FOUNDATIONS IN ACCOUNTANCY

FAU

FOUNDATIONS IN AUDIT

COURSE EXAMINATION 2

FOR EXAMS FROM SEPTEMBER 2019

SUGGESTED SOLUTIONS, MARKING SCHEME

AND COMMENTARY
 FOUNDATIONS IN ACCOUNTANCY

FAU

FOUNDATIONS IN AUDIT

COURSE EXAMINATION 2

COMMENTARY

TUTOR GUIDANCE ON IMPROVING PERFORMANCE ON THE EXAM PAPER

The questions are of exam standard and represent a good test of your knowledge. It is quite a
challenging exam with some questions covering a range of points. You need to carefully target
what you write to the marks awarded for each point. Don’t overrun your time by spending too
long on the smaller elements of the questions.

As you will see from the marking schemes and suggested solutions the key to scoring well in this
paper is to explain your points. You need to write a few lines about each point you make. The
suggested solutions here will probably be a bit longer than you would be expected to produce
under exam conditions, as they attempt to cover a variety of points that you could have included.
Review the suggested solutions as a learning exercise.

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MULTIPLE CHOICE ANSWERS

1 C
2 D
3 C
4 A
5 B
6 C
7 D
8 A
9 C
10 A

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1 LEONARD VINCI

Marking guide
Marks
(a) (i) Statement that the primary objective of an audit is for the
auditors to report to members on the company's financial 1
statements.
Expressing an opinion on whether the financial statements
give a true and fair view of the company at the balance sheet 1
date and of the profit and loss for the period under review.
(ii) Outline of how the shareholders and directors of Jar Limited
should benefit from an audit.
Generally 1 mark per point up to a maximum of 6
(b) (i) Explanation of why auditors do not normally check every
transaction reflected in a company's financial statements.
Generally 1 mark per point up to a maximum of 4
(ii) Explanation of the terms 'assurance required' and 'tolerable
error'.
Generally 1 mark per point in respect of each term up to a 3
maximum of (2 × 2)
15
*Note up to 2 additional marks available for style and presentation
of letter, within maximum mark of 15

SUGGESTED SOLUTION
1 The Street
Town
T1 1TT
Mr L Vinci
Jar Limited
2 High Road
Town
T1 2TT
1/XX/X0
Dear Mr Vinci
Audit of a limited liability company
Thank you for your letter containing several questions about the audit of a limited liability
company. I shall attempt to address your queries here.
(a) Objectives and benefits
(i) Objective
The principal objective of an audit of a limited liability company is for auditors to
express an opinion to the shareholders of the company whether the financial
statements prepared by the directors give a true and fair view of the company's
affairs at the date of the balance sheet and of the results for the period up to that
date.
This will include the auditors commenting on whether the financial statements have
been properly prepared according to the reporting framework, which includes the
law and also requirements of accounting standards.
(ii) Benefits
Having an audit gives shareholders of the company assurance that the financial
statements have been subject to a rigorous independent review by a suitably
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 qualified professional.
This adds credibility to the published financial statements, not merely for the
shareholders themselves, but for other parties connected to the company, for
example, suppliers, customers and tax authorities, which is likely to make those
parties more confident in their dealings with the company.
There may be other benefits, such as the fact that the financial statements and
records are being scrutinised by an independent professional may deter staff from
fraud, it may make the directors more careful to avoid mistakes when drafting
the financial statements. In addition, the external auditors may make helpful
suggestions about internal control weaknesses in the company, enabling the
company to improve the system of control.
Lastly, if a fraud is being perpetrated at the company, it is possible that the
independent enquiries involved in an audit could detect a fraud, although this is not
guaranteed.
(b) (i) Sampling
An audit is subject to restraints, not least the fact that the company needs it to be
completed within a certain timeframe, so that financial statements can be filed on
time. In addition, the auditors need to charge a fee that the company believes is
reasonable and is willing to pay. Both these factors will affect the volume of work
that the auditors can carry out as part of an audit.
It is usually not practical for auditors to check every single transaction reflected in
the financial statements. This results in auditors testing only a sample of the
transactions.
If the system of controls at the company appears to be effective, the auditor may
choose to place reliance on the system as being effective in ensuring that
transactions are validly recorded in the financial statements. If he does so, he will
test controls to ensure that his belief that they are effective is accurate. This will also
be done on a sample basis.
(ii) Sampling terminology
When determining how big the sample an auditor is using is going to be, he
considers a number of factors, including:
Assurance required
The auditor needs to ensure that he carries out sufficient tests to reduce overall
audit risk to an acceptable level. (Audit risk is the risk that the auditor will give an
inappropriate opinion on financial statements.)
One aspect of audit risk is that auditors will fail to detect material misstatements in
financial statements (detection risk). This risk is relative to the risk of material
misstatements existing in the financial statements (inherent and control risks).
Sample sizes will be affected by the level of inherent and control risk. If inherent and
control risks are high, then in order to achieve a low level of audit risk, a high level of
assurance is required from the audit. Therefore large sample sizes would be
required.
Tolerable error
The auditors will determine a level of discovered error up to which the auditors will
accept and conclude that audit objectives have been reached. This is known as
tolerable error.
The rule for auditors is that as tolerable error decreases, the planned sample size
must increase.
I hope that this has answered your queries. Please do not hesitate to contact me if I can be of
further assistance.
Yours sincerely,
Auditor
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2 CAMPIES LIMITED

