Audit Planning

• Audit planning

  Developing a general audit strategy and a detailed approach for the expected conduct of the audit
• Auditor's main objective in planning the audit

  To determine the scope of the audit procedures to be performed
• Audit planning

  • Helps ensure appropriate attention is devoted to important areas of the audit
  • Helps identify potential problems
  • Allows the work to be completed expeditiously
  • Assists in the proper assignment and coordination of work
  • Helps ensure the audit is conducted effectively and efficiently
• Obtaining understanding of the entity

  1. Review of prior years' working papers

  2. Tour of the client's facilities

  3. Reading relevant books, periodicals and other publications

  4. Discussion with people within and outside the entity

  5. Reading corporate documents and financial reports
• Knowledge of the client's business and industry

  Essential for the audit to be carried out effectively and efficiently
• Understanding the entity's objectives, strategies and related business risks


  Increases the likelihood of identifying risks of material misstatement and helps the auditor design appropriate audit procedures
• Understanding the entity's measurement and review of performance


  May create pressures on the entity that may either motivate management to take action to improve the business performance or it may lead management to manipulate the financial statements
• Obtaining understanding of the client's business

  A continuous and cumulative process
• First-time audit engagement


  Requires more work than a repeat engagement
• Understanding the entity's internal control


  Helps the auditor anticipate the type of potential misstatements that can occur in the financial statements and thus helping the auditor plan the appropriate audit procedures
• Developing an overall audit strategy

  1. Determine how much evidence to accumulate

  2. Determine what procedures to be performed

  3. Determine when procedures should be performed
• Materiality


  Information is material if its omission or misstatement could influence the economic decision of users taken on the basis of the financial statements
• Using materiality in an audit

  1. Determine the overall materiality (financial statement level)

  2. Determine the tolerable misstatement (account balance level)

  3. Perform audit procedures

  4. Compare the aggregate amount of misstatements with the overall materiality
• Performance materiality

  The reduced level of materiality which the auditors use both at the financial statement and account balance level
• Audit risk


  The risk that the auditor might give an inappropriate audit opinion on the financial statements
• Audit risk

  • Audit risk is the complement of audit assurance
  • As the acceptable level of audit risk decreases, the amount of audit evidence needed to support the auditor's opinion increases
• Inherent risk


  The susceptibility of an account balance or class of transactions to a material misstatement assuming that there were no related internal controls
• sk


  Means that there is 95% assurance or confidence level that the opinion expressed by the auditor on the financial statements is appropriate in the circumstances
• Auditor's judgment about the acceptable level of audit risk

  • Influenced by the type of client
  • Auditors will choose a lower level for public companies over private companies because more users depend on the financial statements of publicly-held companies
  • As the acceptable level of audit risk decreases, the amount of audit evidence needed to support the auditor's opinion increases
• Some account balances, by nature, are more susceptible to misstatement than others (e.g. accounts susceptible to misappropriation like cash or accounts subject to complex calculations, such as leases)
• Assessing inherent risk

  1. Auditor assesses inherent risk at the financial statement and account balance or transaction class levels

  2. Factors that may influence the auditor's assessment of the risk of misstatement at the financial statement level include management integrity, management characteristics, operating characteristics, and industry characteristics

  3. Factors affecting inherent risk at the account balance level may include susceptibility of the account to theft, complexity of calculations related to account, the complexity underlying transactions and other events, and the degree of judgment involved in determining account balances
• As the assessed level of inherent risk increases


  The auditor should design more effective substantive procedures
• Control risk


  The risk that a material misstatement that could occur in an account balance or class of transactions will not be prevented or detected, and corrected in a timely manner by accounting and internal control systems
• If the entity's internal control is effective


  The risk that the control will fail to detect or prevent material misstatement (control risk) decreases
• Holding other planning considerations equal, as the assessed level of control risk increases


  The auditor should design more effective substantive procedures
• Detection risk


  The risk that an auditor may not detect a material misstatement that exists in an assertion
• As the acceptable level of detection risk decreases

  The assurance provided by substantive tests should increase with the application of more effective substantive procedures
• Steps in using the audit risk model

  1. Set the Acceptable Level of Audit Risk

  2. Assess the Level of Inherent Risk

  3. Assess the Level of Control Risk

  4. Determine the Acceptable Level of Detection Risk

  5. Design Substantive Tests
• It is the auditor, not the entity being audited, who determines the acceptable level of audit risk
• The lower the level of acceptable audit risk, the higher the desired level of assurance/certainty, and vice versa
• Some control risk will always be present no matter how effective the internal control may be
• As the acceptable level of detection risk decreases, the assurance provided by substantive tests increases
• Designing substantive tests

  Modifying the nature, timing and extent of substantive tests
• Of the three components (inherent, control, and detection risk), only the detection risk can be controlled by the auditor
• If the assessed level of inherent and control risk is high

  The auditor should lower the acceptable level of detection risk to be able to maintain the acceptable audit risk level
• If the assessed level of inherent and control risk is low


  The auditor may accept a higher level of detection risk without sacrificing the desired audit risk level
• Compensating for increased audit risk due to lower materiality level

  1. Reducing the assessed level of control risk and supporting the reduced level by carrying out extended or additional tests of control

  2. Reducing detection risk by modifying the nature, timing and extent of planned substantive tests
• Risk assessment procedures


  Procedures performed by auditors to obtain an understanding of the entity and its environment including its internal control and to assess the risks of material misstatements in the financial statements
• Risk assessment procedures

  • Inquiries of management and others within the entity
  • Analytical procedures
  • Observation and inspection
• Analytical procedures


  Analysis of significant ratios and trends, including the resulting investigation of fluctuations and relationships that are inconsistent with other relevant information or deviate from predicted amounts