DESIGN OF THE AUDIT PROGRAM

After we determine the appropriate emphasis on each of the other four

types of tests, the specific audit procedures for each type of test must be
designed. These audit procedures are then combined to form the audit
program. Firstly, we talk about designing audit programs to satisfy
transaction-related and balance-related audit objectives. The audit
program for most audits is designed in three additional parts: tests of
controls and substantive tests of transactions, substantive
analytical procedures, and tests of details of balances.

Each transaction cycle will likely be evaluated using a separate set of sub-
audit
programs. In the sales and collection cycle, for example, the auditor might
use:
A test of controls and substantive tests of transactions audit program for
sales
and cash receipts
A substantive analytical procedures audit program for the entire cycle
Tests of details of balances audit programs for cash, accounts
receivable, bad
debt expense, allowance for uncollectible accounts, and miscellaneous
accounts
receivable.

Tests of Controls and Substantive Tests of Transactions

The tests of controls and substantive tests of transactions audit program
normally includes a descriptive section documenting the understanding of
internal control obtained during the performance of risk assessment
procedures . It likely to include a description of the procedures performed
to obtain an under standing.

..

Audit Procedures

When designing tests of controls and substantive tests of trans - actions,

auditors emphasize satisfying the transaction-related audit objectives

Auditors follow a four-step approach to reduce assessed control risk

1. Apply the transaction-related audit objectives to the class of
transactions being tested, such as sales.
2. Identify key controls that should reduce control risk for each
transactionrelated audit objective.
3. Develop appropriate tests of controls for all internal controls that are
used to
reduce the preliminary assessment of control risk below maximum (key
controls).
4. For potential types of misstatements related to each transaction-related
audit
objective, design appropriate substantive tests of transactions,
considering
deficiencies in internal control and expected results of the tests of controls
in
step 3.

Analytical Procedures
Because substantive analytical procedures are relatively inexpensive,
many auditors perform them on all audits. Accounts receivable, are
typically more focused and more extensive than those done as part of
planning. The auditor is likely to use disaggregated data to increase the
precision of the auditors expectations. Analytical procedures calculated
using monthly amounts will typically be more effective in detecting
misstatements than those calculated using annual amounts, and
comparisons by line of business will usually be more effective than
companywide comparisons. If sales and accounts receivable are based on
predictable relationships with nonfinancial data, the auditor often uses
that information for analytical procedures.

When the auditor plans to use analytical procedures to provide

substantive assurance about an account balance, the data used in the
calculations must be considered sufficiently reliable. This is true for all
data, especially nonfinancial data. For example, if auditors estimate total
revenue using hours billed and the average billing rate, they must be
confident that both numbers are reasonably reliable.

Tests of Details of Balances

To design tests of details of balances audit procedures, auditors use a
methodology oriented to the balance-related audit objectives. If the
auditor is verifying accounts receivable, for example, the planned audit
pro cedures must be sufficient to satisfy each of the balance-related audit
objectives. to satisfy these objectives, many auditors follow a
methodology such as the one shown in Figure 13-6 for accounts
receivable. The design is normally the most difficult part of the entire
planning process
because it is subjective and requires considerable pro fessional judgment.

Lets discuss the key decisions in designing tests of details of balances

audit procedures as shown in Figure 13-6.

Identify Client Business Risks Affecting Accounts Receivable

In this part, the auditor identifies and evaluates significant client business
risks to determine whether they result in increased risk of material
misstatements in the financial statements. If the auditor indentifies a
significant risk due to fraud and error, and auditor should identify client
controls to mitigate the risk. After that, the auditor will assess inherent
risk. In assessing inherent risk of accounts, Account balances for which
inherent risk has been assessed as high will result in more evidence
accumulation than for an account with low inherent risk. Inherent risk also
can be extended to individual balance-related audit objectives. For
example, adverse economic conditions in the clients industry may make
the auditor conclude that a high risk of uncollectible accounts receivable.

