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REO CPA REVIEW AUDIT PLANNING

RAYMUND FRANCIS A ESCALA CPA, MBA
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AUDIT PLANNING
RAYMUND FRANCIS A. ESCALA, CPA. MBA

PLANNING AN AUDIT OF FINANCIAL STATEMENTS

PSA 300 provides that the objective of the auditor is to plan the audit so that it will be performe.d in an effective manner.

1. Roles of planning
Adequate planning benefits the audit of financial statements in several ways, including the following:
Helping the auditor to devote appropriate attention to important areas of the audit
Helping the auditor identify and resolve potential problems on a timely basis
Helping the auditor properly organize and manage the audit engagement so that it is performed in an effective
and efficient manner
*r• Assisting in the selection of engagement team members with appropriate levels of capabilities and competence to
respond to anticipated risks, and the proper assignment of work to them
Facilitating the direction and supervision of engagement team members and the review of their work
Assisting, where applicable, in coordination of work done by auditors of components and experts

2. Factors affecting the nature and extent of planning activities

The nature and extent of planning activities will vary according to the
a. Size and complexity of the entity
b. The key engagement team members' previous experience with the entity
c. Changes in circumstances that occur during the audit engagement.
d. Timing of the appointment of the independent auditor.

3. Planning as a phase of and audit

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 completion of the current audit
engagement.

4. Outputs of Audit Planning

Planning an audit involves establishing the overall audit strategy for the engagement and developing an audit
plan. With this, the following are the main outputs of audit planning:
a. Overall audit strategy which sets the scope, timing and direction of the audit, and that guides the development
of the audit plan.
b. Audit plan which shall include a description of
the nature, timing and extent of the following audit procedures
planned risk assessment procedures
further audit procedures at the assertion level
ii. other planned audit procedures that are required to be carried out so that the engagement complies with
PSAs.
Moreover, the auditor shall update and change the overall audit strategy and the audit plan as necessary during the
course of the audit.

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AUDIT PLANNING

5. Documentation
The auditor shall document:
a The overall audit strategy;
b. The audit plan; and
C. Any significant changes made during the audit engag ement to the overall audit strategy or the audit plan, and the
reasons for such changes.

MAJOR AUDIT PLANNING ACTIVITIES

A. IDENTIFYING AND ASSESSING RISK OF MATERIAL MISSTATEMENTS THROUGH UNDERSTANDING THE
ENTITY AND ITS ENVIRONMENT
To establish an overall audit strategy. which guides the development of the audit plan, the auditor needs to perform
procedures which will enable him or her to (1) obtain an understanding of the entity and its environment; and (2)
identify and assess risk of material misstatements. These procedures are known as risk assessment procedures
(RAPs).

Risk assessment procedures

Definition
As defined in PSA 315. risk assessment procedures are audit procedures performed to obtain an understanding of the
entity and its environment, including the entity's internal control. to identify and assess the risks of material
misstatement. whether due to fraud or error, at the financial statement and assertion levels.
Identifying and assessment of risk of material misstatement
Objective of the auditor
The objective of the auditor is to identify and assess the risks of material misstatement, whether due to fraud or error.
at the financial statement and assertion levels thereby providing a basis for designing and implementing responses to
the assessed risks of material misstatement.
Identification and assessment
Risks of material misstatement are assessed at the assertion level in order to determine the nature, timing and extent
of further audit procedures necessary to obtain sufficient appropriate audit evidence. For the identified risks of
material misstatement at the assertion level, a separate assessment of inherent risk and control risk is required.
Risks of material misstatement identified and assessed by the auditor include both those due to error and those due
to fraud.
The auditor's risk identification and assessment process is iterative and dynamic. The auditor's understanding of the
entity and its environment, the applicable financial reporting framework, and the entity's system of internal control are
interdependent with concepts within the requirements to identify and assess the risks of material misstatement. In
obtaining the understanding, initial expectations of risks may be developed, which may be further refined as the
auditor progresses through the risk identification and assessment process.
In addition, the auditor is required to revise the risk assessments, and modify further overall responses and further
audit procedures. based on audit evidence obtained from performing further audit procedures or if new information is
obtained.
The auditor is required to design and implement overall responses to address the assessed risks of material
misstatement at the financial statement level. The auditor's assessment of the risks of material misstatement at the
financial statement level, and the auditor's overall responses, is affected by the auditor's understanding of the control
environment Also, thc auditor is required to design and perform further audit procedures whose nature, timing and
extent are based on and are responsive to the assessed risks of material misstatement at the assertion level.
Components of risk of material misstatement
Risks at the financial statement level relate pervasively to the financial statements as a whole and potentially affect
many assertions. Risks of material misstatement at th e assertion level consist of two components, inherent and
control risk:

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Inherent risk is described as the susceptibility of an assertion about a class of transaction, account balance or
disclosure to a misstatement that could be material, either individually or when aggregated with other
misstatements, before consideration of any related controls.
Inherent risk is higher for some assertions and related classes of transactions, account balances and disclosures
than for others. The degree to which inherent risk varies is referred to as the 'spectrum of inherent risk.'
Control risk is described as the risk that a misstatement that could occur in an assertion about a class of
transaction, account balance or disclosure and that could be material, either individually or when aggregated with
other misstatements, will not be prevented, or detected and corrected, on a timely basis by the entity's system of
internal control.

