TOPIC 3

AUDIT PLANNING &

FRAMEWORK – PART 1, 2 &
3

AUD339
 CHAPTER OUTLINE

 Overview of Audit Planning

 Pre-plan: client’s acceptance
 Scope of audit work
 Knowledge of client’s business and industry:
 Client business risk
 Preliminary analytical procedures
 Materiality
 Sampling
 Assessment of Risk
 Audit risk model
 Engagement letter Client acceptance

Development of audit strategy

No
Probable intention to
rely on internal control

Yes
Identify and document internal controls

Make preliminary evaluation

Still intend to rely?

No Identify weaknesses in or

Overview Yes
Absence of internal control

of the Identify and document internal control

on which reliance will be placed

Audit Perform compliance test

Process Evaluate internal controls in action

Yes

Rely on internal control No Other controls on No

for substantive which reliance is
procedure? possible?

Yes

Evaluate internal controls in action Evaluate internal controls in action

Do results of
No
substantive test satisfy
and assure audit?

Yes

Legal representation letter

Dose evidence No
constitute sufficient
Client’s representation appropriate evidence to
Subsequent event review support an opinion?

Possible disclaimer

Issue audit report

 OVERVIEW OF AUDIT PLANNING
 Definition: involves general strategy and detail approach for the
expected:
 nature

 timing

 extent of an audit

 Reasons for planning the audit:

 To enable the auditor to obtain sufficient competent evidence for

the circumstances
 To help keep audit costs reasonable

 To avoid misunderstandings with the client

 To achieve audit objectives

 To minimize the possibility of audit failure

STAGES OF AUDIT PLANNING

Pre-plan: client’s acceptance

Understand the client’s business & industry
Assess client business risk
Perform preliminary analytical procedures
Set materiality & assess AAR & IR
Understand internal control & assess CR
Gather information to assess fraud risk
Develop overall audit plan & audit program
 Pre-plan: Client’s Acceptance

 Initial Audit Planning:

1. Decides whether to accept a new or continue serving
an existing one
2. Identifies why the client wants or needs an audit
3. Obtains an understanding with the client about the
terms of the engagement
4. Develop Overall Strategy for the Audit
 1. Client Acceptance & Continuance
 New Client Investigation
 Reasons for investigation:
 Prospective client’s standing in the business community
 Financial stability
 Relations with previous auditor

 Apply procedure to communicate with predecessor

auditor
 Cont…
 The successor auditor should get the prospective client’s
permission to communicate with the existing predecessor auditor.
If the permission is not given, the successor auditor should
decline the appointment.
 The successor auditor should inquire the predecessor auditor
whether there is any professional reason for the proposed change.
If there are such reasons, the successor auditor should request the
predecessor auditor to provide him with all necessary details in
order to decide the acceptance of the appointment.
 Cont…
 If the successor auditor does not receive a reply to his
inquiry, he is required to send a reminder to the
predecessor auditor or communicate with him through
other means.
 If no response within a reasonable period after sending of
2 reminders, the successor auditor should inform the
predecessor auditor of his intention to accept the
engagement.
 Cont…
 Continuing Clients
 Determine reason for not continuing to do the audit
 Is there any previous conflicts over scope of audit, the
type of opinion to issue or audit fees?
 Excessive risk exist?
 2. Identify Client’s Reason for Audit
 Statutory requirements
 Financial statement audit
 Compliance audit
 Weaknesses noted in the operations
 Operations audit
 Audit on Internal Control System
 3. Obtain an Understanding With the Client

 ISA210 requires that auditors must document their

understanding of an engagement in the audit files, including
the engagement’s objectives, the responsibility of the auditor
& management, and the engagement’s limitations
 Engagement Letter
 An agreement between the CA firm and the client for the

conduct of the audit and related services

 Cont…

 Contents of Engagement Letter:

 Specify job to be performed by the auditor (audit, review,
compilation, tax return, etc.)
 Restriction to be imposed on the auditor’s work
 Deadlines for completing the audit
 Assistance to be provided by clients
 Schedules of audit to be performed by auditor
 Audit fees
 4. Develop Overall Strategy for the Audit
(a) Select Staff for Engagement

 MIA By-Laws stated:

 A member should carry out his work with a proper
regard for the technical & professional standards
expected of him as a member and should not undertake
or continue professional work which he is not himself
competent to perform unless he obtains such advice
and assistance as will enable him competently to
carry out his work
 4. Develop Overall Strategy for the Audit
(b) Setting audit objectives – Management assertions
 Implied or expressed representations by management about
classes of transactions and related accounts in the financial
statements
 Act as criteria that management uses to record and disclose
accounting information in financial statements
 Auditors use these assertions to identify and assess risks by
considering different types of potential misstatements that
may occur and designing audit procedures in response to
risks.
 There are three categories of assertions:
1. classes of transactions and events
2. account balances
3. presentation and disclosure.
 4. Develop Overall Strategy for the Audit
(b) Setting audit objectives – Management
assertions
Assertions about classes of transactions and events (SOPL) for
the period under audit:
 Occurrence—transactions and events that have been
recorded have occurred and pertain to the entity.
 Completeness—all transactions and events that should have
been recorded have been recorded.
 Accuracy—amounts and other data relating to recorded
transactions and events have been
recorded appropriately.
 Cut-off—transactions and events have been
recorded in the correct accounting period.
 Classification—transactions and events have
been recorded in the proper accounts.
 4. Develop Overall Strategy for the Audit
(b) Setting audit objectives – Management assertions

Assertions about account balances (SOFP) at the period end:

 Existence—assets, liabilities and equity interests exist.
 Rights and obligations—the entity holds or controls the
rights to assets, and liabilities are the obligation of the entity.
 Completeness—all assets, liabilities and equity interests that
should have been recorded have been recorded.
 Valuation and allocation—assets, liability and equity
interests are included in the financial report at appropriate
amounts and any resulting valuation adjustments are
appropriately recorded.
 4. Develop Overall Strategy for the Audit
(b) Setting audit objectives – Management assertions

Assertions about presentation and disclosure:

 Occurrence and rights and obligations—disclosed events,

transactions and other matters have occurred and pertain to

the entity.
 Completeness—all disclosures that should be included in the

financial report have been included.

 Classification and understand ability—financial

information is appropriately presented and described, and

disclosures are clearly expressed.
 Accuracy and valuation—financial and other information is

disclosed fairly and at appropriate amounts.

 4. Develop Overall Strategy for the Audit
(b) Setting audit objectives – Audit Objectives

 Auditors develop their audit objectives and design audit

procedures based on preceding assertions
 Auditors tests each relevant mgnt. assertions and then conduct
audits by using the cycle approach by performing audit tests
of the transactions making up ending balances and by
performing audit tests of the account balances.
 The auditor uses assertions in assessing risks by considering
potential misstatements that may occur, and thereby designing
audit procedures that are responsive to the particular risks.
 4. Develop Overall Strategy for the Audit
(b) Setting audit objectives – Audit Objectives

 Transaction-related audit objectives

 These objectives are closely related to management assertions. They

are intended to provide a framework to help the auditor accumulate

sufficient competent evidence and decide the proper evidence to
accumulate for classes of transactions given the circumstances of the
engagement.
 Help auditor accumulate evidence for classes of transactions

 Balance-related audit objectives

 Balance-related audit objectives are almost always applied to ending

balances in balance sheet account (i.e. accounts receivable, inventory,

notes payable). Some are applied to certain income statement
accounts. Usually for non-routine transactions or unexpected expenses
(i.e. legal expenses, repairs or maintenance).
 Help auditor accumulates evidence to verify detail that supports the

account balance
 Assertions and objectives for inventory in a
manufacturing company
Financial report Illustrative audit objectives
assertion

Existence  Inventories included in the balance sheet physically exist.

