5-1
Chapter Five
Audit Planning
and Types of Audit Tests
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5-2
The Phases of an Audit That Relate
to Audit Planning
Client acceptance
and continuance
Establish the terms
of the engagement
Preplanning
Assess risks and
establish materiality
Plan the audit
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5-3
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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5-4
Continuing Client Retention
Evaluate client
retention periodically
Near audit completion
or after a significant
event
Conflicts over
accounting & auditing
issues
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Dispute over fees
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5-5
Establish Terms of the Engagement
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.
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.
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5-6
The Engagement Letter
The engagement letter formalizes 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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5-7
Internal
Auditors
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5-8
Internal Auditors
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5-9
Those Charged with Governance
Board of
Directors
Audit Committee
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5-10
Preplanning
Determine the Audit
Engagement Team
Requirements
Assess
Independence
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5-11
Assess Risks and Establish
Materiality
Use audit
risk model
Restrict risk at
account
balance level
Achieve
acceptable
level of 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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5-12
Planning the Audit
When planning the audit, the auditor should be guided by the
results of the risk assessment procedures performed to gain
an understanding of the entity.
Additional steps:
•Assess a preliminary level of control risk
by account and assertion.
•Consider the possibility of non-compliance
(illegal) acts.
Let’s look at each
of these steps.
•Identify related parties.
•Conduct preliminary analytical
procedures.
•Develop an overall audit strategy and
prepare an audit plan.
•Consider additional value-added services.
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5-13
Assess a Preliminary Level for Control
Risk by Account and Assertion
Control risk is the risk that material misstatements will not be
prevented or detected by internal controls.
A preliminary
assessment of
control risk is
necessary for the
auditor to plan the
nature, timing,
and extent of
testing.
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The presence of complex
information technology may
require the use of an IT
specialist.
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5-14
Assess the Possibility of Non-compliance
(Illegal) Acts
Noncompliance
Acts
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Materially
affecting the
financial
statements
Not materially
affecting the
financial
statement
Obtain evidence of
compliance
Be aware may have
occurred;
investigate if
brought to attention
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5-15
Assess the Possibility of Non-compliance
Acts
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5-16
Identify Related Parties
Some examples from IAS 24
Related Party Disclosure
•Parents and subsidiaries.
•Significant influence.
•Joint control.
•Associate entity.
•Joint venture.
•Management.
•Close family of the
principal owners & management.
•Other parties that can have
significant influence.
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How to Identify Related Parties in
Addition to Request Management
•Review contracts and
agreements.
•Review bank and legal
confirmations.
•Review transactions with major
customers, suppliers, borrowers,
and lenders.
•Review large, unusual, or
non-recurring transactions
especially at year end.
•Review minutes of meetings of
boards and management.
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5-17
Conduct Preliminary Analytical
Procedures
To understand the
client’s business
and transactions
To identify
financial statement
accounts likely to
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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5-18
Develop an Overall Audit Strategy
Scope
Timing
Direction
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Complete other planning
steps.
Compile knowledge about the
client’s business objectives
and strategies, business risks,
audit risks, and controls.
Document effects of identified
risks and controls on planned
audit procedures.
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5-19
Prepare Audit Plan
Nature
Timing
The audit plan addresses in
more detail the matters
identified in the audit strategy.
An audit plan contains the
nature, timing and extent of
specific audit procedures.
Extent
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5-20
Consider Additional Value-Added
Services
Tax Planning
IT
Consultancy
Internal
Reporting
Risk
Assessment
Benchmarkin
g
Electronic
Commerce
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5-21
Types of Audit Tests
Risk Assessment
Procedures
Used to obtain an understanding of
the entity and its environment,
including internal controls.
Tests of Controls
Performed to obtain audit evidence
about the operating effectiveness of
controls in preventing, detecting and
correcting material misstatements.
Substantive
Procedures
Detect material misstatements in a
transaction class, account balance,
and disclosure component of the
financial statements.
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5-22
Tests of Controls
Inquiry
Inspection
Observation
Walk
Through
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Reperformance
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5-23
Tests of Controls
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5-24
Substantive Procedures
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Tests of
Details
Analytical
Procedures
Tests for errors
or fraud in
individual
transactions
Obtains evidence
about particular
assertions related to
account balances or
classes of
transactions
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5-25
Dual Purpose Tests
Tests of
Controls
Substantive
Tests
Dual
Purpose
Test
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5-26
Purposes of Analytical Procedures
Preliminary
Analytical
Procedures
Used as risk assessment procedure to
assist the auditor to better understand the
business and to plan the nature, timing,
and extent of audit procedures.
Substantive
Analytical
Procedures
Used to obtain evidence about particular
assertions related to account balances or
classes of transactions.
Final
Analytical
Procedures
Used as an overall review of the financial
information in the final review stage of the
audit.
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5-27
Purposes of Analytical Procedures
Trend Analysis
Ratio
Analysis
Reasonableness
Analysis
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5-28
Substantive Analytical Procedures
Decision Process
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5-29
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.
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5-30
The Investigation of Differences for
Planning and Final Analytical Procedures
Preliminary
Analytical
Procedures
Differences
Final
Analytical
Procedures
Differences
Corroboratin
g evidence
not required
Corroboratin
g evidence is
required
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5-31
Audit
Testing
Hierarchy
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5-32
Filling the Assurance Bucket
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5-33
Accounts Payable Example of Filling the
Assurance Buckets for Each Assertion
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5-34
Short-Term Liquidity Ratios
Current
Ratio
Quick Ratio
Operating
Cash Flow
Ratio
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5-35
Activity Ratios
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Receivables
Turnover
Days
Outstanding
in Accounts
Receivable
Inventory
Turnover
Days of
Inventory on
Hand
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5-36
Profitability Ratios
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Gross Profit
Percentage
Profit Margin
Return on
Assets
Return on
Equity
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5-37
Coverage Ratios
Debt to
Equity
Times
Interest
Earned
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5-38
End of Chapter 5
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