ACCTG 3220: AUDITING IN CIS ENVIRONMENT

AUDIT PLANNING (Lecture #1)  To obtain understanding of entity’s

Importance of Audit Planning measurement of performance
“Plans are worthless but planning is everything.” –
Sources of Information
Dwight D. Eisenhower
 Review of prior year’s working papers
 Even if the auditor or auditing team has already
reviewed the same firm or client with the same  Tour of the client’s facilities
internal controls for the current year, it is critical  Reading relevant books, periodicals, and
to interview as many workers as possible to other publications
avoid assessment failure. Audit planning should  Discussion with people within and outside the
be continuous and cumulative. entity
 An engagement that is effectively planned could  Reading corporate documents (e.g. minutes
eliminate over-or-under-testing, lead to more of meeting) and financial reports
relevant documentation, and help reduce the Uses of Information Obtained
likelihood of audit failure or a potential  Assessing risks and identifying potential
professional liability claim, saving time in the problems
long run.  Planning and performing the audit effectively
Understanding the Client and efficiently
PSA 315  Evaluating audit evidence as well as the
 Requires the auditor to obtain sufficient reasonableness of client’s representations
understanding of the entity and its environment and estimates
including its internal control  Providing better service to the client – focus
 Such understanding involves obtaining on adding value to the client not just to
knowledge about the entity’s comply or finish the audit
o Industry, regulatory, and other external
factors, including financial reporting Additional Consideration on New Engagements
framework; - Full PFRS PFRS for SMEs etc  A firs-time audit engagement requires more
o Nature of the entity, including its selection work than a repeat engagement. This is
and application of accounting policies; - mngt because there are additional audit
decides the accounting policy; accounting procedures that need to be performed in
standards connection with the opening balances. –
o Objectives and strategies and the related review prior year documentation of papers, fs
business risks that may result in a material etc.
misstatement of the financial statements; - PSA 510 requires the auditor to sufficient
during interview with managers and appropriate audit evidence that:
employees; management letter points  The opening balances do not contain
 Such understanding involves obtaining misstatements that materially affect the
knowledge about the entity’s current year’s financial statements;
o Measurement and review of the entity’s  The prior period’s closing balances have
performance; and been correctly brought forward to the
o Internal Control current period or, when appropriate, have
Importance of Understanding the Client been restated; and
 To identify and understand the events,  Accounting policies are appropriate and have
transactions and practices that may have a been consistently applied
significant effect on the financial statements
 To evaluate the reasonableness of the client’s Understanding the Internal Control
estimates  To obtain sufficient understanding of the
 To understand entity’s objectives and entity’s internal control systems
strategies, and the related business risks
 ACCTG 3220: AUDITING IN CIS ENVIRONMENT
 To anticipate the type of potential  PSAs do not provide specific guidelines as to
misstatements that can occur in the financial how the allocation should be done. This process
statements is highly subjective and requires the exercise of
great deal of professional judgment.
Developing an Overall Audit Strategy
 How much evidence to accumulate? Performance of Audit Procedures (substantive
 What are the procedures to be performed testing)…
 When should the procedures be performed?
Step 3: Compare the aggregate amount of
Materiality uncorrected misstatements with the overall
 Information is material if its omission or materiality (Completion Phase)
misstatement could influence economic decision
of users taken on the basis of the financial Performance Materiality
statements.  It is the reduced level of materiality that auditors
 In audit, materiality may be viewed as: use to both at the fs and account balance level
o The largest amount of misstatement that the  When auditing financial statements, it is
auditor could tolerate in the financial common for auditors to exercise prudence by
statements; or setting materiality at an amount lower than the
o The smallest aggregate amount that could overall materiality
misstate any one of the financial statements  The extent of the audit procedures is increased
 Materiality is a matter of professional judgment thereby reducing the risk that the amount of
and necessarily involves quantitative factors uncorrected and undetected misstatements will
