Chapter PHASE I -. RISK ASSESSMENT: PLANNING THE AUDIT AND DEVELOPMENT OF OVERALL AUDIT STRATEGY Expected Learning Outcomes : After studying this chapter, you should be able to: 4 4. Explain the nature, scope and benefits of audit planning. & Unclerstand the concept of materiality as applied to financial audit. 3. Know the levels of planning for the audit such as: ¢ Establishment of overall audit strategy, and © Development of detailed audit plan 4. Describe the process, benefits and documenting the overall audit strategy 5. Explain the significant matters embodied in the detailed audit plan * such as the Scope, objectives, timing and required communications : e «Direction, supervision and review of audit work done % 6. Understand the‘critical matters in engagement planning including, but not limited to, the following: q Application of analytical procedures « Establishment of audit team Consideration of work by other auditors / parties Assessment of going concern assumption, related parties; © | client's legal obligations a Preparation of initial audit program, time budget t 2G. Scanned with CamScannerCHAPTER 3 PHASE I - RISK ASESSMENT: PLANNING THE AUDIT AND DEVELOPMENT OF OVERALL AUDIT STRATEGY PLANNING THE AUDIT Nature and Scope of Audit Planning Audit planning involves the establishment of the overall audit strategy for the engagement and developing an audit plan, in order to reduce audit risk to an acceptably low level. Planning involves the engagement partner and other key members of thé engagement team to benefit from their experience and insight _and to enhance the effectiveness and efficiency of the planning process. The nature and extent of planning activities will vary according to the size and complexity of the entity, the auditor's previous experience with the entity, and changes in circumstances that occur during the audit engagement. Planning is a continuous and iterative process that often begins shortly after or in connection with the completion of the previous ‘audit and continues until the completion of the current audit engagement. However, in planning an audit, the auditor considers the timing of certain planning activities and audit procedures that need to be completed prior to the performance of further audit procedures. For example, the auditor plans the discussion among engagement team members, the analytical procedures to be applied as risk assessment procedures, the obtaining of a general understanding of the legal and regulatory framework applicable to the entity and how the entity is complying with that framework, the determination of materiality, the involvement of experts and the performance of other risk assessment procedures prior to identifying and assessing the risks of material misstatement and performing further audit procedures at the assertion level for classes of transactions, account balances, and disclosures that are responsive to those risks. Scanned with CamScanner40 Chapter 3 Benefits of Audit Planning i terminati ted_nature, jit _plannin, nerally involves the determination of the expecte ure, ae ca catent of the audit. Among the benefits derived from audit planning are the following: (a) It helps ensure that appropriate attention is devoted to important areas of the audit. (b) It aids in identifying potential problems and resolving them on a timely basi (c) Ithelps ensure that the audit is properly organized, managed and performed in an effective and efficient manner. (d) It assists in-the proper assignment and review of the work of the engagement team members. (€) It helps coordinate the work to be done by auditors of components and other parties involved such as experts, specialists, etc. Concept of Materiality Applied to Audit Planning Assuring that the audit is conducted in a quality manner is paramount to fulfilling the users’ expectations about the approach and methodology used by the auditor, And one of the drivers of audit quality is the auditor’s thorough understanding and effective application of the concept of materiality in conducting the audit. \ Materiality provides a quantitative threshold or Cut-off point, rather than being a primary qualitative characteristic, which information must have if it is to e useful. ‘The auditor establishes materiality level based on his Professional judgment so as to detect quantitatively material misstatements, Information is material if its omission or misstatement could influence the economic decisions of users taken on the basis of the financial statements, When establishing overall audit Strategy, the auditor shall determine materiality for the financial statements as a whole. If, in the specific circumstances.of the entity, there is one or more particular classes Of transactions, account balances of disclosures for which material misstatements of lesser amounts that the materiality for the financial statements as a whole could be reasonably expected to influence the economic decisions of users taken on the basis of the financial misstatements, the auditor shall also determine the materiality level(s) to be applied to those particular classes of transactions, account balances or disclosures. Scanned with CamScannerPhase | - Risk Assessment: Planning the Audit and Development .._41 PSA 320, “Materiality in Plannin ; ‘ A 1g and Performing an Audit” establishes standards and deals with the auditor’s responsibility to apply the concept