Chapter three: Planning and

conducting the Audit

 Presentation outline:
1. Meaning and reasons of audit
planning,
2. Audit planning procedures,
3. Materiality and audit risk, and
4. Audit working paper.
1. Meaning and reasons of audit
planning

 Audit planning is the same with

general planning concept.
 The first generally accepted auditing

standard of field work requires

adequate planning.
 The auditor must adequately plan

the work and must properly

supervise any assistants.
Cont…
 There are three main reasons why the auditor
should properly plan engagements:
 To enable the auditor to obtain sufficient

appropriate evidence for the circumstances,

 To help keep audit costs reasonable, and
 To avoid misunderstandings with the client.
 Much of the early planning of audits deals with

obtaining information to help auditors assess

Acceptable audit risk and Inherent risk.
2. Audit planning
procedures
 Planning and conducting the audit
involves the following eight procedures:
1. Accept client and perform initial
audit planning,
2. Understand the client’s business
and industry,
3. Assess client business risk,
4. Perform preliminary analytical
procedures,
Cont…
5. Set materiality and assess acceptable
audit risk and inherent risk,
6. Understand internal control and assess
control risk,
7. Gather information to assess fraud risks,
and
8. Develop overall audit plan and audit
program.
 The following slides present each step one

by one.
1. Accept client and perform initial audit
planning

 Accept client and perform Initial audit

planning involves four things, all of
which should be done early in the audit:
 The auditor decides whether to
accept a new client or continue
serving an existing one.
 The auditor identifies why the
client wants or needs an audit.
Cont…
 To avoid misunderstandings, the
auditor obtains an understanding
with the client about the terms of
the engagement.
 The auditor develops an overall
strategy for the audit, including
engagement staffing and any
required audit specialists.
2. Understand client’s business and
industry
 An understanding of the client’s
business and industry and knowledge
about the company’s operations are
essential for the auditor to conduct an
adequate audit.
 the auditor must obtain a sufficient
understanding of the entity and its
environment, including its internal
control, to assess the risk of material
misstatement of the financial
statements whether due to error or
Cont…
 Auditors’ consideration focuses on the
following to understand client’s business
and industry:
 Industry and External Environment,
 Business Operations and Processes,
 Management and Governance,
 Client Objectives and Strategies,
and
 Measurement and Performance.
3. Assess client business
risk
 The auditor uses knowledge gained
from the understanding of the
client’s business and industry to
assess client business risk.
 it can arise from any of the factors

affecting the client and its

environment, such as significant
declines in the economy, new
technology eroding a client’s
competitive advantage, or a client
4. perform preliminary analytical
procedures
 Auditors perform preliminary analytical
procedures to better understand the client’s
business and to assess client business risk.
 One such procedure compares client ratios to
industry or competitor benchmarks to provide
an indication of the company’s performance.
 Such preliminary tests can reveal unusual
changes in ratios compared to prior years, or
to industry averages, and help the auditor
identify areas with increased risk of
misstatements that require further attention
during the audit.
5. Set materiality and assess acceptable
audit risk and inherent risk
 Materiality and risk are fundamental to
planning the audit and designing an audit
approach.
 Materiality is a major consideration in
determining the appropriate audit report to
issue.
 According to FASB Concept Statement 2,

Materiality is the magnitude of an

omission or misstatement of accounting
information that influence the
judgment/decision of a reasonable person
relying on the information.
Cont…
 A careful reading of the FASB definition
reveals the difficulty that auditors have
in applying materiality in practice.
 While the definition emphasizes
reasonable users who rely on the
statements to make decisions, auditors
must have knowledge of the likely users
of the client’s statements and the
decisions that are being made.
Cont…
 For example, if an auditor knows that
financial statements will be relied on in a
buy–sell agreement for the entire
business, the amount that the auditor
considers material may be smaller than
that for an otherwise similar audit.
 In practice, of course, auditors may not
know who all the users are or what
decisions they may make based on the
financial statements.
Cont…
 Auditors follow five closely related steps
in applying materiality:
 Stepe1: sets a preliminary
judgment about materiality,
 Stepe2: Allocate preliminary
judgment about materiality to
segments,
 Stepe3: Estimate total
misstatement in the segment,
Cont…
 Stepe4: Estimate combined
misstatement, and
 Stepe5: compare combined
estimate with preliminary or
revised judgment about materiality
Audit Risk
 Audit risk is the risk that the auditor
expresses an inappropriate audit opinion
that, when the financial statements are
materially misstated, typically stating that
the financial statements are true and fair.
 Audit risk can be further defined by the
formula:
 Audit risk = Inherent risk × Control
risk × Planned Detection risk
Cont…
 Inherent risk measures the
auditor’s assessment of the
likelihood that there are material
misstatements due to error or fraud
in a segment before considering the
effectiveness of internal control.
 Control risk measures the auditor’s

