Topic 7 audit planning

1. Topic 7: Audit Planning
Chapter 8 & 13
AUD390 AUDITING DIA

2. TOPIC 7: AUDIT PLANNING
References: Chapter 8 & 13
AUD390 2011

3. AUD390 AUDITING DIA
AUDIT PLANNING
OVERVIEW OF
AUDIT PLANNING
STAGES OF
AUDIT PLANNING

4.  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

5. AUD390 AUDITING DIA

6.  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. Select the staff for the engagement
AUD390 AUDITING DIA

7.  New Client Investigation
Reasons for investigation:
 Prospective client’s standing in the business
community
 Financial stability
 Relations with previous auditor
Procedure to communicate with predecessor
auditor
AUD390 AUDITING DIA

8.  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.
AUD390 AUDITING DIA

9.  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.
AUD390 AUDITING DIA

10.  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?
AUD390 AUDITING DIA

11.  Statutory requirements
Financial statement audit
Compliance audit
 Weaknesses noted in the operations
Operations audit
Audit on Internal Control System
AUD390 AUDITING DIA

12.  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
AUD390 AUDITING DIA

13. Contents:
 Specify job 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
AUD390 AUDITING DIA

14.  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
AUD390 AUDITING DIA

15. AUD390 AUDITING DIA

16.  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
AUD390 AUDITING DIA

17. › Auditors need to understand client’s business
& industry to provide additional value-added
services to clients
 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
AUD390 AUDITING DIA

18.  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
AUD390 AUDITING DIA

19.  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 materials
AUD390 AUDITING DIA

20.  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
AUD390 AUDITING DIA

21.  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
AUD390 AUDITING DIA

22.  Auditors should understand client objectives
related to:
Reliability of financial reporting
Effectiveness & efficiency of operations
Compliance with laws and regulations
AUD390 AUDITING DIA

23.  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 foot for a retailer, ratio analysis,
benchmarking against key competitors
AUD390 AUDITING DIA

24. AUD390 AUDITING DIA

25.  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
AUD390 AUDITING DIA

26.  Known as Acceptable Audit Risk
Measure of how willing the auditor is to accept
that the FS may be materially misstated after
the audit is completed & unqualified audit
opinion has been issued
 Factors result in uncertainty in audit
performance
Nature of audit test
Inherent limitations of an audit
Inherent limitations of the effectiveness of
client’s internal control system
AUD390 AUDITING DIA

27. 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

28.  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

29.  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
AUD390 AUDITING DIA

30.  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

31.  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

32. AUD390 AUDITING DIA

33.  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

34.  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

35.  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

36. 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

37. AUD390 AUDITING DIA

38.  MATERIALITY
Definition
 A misstatement or omission of financial
information that may influence or affect the
decision made by the user of financial
statements
AUD390 AUDITING DIA

39. Factors effecting preliminary judgment about
materiality
 Materiality is a relative rather than an
absolute concept
 Bases is needed for evaluating materiality
 Qualitative factors will affect materiality
decisions
 Expected dissemination (various types of
users) of FS
 The level of acceptable audit risk
AUD390 AUDITING DIA

40. Assessment of audit risk & materiality
 The assessment of audit risk & materiality is
a matter of the auditor’s professional
judgment
Factors that auditor consider to decide
whether an item is material or not:
 Its absolute size
 Its nature
 Its relative size
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42.  Refer topic on Internal Control System & Control
Risk
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43. AUD390 AUDITING DIA

44.  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 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
AUD390 AUDITING DIA

45. AUD390 AUDITING DIA

46. 1. Procedure to obtain an understanding of
internal control
2. Tests of controls
3. Substantive tests of transactions
4. Analytical procedures
5. Tests of detailed of balances
AUD390 AUDITING DIA

47. 1. What are the purposes of an engagement letter?
2. What are the contents of an engagement letter?
3. Preliminary engagement activities are undertaken at the
beginning stage of an audit process. List and explain 3
activities to be performed by external auditor during the
preliminary engagement.
4. State 2 benefits of audit planning.
AUD390 AUDITING DIA