Chapter 3 Audit Planning, Types of Audit Tests, and Materiality McGraw-Hill/IrwinCopyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
The Phases of an Audit That Relate to Audit Planning LO# 1 3-2
Preliminary Engagement Activities Determine the Audit Engagement Team Requirements Assess Compliance with Ethical Requirements, Including Independence LO# 2 3-3
Establish Terms of the Engagement The terms of the engagement, which are documented in the engagement letter, should include the objectives of the engagement, management’s responsibilities, the auditor’s responsibilities, and the limitations of the engagement. Who signs the engagement letter? In establishing the terms of the engagement, three topics must be discussed: 1.The engagement letter; 2.Using the work of the internal auditors; and 3.The role of the audit committee. LO# 3 3-4
The Engagement Letter The engagement letter formalizes the arrangement reached between the auditor and the client. In addition to the items mentioned in the sample engagement letter in Exhibit 3-1 in the textbook, the engagement letter may include: Arrangements for use of specialists or internal auditors. Any limitations of liability of the auditor or client. Additional services to be provided. Arrangements regarding other services. LO# 4 3-5
Internal Auditors LO# 5 3-6
The Audit Committee Subcommittee of the board of directors No specific requirements for privately held companies Section 301 of Sarbanes-Oxley Act requires the following for audit committee members of publicly held companies: Member of board of directors and independent. Directly responsible for overseeing work of any registered public accounting firm employed by the company. Must preapprove all audit and nonaudit services provided by its auditors. Must establish procedures to follow for complaints. Must have authority to engage independent counsel. LO# 6 3-7
Planning the Audit When preparing the audit plan, the auditor should be guided by the results of the client acceptance/continuance process, procedures performed to gain an understanding of the entity, and preliminary engagement activities. Additional steps: Assess business risks. Establish materiality. Consider multilocations. Assess the need for specialists. Assess the possibility of illegal acts. Identify related parties. Consider additional value-added services. Let’s look at each of these steps. LO# 7 3-8
Document Audit Strategy LO# 7 3-9
Types of Audit Tests Risk Assessment Procedures Used to obtain an understanding of the entity and its environment, including its internal control. Tests of Controls Directed toward the evaluation of the effectiveness of the design and operation of internal controls. Substantive Procedures Detect material misstatements in a transaction class, account balance, and disclosure component of the financial statements. LO#
Materiality The magnitude of an omission or misstatement of accounting information that makes it probable that the judgment of a reasonable person relying on the information would be changed or influenced by the omission or misstatement. Materiality is not an absolute and it is not a black or white issue! The determination of materiality requires professional judgment. LO#
Steps in Applying Materiality on an Audit Step 1: Determine a materiality level for the overall financial statements (planning materiality) Step 1: Determine a materiality level for the overall financial statements (planning materiality) Step 2: Determine tolerable misstatement (allocation of materiality at individual account/class of transactions level) Step 2: Determine tolerable misstatement (allocation of materiality at individual account/class of transactions level) Step 3: Evaluate auditing findings (near the end of the audit) Step 3: Evaluate auditing findings (near the end of the audit) LO#
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