QUESTION ONE

Modern Furniture Ltd., a furniture manufacturer which is an audit client of your firm has decided to acquire 21^st century Furniture Ltd. A company is the same business.

As audit partner in charge of Modern Furniture Ltd., you have been asked to carry out brie review of 21^st Century Furniture Ltd.’s operations with particular emphasis on its accounting practices, its current trading performance and future prospects. Mr. Fred Ransley, the managing director of Modern Furniture ltd. Believes 21^st Century Furniture ltd. Has a sound and expanding business which offers attractive prospects to Modern Furniture Ltd. The managing director of 21^st century Furniture Ltd. Is Miss Claire Smith. From your inquiries, you discover the following:

1. About 10% of 21^st Century Furniture Ltd.’s sales are to Deedee ltd. Two members of the board of directors of 21^st Century Furniture Ltd. Hold a minority interest in Deedee Ltd. Prices arranged between 21^st Century Furniture ltd. And Deedee Ltd. Appear to be at arm’s length basis.
2. The current year’s results reflect an exceptional profit of Sh.8,480,000 form the sales of a property which had been carried in the books at historical cost.
3. Management accounts for the first six months of the current year have been used to support an application to the bank manager for additional loan facility.

This facility has been requested to enable replacement of directors’ motor vehicles and to build a new staff canteen and washroom facilities insisted upon by the unions. The accounts submitted to the bank contain stock and debtor balances which exceed the figures in the books of accounts by Sh.21,200,000. This ‘difference’ has also been added to reported profit. After careful enquiry, you established that the board agreed to these revisions in order to assist with their loan application. A down run in trading necessitated the revisions in order to demonstrate to the bank that 21^st Century Furniture Ltd. was on budget for the year. Miss Claire Smith tells you that she is very confident of a recovery in demand for the company’s products which will enable results to exceed budget.

4. No provision for sales returns is made ion the company’s accounts. No reliable information is readily available as to the volume of returns as a proportion of sales and the extent of repair work needed to rectify the faults. Miss Claire Smith informs you that from past experience the impact of sales returns is not material to the financial results of 21^st Century Furniture Ltd.

No other matters of significance arise from your review. You are provided with a budget forecast for 21^st Century Furniture Ltd. For the current year and for the following year to append to your report. These reflects arising profit trend.

Required

From your brief review as specified by your client, draft a report to the board of Modern Furniture Ltd. Containing your findings, conclusions and recommendations.

(25 marks)

QUESTION TWO

You are the auditor of TNP Group and its subsidiaries. TNP Group Limited, a company quoted on the Nairobi Stock Exchange is the holding company of a group of companies involved in various specialized activities connected with the printing industry. Your audit of the accounts for the year ended 30 September 1997 disclosed the following:

1. A freehold property occupied and owned by the group was sold during the year and leased back on a long lease. The proceeds from the sale and rents payable under the lease are both well in excess of open market. The proceeds of the sale and lease back transactions have been used as a basis for capitalizing the property in the accounts and for determining the finance lease obligation which is to be incorporated in the balance sheet.

2. The holding company has given guarantees on bank borrowings by subsidiaries which are noted in the accounts. However, there is no provision in the holding company’s accounts for one subsidiary which is insolvent and dependent upon increasing support from the bank.

3. Unlisted investments include a trade investment in a significant supplier stated at original cost. The investment represents 12½% of the equity of the supplier concerned and no dividend have been paid for many years. The supplier may be seeking permission for its shares to be listed in the Nairobi Stock Exchange and there is speculation that the market value may be greatly in excess of the original cost.

Required

(a) Comment on the treatment of the items detailed above (9 marks)

(b) Suggest possible alternative treatments which you consider could be adopted

in order for the accounts to show a true and fair view. (9 marks)

(Total: 18 marks)

QUESTION THREE

You are the auditor of Motor Vehicle Parts Ltd., an engineering company producing components for the motor car industry. Following your discussions with the fiancé director, it appears that the company may have a liquidity problem.

Required

Describe the factors which, by themselves, or taken together, could indicate that the going concern concept of the company may be brought into question.

(18marks)

QUESTION FOUR

In carrying out an audit, the independent auditor must consider the reliability of audit evidence. Among other things, the auditor is required to pay attention to reliability of evidence from third partied and specialists. The audit procedures must ensure that the auditor is able to verify and ascertain the reasons for material differences between balances stated in the books of the cline and those available from external sources.

Required

(a) Give a concise definition of:

(i) Audit evidence (2 marks)

(ii) Third party (2 marks)

(iii) Specialist evidence (2 marks)

(b) Detail the procedures you would follow in verifying material differences, stated in

the above preamble, with regard to:

(i) Matters confirmed in the letter, the auditor received direct from the bank (4 Marks)

(ii) The replies to a debtors’ circularization (4 Marks)

(iii) Valuation of the company’s properties by a valuer. The valuation is to be

Incorporated in the company’s accounts (4 Marks)

(c) Consider the reliability of statements made by the directors in the letter of

representation (4 Marks)

(Total: 22 marks)

QUESTION FIVE

Information revolution using computers in the banking sector has meant simplifying the processes of:

1. Transfer of funds

2. Payment of cheques at cash counters by the cashier without referral to their seniors

withdrawal and banking of funds using Automatic Teller Machines

Required

With reference to a full computerized banking system, explain for each of the three areas specified above, the controls the auditor would expect to find in place to ensure that the risk of errors and fraud is minimized.

(17 marks)