AUDIT PLANNING

TOPIC OVERVIEW:

 This chapter discusses the audit planning process, audit strategy, and risk
assessment procedures.
LEARNING OBJECTIVES

 After studying this chapter, you should be able to:

1. Explain audit planning.
2. Identify and explain the major audit planning activities.
3. Identify considerations in establishing an audit strategy.
4. Describe the difference between audit strategy, audit plan, and audit
program.
5. Identify the activities in risk assessment.
6. Describe audit risk and its components and how will it affect the audit
procedures.
 PLANNING AN AUDIT OF FINANCIAL
STATEMENTS
 The primary objective of the auditor is to plan the audit so that the audit
will be performed in an effective manner.
 Adequate planning leads to an efficient and timely audit engagement.
 PLANNING AN AUDIT OF FINANCIAL
STATEMENTS
The Role and Timing of Planning
 Planning an audit involves establishing the overall audit strategy for the
engagement and developing an audit plan.
 Adequate planning benefits the audit of financial statements in several ways,
including the following:
❖ Appropriate attention is devoted to important areas
❖ Potential problems are identified and resolved on a timely basis
❖ Proper organization and management of the audit engagement leading to an
effective and efficient performance
❖ Work is properly assigned to appropriate engagement team members
❖ Assistance in coordinating work done by other auditors and experts
❖ Assistance in facilitating direction, supervision and review
 PLANNING AN AUDIT OF FINANCIAL
STATEMENTS
 The nature and extent of planning activities will vary according to the
(SECTa)
❖ Size and complexity of the entity
❖ Previous Experience with the entity of key engagement team members
(partner, manager, and staff-in-charge)
❖ Changes in circumstances that occur during the audit engagement
❖ Timing of the Appointment of the independent auditor
 PLANNING AN AUDIT OF FINANCIAL
STATEMENTS
Planning as a phase of the audit process
 Planning is not a discrete phase of an audit, but rather a continual and
iterative process that often begins shortly after (or in connection with) the
completion of the previous audit and continues until the completion of the
current audit engagement.
 PLANNING AN AUDIT OF FINANCIAL
STATEMENTS
Major Audit Planning Activities
 Planning is required regardless of whether it is a new engagement or a recurring
engagement.
 Planning activities may differ from one client to another client but normally include
the following:
1. Obtaining an understanding of the client and its environment
2. Performing preliminary analytical procedures
3. Establishing materiality and assessing risks
4. Development of the overall audit strategy and detailed audit plan
5. Preparation of preliminary audit programs
6. Determining the need for experts and using the work of internal auditors
7. Determining the appropriateness of management use of going concern assumption
8. Assessing the possibility of non-compliance
9. Identifying the related parties
 THE OVERALL AUDIT STRATEGY AND
AUDIT PLAN
Overall Audit Strategy
 The auditor shall establish an overall audit strategy that sets the scope, timing and
direction of the audit
 And that guides the development of the audit plan.
 In establishing the overall strategy, the auditor shall:
❖ Identify the characteristics of the engagement that define its scope;
❖ Ascertain the reporting objectives of the engagement to plan the timing of the
audit and the nature of the communications required;
❖ Consider the factors that, in the auditor’s professional judgment, are significant in
directing the engagement team’s efforts
❖ Consider the results of preliminary engagement activities and, where practicable,
whether knowledge gained on other engagements performed by the engagement
partner for the entity is relevant
❖ Ascertain the nature, timing, and extent of resources necessary to perform the
engagement
 AUDIT PLAN
 After the overall audit strategy has been established, an audit plan can be
developed to address the various matters identified in the overall audit
strategy, taking into account the need to achieve the audit objectives through
the efficient use of the auditor’s resources.
 The audit plan is more detailed than the overall audit strategy in that
includes the nature, timing, and extent of audit procedures to be performed
by engagement team members.
 There procedures include:
❑ Planned risk assessment procedures,
❑ Further audit procedures at the assertion level, and
❑ Other planned audit procedures
➢ Furthermore, these procedures may be documented in an audit program.
 AUDIT PLAN

 The audit program shall serve as a:

o Set of instructions to assistants involved in the audit; and
o Means to control and record the proper execution of the work.

