Chapter2 - Audit Planning

Chapter 2 - Audit Planning

CHAPTER 2
Timing of the Appointment of the independent auditor
AUDIT PLANNING - INTRODUCTION AND RISK Planning as a phase of the audit process
ASSESSMENT PROCEDURES Planning is not adiscrete phase of an audit, but rather a continual and
iterative process that often begins shortly after (or in connection with) the
TOPICOVERVIEW: completion of the previous audit and continues until the completion of the
current audit engagement.
This chapter discusses the audit planning process, audit strategy,and riel.
assessment procedures.
Major Audit Planning Activities
LEARNING OBJECTIVES: Planning is required regardless of whether it is a new engagement or a
recurring engagement. Planning activities may differ from one client to
After studying this chapter, you should be able to: another client but normally include the following:
1. Explain audit planning. 1. Obtaining an understanding of the client and its environment
2. ldentify and explain the major audit planning activities. 2. Performing preliminary analytical procedures
3. ldentify considerations in establishing an audit strategy.
4. Describe the difference between audit strategy, audit plan, 3. Establishing materiality and assessing risks
and audit 4. Development of the overall audit strategy and detailed audit plan
program. 5. Preparation of preliminary audit programs.
5. ldentify the activities in risk assessment.
6. Determining the need for experts and using the work of internal
6 Describe audit risk and its components and how will it affect the audit auditors
procedures. 7. Determining the appropriateness of management use of going concern
assumption
PLANNING AN AUDIT OF FINANCIAL STATEMENTS 8. Assessing the possibility of non-compliance
The primary objective of the auditor is to plan the audit so that the 9. Identifying related parties
will be performed in an effective manner. However, audit THE OVERALL AUDIT STRATEGY AND AUDIT PLAN
leads to an efficient and timely audit adequate planning also Overall Audit Strategy
engagement. The auditor shall establish an overall audit strategy that sets the scope,
The Role and Timing of Planning timing, and direction of the audit, and that guides the development of the
Planning an audit involves establishing the overallaudit strategy for the audit plan.
engagement and developing an audit plan. Adequate planning benefits In establishing the overall audit strategy, the auditor shall:
the audit of financial statements in several
ways, including the Identify the characteristics of the engagement that define its scope;
Appropriate attention is devoted to important areas following: Ascertain the reporting objectives of the engagement to plan the
Potential problems are identified and resolved on a timely timing of the audit and the nature of the communications required;
Proper organization and management of the basis
audit engagement Consider the factors that, in the auditor's professional judgment, are
leading to an effective and efficient
Work is properly assigned to performance significant in directing the engagement team's efforts
appropriate engagement team members Consider the results of preliminary engagement activities and, where
Assistance in coordinating work done by other practicable, whether knowledge gained on other engagements
Assistance in facilitating direction, supervision, auditors and expers
and review performed by the engagement partner for the entity is relevant
to
The nature and extent of Ascertain the nature, timing, and extent of resources necessary
(SECTa) planning activities will vary according to th perform the engagement
Size and complexity of the
Previous Experience withentity
Audit Plan
an audit plan can be
the entity of key After the overall audit strategy has been established, in the overall audit
members (partner, manager, and engagement developed to address the various matters identified
Changes in circumstances staff-in-charge)
that occur during the audit
14
engagement 15
Chapter2- Audit Planning Chapter 2 - Audit Planning
the audit
into account the need to achieve objectives Arrangements to be made with the predecessor auditor to review
strategy, taking resources.
of the auditor's prior years' working papers;
through the efficient use
overall audit strategy in that
audit plan is more detailed than the procedures to be
Any major issues discussed with management in connection with the
The performed
and extent of audit initial selection as auditors, the communication of these matters to
includes the nature, timing, planned riel
These procedures include those charged with governance, and how these matters affect the
by engagement team members.audit procedures at the assertion ]evel overallaudit strategy and audit plan;
assessment procedures, further H
are required to be carried out so
other planned audit procedures that
The planned audit procedures to obtain sufficient appropriate audit
with PSAs. evidence regarding opening balances; and
the engagement complies
program. Other procedures required by the firm's system of quality control for
Furthermore, these procedures may be documented in an audit initial audit engagementsS.
The audit program shall serve as a: DIRECTION,SUPERVISION, AND REVIEW
Set of instructions to assistants involved in the audit; and The auditor should plan the nature, timing, and extent of direction and
Means to control and record the proper execution of the work. supervision of engagement team members and review of their work.
