Acctg 17N - Integrated Accounting

Auditing and Assurance Services

Prof. Remark M. Montalban, CPA (PH), ACPA, CMA, MSA-IA

AUDIT PLANNING

Introduction
The auditor plans the audit so that it will be performed in an effective manner, i.e., to appropriately gain reasonable assurance
that the FSs are free from material misstatement.

Audit planning involves:

• establishing the overall audit strategy (a general strategy) for the engagement; and
• developing an audit plan (a detailed approach for the expected nature, timing and extent of the audit), in order to reduce
audit risk (i.e. the chance that audit opinion is inappropriate) to an acceptably low level.
The main outputs after planning the audit are:
• the overall audit strategy (a.k.a., audit planning memorandum)
• the audit plan (a.k.a., audit programs or audit completion checklist)

Benefits of Audit Planning

• Appropriate attention to important areas of the audit
• Identify and resolve potential problems timely
• Organize and manage the audit engagement so that it is performed in an effective and efficient manner
• Assist in the proper selection of engagement team members and the assignment of work to them
• Facilitate the direction and supervision of engagement team members and the review of their work
• Assist, where applicable, in coordination of work done by auditors of components and experts

Overview of Audit Planning & Risks Assessment Activities

Planning is not a discrete phase of an audit but rather a continual and iterative process. Planning, however, includes
consideration of the timing of certain activities and audit procedures that need to be completed prior to the performance of
further audit procedures (FAP), i.e., the tests of controls and substantive procedures.

The following are the activities and procedures performed in audit planning and risks assessment:
• Performing risks audit procedures (RAP), including analytical procedures, to understand the entity and its environment,
including the entity’s internal control
• Determining materiality
• Identifying material classes of transactions, account balances and disclosures
• Identifying and assessing the risks of material misstatements of the financial statements; and
• Finally preparing the outputs of audit planning – overall audit strategy and audit plan—containing the auditor’s
responses to the identified risks

The nature and extent of the above planning activities will vary according to:
• The size and complexity of the entity
• The key engagement team members’ previous experience with the entity; and
• The changes in circumstances that occur during the audit engagement

Change to Planning Decisions during the Course of the Audit

The audit shall update and change the overall audit strategy and the audit plan as necessary during the course of the audit.

The establishment of the overall audit strategy and the detailed audit plan are not necessarily discrete or sequential processes,
but are closely inter-related since changes in one may result in consequential changes to the other.

Results of Preliminary Engagement Activities

The results of preliminary engagement activities:
• Assist the auditor in identifying and evaluating events or circumstances that may adversely affect the auditor’s ability to
plan and perform the audit engagement
• Enables the auditor to plan an audit engagement for which, for example:
o The auditor maintains the necessary independence and ability to perform the engagement
o There are no issues with management integrity that may affect the auditor’s willingness to continue the engagement
o There is no misunderstanding with the client as to the terms of the engagement
In an initial audit, the auditor may need to expand the planning activities because the auditor does not ordinarily have the
previous experience with the entity than when planning recurring engagements. For an initial audit engagement, additional
matters the auditor may consider in establishing the overall audit strategy and audit plan include the following:
• Arrangements to review the predecessor auditor’s working papers
• Any major issues (including the application of accounting principles or of auditing and reporting standards)
• The audit procedures necessary to obtain sufficient appropriate audit evidence regarding opening balances
• Other procedures required by the firm’s system of quality control for initial audit engagements.

Establishing Overall Audit Strategy

Overall audit strategy sets the scope, timing and direction of the audit, and guides the development of the audit plan. The auditor
shall document the overall audit strategy commonly in the form of a memorandum.

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In establishing overall audit strategy, the auditor is required to:

a. Identify the characteristics of the engagement that define it scope
b. Ascertain the reporting objectives of the engagement to plan the timing of the audit and the nature of the
communications required
c. Consider the factors that, in our professional judgment, are significant in directing the engagement team’s efforts
d. Consider the results of preliminary engagement activities and, where applicable, whether knowledge gained on other
engagements performed by the engagement partner for the entity is relevant
e. Ascertain the nature, timing and extent of resources necessary to perform the engagement

Characteristics that define the Scope of Engagement

• The applicable FRF • The entity’s use of service organizations
• Industry-specific reporting requirements • The effect of information technology
• The expected audit coverage • The availability of client personnel and data
• The work of internal auditors