Marking guide
Marks
(a) Explanation of the term 'high inherent risk and control risk' as applied
to Campies Limited
Generally 1 mark per point up to a maximum of 4
(b) Identification and explanation of the specific factors that are likely to
have given Sal cause for concern in connection with the reported
sales figures.
Generally 1 mark per point with a maximum of 4 marks for each 11
factor up to a maximum of
15
SUGGESTED SOLUTION
(a) Risk
Inherent and control risk are part of the overall risk of material misstatements arising in
financial statements.
Inherent risk is the risk arising as a result of the nature of client operations and business,
or areas in the financial statements that are naturally susceptible to material
misstatement.
Control risk is the risk that the internal control systems are not sufficiently capable of
preventing and detecting errors in transactions, so that such errors may be carried
through to the financial statements.
(b) Concerns over the sales figure
(i) The company has a high number of different sources of cash income ('on
demand' caravans, washing and laundry rooms, child-care facilities, restaurant,
social club, grocery and amusement arcade). Most of these facilities are likely to
result in a high number of relatively low value transactions. Sal may have concerns
that management controls over the cash receipts over all these transactions and
facilities are not sufficiently strong to have confidence in the reported cash figure.
(ii) The company has a high degree of cash income. This cash is at high risk of
misappropriation.
(iii) We have already mentioned that the controls over cash may not be sufficient to
ensure completeness of cash income. There may also be concerns over the
measurement of sales income.
There are two key factors to this concern. The first is that income for caravans in
paid in advance, and income should be matched to the correct period, which may
not have been done, or done properly.
The second is that sales income should be disclosed in the financial statements
net of any sales tax. This may not have been done properly for all sources of
income, and will be complicated by the fact that some of the sources of income may
be subject to sales tax at a different rate to others.
(iv) Lastly, the company employs a large number of inexperienced, temporary staff.
This is likely to exacerbate the control problems over sales income already
mentioned.

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3 FOODPRO LIMITED

Marking guide
Marks
(a) Explanation of the purpose and nature of ICQs and ICEQs.
Generally 1 mark per point with a maximum of 2 marks for each 4
document up to a maximum of
(b) List of six key control questions for inclusion on an ICEQ for the
sales and trade debtors systems.
Generally 1 marks per question listed up to a maximum of 6
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SUGGESTED SOLUTION
(a) ICQs and ICEQs
An internal control questionnaire (ICQ) is designed to discover the extent of internal
controls in an entity. Simple ICQs will contain a list of questions designed to discover
where an entity has controls and any possible weakness.
ICQs are usually structured in such a way that a positive answer indicates a good control,
and a negative answer indicates where a control is lacking.
An internal control evaluation questionnaire (ICEQ) is designed to evaluate the
effectiveness of controls in an entity. Auditors may use it in conjunction with an ICQ or
instead of one.
ICEQs contain a series of key questions designed to ascertain whether control objectives
in an entity are being met by the controls in place. Each key question has an attached list
of other questions. A positive answer to these questions usually indicates that a control
objective is not being met.
(b) Key control questions for the sales and trade debtors system
(Tutor's note: your answer should include six of the following.)

 Can goods be despatched without being invoiced?

 Can goods be despatched to a poor credit risk?
 Can invoices with errors on them be sent out to customers?
 Can sales be invoiced but not included in the financial records?
 Can credit notes be issued incorrectly?
 Can debtors' accounts be credited in error?
 Can outstanding balances from debtors remain outstanding?
 Can receipts be received from debtors but not be banked?
 Can sales be overstated?

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4 SUFFICIENT AND APPROPRIATE EVIDENCE

Marking guide
Marks
(a) Listing four factors to be taken into account when making a
judgment as to what constitutes sufficient appropriate audit
evidence.
Generally 1 mark per point up to a maximum of 4
(b) Listing of six verification procedures with regard to a fleet of motor
vehicles that an auditor should carry out to test for:
(i) Ownership
Generally 1 mark for each procedure up to a maximum of 3
(ii) Valuation
Generally 1 mark for each procedure up to a maximum of 3
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SUGGESTED SOLUTION
(a) Factors to take into account
(Tutor's note: your answer should include five of the following.)
 The assessment of risk at the financial statement and account balance or class of
transaction level
 The nature of the accounting and internal control systems
 The materiality of the relevant item
 The auditors' knowledge of the business, including knowledge from previous
audits
 Findings from other audit work in other areas and indications of fraud or error
 The source and reliability of available evidence
(b) Verification procedures for motor vehicles
(i) Ownership
 Inspect title documentation, for example, the registration documents
 Examine the company's fixed asset register to ensure that the motor vehicles
are included in it
 Review the insurance policies for the motor vehicles which corroborates that
the company owns the vehicles
 Inspect purchase documentation for any of the vehicles purchased in the year
to ascertain who was invoiced
 Examine documents relating to repairs and maintenance of the vehicles to see
if the cost is borne by the company (again, this would suggest that they own the
vehicles)
(ii) Valuation
 Agree additions in the year to purchase documentation
 Check that the correct cost and depreciation has been eliminated for disposed
of vehicles
 Ensure that the depreciation policies are appropriate and consistent

