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468 viewsChapter 2
Auditing and Assurance Principle lecture notes for BS Accounting students.
Uploaded by
Aerin ParkCopyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF or read online on Scribd
/ 14
jnunt * Work are properly assigned
WioM © Assistance in fa
the audit of financial statements in
one
|... 7
Chapter 2 ~ Audit Planning
CHAPTER 2
AUDIT PLANNING - INTRODUCTION AND RISK
ASSESSMENT PROCEDURES
TOPIC OVERVIE!
This chapter discusses the audit planning process, audit strategy and risk
assessment procedures,
LEARNING OBJECTIVES:
After studying this chapter, you should be able to:
1. Explain audit planning. oe
Identify and explain the major audit planning activities.
Identify considerations in es blishing audit strategy.
Describe the difference of audit strategy, audit plan and audit program,
Identify the activities in risk assessment.
Describe audit risk and its components and how will it affect the audit
procedures,
AAPWN
PLANNING AN AUDIT OF FINANCIAL STATEMENTS
‘The primary objective of the auditor is to
so that the audit
will be performed in an effectivemanni@r. H er, also
leads to an efficientanditimelyaudiviengagement.
The Role and Timing of Planning
Planning an audit involves establis
engagement and developing an a
hing the overall audit strategy for the
udit plan. Adequate planning benefits
Several ways, including the following:
* Appropriate attention is devoted to important areas
. re identified andesolvedion a timely basis
Proper organization and management of the audit engagement
leading to an effective and efficient performance
to appropriate engagement team
members
Assistance in coordinating work done by other auditors and experts
‘ting direction, supervision and review
A etna
The
Titik of planning ace will vary according to the:
= with the
of key engagement team
members (partner, manager, and staff-i
.
-charge)
that occur during the audit engagement q
14Kap
Fap
Chapter 2 - Audit Planning
* Timingiofthevappointitiént of the independent auditor
Planning as a phase of the audit process
Planning is not a discrete phase of an audit, but rather a
that often begii (or in connection with)
ind continues until the completion of the
current audit engagement.
Major Audit Planning Activities
Planning is regardless whether it is amewlengagementto
womens activities may differ from one client to another client.
but normally includes the followin;
1, Obtaining an understanding of the client and its environment
2. Determining the need for experts
3. Determining the appropriateness of management use of going concern
assumption
Establishing materiality and assessing risks
Assessing the possibility of non-compliance
Identifying related parties
Performing preliminary analytical procedures
Development of the overall audit strategy and detailed audit plan
Preparation of preliminary audit programs.
THE OVERALL AUDIT STRATEGY AND AUDIT PLAN
Overall Audit Strategy
The auditor shall establish an \everallauditistrateBy that .
we ee
In establishing the overall audit strategy, the auditor shall:
* Identify the characteristics Of the engagement that define its scope;
© Ascertain the reportingObjectivés of the engagement to planuthe
timing OAthelaudit and the Hatt of the Communicationsrequired;
© Consider the factors that, in the auditer’s"professional judgment, are
significant in directing the engagement team’s efforts
© Consider the Se where
practicable, whether knowledge gained on other engagements
performed by the engagement partner for the enti aay
it
Audit Plan (specific)
After the overall audit strategy has been established, an audit plan can be
developed to addvessithelvaridus matters identified in the overall audit
strategy, taking into account the need to achievelitheaudite objectives
efficient use of the auditor's resources.
through the
Pen ans
pL |Chapter 2 udit Planning _
Chapter 2 - Audit SS
The audit plan is moredeétailed Io'th
includes the (atieytiminiy and extent of tbe pee
by engagement team members. These procedures may be documentey
in
an audit program.
The audit program shall serve as a:
; to assistants involved in the audit; and
* Means to the proper execution of the work.
The audit program also contains: t
. 7h tera: and
oA in which hours are budgeted for the various audit area
s
or procedures.
Changes to Planning Decisions During the Course of the Audit
The Overalllauditlplan and the¥auditeprogram "should"bélirevised as
mecessary during the course of the audit. Planning is continuous
because ol
results of audit procedures.
Completion of Overall Strategy and Audit Plan
The and the
are not necessarily discrete or sequential processes, but are .
related eine "get naRaSea vec MESriocy Menta
Also, preferably, a plan shall be initially completed prior to
consideration of internal controls or performance of specific procedures.
