Audit Risk Audit Planning

involves developing a general audit strategy

and a detailed approach for the expected
PSA 315
requires the auditor to obtain sufficient
understanding of the entity and its environment
Developing an Overall
Audit Strategy
Additional Consideration on
New Engagements
refers to the risk that the auditor gives an conduct of the audit. The auditor’s main including the internal control. The best strategy is, an effective audit PSA 510 requires the auditor to obtain sufficient
inappropriate audit opinion on the FS. This objective in planning the audit is to determine Obtaining knowledge of entity’s: performed at the least possible cost. appropriate audit evidence that:
occurs because the auditor believes that the the scope of the audit procedures to be An audit plan should be made regarding: The opening balances do not contain misstatements
FS are fairly stated when in fact the FS are performed. that materially affect the current year’s FS
mulate
How much evidence to accu
materially misstated Industry, regulatory, and other external factors, including
The prior period’s closing balances have been
How and when this should be done
financial reporting framework
correctly brought forward to the current period
Nature of the entity or, when appropriate, have been restated
Appropriate accounting policies are consistently
applied or changes in accounting policies have

Audit Risk Model:

Objectives and strategies and the related risks that may result in

Materiality
material misstatement of FS been properly accounted for and properly
disclosed

=
Measurement and review of entity’s performance
Internal control
Audit Inherent Control Detection Information is material : Designing an audit plan :

Risk
Level of INHERENT RISK INCREASES, the
auditor should design MORE EFFECTIVE
SUBSTANTIVE PROCEDURES
Inherent Risk
is the susceptibility of an
account balance or class of
transactions to a material
misstatement
assuming that there are no
related internal controls.
PSA 315:
requires the auditor to
assess inherent risk at FS
level and account
balance/transaction level.
Factors that affect the risk
of misstatement at FS level
* *
Risk Risk
Level of CONTROL RISK INCREASES, the
auditor should design MORE EFFECTIVE
SUBSTANTIVE PROCEDURES
Control Risk
is the risk that the material
misstatement that could occur
in an account balance or class
of transactions will not be
prevented or detected on a
timely basis by accounting and
control systems
Internal control is
effective:
the assessed level of
control risk decreases
(and vice versa).
related to the
If its omission or misstatement the auditor should make a
Risk could influence the economic preliminary estimate of
decision of users materiality.
Level of DETECTION RISK DECREASES, the
ASSURANCE DIRECTLY PROVIDED FROM
SUBSTANTIVE TESTS INCREASES
Inverse relationship: Bases that can be used to
Detection Risk between materiality and
evidence. determine materiality level:
is the risk that an auditor’s Alternative for annual FS if not
substantive procedure will not available – annualized
detect a material misstatement
interim FS
prior year’s FS
Developing an audit strategy, Use of Materiality: budgeted FS for the current
is a function of the , completion stage to evaluate
effectiveness of the the auditor must consider carefully the appropriate levels of year
auditor’s substantive materiality and audit risk. the effect of misstatements of
FS.
procedures
Auditor should design more Audit Risk Materiality Planning stage, Completion Stage,
effective audit procedures
to evaluate the effect of
Materiality may be viewed as :
in order to achieve the to determine the auditor should make a
misstatements of FS.
desired level of
scope of the audit preliminary estimate of
RELATIONSHIP BETWEEN
assurance.
Unlike inherent and materiality.
control risk, THE AUDITOR

MATERIALITY AND RISK t of MisstatinemtheentFS

include effectiveness of the CAN CONTROL THE LEVEL OF
Management integrity client’s internal control DETECTION RISKS by amoun
Largestaudi
Management Characteristics performing more effective that the tor could tolerate
Operating Characteristics
Industry Characteristics
substantive procedures INVERSE RELATIONSHIP: Using Materiality Levels: Smallest aggregate the amount
FS
MATERIALITY and the LEVEL OF AUDIT RISK that could misstate

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* Common method of
Step 1: Determine the Overall Materiality –
Factors affecting inherent risk at the account balance level include: Reducing the assessed level of Financial Statement Level*
estimating materiality

