Answers

FOUNDATIONS IN ACCOUNTANCY – FAU

Foundations in Audit (FAU) June 2020 Answers

Section A

1 3 only
ISAs should be applied to the audit of any entity or organisation but they do not override local regulations governing the audit.
They are the standards by which the quality of an audit should be judged, so the extent of compliance with them should always be
considered when determining whether an audit has been performed effectively.

2 Being straightforward and honest when raising concerns about a position taken by a client
Being straightforward and honest when raising concerns about a position taken by a client is an example of compliance with the
fundamental principle of integrity. All of the other actions described are examples of compliance with the fundamental principle of
professional competence and due care.

3 2 and 3
Goods received notes issued prior to the period end and credit notes from suppliers received after the period end are documents
relating to actual purchase transactions, which need to be accurately recorded in the accounting records. As such, they should be
subject to audit inspection as part of cut-off testing. Purchase requisitions are documents raised prior to purchase orders, and do not
in themselves generate purchase transactions and are therefore not relevant to cut-off testing.

4 It may be appropriate to test the effectiveness of controls at the same time as determining whether they’ve been implemented
Where walk-through tests are performed, they are carried out before tests of controls. Inquiry alone is not sufficient to test operating
effectiveness of controls and tests designed to detect material misstatement at the assertion level are referred to as substantive
procedures.

5 Completeness
For each of the other assertions, audit assurance is often obtained by an auditor carrying out procedures which are independent of,
and not reliant on, a company’s internal controls. When seeking assurance about completeness aspects, auditors often rely on the
robustness of control activities in their evaluation process. For example, they may rely on the robustness of cash sale policies and
procedures to determine whether the reported sales figure is complete. Significant deficiencies in internal control makes this process
difficult.

6 The sample is selected using a constant interval between selections, with the starting point being selected at random
A systematic selection is a sampling method in which the sample is selected using a constant interval between selections, the
starting point being selected at random.

7 Comparing the trade payables payment period with that for the previous year
Comparing the trade payables payment period with that for the previous year is classed as a substantive procedure. The procedures
reperforming a wages control account reconciliation, and examining a sample of purchase orders for evidence of authorisation are
tests of controls, and tracing the steps of sales transactions through the system into the accounting records is a walk-through test.

8 Petty cash balances, irrespective of size, should always be counted

The nature of bank and cash balances means that there is a high risk of material misstatement in reported balances. It is therefore
particularly apt that performance materiality should be set at a lower level than that set for the financial statements as a whole.
It is important that bank letters should be obtained for all reported bank balances and to maintain the integrity of the distribution
progress, they should be sent directly by the auditor. Petty cash balances should be counted only where they are considered to be
material, or of particularly high risk to misappropriation.

9 They include written representations from management

Working papers should include written representations from management. Auditors should also disclose information when required
by law and where there is a professional duty or right to disclose. They may be in electronic as well as paper form and are owned
solely by the auditor.

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10 To obtain assurance about the existence and condition of inventory
An auditor should attend an inventory count to obtain assurance about the independence and quality of the inventory count team
and to obtain corroborative assurance about ownership and presentation of inventory. However, the overriding purpose of attendance
is to obtain assurance about the existence and condition of inventory.

11 2, 1, 3
The order of events is employee existence check, reasonableness check of hours worked, and programmed agreement of batch total
printout for the batch of clock cards input, to check the completeness of input.

12 Designing and implementing a new system to control the company’s non-current assets
Designing and implementing a new system to control the company’s non-current assets (or indeed, any internal control system),
represents a self-review interest threat to the objectivity of the internal audit function, and therefore this activity should not be carried
out by the internal audit function.

13 2 only
Occurrence is the only assertion listed which is relevant to motor vehicles running expenses – a class of transactions reported in the
financial statements.

14 Costs of distributing manufactured products to customers

Distribution costs are not part of the cost of production of inventory, so should not be absorbed into its value. All of the other costs
identified are costs of production, so should be absorbed.

