Chapter 8 Financial Auditing Slides

8/4/2023
Auditing and Assurance Services

Seventeenth Edition
Chapter 8
Audit Planning and Materiality
Copyright © 2020, 2017, 2014 by Pearson Education, Inc. All Rights Reserved
Learning Objectives (1 of 2)
8.1 Discuss why adequate audit planning is essential
8.2 Make client acceptance decisions and perform initial
audit planning
8.3 Gain an understanding of the client’s business and
industry
8.4 Perform preliminary analytical procedures
Learning Objectives (2 of 2)
8.5 Apply the concept of materiality to the audit
8.6 Make a preliminary judgment about what amounts to
consider material
8.7 Determine performance materiality during audit planning
8.8 Use materiality to evaluate audit findings
1
8/4/2023
Learning Objective 8.1

Discuss why adequate audit planning is essential
Planning (1 of 2)
• There are three main reasons why the auditor should
properly plan engagements:
– Enable the auditor to obtain sufficient appropriate
evidence for the circumstances
– Help keep audit costs reasonable
– Avoid misunderstandings with the client
Planning (2 of 2)
• Much of the early planning of audits deals with
obtaining information to help auditors assess the
following risks:
– Acceptable audit risk
– Client business risk
– Risk of material misstatement
2
8/4/2023
Figure 8.1 Planning an Audit and

Designing an Audit Approach

Make client acceptance decisions and perform initial audit
planning
Accept Client and Perform Initial

Audit Planning (1 of 3)
• Initial audit planning involves four things that should
be done early in the audit:
– Decides whether to accept a new client or continue
serving an existing one
– Identifies why the client wants or needs an audit
– Obtains an understanding with the client about the
terms of the engagement
– Develops the overall strategy for the audit
3
8/4/2023

• Client Acceptance and Continuance
– New client investigation:
 Investigate the company to determine its
acceptability
 New (successor) auditor is required by auditing
standards to communicate with the predecessor
auditor
– Continuing clients:
 Evaluate existing clients annually to determine
whether there are reasons for not continuing to do
the audit

• Identify Client’s Reasons for Audit
– Auditor’s acceptable audit risk may be affected by the
client’s reasons for audit
• Obtaining and Understanding with the Client
– Auditing standards require that auditors obtain an
understanding with the client in an engagement letter
• Develop Overall Audit Strategy
– Develop and document a preliminary audit strategy
that sets the scope, timing, and direction of the audit
and that guides the development of the audit plan

Gain an understanding of the client’s business and industry
4
8/4/2023
Understand the Client’s Business

and Industry (1 of 2)
• Auditing standards require the auditor to perform risk
assessment procedures to:
– Obtain an understanding of the client’s business and
its environment
– Assess the risk of material misstatements in the
financial statements, including inquiries of
management and analytical procedures
Understand the Client’s Business

and Industry (2 of 2)
• Obtaining a good understanding of the following
components allow auditors to develop a strategic
approach to understand the client’s business and
industry:
– Industry and external environment
– Business operations and processes
– Management and governance
– Client objectives and strategies
– Measurement and performance
Figure 8.3 Strategic Understanding of

the Client’s Business and Industry
5
8/4/2023
Let’s Discuss (1 of 7)
• Identify the eight major steps in planning audits.
• What factors should an auditor consider prior to accepting
an engagement?
• Explain the five elements that are part of a strategic
understanding of the client’s business.
• What are the benefits derived from planning audits?
• What is the purpose of an engagement letter?
– What subjects should be covered in such a letter?
• Explain why auditors need an understanding of the client’s
industry.
– What information sources are commonly used by
auditors to learn about the client’s industry?

Perform preliminary analytical procedures
6
8/4/2023
Perform Preliminary Analytical

Procedures (1 of 2)
• Auditing standards require the auditor to perform risk
assessment procedures to:
– Obtain an understanding of the client’s business and
its environment
– Assess the risk of material misstatements in the
financial statements, including inquiries of
management and analytical procedures
Perform Preliminary Analytical

Procedures (2 of 2)
• Auditors are required to perform preliminary analytical
procedures as part of risk assessment procedures to
better understand the client’s business and industry, and
to assess client business risk
• Preliminary analytical tests can:
– Reveal unusual changes in ratios compared to prior
years, or to industry averages
– Help the auditor identify areas with increased risk of
misstatements that require further attention during the
audit
• In the audit of the Worldwide Wholesale Company, you did
extensive ratio and trend analysis as part of preliminary
audit planning. Your analytical procedures identified the
following:
– The rate of inventory turnover has steadily
decreased for 3 years.
• Evaluate the potential significance of this change on the
fair presentation of financial statements.
• State the follow-up procedures you would perform for this
fluctuation to determine whether a material misstatement
exists.
7
8/4/2023