 Inventories represent items held for sale in normal course
of business.
Completeness  Inventory quantities as per the accounting records include
all products, materials and supplies owned by the
company that are on hand.
 Inventory quantities include all products, materials and
supplies owned by the company that are in transit or
stored at outside locations.
Rights and  The company has legal title or similar rights of ownership
obligations to the inventories.
 Inventories exclude items billed to customers or owned
by others.
Valuation and  Inventories are properly stated at cost (except when the
allocation net realisable value is lower).
 Slow-moving, excess, defective and obsolete items
included in inventories are properly identified and valued.
 Relationships among Management’s Assertion,
Audit Objectives, Audit Procedures, and Audit
Evidence

Management’s assertions are contained in the financial statements

Auditor develops audit objectives based on management’s assertions

Audit procedures are conducted to test the audit objectives

Audit Evidence is developed to support management’s assertions

STAGES OF AUDIT PLANNING

Accept client & perform initial audit planning

Understand the client’s business & industry
Assess client business risk
Perform preliminary analytical procedures
Set materiality & assess AAR & IR
Understand internal control & assess CR
Gather information to assess fraud risk
Develop overall audit plan & audit program
 2nd STAGE – UNDERSTAND THE CLIENT’S
BUSINESS & INDUSTRY
 Factors that increased the importance of understanding the
client’s business & industry:
 IT connects client companies with major customers &
suppliers
 Clients have expanded operations globally
 IT affects internal client process, improving the quality
& timeliness of accounting information
 The increased importance of human capital & other
intangible assets has increased accounting complexity
and the importance of management judgments and
estimates
 Knowledge of Client Business

Important element to ensure effective risks assessments and evaluation.

ISA 315 identify four broad areas of a client’s business and its
environment:
 industry conditions, regulatory environment and other external factors,
including the applicable financial reporting framework
 nature of the entity including business operations (eg products or
services and geographic dispersion), investments (eg acquisitions and
mergers), financing (eg debt structure) and financial reporting (eg
accounting principles and revenue recognitions)
 objectives and strategies and related business risks such as industry
developments, new products and services, expansion of the business and
use of IT, etc
 measurement and review of the entity’s financial performance
STAGES OF AUDIT PLANNING

Accept client & perform initial audit planning

Understand the client’s business & industry
Assess client business risk
Perform preliminary analytical procedures
Set materiality & assess AAR & IR
Understand internal control & assess CR
Gather information to assess fraud risk
Develop overall audit plan & audit program
 Audit Risks

Audit risk is the risk that the

auditor gives an unqualified audit
opinion when the financial report is
materially misstated

Audit risk (AR) = Inherent risk (IR) × Control risk

(CR) × Planned Detection risk (PDR)
 Cont…
 INHERENT RISK (IR)
 Risk related to the characteristics of the business that
may cause material misstatement
 Factors used in assessing inherent risks
 Nature of client’s business
 Integrity of management
 Client motivation
 Client’s knowledge of accounting standards
 Results of previous audit
 Cont…
 Susceptibility
of defalcation
 Nature of client’s inventory & technological
development
 E.g.
 External factors such as technological development
might make a particular product obsolete
 Financial transactions that require complex calculations
are inherently more likely to be misstated than simple
calculations.
 Cash on hand is by nature more susceptible to theft than
a large inventory of coal.
 Rapid technological developments may create a higher risk of
inventory becoming obsolete more quickly than in other
industries.
 A struggling company may inherently have a greater incentive

to misstate financial information to meet certain covenants.

 A company that has improperly reported a particular balance

in the past may be inherently more likely to misstate it again.

