Chapter 9 AUDIT STRATEGY

Other activities in audit planning PSA 300 par 6

Modifying (updating) the overall audit strategy and the audit plan as necessary - Requires that the auditor establishes the overall strategy for the audit.
during the audit
- This overall audit strategy sets the scope, timing and direction of the audit
➢ Unexpected events and guide the development of the more detailed audit plan.
➢ Changes in conditions
- An abstract idea that occurs in the brainstorming stage of the audit planning
➢ Audit evidence obtained from audit procedures
process
Two levels of planning
- Main ideas of the auditor on how to plan and conduct the audit and set the
1. Overall audit strategy scope, timing, and direction of the audit

• Scope - This guides the development of the more detailed audit plan
• Objectives and training
• Materiality
• Key aspect of focus The process of establishing the audit strategy should involve:
• Staffing needs, selections and supervision
- Identifying the characteristic of the engagement that defines the scope
• Approach to audit
- Ascertaining the reporting objectives of the engagement to plan the timing of
2. Detailed audit plan
the audit and the nature of the communication required
• Understanding the entity and its environment (PSA 315) - Considering the important factors that will determine the focus and direction
• Auditor’s response to assessed risk (PSA 330) RISK BASED of the engagement team efforts
APPROACH
• Other planned audit procedures for compliance to PSA - Considering the results of preliminary engagerent acwines, and relevance of
knowledge gained by the team om other engagement performed
- Ascertaining the nature, timing and ev necessary to perform the engagement
Overall Audit Strategy Considering the results of preliminary engagement activities, and relevance of
knowledge gained by the team on other engagements performed
Identifying the characteristic of the Engagement that defines the scope
Ascertaining the nature, timing and extent of resources necessary to perform
* Financial Reporting Framework
the engagement
* Industry specific reporting requirements
AUDIT STRATEGY
* Locations of the components of the entity
Other Benefits of Audit Strategy:
Ascertaining the reporting objectives of the engagement to plan the ■ Resources to deploy for specific areas
timing of the audit and the nature of the communication required
■ Amount of resources to be allocated in specific areas
* Deadline for interim and final reporting
■ When the resources are to be deployed
* Key dates and organizations of meeting with management and those charged
with governance to discuss the nature and extent of audit work ■ How such resources are managed, directed and supervised
* Discussion with management regarding the expated communication on the The Best Audit Strategy:
status of audit work
The approach that results in the most efficient audit, that is, an effective audit
Considering the important factors that will determine the focus and performed at the least possible cost.
direction of the engagement team efforts
Audit strategy normally identifies and sets after the audit objective but before
- Determination of appropriate materiality level or at the same time as the audit plan is performed. Managing the time frame of
the audit assignment is also part of the audit strategy.
- Identification of areas where there may be higher risks of material
misstatements The right audit strategy could lead to minimizing auditor risks, meeting audit
deadlines, and using audit resources efficiently.
- Identification of material components and account balances
The auditor will have to make sure that the audit assignment is not only
- Evaluation whether the auditor plan to obtain evidence on effectivity of internal
complete within the time required by its client, but they have to make sure that
control
there is sufficient time to ensure that the maximum audit quality is maintained.
- Identification of recent entity specific, industry, financial reporting, or other
relevant developments
Examples of Audit Strategy • the professionals in charge of the audit.
Auditors will: Typical Audit Plan
✓ use risks-based audit approach • Description of the client company
✓ apply a top-down approach to conduct audit assignments
✓ audit of new clients and they decided not to rely on the internal control - Structure
financial statements by deciding not to test of control. Go to a - Nature of business
substantive test.
✓ Income Tax season, audit the classes of transactions then account - Organization
balances.
