Week 8

1
Week 7 Planning and documentation

• Week 7 Preliminary planning procedures (syllabus
  ref 9)
• Distinguish between risk-based, procedural and
  other approaches to audit and review work.
• Describe
• Sources and nature of information gathered in
  planning audit and review assignments.
• Understanding of the entity required by auditors.
• Purpose of analytical procedures in planning
  (should be able to illustrate the application of
  these).
• Components of risk and the use of IT for risk
  analysis.
• Illustrate explain the importance of
  application of risk analysis.
• Define illustrate the concepts of materiality
  and tolerable error.
• Evaluate misstatements.

2
Week 7 Planning and documentation

• Week 7 Work plan, program and documentation (ref
  10)
• Describe and illustrate the contents of work
  plans, work programs and working papers.
• Describe the nature of documentation required for
  different types of assignment.
• Explain the importance of documentation.
• Illustrate the use of IT in the audit.

3
Week 7

• Planning.
• Knowledge of the business.
• Materiality and risk.
• Analytical procedures for planning.
• Planning an internal audit.
• Working papers and documentation.

4
Why audit planning?

• If any task is to be completed effectively and
  efficiently it must be planned.
• ISA 300
• The auditor should plan the audit so that the
  engagement will be performed in an effective
  manner.
• Benefits
• Attention is devoted to important areas.
• Potential problems are identified and resolved.
• Work is performed in an efficient, effective and
  timely manner.
• Assists in proper assignment of work to
  assistants.
• Coordinates the work of other auditors and
  experts.

5
Audit Planning

• Planning has two stages
• Audit strategy development.
• Sets direction for the audit.
• Describes expected scope and conduct of the
  audit.
• Provides guidance for the development of the
  audit plan.
• Audit plan.
• More detailed.
• Includes instructions to the team and sets out
  the audit procedures.
• Includes references to audit objectives, timing,
  sample size and basis of selection for each
  auditable area.
• Serves as a means of controlling and recording
  the work.

6
Considerations in developing and audit strategy

• ISA 300
• Knowledge of the business.
• Understanding of the accounting and internal
  control systems.
• Risk and materiality.
• Nature timing and extent of the procedures.
• Coordination, direction, supervision and review.
• Other matters.
• Note see BPP page 125

7
Audit plan design

• The operational aspect.
• Sets out detailed procedures to be performed
• For each auditable area.
• Whether interim/final work.
• Type of test.
• Size of sample.
• Instructions for audit staff to follow.
• Allows for working papers to be prepared and
  cross referenced to other evidence.
• Allows staff to sign off the work.
• Assists with review of work.

8
Typical Planning Procedures

• Background.
• Outline plan.
• Matters raised in last years audit.
• Changes in legislation or accounting practice.
• Management or interim accounts.
• Preliminary analytical review.
• Meet with senior management.
• Consider the timing of significant phases.

9
Typical Planning Procedures

• Clients employees to work on behalf of the
  auditor.
• Expert help?
• Number and grade of staff.
• Consult with audit team members.
• A budget of time prepared.
• Expected date of visit to clients offices.

10
Knowledge of the business

• ISA 315 Understanding the entity and its
  environment and assessing the risks of material
  misstatement
• The auditor should obtain an understanding of the
  entity and its environment, including its
  internal control, sufficient to identify and
  assess the risks of material misstatement of the
  financial statements, whether due to fraud or
  error, and sufficient to design and perform
  further audit procedures.

11
Knowledge of the business

• How?
• Inquiries of management and others
• Analytical procedures
• Observation and inspection
• Prior period knowledge
• Discussion among the audit team.

12
Analytical procedures

• Used at 3 stages of the audit
• Planning
• Liquidity
• Solvency
• Profitability
• Substantive tests
• Final review

13
Analytical procedures

• Key features
• Investigation
• Explanation
• Corroboration
• Prediction

14
Assessing the risk of material misstatement

• Once an understanding of the entity is gained
  and documented then you must assess the risk of
  material misstatement at
• Financial statement level.
• Assertion level for
• Classes of transaction,
• Account balances, and
• Disclosures.

