CHAPTER 5: AUDIT PLANNING
evaluate information gathered previously, including
AUDIT PLANNING
- Developing a general audit strategy and a
detailed approach for the expected conduct
of the audit.
Main objective:
 To determine the scope of the audit
procedures to be performed.
The extent of planning varies to:
 size of the entity;
 complexity of the audit;
 auditor’s experience with the entity; and
 knowledge of the business.
Importance:
 ensure that appropriate attention is devoted
to important areas of the audit
 helps identify potential problems
 allows the work to be completed
expeditiously
 assists in the proper assignment and
coordination of work
 helps ensure that the audit is conducted
effectively and efficiently
PSA 315 (Risk of Material Misstatements) requires
auditor to obtain sufficient understanding of the entity
and its environment including its internal control.
Understanding the client
 To identify and understand the events,
transactions, and practices that may have a
significant effect on the financial
statements.
Sources of information:
- review of prior years’ working papers
- tour of the client’s facilities
- reading relevant books, periodicals and
other publications
- discussion with people within and outside of
the entity
- reading corporate documents and financial
reports
Use of information obtained:
Knowledge of the client’s business is a frame of
reference within which the auditor exercises
professional judgment.
- assessing risks and identifying potential
problems
- planning and performing the audit
effectively and efficiently
- evaluating audit evidence as well as the
reasonableness of client’s representations
and estimates
- providing better service to the client
For continuing engagements, the auditor should re-
information in the prior years’ working papers and
update this information if needed.
Additional consideration on new engagements
 A first-time audit engagement requires
more work than a repeat engagement.
 PSA 510 (Initial Audit Engagements)
requires the auditor to obtain sufficient
appropriate audit evidence that:
o opening balances do not contain
misstatements that materially
affect the current year’s financial
statements
o prior period’s closing balances
have been correctly brought
forward to the current period, or
when appropriate, have been
restated
o accounting policies are
appropriate and have been
consistently applied
When the prior year FS were audited by another
auditor, the auditor may be able to obtain sufficient
appropriate evidence regarding opening balance by
reviewing the predecessor auditor’s working
papers.
Understanding the internal control
 To obtain sufficient understanding about the
entity’s internal control systems for the
auditor to anticipate the type of potential
misstatements that can occur in the FS and
thus helping the auditor plan the
appropriate audit procedures.
Developing an overall audit strategy
 The best audit strategy is the approach that
results in the most efficient audit – effective
audit performed at the least possible
cost.
 An audit plan should be made regarding:
o how much evidence to accumulate
o what are the procedures to be
performed
o when should the procedures be
performed
Adequate considerations of
materiality and audit risk should
enable the auditor to answer these
questions.
MATERIALITY
- information is material if its omission or
misstatement could influence the
 economic decision of users taken on the
basis of the financial statements.
 In designing an audit plan, PSA 320
(Materiality) requires the auditor to make a
preliminary estimate of materiality for
use during the examination to assist them
in determining the amount of evidence
needed to support their opinion.
 There is an inverse relationship between
materiality and audit evidence – more
evidence is needed as the level of
materiality for the account decreases.
 The concept of materiality recognizes that
some matters are important for fair
presentation of FS while other matters are
not.
 May be viewed as:
o the largest amount of
misstatement that the auditor
could tolerate in the FS
o the smallest aggregate amount
that could misstate any one of the
FS
 Materiality is a matter of professional
judgment and necessarily involves
quantitative factors (amount of the item in
relation to the FS) and qualitative factors
(the nature of misstatement).
Uses of materiality
 In the planning stage, to determine the
scope of audit procedures.
 In the completion phase of the audit, to
evaluate the effect of misstatements on the
FS.
Determine the Overall Materiality
(Financial Statement Level)
Planning
Determine the Tolerable Stage
Misstatement
(Account Balance Level)
Perform audit procedures
Compare the aggregate amount of
misstatements with the overall
materiality Completion
Stage
Performance materiality
 When auditing FS, it is common for auditors
to exercise prudence by setting materiality
at an amount lower than the overall
materiality.
 By using a lower level of materiality in the
performance of the audit, the extent of the
audit procedures is increased thereby
reducing the risk that the amount of
uncorrected and undetected misstatements
will exceed the overall materiality.
 Performance materiality – the reduced
level of materiality which the auditors use
both at the FS and account balance level.
Bases that can be used to determine the materiality
level
 Annualized interim FS
 Prior year FS
 Budgeted FS of the current year
Adjustments should be made to the preliminary
estimate of materiality as the year-end FS account
balances become available.