AUDIT PROCEDURES
1. Obtain an understanding of the entity and its environment, including its internal control
Risk Assessment Procedures and Related Activities
The auditor shall design and perform risk assessment procedures to obtain audit evidence that provides an
appropriate basis for:
a. The identification and assessment of risks of material misstatement, whether due to fraud or error, at the
financial statement and assertion levels: and
b. The design of further audit procedures.
Professional skepticism
Professional skepticism is necessary for the critical assessment of audit evidence gathered when performing the
risk assessment procedures, and assists the auditor in remaining alert to audit evidence that is not biased
towards corroborating the existence of risks or that may be contradictory to the existence of risks.
Professional skepticism is an attitude that is applied by the auditor when making professional judgments that then
provides the basis for the auditor's actions. The auditor applies professional judgment in determining when the
auditor has audit evidence that provides an appropriate basis for risk assessment.
The application of professional skepticism by the auditor may include:
• Questioning contradictory information and the reliability of documents:
• Considering responses to inquiries and other information obtained from management and those charged with
governance:
• Being alert to conditions that may indicate possible misstatement due to fraud or error: and
• Considering whether audit evidence obtained supports the auditor's identification and assessment of the risks
of material misstatement in light of the entity's nature and circumstances.
Obtaining Audit Evidence in an Unbiased Manner Is Important
The auditor shall design and perform risk assessment procedures in a manner that is not biased towards
obtaining audit evidence that may be corroborative or towards excluding audit evidence that may be contradictory.
Designing and performing risk assessment procedures to obtain audit evidence to support the identification and
assessment of the risks of material misstatement in an unbiased manner may assist the auditor in identifying
potentially contradictory information, which may assist the auditor in exercising professional skepticism in
identifying and assessing the risks of material misstatement.
Sources of Audit Evidence
Designing and performing risk assessment procedures to obtain audit evidence in an unbiased manner may
involve obtaining evidence from multiple sources within and outside the entity. However, the auditor is not
required to perform an exhaustive search to identify all possible sources of audit evidence. In addition to
information from other sources. sources of information for risk assessment procedures may include:
✓ Interactions with management, those charged with governance, and other key entity personnel, such as
internal auditors.
• Certain external parties such as regulators, whether obtained directly or indirectly.

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• Publicly available information about the entity. for example entity-issued press releases, materials for analysts
or investor group meetings. analysts' reports or information about trading activity.
Regardless of the source of information, the auditor considers the relevance and reliability of the information to be
used as audit evidence.
Scala bility
The nature and extent of risk assessment procedures will vary based on the nature and circumstances of the
entity (e.g.. the formality of the entity's policies and procedures, and processes and systems). The auditor uses
professional judgment to determine the nature and extent of the risk assessment procedures to be performed to
meet the requirements of the standards.
Although the extent to which an entity's policies and procedures. and processes and systems are formalized may
vary, the auditor is still required to obtain the understanding.
The nature and extent of risk assessment procedures to be performed the first time an engagement is undertaken
may be more extensive than procedures for a recurring engagement. In subsequent periods, the auditor may
focus on changes that have occurred since the preced ing period.
Specific procedures
a. Inquiry
Inquiries during planning stage
Much of the information obtained by the auditor's inquiries is obtained from management and those
responsible for financial reporting. However. the auditor may also obtain information, or a different
perspective in identifying risks of material misstatE r-rient, through inquiries of others within the entity and other
employees with different levels of authority. For e):ample:
• those charged with governance
• internal audit personnel
• employees involved in initiating, processing or recording complex or unusual transactions
• in-house legal counsel
• marketing or sales personnel
b. Observation
Auditor aims to obtain an understanding of the ent.ity thru observation of entity's:
• processes used in processing information to b e reported: and
• activities and operations.
c. Inspection
Inspection during planning stage
The auditor can obtain an understanding of the entity through the following inspection activities during
planning:
• Review of prior year's working papers and pric)r year's financial statements
• Review of reports prepared by the entity's management (such as quarterly management reports and
interim financial statements) and those charged with governance (such as minutes of board of directors'
meetings)
• Review of documents (such as business plan: and strategies), records, and internal control manuals
• Reading articles, books, periodicals, and other publications related to the entity's industry
• Visits to the entity's premises and plant facilitil
d. Analytical procedures
A basic premise underlying the application of analytical procedures is that plausible relationships among data
may reasonably be expected to exist and continue in the absence of known conditions to the contrary.

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Uses of analytical procedures

Below is a summary of chases where analytical crocedures may be acelied.
Phase Objective Required?
Planning • To enhance the understanding of the business
• To identify areas that may represent specific risks relevant to the audit
• To determine the nature, timing and extent of FAPs
Substantive • To evaluate the reasonableness of financial information
tests • To obtain corroborative evidence relating to a particular assertion
• To detect material misstatement
Overall • To identify unusual or unexpected account balances that were not previously
review identified in planning and substantive testing
• To assist in determining whether or not the auditor has the ability to issue the
report
Analytical procedures during planning stage
Analytical procedures may help identify the existence of unusual transactions or events, and amounts, ratios,
and trends that might indicate matters that have audit implications. Unusual or unexpected relationships that
are identified may assist the auditor in identifying risks of material misstatement, especially risks of material
misstatement due to fraud.
Procedures when applying analytical procedures
1. Develop expectations regarding financial statements using (PAA RIN)
• Prior year's financial statements
si Annualized interim financial statements
• Anticipated results such as budgets, forecasts or projections
• Typical Relationships among financial statements account balances
• Industry averages
• Non-financial information
2. Compare expectations with the items presented in the financial statements
3. Define and investigate significant differences
Information from Other Sources
In obtaining audit evidence, the auditor shall consider information from:
a) The auditor's procedures regarding acceptance or continuance of the client relationship or the audit
engagement; and
b) When applicable, other engagements performed by the engagement partner for the entity.
When the auditor intends to use information obtained from the auditor's previous experience with the entity and
from audit procedures performed in previous audits, the auditor shall evaluate whether such information remains
relevant and reliable as audit evidence for the current audit.
Engagement Team Discussion
The engagement partner and other key engagement team members shall discuss the application of the applicable
financial reporting framework and the susceptibility of the entity's financial statements to material misstatement.
When there are engagement team members not involved in the engagement team discussion, the engagement
partner shall determine which matters are to be communicated to those members.

2. Consider materiality
Definition
Information is material if its omission or misstatement could influence the economic decisions of users taken on
the basis of the financial statements. Materiality depends on the size of the item or error judged in the particular
circumstances of its omission or misstatement.