The audit program also contains: The nature, timing, and extent of the direction and supervision of
" The audit objectives for each area; and engagement team members and review of their work vary depending on
" Atime budget in which hours are budgeted for the various audit areas many factors, including
or procedures. the assessed risks of material misstatement;
Changes to Planning Decisions During the Course of the Audit size and complexity of the entity;
The overall audit strategy and the audit plan should be revised as the area of audit; and
necessary during the course of the audit. Planning is continuous capabilities and competence of personnel performing the audit work.
throughout the engagement because of changes in conditions or unexpected
results of audit procedures. Considerations Specific to Smaller Entities
Completion of Overall Strategy and Audit Plan
When an audit is carried out entirely by an audit engagement partner, who
The establishment of the overall audit strategy and the detailed audit plan may be a sole practitioner, it may be desirable to consult with other suitably
are not necessarily discrete or sequential processes, but are closely experienced auditors or the auditor's professional body.
interrelated since changes in one may result in consequential changes to the IDENTIFYING AND ASSESSING THE RISKS OF MATERIAL
other. Also, preferably, a plan shall be initially completed prior to MISSTATEMENT (RMM)
consideration of internal controls or the performance of specific procedures. It is the objective of the auditor to identify and assess risks of material
Planning documentation misstatements, whether due to fraud or error, at the financial statement and
The auditor shall document: assertion levels, through Understanding of the entity and its environment,
a. the overall audit
b.
strategy the applicable financial reporting framework and the entity's system of
the audit plan internal control, thereby providing a basis for designing and implementing
C. any significant changes made responses to the assessed risks of material misstatements.
overallstrategy or audit plan, andduring the audít engagement to the
the reasons for such
changes Understanding of the Entity and Its Environment, the Applicable
Additional Considerations in Initial Audit Financial Reporting Framework
After performing preliminary Engagements
auditor may need to expand theengagement activities, for an initial audit, the
The auditor shall perform risk assessment procedures to obtain an
planning activities because he/she does no
ordinarily have previous experience understanding of: environment:
(a) The following aspects of the entity and its
planning recurring engagements. Forwith the entity that is considered wne () The entity's organizational structure, ownership and
governance,
auditor may consider in initial audits, additional to which the business
include the following: developing the overall audit strategy matters and its business model, including the extent
and audit pa model integrates the use of IT;
16 17
 Planning
Chapter2 - Audit Chapter2 - Audit Planning
factors; and
Industry,regulatory and other external
(i)
(ii) The measures used, internally and externally, to assess the entity's Analytical Procedures during Planning Stage
financial performance; Analytical procedures consist of evaluations of financial information made
Tamework, and the entit. by astudy of plausible relationships among both financial and non-financial
(b) The applicable financial reporting changes thereto; and data. Analytical procedures also encompass the investigation of identified
accounting policies and the reasons tor any
susceptibility of assertions to fluctuations and relationships that are consistent with other relevant
(c) How inherent risk factors affect information or that differ from expected values by a significant amount.
misstatement and the degree to which they do S0, in the preparation of
the financial statements in accordance with the applicable financial Analytical procedures are required to be performed during planning stage
an
reporting framework, based on the understanding obtained in (a) and overall review stage of the audit. Analytical procedures performed
(b). during audit planning are designed to:
1. Enhance the auditor's understanding of the entity's business and
The auditor shall evaluate whether the entity's accounting policies are transactionsto help plan the nature, timing, and extent of substantive
appropriate and consistent with the applicable financial reportine auditing procedures that willbe used to gather audit evidence.
framework.
2. Identify areas that may represent specific risks (such as unusual
Understanding the components of the entity's system of internal control is transactions and events or abnormal/significant fluctuations in
covered in the next chapter. amounts, ratios, or trends) that the auditor may need to investigate
further
RISK ASSESSMENT PROCEDURES
AUDIT RISK AND MATERIALITY
Risk assessment procedures are audit procedures performed to obtain an Materiality and audit risk affect the application of PSA, and are reflected in
understanding of the entity and its environment, including the entity's the auditor's report. The auditor must make judgments about materiality
internal control, to identify and assess the risks of material misstatement, and audit risk in determining the nature, timing, and extent of procedures to
whether due to fraud or error, at the financial statement and assertion apply and in evaluating the results.
levels.

