1. Lecture 2 Audit Engagement and Audit Planning
BA 202 Auditing
Lecture 2
Audit Engagement and Audit Planning

2. Increased Substantive Test Reduced Substantive Test
The Audit Process
Planning
Risk Assessment
Ascertaining & Recording of Accounting System & Internal Control
Preliminary Evaluation of Internal Control
Bad IC
Good IC
Increased Substantive Test
Compliance Test
Final Evaluation of IC
Bad IC
Good IC
Reduced Substantive Test
Final review and Concluding the Audit
Audit Report

3. Preliminary Engagement Activities
ISA 220
Continuance of the client relationship and specific audit engagement
Ethical requirements, including independent
ISA 210
Terms of engagement

4. Engagement Letter ISA 210
Sent to the client by auditors upon appointment
To confirm
Appointment
Scope of the audit
Objective of the audit
Extent of auditors responsibilities and reports

5. Engagement Letter AI 210
Circumstances require engagement letter to be revised?
Need to remind client of terms of engagement?
If change in terms, client and auditor must agree on the new terms.
Consider withdrawal & any obligation
(AI 250 para. 39 – 40)

6. Audit Planning
ISA 300 para.2 : The auditor should plan the audit work so that the audit will be performed in an effective manner
ISA 300 para. 13: The auditor should develop an audit plan for the audit in order to reduce audit risk to an acceptably low level

7. Audit Planning Conduct planning in accordance with
AI 300 Planning
AI 310 Knowledge of the Business
AI 230 para. 6 - Record in the working paper information on planning the audit work
AI 1005 – Audit of small business

8. Audit Planning AI 210 Term of audit engagement
AI 320 Audit materiality
AI 400 Risk Assessment
AI 530 Audit Sampling
AI 520 Analytical procedures
AI 620 Using the work of an expert
AI 4410 Engagement to compile financial information

9. Audit Planning – WHY PLAN?
Overall Audit Strategy and Direction
Identify laws and standards affecting the audit
Appropriate attention is devoted to important areas of audit
Potential problems are identified
Work is completed expeditiously

10. Audit Planning – WHY PLAN?
Assists proper assignment of work to assistance
Coordination of work done by other auditors and experts
Nature, timing, extend of audit procedures
Reduce risk of material misstatements
Conduct audit effectively and efficiently

11. Extent of planning Size of entity Complexity of audit
Auditor’s experience with entity
Auditor’s knowledge of business

12. Preliminary Planning Activities
Client Acceptance and Continuance
Assess Competence and Independence
Establishing the Terms of the Engagement

13. Audit Planning ISA300 para.8
The auditor should plan the audit so that the engagement will be performed in an effective manner.

15. Why auditor should obtained knowledge of business?
ISA 315 Understanding the Entity and its Environment and Assessing the Risks of Material Misstatement
Why auditor should obtained knowledge of business?
To enable the auditor to identify and understand the events, transactions and practices that, in the auditor’s judgment, may have a significant effect on the financial statements or on the examination of audit report.

16. Does the auditor need to know more than the management?
ISA 315 Understanding the Entity and its Environment and Assessing the Risks of Material Misstatement
Does the auditor need to know more than the management?
Generally no
How should auditor obtain the knowledge?
Preliminary knowledge prior to engagement
Further knowledge following year
Update and enhance information in subsequent years

17. Where are the sources of knowledge of the business?
ISA 315 Understanding the Entity and its Environment and Assessing the Risks of Material Misstatement
Where are the sources of knowledge of the business?
External sources
Prior years experience
Publication
Discussion with knowledgeable people
Internal sources
Discussion with management and staff
Documents produced by the entity

18. The general level of competence of management
ISA 315 Understanding the Entity and its Environment and Assessing the Risks of Material Misstatement
General economic factors and industry conditions affecting the entity’s business
Important characteristics of the entity, its business, its financial performance and its reporting requirements including changes since the date of the prior audit.
The general level of competence of management

19. General Economic Factors
ISA 315 Understanding the Entity and its Environment and Assessing the Risks of Material Misstatement
General Economic Factors
General Level of economic activity
Interest rates and availability of financing
Inflation, currency revaluation
Government policies (financial incentives
Foreign currency rates and controls

