 300, par 9):

(a) the nature, timing and extent of the planned risk assessment procedures, as determined
under ISA 315R.

(b) the nature, timing and extent of the planned further audit procedures at the assertion level,
as determined under ISA 330.

(c) other planned audit procedures that should be carried out to ensure that the engagement
complies with the ISAs. (ISA300, par A12 to A14)

The auditor’s assessment of the identified risks at the assertion level provides a basis for
considering the appropriate audit approach (combined audit approach or substantive audit
approach) to adopt when designing and performing further audit procedures (ISA 330, par A4).

The auditor may decide to follow either of the following approaches:

A combined audit approach entails tests of controls and substantive procedures to follow.
The auditor then tends to rely on the operating effectiveness of the controls, or when substantive
procedures alone cannot provide sufficient appropriate audit evidence at the assertion level (ISA
330, par 8).
OR
A substantive approach may be followed, entailing both tests of detail and substantive
analytical procedures.

IMPORTANT PRINCIPLE

Irrespective of the assessed risks of material misstatement, the auditor designs and
performs substantive procedures for each material class of transaction, account
balance and disclosure (ISA 330, par 18 and A43 to A49).

HJB
QUESTION 7.3 – SELF ASSESSMENT QUESTION 27 marks

Estimated Time
Activity
Reading Writing Marking and review Total
Hofflows Ltd 8 minutes 40 minutes 16 minutes 64 minutes

Background information

You are an audit trainee at ZWE Inc (ZWE), a small firm of registered auditors. ZWE is situated in
Pretoria, with a broad client base in the real estate investments and services industry, spread over the
Gauteng province. ZWE was recently appointed as the auditors of the stand-alone financial statements
of Hofflows Ltd (Hofflows), as well as of the consolidated financial statements for the Hofflows Ltd Group
(Hofflows Group) for the financial year ended 28 February 2024. The effective date of the appointment
was 1 May 2023.

As part of ZWE’s considerations regarding their acceptance of their appointment as the external auditors
of Hofflows, permission was obtained from the latter company to contact the predecessor auditor, JESS
& Associates (JESS). The audit partner, Ms Elsa Mulan, and the audit manager, Mr Simba Mawela,
assigned to the audit engagement of Hofflows, held a meeting with the audit partner at JESS. JESS had
been responsible for the auditing of Hofflows for the previous four years.

Shortly after the meeting with the predecessor auditor, Ms Elsa Mulan had a meeting with the
engagement team, in which she expressed some of her concerns regarding the Hofflows audit. A major
concern raised by her was that the audit software used by ZWE might not be compatible with Hofflows’
integrated computer system. She, however, indicated that she would find a way of working around the
situation.

The following audit working papers are available for your consideration:

Working paper Description

reference
A100 Hofflows: Minutes of meeting held with predecessor auditor on 7 April 2023
(extract)
B100 Hofflows Group: Audit strategy for the Hofflows Ltd Group year-end audit
C100 Hofflows: Accounting policy – IFRS 15 – Revenue from contracts with customers
(extract)

HJB
Client: Hofflows Ltd Year end: 28/02/2024
WP reference
Prepared by: Simba Mawela Date: 18/04/2023
A100
Reviewed by: Date: Page 1 of 1
Subject: Minutes of meeting held with predecessor auditor on
7 April 2017 (extract)
Minutes of meeting (extract)

Venue: JESS & Associates’ office – Eagle Boardroom

Date: 6 April 2023
Time: 09:00

Attendance:
The following people attended the meeting:

Audit partner at ZWE – Ms Elsa Mulan

Audit manager at ZWE – Mr Simba Mawela
Audit partner at JESS – Ms Ursula Dey

Matters discussed

Matter 1: Access to audit working papers for the 2023 financial year
At this point in time, JESS will be unable to provide ZWE with the working papers for the audit of the
previous financial year, since unresolved accounting irregularities were reported to the Independent
Regulatory Board for Auditors (IRBA). Due to the unresolved matter, Hofflows’ management are
refusing to pay the outstanding audit fees for the 2017 financial year-end audit.

