©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley Overall Audit Plan and Audit Program Chapter 13

©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley Learning Objective 1 Use the five types of audit tests to determine whether financial statements are fairly stated.

©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley Types of Tests Risk assessment: BR, FR, AR, IR, CR, and DR Note: BR and FR feed into AR, IR, and CR Tests of control-credit check performed → CR → DR Substantive tests of transactions- trace doc. from ship. to g/l (comp) trace from g/l to ship. (exist) Analytical procedures – compare sales acct. to expect. Tests of details of balances – confirm A/R accounts

©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley Types of Audit Tests and the Audit Risk Model Audit Risk Model Procedures to obtain an understanding of internal control Tests of controls (TOC) Substantive tests of transactions (STOT) Types of Audit Tests ++ AAR IR × CR = PDR

©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley Types of Audit Tests and the Audit Risk Model Analytical procedures (AP) Tests of details of balances (TDB) Sufficient appropriate evidence per GAAS + = AAR IR × CR = PDR Audit Risk Model Types of Audit Tests

©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley Role of all Audit Tests in the Sales and Collection Cycle Sales Accounts Receivable Cash in Bank Sales transactions Cash receipts transactions Ending balance Ending balance TOC + STOT + AP + TDB = Sufficient appropriate evidence per GAAS Audited by TOC, STOT Audited by AP and TDB Audited by TOC, STOT Audited by AP and TDB Ending balance

©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley Learning Objective 2 Select the appropriate types of audit tests.

©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley Relationship Between Types of Tests and Evidence Type of Test Procedures for internal control Tests of controls Substantive tests of transactions Analytical procedures Tests of details of balances Physical Examination Confirmation Documentation Observation     Type of Evidence

©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley Relationship Between Types of Tests and Evidence Type of Test Procedures for internal control Tests of controls Substantive tests of transactions Analytical procedures Tests of details of balances Inquiries of the client Reperformance Analytic procedures      Type of Evidence Recalculation  

©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley Audit Assurance at Different Levels of Internal Control Effectiveness Acceptable assurance No assurance INTERNAL CONTROL EFFECTIVENESS Weak controlStrong control Reliance on controls: C 3 – None, C 2 – Some, C 1 – Maximum Audit assurance from control risk assessment and tests of control Audit assurance from substantive tests ACB C3C3 C2C2 C1C1 AUDIT ASSURANCE

©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley Learning Objective 3 Understand how information technology affects audit testing.

©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley Impact of Information Technology on Audit Testing SAS 80 (AU 326) and SAS 94 (AU 319) and SAS 109 provide guidance for auditors of entities that transmit, process, maintain, or access significant information electronically. Computer assisted audit techniques may be used to test automated controls or data. Examples? IT audit specialists, timing of tests/availability of ONLINE/INTERNAL documentation, MAX CR? – Can’t get DR low enough w/ subst. tests

©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley Learning Objective 4 Understand the concept of evidence mix and how it should be varied in different circumstances.

©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley Variations in Evidence Mix Procedures to Obtain an Understanding of Internal Control Tests of Controls Audit 1EE Audit 4MM Amount of testing: Extensive, Medium, Small, None

©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley Variations in Evidence Mix Substantive Tests of Transactions Analytical Procedures Tests of Details of Balances Audit 1S ES Audit 4E EE Amount of testing: Extensive, Medium, Small, None

©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley Learning Objective 5 Design an audit program.

©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley Audit Program Part 1: Tests of controls and substantive tests of transactions Part 2: Analytical procedures Part 3: Tests of details and balances

©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley Audit Procedures - Transactions 1.Apply the transaction-related audit objectives to the class of transactions (cycle) being tested. Ex. All shipments are recorded as sales (completeness) 2. Identify key controls that should reduce control risk for each audit objective: checklist and matrix. Ex. Weekly rec of units shipped to units billed 3. Develop appropriate tests of controls –> final CR 4. Given DR, design substantive tests of transactions.

©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley Methodology for Designing Controls and Substantive Tests of Transactions Perform procedures to understand internal control. P. Assess control risk. Evaluate cost-benefit of testing controls. Design tests of controls and substantive tests of transactions to meet transaction-related audit objectives. Audit procedures/Staffing Sample size/Budget Items to select Timing

©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley Why ToC and ToT at the Same Time?? Efficiencies!!!! Time = Cost! Take a sample of 25 sales journal entries: Dr. A/R$xxxxx Cr. Sales$xxxxx ToC for Occurrence – test for credit check/cust. approval. ToT for Occurrence – trace AMOUNT from J/E to invoice to shipping doc to Purchase Order. Simultaneous testing requires us to have a prel. CR!!

©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley Methodology for Designing Tests of Balances – Accounts Receivable Determine acceptable audit risk. Set tolerable misstatement and assess inherent risk for accounts receivable. Assess control risk for sales and collection cycle.

©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley Methodology for Designing Tests of Balances – Accounts Receivable Design and perform tests of controls and substantive tests of transactions for sales and collection cycle. Get final CR. Design and perform analytical procedures for accounts receivable balance.

©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley Methodology for Designing Tests of Balances – Accounts Receivable Design tests of details of accounts receivable balance to satisfy balance-related audit objectives. Audit procedures/Staffing Sample size/Budget Items to select Timing

©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley Approach to Designing Tests of Details of Balances Apply balance- related audit objectives to an account balance. Design tests of details of balances. Decide tolerable misstatement. Make preliminary judgment about materiality. Design analytical procedures, ToT and assess CR Decide acceptable audit risk. Assess inherent risk. Assess client business risk.

©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley Learning Objective 6 Compare and contrast transaction-related audit objectives with balance- related audit objectives and presentation and disclosure-related audit objectives.

©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley Relationship of Transaction-related Audit Objectives to Balance-related Audit Objectives Transaction- related Audit Objective Balance- related Audit Objective Nature of Relationship Occurrence Completeness Accuracy Posting and summarization Classification Timing Existence or completeness Completeness or existence Accuracy Detail tie-in Classification Cutoff Realizable value Rights and obligation Direct None What about Presentation and Disclosure Objectives??

©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley Learning Objective 7 Integrate the four phases of the audit process.

©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley Summary of the Audit Process Phase I Phase II Phase III Phase IV Plan and design an audit approach. Perform tests of controls and substantive tests of transactions. Perform analytical procedures and tests of details of balances. Complete the audit and issue an audit report.

©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley Summary of the Audit Process Phase I Accept client and perform initial planning. Understand the client’s business and industry. Assess client’s business risk and fraud risk. Perform preliminary analytical procedures. Set materiality and assess acceptable audit risk and inherent risk. Understand internal control and pr. assess control risk. Develop overall audit plan and audit program.

©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley Summary of the Audit Process Phase II Perform tests of controls. Perform substantive tests of transactions. Plan to reduce assessed level of control risk below max? Yes No

©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley Summary of the Audit Process Phase III Perform analytical procedures. Perform tests of details of balances. LowMediumHigh Dependent upon CR/DR and ToT

©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley Summary of the Audit Process Phase IV Review for contingent liabilities. Review for subsequent events. Evaluate results / audit adjustments. Issue audit report. SOX – opinion on I/C Communicate with audit committee and management. Perform additional tests for presentation and disclosure

©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley End of Chapter 13