15 2 only
If the auditor determines that there is already sufficient appropriate evidence to support an opinion, then there is no requirement to
obtain additional supporting evidence. If management refuses to correct the misstatement, they should be informed that the auditor
will be unable to express an unmodified opinion and, because the misstatement is material and pervasive, the auditor should
prepare to express an adverse opinion in the auditor’s report.

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Section B

16 (a) Inherent risk – Inventory

Reasons why inventory is an area of high inherent risk in Field Co’s financial statements include:
– The nature of and range of the product lines, included in inventory, present particularly difficult challenges in ascertaining
the quantity of inventory held. The need to ascertain the amounts of large quantities of raw materials, work-in-progress
and finished goods inventory spread over three factories will present particular complexities, which need to be addressed
to ensure accuracy in ascertainment of quantities at the period end.
– Inventory should be valued at the lower of cost and net realisable value. There are complex valuation issues to be
considered in ensuring accuracy in this respect, including the absorption of production costs into work-in-progress and
finished goods inventory. Given the high level of factory overhead costs, these are likely to be material in the context of
the inventory valuation process and the inherent risk associated with the absorption method is particularly high.
– Raw materials, work-in-progress and finished goods inventory are spread across three factories. There is therefore a
high inherent risk that there will be errors in the communication, transmission and recording of information within the
company leading to material misstatements on reported balances.
– Damage to some inventory lines and obsolescence where lines have been held for a long duration are inevitabilities of
manufacturing operations. Such inventory could be significantly overvalued because their impaired state has not been
identified. There is a high inherent risk in this regard.
– The sheer volume and complexity of the inventory lines held represents a particular problem for Field Co, in ensuring
that only owned inventory is included in the reported inventory balance. All inventory held is not necessarily owned by
Field Co, and there is a high risk of incorrect categorisation in this regard – resulting in material misstatement in reported
inventory.

(b) Control activities – Inventory

The following control activities should form a part of the company’s continuous (perpetual) inventory counting system:
– The count team members should be sufficiently independent, skilled and resourced so that their work can be relied upon.
– All inventory lines should be counted and physically inspected at least once annually, with high value lines being subject
to more regular counts and inspections, as deemed appropriate by management.
– Inventory count teams should check for, identify, and formally record damaged or obsolete inventory items on a monthly
basis and report findings to management for follow-up and write-down of value in the accounting records.
– Inventory count teams should formally report discrepancies and anomalies found, immediately after counts, for prompt
investigation and appropriate action by management – including appropriate adjustments in the accounting records.

(c) Control environment

The other elements of Field Co’s control environment comprise:
– Communication and enforcement of integrity and ethical values – These are essential elements which influence the
effectiveness of the design, administration and monitoring controls.
– Commitment to competence – Matters such as management’s consideration the competence levels for particular jobs and
how those levels translate in requisite skills and knowledge.
– Organisational structure – The framework within which an entity’s activities for achieving its objectives are planned,
executed, controlled, and reviewed.
– Assignment of authority and responsibility – Matters such as how authority and responsibility for operating activities are
assigned and how reporting relationships and authorisation hierarchies are established.
– Human resource policies and practices – Policies and practices which relate to, for example, recruitment, orientation,
training, evaluation, counselling, promotion compensation, and remedial actions.

17 (a) Audit evidence

By its very nature, audit evidence provided by way of an external confirmation, a direct written response to the auditor from
a third party, is deemed to be reliable, on the basis that third parties are considered to be impartial and objective, with no
motivation to provide untruthful and inaccurate confirmations to the auditor. In contrast, audit evidence generated internally by
the audit client may have been produced by individuals who are not objective, who have a self-interest in falsifying accounting
records and concealing errors and omissions. That evidence obtained from external confirmation is sent directly to the auditor,
so reducing the opportunity to intercept and alter the representations made, adds to its reliability as compared to evidence
obtained indirectly through the client or by inference. Finally, it is generally accepted that audit evidence is more reliable when
it exists in documentary form; a pertinent point when determining the extent of reliance to be placed on external confirmations
as compared to evidence sourced from the audit client.

