CHAPTER 5

AUDIT PL ANNING
LEARNING OBJECTIVES
• State the general objective in planning an audit
• Describe the standard planning procedures
• Understand how the auditor obtains an understanding of the client
and its environment
• Define analytical procedures and explain why they are important at
the planning stage of the audit
• Discuss the contents of the audit plan and the audit program
• List and explain other planning considerations.
AUDIT PLANNING
• Involves developing a general audit strategy and a detailed approach for the
expected conduct of the audit
• Main objective is to determine the scope of the audit procedures to be performed
• Extent of planning varies according to the size of the entity; complexity of the audit
and the auditor’s experience with the entity, and knowledge of the business
• BENEFITS OF ADEQUATE PLANNING:
– Appropriate attention is devoted to important areas
– Completed expeditiously
– Potential problems are identified and resolved
– Assignment and coordination of work
– Effective and efficient manner
OUTPUTS OF AUDIT PLANNING
• Overall audit strategy
• Overall audit plan
• Draft audit programs detailing the work to be performed

PLANNING MEMORANDUM
- Summarizes the decisions taken during the planning process
- Includes the main emphasis of the decisions and can be referred to by the audit team at any
time during the audit
- A tool in providing proper direction to all members of the audit team
MAJOR PLANNING ACTIVITIES
Obtain an understanding of client and its environment

Assessing the possibility of non-compliance

Establishing the materiality and risk

Identifying related parties

Performing preliminary analytical procedures

Determining the need for experts

Development of the overall audit strategy and detailed audit plan

Preparation of preliminary audit programs

MAJOR PLANNING ACTIVITIES
Obtain an understanding of client and its environment

Assessing the possibility of non-compliance

Establishing the materiality and risk

Identifying related parties

Performing preliminary analytical procedures

Determining the need for experts

Development of the overall audit strategy and detailed audit plan

Preparation of preliminary audit programs

UNDERSTANDING THE ENTITY AND
ITS ENVIRONMENT
Industry, regulatory, other
external factors, financial
reporting framework
Nature of the entity, entity’s
selection and application of
accounting principles

Objectives, strategies and

related business risks that may Measurement and review of
result in a material the entity’s performance
misstatement of the FS

Internal Control
UNDERSTANDING THE ENTITY AND
ITS ENVIRONMENT
How and why a client
does what it does?
 UNDERSTANDING THE ENTITY AND
ITS ENVIRONMENT
• Importance:
Helps the auditor identify and understand the events, transactions, and
practices that may have a significant effect on the FS
• The better the auditor understands the client’s operations, the more efficient the examination is likely to be, the
greater the value to the client of the audit

Helps the auditor evaluate the reasonableness of the client’s estimates

• Procedures can be selected with more assurance or can be uniquely designed

Increases the likelihood of identifying risks of material misstatement and

helps the auditor design appropriate audit procedures
UNDERSTANDING THE ENTITY AND
ITS ENVIRONMENT
RISK ASSESSMENT PROCEDURES
- Audit procedures to obtain an understanding of the entity and its
environment, internal control, to identify and assess the risks of material
misstatement at the FS and assertions level
- Different RAP:
1) Inquiries
2) Analytical Procedures
3) Observation and Inspection
UNDERSTANDING THE ENTITY AND
ITS ENVIRONMENT
Inquiries
- Consists of seeking information from knowledgeable persons inside or
outside the entity
Analytical Procedures
- Consists of the analysis of significant ratios and trend including the resulting
investigation of fluctuations and relationships that are inconsistent with other
relevant information or deviate from predicted amount
Observation
- Consists of looking at a process or procedures being performed by others
Inspection
- Involves examining of records, documented or tangible assets
UNDERSTANDING THE ENTITY AND
ITS ENVIRONMENT
SOURCES OF INFORMATION
a) Review of prior years’ working papers
b) Tour of client’s facilities
c) Discussion with people within and outside the entity
d) Reading books, periodicals and other publications related to the client’s
industry
e) Reading corporate documents and financial reports
UNDERSTANDING THE ENTITY AND
ITS ENVIRONMENT
Knowledge of the client’s business is a frame of reference within which the
auditor exercises professional judgment

USES OF INFORMATION OBTAINED:

a) Assessing risks and identifying potential problems
b) Planning and performing the audit effectively and efficiently
c) Evaluating audit evidence as well as the reasonableness of client’s
representations and estimates
d) Providing better service to the client
ADDITIONAL CONSIDERATION ON
NEW ENGAGEMENTS
• PSA 510 requires the auditor to obtain sufficient appropriate audit evidence that:
– The opening balances do not contain misstatements that materially affect the current year’s
FS
– 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
 Review predecessor auditor’s working papers
 Consider the independence and professional reputation of the predecessor auditor
MAJOR PLANNING ACTIVITIES
Obtain an understanding of client and its environment

