Audit Planning

Chapter 5
Audit planning
It involves developing a general 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.
Adequate planning of an 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 expeditiously.
 It assists in the proper assignments and coordination of work.
 It helps ensure that the audit is conducted efficiently and
effectively.
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 immaterial misstatement of the financial
statements;
d. Measurement and review of the entity’s performance; and
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.
 Knowledge of entity would also include understanding the entity’s
objectives and strategies, and the related business risks. An
auditor’s understanding of business risk encountered by the entity
increases the likelihood of identifying risks of material
misstatement and helps the auditor design appropriate audit
procedures.
Source of information

The auditor can obtain knowledge of the industry and the

entity from a number of sources. This 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 client’s industry
 Reading corporate documents and financial reports
Uses of information obtained
 Knowledge of the client’s business is a frame of
reference within the auditor exercise professional
judgement. Understanding the business and using this
information appropriately assists the auditor in:
 Assessing risks and identifying potential problems
 Planning and performing the audit effectively and efficiently
 Evaluating audit audience 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; and
 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
accounting and internal control systems sufficient
to plan the audit and developed 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 efficient audit-
that is, an effective audit performed at the least possible
cost.
 How much evidence to accumulate;
 How and when this should be done.
Materiality
 It is defined in the FRS Council’s “Framework for the preparation
and presentation of the financial statements,” in the following
terms: “information is material if its omission or misstatements
could influence the economic decision of users taken on the
basis of the financial statements.
 In designing an audit plan, the auditor should make a
preliminary estimates of materiality for use during examination.
Materiality may be viewed as:
 The largest amount of misstatement that the auditor could tolerate in the
financial statements, or
 The smallest aggregate amount that could mistake the financial
statement
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. This means more evidence will be
required for a low peso amount of materiality
than for a high peso amount.
Uses of materiality
According to PSA 320, materiality should be
considered by the auditor:
 Inthe planning stage, to determine the scope of audit
procedures;
 In the completion phase of the audit, to evaluate the
effect of misstatements on the FS
Using Materiality levels

Step 1 Determine the overall Materiality- FS level

Step 2 Determine the tolerable misstatement- Account

Balance Level

Step 3 Compare the aggregate amount of uncorrected

misstatements with the overall materiality.
Bases 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 FS
 Prior years’ FS
 Budgeted FS of the current year
Audit risk
 Theauditor should use professional judgement to
assess audit risk and to design audit procedures to
ensure it is reduced to an acceptably low level.
 When level of assurance does the auditor wish to attain
that the FS do not contain material misstatements?
 How susceptible is the account to material
misstatements?
 Howeffective is the client’s internal control in
preventing or detecting misstatements?
Audit risk model
These three issues are the primarily basis for the
development of the audit risk model:
Audit Risk = Inherent Risk * Control Risk * Detection
Risk
 Audit Risk- refers to the risk that the auditor gives
an inappropriate audit opinion on the FS. This
occurs because the auditor believes that the FS
are fairly stated when in fact the FS are
materially misstated.
 Inherent risk- is the susceptibility of an account balances or class of
transactions to material misstatement assuming that there were no related
internal controls
PAS 315 requires that auditor to assess inherent risk at the financial
statements and account balance or transaction class level. Factor that affect
the risk misstatements at the FS level include
1. The management integrity
2. Management Characteristics
3. Operating Characteristics
4. Industry Characteristics

Factors affecting inherent risk at the account balance level include:

5. Susceptibility of the account to theft
6. Complexity of calculations related to account
7. The complexity underlying transactions and other events
8. The degree of judgement involved in determining account balances
 Control Risk- is the risk that a material misstatement that
could occur in an account balances or class of transactions
will not be prevented or detected and corrected on a
timely basis by accounting and internal control system.

 Detection risk- is the risk that an auditor’s substantive

procedure will not detect a material misstatement.
Detection risk 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
 Step 5 Design Substantive Tests

Fig. 5.2- Using the Audit Risk Model

Determine
Set desired
Assess Assess Control acceptable
level of Audit
Inherent Risk Risk level of
Risk
detection risk

Consideration Performing
Audit Substantive
of Internal
Planning Test
Control
 Relating inherent , control, and detection risk to the overall audit
risk.
-an increase or decrease in any of these components would cause a
corresponding increase or decrease in the overall audit risk.

 Relationship between materiality and risk.

- When planning the audit, the auditor considers what would make
the financial statements materially misstated.
-There is an inverse relationship between materiality and level of
audit risk, that is , the higher the ,materiality level, the lower the
audit risk vice versa.
Figure 5.3 Effect if materiality on audit risk and planned audit
procedures.

MATERIALITY AUDIT RISK

Planning Risk of material error PLANNED AUDIT
materiality and or occurring and or not PROCEDURES
tolerable error being determined

LOW HIGH MORE EXPENSIVE

HIGH LOW LESS EXPENSIVE

Risk assessment procedures
 The procedures performed by auditors to obtain an understanding of
the entity and its environment including its internal control and to
assets the risks of material misstatements in the financial statement.

a. Inquiries of management
b. Analytical procedures
c. Observation and inspection
ANALYTICAL PROCEDURES
 Analytical 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 amount.

 PSA 520 requires the auditor to use analytical procedures

in the planning and overall review stages of the audit.
Steps in Applying Analytical Procedures

 Steps in Applying Analytical Procedures

 Step 1 Develop expectations regarding financial statements

 Step 2 Compare the expectations with the financial statements under
audit
 Step 3 Investigate significant differences
Uses of analytical procedures
Analytical procedures may be used for the 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 review of the financial statements in the completion phase of
the audit.
Analytical procedures in planning an audit
 Analytical procedures used in planning an audit should focus on:
1. Enhancing the auditor’s understanding of the client’s business
2. Identifying areas that may represent specific risks.
 Documenting the audit plan

 Audit Plan
An audit plan is an overview of the expected scope and conduct of the
audit.

 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
overall audit plan .
 Time Budget
A time budget is an estimate of the time that will be spent in executing the
audit procedures listed in the audit program.
Changes to audit plan and program

 Planning is condition throughout the engagement

because of changes in conditions or unexpected
results procedures.