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The concept of materiality recognizes that some mat.ters. but not all, are important for fair presentation of the
financial statements in conformity with PFRS.
Materiality in the Context of an Audit
Materiality generally explains that:
Misstatements, including omissions, are consider,ed to be material if they, individually or in the aggregate,
could reasonably be expected to influence the economic decisions of users taken on the basis of the
financial statements;
Judgments about materiality are made in light of siJrrounding circumstances, and are affected by the size or
nature of a misstatement, or a combination of t loth: and
Judgments about matters that are material to useri3 of the financial statements are based on a consideration
of the common financial information needs of isers as a group. The possible effect of misstatements on
specific individual users, whose needs may vary wi1dely, is not considered.
Uses of materiality
Accordingly, materiality should be considered by the al.iditor in the following phases:
a. Planning phase
• To identify and assess the risks of material MiEistatement,
• To determine the nature, timing and extent of flurther audit procedures
b. Completion phase
✓ To evaluate the effect of uncorrected misstaterrents, if any, on the financial statements and in forming the
opinion in the auditor's report
Determination of materiality
The auditor's determination of materiality is a matter ()f professional judgment. and is affected by the auditor's
perception of the financial information needs of users ,f the financial statements.
Using professional judgment, auditor is required to det(?rmine the following three different levels of materiality.
A Materiality for the financial statements as a whc)le
D the materiality determined at the overall financi al statement level
D represented by the smallest aggregate amount: of misstatement applicable to all financial statements
> it helps the auditor determine whether the prop osed audit adjustments are significant or not
> if the audit adjustments exceed this level, the eiuditor may need to adjust the financial statements
B. Materiality applied to specific classes of transactions, account balance or disclosures
is the amount set by the auditor for particular classes of transactions, account balances or disclosures for
which misstatements,
though lower than overall materiality, it could reasonably be expected to influence the economic decisions
of users of the financial statements
In determining the specific materiality, the auditor normally considers the following factors:
• laws and regulations (e.g. related party transac;tions)
• financial reporting framework
• key industry disclosures of the entity
si particular aspects of the entity's business
si understanding of the view of those charged wit h governance and management
C. Performance materiality
▪ the amount or amounts set by the auditor at le ss than materiality for the financial statements, as a whole,
to reduce to an appropriately low level the prc)bability that the aggregate of uncorrected and undetected
misstatements exceeds materiality for the finar)ciaI statements as a whole
also refers to the amount or amounts set by the auditor at less than the materiality level or levels for
particular classes of transactions, account baleinces, or disclosures
calculated as a certain percentage of o‘,'era!' materiality in order to capture any uncorrected
misstatements, the total amount of which may exceed overall materiality

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used in scoping of financial statement line items to be tested by the auditor and ensures that significant
accounts in the financial statements are covered by audit testing
In determining performance materiality, an understanding of the following factors may affect the auditor's
judgment such as.
✓ nature of the entity's business and transactions
• risk assessment procedures
• nature and extent of misstatements identified in previous audits

AUDIT RISK
Definition
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
Risk of material misstatement is the possibility that material misstatements exist on the financial statements
prepared and presented by the entity. Items contributing to this -risk include inherent risk and control risk (see
definitions above).
Risk of not Detecting the Misstatement (more popularly known as detection risk)
• Detection Risk is the risk that the auditor's substantive procedures will not detect a misstatement that
exists in an account balance or class of transactions that could be material, individually or when
aggregated with misstatements in other balances or classes.
These components may be expressed in a formula which shows how they will comprise the audit risk:
AUDIT RISK = Risk of material misstatement x Risk of non-detection
OR
AUDIT RISK = Inherent risk x Control risk x Detection risk

3. Identifying and Assessing the Risks of Material Misstatement

Using the understanding of the entity and its environment, including its internal control, obtained by the auditor.
the auditor identifies and assesses risk of material misstatement at
✓ financial statements level: and
✓ assertion level for classes of transactions, account balances, and disclosures.
Effects of assessment to auditor's procedures
Since the objective of the auditor when auditing financial statements is to provide reasonable assurance that the
financial statements are free from material misstatements. a higher risk of material misstatements will require
the auditor to perform more effective and extensive audit procedures.

INHERENT RISK ASSESSMENT PROCESS

A. Understand the entity and its environment and the applicable financial reporting framework.
The auditor's understanding of the entity and its environment, and the applicable financial reporting
framework, assists the auditor in understanding the events and conditions that are relevant to the entity, and
in identifying how inherent risk factors affect the susceptibility of assertions to misstatement in the preparation
of the financial statements, in accordance with the applicable financial reporting framework, and the degree to
which they do so. Such information establishes a frame of reference within which the auditor identifies and
assesses risks of material misstatement.
The auditor's understanding of the entity and its environment, and the applicable financial reporting
framework, also informs how the auditor plans and performs further audit procedures, for example, when:
✓ Developing expectations for use when performing analytical procedures:
✓ Designing and performing further audit procedures to obtain sufficient appropriate audit evidence: and

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✓ Evaluating the sufficiency and appropriateness of audit evidence obtained (e.g., relating to assumptions
or management's oral and written representati ons)
The auditor shall perform risk assessment procedures to obtain an understanding of:
a. The following aspects of the entity and its environment:
i. The entity's organizational structure, ownership and governance, and its business model, including
the extent to which the business model integrates the use of IT;
ii. Industry, regulatory and other external factors; and
iii. The measures used, internally and externally, to assess the entity's financial performance;
The applicable financial reporting framework, and the entity's accounting policies and the reasons for any
changes thereto; and
c. How inherent risk factors affect susceptibility of assertions to misstatement and the degree to which they
do so, in the preparation of the financial statements in accordance with the applicable financial reporting
framework, based on the understanding obtained in (a) and (b).
The auditor shall evaluate whether the entity's a ccounting policies are appropriate and consistent with the
applicable financial reporting framework.
Scalability
The nature and extent of the required understanding is a matter of the auditor's professional judgment and
varies from entity to entity based on the nature and circumstances of the entity, including:
✓ The size and complexity of the entity, including its IT environment:
✓ The auditor's previous experience with the entity:
✓ The nature of the entity's systems and processes, including whether they are formalized or not: and
✓ The nature and form of the entity's documentation.
The auditor's risk assessment procedures to obtain the required understanding may be less extensive in
audits of less complex entities and more extensive for entities that are more complex. The depth of the
understanding that is required by the auditor is expected.to ie less than that possessed by management in
managing the entity.
Some financial reporting frameworks allow smaller entities to provide simpler and less detailed disclosures in
the financial statements. However, this does not relieve the auditor of the responsibility to obtain an
understanding of the entity and its environment and the applicable financial reporting framework as it applies
to the entity.
The entity's use of IT and the nature and exte nt of changes in the IT environment may also affect the
specialized skills that are needed to assist with ob taming the required understanding.