Risk Assessment Procedures and Related Activities Materiality

The auditor shall: Information is material if its omission or misstatement could influence the
economic decisions of users talken on the basis of the financial statements.
a. Identify risks throughout the process of obtaining an understanding of
the entity and its environment, including relevant controls that relate Materiality depends on the size of the item or error judged in the particular
circumstances of its omission or misstatement.
to the risks, and consider the classes of transactions, account balances,
and disclosures in the financial statements; The concept of materiality recognizes that some matters, but not all, are
b. Relate the identified risks to what can go wrong at the
assertion level; important for the fair presentation of the financial statements in conformity
C
Consider whether the risks are of a magnitude that could result in a with PFRS.
material misstatement of the financial statements; and about the size of
d. Consider the likelihood that the risks In planning the audit, the auditor makes judgmentsjudgments provide a
could result in a material misstatements that will be considered material. These
misstatement of the financial statements. basis for:
assessment
Therisk assessment procedures shall Determining the nature, timing, and extent of risk
a. Inquiries of management, and of others include the following:
within the entity who in the procedures; material misstatement; and
auditor's judgment may have information that is likely b. Identifying andassessing the risks of of further audit
identifying risks of material misstatement due to fraud or to assist C. Determining the nature, timing, and extent
b. Analytical
procedures; and error; procedures
Observation and inspection. shall determine the following
C

Note: Risk assessment Using professional judgment, the auditor

sufficient appropriate auditprocedures by themselves, however, do not provide materiality:
evidence on which to base the audit
opinion. 19
 Chap
AUait Planning Chapter2 - Audit Planning
Financial statement level materiality - the smallest aggreno Summary of Procedures Performed in Planning an Audit
1, to all financial statements.
amount of misstatement applicable individual .
2. Assertion level materiality - materiality level for an Obtain an understanding of the
account balance, or disclosure where
particular class of transactions, misstatement
entity and its environment
tolerable
appropriate;this is also known as auditor
3. Performance materiality - amount or amounts set by the
statements as a whole. and it
less than materiality for the financial particular classes nf
Establish materiality and set
applicable, at less than materiality level or levels for
desired level of audit risk

transactions, account balances, or disclosures

Assess inherent and control
Audit Risk risks separately
Audit risk is the risk that the auditor gives an inappropriate audit opinion
when the financial statements are materially misstated. Identify detection risk to
Components of Audit Risk determine the nature, timing
and extent of further audit
1. Risk of Material Misstatement (RMM) or the possibility that material procedures
misstatements exist on the financial statements prepared and presented
by the entity.
Inherent Risk is the susceptibility of an account balance or class of
transactions to misstatement that could be material, individually, or
when aggregated with misstatements in other balances or classes,
assuming that there were no related controls.
Control Risk the risk that a misstatement, that could occur inan
account balance or class of transactions that could be material,
individually or when aggregated with misstatements in other
balances or classes, will not be prevented or detected and corrected
on a timely basis by the accounting and internal control systems.
Note: PSA 315 ldentifying and Assessing the Risks of Material Misstatements
requires a separate assessment of inherent and controlrisks.
2. Risk of not Detecting the Misstatement
Detection Risk is the risk that the auditor's substantive procedures
will not detect a misstatement that exists in an account balance or
class of transactions that could be material, individually, or when
aggregated with misstatements in other balances or classes.
If the auditor wishes to reduce detection risk, procedures to De
performed shall be
As to nature - more effective procedures
b As to timing - closer or
nearer to year-end
C As toextent - larger sample size
Relationships of Risk and Materialíty to Substantive Procedures
Risk of material misstatement (inherent and Direct
control risks)
Risk of not detecting the
misstatement (detection risk) Inverse
Materiality Inverse 21

