1.1.Audit Planning

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AUDIT PLANNING


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DEFINITION

According to AAS-8, Audit planning refers toplanning by the auditor made to enable him toconduct an effective audit, in an efficient andtimely manner, and includes planning about area,

scope, depth of transactions to be audited,persons to be deployed for audit etc.,.

Audit planning is the process of deciding inadvance what is to be done, who is to do it, how itis to be done, and when it is to be done by theauditor in order to have an effective and efficientcompletion of audit.


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OVERVIEW OF THE AUDIT PROCESS

The overall objective of the financial statement auditis the expression of an opinion on whether theclients financial statements are presented fairly, in

all material respects, in conformity with GAAP.

The diagnostic process of making judgments about

the accounts likely to contain material misstatementand obtaining evidence about fair presentation inthe financial statements involves a number of steps.


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1. Knowledge of the Business and Industry:

The auditor should obtain sufficient knowledge andunderstanding of the clients business and industry tounderstand the events, transactions, and practices thatmay have a significant effect on the financial statements.

Developing expectations of financial statementsinvolves using knowledge of business performance todevelop an expectation of the amounts reported in thefinancial statements.

When an entity makes extensive use of electronic datainterchange, the auditor might decide to increase thelevel of audit personnel with computer specialization.


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Evaluation of reasonableness of accountingestimates involves that many critical aspects of financialstatements, such as the valuation of the allowance fordoubtful accounts, or the inventory obsolescence, orwarranty reserves, often involve significant professional

judgment.

There are many key aspects GAAP that are industryspecific. Many industries (such as Agricultural producersand cooperatives, to casinos, Health care organizations, orInvestment companies.

Several members of an audit team usually have significantexperience in an industry and understand the resourcesand core processes that are needed to compete effectively

in the industry.


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2. Managements Assertions:

Financial statements include both explicit and implicitassertions and are important as they guide the auditor inthe collection of evidence

Auditing Standards Board has recognized the five broad

categories of financial statement assertions. They are:

a.Existence or Occurrence: It deals with whether assets orliabilities of the entity exist at a given date and whether

recorded transactions have occurred during a given period.b.Completeness: It deals with whether all transactions and

account that should be presented in the financial

statements are indeed included.


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c.Rights and Obligations: It deals with whetherassets are the rights of the entity and liabilities are

the obligations of the entity at a given date.

d.Valuation or Allocation: It deals with whetherasset, liability, revenue, and expense componentshave been included in the financial statements atappropriate amounts (i.e., in conformity with GAAPand is clerically and mathematically accurate).

e.Presentation and Disclosure: It deals with whetherparticular components of the financial statements areproperly classified, described, and disclosed.


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3. Materiality:

FASB Concepts Statement No.2 defines materiality as the

magnitude of an omission or misstatement of accountinginformation that, in light of surrounding circumstances,makes it probable that the judgment of a reasonable personrelying on the information would have been changed orinfluence by the omission or misstatement.

The auditor makes a judgment about materiality whileplanning the engagement in order to make importantdecisions about the scope of the audit

Materiality is an important concept that guides the auditor insetting the scope of audit work to find omission ormisstatements that would potentially aggregate to an

amount that would influence financial statement users.


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The concept of materiality guides the auditor whenevaluating audit findings. Once auditors collect audit

evidence, they must assess the significance of auditfindings.

4. Audit Risk:

Since the audit does not guarantee that the financialstatements are free of material misstatement, somedegree of risk exists that the financial statements may

contain misstatements that go undetected by the auditor. SAS-47 (AU 312.02) defines as Audit risk is the risk that

the auditor may unknowingly fail to appropriately modifyhis or her opinion on financial statements that contain a

material misstatement.


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If the auditor interprets reasonable assurance as a 99%level of certainty that the financial statements are free of

material misstatement, then the audit risk is 1%,whereas if 95% certainty is considered satisfactory, thenaudit risk is 5%.

The ultimate challenge of the audit is that auditorscannot examine all possible evidence regarding everyassertion for every account balance and transactionclass.

Audit Risk Components:

As a practical matter the auditor must consider audit risknot only for each account balance and transaction class,but for each assertion relevant to material accountbalances or transaction classes.


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a.Inherent Risk:

It is the susceptibility of an assertion to a material

misstatement, assuming that there are no relatedinternal controls.

The assessment of inherent risk involves evaluatingfactors that may cause misstatements in an assertion.

Example: Valuations requiring complex calculations aremore likely to be misstated than simple calculations.

b.Control Risk:

It is the risk that a material misstatement that couldoccur in an assertion will not be prevented or detectedon a timely basis by the entitys internal controls.

