AUD 589

AUDITING 1

Audit Planning

Prepared by:
Yusarina Mat Isa
UiTM Kampus Puncak Alam
 Learning Objectives
 Able to:
Explain the steps involved in planning for an audit
engagement

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 Phases of an Audit

CLIENT ACCEPTANCE AND

RETENTION PLANNING THE AUDIT
• Involve decisions to accept or • Development of audit
decline the opportunity to strategy for the conduct
become the auditor. Evaluate and scope of the audit
management integrity (follow
audit quality guidelines),
auditors independence and
prepare engagement letter

REPORTING THE PERFORMING AUDIT TESTS

FINDINGS • Performing the audit tests
• Communication of (fieldwork)
audit findings
 Accepting Audit Engagement

CLIENT ETHICAL
EVALUATION CONSIDERATIONS ENGAGEMENT

Evaluate integrity Evaluate Prepare

of the management independence engagement letter

Identify special Assess

circumstances and competence to
unusual risks perform audit

Determine ability
to use due care
 Client Acceptance
• Accept new clients or continue service the
existing one
• Identify why the client wants or needs an
audit
• Understanding with the client about the terms
of the engagement
• Selection of staff for the engagement

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 New Client Engagement
• Evaluate the standing of the prospective client in the
business community, financial stability, and relation
with its previous auditor
– E.g. if the business fail financially, the auditor will be
exposed to significant financial liability
• Requirement MIA By-Laws – to communicate with
former auditor
– E.g. client may lack of integrity, disputes over accounting
principles, audit procedures, fees
• If no previous auditor, more extensive investigation is
appropriate

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 Continuing Client
• Evaluate existing client annually to determine
whether there are reasons for not continuing audit
• Conflicts could have arisen over:
– Scope of audit, type of opinion issued, fees
• Auditor may discontinue service due to:
– Client lacks integrity
– Unpaid fees
– Excessive risk – acceptable audit risk not within the
auditor’s threshold
• E.g. regulatory conflict between regulator and client, which would
result in financial failure of the client and ultimately lawsuit
against the auditor

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 Client’s Reasons for Audit
• Major factors:
– Likely financial statement users
– Intended use of financial statements
• Auditor more likely to accumulate more
evidence when the financial statements are to
be used more extensively
– E.g. publicly held companies, companies that are
to be sold in the near future

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 Understanding with Client
• Engagement letter
– Agreement between auditor and client for the conduct of
audit
– Formal letter that formalise the contract between auditor
and client – outlines responsibilities of both parties
– Recipient – Board of Directors/management

• Purpose of engagement letter

– To define clearly the extent of auditor’s and client’s
responsibilities
– To avoid misunderstanding between auditor and client
– To provide written confirmation on auditor’s acceptance of
the appointment, the scope of audit, form of report and
scope of non-audit services
(if any)
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 Engagement Letter
• Principal contents of engagement letter
– The objective of financial statement audit
– Management’s responsibility for the financial statements
– The scope of audit, including reference to applicable
standards
– The form of report – inability to form report if audit is not
completed
– The inherent limitations of an audit (fraud/error) and there
are risk that material misstatement may be uncovered
– Deadlines
– Schedules to be prepared for auditor
– Audit fees

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 Staff Engagement
• Assigned competent staff who is knowledgeable
about the client’s industry
– E.g. in auditing a computer manufacturing client, it is
essential to assign staff who have experience in auditing
extensive inventory of computer and computer parts and
have good understanding on computer manufacturing
industry
• Evaluate need for a specialist
– E.g. actuary for determining the appropriateness of the
recorded value of the insurance loss reserve, diamond
expert in evaluating the replacement cost of diamonds

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 Audit Planning

Obtain knowledge Make preliminary

Perform analytical
of the client’s judgments about
procedures
business materiality

Obtain an Develop preliminary

understanding of audit strategies for
Consider audit risk
the entity’s internal significant
control structure assertions
 Benefits of Planning the Audit
• Increase effectiveness and efficiency in audit work
• Enable the auditor to obtain relevant and reliable
evidences
• Helps to minimize audit costs by eliminating
unproductive works and focusing on high risk areas
• Potential problems can be detected early and
avoided
• Audit procedures can be performed systematically
• Avoid misunderstanding with the clients

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 Audit Planning – Step 1

• Auditor need to know about the

Obtaining economy and industry within the entity
operates
knowledg • Major industry policies and practices
• Types of business, product and services
e about • Entity internal control structure
client’s • Government regulations that effect the
entity (price control)
business • Nature of report to be filed with
regulatory agencies (Bursa Malaysia etc)

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 Audit Planning – Step 1
• Determining the existence of related
parties – the duty of management
to disclose to the auditor
• Considering the impact of applicable
accounting standards
Other • Considering of laws and regulations
specific • Considering of fraud and errors
• Review prior year audit working
knowledg paper
• Review industry and business data –
e minutes of meetings
• Touring operating facilities and
offices
• Making inquiries of management
• Making inquiries of audit committee

