AP T E R 5: P L A N N I N G

CH L
AU D I T O F F I N AN C I A
AN
STA T E M E N T S
PAU LN, CPA
C . DE G UZ MA
ARED BY: INS T. JOHN
P R EP
AUDIT PLANNING
AUDIT PLANNING INVOLVES:
 ESTABLISHING THE OVERALL AUDIT STRATEGY (A GENERAL STRATEGY) FOR THE
ENGAGEMENT; AND
 DEVELOPING AN AUDIT PLAN (A DETAILED APPROACH FOR THE EXPECTED NATURE,
TIMING AND EXTENT OF THE AUDIT), IN ORDER TO REDUCE AUDIT RISK (I.E., THE CHANCE
THAT AUDIT OPINION IS INAPPROPRIATE) TO AN ACCEPTABLY LOW LEVEL.
MAIN OUTPUTS OF AUDIT
PLANNING
 THE OVERALL AUDIT STRATEGY OR AUDIT PLANNING MEMORANDUM
 THE AUDIT PLAN OR AUDIT PROGRAMS OR AUDIT COMPLETION CHECKLISTS
BENEFITS OF AUDIT
PLANNING
 APPROPRIATE ATTENTION TO IMPORTANT AREAS OF THE AUDIT.
 IDENTIFY AND RESOLVE POTENTIAL PROBLEMS ON A TIMELY BASIS.
 ORGANIZE AND MANAGE THE AUDIT ENGAGEMENT SO THAT IT IS
PERFORMED IN AN EFFECTIVE AND EFFICIENT MANNER.
 ASSIST IN THE PROPER SELECTION OF ENGAGEMENT TEAM MEMBERS AND
THE ASSIGNMENT OF WORK TO THEM.
 FACILITATE THE DIRECTION AND SUPERVISION OF ENGAGEMENT TEAM
MEMBERS AND THE REVIEW OF THEIR WORK.
 ASSIST, WHERE APPLICABLE, IN COORDINATION OF WORK DONE BY
AUDITORS OF COMPONENTS AND EXPERTS.
FACTORS AFFECTING THE NATURE AND
EXTENT OF PLANNING ACTIVITIES

 THE SIZE AND COMPLEXITY OF THE ENTITY;

 THE KEY ENGAGEMENT TEAM MEMBERS’ PREVIOUS EXPERIENCE WITH THE ENTITY; AND
 THE CHANGES IN CIRCUMSTANCES THAT OCCUR DURING THE AUDIT ENGAGEMENT.
 TIMING OF THE APPOINTMENT OF THE INDEPENDENT AUDITOR.
PLANNING: AS A PHASE OF
AUDIT
• PLANNING IS NOT A DISCRETE PHASE OF AN AUDIT, BUT RATHER A CONTINUAL AND
ITERATIVE PROCESS. PLANNING, HOWEVER, INCLUDES CONSIDERATION OF THE TIMING
OF CERTAIN ACTIVITIES AND AUDIT PROCEDURES THAT NEED TO BE COMPLETED PRIOR TO
THE PERFORMANCE OF FURTHER AUDIT PROCEDURES.
OUTPUTS OF AUDIT
PLANNING
• OVERALL AUDIT STRATEGY
• SETS THE SCOPE, TIMING, AND DIRECTION OF THE AUDIT, AND THAT GUIDES THE
DEVELOPMENT OF THE AUDIT PLAN.

• AUDIT PLAN
• INCLUDES A DESCRIPTION OF:
• THE NATURE, TIMING AND EXTENT OF THE FOLLOWING PROCEDURES
• PLANNED RISK ASSESSMENT PROCEDURES
• FURTHER AUDIT PROCEDURES AT THE ASSERTION LEVEL

• OTHER PLANNED AUDIT PROCEDURES THAT ARE REQUIRED TO BE CARRIED OUT SO

THAT ENGAGEMENT COMPLIES WITH PSA.
GENERAL DOCUMENTATION
REQUIREMENTS

• THE OVERALL AUDIT STRATEGY

• AUDIT PLAN
• CHANGES MADE DURING THE ENGAGEMENT
MAJOR AUDIT PLANNING
ACTIVITIES
• IDENTIFYING AND ASSESSING RISK OF MATERIAL MISSTATEMENTS THROUGH
UNDERSTANDING THE ENTITY AND ITS ENVIRONMENT

