Question
QUESTION ONE (65 MARKS)
You are currently preparing for the year-end audit of Supa Glass Limited (SG) for the year ended 31 August 2018. SG is listed on the JSE Securities Exchange. The audit must be completed before 15 September 2018.
SG is a new audit client to your audit firm and you have already gathered information to gain an understanding of the entity and its environment, including its system of internal control.
STRATEGIC OVERVIEW
SG is a highly focused business based on a customer-driven culture that places partnerships with customers at the core of its business. Their drive for operational excellence has enabled the delivery of lower costs, improved quality, and innovative solutions.
Strong cash flows from operations in previous years have enabled the group to comfortably fund investments to support its existing operations and build additional capacity. In the current financial year, operating profit has, however, been negatively impacted by the effect of a strong rand on selling prices of tableware which competes directly with imports. This has placed cash flow under pressure. The company has therefore decided to also sell to smaller customers from a warehouse in Kempton Park. A long-term lease agreement has been entered into for this warehouse.
Commercial container glass is made by melting silica sand, soda ash, and limestone or melting recycled glass ("cullet"). The holding bin of the furnace is filled with a batch of either raw materials or recycled glass. From the holding bin of the furnace, the raw materials are continuously fed to the furnace where these are converted to molten glass and maintained at temperatures in excess of 1,500°C. Molten glass is continuously withdrawn through a submerged throat where it flows to the refinery area of the furnace and is cooled to approximately 1,200°C, before being delivered to the individual bottle-making machines via the fore-hearths.
The molten glass then enters the feeder to the bottle-making machine, where the streams of glass are cut into pieces of predetermined weight ("gobs"), each of which is required to make a single bottle. These gobs of molten glass are then individually fed into the molds of the bottle-making machine.
The furnaces are fully computerized, and critical parameters are controlled within very close tolerance margins. SG’s furnaces are designed to be the most modern in the world with a productive lifespan of more than ten years. The lifespan of the refractory (lining) part of the furnace is only three years. The company must rebuild a furnace after the three-year lifespan of the refractory by replacing only the refractory of the furnace.
PROPERTY, PLANT AND EQUIPMENT
Accounting policy: Property, plant, and equipment
Property, plant, and equipment are carried at cost, less accumulated depreciation and impairment losses.
Depreciation is charged on a straight-line basis over the estimated useful lives of each component of an item of property, plant, and equipment. Land is not depreciated. The estimated useful life of plant and machinery is between three and ten years.
Where appropriate, and if material, expected residual values are taken into account in determining the depreciable values of assets.
Accounting policy: Investment property
Investment property is stated at fair value at the balance sheet date. Gains or losses arising from changes in the fair value of investment property are included in profit or loss for the period in which they arise.
Acquisitions
Capital expenditure of SG amounted to R416 million in the current year. The capital expenditure projects were:
Bellville number 4 furnace – refractory rebuilt at the end of its three-year useful life;
Glass recycling cullet plant in Pretoria, constructed by an established international firm;
Glass forming machines at the Wadeville plant, bought in Italy and installed by the company; and
A third furnace and production line at Clayville, constructed by an established international firm.
During the year, all glass manufacturing facilities operated at full capacity and also above the standard efficiency. In addition to the above capital projects, the Bellville number 1 furnace will be rebuilt during July 2018 in the next financial year, adding 60,000 tons of capacity. This will result in a 25% increase in the total glass capacity of SG.
Disposals
SG sold special glass-blowing equipment, used for the manufacture of lead-cut glass, to an artist from the White River vicinity. At year-end, this equipment was not yet delivered to the artist’s studio due to delays by the building contractors in the completion of his studio. The equipment had already been packaged and full payment for the equipment was received, but the artist requested the company not to deliver it. Ownership has passed to the artist in White River.
Investment property
The investment property relates to properties that are no longer needed for retail purposes and are available for rental to third parties. The fair value of the investment property was determined by the estate agent responsible for the management of the company's property portfolio.
REQUIRED:
(a) Based on the information provided and as part of the formulation of your audit plan, identify the risks of material misstatement at the assertion level for the ac-count balances of property, plant and equipment. For each of the risks identified, also indicate which assertions will be affected by the risk. Do not deal with assertions regarding presentation and disclosure. (25)
(b) Describe the audit procedures that you should perform in respect of the acquisition and disposal of property, plant and equipment during the year and the valuation and allocation of property, plant and equipment for the year ended 31 August 2018 at Star Limited. (40)
You are currently preparing for the year-end audit of Supa Glass Limited (SG) for the year ended 31 August 2018. SG is listed on the JSE Securities Exchange. The audit must be completed before 15 September 2018.
SG is a new audit client to your audit firm and you have already gathered information to gain an understanding of the entity and its environment, including its system of internal control.