of materiality in planning and performing an audit of financial statements. To reiterate the importance of the concept of materiality to audit, the definition of materiality in accordance with the FRSC’s “Framework for the Preparation and Presentation of Financial Statements” follows: its omission or misstatement could influence cisions of users taken on the basis of the financial er lity depends on the size of the item or error judged in ‘umstances of its omission or. misstatement. Thus, a rovides a threshold or cut-off point rather than being a primary qualitative characteristic which information must have if it is to be useful.” This definition emphasizes the importance of materiality to reasonable users who rely on the statements to make decisions. Auditors, therefore, must have knowledge of the likely uses of their client’s statements and the decisions that are being made. In planning the audit, materiality should be considered by the auditor when: (a) determining the nature,timing and extent of audit procedures, \(b) identifying and assessing the risks of material misstatement; and (©) determining the nature, timing and extent of further audit. ‘The auditor’s determination of materiality is a matter of professional judgment and is ‘affected by the auditor's perception of the financial information needs of users of the financial statements. In this context, it is reasonable for the auditor to assume that users: (a) Have a reasonable knowledge of business and economic activities and accounting and a willingness to study the information in the financial statements with renewable diligence; | (b) Understand that financial statements at prepared mud and audited to levels of materiality; : (c) Recognize the uncertainties inherent in the measurement of amounts based on the use of estimates, judgment and the consideration of future events; and (@) Make reasonable economic decisions on the basis of the information inthe financial statements. Scanned with CamScanner42 Chapter 3 Levels of Materiality The auditor assesses materiality at two levels: First is the overall materiality (or materiality level for the financial ‘statements as a whole) i «Second is the specific materiality (or materiality level for particular classes of transactions. account balances or disclosures) : and in relation to individual account balances, classes of transactions and disclosures. Materiality may be influenced by considerations such as legal and regulatory requirements and considerations relating to individual financial statement account balances and relationships. This process may result in different materiality levels depending on the aspect of the financial statements being considered. 1. Overall materiality Materiality for the financial statements as a whole (overall materiality) is based on the auditor’s professional judgment as to the highest amount of misstatement(s) that could be included in the financial | statements without affecting the economic decisions taken by a financial statement user. If the amount of unconnected misstatements, ividually or in the aggregate, is higher than the overall . | established for the engagement, it would mean that the 1 financial statements are materially misstated. . Overall materiality is based on the common financial information needs of the various users as a group. Consequently, the possible effect of misstatements on specific individual users, whose needs may vary widely, is not considered. | ‘The auditor considers materiality at both the overall financial statement level ) 4 4 | 2. Specific materiality In some cases, there may be a need to identify misstatements of lesser amounts than -overall materiality that would affect the economic decisions of financial statement users. This could, relate to sensitive areas such as particular note disclosures (i¢., management | remuneration or industry-specific data), compliance with legislation or certain terms in a contract, or transactions upon which bonuses are based. It could also relate to the nature of a potential misstatement. PSA 320 likewise requires that performance materiality be set. aa Scanned with CamScannerPhase I~ Risk Assessment: Planning the Audit and Development ._4. Performance Materiality Performance materiality is used by the auditor to reduce the risk to an appropriate low level that the accumulation of uncorrected and unidentified misstatements exceeds materiality for the financial statements as a whole (overall materiality), or materiality levels established for particular classes of transactions, account balances, or disclosures (specific materiality). Performance materiality is set at a lower amount (or amounts) than overall specific materiality. The objective. is to perform more audit work than would be required by the overall or a specific materiality to: ¢ Ensure that misstatements less than overall or specific materiality are detected, so as to appropriately reduce the probability that the aggregate of uncorrected errors and undetected misstatements exceed materiality for the financial statements as a whole; and thus © Provide a margin or buffer for possible undetected misstatements. This buffer is between detected but uncorrected misstatements in the aggregate and the overall or specific materiality. The margin provides some assurance for the auditor that undetected misstatements, along with all uncorrected misstatements, will