Chapter 2 - Audit Planning CHAPTER 2 AUDIT PLANNING - INTRODUCTION AND RISK ASSESSMENT PROCEDURES TOPIC OVERVIEW: This chapter discusses the audit planning process, audit strategy and risk assessment procedures, LEARNING OBJECTIVES: After studying this chapter, you should be able to: Explain audit planning. Identify and explain the major audit planning activities. Identify considerations in establishing 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. DPW PLANNING AN AUDIT OF FINANCIAL STATEMENTS The primary objective of the auditor is to plan the audit so that the audit will be performed in an effective manner. However, adequate planning also leads to an efficient and timely audit engagement. The Role and Timing of Planning Planning an audit involves establishing the overall audit strategy for the engagement and developing an audit plan. Adequate planning benefits the audit of financial statements in several ways, including the following: * Appropriate attention is devoted to important areas © Potential problems are identified and resolved on a timely basis * Proper organization and management of the audit engagement leading to an effective and efficient performance * Work are properly assigned to appropriate engagement team members © Assistance in coordinating work done by other auditors and experts * Assistance in facilitating direction, supervision and review The nature and extent of planning activities will vary according to the: (SECTa) Size and complexity of the entity * Previous Experience with the entity of key engagement team members (partner, manager, and staff-in-charge) © Changes in circumstances that occur during the audit engagement 15 Scanned wth Camscannerindependent auditor ait panning coaster al raring oft appoineenn One ofthe audit PFO planning asa phase oF tHe Tan audit, but rather a continyy Planning is not @ GSC P gins shorty after (or in connection lag Fee rset and cotines url the ome completion of the compre aud engagement vies Major Audit Planning Ary all audit strateay that sets the The auditor shall establish 27 OE cat guides the development 6% The audio ean af the at ea ar ts ermining the need for exe ; are ntshing materiality and assessing risks ‘Aaessing the possibility of ion-compliance identifying related parties resorming preliminary analytical procedures evelopment of the overall audit strategy and detailed audit play Preparation of preliminary audit programs. ‘THE OVERALL AUDIT STRATEGY AND AUDIT PLAN Overall Audit Strategy . Inestablishing the overall audit strategy, the auditor shall: "Identify the characteristics of the engagement that define its scope; 2 Ascertain the reporting objectives of the engagement to plan the timing ofthe audit and the nature of the communications required; + Consider the factors that, in the auditor's professional judgment, a significant in directing the engagement team’s efforts «Consider the results of preliminary engagement activities and, whee practicable, whether knowledge gained on other engagemens performed by the engagement partner for the entity is relevant | ‘+ Ascertain the nature, timing and extent of resources necessary t perform the engagement Audit Plan After the overall audit strategy has been established, an audit plan can bt developed to address the various matters identified in the overall audt strategy, taking into account the need to achieve the audit object through the efficent use of the auditor's resources, = aul Plan is more detailed than the overall audit strategy in tit ft ty eee nature ting and eatent of auit procedures to be perform anaudtprogram, members. These procedures may be document Chapter 2 - Audit Planning ‘The audit program shall serve asa: + Set of instructions to assistants involved in the audit; and ‘+ Means to control and record the proper execution of the work, ‘The audit program also contains: ‘© The audit objectives for each area; and + Atime budget in which hours are bu for the various a Aime budget re budgeted for the uudit areas ‘Changes to Planning Decisions during the Course ofthe Audit ‘The overall audit plan and the audit program should be revised as necessary during the course of the audit. Planning is continuous throughout the engagement because of changes in conditions or unexpected results of audit procedures. Completion of Overall Strategy and Audit Plan ‘The establishment of the overall audit strategy and the detailed audit plan are not necessarily discrete or sequential processes, but are closely inter- related since changes in one may result in consequential changes to the other. 