SESSION 3
AUDIT PLANNING
Learning Objectives: identify and explain the need for planning an audit
identify and describe the contents of the overall audit strategy and the audit plan
explain the difference between interim and final audit
discuss the effect of fraud and misstatements on the audit strategy and extent of audit work
explain and describe the relationship between the overall audit strategy and the audit plan
explain how auditors obtain an initial understanding of the entity and knowledge of its business environment
ISA 300 PLANNING AUDIT OF FINANCIAL STATEMENTS Stages in the audit (Summary):
1. The planning phase: Know your client
Internal control systems review Planning the audit
Evaluation of audit risk
Develop the audit programme 2. The operational phase:
Audit testing
Analytical review techniques
Analytical review of financial statement 3. The reporting phase
Preparation and signing of the audit report The management letter or letter of weakness
ISA 315 UNDERSTANDING THE ENTITY AND ITS ENVIRONMENT AND ASSESSING THE RISK OF MATERIAL MISSTATEMENT
I
This is a new ISA designed to ensure the auditors have or obtain knowledge of the business of the entity sufficient to enable them to identify and understand the events, transactions or practice that may have a significant effect on the financial
This knowledge of the business helps to assess the levels of control and inherent risk and to determine audit procedures. The auditor should consider the following matters:
Provide guidance on the engagement team’s discussion of the susceptibility of
the entity to material misstatements of the financial statements.
The planning phase Know your client:
General economic factor: State of economy Interest rate Inflation rates Government policy Industry factors:
The market and competition from other similar firms. Seasonal factors effecting the sales revenue
Environmental issues affect the client’s business. The regulatory framework, which affect on the client. The entity:
The ownership and management of the business Type of product
Type of market
Key supplier and customers Details of significant contracts
The financial performance of the business
The reporting framework and external influences. Location of all the client’s operations
Other factors
Any accounting and internal control systems problems Any changes in law and reporting requirement.
Previous year’s working paper file Internet searches
Discussion with management Discussion audit team
Operational phase: Audit testing:
Compliance testing: -
Tests that seeks to provide audit evidence of the internal control procedures are being applied as prescribed. If the controls are found to be satisfactory, the auditor will seek to place reliance on them in order to reduce the volume of detailed
“substantive tests”. Substantive test: -
Tests of transactions, balances and other procedures such analytical review that seeks to provide audit evidence as to the completeness, accuracy and validity of the information contained in the accounting records or financial statements of the entity. The Balance sheet audit: -
The objectives are to verify the following:
The existence, ownership, valuation and presentation of balance sheet items. To prove that the transaction has occurred.
The approach concerns itself with:
The validity of the transaction recorded.
The completeness of the recorded transactions and balances. The Systems-based audit: -
The objectives are to derive audit assurance:
o Acquiring an in depth understanding of the client’s business, nature of its transaction, appropriateness of its accounting policies.
o Placing extensive reliance on confirmations from third parties and observation procedures in relation to assets and liabilities.
o Placing extensive reliance on the evaluation and testing of internal control systems and in so doing to reduce the amount of detailed substantive testing of transactions and balances.
The Procedural Approach:
This approach does not take into account risk attaching to specific areas. Contains a high level of testing of all systems.
Is therefore not cost-effective, the approach is more adopted by internal auditors.
The Risk-based Approach:
To overcome the deficiencies of the systems-based approach that suffers from the accumulation of audit evidence without reference to the adequacy of the audit evidence and hence claims of over-auditing.
The risk approach adopts a more scientific approach through the use of decision model providing a basis for specifying the objectives of individual audit procedures and hence ensuring the evidence gathered covers all the relevant aspect of the audit.
Its objectives are therefore to ensure that a consistent level if assurance is obtained for each transaction class or account balance relative to their materiality and that where areas are identified as having a low risk of material error, audit resources are not wasted on those areas.
ISA 320 AUDIT MATERIALITY Definition:
Information is material if its omission or misstatement could influence the economic decisions of users taken on the basis of the financial statements.
Materiality is an important concept in the audit process and affect. Audit risk evaluation
The nature, timing and extent of audit procedures (e.g. sample sizes). The determination of whether the financial statement are distorted by
The auditor’s assessment of materiality These will be influenced by the following: -
The overall impact on the financial statements Individual account balances and transactions ISA 520 Analytical Review Procedures
The ISA requires that auditors should apply analytical procedures at the planning stage and overall review stages of the audit.
Definition of Analytical Review:
The relationship between elements of financial information expected to conform to predictable pattern based on the organisation’s experience and between financial and non-financial information.
Investigate unusual variation in financial and non-financial data of the company.
Obtaining and substantiating explanation for such variation.
Evaluating the results of analytical review with other audit evidence obtained e.g. by systems or substantive test,
Comparison with previous years Trends and ratios.
Factors determining extent of use of analytical review: Type of enterprise
Knowledge of client and similar audits Availability of relevant information
Reliability, relevance, comparability and independence of information. Cost effectiveness
The procedures are particularly useful in diversified enterprise; it should be applied to financial information on individual business segments.
Timing:
At planning stage where the auditor hope to identify possible areas of potential risk.
At the final review stage of audit, the analytical review technique can provide support for the conclusion arrived at as result of other work.
Procedures:
Identify factors likely to have a material effect on items in the financial statements.
Ascertain the probable relationship between these factors and such items. Predict the likely range of values of individual items.
Compare the prediction with actual recorded amounts.
Management explanations should be obtained for significant fluctuations and corroborated by independent evidence.
If management perform Analytical review procedures the auditor should consider whether the approach, the data used and the results obtained are relevant for audit purposes.
Analytical review is audit evidence; it is a form of substantive testing carried out on the transactions.
Where explanations received for material unexpected variations cannot be substantiated, sufficient audit evidence must be obtained by other means. Stages in auditing:
Interim audit:
Audit may be conducted at early stages.
To obtain information about the operational system on a theoretical basis for example:
Organisational chart Procedures manual Systems notes
Gather information about the system and perform walk through test.
Ascertain strengths and weaknesses of major operational areas for example: Complete internal Control Questionnaires
Perform tests of control Final audit:
Final audit of the company at year-end is to produce statutory financial statement.
Audit concentrates on verifying the items and management assertions in the balance sheet and profit and loss contained in the financial statement. Complete substantive procedures, perform subsequent events review and
obtain management representation and form an opinion. Report opinion
