Overall Audit Strategy

sets out in general terms how the audit is to be conducted and sets the
scope, timing and direction of the audit.
 Scope
 Timing
 Direction
The audit strategy then guides the development of the audit plan,
which contains the detailed responses to the auditor's risk assessment.

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Overall Audit Strategy
• It should consider the following main areas.
• It should identify the main characteristics of the engagement which define its
scope.
• For example the following:
– Whether the financial information to be audited has been prepared in
accordance with IFRS.
– To what extent audit evidence obtained in previous audits will be
utilised.
– Whether computer-assisted audit techniques will be used and the
effect of IT on audit procedures.
• – The availability of key personnel.
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Overall Audit Strategy
• It should ascertain the reporting objectives of the engagement to plan
the timing of the audit and the nature of the communications
required, such as:
– The audit timetable for reporting and whether there will be an interim as
well as final audit.
– Organisation of meetings with management to discuss any audit issues
arising.
– Location of sites for inventory counts.
– Any discussions with management regarding the reports to be issued.
– The timings of the audit team meetings and review of work performed.
– If there are any expected communications with third parties.

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Overall Audit Strategy
• The strategy should consider the factors that, in the auditor’s professional judgement, are significant in
directing the audit team’s efforts, such as:
• – The determination of materiality for the audit.
• – The need to maintain a questioning mind and to exercise professional skepticism in gathering and evaluating audit
evidence.
• It should consider the results of preliminary audit planning activities and, where applicable, whether
knowledge gained on other engagements is relevant, such as:
• – Results of previous audits and the results of any tests over the effectiveness of internal controls.
• – Evidence of management’s commitment to the design, implementation and maintenance of sound internal control.
• – Volume of transactions, which may determine whether it is more efficient for the audit team to rely on internal control.
• – Significant business developments such as the change in the accounting system and the significant expenditure on an
overhaul of the factory.
• The audit strategy should ascertain the nature, timing and extent of resources necessary to perform the
audit, such as:
• – The selection of the audit team with experience of this type of industry.
• – Assignment of audit work to the team members.
• – Setting the audit budget.

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Audit plan
• The audit plan describes the nature, timing and extent of risk
assessment procedures, further audit procedures to be carried out at
the assertion level, and other procedures required for the execution
of an effective audit

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Generally Accepted Accounting Principles(G
AAP)
• GAAP, or Generally Accepted Accounting Principles, is a commonly recognized set of
rules and procedures designed to govern corporate accounting and financial reporting
The Core GAAP Principles
• GAAP is set forth in 10 primary principles, as follows:
• Principle of consistency: This principle ensures that consistent standards are followed in financial
reporting from period to period.
• Principle of permanent methods: Closely related to the previous principle is that of consistent
procedures and practices being applied in accounting and financial reporting to allow comparison.
• Principle of non-compensation: This principle states that all aspects of an organization’s
performance, whether positive or negative, are to be reported. In other words, it should not
compensate (offset) a debt with an asset.
• Principle of prudence: All reporting of financial data is to be factual, reasonable, and not
speculative.
• Principle of regularity: This principle means that all accountants are to consistently abide by the
GAAP.
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The GAAP
• Principle of sincerity: Accountants should perform and report with basic honesty
and accuracy.
• Principle of good faith: Similar to the previous principle, this principle asserts
that anyone involved in financial reporting is expected to be acting honestly and
in good faith.
• Principle of materiality: All financial reporting should clearly disclose the
organization’s genuine financial position.
• Principle of continuity: This principle states that all asset valuations in financial
reporting are based on the assumption that the business or other entity will
continue to operate going forward.
• Principle of periodicity: This principle refers to entities abiding by commonly
accepted financial reporting periods, such as quarterly or annually.
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Assertions
• Assertions are defined as “a statement that is believed to be true by
the speaker. “the financial statements are assertions by management
on the performance of the company”. If indeed GAAP was used in the
preparation of the income statement, then transactions should have
the following characteristics; occurred , complete, accurate, cut-off,
classification and presentation.
• Management is making the following assertions on the account
balances in the Balance Sheet; existence, rights and obligations
completeness, Valuation, classification and presentation

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Transaction Level Assertions
Transaction Level Assertions (Income Statement)
• Transaction level assertions are made in relation to classes of transactions, such as
revenues and expenses
• There are five types of transaction-level assertions:
• Occurrence: Transactions that are recognized in the financial records as having occurred, i.e., did
it really happen?
• Completeness: Transactions that are completed and supposed to be recorded have been
recognized in the financial statements, i.e., did it include all transactions?
• Accuracy: Transactions have been accurately reflected within the financial statements at
appropriate amounts, i.e., have correct prices, quantities, and calculations been used?
• Cut-off: Transactions that have been recognized in correct and relevant accounting time periods.
• Classification: Transactions have been classified properly .
• Presentation: Transactions are fairly presented in the financial statements.