not likely ‘accumulate to reach an amount that would cause the financial statements to be materially misstated. Performance materiality is set in relation to overall materiality or specific materiality. For example, @ specific performance materiality can be set at a lower amount than overall performance materiality for testing repairs and maintenance expenses if there is a higher risk of assets. not being capitalized. Specific performance materiality may also be used to perform additional work: jin areas that may be sensitive due to the nature of potential misstatements and their occurrence, rather than their monetary size. For example, if overall materiality was set at P200,000 and the audit procedures were planned to detect all errors in excess of P200,000, it is quite possible that an error of say P80,000 would go undetected. If three such errors existed totaling to P240,000, the financial statements would be materially misstated. If performance materiality was set at P120,000, it ‘would be much more likely that at least one or all of the P80,000 errors would be detected. Even if only one of the three errors is identified and corrected, the remaining P160,000 misstatement would still be less than P200,000 and the financial statements as a whole would not be materially misstated. * Scanned with CamScanner44 Chapter 3 How to Determine Materiality a Auditors make a preliminary assessment of materiality of the financial statements as a whole by determining the amount by which they betieve the financial statements could be misstated without affecting users’ decisions, This-amount is called “preliminary judgment about materiality” or “planning materiality”. This judgment need not be quantified but often is, It is called a preliminary judgment about materiality because it is a » professional: judgment and may change during the engagement if circumstances change. The reason for determining “planning materiality” is to help the auditor plan the appropriate evidence to accumulate. If the auditor sets a low peso amount, more evidence is required than for a high amount. In establishing planning materiality or preliminary judgment about materiality, an auditor must also consider any potential effect. a misstatement might have which may be greater than the peso amount involved. A misstatement which may not be material based on quantitative factors but that does not allow a client to meet a condition in a contractual Obligation or expectations of a financial statement user may be considered material. In these instances, amount of planning materiality based on the Users expectations of income or alter those working on the engagement to the potential for these types of material misstatement. Rules of Thumb (For Use as a Starting Point) Overall Specific Performance Materiality is a matter of professional Establish a lower, | No specific judgment rather than a mechanical ‘specific guidance is existence. As a result, no specific guidance materiality provided in the is provided in the PSA. However, profit ‘amount (based on. | PSAs, Percentages from continuing profit from continuing Professional ange from 60% (of operations (3% to 7%) is often used in judgment) for the | overall or speciic Practice as having the greatest significance audit of specific or | materiality), where to financial statement users. f this is not a Sensitive financial | there is a higher Useful measure (such as for a not-for-profit Statement areas. | risk of material entity or where profit is not a stable base), misstatement, up to then consider other bases such as: 85% where the © Revenues or expenditures - 1% to material a 3% : 7 1% 103% a Is © Equity - 3% to 5%, : Scanned with CamScannerPhase I~ Risk Assessment: Planning the Audit and Development ..._48 Other Considerations * When accepting new audit engagement, inquire about the overall materiality.used by the previous auditor. If available, this would help i determi ining whether further audit procedures may be required on 'e opening asset and liability balances. Ensure that any experts employed by the entity (to assist the entity in Preparing the financial statements) or used by the audit team are instructed to use an appropriate materiality level in relation to the work they perform. m o Relationship between Materiality and Audit Risk When planning the audit, the auditor considers what would make the financial Statements materially misstated. The auditor’s assessment of materiality, related to specific account balances and classes of transactions, helps the auditor decide such questions as what items to examine and whether to use sampling and: analytical procedures. This enables the auditor to select audit procedures that, in combination, can be expected to reduce audit risk to an acceptably low level. There is an inverse relationship between materiality and the level of audit risk, that is, the higher the materiality level, the lower the audit risk and ice versa. The auditor takes the inverse relationship between materiality and audit risk into account when determining the nature, timing and extent of audit procedures For example, if, after planning for specific audit procedures, the auditor determines that the acceptable materiality level is lower, audit risk is increased. The auditor would compensate for this.by either: (a) reducing the assessed level of control risk, where this is possible. and supporting