ACCTG 3220: AUDITING IN CIS ENVIRONMENT
AUDIT PLANNING (Lecture #1)
Importance of Audit Planning
“Plans are worthless but planning is everything.” –
Dwight D. Eisenhower
 Even if the auditor or auditing team has already
reviewed the same firm or client with the same
internal controls for the current year, it is critical
to interview as many workers as possible to
avoid assessment failure. Audit planning should
be continuous and cumulative.
 An engagement that is effectively planned could
eliminate over-or-under-testing, lead to more
relevant documentation, and help reduce the
likelihood of audit failure or a potential
professional liability claim, saving time in the
long run.
Understanding the Client
PSA 315
 Requires the auditor to obtain sufficient
understanding of the entity and its environment
including its internal control
 Such understanding involves obtaining
knowledge about the entity’s
o Industry, regulatory, and other external
factors, including financial reporting
framework; - Full PFRS PFRS for SMEs etc
o Nature of the entity, including its selection
and application of accounting policies; - mngt
decides the accounting policy; accounting
standards
o Objectives and strategies and the related
business risks that may result in a material
misstatement of the financial statements; -
during interview with managers and
employees; management letter points
 Such understanding involves obtaining
knowledge about the entity’s
o Measurement and review of the entity’s
performance; and
o Internal Control
Importance of Understanding the Client
 To identify and understand the events,
transactions and practices that may have a
significant effect on the financial statements
 To evaluate the reasonableness of the client’s
estimates
 To understand entity’s objectives and
strategies, and the related business risks
 To obtain understanding of entity’s
measurement of performance
Sources of Information
 Review of prior year’s working papers
 Tour of the client’s facilities
 Reading relevant books, periodicals, and
other publications
 Discussion with people within and outside the
entity
 Reading corporate documents (e.g. minutes
of meeting) and financial reports
Uses of Information Obtained
 Assessing risks and identifying potential
problems
 Planning and performing the audit effectively
and efficiently
 Evaluating audit evidence as well as the
reasonableness of client’s representations
and estimates
 Providing better service to the client – focus
on adding value to the client not just to
comply or finish the audit
Additional Consideration on New Engagements
 A firs-time audit engagement requires more
work than a repeat engagement. This is
because there are additional audit
procedures that need to be performed in
connection with the opening balances. –
review prior year documentation of papers, fs
etc.
PSA 510 requires the auditor to sufficient
appropriate audit evidence that:
 The opening balances do not contain
misstatements that materially affect the
current year’s financial statements;
 The prior period’s closing balances have
been correctly brought forward to the
current period or, when appropriate, have
been restated; and
 Accounting policies are appropriate and have
been consistently applied
Understanding the Internal Control
 To obtain sufficient understanding of the
entity’s internal control systems
 ACCTG 3220: AUDITING IN CIS ENVIRONMENT
 To anticipate the type of potential
misstatements that can occur in the financial
statements
Developing an Overall Audit Strategy
 How much evidence to accumulate?
 What are the procedures to be performed
 When should the procedures be performed?
Materiality
 Information is material if its omission or
misstatement could influence economic decision
of users taken on the basis of the financial
statements.
 In audit, materiality may be viewed as:
o The largest amount of misstatement that the
auditor could tolerate in the financial
statements; or
o The smallest aggregate amount that could
misstate any one of the financial statements
 Materiality is a matter of professional judgment
and necessarily involves quantitative factors
(amount of item in relation to the financial
statements) and qualitative factors (the nature
of misstatement)
Using Materiality in an Audit
Step 1: Determine the Overall Materiality –
Financial Statement Level (Planning Phase)
 The auditor should determine the amount of
misstatement that could be material to the
financial statements taken as a whole.
 The auditor should consider materiality in
terms of the smallest aggregate level of
misstatement that could distort any one of
the fs.
 Statement of Financial position: 500k
Statement of Financial performance: 300k –
overall materiality level
300k < 500k
A common method of estimating the overall
materiality at the financial statement level is
to multiply a financial statement base (total
assets, sales, net income etc.) by a certain
percentage.