• ESTABLISH OVERALL AUDIT STRATEGY

• DEVELOPING AN AUDIT PLAN
• DIRECTION, SUPERVISION AND REVIEW
• OTHER PLANNING CONSIDERATIONS
IDENTIFYING AND ASSESSING RISKS OF
MATERIAL MISSTATEMENTS THROUGH
UNDERSTANDING THE ENTITY AND ITS
ENVIRONMENT

• TO ESTABLISH AN OVERALL AUDIT STRATEGY, THE AUDITOR NEEDS TO PERFORM

PROCEDURES THAT WILL ENABLE HIM/HER TO OBTAIN UNDERSTANDING OF
THE ENTITY AND ITS ENVIRONMENT, AND IDENTIFY AND ASSESS THE RISK OF
MATERIAL MISSTATEMENTS. (RISK ASSESSMENT PROCEDURES)
RISK ASSESSMENT
PROCEDURES
• OBTAIN AN UNDERSTANDING OF THE ENTITY AND ITS ENVIRONMENT, APPLICABLE
FINANCIAL REPORTING FRAMEWORK, ENTITY’S SYSTEM OF INTERNAL CONTROL.

• CONSIDER MATERIALITY
• IDENTIFY AND ASSESS RISKS OF MATERIAL MISSTATEMENTS
• DETERMINE THE ACCEPTABLE LEVEL OF AUDIT RISK
• IDENTIFY DETECTION RISK TO DETERMINE THE NATURE, TIMING AND EXTENT OF
FURTHER AUDIT PROCEDURES
OBJECTIVE WHEN
PERFORMING RAP
• THE OBJECTIVE OF THE AUDITOR IS TO IDENTIFY AND ASSESS THE RISK OF
MATERIAL MISSTATEMENT, WHETHER DUE TO FRAUD OR ERROR, AT THE FS
LEVEL AND ASSERTION LEVELS, THROUGH UNDERSTANDING THE ENTITY AND
ITS ENVIRONMENT, INCLUDING THE ENTITY’S INTERNAL CONTROL, THEREBY
PROVIDING A BASIS FOR DESIGNING AND IMPLEMENTING RESPONSES TO RISKS
OF MATERIAL MISSTATEMENT.
PROFESSIONAL SKEPTICISM

• IT IS NECESSARY FOR THE CRITICAL ASSESSMENT OF AUDIT EVIDENCE

GATHERED WHEN PERFORMING RAP PROCEDURES AND ASSIST THE AUDITOR IN
REMAINING ALERT TO AUDIT EVIDENCE THAT IS NOT BIASED TOWARDS
CORROBORATING THE EXISTENCE OF RISKS OR THAT MAY BE CONTRADICTORY
TO THE EXISTENCE OF RISKS.
APPLICATION OF PROFESSIONAL
SKEPTICISM
• QUESTIONING CONTRADICTORY INFORMATION AND RELIABILITY OF DOCUMENTS
• CONSIDERING RESPONSES TO INQUIRIES OF THE MANAGEMENT AND OTHER
INFORMATION OBTAINED FROM MANAGEMENT AND THOSE CHARGE WITH
GOVERNANCE

• BEING ALERT TO CONDITIONS THAT MAY INDICATE THE POSSIBLE MISSTATEMENT

DUE TO FRAUD OR ERROR

• CONSIDERING WHETHER AUDIT EVIDENCE OBTAINED SUPPORTS THE AUDITOR’S

IDENTIFICATION AND ASSESSMENT OF THE RISK OF MATERIAL MISSTATEMENT IN
LIGHT OF THE ENTITY’S NATURE AND CONDITIONS
SOURCES OF AUDIT
EVIDENCE
• INTERACTIONS WITH MANAGEMENT, THOSE CHARGE WITH GOVERNANCE, AND
OTHER KEY ENTITY PERSONNEL, SUCH AS INTERNAL AUDITORS.