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 (b) (i) Sampling risk
Sampling risk is the risk that the conclusion drawn by the auditor from the results of the circularisation may be different
from the conclusion which would be reached if the whole population of trade receivables balances were to be circularised.
(ii) Non-sampling risk
Non-sampling risk is the risk that the auditor reaches an erroneous conclusion for any reason not related to sampling
risk. For example, by misinterpreting the results of the circularisation or failing to link the results of the circularisation with
evidence from other audit tests carried out. Non-sampling risk will be increased if there is poor quality control over the
audit work.

(c) Trade receivables circularisation

(i) A positive confirmation request consists of letters being sent, directly by the auditor, to a sample of trade receivables. The
letters request addressees to respond directly to the auditor indicating whether they agree or disagree with the balance
owed by them or to them, as reflected in the client’s accounting records.
A negative confirmation request consists of similar letters being sent to a sample of trade receivables, but it requests
addressees to respond only if they disagree with the balance shown as owed by them or to them.
(ii) Positive confirmation requests are preferable to negative confirmation requests because they provide a higher degree of
certainty to the auditor. This is particularly important in the audit of Meadow Co, where the risk material misstatement
is deemed to be high and given the average level of individual trade receivable balances ($2·4 million/200 = $12,000)
against profit before tax of $1 million, with an average payment period of 49 days. If no response is received to a
negative confirmation request, the auditor assumes that there is agreement to the receivables balance as stated. However,
non‑response could be for a range of reasons including non-receipt of the request letter, a significant dispute or perhaps
a refusal to acknowledge that a debt shown is materially understated.

(d) Disagreement with balances

Reasons why there could be disagreement include:
– Dispute(s) about the price or quality of service provided.
– Cut-off problems existing in the accounting records of Meadow Co and/or its customers.
– Monies in transit sent by customers not received by Meadow Co at the reporting date.
– Posting errors in the accounting records of Meadow Co and/or its customers.
– Where customers of Meadow Co are also suppliers, netting-off of balances owed by and owed to in their accounting
records are not mirrored in the accounting records of Meadow Co.

18 (a) Auditor independence

Auditor independence includes independence of mind and independence of appearance. Independence of mind is the state
of mind which permits the expression of a conclusion without being affected by influences which compromise professional
judgement, thereby allowing an individual to act with integrity, and exercise objectivity and professional scepticism.
(Independence in appearance is the avoidance of facts and circumstances which are so significant that a reasonable and
informed third party would be likely to conclude that a firm’s, or an audit team member’s, integrity, objectivity or professional
scepticism has been compromised.

(b) Professional judgement

An auditor may be expected to exercise their professional judgement in such a situation on a very broad range and high volume
of aspects including:
– In determining materiality at the planning stage for the financial statements as a whole, and also that set at a lower level
or levels for particular classes of transactions, account balances or disclosures (performance materiality).
– In assessing inherent risk, control risk and determining acceptable levels of detection risk in the various areas of the
financial statements.
– In deciding on the nature, timing and extent of substantive procedures to carry out in the area of room hire, to reduce
audit risk to an acceptable level.
– In selecting appropriate members of the audit team to carry out testing and in the delegation of specific responsibilities
and duties to them.
– In selecting the hotels to be visited to carry out tests and the tests to carry out.
– In evaluating the reasonableness of the company’s depreciation policies and rates pertaining to its various categories of
non-current assets.
– In determining the extent of use of computer-assisted audit techniques to obtain audit evidence.

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 – In evaluating management’s judgements in applying the applicable financial reporting framework.
– In determining the type of audit opinion to be expressed in the auditor’s report.

19 (a) Risk assessment procedures

The other three risk assessment procedures are:
– Analytical procedures.
– Inquiries of management and others within the entity.
– Observation.

