CHAPTER 5

AUDIT PLANNING

5.1 OVERVIEW OF AUDIT PLANNING

 Audit planning involves general strategy and detailed approach for the expected nature,
timing and extent of an audit.

 Purpose or Benefits of Audit Planning:

 To conduct audit in an efficient and timely manner
 To obtain sufficient appropriate audit evidence
 To ensure adequate attentions are paid to the critical aspects of an audit
 To keep audit costs at a reasonable minimum level
 To minimize legal liability
 To help avoid misunderstanding with the client

5.2 STEPS IN AN AUDIT

STEP 1: PRE – PLAN CLIENT ACCEPTANCE AND CONTINUANCE

 The firm should establish policies and procedures for the acceptance and continuance of
client relationships and specific engagements, designed to provide it with reasonable
assurance that it will only undertake or continue relationships and engagements where it:
a) Considered the integrity of the client and does not have information that would lead to
conclude that the client lacks integrity
b) Competent to perform the engagement and has the capabilities, time and resources to
do so
c) Can comply with ethical requirements
 Investigate new client – management integrity, overall risk, familiarity with the nature of the
client’s business, ability to perform the audit work.
 Evaluate existing client
 Staff requirements for the audit management – select appropriate staff and considering
some factors such as engagement size, complexity, level of risk, special expertise required,
timing of audit and personnel availability.
 The auditor should take into account business risk when considering whether or not to
accept an engagement.

Engagement Letter
 Engagement letter is an agreement between firm and the client for conducting the audit
work and related services.
 Purpose:

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 - To provide written confirmation of the acceptance of the appointment
- To minimize the possibility of misunderstandings between client and its auditor
- To clearly define auditor’s responsibility and scope of audit
 Content:-
The objective and scope of the audit
Management’s responsibility (assertions) for the financial information
Degree of auditors assurance (auditor is not responsible for the discovery of ALL
fraud).
The terms of the engagement including a statement that because of the test nature
and other inherent limitations of the audit, there is unavoidable risk that some
material misstatements may remain undiscovered.
Auditor’s right to access to whatever records, document and information the auditor
requires.
A request for the client to confirm the terms of the engagement by acknowledging
receipt of the letter.
Audit fees
Form of any report

STEP 2: OBTAIN BACKGROUND INFO OF THE CLIENT

 To have better understanding about client, the auditor should obtain:

 Client’s history, owner and management of the company.
 Major activity, organizational structure and management integrity.
 Reliability of the work done by internal auditor.

 The auditing standards also advocate that the auditor should obtain information about
FOUR broad areas of a client’s business and its environment:
 Industry conditions, regulatory environment and other external factors including the
applicable financial reporting standards.
 Nature of the entity including business operations (eg: products or services and
geographic dispersion), investments (eg: acquisitions and mergers), financing (eg: debt
structure) and financial reporting (eg: accounting principles and revenue recognition).
 Objectives and strategies and related business risks such as industry development, new
products or services, expansion of the business and use of IT.
 Measurement and review of the entity’s financial performance (eg: key ratios, key
performance indicators, employee performance measures, use of forecasts, analyst
reports and credit rating reports, competitor analysis and period-on-period financial
performance).

 Tour of client’s facilities

 Identify related party information such as government regulation.
 Determine the requirement of an expert work / outside specialists.

STEP 3: OBTAIN INFO ABOUT CLIENT’S LEGAL OBLIGATION

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 The auditor should examine client’s Constitution of Company (previously known as MOA
and AOA), minutes of BOD’s meeting, minutes of shareholders’ meeting and contracts.

STEP 4: PERFORM PRELIMINARY ANALYTICAL PROCEDURE

 Purpose:
- To assist planning the nature, timing and extent of the audit program.
- To identify potential errors.
- To determine the area that requires detailed checking and substantive test.

 Once sufficient information has been obtained, audit procedures will be selected. The
selection should concentrate on obtaining sufficient appropriate evidence about the
assertions underlying the accounting records. It involves:
 Analytical procedures - It involves analysis of ratios, study of relationships between
financial and operating information of the client, and comparisons with similar companies
in the industry. Those procedures are used to understand client business and industry to
identify possible misstatements, reduced detailed test that able to increase the
effectiveness and reduce audit cost.
 Evaluation of the internal control structure (tests of controls and assessing control risks).
 Substantive test of transactions and account balances including statistical sampling
techniques. Substantive tests emphasise clerical proficiency and deal with specific data,
accuracy and reliability.

