Chapter 5:

AUDIT
PLANNING
Audit planning
 Auditplanning involves
developing a general audit
strategy and a detailed approach
for the expected conduct of the
audit. The auditor's main
objective in planning the audit is
to determine the scope of the
audit procedures to be performed.
 The auditor should plan the audit
work so that audit will be
performed in an effective and
efficient manner. The extent of
planning will vary according to the
size of the entity, the complexity
of the audit and the auditor's
experience with the entity, and
knowledge of the business.
 Adequate planning of the audit work is
important because:
 Planning helps ensure that appropriate
attention is devoted to important areas of the
audit
 It helps identify potential problems
 It allows the work to be completed
espeditiously
 It assists in the proper assignment abd
coordination of work
 It helps ensure that the audit is conducted
effectively and efficientl
 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:

 a. Industry, Regulatory, and other external factors,

including financial reporting framework
 b. Nature of the entity, Including entity's selection and

application of accounting policies

 c. Objectives and strategies and the related business

risks that may result in a material misstatement of the

financial statements
 d. Measurement and Review of the entity's

performance
 e. Internal Control
Understanding The entity and its
environment
 Knowledge of the client's business and industry -
how and why a client does what it does- is essential
if the audit is to be carried out effectively and
efficiently. The auditor should obtain a sufficient
level of knowledge of the entity's business to
identify and understand the events, transactions
and practices that may have a significant effect on
the financial statements. The better the auditor
understand the client's operations, the more
efficient the examination is likely to be, and the
greater the value to the client of the auditor's
services.
Sources of information
 The auditor can obtain knowledge of the industry
and the entity from a number of sources. These
may include:

 Review of prior years' working papers

 Tour of client's facilities
 Discussion with people within and outside the
entity
 Reading books, periodicals and other publications
related to the clients industry -Reading corporate
documents and financial report
Uses of Information Obtained
 Knowledge of the client's business is a frame of
reference within which the auditor exercises
professional judgment. Understanding the business
and using the information appropriately assists the
auditor in:
-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.
Additional consideration on New
Engagements
 A first time audit requires more work than a repeat
engagement because of the problem associated with the
verification of the opening balances of the balance sheet
accounts. In this regard, PSA 510 requires the auditor
obtain 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
 Appropriate accounting policies are consistently applied or
changes in accounting policies have been properly
accounted for and adequately disclosed.
Understanding the Internal Control
 Another very important step in
planning an audit is to obtain an
understanding of the entity's
accounting and internal control
systems. The auditor should obtain an
understanding of the accounting and
internal control systems sufficient to
plan the audit and develop an effective
audit approach.
Developing an Overall Audit Strategy
 Once the auditor has gained a sufficient
understanding about the entity and its
environment including its internal control, the
auditor should formulate an overall audit
strategy for the upcoming engagement. The
best audit strategy is the approach that results
in the most efficient audit- that us, an effective
audit performed at the least possible cost. An
audit plan should be made regarding: -how
much evidence to accumulate -how and when
this should be done
Materiality
 Materiality defined in the FRSC's "Framework for the
Preparation and Presentation of Financial Statements"

-Information is material if its omission or misstatement

could influence the economic decision of users taken on the
basis of the financial statements In design of an audit plan

the auditor should make a preliminary estimate of

materiality for use during the examination, Materiality may
be viewed as:
 the largest amount of misstatement that the auditor could

tolerate in the FS or
 the small aggregate amount that could misstate the FS
Importance of materiality in planning
an audit
 Importance of materiality in
planning an audit The auditor
should make a preliminary
estimate of materiality to
determine the amount of evidence
to accumulate. There is an inverse
relationship between materiality
and evidence.
Uses of materiality
 According To PSA 320, materiality
should be considered by the
auditor:
 -PLANNING STAGE, to determine

the scope of audit procedures and

 -COMPLETION PHASE of the audit,

to evaluate the effect of

misstatements on the FS.
Using Materiality Levels
 The following steps may be used as a guide when
using materiality levels. Steps 1 and 2 are
performed in the planning phase while Step 3 is
performed in the completion phase of the audit
 Step 1: Determine the Overall materiality-

Financial Statement Level

 Step 2: Determine the tolerable misstatement-

Account Balance Level

 Step 3: Compare the Aggregate amount of

uncorrected misstatements with the overall

materiality.
Bases that can be used to determine
the materiality level
 Since audit planning is often performed
before year end, annual FS are usually not
available. As a result, the auditor uses
alternative bases to compute for the
materiality levels, such as:
 -Annualized Interim Financial Statements
 -Prior Years' Financial Statements
 -Budgeted Financial Statements of the

current year
Audit Risk
 After determining the materiality levels, the
auditor should design the audit to provide
reasonable assurance that the financial
statements taken as a whole are free from
material misstatements. The auditor should
use professional judgment to assess audit
risk and to design audit procedures to ensure
it is reduced to an acceptably low level. When
designing substantive audit procedures, 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
misstatements? As this level of assurance
increases, the scope of the auditor's substantive
tests increases
 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.
 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 auditor's substantive tests
decreases.
Audit Risk Model
 Audit Risk = Inherent Risk x Control Risk x
Detection Risk
Audit Risk
 refers to the risk that the auditor gives an
inappropriate audit opinion on the financial
statements. This Occurs because the auditor
believes that the financial statements are
fairly stated when in fact the FS are materially
misstated.
Inherent Risk
 is the susceptibility of an account balance or
class of transactions to a matrerial
misstatement assuming there were nk related
internal controls. This concept recognizes that
some account balances, by nature, are more
susceptible to misstatement than others.
 Example: Accounts that are subject to complex
calculations such as pensions are more likely
to be misstated compared to other accounts
 Factors that affect the risk of misstatement at
the financial statement level include:

 1. Management Integrity
 2. Management Characteristics(e.g. aggressive
attitude toward financial reporting)
 3.Operating Characteristics(e.g. profitability of
the entity relative to its industry is inadequate)
 4.Industry Characteristics(e.g. Industry is
experiencing a large number of business
failures
 Factors affecting inherent risk at the account
balance level include:

 1. Susceptibility of the account to theft

 2.Complexity of calculations related to

account
 3. Complexity underlying transactions and

other events
 4.Degree Of Judgment involved in

determining account balances.

