Topic 7 audit planning (1)

1. TOPIC 7: AUDIT PLANNING
References: Chapter 5,6,7 & 11
AUD390 2011

2.  Engagement letter
 Planning activities
 Understanding the client’s business & industry
 Fundamental concepts of materiality & audit
risk
 Relationship between materiality value &
evidence
 Preparation of audit programme
 Determination of audit objectives
 Analytical procedures - planning, fieldwork &
completion stage
AUD390 2011

4.  Procedures carried out before accepting a new client
or continuing with an existing client include:
obtaining and reviewing available financial
information regarding the client
making inquiries of third parties such as solicitors
and bankers
communicating with previous auditor
evaluating the firm’s independence and ability to
serve the client, including technical skills and
knowledge of industry and personnel
ensuring accepting engagement will not violate the
Code of Ethics.

5. 6-5
 To ensure the interests of shareholders, the
incoming auditor and existing auditor are protected.
It allows the existing auditor to advise the
prospective auditor of any professional matters they
should be aware of before accepting the
engagement.

6.  After accepting the appointment, it requires that
the auditor and entity to agrees on terms of
engagement.
 The agreed terms of the engagement shall be
recorded in an engagement letter.

7.  EL is from the auditor to the client, document the
arrangements made with the client and clarify
matters that may be misunderstood.
 Contents:
the objectives and scope of the audit
the responsibilities of the auditor
the responsibilities of management
identification of the applicable financial reporting
framework
the form and contents of any reports, and a
statement that there may be circumstances in
which a report may differ from its expected form
and content.
 Refer Exhibit 6.1(pp.236)

8.  Definition: involves general strategy and detail
approach for the expected nature, timing and
extent of an audit
 Reasons for Audit Planning
To enable the auditor to obtain sufficient
competent evidence for the circumstances
To help keep audit costs reasonable
To avoid misunderstandings with the client
AUD390 AUDITING DIA

9. 1. Understanding the entity and its environment
2. Understanding internal controls
3. Assessing risks of material misstatement
4. Developing responses to assessed risks
5. Performing tests of controls
6. Performing substantive procedures
7. Completion and review.
Source: Gay & Simnet (2012, pp. 241-243)

10. The three phases of the audit—planning, interim and final—are
normally related to the major stages.
The first four stages: the planning phase of the
audit.
The evidence gathering phase, performing tests
of controls and substantive procedures: the
interim phase (before year end) or final phase
(after year end).
Some substantive tests (e.g. counting inventory)
are usually best done at balance date others:
engagement completion

12.  Audit Risk :
Risk that the auditor gives an inappropriate
opinion when the FS are materially misstated
Risk that the auditor delivers an incorrect audit
opinion – an opinion which states that the
account presents a true & fair view while in
reality they do not

13. AUD390 AUDITING DIA
INHERENT RISK
Risk that the accounts may contain misstatements
DETECTION RISKCONTROL RISK
Derived from the
characteristics of
the enterprise & of
its components
Risk that internal
controls will not
prevent or detect
material errors
Risk that the
auditor may fail to
detect
misstatements

14.  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
AUD390 AUDITING DIA

15.  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 if internal control exist
AUD390 AUDITING DIA

16.  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
AUD390 AUDITING DIA

17.  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
AUD390 AUDITING DIA

18.  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
AUD390 AUDITING DIA
Types of data, ratios, etc Comparison with
Financial Data (Account balances,
budgets, etc)
Corresponding period, budget &
forecasts
Non Financial Data (Production,
employment statistics)
Entries in accounting records, other
financial data
Ratios & Percentage Preceding period, budget & forecast,
industry statistics

19.  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
AUD390 AUDITING DIA

20.  Common financial ratios
1. Short-term Debt-Paying Ability
 E.g. Cash ratio, quick ratio & current ratio
1. Liquidity Activity Ratios
 E.g. Accounts receivable turnover, Days to
collect receivables, Inventory turnover, Days to
sell inventory
1. Ability to meet Long-term Debt Obligations
 E.g. Debt to equity, Times interest earned
1. Profitability Ratios
 E.g. Earnings per share, Gross profit margin,
Profit margin, Return on assets, Return on
common equity
AUD390 AUDITING DIA

21. AUD390 AUDITING DIA
STAGES PLANNING DETAILED TEST REVIEW FS
TIMING Before the FS are
available
Start after client had
submitted FS with
supporting schedules
Carry out overall review
of FS when most of
audit testing are
completed
PURPOSES 1.To understand the
client’s industry &
business
2.To assess going
concern
3.To indicate possible
misstatement
4.To reduced detailed
tests
1. To ensure
completeness, accuracy
& validity of information
contain in the FS
2.To obtain sufficient
audit evidence by
reducing the work done
through substantive
tests
1.To update auditor’s
knowledge of client’s
business
2.To ensure the FS are
not materially misstated
3.To corroborate
conclusions form during
the audit
SOURCES OF
INFORMATIONS
Interim FS,
Management reports,
Budget & forecasts,
Internal audit report
Annual FS, Accounting &
other records,
Management reports,
Internal audit reports
Drafted audited FS
EXAMPLES Calculate key ratios
for client and
compare against
industry’s ratios
Reasonable test on EPF
contribution account
Gearing ratio