20
Chapter 2 - Audit Planning Chapter 2- Audit Planning
THEORETICAL
CHAPTER 2: REVIEW QUESTIONS - 6 Which of the following
statements is/arecorrect?
Statement 1: Obtaining knowledge of the entity business is an important
1. Which of the following statements is incorrect? part of planning the audit work.
The auditor should plan the audit so that the engagement will he Statement 2: The auditor's knowledge of the entity's business assists in
performed in an effective manner. the identification of events,
b. Planning an audit involves establishing the overall audit strategy for transactions, and practices that may have a
material effect on the financial statements.
th¹ engagement and developing the audit plan, in order to reduce audit
risk to an acceptably low level. Only statement 1is correct
C Planning involves the engagement partner and other key members of b. Both statements are correct
the engagement team to benefit from their experience and insight and C. Only statement 2 is correct
toenhance the effectiveness and efficiency of the planning process. d. Both statements are incorrect
d. Planning is not a discrete phase of an audit, but rather a continual and 7. Which of the following statements is/are correct?
iterative process that often begins shortly after (or in connection with) Statement 1: According to PSA 300, the auditor may discuss elements of
the completion of the previous audit and continues until the finalization planning with those charged with governance and the entity's management.
of the audit program.
2
Statement 2: The audit plan sets the scope, timing, and direction of the
Which of the following statements is/are correct?
Statement 1:The client should plan the audit work sothat the audit willbe audit and guides the development ofamore detailed overallaudit strategy.
performed in an effective manner. Statement 3: The overall audit strategy is more detailed than the audit
plan and includes the nature, timing, and extent of audit procedures to be
Statement 2: The auditor should develop and document an overall audit performed by engagement team members to obtain sufficient appropriate
plan describing the scope and conduct of the audit. audit evidence toreduce audit risk to an acceptably low level.
a Only statement 1 is correct
b. Both statements are correct Only 1 statement is correct
C Only statement 2 is correct b. All statements are correct
d. Both statements are incorrect C. Only 2statements are correct
d. Allstatements are incorrect
3. Adequate planning of the audit work helps the auditor of accomplishing the 8. Which of the following helps prevent misunderstandings during audit
following objectives, except:
a. Ensuring that appropriate attention is devoted to important areas of planning?
the audit. a. Auditor involvement in the preparation of the client's financial records.
b Identifying the areas that need the service of an expert. b. Client involvement in determining specific audit planning issues.
c. Gathering of allcorroborating audit evidence. C A preliminary meeting conference with the client to discuss fees,
d. The audit work is completed efficiently. timing, client assistance, and related issues.
d. Involvement of the client's internal auditors in setting materiality levels
4 The auditor should plan the audit work so that the audit will be performed and determining the scope of audit tests.
in an effective manner. The extent of planning will vary according to any of
the following, except: 9. Which of the following statements is/are correct?
Auditor's experience with the entity and knowledge of the business. Statement 1: The overall audit plan and the audit program should not be
b Thenature and complexity of the audit engagement revised during the course of the audit.
C The assessed level of control risk. Statement 2: The auditor should develop and document an audit program
d. Size of the audit client. planned audit procedures
setting out the nature, timing, and extent of
5 The auditor's plan should required to implement the overall audit plan.
A B C D a. Only statement 1 is correct
Succeed action Yes Yes b. Both statements are correct
Be flexible No No
Yes Yes Yes Yes C. Only statement 2is correct
Be cost-beneficial Yes No Yes Yes d. Both statements are incorrect
23
Chapter 2 - Audit Planning Chapter 2 - Audit Planning
10. In planning the audit engagement, the auditor should consider each of the
