Audit Planning

“
Planning is almost 50%
completion of the job.

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Audit Planning
⬥ Involves overall audit strategy and audit plan.

⬥ Setting:
❑ What to do?
❑ When to do?
❑ How much to do?

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 Benefits of audit planning
⬥ Ensure that appropriate attention is devoted to the
important areas of the audit
⬥ Identify potential problems and resolve them on timely
basis
⬥ Ensure that audit is properly organized and managed
⬥ Assign works to engagement team members properly
⬥ Facilitate direction and supervision of team members
⬥ Facilitate review of works.
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Benefits of audit planning

Right Right
work conclusion
done drawn

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Audit Planning

Audit Guides the Audit

development of
Strategy Plan
Scope Nature
Timing Timing
Direction Extent

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Audit Planning
Audit Strategy Audit Plan
-Materiality
-Risk -Risk assessment process
-Understanding the entity -Further audit procedure
through understanding ICS -other procedure
-Audit approach
-Use of Experts /Internal Audit
- Timing
-Team
-Budget
-Deadline 7
Materiality
⬥ Information is material if its omission or misstatement
could influence the economic decisions of the users
taken on the basis of the F/S.
⬥ Materiality provides a threshold or cut-off point.
⬥ An item can be material due to:
⬦ Amount/quantity
⬦ Nature
⬥ “An account with immaterial balance may contain
material misstatements” 8
Materiality
⬥ Materiality is a relative concept rather than absolute

⬥ Common range of standard:

⬦ Revenue: 0.5%-1%
⬦ PBT: 5%-10%
⬦ Gross Assets: 1%-2%

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Steps in applying materiality
Set Allocate Estimate Estimate Compare
preliminary preliminary total combined combined
judgement judgement to misstatement misstateme misstatement
about segments s in segment with
nts
materiality preliminary
or revised
one

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Steps in applying materiality
Set Allocate Estimate total Estimate Compare
preliminary preliminary misstatements combined combined
judgement judgement to in segment misstatements misstatement
segments with preliminary
about or revised one
materiality

Gross asset
1% - 2%

e.g. GA
50,00,000

Materiality
=50,000
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Steps in applying materiality
Set preliminary Allocate Estimate total Estimate Compare
judgement about preliminary misstatements combined combined
materiality in segment misstatements misstatement
judgement to
with preliminary
segments or revised one

Gross asset Items Amount Materiality

Cash 100000 1000
1% - 2% Receivable 5,00000 5000 Tolerable
Inventor 900000 9000
e.g. GA error
50,00,000 PPE 2500000 25000
Others 500000 5000
Total 50,00,000 50,000
Materiality
=50,000
Materiality= 1% 12
Steps in applying materiality
Set preliminary Allocate Estimate Estimate Compare
judgement about preliminary total combined combined
materiality judgement to misstatements misstatement
misstatement
segments with preliminary
s in segment or revised one

Items Amount material. Sample Misstatement Misstatement

Size (sample) (population)
Cash 100000 1000 50000 2000 4000*
Receivable 5,00000 5000 - -
Inventory 900000 9000 - -
PPE 2500000 25000 - -
Others 500000 5000 - -
Total 50,00,000 50,000
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Steps in applying materiality
Set preliminary Allocate Estimate total Estimate Compare
judgement about preliminary misstatements combined combined
materiality judgement to in segment misstatement
misstatements
segments with preliminary
or revised one

Items Amount Materiality Sample Misstatement Misstatement

Size (sample) (population)
Cash 100000 1000 50000 2500 5000
Receivable 5,00000 5000 100000 2500 12500
Inventory 900000 9000 500000 7000 12600
PPE 2500000 25000 1000000 6000 15000
Others 500000 5000 100000 00 00
Total 50,00,000 50,000 45100
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Steps in applying materiality
Set preliminary Allocate Estimate total Estimate Compare
judgement about preliminary misstatements combined combined
materiality judgement to in segment misstatements misstatement
segments with preliminary
or revised one

Items Amount Materiality Sample Misstatement Misstatement

Size (sample) (population)

Cash 100000 1000 50000 2500 5000*

Receivable 5,00000 5000 100000 2500 12500*
Inventory 900000 9000
Material
500000
!
7000 12600*
PPE 2500000 25000 1000000 6000 15000
Others 500000 5000 100000 00 00
Total 50,00,000 50,000 15
45100*
 Performance Materiality
⬥ Performance materiality is the amounts established by
the auditor below the normal materiality of financial
reports to decrease the probability that the aggregate of
uncorrected and undetectable misstatements exceeds the
level of financial reports as a whole.