the reduced level by carrying out extended or additional tests of control; or (b) reducing detection risk by modifying the nature, timing and extent of planned substantive procedures. Scanned with CamScanner46 Chapter 3 Figure 31 shows an illustration of a memo on determining. and: using materiality. Figure 3-1 Client: XYZ Company Materiality Assessment The main users of the financial statements are the bank and the shareholders. The materiality number used in the last period was P80,000. Using our professional judgment, we decided to base our materiality on 5% of the profit before tax. Other bases for materiality, such as revenyes, were also considered but it was felt that profit before tax was the most meaningful ‘amount in relation to the identified financial statement users. j For this period, the plan is to, use P100,000 as the overall materiality. The concept of ‘materiality and its use in the audit has been discussed in general two terms with'the client. Mlustrative Memo on Determining and Using Materiality Using professional judgment, and the types of misstatements identified in previous audits, overall performance materiality has been set at P75,000. A specific materiality for the local sales taxes paid has been set at P10,000 as we are required to audit and report on this amount to the local govemment. Preparedby: Date: Reviewed by: Date: SEC Requirements Relative to Materiality (Amended SRC Rule 68) cima On test of materiality, in case of a disclosure deficiency or inconsistency, information is material if it involves a transaction, amount or account that represents 10% or more of the total of related accounts oF transactions in the financial statements. The test to be used shall be 5% for companies under groups A & B categories. In case of a misstatement or error, it shall be material if the amount of misstatement or error represénts 5% or more of the total of rohit accounts or transaction in the financial statements. The test to be shall be 2% for companies under groups A & B categories. 3 Scanned with CamScannerPhase I~ Risk Assessment: Planning the Audit and Development .._ 47! (pmlaee hall be determined based on the classification and foe a4 on the face of financial statements such as current assets, ‘urrent assets, current liabilities, non-current liabilities, equity items, Tevenues, cost of sales, cost of service, administrative expenses or operating expenses, as the case may be. SEC Requirements for Independent Auditors of Regulated Entities . 7 SEC requires the following regulated entities to be, audited by independent auditors by the Commission under the appropriate category: Group A (1) Issuers of registered securities which have sold a class of securities Pursuant to a registration under Section 12 of the Securities Regulation Code (SRC) except those issuers of registered timeshares, proprietary and non-proprietary membership certificates which are covered in Group B. (2) Issuers with a class of securities listed for trading in an Exchange; (3) Public companies or those which have total assets of at least Fifty million pesos (P50,000,000) or such other amount as the Commission shall-prescribe, and having two hundred (200) or more holders each holding at least One hundred (100) shares of a class of its equity securities. Group B (1) Issuers of registered timeshares, proprietary and non-proprietary membership certificates; (2) Investment Houses; (3) Brokers and Dealers of securities; (4) Investment companies; (5) Government Securities Eligible Dealers (GSEDs); (6) Universal Banks Registered as Underwriters of Securities; (7) Investment Company Advisers; (8) Clearing Agency and Clearing Agency as Depository; (9) Stock and Securities Exchange/s; (10) Special Purpose Vehicles registered under the Special Pu Vehicle act of 2002 and its implementing rules; poe Scanned with CamScanner48 Chapter 3 (11) Special Purpose Corporations registered under the Securitization ag of 2004 and its implementing rules; (12) Such other corporations which may be required by law ‘to be supervised by the Commission. Group C (1) Financial Companies; (2)-Lending Companies; 3) Transfer Agents; (4) Foundations and other non-stock non-profit organizations which solicit or received donations or contributions or with fund balance aggregating to more than’P10 million at any given year; and (5) Large corporations or those with total assets of more than P350. million or total liabilities of more than P250 million. Group D (1) Companies not included above but are mandated by other regulatory agencies to have an independent auditor accredited by the Commission. © For Groups A and B, both the independent auditor and auditing firms (if applicable) shall be accredited by the Commission. © For Group C, the accreditation of the auditing firms shall be sufficient. However, an individual independent auditor shall be accredited by the Commission as such, © Accreditation under Group A shall be considered a general accreditation which shall allow the independent auditor to also audit companies under Groups B, C and D. Independent auditors with Group B accreditation can likewise audit companies under Groups C and D. Accordingly, Group C accredited independent auditors are allowed to audit Group D companies. _d Scanned with CamScannerPhase I~ Risk Assessment: Planning the Audit and Development .._49 LEVELS OF AUDIT PLANNING : The two levels of planning