15. Which of the following procedures would an auditor
following except most likely perform in
planning an audit of financial statements?
The kind of opinion (unqualified, qualified, or adverse) that is likelv to a. Inquiring of the client's legal counsel concerning
be expressed. b. Comparing the financial statements to pending litigation.
b. Matters relating to the entity's business and the industry in which it anticipated results.
C. Examining computer-generated exception reports to verify the
operates. effectiveness of internal controls.
The entity's accounting policies and procedures. d. Searching for unauthorized transactions that may aid in detecting
d. Materiality level and audit risk. unrecorded liabilities.
11. Which of the following matters should be considered by the auditor in 16. This serves as the set of instructions to assistants involved in the audit and
developing the overall audit strategy? as a means to control and record the proper execution of the work of the
a. Important characteristics of the entity, its business, its financial personnel involved in the service.
performance, and its reporting requirements inluding changes since a Audit procedures
the date of the prior audit b Audit program
b. Allof the choices C Audit plan
C Conditions requiring special attention, such as the existence of the Audit risk model
related parties 17. The auditor should design the written audit program, sothat:
d. The setting of materiality level for audit purposes Allmaterial transactions willbe selected for substantive testing.
12. In developing the overall audit strategy,the focus of the engagement team's b Substantive tests prior to the balance sheet date will be minimized.
efforts is considered. Which of the following is not appropriately classified C The audit procedures selected will achieve specific audit objectives.
as a factor affecting the focus of the team's efforts? d Each account balance will be tested under either test of controls or
tests of transactions.
a. The financial reporting framework on which the financial information
tobe audited has been prepared, including any need for reconciliation 18. In designing audit programs, an auditor should establish specific audit
to another reporting framework. objectives that related primarily to the
b. Setting materiality for planning purposes. Selected audit techniques
C. Audit areas where there is a higher risk of material misstatement. b Financialstatement assertions
d. Volume of transactions, which may determine whether it is more C Timing of audit procedures
efficient for the auditor to rely on internal control. Cost-benefit gathering evidence
13. Which of the following is least likely considered by the CPA when he makes 19. The auditor should document the overall audit strategy and the audit plan,
an overall audit plan? including significant changes made during the audit engagement Which of
The nature and timing of reports and other communication with the the following statements on documentation is incorrect?
entity that are expected under the engagement Documentation of the overall audit strategy may be made in the form of
b ldentification of complex accounting areas including those involving a memorandum that contains key decisions regarding the overall scope,
accounting estimates timing,and conduct of the audit.
completion
The effect of information technology on the audit
C b The auditor may use standard audit programs or audit tailored to the
checklists, but such programs and checklists need to be
d. The content of the representation letters
particular client.
to the originally
14. With respect to planning an audit, which of the following statements 1S C The auditor's documentation of any significant changes
audit plan need not
always true? detailed
planned overall audit strategy and the
a. An inventory count must be observed at year-end. include the reasons for the significant changes.
b Anengagement should not be accepted after the client's year-end. d The form and extent of
documentation depend on such matters as the
extent of other
materiality, the
Final staffing decisions must be made prior to size and complexity of the entity, of the specific engagement.
C
completion of u circumstances
d
planning stage. documentation, and the
It is acceptable to perform a portion of the audit of a continuing client
at interim dates.