IR is high if no internal control system & IR is low of internal
control exist

AUD390 AUDITING DIA

 Cont…
 CONTROL RISK (CR)
 Risk that the client’s internal control will not prevent
or detect material errors or misstatements in the
account balance
 Control risk exist due to the inherent limitation of
internal control system & inadequacy of the
segregation of duties such as human error, faulty
judgment
 CR high if internal control system is not effective &
CR low if internal controls system is effective
 Cont…
 DETECTION RISK (DR)
 Risk that any remaining material misstatements after
assessing IR & CR will not be detected by auditor
 Risk that the auditor’s substantive procedures &
review FS will not detect material errors misstatements
 DR high if the auditors are not competent & due care
& DR low if the auditors are competent & exercise due
care
STAGES OF AUDIT PLANNING

Accept client & perform initial audit planning

Understand the client’s business & industry
Assess client business risk
Perform preliminary analytical procedures
Set materiality & assess AAR & IR
Understand internal control & assess CR
Gather information to assess fraud risk
Develop overall audit plan & audit program
 4th STAGE – PERFORM PRELIMINARY
ANALYTICAL PROCEDURES

 Definition: a study of relationship between elements of

financial information expected to conform to a predictable
pattern based on the auditor’s knowledge of the business
relationship between financial and non financial
information
Types of data, ratios, etc Comparison with
Financial Data (Account balances, Corresponding period, budget &
budgets, etc) forecasts
Non Financial Data (Production, Entries in accounting records, other
employment statistics) financial data
Ratios & Percentage Preceding period, budget & forecast,
industry
AUD390 statistics
AUDITING DIA
 Cont…
 Types of analytical procedures:
1. Compare client data& industry data
2. Compare client data with similar prior-period data
3. Compare client data client-determined expected
results
4. Compare client data & auditor-determined expected
results
5. Compare client data with expected results, using non
financial data
 STAGES PLANNING DETAILED TEST REVIEW FS
TIMING Before the FS are Start after client had Carry out overall
available submitted FS with review of FS when
supporting schedules most of audit testing
are completed

PURPOSES 1.To understand the 1. To ensure 1.To update auditor’s

client’s industry & completeness, accuracy knowledge of client’s
business & validity of business
2.To assess going information contain in 2.To ensure the FS are
concern the FS not materially
3.To indicate possible 2.To obtain sufficient misstated
misstatement audit evidence by 3.To corroborate
4.To reduced detailed reducing the work done conclusions form
tests through substantive tests during the audit

SOURCES OF Interim FS, Annual FS, Accounting Drafted audited FS

INFORMATIO Management reports, & other records,
NS Budget & forecasts, Management reports,
Internal audit report Internal audit reports

EXAMPLES Calculate key ratios for Reasonable test on EPF Gearing ratio
client and compareAUD390 contribution
AUDITING account
DIA
against industry’s ratios
Analytical procedures most commonly used in planning

 Comparison of current balances in the financial

report with balances of prior periods, and budgeted
amounts (simple comparisons).

 Computation of ratios and percentage relationships

for comparison with prior years, budgets and
industry averages (ratio analysis).

 Significant variations from expectations indicate

areas requiring investigation.
STAGES OF AUDIT PLANNING

Accept client & perform initial audit planning

Understand the client’s business & industry
Assess client business risk
Perform preliminary analytical procedures
Set materiality & assess AAR & IR
Understand internal control & assess CR
Gather information to assess fraud risk
Develop overall audit plan & audit program
 Materiality

ISA 320

“Information is material if its omission or misstatement could

influence the economic decisions of users taken on the basis of
the financial statements. Materiality depends on the size of the
item or error judged in the particular circumstances of its
omission or misstatement. Thus, materiality provides a threshold
or cut-off point rather than being a primary qualitative
characteristic which information must have if it is to be useful.”
 Materiality level

 As noted by ASA/ISA 320.6, the auditor will consider the nature

of the item when determining the materiality level.
 Materiality is a concept of relative significance.
 it depends on the amount of the item of interest and some

relevant basis of comparison.

 To estimate an amount for planning materiality, the auditor
selects a base and a suitable percentage to apply to that base.
 this requires professional judgment, and not all auditors do it

the same way.

