6 QUESTION 2 25 marks DBJ Inc. (‘DBJ’) is a firm of Registered Auditors which has performed statutory audits of Brekkies (Pty) Ltd (‘Brekkies’) up to the 31 December 2011 financial year end. You are a member of the audit team. At a recent preliminary planning meeting held with the Brekkies management, they advised DBJ that in an attempt to cut costs, they want DBJ to perform an independent review of Brekkies for the 2012 financial year, as opposed to an audit. They expect a significant saving in the fees paid to DBJ. Brekkies’s Memorandum of Incorporation does not require an audit. Background of the company Brekkies is a medium-sized South African enterprise that produces breakfast cereal products. Brekkies is currently owned by Brunchies Ltd and Munchies Ltd, holding 60% and 40% respectively. Both companies are unlisted public companies incorporated in South Africa. The Brekkies workforce on average consists of 50 full-time salaried employees (2011: 54). The company on average employs approximately ten independent contract workers (2011: 5) each month on limited term contracts as and when required. The company’s accounting policies conform to the International Financial Reporting Standard for Small and Medium-sized Entities. The following are extracts from the 2012 audit working papers relating to Brekkies: Document Working paper reference Understanding the entity – financial information A104 Understanding the entity – discussions with management A105 7 Understanding the entity – financial information A104 Client: Brekkies Prepared by: T. Icker Date: 05/11/2012 Year ended: 31 December 2012 Reviewed by: B. Asher Date: 12/11/2012 Extracts from the 2011 audited financial statements and the 2012 management accounts of Brekkies are provided below. These have been prepared by Mr Smith, who acts as an independent external consultant to Brekkies. The 2012 information is based on forecast information provided by the company. Mr Smith, formerly an audit partner at DBJ, was previously involved in the Brekkies audit. Although he retired from the firm in 2007, he still maintains membership of the South African Institute of Chartered Accountants. EXTRACTS FROM THE STATEMENT OF FINANCIAL POSITION R’000 2012 2011 Forecast Audited Assets 224 000 165 000 Property, plant and equipment 125 000 91 000 Inventories 48 000 40 000 Accounts receivable 32 000 23 000 Cash and cash equivalents 19 000 11 000 Equity 160 000 93 000 Share capital 45 000 5 000 Retained earnings 115 000 88 000 Liabilities 64 000 72 000 Bank borrowings 22 000 40 000 Income tax liability 12 000 3 000 Deferred tax liability 15 000 22 000 Accounts payable 15 000 7 000 EXTRACTS FROM THE STATEMENT OF COMPREHENSIVE INCOME R’000 2012 2011 Forecast Audited Revenue 180 000 170 000 Cost of goods sold 121 000 111 000 Gross profit 59 000 59 000 Administration, marketing and finance costs 19 000 23 000 Net profit before taxation 40 000 36 000 Taxation 19 000 9 000 Net profit after taxation 21 000 27 000 8 Understanding the entity – discussions with management A105 Client: Brekkies Prepared by: T. Icker Date: 02/12/2012 Year ended: 31 December 2012 Reviewed by: B. Asher Date: 12/12/2012 2012 financial year At the initial 2012 planning meeting of Brekkies held on 2 December 2012, Mr Sandman, the financial director, noted the following two issues: 1 Resignation of sales director The previous sales director, Miss Nate, had been requested to resign with immediate effect during October 2012. Miss Nate was found guilty of paying four of Brekkies’s major suppliers earlier than the agreed terms, without receiving the appropriate settlement discounts. In exchange she was receiving travel vouchers for her personal use from these suppliers. The situation was brought to the attention of management during September 2012 through an anonymous report to the Brekkies whistle-blowing hotline. Miss Nate was suspended immediately while the matter was being investigated. With the assistance of a firm of external forensic consultants, Brekkies concluded that the misconduct did in fact occur, but that the amounts involved were not significant. Management have not identified any other similar incidents. 2 Tax assessment Brekkies submitted its 2011 IT14 tax return to the South African Revenue Service (SARS) during 2012. Following a tax audit by SARS, Brekkies received an assessment that indicated an underpayment of tax as a result of the incorrect application of inventory costing in the 2011 return. After numerous meetings and correspondence with SARS, the parties agreed that the outstanding amount, which includes both the short payment and penalties and interest, needed to be paid to SARS by 31 March 2012.