QUESTION 1
You are an audit trainee on the audit of EZ-Appliances Holdings Ltd ('EZA'). Your firm was appointed as auditors on 31 March 2010 at the annual general meeting for the 2009 financial year. The financial year of the group ends on 30 September and the audit report for the year ended 30 September 2010 should be issued no later than 15 February 2011. All planning and field work on the EZA audit have been completed except for the audit procedures related to investments. You have been requested by the audit senior to audit investments and the following working papers, information and documentation have been provided to you to assist you:
A - 2 Extracts from 'Understanding the entity and its environment'
A - 3 Audit materiality
B - 1 Media release - Financial Services Board places Investa under curatorship
C - 1 Extracts from the curator's report - Report to the High Court of South Africa
D - 1 Letter from Fortune Ltd's chief financial officer to the curator of Investa
E - 1 Calculation of impairment losses of investments by EZA's financial director
2
Entity name: EZA
Prepared by: C Lerk
Year end: 30/09/10
A-2
Reviewed by: S Enior
Date: 06/04/10
Extracts from 'Understanding the entity and its environment'
Nature of the entity
EZA is the holding company of a group of companies that sells and repairs appliances. It has three wholly owned subsidiaries:
• A low cost appliances business;
• An appliances maintenance business; and
• A top of the range appliances business.
For the year ended 30 September 2009 the group reported R100 million profit after tax. This was mainly attributable to an increase in revenue in the appliances maintenance business. During September 2009, the Audit and Risk Committee recommended to the board that R50 million should be invested through a fund manager in anticipation of future growth. Shortly thereafter EZA appointed Investa (Pty) Ltd ('Investa'), a fund manager, to invest the funds on behalf of EZA. All investments are made in the name of EZA. On 1 October 2009, R50 million was invested through Investa. EZA will account for the underlying investments individually, and not as a portfolio. EZA has no other investments.
To establish a balance between risk and growth in investments EZA gave Investa a specific mandate to invest in a range of instruments ranging from low to high risk instruments. The board, on recommendation of the Audit and Risk Committee, was very specific in stating that Investa may only invest in bonds, the money market and listed equity shares.
Entity name: EZA
Prepared by: C Lerk
Year end: 30/09/10
A-3
Reviewed by: S Enior
Date: 09/04/10
Audit materiality
Audit materiality
The planning and final materiality figures were set at R3 million.
3
Entity name: EZA
Prepared by: C Lerk
Year end: 30/09/10
B-1
Reviewed by: S Enior
Date: 08/10/10
Extract from media release
MEDIA RELEASE
Monday 13 September 2010
Financial Services Board places Investa under curatorship
The High Court of South Africa has appointed Attorney Jake Tick as curator of Investa (Pty) Ltd. The application by the Financial Services Board (FSB) to place this asset management company under curatorship was granted by the Cape High Court on Wednesday last week.
Investa was an authorised financial services provider in terms of the Financial Advisory and Intermediary Services (FAIS) Act, 2002, to provide certain specified services. However, on 1 September 2010 the Independent Regulatory Board for Auditors (IRBA) alerted the FSB to a number of irregularities in the company's dealings, after the auditors of Investa reported a reportable irregularity to the IRBA.
An investigation by the FSB showed that the company had invested client funds outside the terms of its licence and beyond the scope of the mandates received from clients.
The FSB consequently lodged an urgent application in terms of section 5 of the Financial Institutions (Protection of Funds) Act, 2001, for the appointment of a curator to the business of Investa. The purpose of the curatorship is to realise investors' investments as soon as possible with the minimum amount of loss to the investors.
4
Entity name: EZA
Prepared by: C Lerk
Year end: 30/09/10
C-1
Reviewed by: S Enior
Date: 04/01/11
Extracts from curator's report
EXTRACTS FROM THE CURATOR'S REPORT
REPORT TO THE HIGH COURT OF SOUTH AFRICA CASE NO.: 2875/10
INVESTA (PTY) LTD (UNDER CURATORSHIP)
REPORT OF THE CURATOR 15 December 2010
I, Jake Tick, appointed as curator to the abovementioned company under the abovementioned case number by the above Honourable Court, do hereby report as follows:
The following information relates to the cost (on investment date) of the instruments in which Investa (Pty) Ltd invested on behalf of clients, as well as the latest information available for these instruments:
Investments invested in on behalf of EZ-Appliances Holdings Ltd:
Instrument
Cost of the instrument
Notes
R
Johannesburg Securities Exchange listed shares
• AB Ltd (110 000 shares)
• CD Ltd (30 000 shares)
10 936 000
3 592 000
1
Property investment company
19 000 000
2
Money market
2 000 000
3
Bonds in Fortune Ltd
14 472 000
4
Total
50 000 000
Notes
1 The market value on 10 December 2010, before taking 2% transaction costs into account, was: AB Ltd: R105 per share and CD Ltd: R115 per share.