Planning documentation
--- The auditor shall document:
srforined g_ pthe overall audit strategy
tained b the audit plan
‘tathedJe, any significant changes made during the audit engagement to the
overall strategy or audit plan, and the reasons for such changes
Additional Considerations in Initial Audit Engagements
‘after performing (preliminaryengagemientiactivities, for an initial audit, the
auditor imaymieed to expand the planning/activities because t
ordinarily have the previous experienc:
e with the entity that is considered
additional matters
when planning recurring engagements. For initial audits,
vey and atidit
the auditor may consider in
mi W
© AfFaHGemIeHtS!to be made with the predecessorsauditor to revic
prior years’ working papers; -
oa d with managemiésitin connection with
ql | the communication of these matters '°
16
cea|
Chapter 2 - Audit Planning
Ghopter 2— Audit Planning 00
those charged with governance and HOWilthesesmattersjaffectythe
YSIS EP IER
«The planned auditiprocedures t
e regarding opening balafi¢es; and
. s required by the firmisisystem of qualityicontrol for
DIRECTION, SUPERVISION AND REVIEW
‘The @udit6r should plaA the Hatite, timing andlextént of
supervision of engagement team memb«
ers and Kk.
The nature, timing and extent of the direction and supervision of
engagement team members and review of their work vary depending on
many factors, including
‘the assessed risks of material misstatement;
+ size and complexity of the entity;
«the area of audit; and
«capabilities and competence of personnel performing the audit work.
Considerations Specific to Smaller Entities
When an audit is carried out entirely by an audit engagement partner, who
may be a sole practitioner, it may be (desirable to¥iconsultiwithijothier
EES ENETENCE TAN s or the auditor's professional body.
Identifying And Assessing The Risks Of Material Misstatement Through
Understanding The Entity And Its Environment
It is the @bjective) of theyauiditor to identifyyandiassessirisksiofimaterial
misstatements, whether dueitorfraudjorerror, at the financial statement and
assertion levels, through understanding the entity and its environment,
including the entity's internal control, thereby providing a basis for
designing and implementing responses to the assessed risks of material
misstatements.
‘The Required Understanding of the Entity and its Environment
The auditor shall 6btaitilanlwniderstandifig of the following:
a. Relevantindustry, regulatory, and otherextertialifactors including the
pplicable financial reporting framework;
al o
b. The natureofitheventity, including its operations; ownership and
governance structure; types of investments that the entity is making
and plans to make; and the way the entity is structured and how it is
financed;
c. Bitty’ S8I@etiGn and pplication "OPACEOUREINgNPOies, including
reasons for changes thereto;
a Bites Sb ates and Strategies) and those elatedlbusinesstirisks
that may result in risk of material misstatement;
17ASS
Chapter 2 - Audit Planning
‘The measurement and review of the entity’s financial performance;
and
f Internal control (this is covered in the next chapter)
e
RISK ASSESSMENT PROCEDURES a
Risk as are aliditiproeeduires performed to obtain an
Risk assessment procedures
of the entity and its “@nvironmént, including the entity's
|, to identify and/assess the risks of material misstatement
whethereduestowfraudorverror, at the financialstatementiand assertion
I
Risk Assessment Procedures and Related Activities
The auditor shall:
a. Identify risks throughoutithelprocess of obtaining an understanding of
the entity and its environment, including reélévanticontrols that relate
to the fisks, and consider the classes of transactions, account balances,
and disclosures in the financial statements;
b. Sy identified risks to what can go wrong at the assertion level,
© whether the/risks are of agmagnitude that could'resultinva
eS financial statements; and
d. r the likélihodd that the (risk$ could result in a materialy
eo: es .
‘The risk assessment procedures shall include the following:
a. inuainesiefeaenazemer", and of others|withinjtheyentity who in the
auditor’s judgment may have information that is likely to assist in
identifying risks of material misstatement due to fraud or error;
b. ‘ASaIgSLEE SEEETSESs, and
c. Observation'and inspection.
Note: Risk assessment procedures by themselves, however, dojnotyprovide
Dn
Analytical Procedures during Planning Stage
‘anal VHigAlIPROGEMMAEs consist of evaluations/ofifinanciallinforimation made
by a study of plausible welationships among
data. Analytical procedures also encompass the
fluctuations and relationships that are consistent with other relevant
information or that differ from expected values by a significant amount.
Analytical procedure is required to be performed during planning stage and
overall review stage of the audit. Analytical procedures performed during
audit planning is
1, (HEY Sacer of the entity/sibusiness and
transactions to help plan the
that will be used to gather audit evidence.
18Chapter 2 - Audit Planning
2, (deiitifyaFeas that iy EE (such as unusual
transactions and events or abnormal/significant fluctuations in
amounts, ratios, or trends) that the auditor mayineed to investigat
further
AUDIT RISK AND MATERIALITY
Kk affect the application of PSA, and are reflected in_
the rt. The auditor must mak about
Materiality
Information is material if its omission or misstatement could the
ns of users taken on the basis of the financial statements.