15
Assessing the risk of material misstatement

• STEP 1 Identify risks while you are obtaining
  an understanding of the entity. This will
  include considering risk of fraud or
  non- compliance with laws and regulations (see
  week 5).
• STEP 2 Relate the risks to what can go wrong at
  the assertion level.
• STEP 3 Consider if the risks are of a magnitude
  that could result in a material misstatement.
• STEP 4 Consider the likelihood of the risks
  causing a material misstatement.
• See examples page 135 of BPP.

16
Response to risk assessment

• Overall responses (Financial statement level)
• Professional scepticism among team.
• Additional staff.
• Using experts.
• More supervision.
• More unpredictability for audit procedures.

17
Response to risk assessment

• Responses at assertion level
• Tests of control.
• Substantive procedures.
• Timing
• Documentation

18
Desired level of assurance

• Auditors are required under CA 1985 to state an
  opinion.
• Therefore they need to give reasonable assurance
  that the financial statements are true and fair.
• And as such they want to be reasonably confident
  that the financial statements are not materially
  misstated and their opinion is correct.
• ISA 200 Objective and General Principles tries
  to define reasonable assurance. ( para 8-12)

19
Materiality and audit evidence

• Preliminary judgments about materiality are made
  at the planning stage of ALL audits for the
  purpose of determining audit effort.
• The calculation and estimation of materiality is
  based on experience and judgement.
• The more material an item is the more evidence is
  needed for its verification.
• Needs to be reviewed throughout the audit.

20
Applying materiality

• When determining the nature, timing and extent of
  audit procedures AND
• When evaluating the effects of misstatements.
• Note see BPP page 130 for table

21
Impact of materiality

• The auditor needs to consider
• Possibility of small amounts that accumulate into
  a large amount.
• Also consider the classes of transactions,
  account balances and disclosures.
• E.g. for disclosure of directors emoluments and
  related party transactions - materiality is
  irrelevant.

22
Materiality - Quantitative guidelines

• Threshold
• An amount equal to or greater than 10 of
  operating profit is regarded as material.
• An amount equal to or less than 5 of operating
  profit is regarded as immaterial.
• Other bases used
• Turnover (0.5-1)
• Total Assets (1-2)
• Net assets (2-5)
• Note Audit firms tend to have a range of values
  and take the one which most represents the
  business e.g. total assets for an investment
  company, or use an average or weighted average
  across the range

23
Materiality - Qualitative considerations

• Irregularities.
• Inadequate or improper description of accounting
  policy.
• Imposition of regulatory restrictions.
• Related party transaction or event requiring
  disclosure.
• Previous errors.

24
Materiality

• Materiality at the account balance level
• Evidence is gathered at the account balance
  level.
• To determine whether an individual account may be
  materially misstated it is necessary to find some
  method of allocating financial statement
  materiality to individual accounts.
• Tolerable error can be set at overall
  materiality level but is normally reduced to ¾ or
  ½ to take account of sampling risk.

25
Factors to be considered when accepting a
tolerable error rate.

• Significance of the account balance e.g. cash.
• The size of the account balance.
• The auditability of the account.
• Relative significance of over/under statement of
  the account balance e.g. overstated debtors and
  understated liabilities.
• The smaller the tolerable error the more
  evidence/testing is required.

26
Impact of audit risk on planning

• The risk that the auditor gives an inappropriate
  opinion on the financial statements.
• 2 elements to audit risk
• Risk that the financial statements contain a
  material misstatement.
• Risk that the auditors fail to detect any
  material misstatements.
• Some degree of audit risk is unavoidable.
• Components
• Inherent risk (IR)
• Control risk (CR)
• Detection risk (DR)

27
Inherent Risk

• Inherent risk
• A material misstatement will occur in the absence
  of controls.
• It is inherent to the business i.e. a riskier
  business will have a higher inherent risk.

28
Control risk

• Control risk
• Material misstatements will not be prevented,
  detected or corrected by the accounting and
  internal control system.

29
Detection risk

• Detection risk (comprises sampling and
  non-sampling risk)
• Material misstatements will not be detected by
  the auditor.
• This is the only component of audit risk that the
  auditors have any control over!

30
Components of audit risk

• These three components are multiplied together to
  give the total audit risk.
• AR IR x CR x DR
• Inherent and control risk are beyond the direct
  control of the auditor, therefore detection risk
  should be adjusted to achieve the desired level
  of audit risk.
• The emphasis on risk assessment is not only in
  the planning process but also throughout the
  audit.

