CHAPTER- 6

In accordance IAS 300 the objective of the auditor is to plan the audit so that it will be performed
in an effective manner.

Planning consists of a number of elements. However, they could be summarized as:

Preliminary engagement activities:

 Evaluating compliance with ethical requirements; and

 Establishing the terms of the engagement.

Planning activities:

 Developing the audit strategy; and

 Developing an audit plan.

The importance of planning:

 Help the auditor devote appropriate attention to important areas of the audit.
 Help the auditor identify and resolve potential problems on a timely basis.
 Help the auditor properly organize and manage the audit so it is performed in an effective
manner.
 Assist in the selection of appropriate team members and assignment of work to them.
 Facilitate the direction, supervision and review of work.
 Assist in coordination of work done by auditors of components and experts.

A structured approach to planning will include:

Step 1 Ensuring that ethical requirements are met, including independence

Step 2 ensuring the terms of the engagement are understood

Step 3 establishing the overall audit strategy that sets the scope, timing and direction of the audit
and guides the development of the audit plan

Step 4 developing an audit plan that includes the nature, timing and extent of planned risk
assessment procedures and further audit procedures

Audit strategy: The overall audit strategy sets the scope, timing and direction of the audit, and
guides the development of the more detailed audit plan.
The matters that the auditor may consider in establishing an overall audit strategy are:

 Characteristics of the engagement

 Reporting objectives, timing of the audit and nature of communications
 Significant factors, preliminary engagement activities, and knowledge gained on other
engagements
 Nature, timing and extent of resources

In determining the audit strategy, the auditor should:

(i) Identify the characteristics of the engagement;

(ii) Ascertain the reporting objectives to plan the timing of the audit and the nature of
communications;
(iii) Consider the significant factors that will directly affect the team's efforts;
(iv) Consider the results of preliminary engagement activities; and
(v) Ascertain the nature, timing and extent of resources necessary to perform the engagement.

The audit plan: The audit plan converts the audit strategy into a more detailed plan 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.

The audit plan shall include the following:

 A description of the nature, timing and extent of planned risk assessment procedures and
further audit procedures at the assertion level
 Other planned audit procedures required to be carried out for the engagement to comply with
ISAs.

The interim: The interim audit visits are carried out during the period of review and work focuses
on planning and risk assessment and tests of controls and systems, although substantive audit
procedures may also be carried out.

An interim audit involves preliminary audit work that is conducted prior to the fiscal year-end of a

client. The interim audit tasks are conducted in order to compress the period needed to complete
the final audit. Doing so benefits the client, which can issue its audited financial statements sooner

The final: The final audit visit is at the year-end or shortly after and work focuses on the audit of the
financial statements.
Materiality: relates to both the content of the financial statements and the level and type of testing
to be done. The decision is based on judgments about the size, nature and particular circumstances
of misstatements (or omissions) that could influence users of the financial reports.

The bottom line is that the auditor is responsible for providing "an opinion on whether the
financial statements are prepared, in all material respects, in accordance with an applicable
financial reporting framework."

The guidance in ISA 320 states that the determination of materiality is a matter of professional
judgment and that the auditor must consider:

 The circumstances surrounding the entity;

 Both the size and nature of misstatements; and
 The information needs of the users as a group.

Fraud: Major scandals that have affected the accounting profession in recent times have usually
been as a result of fraud. Therefore, in order to maintain confidence in the profession it’s important
for auditors and directors to understand their role in the prevention and detection of fraud.

The external auditor's responsibilities:

The external auditor is responsible for obtaining reasonable assurance that the financial statements,
taken as a whole, are free from material misstatement, whether caused by fraud or error. Therefore,
the external auditor has some responsibility for considering the risk of material misstatement due to
fraud.

The directors' responsibilities

The directors have a primary responsibility for the prevention and detection of fraud. By
implementing an effective system of internal control, they should reduce the possibility of
undetected fraud occurring to a minimum.

The directors should be aware of the potential for fraud and this should feature as an element of
their risk assessment and corporate governance procedures. The audit committee should review
these procedures to ensure that they are in place and working effectively. This will normally be done
in conjunction with the internal auditors.

Responsibilities of the auditor:

The auditor is responsible for obtaining reasonable assurance that the financial statements taken as
a whole, are free from material misstatement, whether caused by fraud or error (ISA 200).
Audit documentation: Audit documentation is the record of audit procedures performed, relevant
audit evidence obtained and conclusions. The term 'working papers' or 'work papers' are also
sometimes used.

Audit documentation is necessary for the following reasons:

 It provides evidence of the auditor’s basis for a conclusion about the achievement of the overall
objective.
 It provides evidence that the audit was planned and performed in accordance with ISAs and
other legal and regulatory requirements.
 It assists the engagement team to plan and perform the audit.
 It assists team members responsible for supervision to direct, supervise and review audit work.
 It enables the team to be accountable for its work.
 It allows a record of matters of continuing significance to be retained.
 It enables the conduct of quality control reviews and inspections (both internal and external).

Types of audit documentation

Audit documentation includes:

 Planning documentation:
(i) Overall audit strategy;
(ii) Audit plan;
(iii) Risk analysis;
 Audit programs;
 Summary of significant matters;
 Letter of confirmation and representation;
 Checklists;
 Correspondence; and
 Abstracts/copies of client records.

Who owns the working papers? (Audit Documentation)

The auditor does. This is important because:

Access to the working papers is controlled by the auditor, not the client, which is an element in
preserving the auditor's independence. In some circumstances care may need to be taken when
copies of client generated schedules are incorporated into the file.
Professional skepticism is an attitude that includes a questioning mind, being alert to
conditions which may indicate possible misstatement due to error or fraud, and a critical
assessment of audit evidence.

