ITC JANUARY 2022 SOLUTION PAPER 2 QUESTION 1 11 © SAICA 2022

Part (e) Discuss, with reference to ethical considerations, whether or not Lebogang should advise RainbowT to accept assistance from MSM.  Do not discuss any aspect of the SAICA and IRBA codes of professional conduct.

answer

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Shorter Version of the Dumbed-Down Version

An accountant named Lebogang must decide if his client, RainbowT, should take a loan from a bank with a corrupt CEO.

He should advise the client not to take the deal because:

• He has a conflict of interest as he would get paid a lot from the deal.

• It would cause reputational damage to his client and himself.

• His professional and ethical duty is to act with integrity and protect his client's best interests, not his own gain.

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Dumbed-Down Version

This part is about a professional accountant named Lebogang who has a tricky choice. His client, RainbowT, needs money, and a bank called MSM Bank has an offer. The problem is, the bank's CEO is rumored to be corrupt. Lebogang's own company could get paid a lot of money if the deal goes through.

So, what should Lebogang do? The answer is simple: He should tell his client not to take the deal.

Here's why:

• Conflict of Interest: Lebogang stands to make a lot of money from the deal. This might make him less objective and tempt him to give bad advice just for the cash. A professional should always put their client's interests first, not their own.

• Bad Reputation: If RainbowT accepts the deal and it turns out the bank is corrupt, it will make both RainbowT and Lebogang look bad. People might think they are involved in shady business. Lebogang has a duty to protect his reputation and that of his profession.

• The Right Thing to Do: As an accountant, Lebogang has a moral duty to act with integrity. He must follow a strong code of conduct that says he shouldn't get involved in things that look like bribery or corruption.

The solution also mentions the idea of "Ubuntu," which means "I am because we are." This suggests Lebogang should think about the whole group, not just himself. If his client fails because of his advice, it will also hurt him.

In the end, Lebogang should explain all these risks to his client and advise them to walk away from the deal. The money isn't worth the risk to their reputation and integrity. 

Explanation of the Solution

Part (e) of the solution focuses on the ethical considerations for Lebogang, a professional accountant, regarding a potential business deal between his client, RainbowT, and a third party, MSM Bank. The core of the analysis is whether Lebogang should advise RainbowT to accept the offer from MSM, considering the ethical and reputational risks involved.

The solution highlights several key ethical principles and professional responsibilities that Lebogang must consider, as outlined in the SAICA and IRBA codes of professional conduct.

1. Conflict of Interest and Professional Judgment:

• Commission-based Fee: Lebogang's firm, TT Consultants, is set to receive a commission based on the financing amount, which creates a potential conflict of interest. This financial incentive might push Lebogang to recommend more financing than RainbowT actually needs, compromising his objectivity.

• Serving the Client's Best Interests: As a partner, Lebogang has a legal and professional duty to act in good faith and in the best interests of his client, RainbowT. The solution emphasizes that the potential referral fee should not cloud his judgment.

2. Reputational and Ethical Risks:

• Association with a Corrupt Entity: The CEO of MSM Bank is allegedly involved in corrupt practices. By advising RainbowT to partner with MSM, Lebogang would be implicitly associating his firm and his client with a potentially unethical and illegal entity. This could cause reputational damage to all parties involved, including Lebogang and his professional body (SAICA). The solution mentions the negative perception of corruption, particularly regarding public interest, and Lebogang's duty to uphold the integrity of the profession.

• Tarnishing the Profession: The solution makes a strong point that Lebogang's actions reflect on the entire accounting profession. Getting involved in a deal with a bank accused of bribery would tarnish the profession's reputation.

3. Application of Ethical Frameworks:

• Virtue Ethics: The solution recommends that Lebogang apply the principles of virtue ethics, which focuses on a person's character. As a CA(SA), he has a professional duty to uphold a high standard of ethics. His virtues should guide him to avoid situations that could compromise his integrity.

• King Principles: While RainbowT is a small company and not required to apply the King principles of corporate governance, Lebogang should still consider the ethical leadership principles they advocate for.

4. The "Ubuntu" Principle:

The solution uniquely brings in the African philosophy of "Ubuntu," which translates to "I am because we are." This principle suggests that Lebogang should prioritize the well-being of all parties involved, not just his own business. If RainbowT fails due to the agreement, it will also reflect poorly on Lebogang, who advised them. This emphasizes a collective responsibility.