(b) Substantive procedures

(i) Appropriate inspection procedures for testing reported bank loans would include:
– Inspect client’s schedule of bank loans outstanding at the period and ensure all loan details and terms agree with
those stated in the related bank report (letter).
– Inspect cash book receipts for the period, identify a sample of loans received and trace to client’s schedule of bank
loans for assurance about the completeness of reporting.
– Inspect presentation of bank loans information in the financial statements and compare to underlying schedules
prepared, to ensure correct classification of loan balances between current liabilities and non-current liabilities.
(ii) Appropriate substantive analytical procedures for testing the reported inventory balance include:
– Compute inventory days’ holding period at the period end and compare for reasonableness, in line with those for
earlier periods and understanding of the business and investigate any significant differences.
– Compute and compare ratios of raw materials, work-in-progress and finished goods inventory to total inventories at
the period end, and consider reasonableness in light of other information.
– Compare inventory balances at the period end with trend of reported balances during the period, and enquire into
reasons for material differences at the period end.
(iii) Appropriate recalculation procedures which would have been appropriate in the testing of trade payables balances
include:
– Recalculating the total trade payable balances at the period-end, manually or using computer software, to confirm
its arithmetical accuracy.
– Using manual or computer software calculation techniques to check the arithmetical accuracy of the reconciliation of
the period-end trade payables control account in the general ledger to the total of individual trade payables balances.
– Checking the arithmetical accuracy of a sample of period-end supplier statement balance reconciliations carried out
by the client’s staff.

20 (a) General IT controls

In the context of a computer environment, general IT controls are policies and procedures which relate to many applications,
and support the effective functioning of applications controls by helping to ensure the continued proper operations of information
systems.

(b) Examples of general IT controls

General IT controls to ensure continuity of operations include:
– Disaster recovery procedures.
– Off-site storage of programs and data files.
– Back-up power sources.
– Repair service and maintenance agreements.
– Break-down insurance agreements.

21 (a) Prospective audit clients

Other sources from which an auditor may obtain information about a prospective audit client include:
– The client’s management and employees.
– The client’s most recent financial statements.

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 – The client’s website.
– Promotional publications and literature distributed by the client.
– Business magazines, journals and newspaper articles.
– Television and radio mediums.
– Credit reference agencies.
– References from existing clients.

(b) Purpose of communication

As a matter of professional courtesy, auditors are required to communicate formally with a prospective client’s existing auditor,
prior to accepting instruction to act as their new auditor. The main purpose of the communication is to find out if there is any
professional reason as to why the instructions to act should not be accepted.

22 (a) Title of auditor’s report

The title should clearly indicate that the report is of an independent auditor, to distinguish it from reports issued by others.

(b) Addressee of auditor’s report

The report should be addressed to the shareholders of the company.

(c) Matters in the basis of opinion paragraph

The matters which must be confirmed in the basis of opinion paragraph comprise:
– That the audit was conducted in accordance with the ISAs.
– That the auditor is independent of the company.
– Whether the auditor believes the audit evidence obtained is sufficient and appropriate to provide a basis for the audit
opinion.

23 (a) Purpose of audit software

The purpose of audit software is to assist the auditor in carrying out substantive procedures on data processed through a
computer-based accountancy system.

(b) Benefits of audit software

Benefits of using audit software comprise:
– Speed of calculations and comparisons as compared to manual testing.
– Increased complexity of testing, for example, by way of exception and search checks.
– Ability to carry out higher volumes of testing.
– Longer term cost savings may arise for the auditor if the same audit software is used for testing over a number of years.