• CERTAIN EXTERNAL PARTIES SUCH AS REGULATORS, WHETHER OBTAINED

DIRECTLY OR INDIRECTLY

• PUBLICLY AVAILABLE INFORMATION ABOUT THE ENTITY

TYPES OF RISK ASSESSMENT
PROCEDURES

• INQUIRY
• INSPECTION
• OBSERVATION
• ANALYTICAL PROCEDURES
INQUIRIES DURING
PLANNING STAGE
INSPECTION AND
OBSERVATION
 THE ENTITY’S OPERATIONS.
 DOCUMENTS (SUCH AS BUSINESS PLANS AND STRATEGIES), RECORDS, AND INTERNAL
CONTROL MANUALS.
 REPORTS PREPARED BY MANAGEMENT (SUCH AS QUARTERLY MANAGEMENT REPORTS
AND INTERIM FINANCIAL STATEMENTS) AND THOSE CHARGED WITH GOVERNANCE
(SUCH AS MINUTES OF BOARD OF DIRECTORS’ MEETINGS).
 THE ENTITY’S PREMISES AND PLANT FACILITIES (TOUR).
 BOOKS, PERIODICALS AND OTHER PUBLICATIONS RELATED TO THE ENTITY AND ITS
ENVIRONMENT.
ANALYTICAL PROCEDURES
• THE FOLLOWING ARE THE TYPES OF TYPICAL ANALYTICAL PROCEDURES APPLIED IN AN
AUDIT:
 TREND ANALYSIS – THIS TYPE IS BASED ON THE ASSUMPTION THAT PERFORMANCE WILL
CONTINUE IN LINE WITH PREVIOUS PERFORMANCE OR INDUSTRY TRENDS UNLESS
SOMETHING UNUSUAL IS HAPPENING IN THE COMPANY.
 RATIO ANALYSIS – THIS TYPE SIMILAR TO FINANCIAL STATEMENT ANALYSIS AND IS HIGHLY
EFFECTIVE TECHNIQUE TO HIGHLIGHT ACCOUNT BALANCES THAT ARE OUT OF LINE AND
MAY SIGNAL THE POTENTIAL FOR FRAUD.
 TEST OF REASONABLENESS – THIS TYPE TESTS WHETHER A RECORDED AMOUNT IS
REASONABLE WITH REGARDS TO THE AUDITOR’S EXPECTATION.
 REGRESSION ANALYSIS – THIS TYPE INVOLVES TIME-SERIES ANALYSIS BY EXAMINING
TRENDS IN RELATIONSHIP WITH PREVIOUS RESULTS.
ANALYTICAL PROCEDURES
• DEVELOP EXPECTATIONS REGARDING FINANCIAL STATEMENTS USING:
• PRIOR YEAR’S FINANCIAL STATEMENTS
• ANNUALIZED INTERIM FINANCIAL STATEMENTS
• ANTICIPATED RESULTS SUCH AS BUDGETS, FORECASTS, OR PROJECTIONS
• TYPICAL RELATIONSHIPS AMONG FINANCIAL STATEMENTS ACCOUNT BALANCES
• INDUSTRY AVERAGES
• NON-FINANCIAL INFORMATION
ANALYTICAL PROCEDURES

• COMPARE EXPECTATIONS WITH ITEMS PRESENTED IN THE FINANCIAL

STATEMENTS

• DEFINE AND INVESTIGATE SIGNIFICANT DIFFERENCES

ANALYTICAL PROCEDURES
PHASE REQUIRED?
PLANNING YES
SUBSTANTIVE PROCEDURES NO
OVERALL REVIEW YES
MATERIALITY

• INFORMATION IS MATERIAL IF ITS OMISSION OR MISSTATEMENT COULD

INFLUENCE THE ECONOMIC DECISIONS OF USERS TAKEN ON THE BASIS OF THE
FINANCIAL STATEMENTS

• QUANTITATIVE AND QUALITATIVE CONSIDERATIONS

• BASED ON PROFESSIONAL JUDGMENT
MATERIALITY
IN PLANNING THE AUDIT, MATERIALITY SHOULD BE CONSIDERED BY THE
AUDITOR WHEN:

• DETERMINING THE NATURE, TIMING AND EXTENT OF AUDIT PROCEDURES

• IDENTIFYING AND ASSESSING ROMM
• DETERMINING THE NATURE, TIMING AND EXTENT OF FURTHER AUDIT
PROCEDURES
LEVELS OF MATERIALITY
• OVERALL MATERIALITY
• FS AS A WHOLE
• HIGHEST AMOUNT OF MISSTATEMENT(S) WITHOUT
AFFECTING THE ECONOMIC DECISION OF FS USER
LEVELS OF MATERIALITY
PERFORMANCE MATERIALITY
• LOWER AMOUNT(S) THAN OVERALL OR SPECIFIC
MATERIALITY
• TO:
• ENSURE THAT MISSTATEMENTS LESS THAN OVERALL OR SPECIFIC
MATERIALITY ARE DETECTED, SO AS TO REDUCE THE
PROBABILITY THAT THE AGGREGATE OF UNCORRECTED
ERRORS/UNDETECTED MISSTATEMENTS EXCEED MATERIALITY
OF THE FS AS A W WHOLE

• PROVIDE A MARGIN OR BUFFER FOR UNDETECTED

MISSTATEMENTS
PERFORMANCE
MATERIALITY
PERFORMANCE MATERIALITY
MARGIN PROVIDES SOME ASSURANCE THAT
LEVELS OF MATERIALITY
• SPECIFIC MATERIALITY
• IN SOME CASES, THERE MAY BE A NEED TO IDENTIFY
MISSTATEMENTS OF LESSER AMOUNTS THAN
OVERALL MATERIALITY THAT WOULD AFFECT THE
ECONOMIC DECISIONS OF FS USERS
• EX“: NOTE DISCLOSURES, COMPLIANCE WITH
LEGISLATION, TERMS IN A CONTRACT, OR
TRANSACTIONS UPON WHICH BONUSES ARE BASED
HOW TO DETERMINE
MATERIALITY
HOW TO DETERMINE MATERIALITY
• PLANNING MATERIALITY/PRELIMINARY JUDGMENT
ABOUT MATERIALITY
• MAY CHANGE DURING THE ENGAGEMENT
• HELP AUDITOR PLAN THE APPROPRIATE EVIDENCE TO
ACCUMULATE
HOW TO DETERMINE
MATERIALITY

THERE IS AN INVERSE RELATIONSHIP BETWEEN MATERIALITY

AND THE LEVEL OF AUDIT RISK, THAT IS, THE HIGHER THE
MATERIALITY LEVEL, THE LOWER THE AUDIT RISK AND VICE
VERSA.
THE AUDIT RISK MODEL
Inherent risk and control risk:
Risk that material misstatements exist

Audit Risk = IR × CR × DR

Detection risk:
Risk that auditor will not detect misstatements

• Inappropriate audit procedure

• Fail to detect when using Nonsampling Sampling
appropriate audit procedure risk risk
• Misinterpreting audit results
USING THE AUDIT RISK
MODEL
 Set
Set aa planned
planned level
level of
of audit
audit risk
risk such
such that
that an
an opinion
opinion
can
can be
be issued
issued on
on the
the financial
financial statements.
statements.
 Assess
Assess inherent
inherent risk
risk and
and control
control risk.
risk.
 Use
Use the
the audit
audit risk
risk equation
equation to
to solve
solve for
for the
the appropriate
appropriate
level
level of
of detection
detection risk:
risk:

AR = IR × CR × DR
AR
DR = IR × CR

Auditors use this level of detection risk to design audit

procedures that will reduce audit risk to an acceptable level.
USING THE AUDIT RISK
MODEL
Qualitative
Qualitative terms
terms may
may also
also be
be used
used in
in the
the audit
audit risk
risk model.
model.
LIMITATIONS OF THE
AUDIT RISK MODEL
The
The audit
audit risk
risk model
model isis aa planning
planning tool,
tool, but
but itit has
has some
some
limitations
limitations that
that must
must bebe considered
considered when
when the
the model
model is
is used
used
to
to revise
revise an
an audit
audit plan
plan or
or toto evaluate
evaluate audit
audit results.
results.
The
The desired
desired level
level of
of audit
audit risk
risk may
may not
not actually
actually be
be
achieved.
achieved.
ItIt does
does not
not consider
consider potential
potential auditor
auditor error.
error.
There
There is is not
not way
way of
of knowing
knowing what
what the
the preliminary
preliminary level
level of
of
risk
risk actually
actually was.
was.