20. ISA 315 Understanding the Entity and its Environment and Assessing the Risks of Material Misstatement
The industry
The market and competition
Cyclical or seasonal activity
Changes in product technology
Business risk (ie high tech, high fashion)
Declining or expanding operations
Environmental requirements

21. The Entity - Management and ownership
ISA 315 Understanding the Entity and its Environment and Assessing the Risks of Material Misstatement
The Entity - Management and ownership
Corporate structure – private,public, government
Related parties
Capital structure
Organization structure
Management objectives, philosophy…
Board of Directors i.e. composition
Operating management
Internal audit function

22. ISA 315 Understanding the Entity and its Environment and Assessing the Risks of Material Misstatement
The Entity – Business
Nature of business
Location
Employment i.e. union, supply, pension
Products or services and markets i.e. major customers, contract, market share
Important suppliers of goods and services
Inventories i.e. location and quantities
Licenses, patents

23. ISA 315 Understanding the Entity and its Environment and Assessing the Risks of Material Misstatement
Legislation
Regulatory environment and requirements
Taxation
Measurement and disclosure issues peculiar to the business
Audit reporting requirements
Users of financial statements

24. Understanding the Accounting and Internal Control Systems ISA 315 & ISA 400
The accounting policies adopted by the entity and changes in those policies
The effect of new accounting or auditing pronouncements
The auditor’s cumulative knowledge of accounting and internal control systems and the relative emphasis expected to be placed on tests of control and substantive procedures

25. Nature, Timing and Extent of Procedures
Possible change of emphasis on specific audit areas
The effect of information technology on the audit
The work of internal auditing and its expected effect on external audit procedures.

26. Coordination, Direction, Supervision and Review
The involvement of other auditors in the audit of components for example subsidiaries, branches and divisions
The involvement of experts
The number of locations
Staffing requirements
Interim Audit and Pre-Final Audit

27. Other Matters
The possibility that the going concern assumption may be subject to questions
Conditions requiring special attention, such as the existence of related parties
The terms of the engagement and any statutory responsibilities
The nature and timing of reports or other communication with the entity that are expected under the engagement
Assessing risk of material misstatement

28. Audit Planning
Discuss overall audit plan and certain audit procedures with
audit committee
management
Staff
In order to improve effectiveness and efficiency of audit. However the overall audit plan and audit program remain the auditor’s responsibility.

29. Audit Program
The auditor should => develop and document an audit program setting out the nature, timing and extent of planned audit procedures required to implements the overall audit plan.

30. Audit Program What is audit program? Purpose of Audit Program?
An audit program consists of specific audit procedures are usually prepared for specific component of audit.
Purpose of Audit Program?
Example of an audit program
Standard?

31. Audit Program
In preparing audit program, the auditor would consider the specific assessments of inherent and control risks and the required level of assurance to be provided by substantive procedures

32. Changes of overall audit plan and audit program
The auditor should
Revised as necessary during the course of audit (because planning is continuous through the engagements)
Record reasons for significant changes

33. Analytical Procedures
To conduct review of financial statements in order to provide an insight into the financial positions of the business and to provide sufficient corroborative evidence to supports conclusion drawn from other source of evidence collected.

34. Analytical Procedures – ISA 520 para.8
The auditor should apply analytical procedures at the planning stage to assist in understanding the business and in identifying area of potential risk.

35. Analytical Procedures
Purposes of Analytical Procedures
Planning
Substantive Procedures
Overall review in final review stage of audit
Type of Analytical Procedures
Current year v. Prior Year
Current year v. budget/ projection or forecasts
Client Financial Info v. Industry data
Financial info v. Non Financial Info

36. Analytical Procedures
Short Term Liquidity Ratios
Current Ratio
Quick Ratio
Operating Cash Flow Ratio
Activity Ratios
Receivables Turnover and Days Outstanding in Account Receivables
Inventory Turnover and Days of Inventory on Hand

37. Analytical Procedures
Profitability Ration
Gross Profit Percentage
Profit Margin
Return on Assets
Return on Equity
Coverage Ratio
Debt to Equity
Times Interest Earned

38. Analytical Procedures
Effectiveness and Efficiency (especially for substantive procedures)
The nature of assertion or audit objective (unable to test ownership and individual transaction but effective to detect omission)
The plausibility and predictability of the relationship
The availability and reliability of data
The precision of the expectation

