QUESTION
Your firm has recently accepted the appointment as external auditor of BM On-Line Proprietary Limited ('BMO'), a subsidiary of Media Supreme Limited ('MSL'). MSL is a large listed group of companies involved in the media industry in South Africa. BMO was founded two years ago to explore opportunities in the cell phone and music download market. MSL funded the initial establishment of BMO in return for a 50% shareholding but has since purchased the remaining 50% from the founders.
The MSL group has a strong visionary management team, led by Mr Solomon Mthetu. The group ensures that its activities are compliant with applicable laws and regulations. Management is dedicated to the growth and development of the company and has a positive attitude towards a sound control environment. Bonuses for executive directors and senior management throughout the group are based on performance and profitability.
You have been assigned as the first-year trainee responsible for the 2012 audit of BMO. The group's financial year end is 29 February 2012. Materiality for the 2012 audit of BMO is R800 000. At an audit planning meeting it was agreed that the overall audit strategy and audit approach for the 2012 audit of the group would be controls based, with the focus on testing the operating effectiveness of key controls where possible. The following extracts from the 2012 audit working papers relating to BMO are attached:
Working paper
reference Document
B100 Understanding the entity and its environment
S104 System for music downloads
AR104 Notes concerning accounts receivable circularisation
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UNDERSTANDING THE ENTITY AND ITS ENVIRONMENT B100
BMO Prepared by: T Rainee Date: 15/12/11
Year ending 29 February 2012 Reviewed by: P Artner Date: 20/12/11
Nature of the business
BMO offers on-line music download facilities (only to South African customers) which enable customers to purchase their favourite music.
BMO sells music from well-known local and overseas artists through the Internet and by means of SMS downloads. BMO has licensing agreements with local and international record companies, which provide for royalties to be paid to the record companies for music downloads.
In line with BMO's objective of reaching all South Africans, payment methods include on-line purchases using credit cards, charges against cell phone airtime and an on-line prepaid system similar to prepaid phone vouchers.
With thousands of transactions taking place daily, BMO is dependent on reliable information technology (IT) systems.
Directors and governance
BMO has five directors, namely the two entrepreneurs who founded the company and three nominees appointed by MSL. The business is managed by the two founders while the three
MSL appointees attend monthly board meetings in a non-executive capacity.
BMO complies fully with MSL's governance policies and procedures.
The industry
The industry is characterised by a high level of competition amongst major players in the market, which are mainly the record companies and various international music download operators.
There is no specific regulatory body for the recording industry except for an association (not a regulatory body) which represents all major record companies. There are also various bodies responsible for protection of intellectual property rights pertaining to the South African music industry.
BMO ensures that all significant contracts are drawn up by the legal division of MSL, which oversees compliance with laws and regulations.
MSL is committed to ensuring general awareness amongst staff towards compliance and BMO follows MSL's policies and procedures in this regard.
Accounting policies
The company's accounting policies conform to International Financial Reporting Standards. Outsourcing arrangements
The company outsources all IT general and application software services to Network
Applications. This involves the maintenance and operation of the company's systems which
run on a server located at the head office in Parktown.
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SYSTEM FOR MUSIC DOWNLOADS S104
BMO Prepared by: T Rainee Date: 15/12/11
Year ending 29 February 2012 Reviewed by: P Artner Date: 20/12/11
The system for music downloads is as follows:
All transactions are denominated in South African rand.
On-line downloads using credit cards
· A customer accesses BMO's music website using a computer or appropriately enabled handheld device.
· The customer is then able to browse through BMO's music catalogues and select tracks.
· Selected tracks are put into an on-line 'shopping basket'.
· After completing the selection of tracks, the customer enters BMO's secure payment website and enters his or her credit card details.
· Once the customer has entered all details, the payment website collects payment from the credit card company.
· The music website then enables the download of the purchased tracks. Cell phone downloads
· A customer who has an appropriately enabled cell phone is able to download an application which facilitates browsing through the music catalogues and selecting tracks for download.
· Customers send an SMS of the music they would like to purchase by artist's name and song title to a five-digit BMO number, which is freely available and is advertised regularly in newspapers and on television.
· The customer will then receive an SMS with the artist's name, title of the song and the airtime required for the download.
· Once the customer has sent an SMS approving the purchase, the track(s) is downloaded to the customer's phone.
· Where a customer has a monthly contract with a cell phone service provider, BMO's IT system interfaces with the relevant cell phone network to enable the purchase. BMO then submits monthly statements to the various cellular service providers detailing airtime used by customers for music downloads. The cellular service providers then invoice the customer for the purchases, and pay BMO the total value of the airtime downloaded for the month, less a 20% administration fee.
· In the case of post-paid (contract) customers, the IT system interfaces with the various cell phone networks to determine if the customers have sufficient credit available with regard to their predetermined monthly credit limits to pay for the downloads.
· Where a customer is using a pay-as-you-go contract for downloads, the BMO IT system interfaces with the relevant cell phone network to deduct the required airtime from the customer's prepaid airtime.
· BMO has service level agreements with the various cellular service providers. The cellular service providers pay BMO the total value of the airtime downloaded for the month, less the 20% administration fee, on a monthly basis.
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SYSTEM FOR MUSIC DOWNLOADS (cont.) S104
BMO Prepared by: T Rainee Date: 15/12/11
Year ending 29 February 2012 Reviewed by: P Artner Date: 20/12/11
Prepaid system
· BMO's banking details are available on the music website and a customer who wishes to pay a prepaid amount may do so through an electronic funds transfer.
· The customer then faxes or e-mails the proof of payment to BMO and, on receipt of the payment, an accounts clerk records the payment as a credit to the customer's prepaid account.
· The accounting system for recording prepaid amounts has appropriate controls in place.
· When these customers want to download music, they follow the process as described under on-line downloads using credit cards. However, after completing the selection of tracks, the customer clicks on an icon entitled 'Use my prepaid balance', logs in with a password and the system then debits the charge to the customer's prepaid account.
· The music website next enables the download of the tracks purchased.
Cellphone service providers
Because of the wide scale of MSL's operations, several of the cell phone service providers are companies within the MSL group.
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NOTES CONCERNING ACCOUNTS RECEIVABLE CIRCULARISATION AR104
BMO Prepared by: T Rainee Date: 20/01/12
Year ending 29 February 2012 Reviewed by: P Artner Date: 22/01/12
The following queries resulting from our circularisation of accounts receivable at
31 December 2011 were noted:
Cell-Bee
'You have requested us to confirm a balance of R1 682 344 outstanding per your client's accounts receivable system. The balance per our system is R844 981. Regrettably, we are not able to provide any further details with regard to this discrepancy as our system does not provide a comparison between our records and your client's records. Our system simply processes transactions recorded on our system and the balance outstanding reflects the total of individual outstanding transactions.'
Verging Cellular
'We are not able to confirm the balance of R956 811 reflected in your letter. We are, however, able to advise that our system reflects a balance of R455 890 at
31 December 2011.'
TMM, Eitsa and Crashua Cellular
Despite second requests and further attempts to contact the following debtors, these debtors have not responded to our requests for confirmation of their balances outstanding:
TMM R428 789
Eitsa R678 633
Crashua Cellular R590 234