• Audit objectives (tax filing, for end users)
The Audit Plan • Description of the nature and extent of other services such as tax
returns
Formalizes the audit strategy and is more detailed than the Audit Strategy
• Required governmental reports
It includes the nature, timing, and extent of audit procedures to be performed
Typical Audit Plan
The purpose is to obtain sufficient appropriate audit evidence to reduce risk to
• Timetable of the audit work
an acceptably low level
• Work to be done by the client's employer
An Audit Plan is a detailed plan that professionals create before performing • Assignment of audit staff
an audit on a company or organization. • Target completion dates
• Preliminary evaluation and judgement about materiality level
This plan includes information about the standards the auditors aim to uphold • Any special problems to be resolved during the engagement
while performing the audit. • Conditions that may require revision in materiality
The Audit Plan Matters of Importance
➤Includes the specific procedures and policies that the auditors are to use to Difference between audit strategy and audit plan
complete the audit.
o An AUDIT STRATEGY is about implementing a program for tackling
➤ Contains information about: the audit, and the AUDIT PLAN will use this strategy to tackle the audit.
is about how you
• the scope of the audit o AN AUDIT PLAN is more detailed than the AUDIT STRATEGY and
• the name and other defining information about the company in includes the nature, timing, and extent of audit procedures to be
question performed to obtain sufficient evidence to reduce the audit risk at an
• the time frame over which the audit occurs acceptable low level
Take note: - Judgement about materiality are made in light of surrounding circumstances,
and are affected by the size and nature of misstatement, or a combination of
✓ Development of audit strategy and audit plans is not sequential
both; and
✓ Audit strategy and audit plans should be updated and changed as
necessary during the course of the audit - Judgement about matters that are material to users of the financial statements
are based on a consideration of the common financial information needs of
Areas for consideration in Audit Strategy
users as a group.
• Characteristics of the engagement that defines the scope PSA 320 par 2
• Reporting objectives to plan the timing and nature of communications
required Definition:
• Results of preliminary activities and previous engagement experience
• Information is material if its omission or misstatement could influence
• Nature, Timing, and extent of available resources the economic decision of users taken on the basis of the financial
AUDIT STRATEGY statements.
• Materiality depends on the size of the item or error judged in the
When developing an audit strategy, the auditor must consider the appropriate particular circumstances of its omission or misstatement.
levels of materiality and audit risk • Thus, materiality provides a threshold or cut-off point rather than being
Inherent Limitations in an Audit: a primary qualitative characteristic which information must have if it is
to be useful.
1. The use of testing or sampling
Financial Reporting Standard Council (FRSC)
2. Error in application of judgment
Concept of Materiality:
3. Reliance on management's representation
- The largest amount of misstatement that the auditor could tolerate
4. Limitation on the client's accounting and internal control system
- The smallest aggregate amount that could misstate the financial statement
5. Nature of evidence (persuasive not conclusive
Materiality therefore relates to:
Materiality
•the significance of transactions
Definition
•balances and errors contained in the financial statements.
- Misstatements, including omissions, are considered to be material if they,
individually or in the aggregate, could reasonably be expected to influence the • threshold or cut-off point after which financial information becomes relevant
economic decisions of users taken on the basis of the financial statements to the decision-making needs of the users.
Consideration of Materiality The auditor's determination of materiality is
Materiality should be considered by the auditor ✓ A matter of professional judgment,
✓ Affected by the auditor's perception of the financial information needs
- Determining the nature, timing and scope of the audit engagement
of the users of financial information.
