CHAPTER 3

Audit Planning and

Analytical Procedures
Chapter Objectives
• After finishing this chapter you will be able to:
Have an understanding of an overview of the audit
process

Be familiar with the types of audit evidence and the

system of documentation

Have an understating of materiality and risk in

auditing.
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 Major Phases of the Audit:

Engagement
Planning
activities

Reporting Test of
controls

Substantive
procedures
Completion
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 Overview of the Audit Process
1) Planning an Audit
• Auditing standards require the audit to be
properly planned; this is to ensure that the
audit is conducted in an effective and efficient
manner.
• Planning involves all the issues the auditor
should consider to develop an overall audit
strategy and audit plan for conducting the
audit.

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 Overview of the Audit Process

• The outcome of the auditor’s planning process

is a written plan that sets forth the overall
audit strategy and the nature, extent, and
timing of the audit work.

• The planning process begins with obtaining

sufficient knowledge of the entity, including its
internal control system. E.g. Cash control,
budgetary control

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 Overview of the Audit Process

• With this knowledge the auditor is able to identify risk of

material misstatement which affects the calculation of
planning materiality.
• After performing all these procedures, the auditor is able to
develop the overall audit strategy and the detailed audit plan,
also referred to as the audit programme.
• Audit program is a guide to the auditor that certain audit
steps will be taken.
The Audit program should be designed to tell the auditor:
What is to be done
When it is to be done
How it is to be done
Who will do it
How long it will take
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 Audit programme.
Gathering Audit Evidence:
• After the auditor has planned the audit, the
auditor needs to gather sufficient appropriate
audit evidence on which to base his/her audit
opinion.
• The auditor gathers evidence by performing
audit procedures.
• These audit procedures consists of test of
controls and substantive procedures.

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 Overview of the Audit Process 10
2) Test of Controls:
 Test of controls are audit procedures to test
the effectiveness of control policies and
procedures.
 Key internal controls must be supported by
tests of controls.
 The extent to which the test of controls are
applied depends on the assessed control risk.

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 Overview of the Audit Process 11
• 3) Substantive tests:
• Substantive tests are procedures designed to
test for dollar misstatements directly affecting
the correctness of financial statement
balances.
• Such misstatements are clear indicators of the
misstatements of the accounts.

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There are three types of substantive tests:
1. substantive tests of transactions: evaluating the
client’s recording of transactions by verifying
the monetary amounts.
2. Analytical procedures: involves comparison of
recorded amounts to expectations developed by
the auditor. They often involve the calculation
of ratios by the auditor for comparison with
previous years’ ratios and other related data
3. Tests of details of balances: focuses on ending
general ledger account balances of both income
statement and balance sheet.
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 Overview of the Audit Process 13
4) Completing the Audit:
• Once the auditor completed gathering
evidence relating to the financial statement
declarations the audit enters the completion
phase

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 Overview of the Audit Process 14

Steps in completion phase:

1)Evaluating the sufficiency and appropriateness
of the evidence gathered.
2) Determine the final materiality figure and
evaluate all misstatements identified.
The auditor then aggregates the total identified
misstatements and determines if it causes the
financial statements to be materially misstated
(compare to the final materiality figure).

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 Overview of the Audit Process 15

3) An overall evaluation of the financial

statements based on analytical procedures as
well as the knowledge of the entity obtained
throughout the previous phases of the audit.
4) Identifying possible subsequent events which
have not been correctly disclosed in the
financial statements.

5) Performing quality control procedures as

required by standards of auditing.

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 Overview of the Audit Process 17
• 5) Reporting:
• The final phase in the audit process is to choose
the appropriate audit opinion to issue based on
the nature of evidence gathered.
• The auditor’s report is the main product or
output of the audit.
• The audit report communicates the auditor’s
findings to the users of the financial
statements.
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 Audit evidence and Documentation
• Audit Evidence- Is the evidence gathered in
the course of an audit that supports the
auditor’s opinion and conclusions.
• Why Audit Evidence?
• A professional requirement by auditing
standard:
Auditor should gather sufficient and
appropriate information to provide factual
basis for audit opinions.

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 Types of Evidence:

• Physical evidence
• Third-party representations
• Documentary evidence
• Computations
• Data Interrelationships
• Client representations
• Accounting records

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Physical Evidence:

Evidence that can actually be seen by auditors.

– This type of evidence is generally effective for
supporting testing existence and condition of the
asset.
– It is the inspection or count by the auditor of a
tangible asset.
– This type of evidence is most often associated with
inventory and cash.
Third Party Representations:
 Confirmations
 Lawyers’ Letters
 Reports of Specialists
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 Documentary Evidence:

 Three basic types Documentary Evidence helps

to determine reliability
1. Created by outside parties and transmitted
directly to auditor (the most reliable)
2. Created by outside parties and held by client
(moderately reliable)
3. Created and held by client (the least reliable)

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 Computations

• Computations: is performed independently by the auditor.

• It Used to verify mathematical accuracy of client’s analyses and
records.
 Evidence obtained via Analysis:
 Data interrelationships (i.e., analytical procedures) rely on plausible
relationships among financial and non-financial data.
 Financial data- examples include advertising costs, sales revenue,
employee compensation and the value of assets.
 nonfinancial information- include environmental impact, your
relationship with your vendors, diversity in the workplace and
social responsibility.
 Effective for testing “reasonableness” of certain account balances
 Can be used as primary or corroborating evidence, depending on
the nature of the account
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 Client Representations

• Oral and Written Client Representations:

• Responses to questions and inquiries to clients
during an audit constitute audit evidence.
– Oral representations are generally not
sufficient as primary evidence, but may
provide justification for other evidence.
– Written representations (representation
letter) are required, but should not be used
as a substitute for other audit procedures.