Step 2: Determine the Tolerable Misstatement
– Account Balance Level (Planning Phase)
 This is done by allocating the overall materiality
to the financial statement account balances.
 PSAs do not provide specific guidelines as to
how the allocation should be done. This process
is highly subjective and requires the exercise of
great deal of professional judgment.
Performance of Audit Procedures (substantive
testing)…
Step 3: Compare the aggregate amount of
uncorrected misstatements with the overall
materiality (Completion Phase)
Performance Materiality
 It is the reduced level of materiality that auditors
use to both at the fs and account balance level
 When auditing financial statements, it is
common for auditors to exercise prudence by
setting materiality at an amount lower than the
overall materiality
 The extent of the audit procedures is increased
thereby reducing the risk that the amount of
uncorrected and undetected misstatements will
exceed the overall materiality
 1M – overall materiality
65% - percentage of performance materiality
1M * 65% = 650,000 – performance materiality
 The determination of performance materiality
involves the exercise of professional judgment
Bases that can be used to determine the
materiality level
 Annualized financial statements
 Prior year financial statements; or
 Budgeted financial statements of the current
year
Audit Risk
When designing substantive tests, the auditor
should consider 3 main issues
1. What level of assurance does the auditor wish to
attain that the financial statements do not
contain material misstatements? As this level of
assurance increases, the scope of the auditor’s
substantive test also increases (Audit Risk)
2. How susceptible is the account to material
misstatement? As the susceptibility of the
account to material misstatement increases, the
scope of the auditor’s substantive tests also
increases (Inherent Risk); and
 ACCTG 3220: AUDITING IN CIS ENVIRONMENT
3. How effective is the client’s internal control in
preventing or detecting misstatements? As the
effectiveness of the client’s internal control
increases, the scope of the auditor’s
substantive test decreases. (Control Risk)
Audit Risk Model
Audit Risk = Inherent Risk * Control Risk *
Detection Risk
Detection Risk – uncontrollable; depends on the
substantive testing used as strategy to decrease
this risk
Audit Risk
 Refers to the risk that the auditor might be
given an appropriate audit opinion on the
financial statements
 Audit Risk is the complement of audit assurance
 If Audit Risk = 5%
Then, Audit Assurance = 95% - confidence level
High confidence lever, low detection risk,
broader substantive testing
Inherent Risk
 The susceptibility of an account balance or class
of transactions to a material misstatement
assuming that there were no internal controls.
 PSA 315 requires the auditor to assess inherent
risk at the financial statement and account
balance or transaction.
Factors that may influence the auditor’s
assessment of the risk of misstatement at the
financial statement level include:
 The management integrity
 Management characteristics
 Operating characteristics
 Industry characteristics
Factors affecting inherent risk at the account
balance level may include the ff:
 Susceptibility of the account to theft
 Complexity of calculations related to account
 The complexity underlying transactions and
other events
 The degree of judgment involved in determining
account balances
Control Risk
 Control risk is directly related to the condition of
the entity’s internal control system.
 If the entity’s internal control is effective, then
the risk that the control will fail to detect or
prevent material misstatement (control risk)
decreases.
Detection Risk
 The risk that an auditor may not detect a
material misstatement that exists in an assertion
 The more effective substantive test are, the
lower misstatement the exists in assertion
Using the Audit Risk Model
1. Set the acceptable level of Audit Risk (Audit
Planning)
2. Assess the level of Inherent Risk (Audit Planning)
3. Assess the level of Control Risk (Consideration of
Internal Control)
4. Determine acceptable level of Detection Risk
(Performing Substantive Tests)
Acceptable Level of Detection Risk = Acceptable
Level of Audit Risk
Inherent Risk * Control Risk
From this equation, we can conclude that for
a given level of Audit Risk, there is an inverse
relationship between the Acceptable level of
Detection Risk and the Assessed level of
Inherent and Control Risk
Designing Substantive Tests
 Designing substantive tests depends on the
acceptable level of detection risk; a after
consideration to the assessment of inherent
and control risks
 As the acceptable level of detection risk
decreases, the assurance provided by
substantive tests increases.
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