 The audit program also contains:

o The audit objectives for each are; and
o A time budget in which hours are budgeted for the various audit areas or
procedures.
Changes to Planning Decisions During the
Course of the Audit
 The overall audit strategy and the audit plan should be revised as necessary
during the course of the audit.
 Planning is continuous throughout the engagement because of changes in
conditions or unexpected results of audit procedures.
 Completion of Overall Strategy and
Audit Plan
 The establishment of the overall audit strategy and the detailed audit plan
are not necessarily discrete or sequential processes, but are closely
interrelated since changes in one may result in consequential changes to the
other.
 Also, preferably, a plan shall be initially completed prior to consideration of
internal controls or the performance of specific procedures.
 Planning Documentation

 The auditor shall document:

a. The overall audit strategy
b. The audit plan
c. Any significant changes made during the audit engagement to the overall
strategy or audit plan, and the reasons for such changes
Additional Considerations in Initial Audit
Engagements
 For initial audit, additional matters the auditor may consider in developing
the overall audit strategy and audit plan include the following:
❖ Arrangements to be made with the predecessor auditor to review prior year’s
working papers;
❖ Any major issues discussed with management in connection with the initial
selection as auditors, the communication of these matters to those charged
with governance, and how these matters affect the overall audit strategy and
audit plan;
❖ The planned audit procedures to obtain sufficient appropriate audit evidence
regarding opening balances; and
❖ Other procedures required by the firm’s system of quality control for initial
audit engagements.
 DIRECTION, SUPERVISION, AND REVIEW

 The auditor should plan the nature, timing, and extent of direction and
supervision of engagement team members and review of their work.
 The nature, timing and extent of the direction and supervision of engagement
team members and review of their work vary depending on many factors,
including:
❖ The assessed of risks of material misstatement;
❖ Size and complexity of the entity;
❖ The area of audit; and
❖ Capabilities and competence of personnel performing the audit work.
 Considerations Specific to Smaller
Entities
 When an audit is carried out entirely by an audit engagement partner, who
may be a sole practitioner, it may be desirable to consult with other suitably
experienced auditors or the auditor’s professional body.
IDENTIFYING AND ASSESSING THE RISKS
OF MATERIAL MISSTATEMENTS (ROMM)
 Objective of the auditor to identify and assess risks of material
misstatements, whether due to fraud or error, at the financial statement and
assertion levels through:
❖ understanding of the entity and its environment,
❖ the applicable financial reporting framework and
❖ the entity’s system of internal control
 Providing a basis for designing and implementing responses to the assessed
risks of material misstatements.
 Understanding of the Entity and Its
Environment, the Applicable Financial
Reporting Framework
 The auditor shall perform risk assessment procedures to obtain an
understanding of:
a) The following aspects of the entity and its environment:
i. The entity’s organizational structure, ownership and governance, and its business
model, including the extent to which the business model integrates the use of IT;
ii. Industry, regulatory and other external factors; and
iii. The measures used, internally and externally, to assess the entity’s financial
performance;
b) The applicable financial reporting framework, and the entity’s accounting
policies and the reasons for any changes thereto; and
c) How inherent risk factors affect susceptibility of assertions to misstatements
and the degree to which they do so, in the preparation of the financial
statements in accordance with the applicable financial reporting framework,
based on the understanding obtained in a and b.
 RISK ASSESSMENT PROCEDURES

 are audit procedures performed to obtain an understanding of the entity and

its environment, including the entity’s internal control
 to identify and assess the risks of material misstatements, whether due to
fraud or error, at the financial statement and assertion levels.
 RISK ASSESSMENT PROCEDURES

Risk Assessment Procedures and Related Activities

 The auditor shall:
a. Identify risks throughout the process of obtaining an understanding of the entity
and its environment, including relevant controls that relate to the risks, and
consider the classes of transactions, account balances, and disclosures in the
financial statements;
b. Relate the identified risks to what can go wrong at the assertion level;
c. Consider whether the risks are of a magnitude that could result in a material
misstatement of the financial statements; and
d. Consider the likelihood that the risks could result in a material misstatement of
the financial statements.
 RISK ASSESSMENT PROCEDURES