- Identifying and assessing the risks of material misstatement
The auditor can assume that users:
- Adjustments, revisions of audit plans
➢ Have knowledge of the business, economic and accounting activities of
Features of Materiality the firm and will diligently study the information in the financial
statement
o Involves both quantitative and qualitative considerations ➢ Understand that FS are prepared and audited to levels of materiality
o Relative to size and particular circumstance of the entity ➢ Recognize uncertainties that measurement used are based on
o To determine what is material is a matter of professional judgment of the estimates, judgment, forecasts
auditor ➢ Make economic decision based on the information in the financial
o In designing audit plan, the auditor should establish materiality level to statement
detect material misstatements
o Even immaterial matters can have material effect in the Financial (PSA 320 par 4)
Statements Use of Materiality
o Materiality may be influenced by legal and regulatory requirements
o In designing an audit plan, make a preliminary estimate of materiality for - Planning and performing the audit
use during the examination
- Evaluating effect of identified misstatements and uncorrected misstatements
o Some matters are important for fair presentation while other matters are
not that important - Forming the opinion in the auditor's report
o The largest amount of misstatement that the auditor could tolerate in the
Financial Statement Importance of materiality: To determine the volume of evidence to be
o The smallest aggregate amount that could misstate the Financial accumulated
Statement Different Levels of Materiality
o An error may not be material quantitatively but material qualitatively
o Small amounts but collectively could have a material effect (PSA 320 par 10)
o Materiality refers to an amount or transaction that would influence the
• Financial Statement level or overall materiality- materiality for the financial
decision of users
statement as a whole
o Materiality depends on the size of the item
o It is a threshold point not a characteristic to be useful •Specific materiality- materiality applied to classes of transactions, account
balances, disclosures
• Performance materiality-scoping of financial statements line items to be - Equity - 3% to 5%
tested by the auditor to ensure that significant accounts are covered in the audit
- Revenues 1% to 3%
testing (PSA 320 par 9)
- Less than 5% immaterial & greater than 10% materiality
Overall materiality
- 1% to 1.5% larger of total assets or revenue
• Based on financial statement as a whole
• The highest amount of misstatement without affecting the economic Suggestion: ranges from 5% - 20% of the factor
decision of the users
• Financial Statements are interrelated Specific Materiality
• Based on the common financial information needs of the users. • Lesser amount than the overall materiality that may be relevant to users
• •Percentage is often applied to a chosen benchmark as starting point • Refers to sensitive accounts in the financial statements or disclosures
Materiality Benchmarks • Done by allocating the overall materiality to the respective account
balances
• The elements of financial statements • Allows the auditor to determine audit procedures to each specific
• Items which users tends to be focused accounts
• Life cycle of the entity • Allocation is not provided in the standards and highly subjective
• Economic environment which the entity operates
• Ownership structure and the way it is financed Performance Materiality

Technical Benchmark Definition (PSA 320 par 9)

• Reported income such as profit before tax, total revenue - The amount or amounts set by the auditor at less than materiality for the
• Gross profit and total expense financial statements as a whole to reduce to an appropriately low level the
• Total equity or net asset value probability that the aggregate of uncorrected and undetected misstatements
• Total Assets exceeds materiality for the financial statements as a whole. If applicable,
• Total Revenues performance materiality also refers to the amount set by the auditor at less than
• Profit before tax from continuing operations (for profit-oriented entities) the materiality level or levels for particular classes of transactions, account
• Average of three years' net income before taxes balances or disclosures

Starting Points
PSA does not require any range of percentages, based in actual practice
- Income from continuing operations - 3% to 7%
- Assets 1% to 3%
Performance Materiality • Comparison of these aggregate misstatements against the adjusted
preliminary materiality
• Margin of safety or buffer against undetected misstatement and
• If aggregate misstatements are less than adjusted preliminary
uncorrected errors
materiality, there is fair presentation
• Consideration of immaterial items on the aggregate to cause
• Conversely, if greater the auditor should recommend adjustments of
misstatement exceeding materiality level
the financial statements
• Set at lower amount than the overall materiality and specific materiality
• If client refuses, the auditor should issue a qualified or adverse opinion
• To lower audit risk to an appropriately low level
WARNING!!!