CHAPTER- 7
For each item in the financial statements, management is making assertions.

Assertions like: (a confident and forceful statement of fact or belief)

 This factory is owned by the company.

 The receivables really do owe us this money and will pay fairly soon.

 The payroll expense was for the company’s genuine employees working on the
company’s business.

The auditors therefore need evidence that these assertions are valid.

Financial statement assertions

Occurrence – did the transaction actually take place?

Completeness – are all transactions or balances that should be included in

the financial statements, actually included?

Accuracy – are the amounts correct?

Cutoff – are transactions accounted for in the correct period?

Classification – are transactions recorded in the proper accounts?

Existence – do the assets or liabilities actually exist?

Rights and obligations – does the client own or have other rights over the assets and have a genuine
obligation to pay liabilities?

Valuation – are assets or liabilities included at appropriate amounts? Allocation – are account
balances included in appropriate accounts?

Classification and understandability – are items in the financial statements disclosed under
appropriate headings and in such a way that they can be readily understood by readers?

Accuracy – are the amounts disclosed in the financial statements appropriate?

Remember that the audit evidence required depends on both:

• the nature of the item being tested and

• the assertion being tested

Why assertions matter to auditors

Assertions matter to auditors because:

 The auditor chooses suitable procedures based on the nature of the item in the financial
statements being audited.

 The procedures will be refined further depending on which assertion about the item the
auditor is testing.

ISA 500 identifies eight procedures that the auditor can adopt to obtain audit evidence:

 Physical examination. Physical examination consists of auditors physically

verifying the existence of various assets.
 Confirmations.
 Documentary evidence.
 Analytical procedures.
 Oral evidence.
 Accounting system.
 Reperformance.
 Observatory evidence.

Persuasive not conclusive

Consider:

• The auditor gives an opinion about the financial statements not a certificate that the financial
statements are correct.

• The audit report gives reasonable not absolute assurance about the financial statements.
• Audit procedures are designed to reduce the risk that the financial statements contain material
misstatements not to eliminate all possibility of error.

The reason for all this lack of absolute, definitive certainty is the nature of audit evidence which is
gathered by human beings in real live organizations.

• The auditor gathers evidence on a test basis (the sample may or may not be representative).

• People make mistakes (both client and auditor).

• Documents could be forged (increasingly easy with digital technology).

• The client’s personnel may not always tell the truth.

The need for sampling

It will usually be impossible to test every item in any accounting population because of the
costs involved – remember the audit gives reasonable not absolute assurance. The audit
evidence gathered, therefore, will be on a test basis – hence the need for the auditor to
understand the implications and effective use of sampling.

However, it is important to understand that:

 there is no requirement to use sampling laid down in the ISAs

 100% testing may be appropriate in certain circumstances – particularly where there is a
small population of highvalue items
 the use of analytical procedures – see section 7 above and the more detailed coverage in
Chapter 10 – and a variation on analytical procedures ‘proof in total’, may be a more
effective and efficient method of gathering audit evidence
 because analytical procedures are a requirement of ISA 520 at the planning and overall
review stages of the audit, it is sensible to make best use of the work done.

In other circumstances some form of sampling will be used.

Definition

The definition of sampling set out in ISA 530 Audit sampling and other means of testing is:

‘Audit sampling’ (sampling) involves the application of audit procedures to less than 100%
of items within a class of transactions or account balance such that all sampling units have a
chance of selection. This will enable the auditor to obtain and evaluate audit evidence about
some characteristic of the items selected in order to form or assist in forming a conclusion
concerning the population from which the sample is drawn. Audit sampling can use either a
statistical or a nonstatistical approach.

Audit documentation

Why do we need working papers?

The job of working papers is to:

 provide a record of the basis for the auditor’s report

 provide evidence that the audit was conducted in accordance with ISAs and legal and
regulatory requirements.

To assist with the planning, performance, supervision and review of the audit.

To aid the auditors' defence if subsequently sued for negligence.

Who owns the working papers?

The auditor does. This is important because:

• Access to the working papers is controlled by the auditor, not the client, which is an element in
preserving the auditor’s independence.

• In some circumstances care may need to be taken when copies of client generated schedules are
incorporated into the file.

Smaller commercial entities will usually have the attributes above most of which are double edged in
a good news/bad news kind of way:

• Lower risk: Smaller entities may well be engaged in activity that is relatively simple and therefore
lower risk. However, this will not be true for small – often one person businesses – where there is a
high level of expertise in a particular field, e.g. consultancy businesses, creative businesses, the
financial sector.

• Direct control by owner managers is a strength because they can know what is going on and have
the ability to exercise real control. They are also in a strong position to manipulate the figures or put
private transactions ‘through the books.

• Simpler systems: Smaller entities are less likely to have sophisticated IT systems, but pure, manual
systems are becoming increasingly rare. This is good news in that many of the bookkeeping errors
associated with smaller entities may now be less prevalent. However, a system is only as good as the
person operating it.

Evidence implications

 The normal rules concerning the relationship between risk and the quality and quantity of
evidence apply irrespective of the size of the entity.
 The quantity of evidence may well be less than for a larger organisation.
 It may be more efficient to carry out 100% testing in a smaller organisation.

Small notforprofit organisations

Small not for profit organisations have all the attributes of other small entities. Arguably,
however, the position is more difficult for the auditor because:
• While most small businesses are under the direct management of the owner, small notfor-
profit organisations tend to be staffed by volunteers and the culture is more likely to be one of
trust rather than accountability.