 Consideration Of Qualitative Factors In
Materiality
An auditor should consider qualitative factors as well as
quantitative assessment. Qualitative factors include:

 the significance of the item to the particular entity

 the pervasiveness (frequency) of the misstatement (e.g. the

misstatement might affect the presentation of numerous items in
the financial report)

 the effect of the misstatement on the financial report as a whole.

 Relationship between Materiality and Audit Risks

 concepts of risks and materiality go hand-in-hand in the sense that the

auditor collects evidence to determine the risk that a material misstatement
exists in the financial statements.

 There is an inverse relationship between materiality and the level of audit

risk and in determining the nature, timing and extent of audit procedures,
auditors should take into account this inverse relationship.

 The auditor’s assessment of materiality and audit risk when evaluating the
results of audit procedures may be different at the time of initially
planning the engagement because of a change in circumstances or because
of a change in the auditor’s knowledge as a result of the audit.
Assessing Risks of Material Misstatement- ISA 315

“The auditor should identify and assess the risks of material

misstatement at the financial statement level, and at the assertion level
for classes of transactions, account balances, and disclosures. For this
purpose, the auditor:

 identifies risks throughout the process of obtaining an understanding

of the entity and its environment, including relevant controls that relate
to the risks, and by considering the classes of transactions, account
balances, and disclosures in the financial statements
 relates the identified risks to what can go wrong at the assertion level
 considers whether the risks are of a magnitude that could result in a
material misstatement of the financial statements
 considers the likelihood that the risks could result in a material
misstatement of the financial statements
STAGES OF AUDIT PLANNING

Accept client & perform initial audit planning

Understand the client’s business & industry
Assess client business risk
Perform preliminary analytical procedures
Set materiality & assess AAR & IR
Understand internal control & assess CR
Gather information to assess fraud risk
Develop overall audit plan & audit program
6th STAGE – UNDERSTAND INTERNAL CONTROL
& ASSESS CR

 Refer topic on Internal Control System & Control Risk

STAGES OF AUDIT PLANNING

Accept client & perform initial audit planning

Understand the client’s business & industry
Assess client business risk
Perform preliminary analytical procedures
Set materiality & assess AAR & IR
Understand internal control & assess CR
Gather information to assess fraud risk
Develop overall audit plan & audit program
 7TH STAGE – GATHER INFORMATION TO
ASSESS FRAUD RISK
 Definition : Intentional misstatement of the FS
 Types of fraud:
 Misappropriation of assets, often called as defalcation
or employee fraud
 E.g. a clerk taking case (ASSETS/INVENTORY) at the time a
sale is made
 Fraudulent financial reporting, often called as
management fraud
 E.g. intentional overstatement of sales near the balance sheet
date to increase reported earnings
STAGES OF AUDIT PLANNING

Accept client & perform initial audit planning

Understand the client’s business & industry
Assess client business risk
Perform preliminary analytical procedures
Set materiality & assess AAR & IR
Understand internal control & assess CR
Gather information to assess fraud risk
Develop overall audit plan & audit program
 Preparing Detailed Audit Plan Or Program

 ASA 300/ISA 300 requires the auditor to develop and document an audit plan/program.
 An audit plan or audit program is a detailed list of audit procedures that need to be
applied to a particular balance or class of transactions to implement the audit strategy.
 Types of audit programs
 Standardized audit programs.
 Is a pre-prepared listing of objectives and tests which may be used in any audit. A
consistent approach to all audits. Reduce risks that procedures are omitted.
 Tailored audit programs
 Some audit programs need to be tailored to the specific circumstances of an
engagement as all clients are different.
 The design of the audit procedures to be followed match exactly to the actual
system of the entity. Reference can be made specifically to particular
procedures/documents.
 ASA 300.A17/ISA 300.A17 notes that auditor may document audit plan by use of
appropriately tailored (for client) standard audit programs and checklists.
Example of audit program for accounts
payable