Control Risk
 is the risk that a material misstatement that
could occur in an account balance or class
of transactions will not be prevented or
detected and corrected on a timely basis by
accounting and internal control systems. It
is related to the effectiveness of the client's
internal control. If the entity's internal
control is effective, the assessed level of
control risk decreases( and vice versa)
Detection Risk
 Is
the risk that an auditor's
substantive procedure will not
detect a material
misstatement. It is a function
of the effectiveness of the
auditor's substantive
procedures.
Steps In Using The Audit Risk Model
Step 1: Set the Desired level of Audit Risk

Step 2: Assess the Level of Inherent Risk

Step 3: Assess the Level of Control Risk

Step 4: Determine the Acceptable Level Of Detection Risk
 Audit Risk = Inherent Risk x Control Risk x Detection Risk

 Detention Risk = Audit Risk/(Inherent Risk x Control Risk)

Step 5: Design Substantive Tests.

To obtain greater assurance, the auditor will have to
modify the scope of his substantive tests such as:
 performing more effective substantive procedures

(nature)
 performing year end procedures (timing)

 using larger sample size(extent)

On the other hand, The auditor could reduce the

scope of his substantive procedures like:
 performing less effective substantive procedures

(nature)
 performing the tests at interim(timing)

 using smaller sample size(extent)

Relating Inherent, Control and Detection
Risk to the overall audit risk
 Of the three Components, only the Detection
Risk can be controlled by the auditor. Inherent
and Control Risks are functions of
management and its environment, and as
such, the auditor can not change the levels of
inherent and control risks. The auditor can
only assess their levels. On the Other Hand,
Detection Risk is a function of the auditor.
Accordingly, the level of detection risk can be
controlled by the auditor by performing
substantive procedures.
 Example:

If the assessed level of inherent and

control risk is high, the auditor should
minimize the level of detection risk to
be able to maintain the planned overall
audit risk level. Conversely, if the
assessed level of inherent and control
risk is low, the auditor could accept a
high level of detection risk and still
maintain the desired audit risk level.
Relationship between materiality and
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
would compensate for this by either:

 - reducing the assessed level of control risk

 -reducing detection risk by modifying the nature, timing

and extent of planned substantive procedures.
Risk Assessment Procedures
 are procedures performed by auditors to
obtain an understanding of an entity and its
environment including its internal control and
to assess the risks of material misstatements
in the Financial Statements These Include:
 a. Inquiries of management and others within

the entity
 b. Analytical Procedures
 c. Observation and Inspection
Analytical Procedures
 AnalyticalProcedures involve
analysis of significant ratios and
trends, including the resulting
investigation of fluctuations and
relationships that are inconsistent
with other relevant information or
deviate from predicted amounts.
 PSA 520 requires the auditor to
use analytical procedures in the
planning and overall review stages
of the audit. In the planning stage
of the audit, the application of
analytical procedures helps the
auditor assess the risk of material
misstatements in the financial
statements
Steps in Applying Analytical
Procedures
 It helps the auditor in identifying unusual transactions and
events that may affect the fair presentation of the financial
statements. Application of Analytical procedures involves the ff.
steps:

 Step 1: Develop expectations regarding financial statements

using
 Prior years' Financial Statements
 Anticipated results such as budgets or forecasts
 Industry Averages(FS of other entities operating within the same
industry)
 Non-Financial Information
 Typical relationships among financial statement account
balances.
 Step 2: Compare the expectations with
the financial statements under audit

 Step
3:Investigate significant
unexpected differences to determine
whether FS contains material
misstatements.
Uses of Analytical Procedures
 Following Purposes:

-As a planning tool, to determine the nature,

timing and extent of other auditing procedures
-As a substantive test to obtain corroborative
evidence about particular assertions related to
the account balance or transaction class
-As an overall view of the financial statements
in the completion phase of the audit
Analytical Procedures in planning an
audit
 Analyticalprocedures used in
planning an audit should focus on:
-Enhancing the auditor's
understanding of the client's
business
-Identifying areas that may
represent specific risks.
Documenting the Audit Plan
The final step in the
planning process is the
documentation of the audit
planning process by
preparing an overall audit
plan, audit program and
time budget
Audit Plan
 Is
an overview of the expected scope
and conduct of the audit. The overall
audit plan sets out in broad terms the
nature, timing and extent of the audit
procedures to be performed. While the
audit plan varies for each client, it
should be sufficiently detailed to
guide in the development of an audit
program
Audit Program
 The auditor should develop and document an
audit program setting out the nature, timing
and extent of planned audit procedures
required to implement the over all audit plan.
In effect, audit program executes the audit
strategy. It sets out in detail the audit
procedures to be performed in each segment
of the audit.The audit program serves as a set
of instructions to assistants involved in the
audit and as a means to control and record the
proper execution of the work
Time Budget
 Isan estimate of the time that will
be spent in executing the audit
procedures listed in the audit
program. This provides a basis for
estimating audit fees and assists
the auditor in assessing the
efficiency of the assistants
Changes to audit plan and program
 Planning is continuous throughout the
engagement because of changes in
conditions or unexpected results of audit
procedures. The overall audit plan and the
audit program should be revised as necessary
during the course of the audit and the
reasons for significant changes would be
recorded