for the audit are L _ Establishment of overall audit strategy, and I. _ Development of detailed audit plan THE OVERALL AUDIT STRATEGY ‘The Process of Establishing the Audit Strategy PSA 300 requires that the auditor establishes the overall strategy for the audit. This overall audit strategy sets the scope, timing and direction of the audit and guides the development of ihe more detailed audit plan. In developing the audit strategy, the auditor considers the results of thé preliminary activities described in the preceding section. The process of establishing the-audit strategy involves A. Identifying the characteristics of the engagément that define its scope. Examples are: 1. The financial reporting framework 2. Industry specific reporting aed 3. The locations of the components of the efttity. B. Ascertaining the reporting objectives of the engagement to plan the timing of the audit and the nature of the communication required such as: 1. Deadlines for interim and final reporting, and 2. - Key dates and organization of meetings with management and those charged with governance to discuss the nature and extent of audit work. 3. Discussion with management regarding the expected communication on the status of audit work throughout the engagement. C. Considering the significant factors and experience that will determine the focus and direction of the engagement teams efforts, such as: 1. Determination of appropriate materiality levels 2. Preliminary identification of areas where there may be higher risks of material misstatement. 3. Preliminary identification of material components and ‘account balances. Scanned with CamScanner“ay 50__Chapter 3 : 4, Evaluation of ‘whether the auditor. may plan to obtain evidence regarding the effectiveness of internal control, and 5. Identification of recent significant entity-specific, industry, financial reporting or other relevant developments. D. Determining whether there are significant business development. affecting the entity such as: a. Significant industry development (e.g. changes in industry regulations and new reporting requirements.) b. Significant changes in information technology and business processes, key management, acquisition, mergers. c. Significant changes in the financial reporting framework such as changes in accounting standards. d. Significant changes in the legal environment. E. Determination of the nature, timing and extent of resources required. The audit strategy sets out clearly, in response to the matters identified in the above mentioned process, and subject to the completion of the auditor’s risk assessment procedures: i (a) The resources to deploy for specific audit areas, such as the use of appropriately experienced team members for high risk aréas or the involvement of experts on complex matters; ' (b) The amount of resources to allocate to specific audit areas, such as 1. The number of team members assigned to observe the inventory count at material locations, 2. The extent of review of other auditors’ work in the case of group audits, or 3. The audit budget in hours to allocate to high risk areas; (c) When these resources are deployed, such as whether at an interim audit stage or at key cut-off dates; and (@) How much resources’are managed, directed and supervised, such a5 when team briefing and debriefing meetings are expected to be held, how engagement partner and-manager reviews are expected to take place (for example, on-site or off-site), and whether to complete engagement quality control reviews. (e) Engagement budgeting including time allocation. 4 ——! Scanned with CamScannerE Phase I~ Risk Assessment: Planning the Audit and Development ... 51 The Appendix of PSA 300 lists examples of matters the auditor may consider in establishing the overall audit strategy for an engagement. Many of these matters will also influence the auditor’s detailed audit plan. Benefits of Developing the Audit Strategy © The resources to deploy for specific audit areas, such as the use of appropriately experienced team members for high risk areas or the involvement of experts on complex matters. © The amount of resources to allocate to specific audit areas, such as the number of team members assigned to observe the inventory count at material locations, the extent of review of other auditors’ work in the case of group audits, or the audit budget in hours to allocate to high risk areas; © When these resources are to be deployed, such as ‘whether at an interim audit stage or at key cut-off dates; and «How such resources are managed, directed and supervised, stich as when team briefing and debriefing meetings are expected to be held, how engagement partner and manager reviews are expected to take place (for example, on-site or off-site), and whether to complete engagement quality control reviews. Scanned with CamScanner52° Chapter 3 Q : S. Figure 3-2 presents an illustrative overall strategy memorandum. Figure 3-2 Illustrative Overall Strategy Memorandum Name of Client: XYZ Company Overall Strategy Memo Period end December 31, 20X6 Scope The scope of the audit has not changed this period. Audit to comply with PSAs and the PFRS ‘accounting framework. There have been no changes in PFRS that affect XYZ Company this year. Entity Changes XYZ Company is planning to make sales to other Southeast Asian Countries. Intemet sales are also increasing and XYZ’ IT capabilities will be