STRATEGIC OVERVIEW
SG is a highly focused business based on a customer-driven culture that places partnerships with customers at the core of its business. Their drive for operational excellence has enabled the delivery of lower costs, improved quality, and innovative solutions.
Strong cash flows from operations in previous years have enabled the group to comfortably fund investments to support its existing operations and build additional capacity. In the current financial year, operating profit has, however, been negatively impacted by the effect of a strong rand on selling prices of tableware which competes directly with imports. This has placed cash flow under pressure. The company has therefore decided to also sell to smaller customers from a warehouse in Kempton Park. A long-term lease agreement has been entered into for this warehouse.
Commercial container glass is made by melting silica sand, soda ash, and limestone or melting recycled glass ("cullet"). The holding bin of the furnace is filled with a batch of either raw materials or recycled glass. From the holding bin of the furnace, the raw materials are continuously fed to the furnace where these are converted to molten glass and maintained at temperatures in excess of 1,500°C. Molten glass is continuously withdrawn through a submerged throat where it flows to the refinery area of the furnace and is cooled to approximately 1,200°C, before being delivered to the individual bottle-making machines via the fore-hearths.
The molten glass then enters the feeder to the bottle-making machine, where the streams of glass are cut into pieces of predetermined weight ("gobs"), each of which is required to make a single bottle. These gobs of molten glass are then individually fed into the molds of the bottle-making machine.
The furnaces are fully computerized, and critical parameters are controlled within very close tolerance margins. SG’s furnaces are designed to be the most modern in the world with a productive lifespan of more than ten years. The lifespan of the refractory (lining) part of the furnace is only three years. The company must rebuild a furnace after the three-year lifespan of the refractory by replacing only the refractory of the furnace.
PROPERTY, PLANT AND EQUIPMENT
Accounting policy: Property, plant, and equipment
Property, plant, and equipment are carried at cost, less accumulated depreciation and impairment losses.
Depreciation is charged on a straight-line basis over the estimated useful lives of each component of an item of property, plant, and equipment. Land is not depreciated. The estimated useful life of plant and machinery is between three and ten years.
Where appropriate, and if material, expected residual values are taken into account in determining the depreciable values of assets.
Accounting policy: Investment property
Investment property is stated at fair value at the balance sheet date. Gains or losses arising from changes in the fair value of investment property are included in profit or loss for the period in which they arise.
Acquisitions
Capital expenditure of SG amounted to R416 million in the current year. The capital expenditure projects were:
Bellville number 4 furnace – refractory rebuilt at the end of its three-year useful life;
Glass recycling cullet plant in Pretoria, constructed by an established international firm;
Glass forming machines at the Wadeville plant, bought in Italy and installed by the company; and
A third furnace and production line at Clayville, constructed by an established international firm.
During the year, all glass manufacturing facilities operated at full capacity and also above the standard efficiency. In addition to the above capital projects, the Bellville number 1 furnace will be rebuilt during July 2018 in the next financial year, adding 60,000 tons of capacity. This will result in a 25% increase in the total glass capacity of SG.
Disposals
SG sold special glass-blowing equipment, used for the manufacture of lead-cut glass, to an artist from the White River vicinity. At year-end, this equipment was not yet delivered to the artist’s studio due to delays by the building contractors in the completion of his studio. The equipment had already been packaged and full payment for the equipment was received, but the artist requested the company not to deliver it. Ownership has passed to the artist in White River.
Investment property
The investment property relates to properties that are no longer needed for retail purposes and are available for rental to third parties. The fair value of the investment property was determined by the estate agent responsible for the management of the company's property portfolio.
REQUIRED:
(a) Based on the information provided and as part of the formulation of your audit plan, identify the risks of material misstatement at the assertion level for the ac-count balances of property, plant and equipment. For each of the risks identified, also indicate which assertions will be affected by the risk. Do not deal with assertions regarding presentation and disclosure. (25)
(b) Describe the audit procedures that you should perform in respect of the acquisition and disposal of property, plant and equipment during the year and the valuation and allocation of property, plant and equipment for the year ended 31 August 2018 at Star Limited. (40)
Answers
Answered by
GPT-4o mini
## QUESTION ONE (65 MARKS)
### (a) Risks of Material Misstatement at the Assertion Level for Property, Plant and Equipment
When considering property, plant, and equipment (PPE), several risks of material misstatement arise that can impact the audit assertions. Below are the identified risks and the corresponding affected assertions:
1. **Risk of Improper Capitalization of Expenses**
- **Assertion Affected**: **Valuation and Allocation**
- **Description**: Costs that should be classified as repairs and maintenance may be improperly capitalized as capital expenditures. This could lead to overstatement of PPE.
