TOPIC 3

AUDIT PLANNING &

FRAMEWORK – PART 1 & 2

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
Overview
of the
Audit
Process
 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
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 attention 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 (IS) 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 (BS) 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 – 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
Transaction-related audit objectives
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
STAGES OF AUDIT
PLANNING
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
Tools to understand the client's business & industry:
Strategic Systems Approach
1.Industry & External Environment
2.Business Operations & Processes
3.Management & Governance
4.Objectives & Strategies
5.Measurement & Performance
 1. INDUSTRY & EXTERNAL
ENVIRONMENT
Reasons for understanding the client’s business &
industry:
There are risk associated with specific industry
There are inherent risk that are typically common to all clients in certain
industry
Many industries have unique accounting requirement that the auditor must
understand before start to audit
 2. BUSINESS OPERATIONS
& PROCESSES
Factors to understand:
Sources of revenues
Key customers & suppliers
Sources of financing
Information about related parties that may indicate areas of increased client
business risk
According to FRS 124, require to disclose
transactions with related parties in the financial
statements if they are material
 CONT…
Related party: “Parties are considered to be
related if one party has the ability to control the
other party or exercise significant influence over
the other party in making financial decisions”
A Related transaction: any transaction between
the client and related party
E.g. sales or purchase transactions between a
parents company & its subsidiary, exchanges of
equipment between 2 companies owned by the
same person
 3. MANAGEMENT &
GOVERNANCE
Areas that require auditor to understand
Management’s philosophy & operating style
Memorandum & Article of Association
Minutes of Meeting
Ability to identify & respond to risk
Significant impact the risk of material misstatement in the financial
statements
E.g. significant annual increase in sales and earnings reported by the company was ultimately
determined to be based on various improper accounting technique encouraged by the CEO
 4. OBJECTIVES &
STRATEGIES
Auditors should understand client objectives related
to:
Reliability of financial reporting
Effectiveness & efficiency of operations
Compliance with laws and regulations
 5. MEASUREMENT &
PERFORMANCE
Performance measurement systems: the key
performance indicators that management uses to
measure progress towards objectives
E.g. market share & sales per employee, unit sales
growth, unique visitors to a Web site, sales per
square ft. for a retailer, ratio analysis, benchmarking
against key competitors
STAGES OF AUDIT
PLANNING
 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 FS
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
IR is high if no internal control system & IR is low of internal control exist
 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
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 Corresponding period, budget &
balances, budgets, etc) forecasts
Non Financial Data Entries in accounting records,
(Production, employment other financial data
statistics)
Ratios & Percentage Preceding period, budget &
AUD390 AUDITING DIA

forecast, industry statistics

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
CONT… are completed
PURPOSES 1.To understand the 1. To ensure 1.To update auditor’s
client’s industry & completeness, knowledge of client’s
business accuracy & validity of business
2.To assess going information contain in 2.To ensure the FS
concern the FS are 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 conclusions form
tests done through during the audit
substantive tests
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 Reasonable test on Gearing ratio

for client and EPF contribution
compare against account
AUD390 AUDITING DIA
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
 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
SAMPLING
 STATISTICS AS AN AUDIT TOOL

Since the auditor cannot examine every item, the auditor has to select a sample of
items for testing, hence, the term “audit sampling”.
Audit sampling means the application of audit procedures to less than 100% of the
items within an account balance or class of transactions
to enable auditors to obtain and evaluate audit evidence about some characteristic of the
items selected in order to form or assist in forming a conclusion concerning the population.

1.1 “Precision” and “Reliability”

METHODS OF SAMPLE SELECTION
 SAMPLE SIZE
Table 8.1
Factors Influencing Compliance Test (Test of Controls) Sample Size
Conditions Leading to:
Factor Smaller Sample Size Larger Sample Size
(a) Planned reliance on (1) Higher reliance on Lower reliance on internal
internal control internal control control

(b) Allowable rate of Higher acceptable rate of Lower acceptable rate of

deviation (tolerable error) deviation for planned deviation for planned
reliance on internal reliance on internal
control control
(c) Allowable risk of over- Higher risk of over- Lower risk of over-
reliance reliance on internal reliance on internal
control control

(d) Likely rate of population (2) Lower expected rate of Higher expected rate of
deviation deviation in population deviation in population
(e)Number of items in Virtually no effect on sample size unless population is
population small
 SAMPLE SIZE (CONT)
Table 8.2 Factors Influencing Substantive Test Sample Size
Conditions Leading to:
Factor Smaller Sample Size Larger Sample Size
(a)Reliance on internal control Higher reliance on internal control Lower reliance on internal
control

(b)Reliance on other substantive Higher reliance to be placed on Lower or no reliance to be

tests related to same audit other substantive tests placed on other substantive
objective and class of tests
transactions
(c)Measure of tolerable error for a Larger measure of tolerable error Smaller measure of tolerable
specific audit objective error

(d)Expected size and frequency of Smaller errors or lower frequency Larger errors or higher
errors frequency

(e)Population value Smaller monetary significance to Larger monetary significance to

the financial information the financial information

(f)Number of items in population Virtually no effect on sample size unless population is small
(g)Overall assurance required Lower overall assurance Higher overall assurance

(h)Stratification Stratification of the population, if No stratification of the

appropriate population
STAGES OF AUDIT
PLANNING
Refer topic on Internal Control System & Control
Risk
STAGES OF AUDIT
PLANNING
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
 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