CHAPTER: Audit Planning AUDIT PLANNING
PLANNING International Standard on Auditing (ISA) requires the auditor to plan and perform the audit with an attitude of professional skepticism recognizing that circumstances may exist which cause the financial statements to be materially misstated.
SOME BENEFITS OF AUDIT PLANNING Enabling the auditor to devote appropriate attention to important areas of the audit Helping the auditor identify and resolve potential problems on a timely basis Helping in the management of audit engagement in an effective and efficient manner.
FOUR PHASES OF FINANCIAL STATEMENT AUDIT PHASE 1
Plan and design an audit approach
PHASE 2
Perform tests and controls and substantive tests of transactions
PHASE 3
Perform analytical procedures and tests of details of balances
PHASE 4
Complete the audit and issue an audit report
Planning & Designing an Audit Approach Accept client and perform initial audit planning Understand the client’s business and industry
Assess the client business risk Perform preliminary analytical procedures Set materiality and assess acceptable audit risk and inherent risk Understand internal control and assess control risk Gather information to assess fraud risk
Develop overall audit plan and audit program
Planning & Designing an Audit Approach New client acceptance and continuance
Accept client and perform initial audit planning
New client investigation Continuing clients
Identify client’s reason for audit
Is audit required for loan application?
Obtain understanding with the client
Obtain an engagement letter
Staff the engagement
Partner, Manager Senior and Assistant
A. CLIENT ACCEPTANCE AND CONTINUANCE New Client Investigation  Before accepting a new client, an accounting firm needs to investigate the company to determine its acceptability Continuing clients  Chartered accounting firm should evaluate existing clients annually to determine whether there are reasons for not continuing to do the audit.
B. IDENTIFY CLIENT’S REASONS FOR AUDIT
Every company is incorporated under the Companies Act to have its accounts audited annually Special audits may also be required for other purposes such as purchase of business, loan applications and take over, etc.
C. OBTAIN AN ENGAGEMENT LETTER An engagement letter is an agreement between the chartered accounting firm and the client for the conduct of the audit and related services A clear understanding of the terms of the engagement should exist between the client and the chartered accounting firm The terms should misunderstandings.
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OBTAIN AN ENGAGEMENT LETTER
Engagement letter is also a means of informing the client that the auditor cannot guarantee that all acts of fraud will be discovered The engagement letter does not affect the auditor’s responsibility to external users of audited financial statement, but it can affect legal responsibilities to the client.
D. SELECT STAFF FOR THE ENGAGEMENT
Assigning the appropriate staff to the engagement to meet the approved auditing standards and to promote audit efficiency
2. UNDERSTANDING THE CLIENT’S BUSINESS AND INDUSTRY
Having good knowledge of the client’s business and industry is vital for adequate audit.
Sufficient understanding of the client is important for assessing the risk of material misstatement of the financial statements.
Thorough understanding of the client’s business environment is necessary for designing the nature, determining the timing and extent of audit procedures.
2. UNDERSTANDING THE CLIENT’S BUSINESS AND INDUSTRY
Three (3) reasons for obtaining a good understanding of the client’s industry. •
Many industries have unique accounting requirements that the auditor must understand to evaluate whether the client's financial statements are in accordance with approved accounting standards
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The auditor can often identify risks in the industry that may affect the auditor’s assessment of acceptable audit risk
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Understanding the client’s business enables the auditor in identifying the client's inherent risks.
B. UNDERSTANDING CLIENT”S OPERATION, STRATEGIES AND PERFORMANCE SYSTEM
Tour the plant and offices for a better understanding of the client’s business and operations.
Identify related parties transaction that are material for disclosure in the financial statement.
Evaluate need for an expert •
If auditor encounters situations requiring specialized knowledge, it may be necessary to consult an expert.
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The auditor should evaluate the expert’s professional qualifications and understand the objectives and scope of the expert’s work.
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The auditor should also consider the expert’s relationship to the client, including circumstances that might impair the expert's objectivity.
B. UNDERSTANDING CLIENT”S OPERATION, STRATEGIES AND PERFORMANCE SYSTEM
Examining legal documents (Memorandum and Articles of Association) and other records such as contracts or agreements that might affect the financial reporting
Reviewing minutes of meeting to obtain authorization and other information relevant to performing the audit.
3. ASSES CLIENT BUSINESS RISK
Industry & External Environment
Understand Client’s Business & Industry
Business Operation & Processes
Management & Governance
Assess Client Business Risk
Objectives & Strategies
Measurement & Performance
ASSESS CLIENT BUSINESS RISK (Cont’d) What is it?
Risk of failing to achieve objectives What factors influence it? New technology
Economic downturn
Strategic failures
4. PERFORM PRELIMINARY ANALYTICAL PROCEDURES Is essential for efficient and effective audits Is the analysis/substantive procedures of significant ratios and trends for comparisons of the client’s financial information with prior periods, similar industry, etc to obtain evidence to support the auditor’s opinion.
TIMING AND PURPOSES OF ANALYTICAL PROCEDURES PURPOSES Understanding the client’s industry and business Assess going concern Planning phase
Indicate possible misstatements Reduce detailed tests
TIMING AND PURPOSES OF ANALYTICAL PROCEDURES PURPOSES Indicate possible misstatements Testing phase Reduce detailed tests
Assess going concern Completion phase
Indicate possible misstatements
TIMING AND PURPOSES OF ANALYTICAL PROCEDURES
AP can be used throughout the audit for the following task:
Planning – to help understand client’s business and identify risks/trends
Detailed testing – to obtain evidence regarding the completeness, accuracy and validity to transactions
ANALYTICAL PROCEDURES 5 types of analytical procedures: Compare client data with similar prior-period data Compare client and industry data Compare client expected results
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Compare client data with auditor determined expected results Compare client data with expected results, using non- financial data
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RISK AND MATERIALITY
The scope paragraph in auditor’s report includes important phrases that are directly related to materiality and risk. “We conducted our audit in accordance with approved auditing standards. Those standards require we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement.” The phrase “free of material misstatement” is intended to inform users that the auditor’s responsibility is limited to material financial information.