STEP 5: SET MATERIALITY & ACCEPTABLE AUDIT RISK

 Definition of materiality:
“Information is material if its omission/misstatement influences the economic decisions of
users taken on the basis of financial statement.”

 Materiality depends on the size of the item/error judged in the particular circumstances
of its omission/misstatement.
 Materiality also considered as a criterion for determining the items require attention and
detail examination.

 Materiality can be divided into two categories:

- Quantitative: Financial effects caused by the misstatements (eg: percentage of
production or sales volume, percentage of total capacity).
- Qualitative: The potential effect of the misstatement on trends especially trends in
profitability (eg: non-compliance with the laws and regulations, use of
inappropriate/inadequate accounting policy, cumulative small amount of
misstatements)

 Definition of audit risk:

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 “Risk that auditor gives inappropriate audit opinion on financial statements that are
materially misstated.”

 Types of Risks
Inherent Risk  Risk that material misstatement will occur due to the absence of internal
control.
 It is influenced by the business characteristics of the client and the
industry it operates.
 For example: amount derived from a complex calculations / accounting
estimates posses greater risks of material misstatement than amount
derived from routine or factual data.
Control Risk  Risk that material misstatements will not be detected/prevented on a
timely basis by entity’s internal control.
Detection  Risk that substantive audit procedures performed will not detect a
Risk material misstatement that exists in an account balance/classes of
transactions.
 It also relate to the nature, timing and extent of the auditor’s procedure.
The risk can be controlled through the design and scope of audit
procedure.

 How to assess audit risk?

Inherent Risk  Knowledge of client’s business
 Management integrity
 Client motivation to make mistake
 Client knowledge of accounting standards
Control Risk  Segregation of duties and inherent limitation of internal control
Detection  Decide on nature, timing and extent of the audit
Risk

 Examples of circumstances indicating increase risk of error & fraud

- Analytical procedure disclose major differences from expectations
- Unreconciled differences between a control account and subsequent record
- Confirmation request disclose significant differences or a lower than expected
response rate
- Transactions lack of proper documentation or authorization
- Error known to the client personnel are not voluntarily disclosed to the auditor

 How to minimize the audit risk?

- Plan and delegate the audit with due care
- Audit evidence are properly documented
- Audit staff selected are competent to perform the audit with due care
- Sample selected should represent the whole population
- Avoid misunderstanding with client
- Good communication between audit staff to solve the problem on timely basis
- The audit fees should be based on the work done

STEP 6: UNDERSTANDING IC AND ACCESS CONTROL RISK

 Auditor needs to access client’s business risk by having thorough understanding of:

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 The industry  Critical issue facing by the industry
 Significant business risk
 Structure and profitability of the industry
 Relationship between industry and broad economic, business
environment
The client’s business  Client’s position within the industry
 Client’s threats and competitions
 Client’s measurement of performance

 Auditor should assess the possibility of fraud and error.

 Error vs Fraud: Error is an unintentional misstatement on the FS whereas fraud is
intentional. Fraud occurs when misstatement is made and there is both of its falsity and
intent to deceive.

 Management Letter - one of the ways for auditor communicate with client relating to matters
done during an audit which is intended to inform client on any recommendations to improve
business operation effectively.

 Procedures in preparing management letter:

 Discuss weaknesses in IC with client verbally.
 Follow up with a formal letter which will include recommendations for improvements.
 Follow up at the next visit to the client.

STEP 7: DEVELOP OVERALL AUDIT PLAN AND AUDIT PROGRAM

 Audit program
“A document which contains audit procedures to be performed by the auditor.”

 Purpose of audit program:

 To provide a set of detailed step by step audit procedures for each auditable areas and
guidance for a systematic audit approach.
 As a means to control and record proper execution of the work before arriving at an
opinion of the financial statements.

When developing an audit program, the internal auditor and its associated audit team should
start with outlining the audit's objectives, goals and obligations.

 Audit program objectives help direct planning of the audit report and are based on the
policies, procedures and guidelines unique to the company. These objectives may relate to
and outline how the auditors will maintain efficiency, professionalism and a specific code of
conduct during audit procedure.

 Advantages of audit program:

 Provide a clear set of instruction on work to be carried out
 Ensure completeness of audit work
 Ensure no duplication of audit work
 Evidence of work done in available for use as defence in court
 Review of works by senior/partners can be easily done
 Reduces time of audit work

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