2. **Risk of Incorrect Depreciation Calculation**
- **Assertion Affected**: **Valuation and Allocation, Completeness**
- **Description**: The estimated useful life and residual value of each asset could be incorrectly determined, resulting in incorrect depreciation expense and, therefore, misstated carrying amounts of assets.
3. **Risk of Overstated Revaluations of Investment Property**
- **Assertion Affected**: **Valuation and Allocation**
- **Description**: The fair value of investment properties might be overstated if determined by an unreliable valuation method or incorrect assumptions used by the estate agent.
4. **Risk Related to Existence of Assets**
- **Assertion Affected**: **Existence**
- **Description**: There is a risk that certain capitalized assets may not exist at year-end, especially with significant capital expenditure reported.
5. **Risk of Improper Disposal Recognition**
- **Assertion Affected**: **Cut-off, Existence**
- **Description**: The sale of the special glass-blowing equipment that was not delivered but for which payment was received raises concerns about the timing of revenue recognition and whether the asset should still be recognized as PPE.
6. **Risk of Impairment**
- **Assertion Affected**: **Valuation and Allocation, Completeness**
- **Description**: There may be a risk that indicators of impairment have not been assessed appropriately for PPE, leading to assets being carried at amounts greater than their recoverable amount.
7. **Risk Related to Incomplete Capture of Acquisitions or Disposals**
- **Assertion Affected**: **Completeness, Existence**
- **Description**: There is a risk that acquisitions of property, plant and equipment or disposals may not have been properly recorded in the accounts.
---
### (b) Audit Procedures in Respect of Acquisition and Disposal of Property, Plant, and Equipment
#### Acquisition Procedures for PPE:
1. **Examine Purchase Agreements and Invoices**:
- Obtain and review contracts, invoices, and shipping documents relating to the acquisition of property, plant, and equipment. Ensure that they properly reflect the costs attributed to the asset.
2. **Test Capitalization of Expenditures**:
- Evaluate costs capitalized to ensure that they comply with the applicable accounting standards. Consider whether the costs associated with the acquisition are appropriate for capitalization (i.e., directly attributable to bringing the asset to its intended use).
3. **Verify Classification and Useful Lives**:
- Assess whether the classification of PPE is correct and if estimated useful lives and residual values are appropriate. This would involve discussions with management to understand the basis for their estimates.
4. **Inspect the Assets**:
- Physically inspect a sample of newly acquired assets to confirm their existence and condition. This ensures that they are in use and functioning as intended.
5. **Confirm Existence of External Services**:
- Where external firms were used for construction or installation (e.g., glass recycling cullet plant), obtain confirmation or audit the documentation to ensure they were engaged and that costs billed are valid.
#### Disposal Procedures for PPE:
1. **Review Disposal Documentation**:
- Obtain the sale agreements and related documentation for the special glass-blowing equipment to evaluate whether the disposal was recorded appropriately (considering revenue recognition principles).
2. **Confirm Transfer of Ownership**:
- Assess whether the ownership of the equipment has truly transferred at year-end despite non-delivery. Ensure that the transaction is classified correctly as a sale in accordance with the applicable revenue recognition standards.
3. **Check Cut-off Procedures**:
- Check the transaction dates for disposals and ensure proper cut-off procedures are followed so that disposals are reflected in the correct accounting period.
4. **Assessment of Gain/Loss on Disposal**:
- Evaluate how gains or losses on disposals are calculated and ensure they are accurately recorded in the financial statements, including assumptions about resale value or impairment.
#### Valuation and Allocation Procedures for PPE:
1. **Evaluate Valuation Methodology**:
- Assess the methodology used for determining the fair values of all relevant PPE and investment properties. Confirm that they are based on current market conditions and relevant economic indicators.
2. **Test Depreciation Calculations**:
- Review the calculations for depreciation to ensure that they’re done in accordance with the accounting policies (e.g., straight-line basis) and that they account for the determined useful life and residual value.
3. **Review Internal Controls Over PPE**:
- Test and evaluate the effectiveness of internal controls regarding the acquisition, maintenance, and disposal of PPE to ensure that they are adequate to prevent and detect misstatements.
4. **Impairment Review**:
- Review management’s assessment of any impairment indicators for PPE at year-end. Test the assumptions used in the impairment calculations and ensure any necessary impairments are recognized according to the accounting policies.
5. **Obtain Management Representations**:
- Obtain written representations from management regarding the completeness and accuracy of the recorded acquisitions and disposals for property, plant, and equipment.
These audit procedures will help identify any misstatements and ensure that the financial statements present a true and fair view of SG's property, plant, and equipment balances.
### (a) Risks of Material Misstatement at the Assertion Level for Property, Plant and Equipment
When considering property, plant, and equipment (PPE), several risks of material misstatement arise that can impact the audit assertions. Below are the identified risks and the corresponding affected assertions:
1. **Risk of Improper Capitalization of Expenses**
- **Assertion Affected**: **Valuation and Allocation**
- **Description**: Costs that should be classified as repairs and maintenance may be improperly capitalized as capital expenditures. This could lead to overstatement of PPE.
