Chapter Five

Audit Planning
and
Types of Audit Tests

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 The Phases of an Audit
That Relate to Audit Planning

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 Prospective Client Acceptance
1. Obtain and review financial information.
2. Inquire of third parties.
3. Communicate with the predecessor
auditor.
4. Consider unusual business or audit
risks.
5. Determine if the firm is independent.
6. Determine if the firm has the necessary
skills and knowledge.
7. Determine if acceptance violates any
applicable regulatory or ethical
requirements.

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 Continuing Client Retention

Evaluate client retention

periodically

Near audit completion or

after a significant event

Conflicts over
accounting & auditing Dispute over fees
issues

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 Establish Terms of the Engagement

In establishing the terms of the engagement,

three topics must be discussed:
1.The engagement letter.
2.The internal auditors.
3.Those charged with governance.

The terms of the engagement, which are

documented in the engagement letter, should
include the objectives of the engagement,
management’s responsibilities, the auditor’s
responsibilities, and the limitations of the
engagement.

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 The Engagement Letter
The engagement letter formalises the arrangement
reached between the auditor and the client.

In addition to the items mentioned in the sample

engagement letter in Exhibit 5-1 in the textbook,
the engagement letter may include:
• Arrangements for use of experts or
internal auditors.
• Any limitations of liability of the auditor
or client.
• Additional services to be provided.
•Arrangements regarding other services.

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 Internal Auditors

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 Those Charged with Governance

Board of Directors

Audit Committee

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 Preliminary Engagement Activities

Determine the Audit

Engagement Team
Requirements

Assess Compliance with

Ethical Requirements,
including Independence

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 Planning the Audit

• The auditor will develop an overall audit strategy

for conducting the audit. This will help the auditor
to determine what resources are needed to perform
the engagement.
• An audit plan is more detailed than the audit
strategy.
• Basically, the audit plan should consider how to
conduct the engagement in an effective and
efficient manner.

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 Planning the Audit
When preparing the audit plan, the auditor should be
guided by the results of the risk assessment procedures
performed to gain an understanding of the entity.
Additional steps:
•Assess business risks and
establish materiality.
• Assess the need for experts.
•Consider the possibility of non- Let’s look at
compliance (illegal) acts. each
of these steps.
•Identify related parties.
•Conduct preliminary analytical
procedures.
•Consider additional value-added
services.

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 Assess Risks and Establish Materiality

Assess Use audit Establish

Risks risk model Materiality

Achieve
Restrict risk at
acceptable
account
low level of
balance level
audit risk

You may want to review the detailed discussion in

Chapter 3 of the process used to assess the client’s
business risks and to establish materiality.

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 Experts

A major consideration in planning the audit is the

need for an auditor’s expert (ISA 620).

The use of an IT expert

is a significant aspect
of most audit
engagements.

The presence of complex

information technology
may require the use of an
IT expert.

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 Non-Compliance (Illegal) Acts

Non-Compliance Acts

Direct & Material &

Material Indirect

Consider laws and Be aware may have

regulations as part occurred;
of audit investigate if
brought to attention

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 Non-Compliance Acts

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 Related Parties
Some examples from IAS 24 Related How to Identify
Party Disclosure Related Parties

•Parents and subsidiaries. •Review minutes of meetings of boards

and management.
•Significant influence.
•Joint control. •Review conflict of interest
statements.
•Associate entity.
•Review records of the entity’s
•Joint venture. investments.
•Management. •Review contracts and agreements with
key management or those charged with
•Close family of the governance.
principal owners & management.
•Other parties that can have •Review significant contracts and
agreements not in the entity’s ordinary
significant influence.
course of business.

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 Preliminary Analytical Procedures
To identify
To understand the
financial statement
client’s business
accounts likely to
and transactions
contain errors

By understanding the client’s business and

identifying where errors are likely to occur, the
auditor can allocate more resources to investigate
necessary accounts.

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 Additional Value-Added Services

Transaction IT-
Tax Planning
Support consultancy

Internal Risk
Benchmarking
reporting Assessment

Auditors are limited in the types of

consulting services that they can offer
their audit clients.