31
Impact of audit risk on planning

• Audit firms focus is on an efficient,
  cost-effective audit and therefore they adopt a
  risk-based approach.
• Risk like materiality is ascertained at the
  overall level and the FSA level.
• Objective of risk-based auditing is
• To achieve maximum effectiveness and efficiency.
• To avoid under/over auditing.

32
Audit Risk, Materiality Planning

• There is an inverse relationship between
  materiality and the level of audit risk.
• The higher the materiality level the lower the
  level of audit risk.
• The lower the materiality level the higher the
  level of audit risk.

33
Management of audit risk

• Auditors want
• AUDIT RISKACCEPTABLE
• They cannot impact
• INHERENT AND CONTROL RISK
• Therefore they manipulate
• DETECTION RISK
• To ensure
• AUDIT RISKACCEPTABLE

34
Management of audit risk
AR IR x CR x DR Acceptable HIGH x HIGH x
has to be LOW!
AR IR x CR x DR Acceptable MEDIUM x LOW x
should be MEDIUM!
NOTE If control risk is high you wouldnt rely
on the Controls and wouldnt test them, instead
you would do More substantive tests on account
balances and classes Of transactions
35
Audit Risk, Materiality Planning

• Audits must be planned to ensure that
• Inherent risk is properly assessed.
• Internal control risk is properly evaluated.
• Sufficient appropriate substantive procedures are
  performed so that detection risk and therefore
  audit risk is reduced to an acceptable level.
• Hence in order to reduce the audit risk to an
  acceptable level, the auditor must carefully plan
  the nature, timing and extent of audit
  procedures.
• Lower materiality, higher audit risk and more
  substantive testing required!

36
Planning an internal audit

• Risk based internal audits
• Assessing.
• Evaluating and prioritising risk.
• In order to direct audit attention effectively.

37
Internal audit planning

• Strategic plan (2-5 years)
• Annual or periodic plan
• Operational / work plans

38

• The following stages are general for internal
  audit planning
• Identify the objectives of the organisation.
• Define internal audit objectives.
• Take account of relevant legal and regulatory
  changes.
• Obtain a comprehensive understanding of the
  systems, structure and operations.
• Identify, evaluate and rank risks to which the
  company is exposed.
• Take account of changes in structure and systems,
  or management concerns during the period.
• Identify audit areas by service, function and
  major systems.
• Determine the type of audit (VFM, systems etc.)
• Take account of any external audit or review
  plans.
• Assess staff resources and match to requirements.

39
Documenting the audit

• The auditor should prepare, on a timely basis,
  audit documentation that provides
• A sufficient and appropriate record of the basis
  for the auditors report, and
• evidence that the audit was carried out in
  accordance with ISAs and applicable legal and
  regulatory requirements.
• ISA 230 (Revised) Audit Documentation

40
Documenting the audit

• Documentation means
• Working papers prepared for and by and retained
  by the auditor.
• In connection with the performance of the audit.
• These may be in the form of papers, film and
  electronic media.

41
Working Papers

• Audit Documentation (Working Papers)
• Assist in planning and performance of the audit.
• Assist in supervision and review of the audit
  work (Note ISA 220 Quality Control).
• Enabling the audit team to be accountable for
  their work.
• Retaining a record of matters of continuing
  significance for future audits.
• They should be sufficiently complete and detailed
  to provide an overall understanding of the audit
  and to allow for quality control reviews and
  inspections by experienced auditors.

42
Form and Content of working papers

• Prepared to be sufficiently detailed and complete
  to allow an overall understanding of the audit,
  (even by an experienced auditor with no previous
  connection with the audit).
• The auditor should record the following
• The planning of the audit
• The nature, timing and extent of audit
  procedures
• The results of the procedures with relevant
  comments
• Significant matters arising during the audit and
• The conclusions drawn with respect to the account
  balance investigated.

43
Form and Content of working papers

• The extent of the working papers is
• Matter for professional judgement.
• Must consider what would be necessary to provide
  another auditor who has no previous experience
  with the audit an understanding of the work
  performed.
• It is never appropriate to follow mechanically a
  standard approach to the conduct and
  documentation of the audit, but you can
  standardise the format of working papers.

44
Use of IT in risk analysis and in the audit

• Assignment Complete slide