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: a. the overall audit strategy b. theaudit plan © any significant changes made during the aut engagement to the overall strategy or audit plan, and the reasons for such changes Additional Considerations in Initial Audit Engagements ‘After performing preliminary engagement activities, for an initial audit, the auditor may need to expand the planning activities because he/she does not ordinarily have the previous experience with the entity that is considered ‘when planning recurring engagements. For initial audits, additional matters the auditor may consider in developing the overall audit strategy and audit plan include the following: ‘© Arrangements to be made with the predecessor auditor to prior years’ working papers; «© Any major issues discussed with management in connection with the initial selection as auditors, the communication of these matters to those charged with governance and how these matters affect the ‘overall audit strategy and audit plan; +The planned audit procedures to obtain suficient appropriate audit evidence regarding opening balances; and + Other procedures required by the firm's system of quality control for ial audit engagements. cu) Scanned ith CamSeanner_ e er 2 - Audit Plannin cater? =A EWN SiON DIRECTION SUPERVISION ue, ining and extent oF ecg ‘The auditor Hho agement team members and review oftheir work” & supervision of — ping and ect of whe crecuon, and. SUperyiggg The nae eer and review of er WOH Vay depend engagement te fran factors including ote assessed risks of material . ‘size and complexity of the entity: 2 theare ofaudtsand J capabites and compe misstatement; sence of personnel performing the audit yoy, {ic to Smaller Entities Considersudit is carried out enttely by an audit engagement partner, yg Mray be a sle pracitioner, it may be desirable to consult with ob Jultably-experienced auditors or the auditor's professional body. Considerations Speci RISK ASSESSMENT PROCEDURES Identifying And Assessing The Risks Of Material Misstatement Through Understanding The Entity And Its Environment Its the objective ofthe auditor to identify and assess risks of mater misstatements, whether due to fraud or error, at the financial statement an assertion levels, through understanding the entity and its environme, including the ents Internal control, thereby providing a basis fr designing and implementing responses to the assessed risks of materi risstatements RISK ASSESSMENT PROCEDURES Fisk assessment procedures are audit procedures perforimed to obtain ks audit procedures performed to obtain sratnding of the entty and its environment, including the enti ntl, to identify and assess the risks of material misstatemett whether ithether due to fraud or error, atthe financial statement and assertit ‘The auditor shall Identify risks the throughout the proces of obtaining an understanding entity and its envi tothe riske and o%mMeNL including relevant controls that Fe ‘what can go wrong at the assertion evel : material mistate kS Pe of@ magnitude that could result ‘of the financial ‘statements; and @ Consider the i he i memento nd 18 mate Chapter 2 - Audit Planning ‘The risk assessment procedures shall include the following: ‘a. Inquiries of management, and of others within the entity who in the auditor's judgment may have information that is likely to as {identifying risks of material misstatement due to fraud or error; b, Analytical procedures; and Observation and inspection, Note: Risk assessment procedures by themselves, however, do not provide sufficient appropriate audit evidence on which to base the audit opinion. Analytical Procedures during Planning Stage ‘Analytical procedures consist of evaluations of financial information made bya study of plausible relationships among both financial and non-financial data. Analytical procedures also encompass the investigation of identified 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. It is designed to assist the auditor in planning the nature, timing and extent of other auditing procedures. ‘The Required Understanding of the Entity and its Environment ‘The auditor shall obtain an understanding ofthe followit ‘a, Relevant industry, regulatory, and other external factors including the applicable financial reporting framework; b. The nature of the entity, 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 itis financed; c Entity’s selection and application of accounting policies, including reasons for changes theret . Entity’s objectives and strategies, and those related business risks that may result in risk of material misstatement; fe. The measurement and review of the entity's financial performance; and £ Internal contro! ASSESSMENT OF AUDIT RISK AND MATERIALITY Materiality and audit risk affect the application of PSA, and are reflected in the auditors report. The auditor must make judgments about materiality land audit risk in determining the nature, timing and extent of procedures to apply and in evaluating the results. Materiality Information is matertal i its omission or misstatement could influence the ‘economic decisions of users taken on the basis of the financial statements, 19 ‘Seanna with Camseanreree Chapter 2 ~ Audit Plannin Materalty depends on the sizeof he tem or - ‘error judged inthe part circumstances of its omission or misstatement. : "3 ‘The concept of materiality recognizes that some matters, but not all, are important for fair presentation of the financial statements in conformity with PFRS. ‘The auditor should consider materiality and its relationship with audit risk when conducting an audit, The auditor's purpose in considering materiality at the planning stage of the audit is to determine the appropriate scope of their audit procedures. Using professional judgment, the auditor shall determine materiality at © Financial