Reporting Objectives, Timing of the Audit and Nature of Communications

• The entity’s timetable for reporting
• Meetings with management and TCWG to discuss the nature, timing and extent of the audit work
• The discussion with management and TCWG regarding the expected type and timing of reports to be issued and other
communications, both written and oral, including the auditor’s, management letters and communications to TCWG; and
regarding the expected communications on the status of audit work throughout the engagement
• Communications with auditors of components
• Communications among engagement team members including the nature and timing of team meetings and timing of the
review of work performed
• Any other expected communications with third parties, including any statutory or contractual reporting responsibilities
arising from the audit

Communicating with TCWG and Management

The auditor may decide to discuss elements of planning with the entity’s management to facilitate the conduct and management
of the audit engagement (for example, to coordinate some of the planned audit procedures with the work of the entity’s
personnel), but not so detailed to compromise the effectiveness of the audit or making the audit procedures too predictable.

Significant Factors, Preliminary Engagement Activities and Knowledge Gained on Other Engagements
• The determination of materiality and identification of material classes of transactions, account balances and disclosures
• Preliminary identification of risk areas
• The impact of the assessed ROMM at the FSs level
• Exercise of professional skepticism
• Internal control of the entity
• Significant business developments and the industry
• Legal and regulatory development and framework

Nature, Timing and Extent of Necessary Resources

• The selection of the engagement team (including, where necessary, the engagement quality control reviewer) and the
assignment of audit.
• Engagement budgeting and timetable

Audit Engagement Team

Engagement team comprises all partners and staff (i.e., professionals, other than partners, including any experts the firm
employs) performing the engagement, and any individuals engaged by the firm or a network firm who perform audit procedures
on the engagement. This excludes an auditor’s external expert engaged by the firm or a network firm.

Engagement partner is the partner (any individual with authority to bind the firm with respect to the performance of a professional
services engagement) or other person in the firm who is responsible for the audit engagement and its performance, and for the
auditor’s report that is issued on behalf of the firm, and who, where required, has the appropriate authority from a professional,
legal or regulatory body.

The typical organizational hierarchy of a CPA firm follows that of pyramidal structure. They include, form the top of the pyramid,
partners, managers or directors, supervisors or seniors or in-charge associates, and staff or junior or associates.

Position Responsibilities/Functions
Partners Owners of the firm. the assigned partner has the overall responsibility for the quality of each audit
engagement
Managers/ Directors Supervises the audits conducted by the seniors
In-charge/Seniors In charge of audit fieldwork. The senior supervises the work of the audit staff, reviews working
papers and time budgets, and assets in drafting the audit report
Staff/Junior/Associate Perform the more detailed routine audit tasks
s
The engagement partner and other key members of the engagement team shall be involved in planning the audit, including
planning and participating in the discussion among engagement team members, to draw on their experience and insight, thereby
enhancing the effectiveness and efficiency of the planning process

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The auditor shall plan the nature, timing and extent of direction and supervision of engagement team members and the review of
their work.

Concept of Materiality
The auditor is expected to design and conduct an audit that provides reasonable assurance that material misstatements will,
whether due to fraud or error, be detected. Hence, the auditor shall determine materiality for the FSs as a whole when
establishing the overall audit strategy, which is part of planning an audit.

Information is material if it influences user’s economic decisions. In audit, materiality is considered in terms of the smallest
aggregate level of misstatements that could be considered material to any one of the statements that comprise the FSs. For any
given client, materiality is not simply a function of specific amounts in the FSs. An auditor must understand who the potential
users are and the type of judgments made by those users when relying on FSs.

Application of Materiality
Materiality is applied both in planning, performing and concluding on the audit. In particular, when:
• Identifying material classes of transactions, account balances and disclosures
• Determining the nature, timing and extent of risk assessment procedures
• Identifying and assessing the risks of material misstatements
• Determining the nature, timing and extent of further audit procedures (testing controls and performing substantive
procedures)
• Evaluating the effect of uncorrected misstatements, if any, on the FSs and in forming the auditor’s opinion.

Materiality, Audit Procedures, Audit Evidence and Audit Risk

The level of materiality has an inverse relationship with audit procedures and audit evidence. The lower the materiality –
specifically performance materiality – the more extensive audit procedures to be performed and the more audit evidence to be
gathered

As stated above, materiality is used in forming an opinion. However, there is a risk that if materiality is set too high the auditor
may conclude that a misstatement is immaterial when indeed material, the opposite could also occur. Therefore, inappropriate
materiality level may lead to inadvertent occurrence of audit risk. Because of this, the auditor takes the view that materiality and
audit risks are inversely related – the higher the audit risk, the lower the materiality, and vice versa.

