C H A P T E R 3

PHASE I – RISK
A S S E S S M E N T:
PLANNING THE AUDIT
AND DEVELOPING AN
OVERALL AUDIT
S T R AT E GY
Learning Objectives

At the end of the chapter, student should be able to:

1. Explain the nature, scope, and benefits of audit planning;
2. Discuss the concept of materiality as applied to financial
statement audit;
3. Describe the process, benefits, and documenting of the
overall audit plan; and
4. Explain the critical matters in engagement planning.
Topics:

1. Nature and Scope of Audit Planning

2. Benefits of Audit Planning
3. Concept of Materiality
4. Levels of Materiality
5. Performance of Materiality
6. How to Determine Materiality
7. Relationship Between Materiality and Audit Risk
8. SEC Requirement Relative to Materiality
9. Levels of Audit Planning
10. The Detailed Audit Plan
What is Audit Planning?

Audit planning involves designing an audit plan

and establishing an overall audit strategy for the
engagement to decrease audit risk to an acceptable
level. It includes the engagement partner and other key
members of the engagement team to benefit from their
experience and insights and improve the planning
process's effectiveness and efficiency.
What is Audit Planning?

The nature and extent of planning activities will

vary according to the :

1. Size and complexity of the entity;

2. Auditor’s previous experience with the entity; and
3. Changes that occur during the audit engagement.
What is Audit Planning?

Planning Activities and Audit Procedures:

1. Auditor plans the discussion among engagement team members.
2. The analytical procedures to be applied as a risk assessment
procedures.
3. Obtaining a general understanding of the legal and regulatory
framework applicable to the entity and how the entity is complying
with the framework.
4. The determination of materiality.
5. The involvement of experts and performance of other risk assessment
procedures.
 Benefits of Audit Planning
1. Ensure appropriate attentions is devoted to
important areas of the audit.

2. Aids in identifying potential problems and

resolving them on a timely basis.

3. Helps ensures that the audit is properly

organized, managed, and performed in an
effective and efficient manner.

4. Assists in the proper assignment and review

of the work engagement team members.

5. Helps coordinate the work to be done by

auditors of components and other parties
involved.
What is Materiality?

Materiality provides a quantitative threshold

or cut-off point, rather than being primary
qualitative characteristic, which information
must have if it is to be useful. The auditor
establishes, materiality level based on his
professional judgment so as to detect
quantitatively material misstatements.
PSA 320 “Materiality in Planning and Performing an Audit”

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:

“Information is material if it 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. Thus, materiality provides a
threshold or cut-off point rather than being a primary qualitative characteristics
which information must have if it is to be useful.”
PSA 320 “Materiality in Planning and Performing an Audit”

In planning the audit, materiality should be considered by the auditor

when:

1. Determining the nature, timing, and extent of audit procedures;

2. Identifying and assessing the risks of material misstatements; and
3. Determining the nature, timing, and extent of further audit.
 Materiality for the financial statement as
a whole (overall materiality) is based on
the auditor’s professional judgment as to
the highest amount of the misstatement(s)
Overall
that could be included in the financial
Materiality
statements without affecting the
economic decision taken by a financial
statement user.
Levels of
Materiality
In some cases, there may be a need to
Specific identify misstatements of lesser
Materiality amounts than overall materiality that
would affect the economic decisions
of financial statement users.
 Is used by the auditor
to reduce the risk to an
appropriate low level
that the accumulation
of uncorrected and
• Ensure that misstatements less
than overall specific materiality
are detected, so as appropriately
reduce the probability that the
aggregate of uncorrected errors

Objectives
unidentified and undetected misstatements
Performance misstatements exceeds
materiality for the
exceed materiality for the
financial statements as a whole;
of financial statements as
a whole (overall
and thus

Materiality materiality), or
materiality levels • Provide a margin or buffer for
established for possible undetected
particular classes of misstatements. This buffer is
transactions, account between detected but
balances, or disclosures uncorrected misstatements in the
(specific materiality). aggregate and the overall or
specific materiality.
How to Determine Materiality?