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 Document Overall Audit Strategy and
Audit Plan
Document overall audit The auditor documents how the client
strategy and audit plan, which is managing its risk (via internal
involves documenting the control processes) and the effects of
decisions about the risks and controls on the planned
audit procedures.
A
U
D Nature Auditors ensure they have addressed the risks they
I
identified by documenting the linkage from the client’s
T business, objectives, and strategy to the audit plan.
The auditor’s preliminary decision concerning control
T Timing risk determines the level of control testing, which in
turn affects the auditor’s substantive tests of the
E
account balances and transactions.
S
T
S Extent

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 Document Overall Audit Strategy and
Audit Plan

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 Types of Audit Tests

Risk Used to obtain an understanding of

Assessment the entity and its environment,
Procedures including internal control.

Performed to obtain audit evidence

about the operating effectiveness
Tests of
of controls in preventing, detecting
Controls and correcting material
misstatements.

Detect material misstatements in a

Substantive transaction class, account balance,
Procedures and disclosure element of the
financial statements.

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 Tests of Controls

Inquiry Inspection

Observation

Walk
Reperformance
Through

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 Tests of Controls

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 Substantive Procedures

Tests of Analytical
Details Procedures

Obtains evidence
Tests for errors or
about particular
fraud in individual
assertions related to
transactions, account
account balances or
balances, and
classes of
disclosures
transactions

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 Dual Purpose Tests

Tests of Substantive
Controls Tests

Dual
Purpose
Test

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 Purposes of Analytical Procedures

Preliminary Used to assist the auditor to better

understand the business and to plan
Analytical the nature, timing, and extent of
Procedures audit procedures.

Used to obtain evidence about

Substantive
particular assertions related to
Analytical account balances or classes of
Procedures transactions.

Final Used as an overall review of the

Analytical financial information in the final
Procedures review stage of the audit.

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 Purposes of Analytical Procedures (See
Table 5-5)

Trend Analysis

Ratio
Analysis

Reasonableness

Analysis

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 Substantive Analytical Procedures
Decision Process

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 Develop an Expectation

Auditing standards require the auditor to have

an expectation whenever analytical procedures
are used. An expectation can be developed
using a variety of information sources such as:
• Financial and operating data.
• Budgets and forecasts.
• Industry publications.
• Competitor information.
• Management’s analyses.
• Analyst’s reports.

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 Define a Tolerable Difference
The size of the tolerable difference depends on:
• The significance of the account.
• The desired degree of reliance on the substantive
analytical procedures.
•The level of disaggregation in the amount being
tested.
• The precision of the expectation.
But the amount is always less than materiality!

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 Compare and Investigate

Compare the expectation to the recorded

amount and investigate any differences
greater than the tolerable difference.

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 The Investigation of Differences for
Planning and Final Analytical Procedures

Preliminary Final
Analytical Analytical
Procedures Procedures
Differences Differences

Corroborating
evidence Corroboratin
is not g evidence
required is required

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 Audit Testing Hierarchy

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 Filling the Assurance Bucket

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 Example of Filling the Assurance Buckets
for Each Assertion (Accounts Payable)

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 Short-Term Liquidity Ratios

Current
Ratio

Quick Ratio

Operating
Cash Flow
Ratio

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 Activity Ratios
Days
Outstanding
Receivables in Accounts
Turnover Receivable

Days of
Inventory
Inventory on
Turnover
Hand

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 Profitability Ratios

Gross Profit
Percentage Profit Margin

Return on Return on
Assets Equity

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 Coverage Ratios

Debt to
Equity

Times
Interest
Earned

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 Audit of Group Financial Statements
Entity or business activity in which
Component financial
information is included in the
of a Group group financial statements.

An auditor who, at the request of the

group engagement team, performs
Component work on financial information related
Auditor to a
component for the group audit.

Auditing standards require the group

engagement team to identify components that are
likely to be significant components.

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 Audit of Group Financial Statements

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 End of Chapter 5

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