Materiality Levels
The auditor establishes the following levels of materiality in an audit of FSs:
a. Materiality for the FSs as a whole
b. Materiality for particular classes of transactions, account balances, or disclosures, if necessary
c. Performance materiality for (a) and (b)

In addition, the auditor also determines a threshold at which misstatements are considered clearly trivial or inconsequential.

Materiality for the FSs as a whole

The auditor’s determination of materiality is a matter of professional judgment, and is affected by the auditor’s perception of the
financial information needs of users of the FSs. The determination of materiality is not a mechanical exercise, if fact, there is no
specific methodologies prescribed in the standard. However, a percentage is often applied to a chosen benchmark as a starting
point to determine materiality. Qualitative conditions should also be considered in determining materiality.

Benchmarks
Factors that may affect the identification of an appropriate benchmark include:
• The elements of the FSs (e.g., assets, liabilities, equity, revenue, expenses)
• Whether there are items on which the attention of the users of the particular entity’s FSs tends to be focused
• The nature of the entity, where the entity is in its life cycle, and the industry and economic environment in which the
entity operates
• The entity’s ownership structure and the way it is financed
• The relative volatility of the benchmark

Profit before tax from continuing operations is often used for profit-oriented entities.

Materiality for Particular Classes of Transactions, Account Balances or Disclosures

For certain entities, there may be one or more particular classes of transactions, account balances, or disclosures for which
misstatements of lesser amounts than materiality for the FSs as a whole could reasonably be expected to influence the
economic decisions of users taken on the basis of the FS.

Factors that may indicate such classes of transactions, account balances, or disclosures exist include the following:
• Whether law, regulation or the applicable financial reporting framework affect users’ expectations regarding the
measurement or disclosure of certain items (e.g., related party transactions, and the remuneration of management and
those charged with governance)
• The key disclosures in relation to the industry in which the entity operates (e.g., research and development costs for a
pharmaceutical company)
• Whether attention is focused on a particular aspect of the entity’s business that is separately disclosed in the financial
statements (e.g., a newly acquired business)

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Performance Materiality (Tolerable Misstatement)

Performance materiality is the amount or amounts set by the auditor at less than materiality for the FSs as a whole to reduce to
an appropriately low level the probability that the aggregate of uncorrected and undetected misstatements exceeds materiality
for the FSs as a whole, i.e., to provide a cushion or margin, so that if misstatements are detected, the auditor may nevertheless
be able to conclude with reasonable assurance that the total misstatement in the FSs does not exceed materiality.

The auditor is required to determine performance materiality for purposes of:

• Assessing the risks of material misstatement; and
• Determining the nature, timing and extent of further audit procedures

If materiality level(s) have been set for particular classes of transactions, account balances, or disclosures, performance
materiality also refers to amount(s) set a less than these levels

Clearly Trivial Misstatement

Though technically a materiality level, clearly trivial misstatement is the amount below which misstatements would be considered
inconsequential and need not to be accumulated because such amounts clearly will not have material effect on the FSs.
However, when it is uncertain whether a misstatement is clearly trivial, such is not considered to be clearly trivial.

Revision of Materiality
Materiality levels are not cast in stone once determined. These may be adjusted, upward or downward, as necessary as the
audit progresses for example due to the following reasons:
• Changes in entity’s circumstances
• New information
• Change in understanding of entity and its operations

Documentation of Materiality
The auditor shall document the following:
• Materiality for financial statements as a whole
• Materiality level(s) for particular items
• Performance materiality for the above
• Revisions to the above as the audit progresses

Identifying Material Classes of Transactions, Account Balances and Disclosures

The auditor, after determining materiality and gaining sufficient understanding of the entity and its environment including internal
controls, identifies material classes of transactions, account balances and disclosures from the entity’s trial balance, list of
accounts and notes to FSs.

By identifying these items, the auditor focuses the audit only on what is deemed material, thereby reduces its work on what is
determined not to be material.