Apply the concept of materiality to the audit
Materiality (1 of 2)
• Auditing standards define materiality as:
– The magnitude of misstatements that individually, or
when aggregated with other misstatements, could
reasonably be expected to influence the economic
decisions of users made on the basis of the financial
statements
Materiality (2 of 2)
• Auditors follow five related steps in applying
materiality:
– Determines materiality for the financial statements as
a whole
– Determines performance materiality
– Estimate the amount of misstatements in each
segment
– Estimate the combined misstatement
– Compare combined estimate with preliminary or
revised judgement about materiality
8
8/4/2023
Figure 8.5 Steps in Applying

Materiality

Make a preliminary judgment about what amounts to
consider material
Materiality for Financial Statements

as a Whole
• Factors affecting preliminary materiality judgment
include:
– Materiality is a relative rather than an absolute concept
– Because materiality is relative, it is necessary to have
benchmarks for establishing whether misstatements
are material
– Qualitative factors affect materiality
9
8/4/2023
• Define the meaning of the term materiality as it is used in
accounting and auditing.
– What is the relationship between materiality and the
phrase obtain reasonable assurance used in the
auditor’s report?
• Explain why materiality is important but difficult to apply in
practice.

Determine performance materiality during audit planning
Determine Performance Materiality

(1 of 3)
• Performance materiality is defined as:

– The amount(s) set by the auditor at less than
materiality for the financial statements as a whole to
reduce to an appropriately low level the probability that
the aggregate of uncorrected and undetected
misstatements exceeds materiality for the financial
statements as a whole
• Performance materiality is inversely related to the amount
of evidence an auditor will accumulate
10
8/4/2023

(2 of 3)
• The process of determining performance materiality is

referred to as the allocation of the preliminary judgment
about materiality to segments
• The determination of performance materiality is based on
professional judgment and reflects the amount of
misstatement an auditor is willing to accept in a particular
segment
– PCAOB refers to this amount as tolerable
misstatement

(3 of 3)
• Auditors face three major difficulties in allocating

materiality to balance sheet accounts:
– Auditors expect certain accounts to have more
misstatements than others
– Both overstatements and understatements must be
considered
– Relative audit costs affect the allocation

Use materiality to evaluate audit findings
11
8/4/2023
Estimate Misstatement and Compare

with Preliminary Judgment
• When auditors perform audit procedures for each
segment of the audit, they document two types of
misstatements:
– Known misstatements
 Those where the auditor can determine the amount of
the misstatement in the account
– Likely misstatements
 Differences between management’s and the auditor’s
judgment about estimates of account balances
 Projections of misstatements based on the auditor’s
tests of a sample from a population
• What is meant by setting a preliminary judgment about
materiality?
– Identify the most important factors affecting the
preliminary judgment.
• Distinguish between the terms performance materiality
and preliminary judgment about materiality.
– How are they related to each other?
• Explain the difference between known and likely
misstatements. Assume the auditor tests a sample of
$100,000 of inventory and finds misstatements totaling
$5,000.
– What is the likely misstatement if the account balance
is $500,000?
12
8/4/2023
• Provide two examples of when an auditor might set a
lower level of performance materiality for a particular class
of transactions, account balance, or disclosure.
• Assume materiality for the financial statements as a whole
is $100,000 and performance materiality for accounts
receivable is set at $40,000.
– If the auditor finds one receivable that is overstated by
$55,000, what should the auditor do?
Copyright
This work is protected by United States copyright laws and is

provided solely for the use of instructors in teaching their
courses and assessing student learning. Dissemination or sale of
any part of this work (including on the World Wide Web) will
destroy the integrity of the work and is not permitted. The work
and materials from it should never be made available to students
except by instructors using the accompanying text in their
classes. All recipients of this work are expected to abide by these
restrictions and to honor the intended pedagogical purposes and
the needs of other instructors who rely on these materials.
13

Chapter 8 Financial Auditing Slides

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Chapter 8 Financial Auditing Slides

Uploaded by

Copyright:

Available Formats

8/4/2023

Auditing and Assurance Services

Learning Objective 8.1

Figure 8.1 Planning an Audit and

Learning Objective 8.2

Accept Client and Perform Initial

Accept Client and Perform Initial

Accept Client and Perform Initial

Learning Objective 8.3

Understand the Client’s Business

Understand the Client’s Business

Figure 8.3 Strategic Understanding of

Learning Objective 8.4

Perform Preliminary Analytical

Perform Preliminary Analytical

Learning Objective 8.5

Figure 8.5 Steps in Applying

Learning Objective 8.6

Materiality for Financial Statements

Learning Objective 8.7

Determine Performance Materiality

• Performance materiality is defined as:

Determine Performance Materiality

• The process of determining performance materiality is

Determine Performance Materiality

• Auditors face three major difficulties in allocating

Learning Objective 8.8

Estimate Misstatement and Compare

This work is protected by United States copyright laws and is

You might also like