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FOUNDATIONS IN ACCOUNTANCY – FAU
Foundations in Audit (FAU) June 2020 Marking Scheme

Section A Marks

Questions 1–15 – each worth 2 marks 30

–––

Section B Marks available

16 (a) Inherent risk (only 2 reasons required)

– Quantification issues 3
– Valuation issues 3
– Classification issues 3
– Damage and obsolescence 3
– Ownership issues 3
–––
Max 2 reasons, 3 marks each 6
–––

(b) Control activities (only 3 control activities required)

– Independent count team 2
– All lines counted – highly valued more regular 2
– Immediate record updating where damage/obsolescence 2
– Prompt management follow-up on discrepancies 2
–––
Max 3 activities, 2 marks each 6
–––

(c) Control environment (only 1 element required)

– Communication and enforcement of integrity and ethical values 3
– Commitment to competence 3
– Organisational structure 3
– Assignment of authority and responsibility and responsibility 3
– Human resource policies and practices 3
–––
Max 1 element, 3 marks 3
–––
Total marks 15
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17 (a) Audit evidence

Explanation external confirmation more reliable than evidence generated internally 3
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(b) Trade receivables circularisation

(i) Sampling risk 2
(ii) Non-sampling risk 2
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4
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(c) Trade receivables circularisation

(i) Difference between a positive and a negative confirmation 3
(ii) Why circularisation should compare positive confirmation 3
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6
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(d) Disagreement with stated balances (only 2 reasons required)

– Dispute(s) about price or services 1
– Cut-off problems in sales/purchases accounting records 1
– Monies in transit 1
– Accounting entry posting errors 1
– Netting-off of balances 1
–––
Max 2 reasons, 1 mark each 2
–––
Total marks 15
–––

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 Marks available
18 (a) Auditor independence
Defining independence of mind 2
Defining independence in appearance 2
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4
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(b) Professional judgement (only 3 aspects required)

– Audit risk 2
– Team selection 2
– Hotel selection 2
– Tests to meet audit objectives 2
– Depreciation policy and rates 2
– Use of CAATs 2
–––
Max 3 aspects, 2 marks each 6
–––
Total marks 10
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19 (a) Risk assessment procedures (only 2 procedures required)

– Analytical procedures 1
– Inquiry of managers and others within the company 1
– Observation 1
–––
Max 2 procedures, 1 mark each 2
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(b) Substantive procedures

(i) Bank loan balances – inspection procedures (only 1 procedure required) 2
(ii) Inventory balance – substantive analytical procedures (only 2 procedures required) 4
(iii) Trade payables balances – recalculation procedures (only 1 procedure required) 2
–––
Max 1 procedure at (i) and (iii) – 2 marks each and 2 procedures at (ii) – 2 marks each 8
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Total marks 10
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20 (a) General IT controls 2

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(b) Examples of general IT controls (only 2 examples required)

– Disaster recovery procedures 1½
– Off-site storage facilities 1½
– Back-up power sources 1½
– Repairs, services and maintenance agreements 1½
– Breakdown insurance agreements 1½
– Other (specify) 1½
–––
Max 2 examples, 1½ marks each 3
–––
Total marks 5
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10
 Marks available
21 (a) Prospective audit client (only 2 sources required)
– Client’s management and employees 1½
– Client’s financial statements 1½
– Client’s website 1½
– Client’s promotional material 1½
– Business magazines, journals and newspapers 1½
– Credit reference agencies 1½
– Existing clients 1½
– Other (specify) 1½
–––
Max 2 sources, 1½ mark each 3
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(b) Purpose of communication

– Professional courtesy 1
– Professional reason(s) not to act 1
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2
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Total marks 5
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22 (a) Title of auditor’s report

Report of an independent auditor 1
–––

(b) Addressee of auditor’s report

Addressed to company’s shareholders 1
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(c) Matters in the basis of opinion paragraph (only 2 matters required)

– Audit conducted in accordance with ISAs 1½
– Auditor’s independence 1½
– Sufficient and appropriate audit evidence 1½
–––
Max 2 matters, each 1½ marks 3
–––
Total marks 5
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23 (a) Purpose of audit software

Explaining purpose of audit software 2
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(b) Benefits of using audit software (only 2 benefits required)

– Speed of calculations and comparison 1½
– Improved complexity of testing 1½
– Volume of testing 1½
– Cost savings 1½
– Other (specify) 1½
–––
Max 2 benefits, 1½ marks each 3
–––
Total marks 5
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