Materiality on the\sizejofithelitem or\errorjudged in the particular
circumstances of its omission or misstatement.
‘The concept of materiality recognizes that sepa: baa are
In planning the audit, the auditor makes judgments about the size of
misstatements that will be considered material. These judgments provide a
basis for:
a. Determining the nature, timing and extent of risk assessment
procedures;
b. Identifying and assessing the risks of material misstatement; and
c. Determining the nature, timing and extent of further audit
procedures
Using professional judgment, the auditor shall determine the following
materiality: ppimoyy (rah ES
1. Financial statement level materiality - the smallest aggregate
amount of misstatement applicable to. .
2. Assertion level materiality - materiality er i or
Pocus of trafisactions, accountibalaice, or re where
raloial 60 jate; this is also known as\golerable misstatement
3. Performance materiality - amount or amounts: ee at
Comuna as le, and if
amount
applicable, a f
re;
pLChapter 2 — Audit Planning
Components of Audit risk
1.
Inherent Risk is th of anjaecouintibalatice or elassiof
transactions to misstatement that could be material, individually or
(uhen aggregated with misstatements in other balances or classes,
assuming that there'weremorrelated control 2
Control Risk is the risk that a ‘misstatement, that could'@ceur in an
that could be material,
acieridually or when aggregated with misstatements in other
balances or classes,
ed
S.
t that exists in an account balance or
wuld be material, individually or when
ts in other balances or classes.
2. Riskofnot Detecting the Misstatemertt
cue Detection Risk is the risk that the auditor's substantive procedures
class of transactions that co
aggregated with misstatemen|
If the auditor wishes to reduce detection risk, procedures to be
performed shall be
a. Asto nature - more effective procedures
b. As to timing - closer or nearer to year-end
c. As to extent - larger sample size
of Risk and Materiality to substantive procedures
‘ent and control risks) Direct
t (detection risk) Inverse__| ,
Inverse
Relationships
Risk of material misstatement (inher’
Risk of not detecting the misstatemen|
Materiality_
summary of Procedures Performed in Planning an Audit
Obtain an understanding of the
entity and its environment
¥v
Establish materiality and set
desired level of audit risk
Assess inherent risk
Identify detection risk to
determine the nature, timing
and extent of further audit
procedures
[eee eee
203.
Green following objectives, except:
‘
Chapter 2 ~ Audit Planning
CHAPTER 2: REVIEW QUESTIONS - THEORETICAL
1, Which of the following statements is incorrect?
a. The auditor should plan the audit so that the engagement will be
performed in an effective manner,
b. Planning an audit involves esta
the engagement and developing
risk to an acceptably low level.
Planning involves the engagement partner and other key members of
the engagement team to benefit from their experience and insight and
to enhance the effectiveness and efficiency of the planning process,
Planning is not a discrete phase of an audit, but rather a continual and
“iterative process that often begins shortly after (or in connection with)
the completion of the previous audit and continues until the finalization
of the audit program, comple
2. Which of the folowing atggements is/are correct?
01
Statement 1: The clie} yuld plan the audit work so that the audit will be
performed in an effective manner.
iblishing the overall audit strategy for
the audit plan, in order to reduce audit
Statement 2: The auditor should develop and document an overall audit
plan describing the scope and conduct of the audit.
a. Only statement 1 is correct
b. Both statements are correct
cy Only statement 2 is correct
d. Both statements are incorrect
Adequate planning of the audit work helps the audi
1 of accomplishing the
a. Ensuring that appropriate attention is devoted to important areas of
the audit.
b. Identifying the areas that need a service of an expert.
c, Gathering of all corroborating audit evidence.
The audit work is completed efficiently.
4, The auditor should plan the audit work so that the audit will be performed
in an effective manner. The extent of planning will vary according to any of
the following, except: ;
a. Auditor's experience with the entity and knowledge of the business.
b, The nature and complexity of the audit engagement
The assessed level of control risk.
d. Size of the audit client.