The auditor applies his professional judgment and should consider both the account’s nature and amount, quantitatively and
qualitatively, in deciding whether an account is material or not. Quantitative consideration may involve comparison of an
account’s amount with the materiality previously determined. If an account’s amount exceeds materiality, this may be considered
material. However, there are accounts that may not be quantitatively material but may deemed material qualitatively such as
those accounts involving accounting estimates (e.g., allowance for doubtful accounts, retirement obligations, etc.) or suspicious
account (miscellaneous accounts, related party transactions)

***NOTHING FOLLOWS***

AAS-005
 Practice Questions

1. This involves establishing the overall audit strategy for the engagement and developing an audit plan, in order to reduce
audit risk to an acceptably low level.
a. Audit procedures c. Audit planning
b. Audit program d. Audit working papers

2. Overall audit strategy sets scope, timing and direction of the audit, and guides the development of the more detailed
audit plan
The audit plan is more detailed than the audit strategy and includes the nature, timing and extent of audit procedures to
be performed by engagement team members in order to obtain sufficient appropriate audit evidence to reduce audit risk
to an acceptably low level.
a. True, True c. False, False
b. True, False d. False, True

3. The audit plan should

a. b. c. d.
Precede action Yes Yes Yes Yes
Be flexible Yes No Yes Yes
Be cost beneficial Yes Yes No Yes

4. Adequate planning helps ensure that:

a. b. c. d.
Appropriate attention is devoted to important areas of the audit Yes Yes Yes Yes
Potential problems can be promptly identified and resolved Yes Yes No No
Work is performed in an effective and efficient manner Yes Yes No Yes
An unqualified opinion is assured to be expressed Yes No No Yes

5. Which of the following is not one of the three other reasons why the auditor should properly plan engagements?
a. To enable the auditor to obtain sufficient appropriate evidence
b. To avoid misunderstandings with the client
c. To help keep audit costs reasonable
d. To enable proper on-the-job training of employees

6. Which of the following is not a component of audit planning?

a. Making arrangements with the client concerning the timing of audit field work and use of the client’s staff in
completing certain phases of the examination
b. Obtaining understanding of the business
c. Developing audit programs and strategy
d. Observing client’s annual physical inventory taking and making test counts of selected items

7. In planning an examination, the auditor would consider all of the following matters, except
a. Anticipated reliance on internal controls
b. Preliminary judgement about materiality levels for audit purposes
c. Financial statement items likely to require adjustment
d. The kind of opinion (unqualified, qualified, disclaimer, or adverse), likely to be given

8. An initial audit requires more audit time to complete than a recurring audit. One of the reasons for this is that
a. new auditors are usually assigned to an initial audit
b. predecessor auditors need to be consumed
c. the client’s business, industry and internal control are unfamiliar to the auditor and need to be carefully studied
d. a larger proportion of customer accounts receivable need to be confirmed on an initial audit

9. The nature and extent of planning will vary according to the following, except
a. Size of the auditing firm
b. Nature and complexity of the entity
c. Auditor’s experience with the entity and knowledge of the business
d. Changes in circumstances that occur during the audit engagement

10. The overall audit strategy should be updated and changed as necessary during the course of the audit
The audit plans should not be updated and changed during the course of audit, as these are detailed plans and revising
them would be impractical in most cases.
a. True, True c. False, False
b. False, True d. True, False

11. Indicate whether the following function would be performed by:

P – Partner S – Senior
M – Manager AS – Audit Staff
I. Supervises two or more concurrent audit engagement
II. Performs detailed audit procedures
III. Overall responsibility for audit
IV. Sign audit report

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 I. II. III. IV.
a. P AS S M
b. M AS M P
c. M AS P P
d. P AS P M

12. The senior auditor responsible for coordinating the field work usually schedules a pre-audit conference with the audit
team primarily to
a. Provide an opportunity to document staff disagreements regarding technical issues
b. Establish the need for using the work of specialist and internal auditors
c. Discuss staff suggestions concerning the establishment and maintenance of time budgets
d. Give guidance to the staff regarding both technical and personnel aspects of the audit

13. Who in a public accounting firm is most likely to schedule the audit staff to perform the audit engagement?
a. Audit partner c. Audit manager
b. Senior auditor or in-charge accountant d. Junior auditor

14. Which of the following is an effective audit planning procedure that helps prevent misunderstandings and inefficient use
of audit personnel?
a. Arrange to make copies, for inclusion in the audit files, of those client supporting documents examined by the
auditor
b. Arrange to provide the client with copies of the audit programs to be used during the audit
c. Arrange a preliminary conference with the client to discuss audit objectives, fees, timing and other information
d. Arrange to have the auditor prepare and post any necessary adjusting or reclassification entries prior to final
closing