stretched. XYZ Company, is now selling to Momentus Merchandising. This company is renowned for ‘squeezing profit margins of suppliers in exchange for giving large orders. It also requires suppliers to maintain additional inventories of some products for instant delivery aS required. Risk Our assessment of risk at the financial level is low. Management is not particularly ‘sophisticated but there is a strong commitment to competence; it has introduced a code of ethics and, in general, has a good attitude toward intemal control. Overall Strategy 1. Materiality for the financial statements as a whole will be increased from P80,000 to 100,000 this period to reflect the growth in sales and profitability during the last period. Performance materiality (based on our assessment of audit risk) has been set at P75,000, except for certain account balances. Use the some senior staff as last period and perform the work at the same time. ex ciaaiaascillcanencnsed Perform our risk assessment procedures at the end of August. There are no plans to change any systems at present. =] Scanned with CamScannerPhase I~ Risk Assessment: Planning the Audit and Development . i 4, Atour team planning meeting to be held on November 15, 20X6 we need to: / a) Consider the susceptibility of the financial statements to fraud, b) Emphasize se of professional skepticism by our staff, ¢c) Identify fraud scenarios by employees and management, and ) . Focus on identification of related party transactions that have been growing and expanding our testing. 5. Attend the period-end inventory counts. There are still no ongoing inventory control Procedures. 6. Use David (who is knowledgeable about IT systems) to identify the risks of material misstatement relating to the Intemet sales and whether any relevant intemal controls exist to mitigate such risks. He will al. assess the general LT controls. ‘Audit Partner (signed): Mauricio Cruz Date: October 30,.20X6 IL THE DETAILED AUDIT PLAN Once the audit strategy has been established, the auditor is able to start‘the development of a more detailed audit plan to address the various matters identified in the audit strategy, taking into account the need to achieve the audit objectives through the efficient use of the auditor's resources. Although the auditor ordinarily establishes the audit strategy before developing the detailed audit plan, the two planning activities are not necessarily discrete or sequential processes but are closely inter-related since changes in one may result in consequential changes to the other. The auditor should develop an audit plan-for the audit in order to reduce audit risk to an acceptably low level. The audit plan is more detailed than the audit strategy and includes the nature, timing and extent of audit procedures to be performed by engagement team members in order to obtain sufficient appropriate audit evidence to reduce audit risk to an acceptably low level. Documentation of the audit plan also serves as a record of the proper planning and performance of the audit procedures that can be reviewed and approved prior to the performance of furtlier audit procedures. Scanned with CamScanneria “4 SA Chapters om n : anaget it Likewise, the auditor should determine vacation on the scope a charged with governance imposes any type of !" the audit. This could include: * A description ofthe naiure, timing and extent of planned Fisk assessmen,. Procedures sufficient to assess the risks of material misstatement, 4 determined under PSA. 315, "Understanding, the Entity and iy Environment and Assessing the Risks of Material Misstalement ‘*. A description of the nature, timing and extent of ines ou er audit procedures at the assertion level for each material class of transactions, account balance, and disclosure, as determined under PSA 330, "The Auditor's Procedures in Response to Assessed Risks.” The plait for further audit procedures reflects the auditor’s decision whether to test the operating effectiveness of controls, and the nature, timing and extent of planned substantive procedures; and : * Such other audit procedures required to be: carried out for the engagement in order to comply with PSAs (for example, seeking direct communication with the entity's lawyers). Planning for these audit procedures takes place over the course of the audit as the audit plan for the engagement develops. For example, planning of the auditor's risk assessment procedures ordinarily occurs early in the audit process. However, planning of the nature, timing ‘and extent of specific further audit procedures depends on the outcome of those risk assessment procedures. In addition, the auditor may begin the execution of further audit procedures for some classes of transactions, account balances and disclosures before completing the more detailed audit plan of all remaining further audit procedures. Scope of the Audit Engagement The auditor may consider the following matters when establishing the scope of the audit engagement: , ¢ The financial reporting framework on which the financial information !0 be audited has been prepared, including any need for reconciliations !