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Account Balance Assertions
Account Balance Assertions (Balance Sheet)
• Account balance assertions apply to the balance sheet items, such as assets,
liabilities, and shareholders’ equity.
• There are Five types of account balance assertions:
• Existence: The assets, equity balances, and liabilities exist at the period ending time.
• Completeness: The assets, equity balances, and the liabilities that are completed and
supposed to be recorded have been recognized in the financial statements.
• Rights and Obligations: The entity has ownership rights or the right to benefit from recognized
assets on the financial statements. Liabilities recognized in the financial statements represent
the actual obligations of the entity.
• Valuation: The assets, equity balances, and liabilities have been valued appropriately.
• Classification: Transactions have been classified properly and
• Presentation: Transactions are fairly presented in the financial statements.

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Assertions
Income Statement Balance Sheet

Occurrence Existence

Completeness Completeness

Accuracy Valuation

Cut-off Rights and Obligations

Classification Classification

Presentation Presentation

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Transaction-Related Audit Objectives
• An audit objective is a statement that defines the desired audit
outcome.
The following are specific transaction-related audit objectives applied
to the audit of e.g Cash
• Occurrence.
• Completeness.
• Accuracy.
• Classification.
• Cutoff.
• Presentation

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Balance-related audit objective
• Existence
• Completeness
• Accuracy
• Classification
• Cutoff
• Realizable value
• Rights

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Audit Procedures or Methods of Collecting
Evidence
An audit procedure is a technique for collecting and analysing data to
provide evidence
• Inspection of records and documents (Trace ,Vouching)
• Inspection of tangible assets (verification)
• Observation of activities
• Inquiry (speak/talk) to appropriate personnel
• Confirmation
• Recalculation
• Re-Performance – re-do client procudures
• Analytical Procedures
• Examination (review documents)
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 Risk Assessment Procedures:
Assess the risk of material misstatement in the financial
5 Types of Audit Test statements due to error or fraud.
To determine whether Obtain Understanding of the company
the financial Environment and Internal control (design and
statements are fairly Implementation)
stated

Test of Control:
Assess I/C

Substantive Testing
Substantive Test Tests of Details Analytical
of Transactions of Balances Procedures
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• Why do we test control?
Test of Control (TOC)
• To assess control risk for each transaction-related audit objective
• Remember: Only test control when control policies and procedures are believed to
be effectively designed and implemented
• the auditor assesses control risk at a level that reflects the relative effectiveness of those
controls.
• How to obtain sufficient evidence for test of control:
 Inquiries (speak/talk) of appropriate client personnel.
 Examine (review) documents, records, and reports.
 Observation of activities.
 Reperform (re-do) client procedures.
• Understand the internal Control:
• Perform a system walkthrough
• Example: Sales transaction and credit approval
• Sales initiation till approval
• Select 50 sales transactions from at various time during the year
• Was credit granted before the shipment of goods UB
 Substantive Tests
• Substantive tests
• Procedures designed to test for Pula misstatements (monetary misstatements) that
directly affect the of financial statement (correctness) balances and disclosures
• Auditors rely on two (or three) types of substantive tests:
1. Substantive tests of transactions (ST of T)
2. Tests of details of balances. (TDB)
3. Analytical Procedures (AP)

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 Substantive Test of Transactions
• Substantive tests of transactions are used to determine whether all seven
transaction-related audit objectives have been satisfied for each class of
transactions.
• The seven transaction-related audits are:
1. Occurrence: recorded disclosures or disclosed transaction have actually occurred
2. Completeness: All transaction have actually been included as well as disclosures
3. Accuracy: Accuracy of information and related disclosure
4. Posting and summarization: the accuracy of the transfer of information from the
recorded transaction in the journals the subsidiary records and the general Ledger
5. Classification: transaction are included in the appropriate accounts
6. Timing: transaction are recorded on the wrong date
7. Presentation: the auditors counterpart to management presentation assertion