39. Analytical Procedures
Advantages
To improve the auditor’s understanding of the entity
To enable auditors to identify recorded value which varies from the auditor’s expectation
Identify unusual transactions, trends and events
Simple and easy to use
Limitations
Provides conclusions on reasonableness of data rather than precision
Less persuasive than test of details
Cannot easily be linked to specific assertions
Financial data analysis only
Require comparative figures/ratio to be meaningful

40. Analytical Procedures
From the industries below, what are the differences you would expect in relation to the components of its individual company’s financial statement (balance sheet/ income statement):
Trading
Services
Property Development
Bank
Trading - Stocks
Services - Human resources
Property Development - Property Development Account
Bank - Cash/Investment

41. Fundamental Concepts in Audit
Materiality
Audit Risk (Inherent/Control/Detection)
Reasonable Assurance
Going Concern
True and Fair View
Independence

42. Materiality AI 320
Information is material if its omission or misstatement could influence the economic decisions of users taken on the basis of the financial statements.
Materiality depends on the size of the item or error judged in the particular circumstances of its omission or misstatement.

43. Materiality ISA 320
Materiality provides a threshold or cut off point rather than being a primary qualitative characteristic which information must have if it is to be useful.
There is an inverse relationship between Materiality & level of Audit Risk
Eg: M AR
Auditor need to CR or DR

44. Common Bases and Qualitative Factors for Considering Materiality
Common Bases for Establishing Materiality:
Total Assets
Total Revenues
Net Income before Tax
Gross Profit
Average of 3 years’ Income before Tax
Selected Qualitative Factors for Assessing Materiality
Fraud or Non-Compliance with Laws or Regulations
Small amounts that might violate covenants in a contracts
Amounts that might affect the trend in earnings

45. Audit Risk ISA 400
Risk is a fundamental concept that underlies the audit process
Audit Risk =
Inherent Risk X Control Risk X Detection Risk

46. Detection Risk Assessment
Having Determined
Audit Risk
Inherent Risk
Control Risk
Detection Risk is just a balancing figures
DR = AR/ (IR X CR)

47. Assessment of Control Risk
Interrelationship of The Components of Audit Risk
AUDIT
RISK
Assessment of Control Risk
High
Medium
Low
Assessment of
Inherent
Risk
Lowest
Lower
Higher
Highest
Acceptable level of Detection Risk

48. Significant Risks ISA 315
Significant Audit Risks that require special audit considerations
Fraud
Related to recent significant economic, accounting or other development
Complexity of transactions
Related parties
Involved in measurement uncertainty
Outside normal course of business for the entity

49. Concept of Reasonable Assurance
A term that implies some risk that a material misstatement could be present in the financial statements without the auditor detecting it.
By expressing reasonable assurance, the auditor does not guarantee that material misstatements will be detected in an audit.
Hence, no absolute assurance due to certain inherent limitations in audit.

50. Concept of Reasonable Assurance
Factors that cause auditor to express reasonable assurance (pg of Messier and Margaret):
Use of testing in audit
Inherent limitations of internal control\
Audit Evidence is Persuasive and Not Conclusive
Use of Judgment

51. Types of Audit Tests
Test of Controls
Substantive Procedures

52. Test of Controls
The category of procedures aimed specifically to test the operating effectiveness of controls in preventing, detecting and correction material misstatements at the assertion level.
Ensure internal controls are operating in the manner intended

53. Substantive Procedures
Test performed to obtain audit evidence to detect material misstatements in the financial statement
Test of detail of transactions and balances
Analytical procedures

54. Working Papers - Overview
Permanent File
Correspondence File
Tax File
Current Audit File

55. Current Audit File - Overview
Planning
Overview
Risk Area
Materiality
Audit Objectives/Procedures
Analytical Review
Budget/ Team Members

56. Current Audit File - Overview
Secretarial Audit
Minutes/ Directors Resolutions
Audit Summary Memorandum
Audit Adjustments
Trial Balance
Audit Programme for respective section
Detail of working paper

57. Current Audit File - Overview
Detail Working Papers
Heading
Indexing and Cross Referencing
Tick Marks
Organization of working papers