 The RAP shall include the following:

a. Inquiries of management, and of others within the entity who in the auditor’s
judgment may have information that is likely to assist in identifying risks of
material misstatement due to fraud or error;
b. Analytical procedures; and
c. Observation and inspection.
 RISK ASSESSMENT PROCEDURES
Analytical Procedures during Planning Stage
 Analytical procedures consists of evaluations of financial information made by
a study of plausible relationships among both financial and non-financial data.
 Analytical procedures also encompass the investigation of identified
fluctuations and relationships that are consistent with other relevant
information or that differ from expected values by a significant amount.
 Analytical procedures performed during audit planning are designed to:
1. Enhance the auditor’s understanding of the entity’s business and transactions
to help plan the nature, timing, and extent of substantive auditing procedures
that will be used to gather audit evidence.
2. Identify areas that may represent specific risks (such as unusual transactions
and events or abnormal/significant fluctuations in amounts, ratios, or trends)
that the auditor may need to investigate further
 AUDIT RISK AND MATERIALITY

 Materiality and audit risk affect the application of PSA, and are reflected in
the auditor’s report.
 The auditor must make judgments about materiality and audit risk in
determining the nature, timing, and extent of procedures to apply and in
evaluating the results.
 AUDIT RISK AND MATERIALITY

Materiality
 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.
 In planning the audit, the auditor makes judgments about the size of
misstatements that will be considered material. These judgments provide a
basis for:
a. Determining the nature, timing, and extent of risk assessment procedures;
b. Identifying and assessing the risks of material misstatement; and
c. Determining the nature, timing and extent of further audit procedures
 AUDIT RISK AND MATERIALITY

Materiality
 Using professional judgment, the auditor shall determine the following
materiality:
1. Financial statement level materiality- the smallest aggregate amount of
misstatement applicable to all financial statements.
2. Assertion level materiality- materiality level for an individual or particular
class of transactions, account balance, or disclosure where appropriate; this
is also known as tolerable misstatement
3. Performance materiality- amount or amounts set by the auditor at less than
materiality for the financial statements as a whole, and if applicable, at less
than materiality level or levels for particular classes of transactions, account
balances, or disclosures.
 Audit Risk

 Audit risk is the risk that the auditor gives an inappropriate audit opinion
when the financial statements are materially misstated.
 Audit Risk

Components of Audit Risk

1. Risk of Material Misstatement (ROMM) or the possibility that material
misstatements exist on the financial statements prepared and presented by
the entity.
▪ Inherent Risk is the susceptibility of an account balance or class of
transactions to misstatement that could be material, individually , or when
aggregated with misstatements in other balances or classes, assuming that
there were no related controls.
▪ Control Risk is the risk that a misstatement, that could occur in an account
balance or class of transactions that could be material individually or when
aggregated with misstatements in other balances or classes, will not be
prevented or detected and corrected on a timely basis by the accounting and
internal control systems.
 Audit Risk

Components of Audit Risk

2. Detection Risk is the risk that the auditor’s substantive procedures will not
detect a misstatement that exists in an account balance or class of
transactions that could be material, individually, or when aggregated with
misstatements in other balances or classes.

If the auditor wishes to reduce detection risk, procedures to be performed shall

be
a. As to nature- more effective procedures
b. As to timing- closer or nearer to year-end
c. As to extent- larger sample size
 Audit Risk

Relationships of Risk and Materiality to Substantive Procedures

Risk of material misstatement (inherent and control risks) Direct

Risk of not detecting the misstatement (detection risk) Inverse
Materiality Inverse
 Audit Risk

Audit Risk= Risk of Audit Risk= Inherent

material misstatement OR Risk x Control Risk x
x Risk of non-detection Detection Risk
Summary of Procedures Performed in
Planning an Audit
Obtain an understanding of the entity and
its environment

Establish materiality and set desired level

of audit risk

Assess inherent and control risks

separately

Identify detection risk to determine the

nature, timing and extent of further audit
procedures