Conclusion:

The final conclusion is clear: Lebogang should not advise RainbowT to accept the offer from MSM Bank. Instead, he should discuss the offer with his client but clearly explain the significant risks involved, including the potential for reputational damage and the ethical implications. He must prioritize his professional duty and the long-term well-being of his client and the profession over any short-term financial gain from the referral fee.

ITC JANUARY 2022 SOLUTION PAPER 2 QUESTION 1

Part (d) In order to assist Tshepo with the working capital analysis – (ii) comment on the outcomes of the analysis.  Round all workings and final answers to the nearest whole number.  Use year-end (and not average) balances in the calculation of any supporting amounts or ratios.  Use 365 days per year when calculating relevant ratios.

answer

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Shorter Version of the Dumbed-Down Version

The company's finances are in trouble because it's running out of cash. This is happening because:

• Customers are paying their bills too slowly.

• The company is paying its own suppliers too quickly.

• Profit margins are shrinking, making it harder to cover costs.

  These issues have led to the company's bank account going from positive to a negative overdraft.

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Dumbed-Down Version

An auditor is looking at a company's money situation, especially how it handles its daily operations. The company, RainbowT, is in trouble because it's running out of cash.

Here's why:

• Customers aren't paying quickly. RainbowT tried to get more sales by letting customers buy things on credit, but now those customers are taking a long time to pay them back. This means RainbowT's cash is stuck in customer debts.

• Inventory is piling up. Even though sales are down, the amount of stuff in the warehouse hasn't gone down. This means money is also stuck in unsold products.

• They're paying bills too fast. While customers are taking their time to pay, RainbowT is paying its own suppliers faster than before. This is like a person with no money who gives away what little they have.

• Profit is shrinking. The profit made on each item sold has dropped. This makes it harder for the company to cover its everyday costs.

• The bank account is empty. All these problems have caused the bank balance to go from a positive amount to an empty account with an overdraft (a negative balance).

In short, the company is struggling with its cash flow because it's giving out money faster than it's bringing it in.

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Explanation of the Solution

Part (d) of the solution provides a detailed analysis of a company's working capital position, focusing on the period affected by lockdowns. Working capital is the difference between current assets (what a company owns that can be turned into cash within a year) and current liabilities (what it owes within a year). The analysis highlights significant issues in three key areas: debtors (accounts receivable), inventory, and creditors (accounts payable).

1. Deterioration of Debtors' Management and Liquidity:

The most critical issue identified is the company's deteriorating liquidity, primarily due to poor debtor management.

• Increased Credit Sales: Despite a drop in total sales, credit sales increased. This suggests the company offered more lenient credit terms to customers to boost sales, a risky strategy that resulted in cash flow problems.

• Worsening Cash Conversion Cycle: Customers are taking much longer to pay their debts, as indicated by the drastic increase in debtors' days in FY2020. This ties up the company's cash and makes it difficult to pay its own bills. The solution suggests investigating whether this is due to increased sales volume or customers struggling financially.

• Ineffective Discounts: The company's offer of discounts for early payment is not working, as customers are not using them. This further indicates that customers may be facing their own financial difficulties.

• Inadequate Credit Controls: The analysis points out a need for stricter credit screening procedures and better debt collection processes.

2. Inventory and Gross Profit Issues:

• Inventory Levels: Inventory days remained constant, which, given the decline in sales, points to a build-up of stock. This could be due to reduced customer spending.

• Declining Gross Profit: The gross profit margin dropped significantly. While this is common during economic downturns (as prices are reduced to move products), the new, lower margin may be insufficient to cover the company's operating costs, which is a major concern.

3. Creditor and Overall Financial Strain:

• Accelerated Creditor Payments: The company is paying its suppliers faster, as accounts payable days have decreased. This, combined with the slow collection from debtors, puts further strain on cash flow.

• Deteriorating Ratios: The current and quick ratios, which measure a company's ability to meet short-term debts, have worsened. This, along with the bank balance turning from positive to a negative overdraft, is a clear sign of a liquidity crisis.

In conclusion, the solution indicates that the company, RainbowT, is facing serious financial challenges. The core problem is the significant mismatch between its slow cash inflows (from debtors) and its accelerating cash outflows (to creditors), a situation likely made worse by a relaxed credit policy in a difficult economic environment.