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 Understanding the Client’s
Business/Industry
• Knowledge auditor must obtain about a client’s
business and industry
– Industry and external environment
• Regulatory and industry-specific accounting requirements
– Business operations and processes
• Key suppliers, major sources of revenues
– Management and governance
• Organization structure, reporting structure
– Objectives and strategies
• Response to change of external environment, redefining and
adapting strategies
– Measurement and performance
• KPI, forecast, statistics, budget, credit rating agency report

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 Understanding the Client’s
Business/Industry
• Sources available for auditor to obtain info about
client:
– Experience with the client or its industry
– Tour to client’s premises
– Inquiries of client’s personnel
– Inquiries from former auditor
– Discussion with knowledgeable people within the entity e.g. directors
– Discussion with knowledgeable people outside the entity e.g. industry
economist/expert, customers, suppliers
– Discussion with internal audit personnel and review of internal audit
files/report
– Memorandum & Articles of Association
– Minutes of meetings

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 Assess Client Business Risk
• Client business risk
– Risks that can adversely affect client’s ability to
achieve its objective and carry out its strategies
– Internal vs. external factors
• E.g. changes in operating environment, new
information systems, corporate restructuring, new
accounting requirements

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Audit Planning – Step 2

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 Audit Planning – Step 2
NATURE OF ANALYTICAL PROCEDURES
• Comparisons of the entity’s financial information with, for example:
• Comparable information for a previous period or periods
• Anticipated results such as budget and forecasts
• Industry averages
• Identify unexpected fluctuations and unusual relationships (Key financial
ratios used. i.e. current ratio, quick ratio, AR turnover ratio, inventory
turnover ratio, gross profit margin, net profit margin, etc)
• Analytical Procedures also included:
• Among elements of financial information: Such as gross profit, net profit etc
• Between financial information and relevant non-financial information such as
payroll cost to number of employee

THE PURPOSE OF ANALYTICAL PROCEDURES

• To assist the auditor in planning the nature, timing and extent of other audit
procedures
• As substantive procedures when their use can be more effective or more
efficient than tests of details in reducing detection risk
• As an overall view of the financial statements in the final review stage or
enhance the understanding of the entity’s business 20
 Audit Planning – Step 2

ANALYTICAL PROCEDURES IN PLANNING THE AUDIT

The Auditor should apply analytical procedures at the

planning stage to assist in understanding the business
and in identifying areas of potential risk

Application of analytical procedures at the planning stage will

help the auditors to get brief understanding about the business
and will assist auditor in determining the nature, timing and
extent other audit procedures

Analytical procedures in planning use in both financial and non-

financial information, for example relationship between increase
number of location rent with rental expenses, staff will increase,
payroll should increase, EPF and Socso increase etc

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 Audit Planning – Step 2
Example: Explain the possible reason for the following changes
highlighted at the planning stage:
• An increase in the current ratio (current asset/current liabilities)
• Indicate increase in current asset. Company may be expanding or may be
having problem to sell inventory or collection problem
• A decrease in the gross profit margin (Gross profit over sales)
• Indicate cost of material increase or selling price decrease
• An increase in the inventory holding period (Inventory over purchase X 365
days)
• The company unable to sell inventory or company expecting additional
sales, obsolete stock may rise or business expanding
• An increase in gearing (debt over equity ratio)
• Indication for interest expenses will higher, the company may face risk of
going concern or company expanding

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*Audit Planning – Step 3 (Topic 3e)

Determine what is the

planning materiality and
which area need to be
focused
Set materiality and
assess acceptable Could be done by looking
at the financial
risks statements of client as
well as after an
understanding the
control system is
obtained

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*Audit Planning – Step 4 (Topic 3e)
The
The risk
risk that
that an
an auditor
auditor will
will issue
issue an
an
unqualified
unqualified opinion
opinion on
on materially
materially
misstated
misstated financial
financial statements.
statements.

Individual account
Financial statement
balance or class
level
of transactions level
 Audit Risk
• Factor of uncertainty in audit performance
lead to creation of audit risk
• Audit risk – auditor give inappropriate audit
opinion on the financial statements
• Components of audit risk
– Inherent risk
– Control risk
– Detection risk

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Audit Planning – Step 5 (Topic 3b)

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 Audit Planning – Step 6

AUDIT PROGRAM
Is a proper instruction to carry out the audit
work

Standard audit program Tailored audit program

Documentation Audit Planning Memorandum 27

 Preparation of Audit Program
• Purpose
– Guiding audit staff
– Evidence for proper planning and recording
– Provide basis for conducting and supervising audit
work
– Future reference
• Content
– Objectives
– Procedures of audit – including sampling, and
timing in performing procedures

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End of Topic 3d