ACCTG 3220: AUDITING IN CIS ENVIRONMENT
AUDIT PLANNING (Lecture #1) Importance of Understanding the Client
Importance of Audit Planning To identify and understand the events,
“Plans are worthless but planning is transactions and practices that may have
everything.” – Dwight D. Eisenhower a significant effect on the financial
Even if the auditor or auditing team has statements
already reviewed the same firm or client To evaluate the reasonableness of the
with the same internal controls for the client’s estimates
current year, it is critical to interview as To understand entity’s objectives and
many workers as possible to avoid strategies, and the related business risks
assessment failure. Audit planning should To obtain understanding of entity’s
be continuous and cumulative. measurement of performance
An engagement that is effectively planned
Sources of Information
could eliminate over-or-under-testing, lead
Review of prior year’s working papers
to more relevant documentation, and help
Tour of the client’s facilities
reduce the likelihood of audit failure or a
Reading relevant books, periodicals, and
potential professional liability claim, saving
other publications
time in the long run.
Discussion with people within and
Understanding the Client outside the entity
PSA 315 Reading corporate documents (e.g.
Requires the auditor to obtain sufficient minutes of meeting) and financial reports
understanding of the entity and its
environment including its internal control Uses of Information Obtained
Such understanding involves obtaining Assessing risks and identifying potential
knowledge about the entity’s problems
o Industry, regulatory, and other external Planning and performing the audit
factors, including financial reporting effectively and efficiently
framework; - Full PFRS PFRS for SMEs etc Evaluating audit evidence as well as the
o Nature of the entity, including its reasonableness of client’s
selection and application of accounting representations and estimates
policies; - mngt decides the accounting Providing better service to the client –
policy; accounting standards focus on adding value to the client not
o Objectives and strategies and the related just to comply or finish the audit
business risks that may result in a
Additional Consideration on New
material misstatement of the financial
Engagements
statements; - during interview with
A firs-time audit engagement requires
managers and employees; management
more work than a repeat engagement.
letter points
This is because there are additional audit
Such understanding involves obtaining
procedures that need to be performed in
knowledge about the entity’s
connection with the opening balances. –
o Measurement and review of the
review prior year documentation of
entity’s performance; and
papers, fs etc.
o Internal Control
ACCTG 3220: AUDITING IN CIS ENVIRONMENT
PSA 510 requires the auditor to sufficient Using Materiality in an Audit
appropriate audit evidence that: Step 1: Determine the Overall Materiality –
The opening balances do not contain Financial Statement Level (Planning Phase)
misstatements that materially affect the The auditor should determine the
current year’s financial statements; amount of misstatement that could be
The prior period’s closing balances have material to the financial statements
been correctly brought forward to the taken as a whole.
current period or, when appropriate, have The auditor should consider materiality
been restated; and in terms of the smallest aggregate level
Accounting policies are appropriate and of misstatement that could distort any
have been consistently applied one of the fs.
Understanding the Internal Control Statement of Financial position: 500k
To obtain sufficient understanding of the Statement of Financial performance:
entity’s internal control systems 300k – overall materiality level
To anticipate the type of potential 300k < 500k
misstatements that can occur in the A common method of estimating the
financial statements overall materiality at the financial
statement level is to multiply a financial
Developing an Overall Audit Strategy statement base (total assets, sales, net
How much evidence to accumulate? income etc.) by a certain percentage.