Auditors make a preliminary assessment of materiality of the

financial statements as a whole by determining the amount by which the
believe the financial statements could be misstated without affecting
user’s 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.
 How to Determine Materiality?

Rules of Thumb
(For Use as a
Starting Point)
 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.
 Relationship Between
Materiality and Audit Risk

• 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 vice versa. The auditor
takes the inverse relationship
between materiality and audit risk
into account when determining the
nature, timing and extent of 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

low level of control risk,
where this is possible, and
supporting the reduced
level by carrying out
Relationship extended or additional
Between tests of control: or
• (b) reducing detection risk
Materiality and by modifying the nature,
Audit Risk timing and extent of
planned substantive
procedures.
 ▪ 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 or 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
represents 5% or more of the total of related
SEC accounts or transactions in the financial
statements. The test to be used shall be 2% for
Requirements companies under groups A & B categories.
Relative to
Materiality • Relative accounts shall be determined based on the
classification ad aggregation on the face of
(Amended SRC financial statements such as current assets, non-
Rule 68) current assets, current liabilities, non-current
liabilities, equity items, revenues, cost of sales, cost
of service, administrative expenses or operating
expenses, as the case may be.
 SEC Requirements for Independent Auditors of
Regulated Entities
The 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 s
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, 000.00) 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.
 SEC Requirements for Independent Auditors of
Regulated Entities
The SEC requires the following regulated entities to be audited by independent auditors by the
Commission under the appropriate category:
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 Purpose Vehicle Act of 2002 and it’s implementing rules;

(11) Special Purpose Corporations registered under the Securitization Act of 2004 and its implementing rules;

(12) Such other corporations which may be required by law to be supervised by the Commission.
 SEC Requirements for Independent Auditors of
Regulated Entities
The SEC requires the following regulated entities to be audited by independent auditors by the
Commission under the appropriate category:
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 Group 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.
 SEC Requirements for Independent Auditors of
Regulated Entities
The SEC requires the following regulated entities to be audited by independent auditors by the
Commission under the appropriate category:
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 Group 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.
 Levels of Audit Planning

Overall Audit Detailed Audit

Strategy Plan

a. Identifying the characteristics of the

Scope of the audit engagement.
engagement that define it scope.
b. Ascertaining the reporting objectives of the Reporting objectives, timing of the
engagement to plan the timing, of the audit and nature
audit , and communication required.
of the communication required.
c. Considering the significant factors and experience
that will determine the focus and direction of the Direction, Supervision, and Review
engagement team’s efforts.

d. Determining whether there are significant business

development affecting the entity.
Documentation

e. Determination of the nature, timing, and Communication w/ those charged

extent of the resources required. with Governance & Mgt.
 Additional Considerations in Initial Audit
Engagements
Additional matters auditor may consider in developing the overall audit strategy and audit plan
include the following:
1. Unless prohibited by law or regulations, arrangements to be made with the previous auditor.
2. Any major issues discussed with management in connection with the initial selection as
auditors, the communication of these matters to those charged with governance and these
matters affect the overall audit strategy and audit plan.
3. The planned audit procedures to obtain sufficient appropriate audit evidence regarding
opening balances.
4. The assignment of personnel with appropriate level of capabilities and competence to
respond to anticipated significant risks.
5. Other procedures required by the firm’s system of quality control for initial audit
engagements.
Other Critical Matters in Engagement Planning

Assist the auditors in planning the

nature, timing, and extent of audit
1. Application procedures that will be used for
of Analytical specific accounts. Approach used
Procedures in may be:
1. Obtaining understanding of the
Planning the client’s business and transactions.
Audit 2. Identifying areas that may
represent higher risks.
Other Critical Matters in Engagement Planning

Audit team consists of people

with different levels of expertise
2. Establishment and experience. Teams usually is
of an composed of:
Engagement 1. Engagement partner
2. Manager
Team 3. At least 1 senior auditor
4. One or more staff auditors
Other Critical Matters in Engagement Planning

