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

2. 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

3. 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

4. Copyright © 2007 Pearson Education Canada 11-4 Practice problem 11-20 (p. 336)  Assessing evidence mix  Why do different work on the same cycles at different locations?

5. 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

6. 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.

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

8. 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

9. 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.

10. Copyright © 2007 Pearson Education Canada 11-10 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)

11. Copyright © 2007 Pearson Education Canada 11-11 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

12. Copyright © 2007 Pearson Education Canada 11-12 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

13. Copyright © 2007 Pearson Education Canada 11-13 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

14. Copyright © 2007 Pearson Education Canada 11-14 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

15. Copyright © 2007 Pearson Education Canada 11-15 Tests of details of balances  Audit tests: – Physical examination – Direct communication – Examine documentation – Client inquiry – Reperformance (includes mechanical accuracy)

16. Copyright © 2007 Pearson Education Canada 11-16 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

17. Copyright © 2007 Pearson Education Canada 11-17 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

18. Copyright © 2007 Pearson Education Canada 11-18 Practice problem 11-15 (p. 334)  Check your understanding of audit tests  Identify the purpose of each audit test and identify the evidence

19. Copyright © 2007 Pearson Education Canada 11-19 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

20. Copyright © 2007 Pearson Education Canada 11-20 Practice problem 11-19 (p. 335)  Three different situations  What type of evidence mix would you recommend?

21. Copyright © 2007 Pearson Education Canada 11-21 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

22. Copyright © 2007 Pearson Education Canada 11-22 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

23. Copyright © 2007 Pearson Education Canada 11-23 Methodology for designing tests of controls

24. Copyright © 2007 Pearson Education Canada 11-24 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)

25. Copyright © 2007 Pearson Education Canada 11-25 Practice problem 11-16 (pp. 334-35)  Practice distinguishing between manual, computer-assisted or fully automated controls  Identify how these controls would be tested

26. Copyright © 2007 Pearson Education Canada 11-26 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

27. Copyright © 2007 Pearson Education Canada 11-27 Methodology for designing tests of details of financial statement balances– accounts receivable

28. Copyright © 2007 Pearson Education Canada 11-28 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

29. Copyright © 2007 Pearson Education Canada 11-29 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

30. Copyright © 2007 Pearson Education Canada 11-30 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

31. Copyright © 2007 Pearson Education Canada 11-31 Practice problem 11-21 (p. 336)  Test your understanding of the audit process  What is the order of task completion?