statement level - the smallest aggregate amount of misstatement applicable to all nancial statements, ‘= Assertion level for classes of transaction, account balances and disclosures - largest tolerable misstatement. Audit Risk ‘Audit Risk is the risk that the auditor gives an inappropriate audit opinion when the financial statements are materially misstated. Components of Audit risk ‘a. Risk of material misstatement + Inherent Risk is the susceptibility of an account balance or class ‘of transactions to misstatement that could be material, individually or when aggregated with misstatements in other balances or classes, assuming that there were no related controls. «Control Risk is the risk that a misstatement, that could occur in an account balance or class of transactions that could be materia, individually or when aggregated with misstatements in other balances or classes, will not_be prevented or detected _and systems. b. Risk of not Detecting the Misstatement «Detection Risk is the risk that the auditor's substantive procedures will at exists inal lance or class of tr that could be material individually or when aggregated with misstatements In other balances or classes. If the auditor wishes to reduce detection risk, procedures tM performed shall be 2. As tonature ~ more effective procedures 'b. Asto timing ~ closer or nearer to year-end c._Astoextent ~larger sample size 20 chapter 2 ~ Audit Plannin Interrelationship of the Components of Audit Risk ‘Auditor's Assessment of control risk is High Medium | _Low ‘Auditor's High Lowest Lower ‘Medium assessment ofinherentrisk | Medium | Lower Medium Higher Low | Medium ‘Higher. Highest Relationships of Risk and Materiality to substantive procedures Risk of material misstatement (inherent and control risks Direct Risk of not detecting the misstatement (detection risk) Inverse ‘Materiality Inverse Summary of Procedures Performed in Planning an Audit ‘Obtain an understanding of the entity's environment q Consider Materiality and ‘Assess Risk of Material Misstatements a Determine the acceptable level of Audit Risk t Identify Detection Risk to determine the nature, timing and extent of further audit procedures 2 ‘canna with CamseanrerCHAPTER 2: REVIEW QUESTIONS THEORETICAL SARTERZ REVIEW QUESTIONS THEORETICAL a > ” It involves estab developing an level, a. Reporting ling the overall audit strategy for the engagement ang lan in order to reduce audit risk to an acceptably low b. Planning ¢ Field work —d. Organizing + Adequate planning of the audit work helps the auditor of accomplishing the following objectives, except: a. Ensuring that appropriate attention is devoted to important areas of the audi /ing the areas that need a service of an expert. c. Gathering of all corroborating a d. The audit work is completed efficiently. Which of the f Statement 1 performed in an eff Statement 2: The auditor should develop and document plan describing the scope and conduct ‘a. Only statement 1 is corre b. Only statement 2s correct Which of the following activities should be performed by the beginning of the current audit engagement? Perform procedures regarding the continuance of the client relationship and the specific audit engagement. 1e requirements of the Code of Ethies for tatements is/are correct? the audit work so that the Ibe a land Il Which of the prior to starting gz 3 3 3 and the specific audit engagement. I. Communicate with the previous auditor, where there has been a change of auditors, in compliance with relevant ethical requirements. 1d. Neither I nor Il a. lonly b. Honly ¢. Both Which of the following statements is incorrect? uta a The auditor should plan the audit so that the engagement wil performed in an effective manne1 b. Planning an audit involves establishing the overall the engagement and developing the audit plan. in or risk to an acceptably low level. 1 aucit states 1% der to reduce audit rT 7. The auditor should plan the audit work so that the audi Planning involves the engagement partner and other key members of the engagement team to benefit from their experience and insight and toenhance the effectiveness and efficiency ofthe planning process 4. Planning is not a discrete phase of an audit, but rather a continual and iterative process that often begins shorty after (or in connection with) the completion ofthe previous audit and continues unt of the audit program. 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 & Theassessed level of control risk. d._ Size of the audi Which of the lowing statements is/are correct? {Obtaining knowledge of the entity business is an important planning the audit work. Statement 2: The auditor's the identification of events, material effect on the financl ledge of the entity's business assists in wsactions and practices which may have a statements. «. Both statements are correct 4d. Both statements are incorrect, Only statement 1 is correct b. Only statement 2is correct The auditors plan should A B c D Succeed action Yes Yes No No Be flexible Yes Yes. =—Yes.