¢ another financial reporting framework, ¢ — Industry-specific reporting requis industry regulators. Teawirements such as reports manele" © The expected audit coverage, includi ions of components to be included, Se ee Scanned with CamScanner udPhase I~ Risk Assessment: Planning the Audit and Development .._55. The nature of the busi Seria . specialize oni segments to be audited, including the need for le Teporting currency to be used, including any need for curren translation for the financial information audited, : « The need for a statutory audit of stand alone financial statements in addition to an audit for consolidation purposes. The availability of the work of internal auditors and the extent of the auditor's potential reliance on such work. The entity's use of service organizations and how the auditor may obtain eae concerning the design or operation of controls performed by The expected use of audit evidence obtained in prior audits, for example, audit evidence related to risk assessment procedures and tests of controls. The effect of information technology on the audit procedures, ineluding the availability of data and the expected use of computer-assisted audit techniques. The coordination of the expected coverage and timing of the audit work with any reviews of interim financial information and the effect on the audit of the information obtained during such reviews. : The discussion of matters that may affect the audit with firm personnel responsible for performing other services to the entity. . The availability of client personnel and data. Reporting Objectives, Timing of the Audit and Communications Required ‘The auditor may consider the following matters when ascertaining the reporting objectives of the engagement, the timing of the audit and the nature of communications required: The entity's timetable for reporting, such as at interim and final stages. ‘The organization of meetings with management and thése charged with governance to discuss the nature, extent and timing of the audit work. The discussion with management and those, charged with governance regarding the expected type ‘and timing of reports to be issued and other communications, both written and oral, including the auditor's report, management letters and communications ‘to those charged with governance. : The expected nature and timing of communications among engagement team members, including the nature and timing of team meetings and timing of the review of work performed. Scanned with CamScanner56 Chapter 3 ¢ Whether there are any other expected communications with third part including any statutory or contractual reporting responsibilities arising from the audit. Direction, Supervision and Review The auditor should plan the nature, timing and extent of direction and supervision of engagement team members and review of their work. The nature, timing and extent of the direction and supervision of engagement team members; and review of their work vary depending on many factors, including the'size and complexity of the entity, the area of audit, the risks of material misstatement, and the capabilities and competence of personnel performing the audit work. PSA 220 contains detailed guidance on-the direction, supervision and review of audit work. The auditor plans the nature, timing and extent of direction and supervision of engagement team members based on the assessed risk of material misstatement, As the assessed risk of material misstatement increases, for the area of audit risk, the auditor ordinarily increases the extent and timeliness of direction and supervision of engagement team members and performs a more detailed review of their work. Similarly, the auditor plans the nature, timing and extent of review of the engagement team's work based on the capabilities and competence of the individual team members performing the audit work. In audits of small entities, an audit may be-carried out entirely by the audit - engagement partner (who may be a sole practitioner). In such situations, questions of direction and supervision of engagement team members and review of their work do not arise as the audit engagement partner, having personally conducted all aspects of the work, is aware of all material issues. The audit engagement partner (or sole practitioner) nevertheless needs to be satisfied that the audit has been conducted in accordance with PSAs. Forming an objective view on the appropriateness of the judgments made in the course of the audit can Present practical problems when the same individual also performed the entire audit. When particularly complex or unusual issues are involved, and the audit is Performed by a sole practitioner, it may be desirable to plan to consult with other Suitably-experienced auditors or the auditor's professional body. Scanned with CamScannerPhase | ~ Risk Assessment: Planning the Audit and Development ..._ 57 Documentation The auditor should document the overall audit strategy and the audit plan, including any significant changes made during the auditengagement, The auditor's documentation of the overall audit strategy records the key decisions considered necessary to properly plan the audit and to communicate significant matters to the engagement team. For example, the auditor may summarize the overall audit strategy in the form of a memorandum that contains key decisions regarding the overall scope, timing and conduct of the audit. The auditor's documentation of the audit plan is sufficient to demonstrate the planned nature, timing and extent of risk assessment procedures, and further audit procedures at the assertion level for each material class of