What are the procedures to be performed Step 2: Determine the Tolerable
When should the procedures be Misstatement – Account Balance Level
performed? (Planning Phase)
Materiality This is done by allocating the overall
Information is material if its omission or materiality to the financial statement
misstatement could influence economic account balances.
decision of users taken on the basis of the PSAs do not provide specific guidelines
financial statements. as to how the allocation should be
In audit, materiality may be viewed as: done. This process is highly subjective
o The largest amount of misstatement and requires the exercise of great deal
of professional judgment.
that the auditor could tolerate in the
financial statements; or Performance of Audit Procedures
o The smallest aggregate amount that (substantive testing)…
could misstate any one of the financial
Step 3: Compare the aggregate amount of
statements
uncorrected misstatements with the
Materiality is a matter of professional
overall materiality (Completion Phase)
judgment and necessarily involves
quantitative factors (amount of item in Performance Materiality
relation to the financial statements) and It is the reduced level of materiality that
qualitative factors (the nature of auditors use to both at the fs and
misstatement) account balance level
ACCTG 3220: AUDITING IN CIS ENVIRONMENT
When auditing financial statements, it is control increases, the scope of the
common for auditors to exercise prudence auditor’s substantive test decreases.
by setting materiality at an amount lower (Control Risk)
than the overall materiality
Audit Risk Model
The extent of the audit procedures is
Audit Risk = Inherent Risk * Control Risk *
increased thereby reducing the risk that the
Detection Risk
amount of uncorrected and undetected
Detection Risk – uncontrollable; depends
misstatements will exceed the overall
on the substantive testing used as strategy
materiality
to decrease this risk
1M – overall materiality
65% - percentage of performance Audit Risk
materiality Refers to the risk that the auditor might
1M * 65% = 650,000 – performance be given an appropriate audit opinion on
materiality the financial statements
The determination of performance Audit Risk is the complement of audit
materiality involves the exercise of assurance
professional judgment If Audit Risk = 5%
Then, Audit Assurance = 95% -
Bases that can be used to determine the
confidence level
materiality level
High confidence lever, low detection
Annualized financial statements risk, broader substantive testing
Prior year financial statements; or
Inherent Risk
Budgeted financial statements of the
The susceptibility of an account balance
current year
or class of transactions to a material
Audit Risk misstatement assuming that there were
When designing substantive tests, the auditor no internal controls.
should consider 3 main issues PSA 315 requires the auditor to assess
1. What level of assurance does the auditor inherent risk at the financial statement
wish to attain that the financial statements and account balance or transaction.
do not contain material misstatements? As
this level of assurance increases, the scope Factors that may influence the auditor’s
of the auditor’s substantive test also assessment of the risk of misstatement at
increases (Audit Risk) the financial statement level include:
2. How susceptible is the account to material The management integrity
misstatement? As the susceptibility of the Management characteristics
account to material misstatement Operating characteristics
increases, the scope of the auditor’s Industry characteristics
substantive tests also increases (Inherent Factors affecting inherent risk at the
Risk); and account balance level may include the ff:
3. How effective is the client’s internal control Susceptibility of the account to theft
in preventing or detecting misstatements? Complexity of calculations related to
As the effectiveness of the client’s internal account
ACCTG 3220: AUDITING IN CIS ENVIRONMENT
The complexity underlying transactions and consideration to the assessment of inherent
other events and control risks
The degree of judgment involved in As the acceptable level of detection risk
determining account balances decreases, the assurance provided by
substantive tests increases.
Control Risk
Control risk is directly related to the
condition of the entity’s internal control
system.
If the entity’s internal control is effective,
then the risk that the control will fail to
detect or prevent material misstatement
(control risk) decreases.
Detection Risk
The risk that an auditor may not detect a
material misstatement that exists in an
assertion
The more effective substantive test are, the
lower misstatement the exists in assertion
Using the Audit Risk Model
1. Set the acceptable level of Audit Risk (Audit
Planning)
2. Assess the level of Inherent Risk (Audit
Planning)
3. Assess the level of Control Risk
(Consideration of Internal Control)
4. Determine acceptable level of Detection
Risk (Performing Substantive Tests)
Acceptable Level of Detection Risk =
Acceptable Level of Audit Risk
Inherent Risk * Control Risk
From this equation, we can conclude
that for a given level of Audit Risk, there is an
inverse relationship between the Acceptable
level of Detection Risk and the Assessed level
of Inherent and Control Risk
Designing Substantive Tests
Designing substantive tests depends on the
acceptable level of detection risk; a after
