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McGraw-Hill/Irwin © The McGraw-Hill Companies 2010
Audit Planning
and
Types of Audit Tests
Chapter Five
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The Phases of an Audit That Relate to Audit Planning
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Prospective Client Acceptance1. 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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Continuing Client Retention
Evaluate client retention periodically
Near audit completion or after a significant event
Conflicts over accounting & auditing
issuesDispute over fees
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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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The Engagement Letter
The engagement letter formalises 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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Those Charged with Governance
Board of Directors
Audit Committee
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Preliminary Engagement Activities
Determine the Audit Engagement Team
Requirements
Assess Compliance with Ethical Requirements,
including Independence
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Planning the Audit
• The auditor will develop an overall audit strategy for conducting the audit. This will help the auditor to determine what resources are needed to perform the engagement.
• An audit plan is more detailed than the audit strategy.
• Basically, the audit plan should consider how to conduct the engagement in an effective and efficient manner.
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Planning the AuditWhen preparing the audit plan, the auditor should be
guided by the results of the risk assessment procedures performed to gain an understanding of the entity.
Additional steps:
•Assess business risks and establish materiality.
• Assess the need for experts.
•Consider the possibility of non-compliance (illegal) acts.
•Identify related parties.
•Conduct preliminary analytical procedures.
•Consider additional value-added services.
Let’s look at each
of these steps.
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Assess Risks and Establish Materiality
Use audit risk model
Restrict risk at account
balance level
Achieve acceptable low 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.
Assess Risks
Establish Materiality
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Experts
A major consideration in planning the audit is the need for an auditor’s expert (ISA 620).
The use of an IT expert is a significant aspect
of most audit engagements.
The presence of complex information technology
may require the use of an IT expert.
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Non-Compliance (Illegal) Acts
Non-Compliance Acts
Direct & Material
Consider laws and regulations as part
of audit
Material & Indirect
Be aware may have occurred;
investigate if brought to attention
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Related PartiesSome 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.
How to Identify Related Parties
•Review minutes of meetings of boards and management.
•Review conflict of interest statements.
•Review records of the entity’s investments.
•Review contracts and agreements with key management or those charged with governance.
•Review significant contracts and agreements not in the entity’s ordinary course of business.
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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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Additional Value-Added Services
Tax PlanningTransaction
SupportIT-
consultancy
Internal reporting
BenchmarkingRisk
Assessment
Auditors are limited in the types of consulting services that they can offer
their audit clients.
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Document Overall Audit Strategy and Audit Plan
Auditors ensure they have addressed the risks they identified by documenting the linkage from the client’s
business, objectives, and strategy to the audit plan.
The auditor’s preliminary decision concerning control risk determines the level of control testing, which in
turn affects the auditor’s substantive tests of the account balances and transactions.
Document overall audit strategy and audit plan, which
involves documenting the decisions about
The auditor documents how the client is managing its risk (via internal
control processes) and the effects of the risks and controls on the planned
audit procedures. A
U
D
I
T
T
E
S
T
S
Nature
Timing
Extent
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Types of Audit Tests
Risk Assessment Procedures
Used to obtain an understanding of the entity and its environment,
including internal control.
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 element of the financial statements.
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Tests of Controls
Inquiry Inspection
Walk Through
Reperformance
Observation
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Substantive Procedures
Analytical Procedures
Obtains evidence about particular
assertions related to account balances or
classes of transactions
Tests of Details
Tests for errors or fraud in individual
transactions, account balances, and disclosures
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Dual Purpose Tests
Substantive Tests
Tests of Controls
Dual Purpose
Test
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Purposes of Analytical Procedures
Preliminary Analytical
Procedures
Used 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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Purposes of Analytical Procedures (See Table 5-5)
Trend Analysis
Ratio Analysis
Reasonableness
Analysis
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Substantive Analytical Procedures Decision Process
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Develop an Expectation
Auditing standards require the auditor to have an expectation whenever analytical procedures are used. An expectation can be developed using a variety of information sources such as:
• Financial and operating data.
• Budgets and forecasts.
• Industry publications.
• Competitor information.
• Management’s analyses.
• Analyst’s reports.
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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.
But the amount is always less than materiality!
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Compare and Investigate
Compare the expectation to the recorded amount and investigate any differences greater than the tolerable difference.
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The Investigation of Differences for Planning and Final Analytical Procedures
Preliminary Analytical
Procedures Differences
Corroborating evidence
is not required
Final Analytical
Procedures Differences
Corroborating evidence is required
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Example of Filling the Assurance Buckets for Each Assertion (Accounts Payable)
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Short-Term Liquidity Ratios
Current Ratio
Quick Ratio
Operating Cash Flow
Ratio
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Activity Ratios
Receivables Turnover
Days Outstanding in Accounts Receivable
Inventory Turnover
Days of Inventory on
Hand
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Profitability Ratios
Gross Profit Percentage Profit Margin
Return on Assets
Return on Equity
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Coverage Ratios
Debt to Equity
Times Interest Earned
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Audit of Group Financial Statements
Component of a Group
Entity or business activity in which financial
information is included in the group financial statements.
Component Auditor
An auditor who, at the request of the group engagement team, performs
work on financial information related to a
component for the group audit.
Auditing standards require the group engagement team to identify components that are
likely to be significant components.