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 Tests of Details of Balances (TBD)
Focus on the ending general ledger balances for both
1. balance sheet (primary focus)
2. income statement accounts, including related disclosures.
Examples
 confirmation of customer balances for accounts receivable
 Sales cutoff test
 physical examination of inventory, and
 examination of vendors’ statements for accounts payable.
Why TBD is considered essentials?
evidence is usually obtained from a source independent of the client (highly reliable).
Like for ST of T, TDB must satisfy all balance-related audit objectives for each significant
balance sheet account.
How much testing? Depends on
1. Results of tests of controls,
2. Substantive tests of transactions, and
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3. Substantive analytical procedures for these accounts.
 Note:
• TOC can be performed separately or more efficiently to perform TOC
and ST of T simultaneously.
• apply tests of controls involving inspection and reperformance to the same
transactions tested for monetary misstatements.
• TOC and P
 Analytical Procedures
• Comparisons of recorded amounts to expectations developed by the auditor.
• Financial and non-Financial Data
• Interest expense and debt
• COGS and sales
• Hotel occupancy rate and revenue
• Sales per square foot
• Required during planning and competing the audit (final review)!
• Same or different ones
• Not required for substantive procedures
• Purpose:
• 1. Easy Red flag for possible misstatements in F/S
• 2. Provide substantive evidence.
• If AP is reliable; Tests of details of balances may be eliminated or sample sizes
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 How Good is A/P?
• Precision of the expectation developed by the auditor
• YOY or QOQ or MOM
• Predictability of the relationship
• Stable vs dynamic
• Income statement vs balance sheet
• I/S Period
• Balance sheet one point in time
• Account subject to discretion (bad debt)
• Reliability of the data
• Good i/C
• Industry (outside)
• Audited
• The ratios are covered in detail in other lessons:
• Liquidity, probability, coverage, activities etc…
 Risk Assessment Procedures (always):
Assess the risk of material misstatement in the financial
5 Types of Audit Test statements due to error or fraud.
To determine whether Obtain Understanding of the company
the financial Environment and Internal control (design and
statements are fairly Implementation)
stated

Test of Control:
Assess I/C

Substantive Testing
Substantive Test Tests of Details Analytical
of Transactions of Balances Procedures
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 Why type of tests to use?

• Several factors influence the auditor’s choice

1.The availability of the eight types of evidence
2. the relative costs of each type of test
3. the effectiveness of internal controls, and
4. Inherent risks
 Type of Evidence
1. 6 out 8 are used for tests

Inquiries of the Client

Physical Examination
of details of balances

Reperformance
2. Physical examination and

Recalculation
Confirmation

Observation

Procedures
Inspection

Analytical
confirmation TDB.
3. Inquiries for everything
4. Inspection for everything
except substantive
analytical.
Audit Procedures 5. 5. Reperformance same
as inspection
✔ ✔
✔ ✔
Tests of controls (including
understanding of internal control
✔ ✔ ✔ ✔
Substantive tests of transactions
✔ ✔
Substantive analytical procedures
✔ ✔ ✔ ✔ ✔ ✔
Tests of details of balances
6. Recalculation (mathematical accuracy) used substantive tests of transactions and account balances when performing
tests of details of balances.
7. Add observation to TOC
 Cost of Evidence
• The cost of the evidence is an important consideration (the only
consideration!).
• Cost from lowest to highest:
Substantive analytical procedures
Risk assessment procedures, including procedures to obtain an understanding
of internal control
Tests of controls
Substantive tests of transactions
Tests of details of balances

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 Substantive analytical procedures

• Least costly:
• ease of making calculations and comparisons.
• Could red flag for potential misstatements
• IF substantive analytical procedures:
• are the primary evidence for an account balance, or
• are used to reduce tests of details of balances,
•  precise expectation to support the account balance.
• Complex and advanced calculation will be involved.

