QUESTION $2$

$(40$ MARKS$)$

You are the senior partner in an audit firm. Your audit firm has recently been appointed as the auditors of Free Style SA Limited "Free Style SA$",$ a recently listed company on the JSE Securities Exchange. The year$-$end of Free Style SA is $31$ January $2011.$ Upon discussions with management, you discover that the previous auditor resigned as a result of a disagreement with management.

The company specialises in organising diving excursions to popular dive sites off the coast of South Africa as well as Mozambique. The company caters for both South African and overseas customers. Free Style SA accepts foreign currency from overseas customers, and although it is not widely publicised, prefers to receive cash, rather than credit card payments or electronic transfers. The head office of the company is situated in Durban, and it has branches situated in Sodwana, East London and Hermanus.

The company is doing extremely well, and has recently shown a steady increase in turnover. Due to the recent growth in the company, the previous manual accounting system became inadequate for the company, and it was decided during the year ended $31$ January $2011,$ to change over to a computerised system. The computerised accounting package is an "off the shelf package". None of the staff were familiar with the package, so it was decided to employ an IT manager to oversee the processing of the accounting records, as well as monitoring the integrity of the system. The

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newly appointed IT manager's previous job, was as a skipper of a ferry that was used to transport tourists to and from Robben Island.

The growth in turnover in previous years is mainly due to the fact that the company has implemented a new bonus system for the management staff of the company. The bonus system states that if turnover exceeds budgeted turnover by more than $10\%,$ a percentage of the excess turnover will be paid out to management. Management is extremely excited about this incentive.

Free Style SA suffered a substantial loss in the previous year as a result of a legal claim against the company. One of the activities of the company up until last year, was extreme shark$-$cage diving. The skippers of the boats were enticing sharks to venture closer to the boats, by "chumming" the water $($throwing fish scraps into the water$).$ The sharks began to lose their fear of boats, and began harassing other vessels, specifically the smaller vessels that took foreign tourists to view the local penguin and seal populations. After a number of attempts by the local police to put a stop to these practices, the company was eventually taken to court where they lost their case and were forced to pay damages.

The date the audit report is required is set for the $7$ March $2011$

REQUIRED:

a$)$ Describe the factors you as auditor should have considered and the procedures you should have performed prior to acceptance as auditor of Free Style SA Ltd$.$

b$)$ A good system of internal control consists of $5$ main components. List the $5$ components and briefly describe each of the components.

c$)$ Audit risk consists of $3$ types of risks, detection risk being one of them. Name and define the other $2$ risks, and discuss their effect on detection risk.

d$)$ Differentiate between the audit strategy and the audit plan and their components.

e$)$ State whether the risk of material misstatement at financial statement level should be assessed as low, medium or high. Give reasons for your decision.