2. **Risk of Incorrect Depreciation Calculation**
- **Assertion Affected**: **Valuation and Allocation, Completeness**
- **Description**: The estimated useful life and residual value of each asset could be incorrectly determined, resulting in incorrect depreciation expense and, therefore, misstated carrying amounts of assets.
3. **Risk of Overstated Revaluations of Investment Property**
- **Assertion Affected**: **Valuation and Allocation**
- **Description**: The fair value of investment properties might be overstated if determined by an unreliable valuation method or incorrect assumptions used by the estate agent.
4. **Risk Related to Existence of Assets**
- **Assertion Affected**: **Existence**
- **Description**: There is a risk that certain capitalized assets may not exist at year-end, especially with significant capital expenditure reported.
5. **Risk of Improper Disposal Recognition**
- **Assertion Affected**: **Cut-off, Existence**
- **Description**: The sale of the special glass-blowing equipment that was not delivered but for which payment was received raises concerns about the timing of revenue recognition and whether the asset should still be recognized as PPE.
6. **Risk of Impairment**
- **Assertion Affected**: **Valuation and Allocation, Completeness**
- **Description**: There may be a risk that indicators of impairment have not been assessed appropriately for PPE, leading to assets being carried at amounts greater than their recoverable amount.
7. **Risk Related to Incomplete Capture of Acquisitions or Disposals**
- **Assertion Affected**: **Completeness, Existence**
- **Description**: There is a risk that acquisitions of property, plant and equipment or disposals may not have been properly recorded in the accounts.
---
### (b) Audit Procedures in Respect of Acquisition and Disposal of Property, Plant, and Equipment
#### Acquisition Procedures for PPE:
1. **Examine Purchase Agreements and Invoices**:
- Obtain and review contracts, invoices, and shipping documents relating to the acquisition of property, plant, and equipment. Ensure that they properly reflect the costs attributed to the asset.
2. **Test Capitalization of Expenditures**:
- Evaluate costs capitalized to ensure that they comply with the applicable accounting standards. Consider whether the costs associated with the acquisition are appropriate for capitalization (i.e., directly attributable to bringing the asset to its intended use).
3. **Verify Classification and Useful Lives**:
- Assess whether the classification of PPE is correct and if estimated useful lives and residual values are appropriate. This would involve discussions with management to understand the basis for their estimates.
4. **Inspect the Assets**:
- Physically inspect a sample of newly acquired assets to confirm their existence and condition. This ensures that they are in use and functioning as intended.
5. **Confirm Existence of External Services**:
- Where external firms were used for construction or installation (e.g., glass recycling cullet plant), obtain confirmation or audit the documentation to ensure they were engaged and that costs billed are valid.
#### Disposal Procedures for PPE:
1. **Review Disposal Documentation**:
- Obtain the sale agreements and related documentation for the special glass-blowing equipment to evaluate whether the disposal was recorded appropriately (considering revenue recognition principles).
2. **Confirm Transfer of Ownership**:
- Assess whether the ownership of the equipment has truly transferred at year-end despite non-delivery. Ensure that the transaction is classified correctly as a sale in accordance with the applicable revenue recognition standards.
3. **Check Cut-off Procedures**:
- Check the transaction dates for disposals and ensure proper cut-off procedures are followed so that disposals are reflected in the correct accounting period.
4. **Assessment of Gain/Loss on Disposal**:
- Evaluate how gains or losses on disposals are calculated and ensure they are accurately recorded in the financial statements, including assumptions about resale value or impairment.
#### Valuation and Allocation Procedures for PPE:
1. **Evaluate Valuation Methodology**:
- Assess the methodology used for determining the fair values of all relevant PPE and investment properties. Confirm that they are based on current market conditions and relevant economic indicators.
2. **Test Depreciation Calculations**:
- Review the calculations for depreciation to ensure that they’re done in accordance with the accounting policies (e.g., straight-line basis) and that they account for the determined useful life and residual value.
3. **Review Internal Controls Over PPE**:
- Test and evaluate the effectiveness of internal controls regarding the acquisition, maintenance, and disposal of PPE to ensure that they are adequate to prevent and detect misstatements.
4. **Impairment Review**:
- Review management’s assessment of any impairment indicators for PPE at year-end. Test the assumptions used in the impairment calculations and ensure any necessary impairments are recognized according to the accounting policies.
5. **Obtain Management Representations**:
- Obtain written representations from management regarding the completeness and accuracy of the recorded acquisitions and disposals for property, plant, and equipment.
These audit procedures will help identify any misstatements and ensure that the financial statements present a true and fair view of SG's property, plant, and equipment balances.
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