Assessing the possibility of non-compliance

Establishing the materiality and risk

Identifying related parties

Performing preliminary analytical procedures

Determining the need for experts

Development of the overall audit strategy and detailed audit plan

Preparation of preliminary audit programs

MAJOR PLANNING ACTIVITIES
Obtain an understanding of client and its environment

Assessing the possibility of non-compliance

Establishing the materiality and risk

Identifying related parties

Performing preliminary analytical procedures

Determining the need for experts

Development of the overall audit strategy and detailed audit plan

Preparation of preliminary audit programs

ESTABLISHING MATERIALITY AND
ASSESSING RISK
• Auditor should make a preliminary estimate of materiality for use during the
examination
• Materiality may be viewed as:
– Largest amount of misstatement that the auditor could tolerate in the FS
– Smallest aggregate amount that could misstate the FS
• IMPORTANCE of preliminary estimate of materiality
• Helps in determining the amount of evidence that needs to be accumulated

Peso Evidence
amount Audit Procedures
ESTABLISHING MATERIALITY AND
ASSESSING RISK
• Uses of Materiality

PLANNING STAGE
COMPLETION PHASE
-To determine the scope of
-To evaluate the effects of
audit procedures
misstatements on the FS
Step 1: Determine the
Step 3: Compare the
Overall Materiality
aggregate amount of
Step 2: Determine the
uncorrected misstatements
Tolerable Misstatement
with the overall materiality
ESTABLISHING MATERIALITY AND
ASSESSING RISK
• OVERALL MATERIALITY
– Amount of misstatement that could be material to the FS taken as a
whole
• PLANNING MATERIALITY
– Allocating overall materiality to the FS account balances
– To determine the audit procedures that will be applied to specific
accounts
– The allocated amount is known as TOLERABLE
MISSTATEMENT
ESTABLISHING MATERIALITY AND
ASSESSING RISK
Tolerable
Account Misstatement
Cash Php 4,000
Accounts receivable 20,000
Inventory 36,000

Preliminary judgment
about materiality Php50,000

An allocation is necessary because evidence is accumulated by

segments rather than the financial statements taken as a whole. The
allocation to account balances is known as the tolerable misstatement.
• PERFORMANCE MATERIALITY
• Set to reduce to an appropriately low level the probability that the
aggregate uncorrected and undetected misstatements in the FS
exceeds materiality for the FS as a whole
Performance materiality vs. tolerable misstatements:
• Performance materiality is determined in order to address the risk
that the aggregate of individually immaterial misstatements may cause
the financial statements to be materially misstated and provide a
margin for possible undetected misstatements. Tolerable misstatement
is the application of performance materiality to a particular sampling
procedure. Tolerable misstatement may be the same amount or an
amount lower than performance materiality (for example, when the
sample population is lower than the account balance)
ESTABLISHING MATERIALITY AND
ASSESSING RISK
AUDIT RISK- risk that the auditor gives an inappropriate audit
opinion on the FS
100%

AUDIT
RISK

ASSURANCE
ESTABLISHING MATERIALITY AND ASSESSING RISK
Set the desired level of Audit risk
Obtain an understanding
Assess the level of Inherent Risk of the entity and its
environment
Obtain an understanding
Assess the level of Control Risk the internal control
structure

Determine the Acceptable level of

Detection Risk

Design Substantive Tests

 PLANNED AUDIT RISK
DETECTION =
RISK INHERENT CONTROL
*
RISK RISK
GENERALIZATIONS
Assessed level Effect on Audit
(Preliminary) Procedures
Inherent Risk is More effective ST
high
Control Risk is high More effective ST

Detection risk is LOW

GENERALIZATIONS
SCOPE DETECTION DETECTION
OF ST RISK IS LOW RISK IS HIGH
NATURE More effective Less effective

TIMING At year-end At interim dates

EXTENT Larger sample size Smaller sample size

GENERALIZATIONS
PLANNING AUDIT RISK PLANNED AUDIT
MATERIALIT PROCEDURES
Y
Low High More extensive ST

High Low Less extensive ST

SIGNIFICANT RISK
• Risk that requires special audit consideration
• Normally related to non-routine transactions and judgmental
matters
Unusual transactions, either due to size Include development of
or nature, that occur infrequently accounting estimates for
which there is significant
measurement of uncertainty
MAJOR PLANNING ACTIVITIES
Obtain an understanding of client and its environment

Assessing the possibility of non-compliance

Establishing the materiality and risk

Identifying related parties

Performing preliminary analytical procedures

Determining the need for experts

Development of the overall audit strategy and detailed audit plan

Preparation of preliminary audit programs

IDENTIFYING RELATED PARTIES
• RELATED PARTY TRANSACTION
– A transfer of resources, services or obligations between related
parties, regardless of whether a price is charged
• RELATED PARTY (PAS 24)
• Identified by:
– inquiries of management, predecessor auditors
– Reviews of stockholder listings and material investment transactions
MAJOR PLANNING ACTIVITIES
Obtain an understanding of client and its environment