MATERIALITY Definition Information is ‘material’ if its omission or misstatement could influence the economic decisions of users taken on the basis of the financial statements. Materiality depends on the size of the item or error judged in the particular circumstances of its omission or misstatement.
MATERIALITY How to assess materiality The assessment of what is material is a matter of the auditor’s professional judgments Material misstatement include the material amounts of the misstatement or any failure to comply with the statutory requirements and GAAP The auditor reviews both the quantitative and quality aspect of material misstatement. Factors that affect the auditor judgment are as follows: Size of the material misstatement in term monetary value Nature of the item The users of the financial statements Cumulative effect
MATERIALITY Factors that can cause material misstatements
Errors
unintentional mistakes in financial statements including mathematical mistakes, wrong application of accounting principles
Fraud
intentional distortions of financial statements like deliberate misrepresentations by management, omission of significant information, manipulation, falsification or alterations of records, etc
RISK Risk in auditing means that the auditor accepts some level of uncertainty in performing the audit function Acceptable audit risk (audit risk) Is a measure of how willing the auditor is to accept that the financial statements may be materially misstated after the audit is completed and an unqualified opinion had been issued Factors of uncertainty in audit performance Nature of an audit test Inherent limitations of an audit Inherent limitations of the effectiveness of client’s internal control system
RISK When an auditor decides that a lower acceptable audit risk on audit is appropriate, 3 possible effects: ďƒź More evidence is required to increase audit assurance that there are no material misstatements. ďƒź The engagement may require more experienced staff. ďƒź The engagement will be reviewed more carefully than usual.
AUDIT RISK ď ľ
Audit risk is a risk that the auditor gives an inappropriate opinion when the financial statements are materially misstated.
ď ľ
In other words, the risk that the auditor delivers an incorrect audit opinion – an opinion which states that the accounts present a true and fair view while in reality they do not.
AUDIT RISK COMPONENTS The risk that the accounts may contain misstatements
INHERENT RISK
CONTROL RISK
The risk that material misstatements will occur
Risk that the client’s system of internal control will not prevent or correct such misstatements
CLIENT’S RESPONSIBILITY
DETECTION RISK The risk that any remaining material misstatement will not be detected by the auditor
AUDITOR’S RESPONSIBILITY
DETECTION RISK The risk that any remaining material misstatement after assessing inherent and control risks will not be detected by the auditor The risk that the auditor’s substantive procedures and review of financial statements will not detect material errors or misstatements Detection risk will be higher if the auditors are not competent and due care Detection risk will be lower if the auditors are competent and exercise due care
CONTROL RISK Auditor’s assessment of the likelihood that misstatements exceeding tolerable amount in a segment will not be prevented or detected by the client’s internal controls Control risk represents an assessment of whether a client’s internal controls are effective for preventing or detecting misstatements. The risk that the client’s system of internal control will not prevent or detect material errors or misstatements in the account balance or class of transactions
CONTROL RISK (cont’d) The control risk may exist due to the inherent limitation of internal control system and inadequacy of the segregation of duties such as human error, faulty judgment, teaming & lading Control risk will be higher if internal control system is not effective Control risk will be lower if internal control risk is effective
INHERENT RISK ďƒźIs a measure of the auditor's assessment of the likelihood that there are material misstatements (errors or fraud) in a segment before considering the effectiveness on internal control. ďƒźThe risk related to the characteristics of the business that may cause material misstatement in financial statements
INHERENT RISK (cont’d) Factors to consider when assessing inherent risk: Nature of client’s business Factors related to misstatements arising from fraudulent financial reporting Results of previous audits Initial versus repeat engagement Related parties Non-routine transactions Judgment required to correctly record account balances and transactions Susceptibility of assets to misappropriation Makeup of the population
RISK VS MATERIALITY VS AUDIT EVIDENCE
The concepts of materiality and risk in auditing are closely related and inseparable Risk is a measure of uncertainty Materiality is a measure of magnitude or size Both risk and materiality determine the planned evidence
AUDIT PROGRAMME Is a set of procedures that an auditor used to obtain reasonable assurance that the financial statements are not affected by material misstatements Purpose: ď ą Guiding audit staff in audit work ď ą Provide evidence of proper planning and recording of audit work to be done ď ą Provide the basis for coordinating and supervising audit work and controlling the time spent
AUDIT PROGRAMME (Cont’d)
Main components: Objectives of audit Audit procedures and conclusions of each audit work performed
AUDIT PROGRAMME (Cont’d)
Standard Standard working papers used on all audits for efficiency and proper delegation, control and review
Tailored Different working papers used to suit the different types of client’s business
AUDIT TIMING Interim Audit
Final Audit
Year End
AUDIT TIMING (Cont’d) Auditing can be done in two stages: Interim audit Audit procedures are performed prior to the company’s statement of financial position (SOFP) date (compliance testing or test of controls) Final audit Audit procedures (substantive test of transactions and balances & analytical review) are performed on or after the company’s SOFP date
AUDIT TIMING (Cont’d) Better audit schedule
Promote efficiency Well-planned Audit Timing
Better schedule for staff