Chapter 3 Audit Planning, Types of Audit

Tests, and Materiality

McGraw-Hill/Irwin Copyright 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

The Phases of an Audit That Relate to

Audit Planning

LO# 1

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Preliminary Engagement Activities

Determine the Audit

Engagement Team

Requirements

Assess Compliance with

Ethical Requirements,

Including Independence

LO# 2

3-3

Establish Terms of the

Engagement

The terms of the engagement, which are documented in

the engagement letter, should include the objectives of

the engagement, managements responsibilities, the auditors responsibilities, and the limitations of the

engagement.

Who signs the engagement letter?

In establishing the terms of the engagement,

three topics must be discussed:

1.The engagement letter;

2.Using the work of the internal auditors; and

3.The role of the audit committee.

LO# 3

3-4

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 3-1 in

the textbook, the engagement letter may

include:

Arrangements for use of specialists or internal auditors.

Any limitations of liability of the auditor or client.

Additional services to be provided.

Arrangements regarding other services.

LO# 4

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Internal Auditors

LO# 5

3-6

The Audit Committee

Subcommittee

of the board of

directors

No specific

requirements

for privately

held companies

Section 301 of Sarbanes-Oxley Act requires the

following for audit committee members of

publicly held companies:

Member of board of directors and independent.

Directly responsible for overseeing work of any registered public accounting firm employed by the

company.

Must preapprove all audit and nonaudit services provided by its auditors.

Must establish procedures to follow for complaints.

Must have authority to engage independent counsel.

LO# 6

3-7

Planning the Audit When preparing the audit plan, the auditor should be guided

by the results of the client acceptance/continuance process,

procedures performed to gain an understanding of the entity,

and preliminary engagement activities.

Additional steps:

Assess business risks.

Establish materiality.

Consider multilocations.

Assess the need for specialists.

Assess the possibility of illegal acts.

Identify related parties.

Consider additional value-added services.

Lets look at each

of these steps.

LO# 7

3-8

Document Audit Strategy LO# 7

3-9

Types of Audit Tests

Risk Assessment

Procedures

Used to obtain an understanding of

the entity and its environment,

including its internal control.

Tests of Controls Directed toward the evaluation of the

effectiveness of the design and

operation of internal controls.

Substantive

Procedures

Detect material misstatements in a

transaction class, account balance,

and disclosure component of the

financial statements.

LO# 9

3-10

Materiality

The magnitude of an omission or misstatement of

accounting information that makes it probable that

the judgment of a reasonable person relying on

the information would be changed or influenced

by the omission or misstatement.

Materiality is not an absolute and

it is not a black or white issue!

The determination of materiality

requires professional judgment.

LO# 10

3-11

Steps in Applying Materiality

on an Audit

Step 1:

Determine a materiality level for the overall financial statements (planning materiality)

Step 2:

Determine tolerable misstatement (allocation of materiality at individual account/class of transactions level)

Step 3:

Evaluate auditing findings (near the end of the audit)

LO# 11

3-12

End of Chapter 3

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