AUDIT RISK
The auditor’s responsibility is to design the audit to
provide reasonable assurance that the FS taken as a
whole are free from material misstatements.
When designing substantive tests, the auditor
should consider three main issues:
1. What level of assurance does the auditor
wish to attain that the FS do not contain
material misstatements?
o level of assurance increases, the
scope of the auditor’s substantive
tests increases
2. How susceptible is the account to material
misstatement?
o susceptibility of the account to
material misstatement increases,
the scope of the auditor’s
substantive tests also increases
3. How effective is the client’s internal control
in preventing or detecting misstatements?
o effectiveness of the client’s
internal control, the scope of
auditor’s substantive tests
decreases
These three issues are the preliminary basis for the
development of the audit risk model:
Audit risk = Inherent risk x Control risk x Detection
risk
 Audit risk – the risk that the auditor might
give an inappropriate audit opinion on the
FS.
level of audit risk decreases, the amount of
audit evidence needed to support the
auditor’s opinion increases
 Inherent risk – the susceptibility of an
account balance or class of transactions to
a material misstatement assuming that
there were no related internal controls.
o Factors that may influence the
auditor’s assessment of the risk
misstatement at the FS level
include:
  management integrity
 management
characteristics
 operating characteristics
 industry characteristics
o Factors affecting inherent risk at
the account balance level may
include the:
 susceptibility of the
account to theft
 complexity of calculations
related to account
 complexity underlying
transactions and other
events
 degree of judgment
involved in determining
account balances
assessed level of inherent risk increases,
the auditor should design more effective
substantive procedures
 Control risk – the risk that a material
misstatement that could occur in an
account balance or class of transactions will
not be prevented or detected, and corrected
in a timely manner by accounting and
internal control system.
assessed level of control risk increases,
the auditor should design more effective
substantive procedures
 Detection risk – the risk that an auditor
may not detect a material misstatement that
exists in an assertion.
acceptable level of detection risk
decreases, the assurance provided by
substantive tests should increase with the
application of more effective substantive
procedures
Set the Acceptable Level
of Audit Risk
Audit Planning
Assess the Level of
Inherent Risk
Assess the Level of Consideration of
Control Risk Internal Control
Determine the Acceptable Performing
Level of Detection Risk Substantive
Tests
Relationship between materiality and risk
 There is an inverse relationship between
materiality and the level of audit risk, that is,
the higher the materiality level, the lower
the audit risk and vice versa.
 The auditor takes the inverse relationship
between materiality and audit risk into
account when determining the nature,
timing and extent of audit procedures.
Materiality Audit Risk Planned Audit
Procedures
LOW HIGH More
extensive
Less
HIGH LOW
extensive
Risk Assessment Procedures
- to obtain an understanding of the entity and
its environment including its internal control
and to assess the risks of material
misstatements in the FS. Includes:
o inquiries of management and
others within the entity
o analytical procedures
o observation and inspection
ANALYTICAL PROCEDURES
- involve analysis of significant ratios and
trends, including the resulting investigation
of fluctuations and relationships that are
inconsistent with other relevant information
or deviate from predicted amounts.
- help the auditor in identifying unusual
transactions and events that may indicate
possible misstatement of the FS.
 PSA requires the auditor to use analytical
procedures in the planning and overall
review stages of the audit.
 In the planning stage, analytical procedures
helps the auditor in assessing the risk of
material misstatements in the FS.
Use of analytical procedures in an audit
Stage of the Audit Objective
Planning the audit To understand the client’s
business.
To identify areas that may
represent specific risks.
Substantive tests To obtain evidence to
confirm/refute individual
account balances.
Overall review To identify unusual
fluctuations that were not
identified in the planning
and testing phases of the
audit.
To confirm conclusions
reached with respect to the
fairness of the FS.
Analytical procedures in planning an audit
 enhancing the auditor’s understanding of
the client’s business
 identifying areas that may represent
specific risks
Analytical procedures performed in the planning
phase of the audit are useful for confirming or
challenging the auditor’s understanding of the
client’s business.
Documenting the audit plan
- the final step in the audit planning process
by preparing:
1. audit plan – overview of the expected
scope and conduct of the audit.
2. audit program – sets out in detail the
audit procedures to be performed in
each segment of the audit.
3. time budget – an estimate of the time
that will be spent in executing the audit
procedures listed in the audit program.