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 Client’s accounting records (e.g. ledgers and
journals) may provide worthwhile evidence in
themselves. Verification of the records
provides evidence with regards to the ff:
 Existence
 Completeness
 Accuracy of amount
 Proper classification

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 Competence of Audit Evidence:
• To be competent evidence must be:
1. Relevant
2. Reliable
3. Sufficient
 Relevant
 Must relate to the audit objective. E.g. purchase order
is not relevant to prove that goods were actually
received.

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 Valid (Reliable)

 Independent sources have greater reliability

than those within the client organization.
 Strong internal control increases reliability of
evidence created within the client organization.
 Directly obtained evidence is more reliable
than evidence obtained second hand.
 Qualification of the provider
 Objectivity of evidence
 Timeliness
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 Reliability of Certain Types of Audit Evidence:

• RELIABILITY TYPE EXAMPLE

– High Physical Inventory
Observation

Documentary
External Bank Statement
External/Internal Purchase Invoice
Internal Sales Invoice
• Low Client Representations Management
Representation
Letter

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 Working Papers

• Audit working papers have the following

objectives:
– Aid in the planning, performance, and
review of audit work.
– Provide the principal support for audit
report and conclusions.
– Facilitate third party/supervisory reviews.
– Support the accuracy and completeness of the
work performed.

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 Contents of Audit working papers
 Audit working papers have the following
Contents
 The name of the client.
 The period covered by the audit.
 The subject matter.
 The file reference.
 The signature of the member of staff who
prepared the working paper, and the date on
which it was prepared .

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 Key characteristics of Working Papers
1. Complete
2. Accurate
3. Organized
4. Relevant
Completeness:
– Each Working Paper should be completely self
standing and self explanatory.
– All questions must be answered, all points raised
by the reviewer must be cleared and a logical,
well thought-out conclusion must be reached for
each audit segment.
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 Key characteristics of Working Papers

Accurate:-High quality working papers include

statements and computations that are accurate
and technically correct.
Organization:-Working papers should have a logical
(reasonable) system of numbering and a reader –
friendly layout so a technically competent person
unfamiliar with the project could understand the
purpose, procedures performed, and results.
Relevance:-Audit working papers and items
included on each working paper should be
relevant to meeting the applicable audit objective.
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 Materiality in Auditing 1
• Materiality, is the magnitude of omission or
misstatement of accounting information that,
in light of surrounding circumstances, make it
probable that the judgment of reasonable
person relying on the information would have
been changed or influenced by the omission
or misstatement.

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 Materiality in Auditing 2
• Auditors determine whether financial statements
are free from material misstatement or not.
• If the f/statements are materiality misstated, the
auditor brings the issue to the attention of client for
correction.

• If the client refuses to correct the misstatement, the

auditor must issue either qualified or adverse
opinion depending on how material the
misstatement is.
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 Materiality in Auditing 7

 Factors affecting the judgment:

I) Relative concept of materiality: amount material to
a given company may not be material for others.
• For e.g. $50,000 may be material for a company
with total assets of $3million; however, it may be
immaterial for a company having billions of assets
amount.
II) The primary base used: net income before taxes is
normally a primary base for deciding what is material
because it is regarded as a critical item of information
for users.
• Some audit firms use other bases such as: net sales,
gross profit, and totalSetassets.
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 Materiality in Auditing 9

III) Qualitative factors: certain types of

misstatements are likely to be more important
to users than others, even if the dollar amounts
are the same.
E.g. Misstatement involving fraud; for instance:
intentional misstatement of inventory is more
important than clerical error of the same
amount.

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 Components of Audit Risk
1. Inherent Risk
2. Control Risk
3. Planned Detection Risk
4. Acceptable Audit Risk

Audit
Risk

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 1 – Inherent Risks

• The inherent risk could not be prevented due

to uncontrollable factors, and it is also not
found in the Audit.
• Example: transactions involving high-value
cash amount carry more inherent risk than
transaction involving high-value cheques.
Sources of Inherent Risk:
• Complex business transactions involving
derivative instruments;

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 2 – Control Risks
• Control Risk is the risk of error or misstatement
in financial statements due to the failure of
internal controls.
• Example: Failure on the part of management to
control and prevent transaction carried out by
staff who is not authorized to carry out those
transactions in the first place.
• Sources of Control Risk:
• Failure of management to instill proper and
effective internal control for financial reporting.

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 3 – Detection Risks

• Detection risk is the risk of failure on the

auditor’s part to detect any errors or
misstatements in financial statements, thereby
giving an incorrect opinion about the firm’s
financial statements.
• Example: Failure by Auditors to identify the
company’s continuous misreporting of financial
statements.
• Sources of Detection Risk:
• Poor audit planning, selection of wrong audit
procedures on the part of the auditor.
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The Audit Risk Model for Planning
PDR = AAR ÷ (IR × CR) or
AAR = IR × CR × PDR
where

PDR = Planned detection risk

AAR= Acceptable Audit Risk
IR = Inherent risk

CR = Control risk
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