Audit Planning and Analytical Procedures

Auditing Theory and Practice Guide: Racaza

Group 2
NOTES

Objectives:

1.Discuss why adequate audit planning is essential.

2. Describe the nature and extent of audit planning.

3. Describe the steps in the planning process.

4. Identify the requirements in establishing the terms of engagements.

5. Identify how an auditor obtains knowledge of the client's industry and business.

6. State the purposes of analytical procedures and the timing of each purpose.

7. Define related party and explain its importance to the auditor.

8. Explain the purpose of an audit program and considerations for audit program design.

9. Describe the timing, staffing, and budgeting factors in planning an audit.

Audit Planning

⮚ It involves developing general strategy and a detailed approach for the expected nature, timing
and extent of the audit.

Adequate planning of the audit is important because:

● Devotes appropriate attention to important areas of the audit

● Helps identify potential problems on a timely basis

● Ensures audit engagement is properly organized and managed in order to be performed in an

effective and efficient manner

● Assists in selection of engagement team members

● Facilitates the direction and supervision of engagement team members

● Assist in the coordination of work done by auditors of components and experts.

Nature and Extent of Planning

Will vary according to:

a) Size of the entity

b) Auditor’s experience with the entity
c) Changes that occur during audit engagement

• Planning is not discrete phase of an audit, but rather a continual and iterative process that
often begins shortly after the completion of the previous audit and continues until the
completion of the current audit engagement.

CLIENT CONTACT AND ACCEPTANCE:

a. CLIENT ACCEPTANCE and CONTINUANCE

⮚ Audit process begins when a potential client contacts the auditor for a proposal on possible
engagement.

⮚ The integrity of management and the auditability of the potential client are considered
before acceptance.

▪ Client needs to possess the technical standards and professional competence required to fulfill audit
responsibilities with due care.

Acceptance and continuance of client relationships and specific audit engagements include considering:

a) The integrity of the principal owners, key management and those charged with governance of
the entity;
b) Whether the engagement team is competent to perform the audit engagement and has the
necessary time and resources; and
 c) Whether the firm and the engagement team can comply with ethical requirements

Communications with predecessors

⮚ About matters that might influence the decision to accept the engagement

⮚ Authorization of prospective client must be obtained

⮚ Inquiry about integrity of management, disagreements over accounting or auditing issues and
the predecessor's understanding of the reason for a change in auditors

Responsibility of Predecessors Auditor

⮚ Respond to the prospective incoming auditor's inquiries

⮚ State that the response is limited

⮚ Limit the prospective incoming auditor access to working papers

TERMS OF ENGAGEMENT

ENGAGEMENT LETTER documents and confirms the auditor's acceptance of the appointment, the
objective and scope of the audit, the extent of the auditor's responsibilities to the client and the form of
any reports.

OTHER ASPECTS of the TERMS of AUDIT ENGAGEMENT

a. Audits of Components

⮚ Who appoints the auditor of the component

⮚ Whether a separate audit report is to be issued on the component

⮚ Legal requirements

⮚ The extent of any work performed by other auditors

⮚ Degree of ownership by parent

⮚ Degree of independence of the component's management

b. Recurring Audits:

⮚ Any indication that the client misunderstands the objective and scope of the audit

⮚ Any revised or special terms of the engagement

 ⮚ A recent change of senior management, board of directors or ownership

⮚ A significant change in nature or size of the client's business

⮚ Leal requirements and other government agencies' pronouncements

c. Acceptance of a Change Engagement:

⮚ The client may request a change of the audit to another related service that provides a lower
level of assurance such as a review or compilation engagement, before the completion of the
audit examination.

GENERAL PLANNING

1) Obtain understanding of client' business & industry

2) Conduct preliminary analytical procedures
3) Establish materiality & audit risk
4) Assess client business risk
5) Review internal control for strategy purposes
6) Assessing the possibility for errors, fraud, and illegal acts
7) Identify related parties & related party transactions
8) Consider other planning issues
o Internal Audit
o Work of Experts
9) Develop overall audit strategy
10) Prepare engagement planning memorandum

General Planning

❑ It includes understanding of

 Client's industry environment,

 Business and management, accounting
 And reporting systems and internal controls

1. Obtain understanding of client' business & industry

- According to PSA 315(Red), understanding the entity and its environment serves as
frame of reference within which the auditor plans the audit and exercise
professional judgment about assessing risks of material misstatements and
responding to them.
Sources of Information:

a) Reviewing prior year’s working paper

b) Inquiring about current developments
c) Reviewing current year financial statements
d) Touring client’s facilities
e) Reading minutes of meeting of shareholders and BODs
f) Reviewing economic conditions

2. Conduct preliminary analytical procedures

- Analytical procedures involve evaluations of financial statement information
- Analytical procedures consist of the analysis of significant ratios and trends

Analytical Procedures Used in Planning the Audit

1. Simple comparisons
2. Ratio analysis
3. Common-size statements
4. Trend statements
5. Time series analysis

3. Establish materiality & audit risk

- Their anticipated reliance on internal controls on prior-year findings
- The greater the anticipated reliance on intern control (lower control risk), the less
substantive tests the auditor will plan to perform.

