Copyright © 2007 Pearson Education Canada 1 Chapter 11: Overall Audit Plan and Audit Program

Copyright © 2007 Pearson Education Canada 11-2 Chapter 11 objectives  Examine the four different types of audit tests  How does the auditor choose evidence mix: the types of audit tests to be completed?  Discuss the process for designing an audit program  Describe the audit strategy and the four phases of the financial statement audit

Copyright © 2007 Pearson Education Canada 11-3 Types of audit tests Procedures to obtain an understanding of internal control + Tests of controls + Analytical procedures + Tests of details of balances = Sufficient competent evidence per GAAS

Copyright © 2007 Pearson Education Canada 11-4 Practice problem (p. 336)  Assessing evidence mix  Why do different work on the same cycles at different locations?

Copyright © 2007 Pearson Education Canada 11-5 Procedures to obtain an understanding of internal control  Update and evaluate the auditor’s previous experience with the entity  Inquiries of client personnel  Review of client’s policy and systems manuals  Examine documents and records  Observe entity activities and operations

Copyright © 2007 Pearson Education Canada 11-6 What is the purpose of tests of controls?  To obtain evidence regarding the effectiveness of controls (which may allow the auditor to assess control risk at a level below maximum).  If controls are to be relied upon then substantive evidence may be reduced.

Copyright © 2007 Pearson Education Canada 11-7 Tests of controls (review)  Transaction-related audit objectives: – Occurrence – Completeness – Accuracy – Classification – Timing – Posting and Summarization

Copyright © 2007 Pearson Education Canada 11-8 Tests of controls  Audit tests used for tests of controls: – Inquiry – Examination – Observation – Reperformance  Similar to procedures used to obtain an understanding of controls

Copyright © 2007 Pearson Education Canada 11-9 Tests of controls are …  Audit procedures designed to verify whether the client’s controls match the auditor’s understanding of those controls (as documented in flowcharts or questionnaires).  Examples include: – Examination of employee time cards for approval of overtime hours worked. – Examination of journal entries for proper approval.

Copyright © 2007 Pearson Education Canada Methodology for designing tests of controls  Perform procedures to understand internal control  Assess control risk  Evaluate cost-benefit of testing controls  Design tests of controls to meet transaction-related audit objectives (audit procedures, sample size, items to select, timing)

Copyright © 2007 Pearson Education Canada Dual-purpose tests  A substantive test is a procedure designed to test for dollar amounts of errors or fraud and other irregularities directly affecting the correctness of financial statement balances  When an auditor conducts an auditing procedure that is both an internal control test and a substantive procedure it is a dual-purpose test

Copyright © 2007 Pearson Education Canada Tests of details of balances  Substantive procedures are performed in order to detect material misstatements at the assertion level. Consist of: – Tests of details of balances, that focus on the ending general ledger balances and – Analytical procedures – Dual-purpose tests

Copyright © 2007 Pearson Education Canada Analytical procedures (review)  Purpose: – Understand business – Assess going concern – Identify potential misstatements – Reduce tests of detail  Procedures: – Compare to industry – Compare to prior years – Calculate ratios/trends – Inquiry for follow up

Copyright © 2007 Pearson Education Canada Tests of details of balances  Balance-related audit objectives: – Existence – Completeness – Realizable value – Accuracy – Classification – Cut-off – Detail Tie-in – Rights and Obligations – Presentation & Disclosure

Copyright © 2007 Pearson Education Canada Tests of details of balances  Audit tests: – Physical examination – Direct communication – Examine documentation – Client inquiry – Reperformance (includes mechanical accuracy)

Copyright © 2007 Pearson Education Canada Examples of tests of details  Examination of vendor invoices in support of amounts recorded for purchases of inventories  Recalculation of payroll amounts  Physical examination of inventory

Copyright © 2007 Pearson Education Canada Which evidence is used for which type of audit test?  Physical examination (tests of details)  Confirmation (tests of details)  Observation (Understanding of & tests of controls)  Inquiry (all four types)  Mechanical accuracy or reperformance (tests of controls and tests of details)  Analytical procedures

Copyright © 2007 Pearson Education Canada Practice problem (p. 334)  Check your understanding of audit tests  Identify the purpose of each audit test and identify the evidence

Copyright © 2007 Pearson Education Canada Evidence mix: it is a trade-off of  Low cost versus high quality of the audit tests – Analytical procedures – Tests of controls – Tests of details  Auditor uses professional judgment to determine the mix of audit tests

Copyright © 2007 Pearson Education Canada Practice problem (p. 335)  Three different situations  What type of evidence mix would you recommend?

Copyright © 2007 Pearson Education Canada Designing the audit program  Most audits use a combined approach: includes both tests of controls and substantive procedures  The audit program is normally split into three parts: – Tests of controls – Analytical procedures – Tests of details

Copyright © 2007 Pearson Education Canada Analytical procedures  Are conducted at each phase of the audit: – During knowledge of business would include overview calculations and comparisons to other business or within the industry – Use of analytical procedures during other phases is discussed in Chapter 6 and within each chapter that examines specific transaction cycles

Copyright © 2007 Pearson Education Canada Methodology for designing tests of controls

Copyright © 2007 Pearson Education Canada Tests of controls audit program  Based upon the descriptive section documenting the understanding obtained about internal control  If cost-beneficial, tests of controls would be conducted for key controls upon which the auditor intends to rely  Audit program is normally listed in a performance format (i.e. in the order in which tests will be conducted)

Copyright © 2007 Pearson Education Canada Practice problem (pp )  Practice distinguishing between manual, computer-assisted or fully automated controls  Identify how these controls would be tested

Copyright © 2007 Pearson Education Canada Before we design substantive tests for accounts receivable we need to:  Set audit risk (overall)  Set materiality (overall and assertion)  Assess inherent risk (overall and assertion)  Assess control risk for sales and collection cycle and at the assertion level  Design, predict results for and conduct tests of controls and analytical procedures for sales and collection cycle

Copyright © 2007 Pearson Education Canada Methodology for designing tests of details of financial statement balances– accounts receivable

Copyright © 2007 Pearson Education Canada Comparing two situations  Results of assessed control risk: Good – Results of tests of controls: Good  Results of analytical procedures: Good – Minimal tests of details required  Results of assessed control risk: Poor – No tests of controls completed  Results of analytical procedures: Good – Medium tests of details required

Copyright © 2007 Pearson Education Canada Comparing two more situations  Results of assessed control risk: Good – Results of tests of controls: Good  Results of analytical procedures: Poor or not performed – Medium tests of details required  Results of assessed control risk: Poor – No tests of controls completed  Results of analytical procedures: Poor or not performed – Extensive tests of details required

Copyright © 2007 Pearson Education Canada Review of audit phases 1.Plan and design an audit approach 2.Perform tests of controls 3.Perform analytical procedures and tests of details of balance 4.Complete the audit

Copyright © 2007 Pearson Education Canada Practice problem (p. 336)  Test your understanding of the audit process  What is the order of task completion?