• Predecessor auditor
3. Consideration • Other CPAs
of Work • Specialists
Performed by • Use of client’s staff
Other • Internal auditors
Auditors/Parties
Other Critical Matters in Engagement Planning

Auditors need to evaluate whether

substantial doubt exists about an
entity’s ability to continue as a
5. Assessment
going concern, based on
of Going procedures planned and
Concern performed to obtain evidence
Assumption about the management assertions
embodied in the financial
statements.
Other Critical Matters in Engagement Planning

▪ Important to the auditor because they

will be disclosed in the financial
statements if they are material.
▪ A related party is defined as an
affiliated company, a principal owner
of the client company, or any other
5. Identification party with which the client deals where
of Related one of the parties can influence the
Parties management or operating policies of
the other.
▪ A related party transaction is any
transaction between the client and the
related party.
▪ Related parties must be identified and
included in the permanent files early in
the engagement.
Other Critical Matters in Engagement Planning

▪ Auditor should review information

relating to prior years.
▪ Review should include:
➢ Minutes of directors and
shareholders’ meetings
6. Clients Legal ➢ Changes in the Article of
Incorporation/By-laws
Obligations ➢ Any significant contracts executed
during the year
▪ Be alert of the following:
➢ Major contracts or agreements
➢ Information about current
situations and future business plan
➢ Authorization of dividends
Other Critical Matters in Engagement Planning

▪ Audit Program is a set of audit procedures

specifically designed for each audit. The
program include both substantive tests and
test of controls.
▪ The audit program is developed in 3 stages:
1. The broad phases of the program can
be outlined at the time of the
7. Completion engagement.
of the Initial 2. Other details of the program can be
identified after the review of the internal
Audit Program control structure and accounting
procedures has begun, and
3. Procedures on specific phases of the
audit can be further challenged and
revised as the work progresses.
▪ On recurring engagements, the program of
the preceding audit should be studied
before preparing the program of the current
audit.
Other Critical Matters in Engagement Planning

▪ A time budget is an estimate of the total

hours an audit is expected to take. It is based
on the information obtained in the first major
step in the audit.
▪ Things to consider are:
1. The client’s size as indicated by its gross
8. Preparation of assets, sales, number of employees
a Time Budget 2. Location of the client facilities
3. The anticipated accounting and auditing
problems
4. The competence and experience of staff
available
▪ The total time budget must be allocated by
the preparation of work schedule indicating
who is to do what and how long it should take
Sample: Time Budget
Other Critical Matters in Engagement Planning

▪ Staff must, therefore,

be assigned with the
9. Assignment
standard in mind.
of Personnel in ▪ Major consideration
the Engagement
affecting staffing is
the need for
continuity from year
to year.
 Engagement Team Conference

▪ PSA 315 requires a discussion among the engagement team members

and a determination by the engagement partner of which matters are
to be communicated to those members not involve in the discussion.
▪ The discussion shall place particular emphasis on how and where the
entity’s financial statements may be susceptible to material
misstatement due to fraud, including how fraud might occur.
▪ Document the significant decisions reached during the discussion
among the engagement team regarding the susceptibility of the
entity’s financial statements to material misstatement due to fraud; and
the identified and assessed risks of material misstatement due to fraud
at the financial statement level and the assertion level.
Other Critical Matters in Engagement Planning

▪ Audit work can always be performed

during the interim period includes the
consideration of internal controls, issuance
of management letter, and substantive
tests of transactions that have occurred to
the interim date.
▪ Interim tests of certain financial statement
balances may also be performed.
10. Scheduling ▪ Performance of other substantive tests is
of Work scheduled near at, and after year-end.
Consideration should be given to these
factors:
1. Deadline of submitting final audit
report and filing of income tax return.
2. Ability of the client staff to submit
required schedules
3. Other audit clients
Planning a Repeat Engagement

Much easier to plan….