⬥ It is generally the amount set below the overall materiality.

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Performance materiality

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Source: Masiulevičius, A.; Lakis, V. 2018
 Differentiate:
Material account balance Account balance materiality

⬥ Size of the recorded account ⬥ Tolerable error/misstatement

balance

⬥ upper limit on the amount ⬥ Lower limit that can exist in an

by which an account can be account balance for it to be
overstated. considered materially
misstated.

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 Relationship between Materiality and
Evidence
⬥ Inverse relationship Materiality
This is the same as saying that it takes
more evidence to obtain reasonable
assurance that any statement in the
recorded inventory balance does not
exceed $100,000 than it does to be
assured the misstatement does not
exceed $200,000.
Evidence
It is also generally correct to say that the
larger or more significant an account
balance is, the greater the amount of
evidence needed (direct relationship). This
is the same as saying that more evidence is
needed for inventory when it represents 30
percent of total assets than when it
represents 10 percent.
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Risk
Business Risk Audit Risk

⬥ Financial Risk ⬥ Inherent Risk Company Specific/

⬥ Operational Risk ⬥ Control Risk ROMM

⬥ Compliance Risk ⬥ Detection Risk Auditor related

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 Audit Risk Model
⬥ Audit Risk is the risk that an auditor expresses an inappropriate
opinion on the financial statements.

Audit Risk = Inherent Risk x Control Risk x Detection Risk

Inherent risk refers to the risk that could not be protected or detected by the entity’s
internal control. E.g. PESTEL effect
Control Risk is the risk of a material misstatement in the financial statements arising due
to absence or failure in the operation of relevant controls of the entity.
Detection Risk is the risk that the auditors fail to detect a material misstatement in the
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financial statements.
 Audit Risk Model
AR = IR x CR x DR If IR=100% ; CR=100%; DR=10%, AR=?
If IR=60% ; CR=60%; DR=10%, AR=?
10%
3.6%
If IR=0% ; CR=0%; DR=10%, AR=? 0%

AR If IR=100% ; CR=100%; AR=10%, PDR=?

DR = 10%
IR x CR If IR=60% ; CR=60%; AR=10%, PDR=? 28%
If IR=0% ; CR=0%; AR=10%, PDR=? ∞%

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A PICTURE IS WORTH
A THOUSAND WORDS
A complex idea can be
conveyed with just a single
still image, namely making
it possible to absorb large
amounts of data quickly.

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 Understanding the entity and Its Environment

Why How What

- Past experience
- To assess risks Entity
-Firm
Internal-Management, system, control,
partner, Manager, Industry
accounting policies
- To comply with expert, Last year team
External-Shareholders, trading partners,
standard - Client: sales/purchase, financing, related parties
Discussion, Observation, website,
brochure Product/Services /process
- External Sources: The industry- Market, competition,
Industry survey, credit technology
reference agency, regulator, Laws and regulation 27
internet etc.
 Audit Approach
An audit approach is the strategy used by an auditor to
conduct the audit. It depends on:

⬥ The nature of the client and the industry

⬥ The scope of the engagement
⬥ The adequacy of the client's system of controls
⬥ The level of cooperation received from the client

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 Audit Approach
General audit approaches depend on circumstances Like:

❖ When the financial reporting system is weak (Substantive test)

❖ When the internal control system is strong (ToC)
❖ When the focus is on client risk (Most concern areas).
❖ When the focus is on the balance sheet (B/S items, not I/S).

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 Use of experts
⬥ Valuation of certain services
⬥ Determination of quantities or physical condition of asset
⬥ Determining the amount using specialized method
⬥ Measurement of work completed
⬥ Life expectancy in life insurance
⬥ Legal opinion

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Use of Internal audit

Organizatio Technical
nal status competence

Scope of Due
function professional
care

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Audit team
⬥ Experience
⬥ Competence
⬥ Specialized knowledge
⬥ Team hierarchy
⬥ Reviewer
⬥ Ensure that the work is done at right level

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Timing
⬥ Interim audit: Income statement

⬥ Annual/Final audit Balance Sheet

Other considering factors:

⬥ Income statement in the last couple of months
⬥ ICS effective in the period
⬥ Inventory/Receivable, Roll forward satisfactory?

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Budget and Deadline
⬥ When is the deadline?