Performance Materiality
NEVER MENTION THE LEVEL OF MATERIALITY TO THE CLIENT OR
Other pertinent matters on performance materiality
AUDITEE OTHERWISE EVIDENCE COULD BE MANIPULATED BY THE
• Not a simple mechanical calculation but an exercise of professional MANAGEMENT
judgment
AUDIT PLAN
• affected by the auditor's understanding of the entity
• updated during the execution of the auditor's risk assessment Detailed Audit Plan
procedures
• Understanding the entity and its environment (PSA 315)
• nature and extent of accumulated misstatements from past
engagements • Auditor's response to assessed risk (PSA 330)
• required for an auditor to establish under PSA 320 par 11
• Other planned audit procedures for compliance to PSA (various PSA)
Steps in using Materiality
NOTE: The auditor shall update and change the overall audit strategy and the
✓ Establish a preliminary judgement about materiality audit plan as necessary during the course of the audit
✓ Determine tolerable misstatement
✓ Establish performance materiality Documentation
✓ Estimate likely misstatements and compare totals to the preliminary • The overall audit strategy
judgement about materiality • The audit plan
Steps in using Materiality • Significant changes discovered during the audit engagement and the
reasons for such changes
• Done near the end of the audit when gathered evidences are evaluated • Pre-engagement activities
• Aggregates misstatements gathered from specific accounts and • Letter of engagement
previous identified unacted & unadjusted misstatements in the prior • Materiality level
periods
Initial Audit Engagements PSA 510-Opening Balances
Considerations in initial audit engagements: PSA 510 par 3
✓ Acceptability of the client relationship and specific engagement Objective of the auditor regarding opening balances whether:
✓ Communication with the previous auditor, if there is a change, in
- Opening balances contain misstatement and affect current period's financial
compliance with ethical requirements
statement
✓ Review the previous auditor's working paper but consider the ethical
requirements - Consistency in the application of appropriate accounting policies reflected in
the opening balances
Direction, Supervision and Review
- Opening balances: those account balances that exist at the beginning of the
Auditor plans the nature, timing, and extent of direction and supervision of
period (PSA 510 par 4)
engagement and review their work
Other Critical Matters in Engagement Planning
Direction and supervision:
• Application of Analytical Procedures
- extent of instructions to team members on procedures to undertake
- supervising how procedures are undertaken • Establishment of an engagement or audit team
• Consideration of work performed by others:
Review: to determine if members have conducted the procedures properly and - predecessor auditor
effectively - other CPA
- specialists
Nature & timing varies and dependent on:
- use of client's staff
- size and complexity of the entity - internal auditors
- area of the audit • Assessment of going concern
- assessed risk of material misstatement • Identification of related parties
- capabilities and competence of individual team members • client's legal obligation
• completion of the initial audit program
Additional Matters • preparation of time budget
• Unless prohibited by law, review the previous auditor's working paper • assignment of personnel to the engagement
• Major issued discussed with management (accounting issues and • scheduling of work
reporting standards)
• Planned audit procedures regarding opening balances (PSA 520 par 3)
• Assignment of firm personnel regarding competence and capabilities
• Other procedures required of the firm's system of quality control
Analytical Procedures Compare and investigate:
Involves analysis of significant ratios and trends, including the resulting ❖ Prior years' Financial Statements
investigation of fluctuations and relationships that are inconsistent with other ❖ Anticipated results such as budget forecasts (income & expense
relevant information or deviations from predicted amounts. performance)
❖ Industry averages
Importance: It helps the auditor in identifying unusual transactions and events
❖ Non-financial factors
that may affect fair presentations of the FS and material misstatements.
❖ Typical relationships among Financial Statement balances
PSA 520 "Analytical procedures" requires the auditor to use analytical ❖ Analysis of significant ratios and trends
procedures in the planning and overall review stages of the audit, ❖ Changes in the industry in which the entity operates
❖ Changes in key personnel
Substantive Analytical procedures: ❖ Observation and inspection
• Existence of unusual transactions or events Analytical procedures used in planning an audit
• Amounts, ratios, and trends that might indicate matters that have
financial statement and audit implications ❖ Simple comparisons
• Development of expectations about plausible relationships that are ❖ Ratio analysis
reasonably expected to exist ❖ Common-size statements
• Ratios and trends should be compared with a certain benchmark ❖ Trend statements
• Ratios and balance indications may contradict each other ❖ Time series
❖ Comparison of client ratio vs. industry
Analytical Procedures
Establishment of an Audit Team
Features:
Matters to consider:
➢ Analytical procedures consist of the analysis of significant ratios and
trends including the resulting investigation of fluctuations and ✓ Qualification
relationships that are inconsistent with other relevant information or ✓ Ability
deviate from predictable amount. ✓ Experienced and knowledgeable
➢ Some material errors, unusual transactions, material deviations, vital ✓ Varied in expertise
activities can be viewed thru the financial statements even prior to the ✓ Audit size and complexity
actual audit engagements. ✓ Continuity and rotation of personnel
➢ Auditors are strictly instructed to do this procedure.