25
Chapter 2 - Audit
Planning Chapter 2- Audit Planning
assessment procedures
Audit procedures may be classified as risk best describes 26. Which of the following procedures would an auditor least likely perform in
20 Which of the following
further audit procedures. planninga financial statement audit?
assessment procedures? Coordinating the assistance of entity personnel in data preparation.
material misstatements at L
detect
a. These procedures are used to b Discussing matters that may afect the audit with firm personnel
assertion level.
details of classes of transactione
responsible for non-audit services to the entity.
b. These procedures include tests of analytical procedures. C
Selecting a sample of vendor's invoices for comparison to receiving
account balances, and disclosures and reports.
effectiveness of controls in
C. These procedures test the operating misstatements at tho d. Reading the current year's interim financial statements.
preventing, or detecting and correcting, material
assertion level. 27. Audit risk has three components: inherent risk, control risk, and detection
d. These are procedures for obtaining an
understanding of the entity and risk. Which of the following statements is correct?
Detection risk is a function of the efficiency of an audit procedure.
its environment, including its internal control, to assess the risks of
a

material misstatement at the financial statement and assertion levels

b Cash is more susceptible to theft than an inventory of coal because it
has a greater inherent risk.
21. The audit program should contain the following, except: C The risk that material misstatement willnot prevent or detected on a
a Audit objective timely basis by internal control can be reduced to zero by effective
b Set of planned audit procedures controls.
C Time budget for the various audit areas d. The existing levels of inherent risk, control risk, and detection risk can
d. The combined assessed level of inherent and control risk be changed at the discretion of the auditor.
22. Which of the folowing procedures is not performed as a part of planning an 28, Some account balances, such as those for retirement benefits and finance
audit engagement? leases, are the results of complex calculations. The susceptibility to
Reviewing working papers of the prior year material misstatements in these types of accounts is referred to as
b. Performing analytical procedures a Audit risk
C Designing an audit program b Control risk
d. Test of controls C Detection risk
d. Inherent risk
23. Cost-benefit considerations are part of audit planning. In relation to this,
which of the following audit procedures is usually the least costly to 29. Inherent risk and control risk differ from detection risk in that inherent risk
perform? and control risk are:
a. Tests of balances a. Elements of audit risk while detection risk is not.
b. Analytical procedures b. Changes at the auditor's discretion while detection risk is not.
C Tests of transactions C. Functions of the client and its environment while detection risk is not.
Tests of controls d. Considered at the individualaccount balance level while detection risk
is not.
24. Analytical procedures are required:
A B C 30. Which of the following statements is not correct about materiality?
As a risk assessment procedure Yes Yes Yes Yes a. The concept of materiality recognizes that some matters are important
performed during planning for a fair presentation of financial statemnents in conformity with GAAP.
As a substantive test while other matters are not important.
procedure during Yes Yes No No
b. An auditor considers materiality for planning purposes in terms of the
evidence-gathering
As an overall review at audit largest aggregate level of misstatements that could be material to
any
completion No Yes No Yes one of the financial statements.
25. Analytical procedures used in planning an audit should C
circumstances
Materiality judgments are made in light of surrounding judgments.
a. Reducing the scope of focus on
tests of controls and substantive and necessarily involve both quantitative and qualitative
b. Providing assurance that tests. An auditor's consideration of materiality is influenced by
the auditor's
C. Enhancing the potential misstatements will be identified. rely on the
d. Assuming the auditor's of perception of the needs of a reasonable person who will
adequacy understanding
of the client's
the available evidential business. financial statements.
matter.
27
26
Chapter 2 - Audit Planning
31. There is an inverse relationship that exists between the acceptable
detection risk and the
a. Risk of failing to discover material misstatement
level of
b. Preliminary judgments about materiality levels
C. Assurance provided by substantive tests
d. Risk of misapplying the audit process
32. In considering materiality for planning purposes, the auditor believes thax
misstatements aggregating P60,000 would have a material effect on
entity's income statement, but that misstatements would have to aggreo
P40,000 to materially affect the balance sheet. Ordinarily, it would ba
appropriate to design auditing procedures that would be expected to dete
misstatements that aggregate:
a. P40,000
b. PS0,000
C. P60,000
d. P100,000
33. Which of the following would an auditor most likely use in determining the
auditor's preliminary judgment about materiality?
a. The anticipated sample size of the planned substantive tests.
b. The entity's annualized interim financial statements.
C.
The results of the internal control questionnaire.
d. The contents of the management representation letter.
34. Which of the following statements is/are correct?
Statement 1: Planning involves developing an overall strategy for the
expected conduct and scope of the audit.
Statement 2: Supervision involves directing the efforts of assistants who
are involved in accomplishing the objectives of the audit and determining
whether those objectives were accomplished.
Only statement 1 is correct
b. Both statements are correct
C. Only statement 2 is correct
d. Both statements are incorrect

35. In performing an audit of financial statements, the auditor should obtall

sufficient knowledge of a client's business and industry to
a. Develop an attitude of professional skepticism concerning
management's financial statement assertions.
b. Make constructive suggestions concerning improvements tothe client's
internal control.
C.
Evaluate whether the aggregation of known misstatements causes
financial statements taken as a whole to be materially misstated. the
d. Understand the events and transactions that may have an effect on
client's financial statements.

28