—SYes Be cost-beneficial Yes No Yes Yes. |. Which of the following statements is/are correct? Statement 1: The overall audit plan and the audit program should not be revised during the course of the audit. Statement 2: The auditor should develop and document an audit program setting out the nature, timing and extent of planned audit procedures required to implement the overall audit plan. Only statement 1 is correct b. Only statement 2 is correct ©. Both statements are correct 4. Both statements are incorrect Which of the following statements is/are correct? Statement 1: According to PSA 300, the auditor may discuss elements planning with those charge with governance andthe eathy's meres ae Statement 2: The audit plan sets the scope, timis ,e. timing and direction o! audit guides the development of the more detailed overall audit strategy 23 ‘Scanned with CanScanner> Statement 3: The overall audit strategy is more detailed than the augit plan and includes the nature, timing and extent of audit procedures to be Performed engagement team members to obtain sufficient appropriate audit evidence to reduce audit risk to an acceptably low level. ¢. All statements are correct, a. Only 1 statementis correct d. All statements are incorrect b. Only 2 statements are correct lanning the audit engagement, the auditor should consider each of the lowing except a. The kind of opinion (unqualified, qualified, or adverse) that i likely to be expressed, b. Matters relating to the en! ing policies and procedures. level and audit risk. 1g is least likely considered by the CPA when he makes 3. Which of the fol an overall audit plan? ‘The nature and timing of reports and other communication with the ‘are expected under the engagement ion of complex accounting areas including those involving accounting estimates The effect of information technology on the audit d. The content of the representation letters . Which of the following matters should be considered by the auditor in developing the overall audit strategy? a. Important characteristics of the entity, Its business, its financial performance and its reporting requirements including changes since the date ofthe prior audit b. Conditions requiring special attention, such as the existence of the related parties The setting of materiality level for audit purposes 4. Allofthe above . In developing the overall audit strategy, the focus of the engagement team's efforts is considered. Which of the following is not appropriately classified asa factor affecting the focus of the team’s efforts? a. 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. ‘Audit areas where there is a higher risk of material misstatement. Volume of transactions, which may determine whether it is more efficient for the auditor to rely on internal control. Chapter 2 - Audit Planning 16, With respect to planning an audit, which of the following statements is 17. 18. 19. 20. 21. always true? "An inventory count must be observed at year-end. b. Anengagement should not be accepted after the client's year-end. Final staffing decisions must be made prior to completion of the ing stage. acceptable to perform a portion of the audit of a continuing client atinterim dates. Im planning stage of an audit engagement, the auditor is required to perform audit procedures to obtain an understanding of the entity and its Environment, including its internal control. These procedures are called a, Substantive tests ¢. Test of controls b. Riskassessment pracedures _d, Dual-purpose tests “Analytical procedures used in planning an audit should focus on identifying: ‘a. Material weaknesses in the internal control system b. The pre ‘of financial data frot fidual transactions The various assertions that are embodied in the d._ Areas that may represent specific risks relevant to the audit Analytical procedures are required: AB Cc D | Asa risk assessment procedure Yes Yes Yes Yes performed dui = As a substantive test procedure during Yes Yes No No evidence review at audit completion No Yes No Yes ‘The objective of performing analytical procedures in planning an audit engagement is to identify the existence of: a. Related party transactions b. Unusual transactions and events © Recorded transactions that were not properly authorized @. legal acts that went undetected because of internal control weaknesses Which of the following procedures would an auditor most likely perform in planning an audit of financial statements? a. Inquiring of the client's legal counsel concerning pending b. Comparing the financial statements to anticipated result Examining computer generated exception reports to ver effectiveness of internal controls. ane Searching for unauthorized transactions that may aid i unrecorded li eens igation. e 25 Scanned wth CamscannerChapter 2 - Audit Planning 22, 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. 23, 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 servi a. Audit procedures b. Audit plan , Audit program d. Audit risk model Each account balance will be tested under either tests of controls or tests of transactions. 25. In designing audit programs, an auditor should establish specific audit objectives that related primarily to the a. Selected audit techniques ¢. Financial statement assertions b. Timing ofaudit procedures _d, Cost-benefit gathering evidence 26. 