(amount of item in relation to the financial exceed the overall materiality
statements) and qualitative factors (the nature  1M – overall materiality
of misstatement) 65% - percentage of performance materiality
1M * 65% = 650,000 – performance materiality
Using Materiality in an Audit  The determination of performance materiality
Step 1: Determine the Overall Materiality – involves the exercise of professional judgment
Financial Statement Level (Planning Phase)
 The auditor should determine the amount of Bases that can be used to determine the
misstatement that could be material to the materiality level
financial statements taken as a whole.  Annualized financial statements
 The auditor should consider materiality in  Prior year financial statements; or
terms of the smallest aggregate level of  Budgeted financial statements of the current
misstatement that could distort any one of year
the fs.
 Statement of Financial position: 500k Audit Risk
Statement of Financial performance: 300k – When designing substantive tests, the auditor
overall materiality level should consider 3 main issues
300k < 500k 1. What level of assurance does the auditor wish to
A common method of estimating the overall attain that the financial statements do not
materiality at the financial statement level is contain material misstatements? As this level of
to multiply a financial statement base (total assurance increases, the scope of the auditor’s
assets, sales, net income etc.) by a certain substantive test also increases (Audit Risk)
percentage. 2. How susceptible is the account to material
Step 2: Determine the Tolerable Misstatement misstatement? As the susceptibility of the
– Account Balance Level (Planning Phase) account to material misstatement increases, the
 This is done by allocating the overall materiality scope of the auditor’s substantive tests also
to the financial statement account balances. increases (Inherent Risk); and
 ACCTG 3220: AUDITING IN CIS ENVIRONMENT
3. How effective is the client’s internal control in  If the entity’s internal control is effective, then
preventing or detecting misstatements? As the the risk that the control will fail to detect or
effectiveness of the client’s internal control prevent material misstatement (control risk)
increases, the scope of the auditor’s decreases.
substantive test decreases. (Control Risk)
Detection Risk
 The risk that an auditor may not detect a
Audit Risk Model
material misstatement that exists in an assertion
Audit Risk = Inherent Risk * Control Risk *
 The more effective substantive test are, the
Detection Risk
lower misstatement the exists in assertion
Detection Risk – uncontrollable; depends on the
substantive testing used as strategy to decrease Using the Audit Risk Model
this risk 1. Set the acceptable level of Audit Risk (Audit
Planning)
Audit Risk 2. Assess the level of Inherent Risk (Audit Planning)
 Refers to the risk that the auditor might be 3. Assess the level of Control Risk (Consideration of
given an appropriate audit opinion on the Internal Control)
financial statements 4. Determine acceptable level of Detection Risk
 Audit Risk is the complement of audit assurance (Performing Substantive Tests)
 If Audit Risk = 5%
Then, Audit Assurance = 95% - confidence level Acceptable Level of Detection Risk = Acceptable
High confidence lever, low detection risk, Level of Audit Risk
broader substantive testing Inherent Risk * Control Risk

Inherent Risk
From this equation, we can conclude that for
 The susceptibility of an account balance or class
a given level of Audit Risk, there is an inverse
of transactions to a material misstatement
relationship between the Acceptable level of
assuming that there were no internal controls.
Detection Risk and the Assessed level of
 PSA 315 requires the auditor to assess inherent
Inherent and Control Risk
risk at the financial statement and account
balance or transaction.
Designing Substantive Tests
Factors that may influence the auditor’s  Designing substantive tests depends on the
assessment of the risk of misstatement at the acceptable level of detection risk; a after
financial statement level include: consideration to the assessment of inherent
 The management integrity and control risks
 Management characteristics  As the acceptable level of detection risk
 Operating characteristics decreases, the assurance provided by
 Industry characteristics substantive tests increases.
Factors affecting inherent risk at the account 
balance level may include the ff:
 Susceptibility of the account to theft
 Complexity of calculations related to account
 The complexity underlying transactions and
other events
 The degree of judgment involved in determining 
account balances

Control Risk
 Control risk is directly related to the condition of
the entity’s internal control system.