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 Risk assessment procedures + I/C
• Not as costly as other audit tests
• make inquiries and observations and perform planning analytical procedures.
• Reviewing documents summarizing the client’s business operations and processes
and
• Leaning management and governance structure are relatively cheaper than other
audit tests.
• However, tests of controls are more costly relative to the auditor’s risk
assessment procedures 
• operating effectively, especially when those tests of controls involve reperformance.
• Audit software can be used to perform large number of test of control
quickly if control is automated
• Sales on Credit to account balance check
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 Substantive Tests of Transactions
• Cost more than tests of controls
• Repronounce cost the same for both tests) because
it require recalculations and tracings.
• Big Data and computerized environment,
• the auditor can often perform substantive tests of
transactions quickly for a large sample of
transactions.

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 Tests of Details of Balances
• Cost the most
• Sending confirmation
• Costing inventory
• Type of inventory (gold, silver, computer chips or
jeans)
• Location!
• Internal control policies
• Auditor try to minimize its use

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 Relationship Between TOC and Substantive
Test
• What is the difference?
• An exception (deviation) in a test of control only means the likelihood
(possible) of misstatements affecting the dollar value of the financial
statements,
• An exception in a substantive test of transactions or a test of details of
balances is (surely)a financial statement misstatement.
• Three levels of control deficiencies:
1. deficiencies
2. significant deficiencies, and
3. material weaknesses.
• 2 and 3: Material dollar misstatements exist in the financial statements
• ST of T and TDB should follow to confirm
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• Let’s assume:
Independent EE is to verify the quantity, price, and extension of each sales invoice  Then initial
• Audit select a sample to verify
1) If a significant # of invoices missing initials  determine implication of IC over financial
reporting
• Response?
• extending tests of duplicate sales invoices to verify extension and footing (ST of T)
• Increase sample size (n) which is TDB
• Be aware: Just because the sample lacks initials it means the sales invoices are incorrect.
• Maybe there is no issues with the sales invoices from the origin (competent EE)
2) if no documents or only a few of them are missing initials  the control will be considered
effective
• Response?
• Decrease substantive tests of transactions and tests of details of balances (save money/time)
• Auditor would still carry some reperformance and recalculation (substantive tests) to provide
assurance
• To be more efficient:
• many auditors perform them as a part of the original tests of controls.
• Others wait for TOC and then determine the needed N (sample size)
 Relationship between AP and Substantive
Testing
• AP is only indicator (like TOC) of the likelihood of misstatements $.
• Unusual fluctuations is a red flag not direct evidence of a material
misstatement. Perform
• substantive tests of transactions or
• tests of details of balances
• If AP does not raise red flags
• Substantive testing may be reduced
• AP is a “good substantive test” for small balances such as
• supplies and
• PP expenses
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 Trade-off Between TOC and Substantive
Audit Assurance
Testing

Internal Control Effectiveness

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 Evidence Mix
• Can vary widely among audits.
• Depends on
• for differing levels of internal control effectiveness and
• inherent risks.
• At the same audit engagement, the evidence mix will vary from cycle
to cycle.
• Combination of the types of tests are employed to obtain sufficient
appropriate evidence in response to risk identified:
• Evidence Mix
 Substantive Substantive Tests of
Test of Tests of
Controls Tests of Analytical Details of
Transactions Procedures Balances

Company 1 E S E S
Company 2 M M E M
Company 3 N E M E
Company 4 M E E E

E= Extensive amount of Testing

M= Medium amount of testing
S = Small amount of testing
N = No testing

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 Test of Control Vs. Substantive Test of
Transaction
1.Trace a number of shipping documents to entry in the accounting system (sales journal).
2. Examine a sample of warehouse removal slips fo signature of authorized individual
1.Occurrence
3. Examine contract terms for large and unusual sales transactions to determine whether
management has included adequate disclosures 2.Completeness
of those transactions in the footnotes
3.Accuracy
4. Examine duplicate copy of shipping documents for evidence that quantities were verified
before shipment. 4.Posting&
summarization
5. Select a sample of payroll payments processed and agree hours to employee time records.
6. Use audit software to foot and cross-foot 5.Classification
the sales journal and trace the balance to the general
ledge 6.Timing
7.Examine voucher packages and related vendor 7.Presentation
invoices for evidence of approval of account
classification
8. Select a sample of sales invoices and agree prices to the approved price list.
9. Select a sample of entries in the cash receipts journal and trace to posting in individual
customer accounts receivable records.
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