4. Assess Client Strategic Business Risk

❑ The auditor must understand how the entity fits within industry, including the entity's position
within the industry in terms of

(1) Profitability and market share;

(2) Opportunities and plans the entity has for increasing or maintaining profitability and
market share;

(3) Threats to the entity's position in the industry;

(4) Ways the entity deals with customers and competitors; and

(5) Methods the entity uses to measure and monitor its performance.

5. Review internal control for strategy purposes

 - Often auditors base their anticipated reliance on internal controls on prior-year
findings.

6. Assessing the possibility for errors, fraud, and illegal acts

Circumstances Indicating an Increased Risk of Errors or Fraud

✔ Analytical procedures disclose differences from expectations.

✔ Unreconciled differences between a control account and subsidiary records

✔ Confirmation requests disclose significant differences or a lower than expected response rate

✔ Lack of proper documentation or authorization for transactions

✔ Errors known to client personnel not voluntarily disclosed to the auditor

Circumstances Indicating an Illegal Acts

✔ Unauthorized transactions

✔ Investigation by a governmental agency or payment of unusual fines or penalties

✔ Violations of laws or regulations

✔ Large payments to consultants, affiliates, and/or employees for unspecified

✔ Sales commissions or agents' fees that appear excessive

✔ Unusually large payments in cash or bank cashiers' checks

✔ Unexplained payments to government officials

✔ Failure to file tax returns or pay government duties and fees

7. Identify Related Parties and Related Party Transactions

Auditor’s Primary Concerns:

(1) That all material related-party transactions are adequately disclosed and

(2) That all related-party transactions are recorded so as to reflect economic substance rather
than form.
Potential Related Party Indicators

a) Agreements under which one party pays expenses on behalf of another party

b) Circular arrangements between related parties

c) Engaging in business deals at more or less than market value

d) Identification of an unidentified related party

e) Inadequate disclosures

f) Payments of services at inflated prices

g) Revenue recognition

h) Sale of land with arranged financing

i) Sale of Securities

j) Sales without substance

k) Services or goods are purchased from a party at little or no cost

l) Unusual, material transactions, particularly close to quarter or year-end

m) Utilization or related party to mitigate market risks

8. Consider other planning issues

1. Using the Work of Internal Auditors

- The key concerns that the external auditor must address are whether the internal auditor are
competent, objective and sufficiently independent of management to generate unbiased conclusion.

2. Work of Experts

- Auditors may encounter situations that require special knowledge of a non-accounting nature

 When using the work of an outside expert, the auditor should:

a) Evaluate experts professional qualifications
b) Understand the expert's work
c) Examine the form and content of the expert's findings
d) Understand the experts relationship with the client
 9. Develop overall audit strategy

Audit Approach should be developed from an:

(1) Understanding of the client's business

(2) Evaluation of inherent risks

(3) Review of internal control for strategy purposes

-The strategy should be supported by a budget and timetable

10. Prepare Engagement Planning Memorandum

Engagement Planning Memorandum

- an overview of planned audit activity by staff level

- describes in general terms the audit approach intended for each area

Planning Implementation

• Audit Program Design

• Timing Considerations
• Staffing
• Time Budgets

1. Planning Implementation

Audit program - serves as a set of instructions to assistants involved in the audit and as a means of
control and record the proper execution of the work.

Audit program contains:

(1) objective for each area

(2) the audit procedures to be performed to achieve the objective

(3) the budgeted time to complete the examination

2. Timing Considerations

Time budget - identifies the amount of time to be spent on each program item
Generally, the audit work is divided into two phases:

1) Interim Work - performed before year-end

2) Year-End Work - performed on or after the year-end

3. Staffing

- Audit firms, according to PSA 220(Red), need to assign the audit work to personnel who have
the degree of technical training and proficiency required in the circumstances.

4. Time Budgets
- For the engagement to be cost-effective, auditors use the time budget, which is simply a
conversion of the professional audit fee into number of hours allocated to each member
of the audit team and to each audit area.