B. Identify significant classes of transactions, account balances, and disclosures; relevant assertions
The auditor shall determine the relevant assertions and the related significant classes of transactions, account
balances and disclosures.
Significant class of transactions, account balance or disclosure is a class of transactions, account
balance or disclosure for which there is one or more relevant assertions. On the other hand, relevant
assertion is an assertion about a class of transactions, account balance or disclosure is relevant when it has
an identified risk of 'material misstatement The determination of whether an assertion is a relevant assertion
is made before consideration of any related controls (i.e., the inherent risk).
Identified risk of material misstatement
a. Assessing risks of material misstatement at the financial statement level
For identified risks of material misstatement 3t the financial statement level the auditor shall assess the
risks and:
i. Determine whether such risks affect the a!ssessment of risks at the assertion level: and
ii. Evaluate the nature and extent of their pelevasive effect on the financial statements.

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b. Assessing risks of material misstatement at the assertion level
RAYMUND FRANCIS A. ESCALA, CPA, MBA
AUDIT PLANNING

Assessing Inherent Risk

For identified risks of material misstatement 3t the assertion level, the auditor shall assess inherent risk by •
assessing the likelihood and magnitude of nlisstatement. In doing so, the auditor shall take into account
how, and the degree to which:
i. Inherent risk factors affect the susceptibi lity of relevant assertions to misstatement: and
ii. The risks of material misstatement at thie financial statement level affect the assessment of inherent
risk for risks of material misstatement at 'the assertion level
Likelihood and magnitude of misstatement
The auditor assesses the likelihood and rm'3gnitude of misstatement for identified risks of material
misstatement because the significance of the cc)mbination of the likelihood of a misstatement occurring and
the magnitude of the potential misstatement w'ere the misstatement to occur determines where on the
spectrum of inherent risk the identified risk iE; assessed, which informs the auditor's design of further
audit procedures to address the risk
Assessing the inherent risk of identified risks of material misstatement also assists the auditor in determining
significant risks. The auditor determines significant risks because specific responses to significant risks are
required in accordance with the standards.
Inherent risk factors
Inherent risk factors pertain to characteristics of events or conditions that affect susceptibility to misstatement.
whether due to fraud or error, of an assertion about a class of transactions, account balance or disclosure.
before consideration of controls.
Such factors may be qualitative or quantitative. a nd include
• Complexity
• Subjectivity
• Change
• Uncertainty
• Susceptibility to misstatement due to management bias or other fraud risk factors insofar as they affect
inherent risk
Inherent risk factors influence the auditor's ass€ ssment of the likelihood and magnitude of misstatement for
the identified risks of material misstatement at th,e assertion level. The greater the degree to which a class of
transactions, account balance or disclosure is susceptible to material misstatement, the higher the inherent
risk assessment is likely to be. Considering the degree to which inherent risk factors affect the susceptibility of
an assertion to misstatement assists the auditor in appropriately assessing inherent risk for risks of material
misstatement at the assertion level and in designing a more precise response to such a risk.

C Spectrum of inherent risk

The degree to which inherent risk varies, is referred to as the "spectrum of inherent risk" — consider likelihood
and magnitude of material misstatement to determine whether where on the spectrum the risk lies.
In assessing inherent risk, the auditor uses professional judgment in determining the significance of the
combination of the likelihood and magnitude of a misstatement.
The auditor uses the significance of the combination of the likelihood and magnitude of a possible
misstatement in determining where on the spectrum of inherent risk (i.e., the range) inherent risk is assessed.
The higher the combination of likelihood and magnitude, the higher the assessment of inherent risk: the lower
the combination of likelihood and magnitude. the lower the assessment of inherent risk.

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AUDIT PLANNING

The assessed inherent risk relating to a particular risk of material misstatement at the assertion level
represents a judgment within a range, from lower to higher. on the spectrum of inherent risk. The judgment
about where in the range inherent risk is assessed. may vary based on the nature, size and complexity of the
entity, and takes into account the assessed likelihood and magnitude of the misstatement and inherent risk
factors.
For a risk to be assessed as higher on the spectrum of inherent risk, it does not mean that both the magnitude
and likelihood need to be assessed as high. Ratller, it is the intersection of the magnitude and likelihood of
the material misstatement on the spectrum of inh( rent risk that will determine whether the assessed inherent
risk is higher or lower on the spectrum of inherent risk. A higher inherent risk assessment may also arise from
different combinations of likelihood and magnitude, for example a higher inherent risk assessment could
result from a lower likelihood but a very high magr