Set the Performance Materiality

Auditors must decide the preliminary judgment about materiality for the
audit as a whole and then allocate the total to account balances, to
establish Performance Materiality for each significant balance. For a lower
tolerable misstatement, more testing of details is required, and vice versa.

Assess Control Risk for the Sales and Collection Cycle

The methodology for evaluating control risk will be applied to both sales
and cash receipts in the audit of accounts receivable. Effective controls
will reduce control risk and, along with it, the amount of evidence required
for substantive tests of transactions and tests of details of balances.
Inadequate controls will increase the substantive evidence needed.

Design and Perform Tests of Controls and Substantive Tests of

Transactions for the Sales and Collection Cycle
Tests of controls and substantive tests of transactions are designed with
the expectation that certain results will be obtained. These predicted
results affect the design of tests of details of balances.

Design and Perform Analytical Procedures for Accounts

Receivable Balance

For two purposes: to identify possible misstatements in the account

balance and to reduce detailed audit tests. The results of substantive
analytical procedures directly affect the extent of tests of details of
balances.

Design Tests of Details of Accounts Receivable Balance to Satisfy

Balance Related Audit Objectives

It includes audit procedures, sample size, items to select, and timing.

Procedures must be selected and designed for each account and each
balance-related audit objective within each account.

A difficulty auditors face in designing tests of details of balances is the

need to predict the outcome of the tests of controls, substantive tests of
transactions, and substantive analytical procedures before they are
performed. In planning tests of details of balances, the auditor usually
predicts few or no exceptions will occur in tests of controls, substantive
tests of transactions, and substantive analytical procedures. If they are
not consistent with predicted results, the auditor should change the tests
as process.

Figure 13-7 summarizes the discussion about the approach to designing

tests of details of balances applied to accounts receivable. The light
shaded boxes on the left side of the figure correspond to the design of
tests of controls and substantive tests of transactions, as presented in
Figure 13-5 (p. 416). Figure 13-7 builds on Figure 13-5 by also showing
how tests of controls and substantive tests of transactions affect the
design of test of details of balances.
One of the most challenging parts of auditing is properly applying the
factors that affect tests of details of balances.

Figure 13-8 shows the primary planning activities and the levels of
disaggregation normally applied. These levels of disaggregation range
from the overall audit to the balancerelated audit objective for each
account. For example, risk assessment procedures related to obtaining
background information about the clients business and industry pertain to
the overall audit. Auditors will first use that information in assessing
acceptable audit risk for the engagement as whole. They will then use
information about the client and industry obtained through risk
assessment procedures to assess inherent risk for specific audit
objectives. As the audit progresses, they will likely use that information
when making decisions about tests of details of balances. Similarly, the
auditor will first assess the risk of fraud for the overall audit, and later
consider whether any fraud risks exist that may affect fraud risk
assessments for specific accounts and the audit procedures and sample
sizes for tests of details of balances for accounts that are affected.

Illustrative Audit Programs

Auditing standards require the auditor to use a written audit program.
Table 13-4 shows the tests of details of balances segment of an audit
program for accounts receivable. The format used relates the audit
procedures to the balance-related audit objectives. Notice that most
procedures satisfy more than one objective, and that more than one audit
procedure is used for each objective. Audit software helps auditors select
appropriate audit procedures and organize them into an audit program,
considering inherent and control risk and other planning considerations.
Summary of key evidence related term
Phases of the Audit Process

The four phases of the audit process in the first column are the primary
way that audits are organized
Audit Objectives

These are the objectives on an audit that must be met before the auditor
can conclude that any given class of transactions or account balance is
fairly stated. here are six transaction-related, eight balance-related, and
four presentation and disclosure-related audit objectives, all of which are
listed in Table 13-6 .

Types of Tests

The five types of audit tests discussed earlier in the chapter that auditors
use to determine whether financial statements are fairly stated are
included in the third column in Table 13-6. Observe that analytical
procedures are used in Phase III and Phase IV. Recall that analytical
procedures are also required at the completion of the audit, which is why
they are included in Phase IV.