Preliminary Actual
Assessment +/– or Achieved
Level of Risk Level of Risk
THE AUDITOR’S RISK
ASSESSMENT PROCESS
Auditors need to
identify business risks and
understand the potential
misstatements that Business risks
may result. include any external or
internal factors, pressures, and
forces that bear on the entity’s
ability to survive and
be profitable.
THE AUDITOR’S RISK
ASSESSMENT PROCESS
UNDERSTANDING THE ENTITY
AND ITS ENVIRONMENT
Financial
Performance
Industry Regulatory
Factors Environment
Objectives and
Strategies

Internal Business
Control Nature of Risks
the Entity
FOR EXAMPLE, IF, AFTER PLANNING FOR SPECIFIC AUDIT
PROCEDURES, THE AUDITOR DETERMINES THAT THE ACCEPTABLE
MATERIALITY LEVEL IS LOWER, AUDIT RISK IS INCREASED.

• THE AUDITOR WOULD COMPENSATE FOR THIS BY EITHER:

a. REDUCING THE ASSESSED LEVEL OF CONTROL RISK, WHERE
THIS IS POSSIBLE, AND SUPPORTING THE REDUCED LEVEL BY
CARRYING OUT EXTENDED OR ADDITIONAL TESTS OF
CONTROL; OR
b. REDUCING DETECTION RISK BY MODIFYING THE NATURE,
TIMING AND EXTENT OF PLANNED SUBSTANTIVE PROCEDURES.
AUDIT PLAN

• THE AUDITOR SHOULD DEVELOP AN AUDIT PLAN FOR THE AUDIT IN

ORDER TO REDUCE AUDIT RISK TO AN ACCEPTABLY LOW LEVEL
• SHOULD INCLUDE:
• NET OF PLANNED RISK ASSESSMENT PROCEDURES
• NET OF PLANNED AUDIT PROCEDURES AT THE ASSERTION LEVEL
• OTHER PLANNED AUDIT PROCEDURES THAT ARE REQUIRED
AUDIT PLAN
• AUDITOR SHALL UPDATE AND CHANGE OVERALL
STRATEGY AND THE AUDIT PLAN AS NECESSARY
• AUDITOR SHALL DOCUMENT:
a. OVERALL AUDIT STRATEGY
b. AUDIT PLAN
c. ANY SIGNIFICANT CHANGES MADE DURING THE AUDIT
ENGAGEMENT TO THE OVERALL AUDIT STRATEGY OR
THE AUDIT PLAN, AND THE REASON FOR SUCH CHANGES
 DISCUSSION OF OTHER CRITICAL MATTERS IN
ENGAGEMENT PLANNING

• APPLICATION OF ANALYTICAL PROCEDURES IN

PLANNING THE AUDIT
• ESTABLISHMENT OF AN ENGAGEMENT OR AUDIT TEAM
• CONSIDERATION OF WORK PERFORMED BY OTHER
AUDITOR/PARTIES
• PREDECESSOR AUDITOR
• OTHER CPA
• SPECIALISTS
• USE OF CLIENT’S STAFF
• INTERNAL AUDITOR
4. ASSESSMENT OF GOING CONCERN ASSUMPTIONS
5. IDENTIFICATION OF RELATED PARTIES
6. CLIENT’S LEGAL OBLIGATIONS
7. COMPLETION OF THE INITIAL AUDIT PROGRAM
8. PREPARATION OF A TIME BUDGET
9. ASSIGNMENT OF PERSONNEL TO THE
ENGAGEMENT
10. SCHEDULING OF WORK
DOCUMENTATION OF AUDIT PLAN / AUDIT PROGRAM
1. DESCRIPTION OF THE CLIENT COMPANY
2. AUDIT OBJECTIVES
3. DESCRIPTION OF NATURE AND EXTENT OF OTHER
SERVICES (EX: TAX RETURNS PREPARATION)
4. TIMETABLE OF THE AUDIT WORK
5. WORK TO BE DONE BY THE CLIENT’S EMPLOYER
6. ASSIGNMENT OF AUDIT STAFF
7. TARGET COMPLETION DATES OF MAJOR SEGMENTS OF
THE ENGAGEMENT
8. PRELIMINARY EVALUATION AND JUDGMENT ABOUT
MATERIALITY LEVEL FOR THE ENGAGEMENT
9. ANY SPECIAL PROBLEMS TO BE RESOLVED DURING
THE ENGAGEMENT PARTICULARLY THOSE REVEALED
BY ANALYTICAL PROCEDURES
10. CONDITIONS THAT MAY REQUIRE CHANGES IN AUDIT
TEST