15. The element of the audit planning process most likely to be agreed upon with the client before implementation of the
audit strategy is the determination of the
a. Methods of statistical sampling to be used in confirming accounts receivable
b. Pending legal matters to be included in the inquiry of the client’s attorney
c. Evidence to be gathered to provide a sufficient basis for the auditor’s opinion
d. Schedules and analyses to be prepared by the client’s staff

16. Which of the following parties would normally attend a planning meeting held before the beginning of an audit
engagement to discuss relevant client information and the audit approach to be taken in performing the engagement?
a. Engagement partner and the client’s chief financial officer
b. Engagement partner and audit manager
c. Engagement partner, audit manager and senior auditor
d. Engagement partner, audit manager, senior auditor and junior audit staff members

17. Financial reporting frameworks often discuss the concept of materiality in the context of the preparation and presentation
of financial statements. Although financial reporting frameworks may discuss materiality in different terms, they generally
explain that (choose the incorrect one)
a. Misstatements, including omissions, are considered to be material if they, individually or in the aggregate, could
reasonably be expected to influence the economic decisions of users taken on the basis of the financial
statements
b. Judgments about materiality are made in the light of surrounding circumstances, and are affected by the size
(amount or quantitative) or nature (qualitative) of a misstatement, or a combination of both
c. Judgments about matters that are material to users of the financial statements are bases on a consideration of
the common financial information needs of users as a group. The possible effect of misstatements on specific
individual users, whose needs may vary widely, is not considered
d. Determination of materiality is mechanical, mathematical and straightforward in nature

18. The auditors must consider materiality in planning an audit engagement. Materiality for planning purposes is
a. The auditors’ preliminary estimate of the largest amount of misstatement that would be material to any one of
the client’s financial statements
b. The auditors’ preliminary estimate of the smallest amount of misstatement that would be material to any one of
the client’s financial statements
c. The auditors’ preliminary estimate of the amount of misstatement that would be material to the client’s balance
sheet
d. An amount that cannot be quantitatively stated since it depends on the nature of the item

19. The preliminary judgment about materiality is the _______ amount by which the auditor believes the statements could
be misstated and still not affect the decisions of reasonable users.
a. Minimum c. Mean average
b. Maximum d. Median average

20. The concept of materiality is applied in which of the following areas of audit of FSs?
Planning Execution Evaluation
a. Yes Yes Yes
b. Yes No Yes
c. Yes Yes No
d. Yes No No

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21. Materiality is least important to an external auditor determining the:
a. Extent of his audit of certain amounts
b. Effects of exceptions upon his opinion in the audit report
c. Specific transactions which should require a detailed review
d. Effect on independence of his direct financial interest in the client

22. If an auditor establishes a relatively high level for materiality, then the auditor will:
a. Accumulate more evidence than if a lower level had been set
b. Accumulate less evidence than if a lower level had been set
c. Accumulate approximately the same evidence as would be the case were materiality is lower
d. Accumulate an undetermined amount of evidence

23. Which of the following statements is true with regard to the relationship among audit risk, audit evidence, and
materiality?
a. The lower the inherent risk and control risk, the lower the aggregate materiality threshold
b. Under conditions of high inherent and control risk, the auditor should place more emphasis on obtaining external
evidences and should reduce reliance on internal evidence
c. Where inherent risk is high and control risk is low, the auditor may safely ignore inherent risk
d. Aggregate materiality thresholds should not change under conditions of changing risks levels

24. Why do auditors establish a preliminary judgment about materiality?

a. To determine the appropriate level of audit experience required for the work
b. So that the client can know what records to make available to the auditor
c. To plan the appropriate audit evidence to accumulate and develop an overall audit strategy
d. To finalize the assessment of control risk

25. Performance materiality should be considered by the auditor when

a. Identifying and assessing the risks of material misstatements
b. Determining the nature, timing and extent of auditor’s further procedures
c. Both a and b
d. Neither a nor b

26. When auditors allocate the preliminary judgement about materiality to account balances, the materiality allocated to any
given account balance is referred to as:
a. The materiality range c. The error range
b. Tolerable materiality d. Tolerable misstatement

***NOTHING FOLLOWS***

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