5. The auditors plan should
A B c D
Succeed action Yes Yes No No
Be flexible Yes Yes Yes Yes
Be cost-beneficial Yes No Yes Yes
21Chapter 2 - Audit Planning
Chapter 2 = Audit “er aa saaenaaemeianmaaneh tt
6. Which of the following statements is/are correct?
Statement 1: Obtaining aowledge of the entity business is an imp
ortant
part of the planning the audit work.
statement 2: The auditor's know!
the identification of events transac
material effect on the financ | statements.
edge of the entity's business a
tions and practices which may ae
ve a
ent 1 is correct
5 are correct
2 is correct
a. Only statem
by Both statement
c. Only statement
d. Both statements are incorrect
7. Which of the following statements is/are correct?
Statement 1:1 ‘According to PSA 300, the auditor may discuss elements
and the entity's iakugeneet
planning with those charged with governance
P :
The alidit plan sets the scope, timing and direction of th
more detailed overall audit strategy, 7
development of the
Statement
audit guides the
‘The overfill audit str
nature, timing
nt team membe!
audit risk to an acce
ategy is more detailed than the audit
‘and extent of audit procedures to be
rs to obtain sufficient appropriate
ptably low level.
Statement
plan and includes the
performed engageme
audit evidence to reduce
a, Only 1 statement is correct
b. Allstatements are correct
Only 2 statements are correct
nts are incorrect
ing helps prevent misunde!
c
d. Allstateme!
8 Which of the follow! standings during audit
planning?
‘Auditor involve
ient's financial records.
planning issues.
Jient to discuss fees,
ent in the preparation of the cli
. Client involvement in determining specific audit
c. A preliminary meeting conference with the cl
timing, client assistance and related issues:
d. Involvement of the client’s internal auditors In setting materiality levels
and determining the scope of audit tests.
wing statements is/are correct?
d the audit program should not be
a
9. Which of the follo
Statement 1: The overall audit plan an
revised during the course of the audit.
Statement 2: The auditor should develop and document an audit program
sing out he mature Timing and extent of planned audit Proe
ed to implement the overall audit plan.
Only statement 1is correct
“ in statements are correct
&, Only statement 2 is correct
oth statements are incorrect.
22Chapter 2 - Audit Plannin
itor should consider each of the
10. In planning the audit engagement, the a
following except
ay The kind of opini
be expressed.
b, Matters relating to the entity's
operates.
¢. The entity's accounting policies and procedures.
d. Materiality level and audit risk.
11. Which of the following matters should be considered by the auditor in
developing the overall audit strategy?
Important characteristics of the entity,
ion (unqualified, qualified, or adverse) that is likely to
business and the industry in which it
its business, its financial
a
performance and its reporting requirements including changes since
the date of the prior audit
b, Allof the choices
4
c.
Conditions requiring special attention, such as the existence of the
related parties
4. The setting of materiality level for audit purposes
12, In developing the overall audit strategy, the focus of the engagement team’s
efforts is considered. Which of the following is not appropriately classified
as. factor affecting the focus of the team’s efforts?
‘The financial reporting framework on which the financial information
to be audited has been prepared, including any need for reconciliation
to another reporting framework.
b. Setting materiality for planning purposes.
c. Audit areas where there is a higher risk of material misstatement.
4. Volume of transactions, which may determine whether it is more
efficient for the auditor to rely on internal control.
»
13, Which of the following is least likely considered by the CPA when he makes
an overall audit plan?
a. The nature and timing of reports and other communication with the
entity that are expected under the engagement
b. Identification of complex accounting areas including those involving
accounting estimates
c. Theeffect of information technology on the audit,
d,, The content of the representation letters
14, With respect to planning an audit, which of the following statements is
always true?
a, An inventory count must be observed at year-end.
b. An engagement should not be accepted after the client's year-end.
¢. Final staffing decisions must be made prior to completion of the
planning stage.
d, It is acceptable to perform a portion of the audit of a continuing client
at interim dates.
23Chapter 2 - Audit Planning
15.
16.
17.
18,
19.
eae
Which of the following procedures would an auditor most likely perform in
planning an audit of financial statements?
Inquiring of the client's legal counsel concerning pending litigation,
Comparing the financial statements to anticipated results,
a.
by
¢ Examining computer generated exception reports to verify the
effectiveness of internal controls.
4. Searching for unauthorized transactions that may aid in detecting
unrecorded liabilities.
‘This serves as the set of instructions to assistants involved in the audit ang
as a means to control and record the proper execution of the work of the
personnel involved in the service.
a. Audit procedures
b. Audit program
cc. Audit plan
d. Audit risk model
The auditor should design the written audit program, so that:
a. All material transactions will be selected for substantive testing.
b. Substantive tests prior to the balance sheet date will be minimized.
c The audit procedures selected will achieve specific audit objectives.
d. Each account balance will be tested under either tests of controls or
tests of transactions.