D Identify significant risks

The auditor shall determine whether any of the assessed risks of material misstatement are significant risks.
Significant risk refers to an identified risk of material misstatement:
i. For which the assessment of inherent risk is close to the upper end of the spectrum of inherent risk due to
the degree to which inherent risk factors affect the combination of the likelihood of a misstatement
occurring and the magnitude of the potential misstatement should that misstatement occur: or
ii. That is to be treated as a significant risk in accordance with the requirements of other ISAs.
Determination of significant risk
The determination of significant risks allows for tt•le auditor to focus more attention on those risks that are on
the upper end of the spectrum of inherent risk . through the performance of certain required responses,
including:
• Controls that address significant risks are req uired to be identified with a requirement to evaluate whether
the control has been designed effectively and implemented.
• Controls that address significant risks are re quired to be tested in the current period (when the auditor
intends to rely on the operating effectivenesis of such controls) and substantive procedures are to .be
planned and performed that are specifically re,sponsive to the identified significant risk.
• To obtain more persuasive audit evidence the higher the auditor's assessment of risk.
• To communicate with those charged with gov(?mance the significant risks identified by the auditor.
• To take into account significant risks when determining those matters that required significant auditor
attention, which are matters that may be key audit matters.
/ Timely review of audit documentation by thE engagement partner at the appropriate stages during the
audit allows significant matters, including s,ignificant risks. to be resolved on a timely basis to the
engagement partner's satisfaction on or before the date of the auditor's report.
For audit of group financial statements, miDre involvement by the group engagement partner if the
significant risk relates to a component in a gi-oup audit and for the group engagement team to direct the
work required at the component by the compc>tient auditor.
The auditor may first identify those assessed risks of material misstatement that have been assessed higher
on the spectrum of inherent risk to form the basis for considering which risks may be close to the upper end.
Being close to the upper end of the spectrum of inherent risk will differ from entity to entity, and will not
necessarily be the same for an entity period on period. It may depend on the nature and circumstances of the
entity for which the risk is being assessed.
The determination of which of the assessed risks of material misstatement are close to the upper end of the
spectrum of inherent risk, and are therefore significant risks, is a matter of professional judgment, unless the
risk is of a type specified to be treated as a significant risk in accordance with the requirements of another
ISA. ISA 240 provides further requirements and guidance in relation to the identification and assessment of
the risks of material misstatement due to fraud.

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The auditor also takes into the account the relative effects of inherent risk factors when assessing inherent
risk. The lower the effect of inherent risk factors, the lower the assessed risk is likely to be. Risks of material
misstatement that may be assessed as having higher inherent risk and may therefore be determined to be a
significant risk, may arise from matters such as the following:
• Transactions for which there are multiple acceptable accounting treatments such that subjectivity is
involved.
• Accounting estimates that have high estimation uncertainty or complex models.
• Complexity in data collection and processing to support account balances.
,1 Account balances or quantitative disclosures that involve complex calculations.
• Accounting principles that may be subject to differing interpretation.
• Changes in the entity's business that involve changes in accounting, for example, mergers and
acquisitions.

CONTROL RISK ASSESSMENT PROCESS (See Category 7)

ASSESSMENT OF RISK OF MATERIAL MISSTATEMENT (Inherent risk x Control risk)

4. Determine the acceptable level of audit risk

The determination of acceptable level of audit risk is a matter of professional judgment to be made by the
auditor. When making that judgment, the auditor considers the level of assurance to be provided by his or report
and the extent of reliance to be placed by users to his or her work.

5. Identify detection risk to determine the nature, timing and extent of further audit procedures
Definition
As defined previously, detection risk is the risk that the auditor's substantive procedures will not detect a
misstatement that exists in an account balance or class of transactions that could be material, individually or when
aggregated with misstatements in other balances or classes.
Determination of detection risk
Detection risk may be determined by rearranging the formula for audit risk:
AUDIT RISK = Inherent risk x Control risk x Detection risk
DETECTION RISK = Audit Risk / (Inherent risk x Control risk)

Use of assessed level of detection risk

From the assessed level of detection risk, the auditor will then design substantive procedures. The following table
summarizes the effects of detection risk to auditor's orocedures.
Lower DR Higher DR
Nature More effective procedures may be applied Less effective procedures may be applied
Timing Procedures will be performed closer or nearer to Procedures will be performed at interim or several
year-end dates
Extent Larger sample size will be tested Smaller sample size will be tested

Materiality in relation to audit risk

There is an inverse relationship between materiality and the level of audit risk, that is, the higher the
materiality level, the lower the audit risk and vice versa

B. ESTABLISHING THE OVERALL AUDIT STRATEGY

In establishing the overall audit strategy, the auditor shall:
Identify the characteristics of the engagement that define its scope such as
1. the financial reporting framework used:
2. industry-specific reporting requirements: and
3. the locations of the components of the entity.

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Ascertain the reporting objectives of the engagem( nt to plan the timing of the audit and the nature of the
communications required such as
1. deadlines for interim and final reporting: and
2. key dates for expected communications with man agement and those charged with governance.
• Consider the factors that, in the auditor's professicinal judgment. are significant in directing the engagement
team's efforts such as
1. determination of appropriate materiality levels:
2. preliminary identification of areas where there ma y be higher risks of material misstatement:
3. preliminary identification of material components and account balances:
4. evaluation of whether the auditor may plan to ob tam n evidence regarding the effectiveness of internal control;
and
5. identification of recent significant entity-specific, irIdustry, financial reporting or other relevant developments.
Considers the results of preliminary engagemen t activities and, where practicable, whether knowledge
(experience) gained on other engagements performe( by the engagement partner for the entity is relevant.
Ascertain the nature, timing and extent of resources n ecessary to perform the engagement.
Considerations in Establishing the Overall Audit Strat egy
Characteristics of the Engagement
The financial reporting framework on which the finaricial information to be audited has been prepared, including
any need for reconciliations to another financial reporting framework.
Industry-specific reporting requirements such as reports mandated by industry regulators.
The expected audit coverage, including the number a nd locations of components to be included.
p. The nature of the control relationships between a pa rent and its components that determine how the group is to
be consolidated.
• The extent to which components are audited by other auditors.
• The nature of the business segments to be audited. irIcluding the need for specialized knowledge.
• The reporting currency to be used, including any need for currency translation for the financial information
audited.
• The need for a statutory audit of standalone fina ncial statements in addition to an audit for consolidation
purposes.
The availability of the work of internal auditors and th(?. extent of the auditor's potential reliance on such work.
The entity's use of service organizations and how the auditor may obtain evidence concerning the design or
operation of controls performed by them.
The expected use of audit evidence obtained in p revious audits, for example. audit evidence related to risk
assessment procedures and tests of controls.
The effect of information technology on the audit prc>cedures, including the availability of data and the expected
use of computer-assisted audit techniques.
The coordination of the expected coverage and tirrling of the audit work with any reviews of interim financial
information and the effect on the audit of the informat ion obtained during such reviews.
The availability of client personnel and data.
Reporting Objectives, Timing of the Audit, and Nature of Communications
The entity's timetable for reporting, such as at interim and final stages.
The organization of meetings with management and those charged with governance to discuss the nature, timing
and extent of the audit work.
The discussion with management and those chargecI with governance regarding the expected type and timing of
reports to be issued and other communications, both written and oral, including the auditor's report, management
letters and communications to those charged with go rernance.
The discussion with management regarding the exp€:cted communications on the status of audit work throughout
the engagement.
Communication with auditors of components regardir)g the expected types and timing of reports to be issued and
other communications in connection with the audit of components.