assessment of whether
misstatements exceeding a tolerable
amount in a segment will be
Cont…
 Planned detection risk is the risk
that audit evidence for a segment will
fail to detect misstatements exceeding
tolerable misstatement.
 There are two key points to know about
planned detection risk.
 Planned detection risk is dependent on
the other three factors in the model.
 It will change only if the auditor
changes one of the other risk model
Acceptable audit risk
 Acceptable audit risk is a measure
of how willing the auditor is to
accept that the financial statements
may be materially misstated after
the audit is completed and an
unqualified opinion has been issued.
 When the auditor decides on a lower

acceptable audit risk, it means that

the auditor wants to be more certain
that the financial statements are not
Cont…
 Zero risk is certainty, and a 100
percent risk is complete uncertainty.
 To assess acceptable audit risk, the

auditor must first assess each of the

factors affecting acceptable audit
risk.
 The factors include:

 The Degree to Which External

Users Rely on the Statements,
Cont…
 The Likelihood That a Client Will
Have Financial Difficulties After the
Audit Report Is Issued,
 The Auditor’s Evaluation of
Management’s Integrity
Audit Program
 An audit program is a detailed list of
the audit procedures to be performed
in the course of the examination.
 ISA 300 requires auditors to ‘develop

and document an audit program setting

out the nature, timing and extent of
planned audit procedures required to
implement the overall audit plan’.
Cont…
 Thus, audit program contains:
 The description of specific audit
procedures to be performed in respect
of different aspects to be covered
 The extent to which the tests will be

performed and the timing of such tests

 Lays down the responsibilities of
various members of the audit team
Cont…
 Sufficient details to serve as set of
instructions to the audit staff and as a means
to control proper execution.
 The audit program serves as:

 A set of instructions to the audit team

 A means to control and record the proper

execution of the work

 A record of the audit procedures to be

adopted, the audit objectives, timing, sample

size and basis of selection for each area.
Audit working papers
 Audit working papers are as the
name suggests audit documents and
evidences gathered during the
progress of audit work.
 These include audit contract entered

to; audit plans and programs; data

gathered; descriptions of work
performed – documents received,
people interviewed, items traced and
reconciled; events and incidences
Cont…
 Working papers should be ‘sufficiently
complete and detailed to provide an
overall understanding of the audit’.
 They should record:

 Planning information
 The work done and when it was

done
 Results and conclusions.
Cont…
 Working papers should not be made
available to third parties without
client consent and extracts from the
papers can be made available to the
client entirely at the discretion of the
auditor.
 However, the auditor’s working
papers are not a substitute for
proper accounting records.
Contents of working papers
 The contents of working papers should be
thoroughly considered to support the total
audit work.
 Audit working papers are produced and

collected for several reasons.

 These include:

 To control the current year's work

 To form a basis for the plan of the audit of

the following year.

 Evidence of work carried out
Cont…

The auditor’s working papers will consist of:
a. Information and documents, which are of
continuing importance to each annual audit.
b. Audit planning and control information.
c. Details of the client's systems and records
with the auditor's evaluation of them.
d. Schedules in support of the accounts
additional to, or summarizing the detail in
the client's Books.
Cont…
e. Details of the audit work carried out, notes
of queries raised with action taken thereon
and the conclusion drawn by the audit staff
concerned.
f. Evidence that the work of the audit staff has
been properly reviewed by more senior
people.
g. A summary of significant points affecting the
financial statements and the audit report,
showing how these points were dealt with.
h. Evidence of the inherent and control risk
assessments and any changes thereto
End Of
Chapter
Three