QUESTION $2$

$45$ marks

You are an auditor on the audit of Generation$-$Z Limited $($GZ$).$ GZ is the manufacturer, distributor, and seller of youth clothing. The factory

and administrative building of GZ are based in Cape Town, and GZ has over $100$ stores across the country.

The management team of GZ places a lot of emphasis on financial management, and management accounts are prepared on a monthly

basis. These management accounts also form the basis for your analytical review procedures for planning purposes of the audit.

FINANCIAL INFORMATION

Your audit team is currently performing the system work of the audit. The audit senior extracted the following information from the

management accounts for the year ended $31$ December $2018$ and performed analytical procedures thereon:

Sales

$30/11/2018(11$ MONTHS$)31/12/2018(12$ MONTHS$)$

The audit senior has discussed the above findings with the financial and production directors, after which he was informed that the

directors are worried about the decline in the gross profit percentage. This was a major concern since there were no changes in the

gross profit mark$-$up percentage.

SYSTEM WORK

One of the trainee accountants on the audit team has done a system description. Some of the strong points of the system as evident

from the description, are the following:

Sales

Immediately after receipt of an order from a client, a numerical internal sales order form is prepared. The sales manager inspects

the numerical sequence of the processed internal sales orders on a regular basis.

The credit controller inspects on a continuous basis the creditworthiness of clients and signs the internal sales order form as evidence

of the client's creditworthiness.

Expenses

The cheque signatories are responsible for agreeing the cheque amount with the order, goods receipt note and suppliers invoice. When

signing the cheque the abovementioned persons cancel the documents by signing the document.

The management accountant is responsible for ensuring that all purchases on which a "settlement discount" is claimable,

are paid timeously, to qualify for the maximum benefits. He then stamps the invoice "pay immediately" as evidence of the payment

thereof.

Fixed assets

The factory manager performs a physical verification of fixed assets per the fixed asset register on an annual basis with the objective

of assessing whether the useful life and carrying amounts are still appropriate. If this is not the case, he then reports this to the

financial manager who processes the necessary adjustments.

FIXED ASSETS

Fixed assets include a significant amount for delivery vehicles, which are used for delivery of goods to shops. As the company has only limited

cash resources, all fixed assets are leased from a finance house. The period of the lease contracts ranges between four and seven years and

the ownership of the vehicles will pass to New Age Limited at the end of the term. It is the policy of the company to capitalise all vehicles

leased.

During the year, two new contracts were entered into for vehicles, while one contract has expired.

REQUIRED:

$($a$)$ List the controls in the system of Generation$-$Z Limited which are of external audit importance $($key controls$)$ and formulate tests of

controls you would perform to test whether the identified key controls function effectively. $(15$ marks$)$

$($b$)$ Discuss, with motivation, whether Generation$-$Z Limited is correct in its accounting treatment to capitalise leased vehicles. $(5$ marks$)$

$($c$)$ Formulate the audit procedures you would perform to obtain sufficient appropriate audit evidence over the vehicles held as

finance lease liabilities. $(25$ marks$)$