Todays business environment usually relies on

computerized internal controls.


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It is important for auditors to have a good understanding ofthe design and operation of computer controls as well as howtechnology may be used to test the effectiveness of

computer controls.

c.Detection Risk:

Detection risk is the risk that the auditor will not detect a

material misstatement that exists in an assertion. Once the auditor has made decisions about overall audit risk,

inherent risk, and control risk, he or she uses the audit riskmodel to guide decisions about the audit evidence that is

needed to restrict detection risk to an appropriately low level. The auditor controls detection risk by using professional

judgment to make decisions about which audit procedures toperform, when to perform audit procedures, theextensiveness of audit procedures, and who should perform

audit procedures.


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Audit Risk Model:

The concept of audit risk is consistent with the fact thatthe audit is designed to provide reasonable assurance,not absolute assurance, that the financial statements arefree of material misstatements.

The audit does not guarantee that the financialstatements are free of material misstatement.

The audit risk model may be expressed quantitatively asfollows:

AR = IRCRDR

The symbols represent audit, inherent, control, and

detection risk respectively.


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To illustrate the use of the model, assume that the auditormade the following professional judgments for a particular

assertion, such as the valuation or allocation assertion foraccounts receivable:

AR=5%, IR=90%, and CR=20%

Detection risk can be determined by solving the model for DR

as follows:DR = (AR) / (IRCR)

= .05 / (.9.2)

=.28 or 28%


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5. Evidence:

Sufficient competent evidential matter is to be obtainedthrough inspection, observations, inquiries, andconfirmations to afford a reasonable basis for an opinionregarding the financial statements under audit.

The standard specifies that sufficient (enough) competent(reliable) evidential matter should be obtained to provide areasonable (rational) basis for an opinion on the financialstatements.

The collection and evaluation of audit evidence is at thecore of the audit.

In general, more evidence is needed for accounts that arematerial to the financial statements than for accounts thatare immaterial.


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An auditor works within economic limits that dictate thatsignificant evidence must be obtained within a reasonabletime and at a reasonable cost.

The size of the accounting populations underlying manyfinancial statement items make sampling a necessity ingathering evidence.

Generally, a larger the population, the larger the quantityof evidence required to obtain a reasonable basis forreaching a conclusion about it.

The reliability of the accounting records is directly relatedto the effectiveness of the clients internal controls.

The competency of confirming information depends onmany factors such as; relevance, source, timeliness, andobjectivity.


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Classification of Audit Procedures:

An auditor performs audit procedures to obtain evidence to

support an opinion on the financial statements. They are:a.Procedures to obtain an understanding: In performing

the audit, an auditor usually performs procedures to obtainan understanding of the client, its business and industry,and factors that may affect the inherent risk ofmisstatement in an assertion.

b.Tests of Controls: They are made to provide evidenceabout the effectiveness of the design and operation ofinternal control structure policies and procedures.Example: A computer control procedure uses batch totalsto ensure that the entire batch of transactions is recorded.

c. Substantive Tests: They provide evidence as to thefairness of managements financial statement assertions.


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Substantive tests consists of:

a. Analytical procedures involve the use of comparisons

to assess fairness. Example: Sale per square foot ofretail price.

b. Tests of details of transactions involve examiningsupport for the individual transactions posted to anaccount. Example: Vouching debits to accountsreceivable to entries in the sales journal and supportingsales invoices.

c. Tests of details of balances involve examiningsupport for the ending balance directly. Example:

Confirming an ending accounts receivable balancedirectly with the customers.


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6. Consideration of Value-Added Services:

In order to effectively audit the financial statements of a

company the CPA must be able to: Apply ethical rules of the profession

Understand an entitys goals and objectives anddetermine the degree to which those goals and

objectives have been met Understand the companys internal controls and evaluate

the degree to which they serve the clients needs

Assess risk, verify managements assertions, and

document audit conclusions Evaluate an entitys cash flow, profitability, liquidity,

solvency, and operating cycle and its performance in anindustry relate to its competitors


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7. Communication of Findings:

The final key element of the audit involves communication offindings.

The audit, and other services performed as part of the audit,are of no value until they are communicated to managementand others who use the audit.

The communication of audit findings can be divided into three

categories, they are:a. The Auditors report on financial statements

b. Other required communications such as internalcontrols, significant accounting policies, management

judgments, significant audit judgments, disagreements withmanagement, consultation with other accountants, difficultiesencountered in performing the audit etc.,

c. Communication of other findings such as value-addedservices, describing the scope of work performed, thefindings and conclusions.

1.1.Audit Planning

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