Susceptibility of the account to theft After planning for specific Planning at FS level is
statement base (total
control risk: Stage assets, sales, etc.) x
Complexity of calculations related to account
The complexity underlying transactions and other events. audit procedure: where this is possible, and
Step 2: Determine the Tolerable Misstatement –
certain %
The degree of judgment involved in determining account balances if the auditor determines supporting the reduced level by
carrying out extended or Account Balance Level**
that the acceptable additional tests of control ** Also known as
performance
materiality level is lower,
audit risk is increased. Perform audit procedures materiality. This
process is highly
Steps in using the audit risk model: * The auditor uses his
judgment in
** Consider the
specific factors The auditor would compensate Reducing detection risk: subjective and requires
the exercise of great
determining the risk
that he is willing to
related to client that
may affect the risk of for this by either: by modifying the nature,
timing, and extent of planned
Completion Step 3: Compare the aggregate amount of deal of
auditor’s judgment

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take of accepting an
assertion as fairly
material misstatement
for a particular
substantive procedures Stage misstatements with overall materiality
Step 1. Set the desired level of audit risk.* stated when in fact is amount. In making this
Audit materially misstated. assessment, the
auditor will rely
MATERIALITY AUDIT RISK PLANNED AUDIT  Analytical Procedures PSA 520
Planning Step 2. Assess the level of inherent risk. ** *** Assessment of
primarily on his
knowledge of the
Planning materiality Risk of material error
PROCEDURES

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client’s business and
control risk would industry, and the and/or tolerable occurring and/or involves analysis of significant ratios and requires the auditor
Consideration involve studying and error Not being determined
evaluating the
results of his
preliminary analytical
trends including the resulting investigation to use analytical
Step 3. Assess the level of control risk. *** of fluctuations and relationships that are procedures in the
of Internal effectiveness of the procedures. LOW HIGH MORE EXTENSIVE

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client’s accounting inconsistent with other relevant information planning and overall
Control and internal control
or deviate from particular amounts stages of the audit.

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systems.
**** The acceptable HIGH LOW LESS EXTENSIVE
Step 4. Determine the acceptable level of level of detection
detection risk. **** risk can be determined
as follows: Prior year’s FS
Performing
RISK ASSESSMENT PROCEDURE:
Substantive tests Step 5. Design substantive tests. AuditRisk the procedures performed by auditors to obtain an
Anticipated results such as
budgets and forecasts
Detection
Risk
= Control
understanding of the entity and its environment STEP 1
Develop expectations regarding FS using
PAINT
Inherent Industry averages
NATURE * including its internal control and to assess the
TIMING EXTENT Risk Risk
risks of material misstatements in the FS. Non-financial information
Compare expectations with the FS under
Low Acceptable More effective year end Large  Inquiries of  Analytical  Observation and STEP 2 audit. Typical relationships among
FS account balances
Level of Detection Risk Substantive Procedure procedure sample size
management and Procedures inspection
High Acceptable Less effective Test at Smaller
others within the STEP 3
Investigate significant unexpected
differences (unusual fluctuations) to Uses of Analytical
Level of Detection Risk Substantive Procedure Interim sample size entity Overall review determine whether FS contain
Procedures:
material misstatements
FS in the completion As a planning tool, to
Documenting the Audit Plan Substantive test phase of the audit determine the nature,
timing, and extent of other
the final step in planning process is the documentation of the to obtain
corroborative
to identify unusual In using analytical procedures as auditing procedures
fluctuations that were
audit planning process by preparing:
evidence about not identified in the a planning tool: to understand the
Audit plan Audit program Time budget particular planning and testing if the difference between recorded client’s business
assertions related phases of the audit balances in FS and expectations is to identify areas that
the overview of the expected sets out in detail the audit is an estimate of the time that to account balance to confirm conclusions significant, the auditor must may represent specific
it will spent in executing the or transaction
scope and conduct of the audit. procedure
audit procedures reached w/ respect to design more extensive substantive risks
class the fairness of the FS tests (or vice versa