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. r may use standard audit programs or audi , but such programs and checklists need to be particular client. c Theauditor’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 th? size and complexity of the entity, materiality, the extent of other documentation, and the circumstances ofthe specific engagement. completion lored to the 27, Audit procedures may be classified as risk assessment procedures and further audit procedures. Which of the following best describes risk assessment procedures? a. These procedures are used detect material misstatements at assertion level. b. These procedures include tests of details of classes of transaction account balances, and disclosures and analytical procedures. > chat 28. 29. 30. 31 32, jpter 2 - Audit Planning c. These procedures test the oper preventing, or detecting and correcting, material misstatemen assertion level 4. These are procedures for obtaining an understanding of the entity and its environment, including its internal control, to assess the risks of material misstatement at the financial statement and assertion levels. ing effectiveness of controls in ts at the ‘The audit program should contain the following, except: a bb. Set of planned audit procedures Time budget for the various audit areas d. The combined assessed level of inherent and control risk Which of the following procedures is not performed as a part of planning an audit engagement? ‘a. Reviewing working papers of the prior year d._ Test of controls 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 bb. Tests of transactions ‘Which ofthe following procedures would an auditor least likely perform in planning a financial statement audit? 2. Coordinating the assistance of entity personnel in data preparation. ‘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 4. Reading the current year’s interim financial statements. Analytical procedures 4d. Tests of controls ‘Audit risk has three components: inherent risk, control risk and detection risk. Which of the following statements is correct? a. Detection risk is a 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. Therisk that material misstatement will not prevent or detected on a timely basis by internal control can be reduced to a zero by effective controls. 4. The existing levels of inherent risk, control risk and detection risk can bbe changed at the discretion of the auditor. Py] Seamed wth Camscaner33. Some accounts balances, such as those for retirement benefits and fina lease, are the results of complex calculations. The susceptibility to mater misstatements in these types of accounts is referred to as srl c, Control risk 4. nherent risk 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 isnot. 35, There is an inverse relationship that exist between the acceptable level of detection risk and the a. Riskof falling to discover material misstatement inary judgments about materiality levels © ince provided by substantive tests ._ Risk of misapplying audit process 36. 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. c. Materiality judgments are made in light of surrounding circumstanced and necessarily involve both quantitative and qualitative judgments 4. An auditor's consideration of materiality is influenced by the auditor’ perception of the needs of a reasonable person who will rely on the financial statements. 37, In considering materiality for planning purposes, Ash, auditor believes that misstatements aggregating P60,000 would have material effect on & entity's income statement, but that misstatements would have to 2g6rei b. Detection risk 34, $40/000 to materially affect the balance sheet. Ordinarily, it would Ne appropriate to design auditing procedures that would be expected to detect ‘misstatements that aggregate a. 40,000 . P50,000 —«. P60,000-—d. P100,000 438, Which ofthe following would an auditor most likely use in determining the auditor's preliminary judgment about materiality? gue e anticipated sample size ofthe planned substantive tests: b. The entity’s annualized interim financial statements C._ The results ofthe internal control questionnaire. §. The contents of the management representation letter. 39. 40. ‘Which of the following statements is/are correct? egmrent 1: Supervision involves developing an overall strategy for the expected conduct and scope of the audit. Statement 2: Planning involves directing the efforts of assistants who are involved in accomplishing the objectives of the audit and determining whether those objectives were accomplished. c. Both statements are correct d. Both statements are incorrect in performing an audit of financial statements, the auditor should obtain a sufficient knowledge of a client's business and industry to a Develop an attitude of professional skepticism concerning ‘management's financial statement assertions. bb, Make constructive suggestions concerning improvements to the client's internal contro. Evaluate whether the aggregation of known misstatements causes the financial statements taken as a whole to be materially misstated. 4. Understand the events and transactions that may have an effect on the client's financial statements, ‘a. Only statement 1 is correct b. Only statement 2 is correct 29 Seamed wth Camscaner