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The expected nature and timing of communications among engagement team members, including the nature and
timing of team meetings and timing of the review of work performed.
• Whether there are any other expected communications with third parties, including any statutory or contractual
reporting responsibilities arising from the audit.
Significant Factors, Preliminary Engagement Activities, and Knowledge Gained on Other Engagements
The determination of appropriate materiality levels. including,
1. Setting materiality for planning purposes.
2. Setting and communicating materiality for auditors of components.
3. Reconsidering materiality as audit procedures are performed during the course of the audit.
4. Preliminary identification of material components and account balances.
• Preliminary identification of areas where there may be a higher risk of material misstatement.
The impact of the assessed risk of material misstatement at the overall financial statement level on direction,
supervision and review.
The manner in which the auditor emphasizes to engagement team members the need to maintain a questioning
mind and to exercise professional skepticism in gathering and evaluating audit evidence.
• Results of previous audits that involved evaluating the operating effectiveness of internal control, including the
nature of identified weaknesses and action taken to address them.
The discussion of matters that may affect the audit with firm personnel responsible for performing other services
to the entity.
Evidence of management's commitment to the design, implementation and maintenance of sound internal control,
including evidence of appropriate documentation of such internal control.
• Volume of transactions, which may determine whether it is more efficient for the auditor to rely on internal control.
• Importance attached to internal control throughout the entity to the successful operation of the business.
> Significant business developments affecting the entity, including changes in information technology and business
processes, changes in key management, and acquisitions, mergers and divestments.
Significant industry developments such as changes in industry regulations and new reporting requirements.
Significant changes in the financial reporting framework, such as changes in accounting standards.
• Other significant relevant developments, such as changes in the legal environment affecting the entity.
Nature, Timing and Extent of Resources
The selection of the engagement team (including, where necessary, the engagement quality control reviewer) and
the assignment of audit work to the team members, including the assignment of appropriately experienced team
members to areas where there may be higher risks of material misstatement.
Engagement budgeting, including considering the appropriate amount of time to set aside for areas where there
may be higher risks of material misstatement.
Important note:
• When establishing the overall audit strategy, the auditor aims to create a strategy or approach that will result to an
effective and efficient audit. Thus, appropriate levels of materiality and audit risk must be considered carefully.

C. DEVELOPING AN AUDIT PLAN

Audit plan
The audit plan is more detailed than the overall audit strategy in that it includes the nature, timing and extent of audit
procedures to be performed by engagement team members. An audit plan shall include a description of the
• nature, timing and extent of the risk assessment procedures;
• further audit procedures, and
• other planned audit procedures that are required to be carried out so that the engagement complies with
PSAs.
Audit program
The form and content of the audit program may vary for each particular engagement but would generally contain the
following:
• The audit objectives for each area:

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The nature, timing, and extent of audit procedures required to implement the overall audit plan: and
• A time budget in which hours are budgeted for the various audit areas or procedures.
The audit program shall serve as a:
✓ Set of instructions to assistants involved in the audit; and
✓ Means to control and record the proper execution of the work
Communication during planning phase
The auditor may decide to discuss elements of planning with the entity's management to facilitate the conduct and
management of the audit engagement (for example, to coordinate some of the planned audit procedures with the
work of the entity's personnel).

D. DIRECTION, SUPERVISION, AND REVIEW

The auditor shall plan the nature, timing and extent of direction and supervision of engagement team members and
the review of their work.

E. OTHER PLANNING CONSIDERATIONS

1. Determining the need of an auditor's expert
An auditor's expert is an individual or organization possessing expertise in a field other than accounting or
auditing. whose work in that field is used by the auditor to assist the auditor in obtaining sufficient appropriate
audit evidence. An auditor's expert may be either an auditor's internal expert (who is a partner or staff, including
temporary staff, of the auditor's firm or a network firm), or an auditor's external expert.
When using the work of an auditor's expert. the following shall be considered by the auditor
• Selecting an expert
Obtaining an understanding of the field of expertise of the expert
Considering the nature, timing and extent of audit procedures
2. Additional considerations in initial audit engagements
Preliminary engagement activities
The auditor shall perform the following activities prior to starting an initial audit:
1. Perform procedures regarding the acceptance of the client relationship and the specific audit engagement:
and
2. WL, re there has been a change of auditors, communicate with the previous auditor in compliance with
relevant ethical requirements.
Establishing overall audit strategy and audit plan
For initial audits, additional matters the auditor may consider in establishing the overall audit strategy and audit
plan include the following:
Unless prohibited by law or regulation, arrangements to be made with the previous auditor (for example: to
review the predecessor auditor's working papers).
Any major issues (including the application of accounting principles or of auditing and reporting standards)
discussed with management in connection with the initial selection as auditor, the communication of these
matters to those charged with governance and how these matters affect the overall audit strategy and audit
plan.
The audit procedures necessary to obtain sufficient appropriate audit evidence regarding opening balances.
• Other procedures required by the firm's system of quality control for initial audit engagements (for example,
the firm's system of quality control may require the involvement of another partner or senior individual to
review the overall audit strategy prior to commencing significant audit procedures or to review reports prior to
their issuance).