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  Inspect the vehicles to ensure that their condition reflects the value they are
given in the financial statements
 Check any revaluations made to ensure they are reasonable

5 ASSERTIONS
Marking guide
Identification and example of four representations of directors that are embodied in the
financial statements of a limited liability company.
Generally 1 mark for identification of and 1 mark for an explanation of each example
up to a maximum of 6 marks

SUGGESTED SOLUTION
Financial statement assertions
(i) Existence: the asset or liability exists. Example: a debtor balance represents goods
invoiced prior to the year end which have not been settled at the year end date.
(ii) Occurrence: The transaction/event pertaining to the entity took place in the period.
Example: goods recorded on a sales invoice were sold on the date stated on the
invoice.
(iii) Completeness: there are no assets, liabilities or transactions relating to the year
which have been excluded from financial statements. Example: sales recorded in
financial statements all relate to the period and no sales relating to the period have
been excluded.
(iv) Measurement: Transactions and events are recorded at the proper amount and
allocated to the correct period. Example: sales are reported net of sales tax.
(v) Presentation and disclosure: Items are disclosed, classified and presented as
required by the law and accounting standards. Example: Fixed assets are presented
at net book value (that is, cost or revaluation subject to depreciation).

6 RELIANCE ON ANALYTICAL PROCEDURES

Marking guide
Explaining relevance of three factors to the auditor when determining how much reliance can
be placed on analytical procedures.

Up to 1 mark for each point for each factor with maximum of 2 marks for each factor up to a
maximum of (2 × 3) 6 marks

SUGGESTED SOLUTION

Factors that determine the reliance to be placed on analytical procedures

The auditor must consider the materiality of the item being examined. For example, the auditor
could rely solely on analytical procedures when testing certain income and expenditure items
when they are not individually material, but would not rely only on them for material items such
as inventory.
The auditor must consider the source and reliability of the data from which expectations of
recorded amounts or ratios are developed. Information is more reliable when it is obtained from
sources outside the entity. If information is produced internally, its reliability is enhanced if it is
produced independently of the accounting system or there are adequate controls over its
preparation.

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 The auditor must consider whether the expectation is sufficiently precise to identify a material
misstatement at the desired level of assurance. For example, the auditor would expect greater
consistency when comparing gross profit margins than when comparing say research or
advertising costs.

The auditor must consider the assessments of inherent and control risks. For example, if
internal controls over purchase order processing are weak then more reliance on tests of
details on transactions and balances than on analytical procedures may be necessary.

The auditor must consider the suitability of using analytical procedures given the assertions.
Substantive analytical procedures are generally more applicable to large volumes of
transactions that tend to be predictable over time.

7 INTERNAL CONTROL

Marking guide
Stating the components of internal control.
Generally 1.5 marks per component up to a maximum of
6 marks
SUGGESTED SOLUTION

Five components of internal control (ISA 315)

 Control environment
 The entity's risk assessment process
 The information system relevant to financial reporting
 Control activities
 Monitoring of controls

8 INVENTORY COUNT

Marking guide

Stating FOUR conditions that would need to apply to the continuous inventory procedures - ½
mark for each point with up to 1½ for each condition up to a maximum of 6 marks

SUGGESTED SOLUTION

Using the continuous inventory as a basis for inventories in the financial statements:

(i) All inventory lines should be counted at least once in every year, with certain
categories of inventories, for example, high value items, items more prone to theft or
items that turnover most frequently, being counted more frequently.
(ii) The counts must be conducted by independent, experienced counters.
(iii) The counts should be documented and reconciled to the computer records of
inventories and any relevant adjustments should be made.
(iv) Significant discrepancies should be noted and reported to the relevant individual and
should be investigated immediately.

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9 OPINIONS

Marking guide

Describing the circumstances when an audit firm should express:

(i) A qualified opinion – up to ½ mark per point up to a maximum of 3 marks

(ii) An adverse opinion – up to ½ mark per point up to maximum of 3 marks

SUGGESTED SOLUTION

(i) A qualified opinion should be expressed when the auditor concludes that an unqualified
opinion cannot be expressed but that the effect of any misstatement is not so material
and pervasive as to require an adverse opinion or a disclaimer of opinion. A qualified
opinion should be expressed as being 'except for’ the effects of the matter to which the
qualification relates.

(ii) An adverse opinion should be expressed when the effect of a misstatement is so material
and pervasive to the financial statements that the auditor concludes that a qualified
report is not adequate to disclose the misleading or incomplete nature of the financial
statements.

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