Matter 2: Understanding the entity and its environment

Ms Ursula Dey provided ZWE with information relating to the entity and to the environment in which it
operates. Hofflows was established in 1978 by the current CEO, Mr Mark Jacobs. The company has
experienced extensive growth over the past five years, acquiring five subsidiaries in the process.
Hofflows expanded to the point where the Hofflows Group is now one of the largest providers of
furniture and appliances in South Africa and Mozambique. The company and its subsidiaries operate
in the furniture and appliance retailing industry, with its operations being widespread, encompassing
14 cities in the two countries concerned. Hofflows is listed on the JSE and the financial year end of all
of the companies in the group is 28 February.

Matter 3: Other matters relating to the audit of Hofflows

All of Hofflows’ operations, including the accounting function, use a fully integrated computerised
system. Hofflows encourages the existence of a paperless environment, so as to leave only a light
carbon footprint on the environment. JESS used appropriate audit software to deal with Hofflows’
operations, which it conducts in a highly computerised environment.

In carrying out the audit, JESS relied on the work of Hofflows’ internal audit function for the low- and
medium-risk classes of transactions and account balances.

JESS was appointed only as the auditors of Hofflows and of three of its five subsidiaries, with the firm
placing reliance on the work of the component auditors for the other two subsidiaries. ZWE has also
been appointed as the auditors of Hofflows and of the three subsidiaries that JESS used to audit.

Hofflows requires the audited financial statements by 30 March of each year, as the company is
required by their bank, which has provided loans over the years, to finance the acquisition of the five
subsidiaries. Significant amounts of the loans are still outstanding.

HJB
Client: Hofflows Ltd Group Year end: 28/02/2024
WP reference
Prepared by: Simba Mawela Date: 01/06/2024
B100
Reviewed by: Ms Elsa Mulan Date: 08/06/2024 Page 1 of 2
Subject: Audit strategy for the Hofflows Ltd Group year-end audit
This working paper sets out the external audit strategy, taking into account all the information available,
for the 28 February 2024 financial year-end audit of the Hofflows Group.

Scope of the audit

The following characteristics of the engagement are documented, so as to determine the scope of the
audit:

• The financial statements are prepared in accordance with the IFRS.

• A significant decline has occurred in Hofflows’ share price, due to the delay in the audited
financial statements from JESS and the sudden resignation of the CEO, Mr Mark Jacobs, during
May 2017.
• Hofflows has over 50% shareholding in each of Hofflows’ five subsidiaries, respectively.
• All five subsidiaries need to be audited in terms of the Companies Act, No. 71 of 2008.
• Stand-alone financial statements will be prepared and audited for all five of the subsidiaries, with
two of the five subsidiaries being audited by the component auditors.
• Hofflows will prepare stand-alone and consolidated financial statements that will be audited by
ZWE.
• Internal control environment:

During the financial year ending 28 February 2017, an override of internal control resulted in
accounting irregularities. Hofflows, which is committed to designing, implementing and
maintaining a sound internal control environment, would want to rectify any deficiencies in
internal control that could have played a role in the accounting irregularities. Further, they are
willing to make all documentation available to ZWE, including any accounting records and the
documentation of system descriptions and internal controls, as Hofflows realises how important
internal controls are to the successful operation of the entity. Reliance will be placed on internal
controls over the material classes of transactions and account balances with a medium to high
risk of material misstatement, due to the high volume of transactions and to the desirability of
supplying Hofflows with value-added comments.

Timing

The audit report on the consolidated financial statements of Hofflows Group needs to be issued by no
later than 30 March 2024. A meeting will be scheduled later on in the current financial year, in which
ZWE will discuss with management the nature, timing and extent of the audit work to be performed.
Further, it will be determined what communication management expects regarding the status of the
audit work throughout the engagement. The following key dates will be set and agreed on with
management:

Key step Key dates

Year-end interim audit to commence 2 January 2024
Year-end audit fieldwork to commence 26 February 2024
Communication of accumulated misstatements 26 March 2024 – 29 March 2024
Final audit report to be issued 30 March 2024

HJB
Client: Hofflows Ltd Group Year end: 28/02/2024
WP reference
Prepared by: Simba Mawela Date: 01/06/2024
B100
Reviewed by: Ms Elsa Mulan Date: 08/06/2024 Page 2 of 2
Subject: Audit strategy for the Hofflows Ltd Group year-end audit
Direction