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Considerations specific to smaller entities
RAYMUND FRANCIS A. ESCALA, CPA, MBA
AUDIT PLANNING

Less complex or time-consuming planning activities

Establishing the overall audit strategy and plan for the audit of a small entity need not be a complex or time-
consuming exercise; it varies according to the size of the entity, the complexity of the audit, and the size of the
engagement team.
Consultation
When an audit is carried out entirely by an audit engagement partner, who may be a sole practitioner, it may be
desirable to consult with other suitably-experienced auditors or the auditor's professional body.

ILLUSTRATIVE QUIZZERS — PART 1

1. Which of the following statements is/are correct?
Statement 1: The client should plan the audit work so that the audit will be performed in an effective manner.
Statement 2. The auditor should conduct the audit with an attitude of professional skepticism.
Statement 3: The auditor should develop and document an overall audit plan describing the scope and conduct of the
audit
A. Only one statement is correct C. All statements are correct
B. Only two statements are correct D. All statements are incorrect
2. Adequate planning benefits the audit of financial statements in several ways, including the following. except
A. Helping the auditor to devote appropriate attention to less important areas of the audit
B. Helping the auditor identify and resolve potential problems on a timely basis
C. Helping the auditor properly organize and manage the audit engagement so that it is performed in an effective
and efficient manner
D. Assisting in the selection of engagement team members with appropriate levels of capabilities and competence to
respond to anticipated risks, and the proper assignment of work to them
3. 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 establishing the overall audit strategy for the engagement and developing the audit
plan, in order to reduce audit risk to an acceptably low level.
C. 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.
D. 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.
4. The auditors plan should
A B C D
9 Precede action Yes No Yes No
• Be flexible Yes No No Yes
• Be cost-beneficial Yes Yes Yes Yes
5. Which of the following statements is/are correct?
Statement 1: According to PSA 300, the auditor may discuss elements of planning with those charged with
governance and the entity's management.
Statement 2. The audit plan sets the scope, timing and direction of the audit guides the development of the more
detailed overall audit strategy.
Statement 3: The overall audit strategy is more detailed than the audit 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.
A. Only 1 statement is correct C. All statements are correct
B. Only 2 statements are correct D. All statements are incorrect

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6. An initial (first-time) audit requires more audit time to complete than a recurring audit. One of the reasons for this is
that
A. New auditors are usually assigned to an initial audit.
B. Predecessor auditors need to be consulted
C. The client's business, industry, and internal control are unfamiliar to the auditor and need to be carefully studied.
D. A larger proportion of customer accounts receivable need to be confirmed on an initial audit.
7. An auditor should design the audit plan 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.
8. In developing an overall audit strategy, an auditor should consider:
A. Whether the allowance for sampling risk exceeds the achieved upper precision limit.
B. Findings from substantive tests performed at interim dates.
C. Whether the inquiry of the client's attorney identifies any litigation, claims, or assessments not disclosed in the
financial statements.
D. Preliminary evaluations of materiality, audit risk, and internal control.
9. Which of the following is least likely considered by the CPA when he makes an overall audit plan?
A. Identification of complex accounting areas including those involving accounting estimates
B. The effect of information technology on the audit
C. The content of the representation letters
D. The nature and timing of reports and other communication with the entity that are expected under the
engagement
10. An audit program provides a proof that
A. Audit work is adequately planned and documented
B. Sufficient appropriate evidence is obtained
C. Generally accepted standards of reporting has been complied
D. Proper study and evaluation of internal control has been performed
11. Which of the following is a basic tool used by the auditor to control the audit work and review the progress of the
audit?
A. Time and expense summary. C. Progress flowchart.
B. Engagement letter. D. Audit program.
12. As part of audit planning. CPAs should design audit programs for each individual audit and should include audit steps
and procedures to
A. Detect and eliminate fraud.
B. Increase the amount of management information available.
C. Provide assurances that the objectives of the audit are met.
D. Ensure that only material items are audited.
13. Which of the following are considered further audit procedures that may be designed after assessing the risks of
material misstatement?
I. Risk assessment procedures
II. Tests of control
III. Substantive tests of details
A. I and II C. I and III
B. II and III D. I, II and III

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14. 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 test the operating effectiveness of controls in preventing, or detecting and correcting, material
misstatements at the assertion level.
B. These procedures are used detect material misstatements at the assertion level.
C. 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.
D. These procedures include tests of details of classes of transactions, account balances, and disclosures and
analytical procedures.
15. The audit plan generally is modified when
A. Results of tests of control differ from expectations.
B. An engagement letter has been signed by the auditor and the client.
C. A significant deficiency has been communicated to the audit committee of the board of directors.
D. The search for unrecorded liabilities has been performed and obtained results as had been expected during the
planning of the audit.
16. On performing risk assessment, which of the following is correct?
A Compared to the management, the auditor is required to have more knowledge of the entity's business.
B. Risk assessment procedures, by themselves, provide sufficient appropriate evidence on which to base the audit
opinion
C "Observation", as a risk assessment procedure is normally applied to records, documents and assets with
physical substance.
D. Risk assessment procedures are required on every audit engagement. even if it is a continuing audit
engagement.
17. An auditor is required to understand (choose the exception)
A. The nature of the entity. including its operations, ownership and governance
B. The measurement and review of the entity's financial performance
C. All the controls established by the entity
D. Entity's selection and application of accounting policies, including reasons for changes thereto
18. The primary purpose for obtaining and understanding of an entity's internal control is to
A. Determine the nature, timing and extent of tests to be performed in the audit.
B. Obtain sufficient appropriate audit evidence from which to draw conclusion as a basis for forming an opinion on
the financial statements.
C. Test whether controls are suitable designed, implemented and operating effectively.
D. Determine whether to accept or reject an audit engagement.
19. In assessing risk of material misstatement. an auditor is required to perform
A. Confirmation C. Inquiry of the entity's legal counsel
B. Inspection D. Recalculation
20. Which of the following is least likely to be considered a risk assessment procedure?
A. Analytical procedures.
B. Confirmation of ending accounts receivable.
C. Inspection of documents.
D. Observation of the performance of certain accounting procedures.