Assessing the possibility of non-compliance

Establishing the materiality and risk

Identifying related parties

Performing preliminary analytical procedures

Determining the need for experts

Development of the overall audit strategy and detailed audit plan

Preparation of preliminary audit programs

ANALYTICAL PROCEDURES
• Evaluations of financial information made by a study of plausible
relationships among both financial and non-financial data
• Consists of the analysis of significant ratios and trend including the
resulting investigation of fluctuations and relationships that are
inconsistent with other relevant information or deviate from
predicted amount
ANALYTICAL PROCEDURES (REQUIRED)
During the planning stage
- To enhance the auditor’s understanding of the client, its business and
the industry in which the client operates
- To identify areas of potential risk or risk of material misstatement
- To determine the nature, timing and extent of other auditing
procedures
During the overall review stage
- To identify unusual fluctuations that were not identified in the
planning and testing phases of the audit
- To conform conclusions reached with respect to the fairness of the FS
ANALYTICAL PROCEDURES (OPTIONAL)
During the testing stage
- As a substantive tool, to obtain evidence to confirm or refute
individual account balances
STEPS IN APPLYING ANALYTICAL PROCEDURES
1. Develop expectations regarding FS
P-rior years’ FS
A-nticipated Results (forecast)
I-ndustry averages
N-onfinancial Information
T-ypical relationships among FS account balances

II. Compare the expectations with

the FS under audit
III. Investigate significant
differences
-Inquiries of management
-Corroboration of management responses
-Other appropriate audit procedures
MAJOR PLANNING ACTIVITIES
Obtain an understanding of client and its environment

Assessing the possibility of non-compliance

Establishing the materiality and risk

Identifying related parties

Performing preliminary analytical procedures

Determining the need for experts

Development of the overall audit strategy and detailed audit plan

Preparation of preliminary audit programs

DETERMINING THE NEED FOR
AUDITOR’S EXPERT
• EXPERT
– A person or firm possessing special skill, knowledge and experience
in a particular field other than accounting and auditing
FACTORS TO BE CONSIDERED IN DETERMINING THE NEED
TO USE THE WORK OF AN AUDITOR’S EXPERT:
1. Engagement team’s knowledge and previous experience of matter
being considered
2. Risk of material misstatement based on the nature, complexity and
materiality
3. Quantity and quality of other audit evidence expected to be obtained
DETERMINING THE NEED FOR
AUDITOR’S EXPERT
WHEN PLANNING TO USE THE WORK OF AN AUDITOR’S
EXPERT, AUDITOR SHOULD:
1. Evaluate the professional competence of the expert
- Consider expert’s professional certification or licensing or membership in
an appropriate professional body
- Consider expert’s experience and reputation in the field in which the
auditor is seeking audit evidence
2. Evaluate the objectivity of the expert
- Impairment of Objectivity increases when:
- Employed by the entity
- Have financial interest in the entity
MAJOR PLANNING ACTIVITIES
Obtain an understanding of client and its environment

Assessing the possibility of non-compliance

Establishing the materiality and risk

Identifying related parties

Performing preliminary analytical procedures

Determining the need for experts

Development of the overall audit strategy and detailed audit plan

Preparation of preliminary audit programs

 AUDIT STRATEGY
• Sets the scope, timing and direction of the audit and guides the development of the
more detailed audit plan
• It involves:
– Determining the characteristics of the engagement that define its scope
– Ascertaining the reporting objectives of the engagement to plan the timing of
the audit and the nature of the communications required
– Considering the important factors that will determine the focus or direction of
the engagement team’s efforts
DETAILED AUDIT PLAN
• Addresses the various matters identified in the overall audit strategy
• Includes description of the nature, timing and extent of risk
assessment procedures, further audit procedures (TOC and ST) and
other audit procedures required to be carried out for the engagement
in order to comply with PSAs
• It serves as a record of the proper planning and performance of the
audit procedures that can be reviewed and approved prior to the
performance of further audit procedures
MAJOR PLANNING ACTIVITIES
Obtain an understanding of client and its environment

Assessing the possibility of non-compliance

Establishing the materiality and risk

Identifying related parties

Performing preliminary analytical procedures

Determining the need for experts

Development of the overall audit strategy and detailed audit plan

Preparation of preliminary audit programs

 AUDIT PROGRAMS
• List of procedures to gather sufficient appropriate audit evidence
• Most important control mechanism in an audit

TWO TYPES:
TEST OF CONTROLS AUDIT
PROGRAM
(Compliance Test Audit Program)
- Prepared when the auditor has
identified controls which he/she
plans to rely on
SUBSTANTIVE TEST AUDIT
PROGRAM
- Prepared regardless of the
approach taken by the auditor
(reliance or no reliance approach)
TIMING OF AUDIT WORK
• Efficient scheduling of audit work is the key to maximizing the
effectiveness and monetary return of an accounting firm
• Not all procedures must be performed after the end of the period
being audited.
• Timing of significant phases of the audit and tentative deadline
dates for completion should be determined, agreed upon with the
client and documented in the engagement timetable
OTHER PLANNING CONSIDERATIONS

• Arrangement for company assistance

• Consider the work of Internal Auditor
• Direction, Supervision and Review