➢ Mastery of analytical process, just a glimpse of the Assertions, errors
and management fraud is suspected
Consideration of Work Performed by Other Auditors/Parties - foreign currency transactions between offices
- intercompany loans: significant transactions with related parties
To be considered:
Client's Legal Obligation
• Involvement of other auditors in the audit components
• Involvement of experts ✓ Changes to articles of incorporation
• Number of locations ✓ Minutes of meeting
• Predecessor Auditor ✓ Significant contracts executed during the year
• Other CPA ✓ major agreements or contracts
• Specialists ✓ current situation and future plans
• Use of Client Staff ✓ authorization of dividends
• Internal Auditors ✓ Inquiries into the entity's operations or financial results by regulatory or
government bodies.
Assessment of Going Concern Assumption
✓ Pending litigation and contingent liabilities
• Financial Scheduling of Work
• Operations
• Loss of customers • Deadline
• Availability of capital and credit • Ability of the audit staff
• Others Matters • Cost
• DANGER OF COMMITING MANAGEMENT FRAUD • Other audit clients
• Non-compliance capital or statutory requirements • Manpower Availability
• Legislations or government policy expected to adversely affect the
Audit Program
entity
Definitions
Identification of Related Parties
• Set of instructions or manuals to assistants or the audit team as a mean to
Related party: if one party has the ability to control the other part or exercise
control the proper execution of the work. A program sets out the nature, timing
significant influence over the other party in making financial and operations
and extent of the planned audit procedures required to implement the overall
decisions
audit plan.
Examples of related party transactions:
• A detailed list of procedures to be performed in an audit.
- sales or purchase transactions between parent company and
• A list of audit procedures to be performed so that the auditor will have
subsidiary
evidence as a basis for expressing an opinion on the financial statements
- cash advances between branches
- inventory warehousing among offices within the holding company
Types of Audit Program: Personnel Assignment
- Standard All-Purpose Audit Program PSA 220 par 8 to 25
- Tailor-Made Audit Program
- The auditor, and assistants with supervisory responsibilities, will consider the
- Modified Standard Form
professional competence of assistants performing work delegated to them
Uses of an audit program: when deciding the extent of direction, supervision and review appropriate for
each assistant responsibilities, will consider the professional competence of
- Aids in the effective and efficient conduct of the evidence gathering
assistants performing work delegated to them when deciding the extent of
phase of the audit direction, supervision and review appropriate for each assistant
- Help in directing and supervising of audit staff
- Facilitates review procedures - Any assignment to team member shall provide reasonable assurance that the
- Coordinate the different audit procedures with client's staff and work will performed with due care by someone with professional competence
personnel required in the situation
- Document the performance of audit procedures
Scheduling of Work
Preparation of the Time Budget
The firm should consider:
Definition;
• Type of engagement
An estimated total hours to finish the audit engagement • Deadline for submission of final audit report
• Ability of the audit staff
• Based on information obtained in understanding the client
• Costs
• Allocated to work schedules indicating who, what to do, and length of
• Other audit clients
time
• Manpower availability
• Basis for determining fees
• Used to measure efficiency of staff Documentation of Audit Plan / Audit Program
• Indicates progress of the engagement
- Audit Strategy
Factors to consider: - Audit Plans
- Audit Programs
• the client's size as indicated by sales, number of employees, branches,
- Time Budget
offices
- Significant Changes
• location of client facilities - Letter of Engagement
• anticipated accounting and auditing problems
• competence and experience of staff available