In designing audit programs, an auditor should establish specific audit
objectives that related primarily to the
a. Selected audit techniques
by Financial statement assertions
c. Timing of audit procedures
d. Cost-benefit gathering evidence
The auditor should document the overall audit strategy and the audit plan,
including significant changes made during the audit engagement. Which of
the following statements on documentation is incorrect?
a. Documentation of the overall audit strategy may be made in the form of
a memorandum that contains key decisions regarding the overall scope,
timing and conduct of the audit.
b. The auditor may use standard audit programs or audit completion
checklists, but such programs and checklists need to be tailored to the
particular client.
cy The auditor’s documentation of any significant changes to the originally
planned overall audit strategy and to the detailed audit plan need not
include the reasons for the significant changes.
4. The form and extent of documentation depend on such matters as the
size and complexity of the entity, materiality, the extent of other
documentation, and the circumstances of the specific engagement.
24Chapter 2 ~ Audit Planning
20.
21.
22.
23.
24,
2s.
Audit procedures may be classified as
‘ risk
further audit procedures, Which living erasers
of the foll
assessment procedures? lowing best describes risk
a These procedures are used detec
etect_ material
assertion level, lal misstatements at the
These Procedures include tests of detalls of clases of transactions
account balances, and disclosures and analytical procedaen "
'e operating effectiveness o
Preventing, or detecting and correcting, material mises
assertion level.
4, These are procedures for obtaini
its environment, including its i
material misstatement at the fin:
ing an understanding of the entity and
internal control, to assess the risks of
ancial statement and assertion levels.
The audit program should contai
a. Audit objective
b. Set of planned audit procedures
© Time budget for the various audit areas
d, The combined assessed level of inherent and control risk
in the following, except:
Which of the following procedures is not
audit engagement?
a. Reviewing working papers of the prior year
b. Performing analytical procedures
c. Designing an audit program
d, Test of controls
performed as a part of planning an
Cost-benefit considerations are part of audit planning. In relation to this,
which of the following audit procedures is usually the least costly to
perform?
a. Tests of balances
by Analytical procedures
¢. Tests of transactions
d. Tests of controls
Analytical procedures are required: ap
* Asarisk assessment procedure Yes Yes Yes Yes
performed during planning :
+ Asasubstantive test procedure during Yes_ “Yes «Noo
evidence gathering .
‘* Asan overall review at audit completion No Yes No
Analytical procedures used in planning an audit should focus on
a. Reducing the scope of tests of controls and substantive tests,
b. Providing assurance that potential misstatements will be identified.
¢, Enhancing the auditor's understanding of the client's business.
d. Assuming the adequacy of the available evidential matter.
25Chapter 2 - Audit Planning pS eee eee
26. Which of the following procedures would an auditor least likely perform in
planning a financial statement audit?
a. Coordinating the assistance of entity personnel in — preperation
b. Discussing matters that may affect the audit with firm personnel
responsible for non-audit services to the entity. ; :
c, Selecting a sample of vendor's invoices for comparison to receiving
reports. a
Reading the current year’s interim financ’
27. Audit risk has three éomponents: inkierent risk control risk and detection
: i rect? ~
sk. Which of the following statements is co!
ren petection risk isa function of the efficiency of an audit procedure.
b.. Cash is more susceptible to theft than an inventory of coal because it
has a greater inherent risk i i
c.. The risk that material misstatement will not prevent or detected on a
timely basis by internal control can be reduced to a zero by effective
controls. 7
4. The existing levels of inherent risk, control risk and detection risk can
be changed at the discretion of the auditor.
28, Some accounts balances, such as those for retirement benefits and finance
Tease, are the results of complex calculations. The susceptibility to material
misstatements in these types of accounts is referred to as
a. Audit risk
b. Control risk
c. Detection risk
d., Inherent risk
29. Inherent risk and control risk differ from detection risk in that inherent risk
and control risk are:
a. Elements of audit risk while detection risk is not.
b. Changes at the auditor's discretion while detection risk is not.
c, Functions of the client and its environment while detection risk is not.
d. Considered at the individual account balance level while detection risk
is not.
ial statements.
30. Which of the following statements is not correct about materiality?
a. The concept of materiality recognizes that some matters are important
for fair presentation of financial statements in conformity with GAAP,
while other matters are not important.
b, An auditor considers materiality for planning purposes in terms of the
largest aggregate level of misstatements that could be material to any
one of the financial statements.
Materiality judgments are made in light of surrounding circumstanced
and necessarily involve both quantitative and qualitative judgments.
d. An auditor’s consideration of materiality is influenced by the auditor’s
perception of the needs of a reasonable person who will rely on the
financial statements.
26