Evidence Decisions

The four subcategories of decisions the auditor makes in accumulating

audit evidence are included in the fourth column in Table 13-6. Except for
analytical procedures, all four evidence decisions apply to each type of
test.
Types of Evidence

The eight broad categories of evidence auditors accumulate are included

in the last column of Table 13-6.

SUMMARY OF THE AUDIT PROCESS

Figure 13-9 shows the four phases for the entire audit process, and Table
13-7 shows the timing of the tests in each phase for an audit with a
December 31 balance sheet date.
Phase I: Plan and Design an Audit Approach
Auditors plan and design an audit approach step by step as of seven
steps in the figure 13-9. At the end of phase I, the auditor should have a
well-defined audit plan and a specific audit program for the entire audit.

Phase II: Perform Tests of Controls and Substantive

Tests of Transactions
Perform test of controls and substantive test of transactions are two types
of main activities in this phase that it should be simultaneously done in
the same transaction. Two type of tests implement other purposes of this
phase. For example, Auditor performs test of Controls to obtain evidence
in support of the specific controls that contribute to the auditors
assessed control risk (that is, where it is reduced below the maximum),
including integrated audits of internal control over financial reporting.
Substantive tests are performed in order to obtain evidence in support
of the monetary correctness of transactions. It is affected by the
result of test of control. The time to complete Phase II is about two to
three months before balance sheet date. This helps auditor review
designing Test detail of balances.

Phase III: Perform Analytical Procedures and Tests of

Details of Balances
The objective of phase III is to obtain sufficient additional evidence to
determine whether the ending balances and footnotes in financial
statements are fairly stated. The two general categories of phase III
procedures are:
1. Substantive analytical procedures that assess the overall
reasonableness of transactions and balances.
2. Tests of details of balances, which are audit procedures to test for
monetary misstatements in the balances in the financial statements.

Because of their low cost, analytical procedures are commonly used

whenever they are relevant. These analytical procedures are done for 3
months, before tests of details of balances, so they can then be used to
determine how extensively to test balances. They are also used as a part
of performing tests of balances and during the completion phase of the
audit.
Phase IV: Complete the Audit and Issue an Audit Report
After the first three phases are completed, auditors must accumulate
additional evidence related to presentation and disclosure-related
objectives, summarize the results, issue the audit report, and perform
other forms of communication. As shown in Figure 13-9, this phase has
several parts:

Perform Additional Tests for Presentation and Disclosure.

The procedures auditors perform to support the four presentation and

disclosure-related objectives are similar to audit procedures performed to
support both transaction- and balance-related audit objectives. . Auditors
also perform substantive tests to obtain sufficient appropriate evidence
that information disclosed in the footnotes reflects actual transactions and
balances that have occurred and that represent obligations of the client to
support the occurrence and rights and obligation objectives. During this
last phase of the audit, auditors perform audit procedures related to con
tingent liabilities and subsequent events. Contingent liabilities are
potential liabilities that must be disclosed in the clients footnotes.
Auditors must make sure that the disclosure is complete and accurate.
Subsequent events represent events that occasionally occur after the
balance sheet date, but before the issuance of the financial statements
and auditors report, that have an effect on the financial statements.

Accumulate Final Evidence Base on accumulate evidence in phase

I, II, III

Auditors must gather the following evidence for the financial statements
as a whole during the completion phase:
Perform final analytical procedures
Evaluate the going-concern assumption
Obtain a client representation letter
Read information in the annual report to make sure that it is consistent
with the financial statements.

Issue Audit Report

The type of audit report issued depends on the evidence accumulated and
the audit findings.

Communicate with Audit Committee and Management

Auditing standards require auditor communicate with Audit Committee
and Management after the engagement be done. Although not required,
auditors often also make suggestions to management to improve business
performance.