transaction, account balance, and disclosure in response to the assessed risks. The auditor may use standard audit programs or audit completion checklists. However, when such standard programs or checklists are used, the auditor appropriately tailors them to reflect the particular engagement circumstances. The form and extent of documentation depend on such matters as the size and complexity of the entity, materiality, the extent of other documentation and the circumstances of the specific audit engagement. Communications With Those Charged With Governance and Management The auditor may discuss elements of planning with those charged with governance and the entity's management. These discussions may be a part of overall communications required to be made to those charged with governance of the entity or may be made to improve the effectiveness and efficiency of the audit, Discussions with those charged with governance drdinarily include the overall audit strategy and timing of the audit, including any limitations thereon, or my additional requirements. Discussions with managemént often occur to facilitate the conduct and management of the audit engagement (for example, to coordingte some of the planned audit procedures with the wark of the entity's personnel). Although these discussions often occur, the overall éudit strategy and the audit plan remain the auditor's responsibility. : Scanned with CamScanner58__Chapter 3 Additional Considerations in Initial Audit Engagements For initial audits, additional matters the auditor may consider in developing the overall audit strategy and audit plan include the following: Unless prohibited by law or regulation, arrangements to be made with the previous auditor, liar example, to review the previous auditor's working Papers. Any major issues (including the application of accounting principles or of auditing and. reporting standards) discussed with management. in connection with the initial selection as auditors, the communication of these matters to those charged with. governance and how these matters affect the overall audit strategy and audit plan. © The planned audit procedures to obtain sufficient. appropriate audit evidence regarding opening: balances (see PSA 510, "Initial Audit Engagements - Opening Balances"). © The assignment of firm personnel with appropriate levels of capabilities and competence to respond to anticipated significant risks. © Other Procedures required by the firm's system of quality control for initial audit engagements (for example, the firm's system of quality control may require the involvement of another partner or senior individual to review the overall audit strategy prior to commencing significant audit procedures or to review reports prior to their issuance). Other Critical Matters In Engagement Planning 1. Application of Analytical Procedures in Planning the Audit When used for planning purposes, analytical procedures assist the auditors in planning the nature, timing, and extent of audit procedures that will be used for the specific accounts. The approach used is one of obtaining an understanding of the client's business and transactions, and identifying areas that may represent higher risks. The auditors will then plan'a more thorough investigation of these potential problem areas, and perform'a more effective audit. PSA 520 requires the atiditors to perfarm analytical procedures as a part of the planning process for every audit. Scanned with CamScanner Adbe Phase 1— Risk Assessment: Planning the Audit and Development 59 2. Establishment of an Engagement.or Audit Team ‘An audit team consists of people with different levels of expertise and experience. The team usually is composed of an engagement partner, @ manager, at least one senior, and one or more staff auditors. In determining the number of people who will be assigned to at engagement, an“ auditor normally considers the audit's size and complexity, the availability and experience of personnel, the necessity for special expertise, the opportunity to train personnel, and the continuity and rotation of personnel. An engagement involving an entity in a regulated industry, such as banking, also requires that the major members of the audit team have necessary knowledge and experience in that industry. 3. Consideration of Work Performed by Other Auditors/Parties © Predecessor Auditor ‘The successor auditor's examination may be greatly faci itated by consulting with the predecessor auditors and reviewing the predecessor's working papers. Communication with the predecessor auditors can provide the successor CPA with background information about the client, details about the client's system of internal control, and evidence as to the account balances at the beginning of the year under audit. Auditors are ethically prohibited from disclosing confidential information obtained in the course of an audit without the consent of the client. auditor should obtain the client's consent before The successor from the predecessor auditors. making inquiries unable to obtain’ cooperation from the preceding auditors, or if he feels that the work done by the preceding auditors does not meet the requirements of PSAs, he may have to treat the audit of the. new client, previously audited by other accountants, just as he would the first audit of a client who has never been audited before. If the auditor is Scanned with CamScanner