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ILLUSTRATIVE QUIZZERS — PART 2

1. Analytical procedures are required to be performed as a:
I. Risk assessment procedure
II. Further audit procedure (Substantive analytical procedure)
III. A procedure in the overall review phase
A. I and II only C. II and Ill only
B. I and III only D ll and III only
2. Analytical procedures performed in planning an audit aims to
A. Enhance the auditor's understanding of the auditee's business
B. Reduce further audit procedures
C. Detect material misstatements
D. Assist the auditor whether to continue of withdraw from the engagement
3. The auditor's aim in performing analytical procedures in planning an audit is to identify the existence of
A. Matters not previously addressed or for which previous conclusions were no longer appropriate
B. Material misstatements
C. Fraud
D. Unusual transactions and events
4. An auditor understands the client's business primarily to
A. Make suggestions on how to improve internal control
B Assess the level of control risk
C. Develop an questioning attitude during the audit
D. Identify transactions that may impact the financial statements
5. It is the risk that the auditor gives an opinion that the financial statements are fairly presented when they are not.
A. Audit risk C. Control risk
B. Inherent risk D. Detection risk
6. A higher level of inherent risk is present in
A. Cash and marketable securities C. Shareholders' equity accounts
B. Revenues and receivables D. Fixed assets
7. Control risk
A. Is the risk that no controls exist to prevent, detect or correct material misstatement on a timely basis
B. Should be assessed in quantitative terms to provide a frame for setting audit risk and materiality levels
C. Can be reduced to zero by a strongly effective opera tion of the controls
D. May be assessed separately or in combination with the assessment of inherent risk
8. 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. Considered at the individual account balance level while detection risk is not.
D. Functions of the client and its environment while detection risk is not.
9. The risk of material misstatement is related to detection risk in what mariner?
A. Direct C. Proportional
B. Inverse D Indeterminable
10. When the combined assessed level of inherent and control risks is high, detection risk is set
A. At the same level C. Low
B. High D. At zero

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11. inherent risk factors pertain to characteristics of events or conditions that affect susceptibility to misstatement,
whether due to fraud or error, of an assertion about a class of transactions, account balance or disclosure, before
consideration of controls. Such factors may be qualitative or quantitative, and include the following (choose the
exception):
A. Complexity C Change
B. Objectivity D. Uncertainty
12. Statement 1: Risks of material misstatement are assessed at the assertion level in order to determine the nature,
timing and extent of further audit procedures necessary to obtain sufficient appropriate audit evidence.
Statement 2: For the identified risks of material misstatement at the assertion level, a separate assessment of
inherent risk and control risk is not required but highly encouraged.
Statement 3: The auditor's process of risk identification and assessment is iterative and dynamic.
A. Only 1 statement is correct C. All statements are correct
B. Only 2 statements are correct D. All statements are incorrect
13. Statement 1: Professional skepticism is necessary for the critical assessment of audit evidence gathered when
performing the risk assessment procedures. and assists the auditor in remaining alert to audit evidence that is not
biased towards corroborating the existence of risks or that may be contradictory to the existence of risks.
Statement 2: The auditor shall design and perform risk assessment procedures in a manner that is not biased
towards obtaining audit evidence that may be corroborative or towards excluding audit evidence that may be
contradictory.
A. Only Statement 1 is correct C. Both statements are correct
B. Only Statement 2 is correct D. Both statements are incorrect
14. Which of the following is incorrect concerning materiality?
A. Information is material if its omission or misstatement could influence the economic decisions of users taken on
the basis of the financial statements
B. Not all matters are important to achieve fair presentation of the financial statements.
C. Materiality is directly related to audit risk.
D. In financial reporting, materiality is not a qualitative characteristic, but rather a threshold or cut-off point.
15. Which of the following would an auditor most likely use in determining the auditor's preliminary judgment about
materiality?
A. The anticipated sample size of the planned substantive tests.
B. The entity's annualized interim financial statements.
C. The results of the internal control questionnaire.
D. The contents of the management representation letter.
16. 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.
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.
17. In considering materiality for planning purposes, the auditor believes that misstatements aggregating P60,000 would
have material effect on an entity's income statement, but that misstatements would have to aggregate P40,000 to
materially affect the statement of financial position. Ordinarily, it would be appropriate to design auditing procedures
that would be expected to detect misstatements that aggregate:
A. P40.000 C. P60,000
B. P50,000 D. P100,000

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18. In connection with the planning phase of an audit engagement, which of the following statements is always correct?
A. Final staffing decisions must be made prior to completion of the planning stage.
B. Observation of inventory count should be performed at year-end.
C. A portion of the audit of a continuing audit client can be performed at interim dates.
D. An engagement should not be accepted after the client's financial year-end
19. A retailing entity uses the Internet to execute and record its purchase transactions. The entity's auditor recognizes that
the documentation of details of transactions will be retained for only a short period of time. To compensate for this
limitation, the auditor most likely would:
A. Compare a sample of paid vendors invoices to the receiving records at year-end.
B. Plan for a large measure of tolerable misstatement in substantive tests.
C. Perform tests several times during the year. rather than only at year-end.
D. Increase the sample of transactions to be selected for cutoff tests.
20. The auditor should plan the nature, timing and extent of direction and supervision of engagement team members and
review their work. Which of the following statements is incorrect regarding direction, supervision and review?
A. The auditor plans the nature, timing, and extent of direction and supervision of engagement team members based
on the assessed risk of material misstatement.
B. As the assessed risk of material misstatement increases, for the area of audit risk, the auditor ordinarily increases
the extent and timeliness of direction and supervision of engagement team members.
C. As the assessed risk of material misstatement decreases, for the area of audit risk, the auditor performs a more
detailed review of their work.
D. The auditor plans the nature, timing and extent of the review of the team's work based on the capabilities and
competence of the individual team members performing the audit work.

"Success isn't always about greatness. It's about consistency. Consistent hard work leads to success.
Greatness will come." — DWAYNE JOHNSON

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