⬥ How much is the budget ?

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Audit Plan
⬥ Risk assessment process
⬥ Further audit procedure
⬥ other procedure

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Risk assessment process

ROMM

Assertions
F/S level
Level

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 ROMM-Assertion Level
⬥ Risk of material misstatement at the assertion level
consists of the inherent risk and control risk. Inherent risk
and control risk are related to company, its environment
and its internal control and the auditor assesses those risks
based on evidence he or she obtains.

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 ROMM-F/S Level
⬥ Risk of material misstatement at the financial statement
level relate pervasively to the financial statements as a whole
and potentially affect many assertions. For example:
inventory is overstated. This misstatement has the following
pervasive impact: COGS understated

Profit overstated

Tax Overstated

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OE overstated
Risk assessment procedure
1. Inquiries of management and others
-Operating personnel not involved in the financial reporting
process
-Employees with different level of authority
-employees involved in dealing unusual or complex
transactions
-In-house legal counsel
-Chief ethics officer
-Internal auditor
-Audit committee
2. Analytical procedure: Comparison of information.
3. Observation: process oriented 39
4. Inspection: examining the documents
Further audit procedure

Test of
control

Test of Analytical
Details procedure

Substantive Test

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 Test of control
When applied:
⬥ intended to rely on control
⬥ Unable to obtain sufficient evidence from substantive
procedure i.e. not present at stock count. Now check the
control over stocks.
Conditions:
⬥ must test the ICS
⬥ must obtain evidence that ICS is effective
⬥ must obtain evidence that ICS was in operation throughout
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the period under review
 Substantive Test
⬥ Applied always Substantive
⬥ Depends on:
Test

-level of risk
-reliance on controls
-results of control testing Test of
Analytical
details of
procedure
balance

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Test of details (TOD)
⬥ applicable for higher risky accounts

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Analytical procedure
⬥ applicable for large volume of transactions that
tend to be predictable over time.

Ratio Gross profit margin

Analysis Receivable turnover
Invertor turnover
Current ratio
Quick ratio
Gearing ratio (debt to equity)
Solvency ratio
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 Analytical procedure
⬥ Five types of AP:
1. Compare client data and industry data
2. Compare client data with similar prior period data
3. Compare client data with client determined expected result
4. Compare client data with auditor determined expected result
5. Compare client data with expected result using non-financial
data (e.g. wages=hours * wage rate; Hotel revenue=no of
room*room rent*occupancy rate)
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 Analytical procedure- Exercise
The following information is extracted from the financial statements of Beximco pharma
Ltd. for the year ended 31st December 2015.
Requirements: determine whether there is any risk of material misstatement in the financial
statement of Beximco pharma.

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 Analytical procedure- Solution

Manipulated areas:
Cost of sales
Operating expense
Other expense 47
 Other procedure
⬥ Walk through test
A walk-through test is used by an auditor to follow each step in a
transaction. The examination starts with the triggering business
transaction and compares each subsequent step to the procedure
for how the transaction is supposed to be processed. The intent
behind this test is to determine the reliability of a system, and
whether there are any issues that should be brought to the
attention of management.
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 Other Procedure
⬥ Directional Testing
Test to discover error (overstatement or understatement) and
omission (understatement). It is termed as directional testing
as it will go for one direction only i.e. overstatement or
understatement.

It uses double entry system to detect misstatements.

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Directional testing

Asset Expense
Overstatement Overstatement

Liabilities Income
understatement understatement

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Directional Testing

⬥ Test automatically done:

1. Revenue is not overstated
Asset 2. Expense is not understated
Overstatement
3. Other asset is not understated
4. Liability is not overstated

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 Tracing
⬥ Tracing refers to first selecting an accounting transaction (a
source document) and then following it into the journal or
ledger or F/S. The direction of testing in this case is from the
source documents to the journals or ledgers and tests whether
transactions that occurred are recorded (completeness) in the
accounting records.

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 Vouching
⬥ Vouching refers to first selecting an item for testing from
the F/S and then examining the underlying source
document. Thus, the direction of testing is from the F/S
back to the source documents. Vouching provides
evidence that items included in the accounting journals or
ledgers have occurred (are valid).

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 Tracing Vs. Vouching

Financial Statements
- Trace Up - Vouch down

- Tracing is the Tracing Vouching - Vouching is the

test of test of Existence
Completeness
Source Documents e.g. Voucher

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THANKS!
ANY QUESTIONS?

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