2 EZA has a 15% interest in an unlisted property investment company, which is currently developing a shopping mall in Pretoria. The property investment company has no other assets and is debt free. The mall is expected to be completed on 30 September 2012. On this date the property will be sold and the property investment company will be liquidated. The appointed valuator has indicated that she expects the property to realise R119 million when sold. She also stated that the fair return on similar investments is 10% per annum. The property currently generates no rental income. The valuator's report is available on request.
5
3 The balance as at 30 September 2010 was R2 200 000, confirmed telephonically with the financial institution.
4 At acquisition the bonds had a nominal value of R15 million. The cost price of the bonds was R14 400 000 and transaction costs of 0,5% were incurred. The coupon rate was 6% per annum and interest was payable on 30 September each year in arrears. The bonds were bought at a discount on 1 October 2009 because the coupon rate of 6% was slightly less than the fair market rate. These bonds were redeemable at par on 30 September 2014. Also see the attached letter (D-1) from Fortune Ltd for the latest information regarding these bonds.
6
Entity name: EZA
Prepared by: C Lerk
Year end: 30/09/10
D-1
Reviewed by: S Enior
Date: 04/01/11
Letter from Fortune Ltd
FORTUNE LTD
15 October 2010
Dear Curator, Jake Tick
RE: INTEREST PAYMENT NOT RECEIVED ON 30 SEPTEMBER 2010
Due to the economic crisis and cash flow problems experienced during the last few months Fortune Ltd has been forced to take action. We are proposing to our bond holders to revise the terms of the bonds. The revised terms have been discussed with the majority of the bond holders who have indicated their support in principle.
The proposed arrangement has the following impact on the five year bonds of Investa (Pty) Ltd (held on behalf of EZ-Appliances Holdings Ltd):
• The interest coupon of R900 000 that was due on 30 September 2010 will only be payable on 30 September 2011 (together with the other interest coupon due on 30 September 2011);
• From 1 October 2010 the coupon rate has been reduced to 3% per annum, payable at the end of each year (30 September) until the revised expiry date;
• The redemption date of the bonds has been postponed until 30 September 2019; and
• The bonds will be redeemable at a discount of 10% on the nominal value.
We will circulate the appropriate documentation to approve and implement this proposal in due course.
We trust that you will understand our current crisis. Please do not hesitate to contact us should you need any further information.
Mr J P Sadley
Chief Financial Officer
Fortune Ltd
7
Entity name: EZA
Prepared by: C Lerk
Year end: 30/09/10
E-1
Reviewed by: S Enior
Date: 04/01/11
Calculation of impairment losses of investments
EZ-APPLIANCES HOLDINGS LTD
Calculation of impairment losses of investments
as at 30 September 2010
(Prepared by Mr A Count (financial director))
Instrument
Carrying amount before impairments
Current value
Difference
Notes
R
R
R
Johannesburg Securities Exchange listed shares
• AB Ltd (110 000 shares)
• CD Ltd (30 000 shares)
9 350 000
3 300 000
11 319 000
3 381 000
1 969 000
81 000
1
Unlisted property investment company
19 000 000
17 850 000
(1 150 000)
2
Money market
2 200 000
2 200 000
-
3
Bonds in Fortune Ltd
14 472 000
13 717 494
(754 506)
4
Total
48 322 000
48 467 494
145 494
5
Notes
1 All listed shares are classified at fair value through profit or loss. The carrying amounts are the market values at 30 September 2010. The current values are the market values at 10 December 2010.
2 This investment is classified as available-for-sale. The current value was determined on the basis of the valuator's report referred to in the curator's report dated 15 December 2010.
3 The funds in money market are available on demand, with no penalty clauses.
4 EZ-Appliances Holdings Ltd classified the investment in the bonds as held-to-maturity. The carrying amount is the cost of the bonds (including transaction costs). Please refer to the letter from Fortune Ltd (D-1) dated 15 October 2010 received by the curator. The current value was determined by discounting all future cash flows over the revised remaining term at 3%, as indicated in the letter from Fortune Ltd.
5 The R145 494 impairment calculated above has been recorded in the profit or loss of EZA.
All the above investments have been measured at their 'current value' as per the table above in the financial statements for the year ended 30 September 2010.