Planning materiality
Planning materiality (0.5% of revenue): R 1 200 000

Nature, timing and extent of the resources

The engagement team for the Hofflows Group audit is as follows:

Audit partner – Ms Elsa Mulan

Audit manager – Mr Simba Mawela
Third-year audit trainee – Mr Mickey Belle
Second-year audit trainee – Ms Minnie von Drake
Second-year audit trainee – you
First-year audit trainee – Mr Olaf Khumalo

The following table illustrates the preliminary identification of the material classes of transactions and
account balances, as well as the team allocation. The detailed risk of material misstatement at the
assertion level will be documented in working paper D100 (not provided in the scenario).
Ms Elsa Mulan will perform a final review, once all the review notes that have been raised are cleared
by the appropriate audit trainee.

Class of transaction/ Preliminary Engagement team Review

Account balance assessment of the member responsible
risk of material
misstatement at the
assertion level
Revenue High Mr Olaf Khumalo Mr Mickey Belle/
Mr Simba Mawela*
Cost of sales Medium Ms Minnie von Drake Mr Simba Mawela
Accounts payable Medium You Mr Simba Mawela
Inventory High Mr Mickey Belle Mr Simba Mawela
Cash and cash equivalents Low Ms Minnie von Drake Mr Simba Mawela
Property, plant and Low You Mr Simba Mawela
equipment

*Mr Mickey Belle will perform a first review, so as to guide and mentor the first-year trainee. Afterwards,
Mr Simba Mawela will perform a second review.

No other matters were considered in establishing the overall audit strategy.

HJB
Client: Hofflows Ltd Year end: 28/02/2024
WP reference
Prepared by: Mickey Belle Date: 02/01/2024
C100
Reviewed by: Date: Page 1 of 1
Subject: Accounting policy – IFRS 15 – Revenue from contracts with
customers (extract)
This working paper sets out the accounting policies applicable to Hofflows’ revenue in the financial
statements for the year ending 28 February 2024.

Hofflows elected to early adopt IFRS 15 – Revenue from contracts with customers.

Revenue from contracts with customers (extract)

Revenue is presented, including net of VAT, rebates and discounts, in terms of the IFRS 15, using the
following five steps:

1. Identify the contract(s) with the customer.

2. Identify the performance obligations in the contract.
3. Determine the transaction price.
4. Allocate the transaction price to the performance obligations.
5. Recognise revenue as/when the entity satisfies a performance obligation (risks a.5.2, b.1.1.2
and b.1.4).

YOU NOW HAVE 60 MINUTES IN WHICH TO ANSWER THIS QUESTION.

REQUIRED Marks
1. Discuss any concerns that you might have relating to the audit strategy of the
Hofflows Ltd Group audit for the year ended 28 February 2024. 15
2. Discuss your considerations in determining the nature and extent of the audit approach
for revenue in the stand-alone financial statements of Hofflows Ltd for the year ended
28 February 2024. 11
Communication skills: clarity of expression 1
TOTAL 27
(Unisa test 2 – 2018, adapted)

HJB
SUGGESTED SOLUTION:
The solution to this self-assessment question will be posted on myUnisa and also discussed
during a live discussion class. Please keep an eye on the announcements posted on myUnisa
for more information.

7.7 Materiality in planning and performing an audit

Materiality in planning and performing an audit is determined when developing an overall audit
strategy.

Study ISA 320 in detail to understand the effect that the determination of materiality in planning
and performing the audit will have on conducting and concluding the audit. Know the difference
between materiality and performance materiality. (Refer to ISA 320, par 10 to 11.) Calculating
the performance materiality lower than the planning materiality enables the auditor to minimise
the risk of expressing an incorrect audit opinion.

An inverse relationship exists between materiality and IR, as you can see below:

• If the IR is assessed as high, a low materiality will be set to compensate for the high IR.
• If the IR is assessed as low, a high materiality will be set, because there is less of a chance
that a material misstatement will occur.

7.8 ADDITIONAL RESOURCES

Please refer to the additional resources on the content of this Learning Unit.

7.8 ANNOUNCEMENTS

Please refer to the Announcements for additional information on the lectures to be held on
Learning Unit 7.

HJB