AUDITING & ASSURANCE

PRINCIPLES
SAN MATEO MUNICIPAL COLLEGE
COLLEGE OF BUSINESS AND ACCOUNTANCY

By:
NILO N. IGLESIAS, CPA, MBA, REA
 Module 7
Audit Planning
 Introduction

⚫ Audit planning involves developing a general audit

strategy and detailed approach for the expected conduct
of the audit.
⚫ The auditor’s main objective in planning the audit is to
determine the scope of the audit procedures to be
performed.
⚫ The auditor should plan the audit work so that the audit
will be performed in an effective and efficient manner.
⚫ The extent of planning will vary according to the size of
the entity , the complexity of the audit and the auditor’s
experience with the entity, and knowledge of the
business.
Learning Objectives:

After completing this module, you should be able to:

• Discuss the importance of understanding the client’s
business industry.
• Understand and explain the objective in planning an
audit.
• Describe the standard planning procedures.
• Define analytical procedures and explain why they are
important at the planning stage of the audit.
• Discuss the contents of the audit plan and the audit
program.
Importance of Adequate Planning of the Audit
Work
• Planning helps ensure that appropriate attention is
devoted to important areas of the audit.
• It helps identify potential problems.
• It allows the work to be completed expeditiously.
• It assist in the proper assignment and coordination of
work.
• It helps ensure that the audit is conducted effectively
and efficiently.
• PSA 315 – Obtain sufficient understanding of the entity and its
environment including its internal control
▪ The auditor should obtain a sufficient knowledge of the entity’s business to
identify and understand the events, transactions and practices that may have a
significant effects on the financial statements.
▪ If the auditor understand the operations of the client, the auditor is often able to
evaluate the reasonableness of the client’s estimate.
▪ Procedures can be selected with more assurance or applicable procedures can
be designed.
▪ Knowledge of the entity also includes understanding of the entity’s objectives
and strategies and the related business risks.
▪ Understanding business risks increases the likelihood of identifying risk of
material misstatement and helps the auditor design appropriate audit
procedures.
▪ The auditor should also obtain an understanding of the entity’s measurement
of performance as this create pressures on the entity that may either motivate
management to take action to improve the business performance or to
manipulate the financial statements.
Sources of Information
▪ The auditor can obtain knowledge of the industry and entity from
the following:
✓ Review of prior year’s working papers
✓ Tour of client’s facilities
✓ Discussion with people within and outside the entity
✓ Reading books, periodicals and other publications related to
the client’s industry
✓ Reading corporate documents and financial reports.
▪ The auditor should also ensure that assistants assigned to an
audit engagement obtain sufficient knowledge of the client’s
business and industry to enable them to carry out the work
delegated to them.
Uses of information Obtained
▪ Understanding the business and using these information appropriately
assists the auditor in:
✓ Assessing risk and identifying potential problems
✓ Planning and performing the audit effectively and efficiently
✓ Evaluating audit evidence as well as the reasonableness of the
client’s representations and estimates
✓ Providing better service to the client.
▪ To make effective use of the knowledge , the auditor should consider
how it affects the financial statements and whether the assertions in
the financial statements are consistent with the auditor’s knowledge of
the business.
▪ Obtaining understanding of the client’s business is a continuous and
cumulative process. For continuing engagements, the auditor should
be update and re-evaluate information gathered previously, including
information in the prior year’s working papers.
Additional Consideration on New Engagement
▪ A first-time audit requires more work than a repeat engagement
because of the problem associated with the verification of the opening
balances of the balance sheet accounts.
▪ In this regards, PSA 510 requires the auditor to obtain sufficient
appropriate audit evidence that:
✓ The opening balances do not contain misstatements that
materially affect the current year’s financial statements.
✓ The prior period’s closing balances have been correctly brought
forward to the current period or when appropriate have been
restated
✓ Appropriate accounting policies are consistently applied or
changes in accounting policies have been properly accounted for
and adequately disclosed.
▪ This can be done by reviewing the predecessor auditor’s working
paper or consider the independence and professional reputation of the
predecessor auditor.
Understanding the Internal Control
▪ Another important step in planning an audit is to obtain an understanding on
the entity’s accounting and internal control systems.
▪ The auditor should obtain an understanding whether accounting and internal
control system sufficient to plan the audit and develop an effective audit
approach.

Developing an Overall Audit Strategy

▪ Once the auditor has gained a sufficient understanding about the entity and its
environment including internal control, the auditor should formulate an overall
audit strategy for the upcoming engagement.
▪ The best audit strategy is the approach that results in the most efficient audit-
that is an effective audit performed at the least possible cost.
▪ An audit plan should be made regarding:
✓ How much evidence to accumulate
✓ How and when this should be done
▪ When developing an audit strategy, the auditor may consider carefully the
appropriate levels of materiality and audit risks.
 Materiality
▪ Information is material if its omission or misstatement could influence the
economic decision of users taken based on financial statements.
▪ In designing an audit plan , the auditor should make a preliminary estimate
of materiality for use during the examination.
▪ The concept of materiality recognizes that some matters are important for
fair presentation of financial statements while other matters are not
important.
▪ Materiality may be viewed as:
✓ The largest amount of misstatement that the auditor could tolerate in
the financial statements.
✓ The smallest aggregate amount that could misstate the financial
statement.

▪ Materiality is a matter of professional judgment and necessarily involves

quantitative factors (amount of the item in relation to the financial
statements) and qualitative factors ( the nature of misstatement).
Importance of Materiality in Planning an Audit
▪ The auditor should make a preliminary estimate of the materiality to
determine the amount of evidence to accumulate.
▪ There is inverse relationship between materiality and evidence.
▪ More evidence will be required for a low peso amount of materiality
than for a high peso amount.

Uses of Materiality

▪ According to PSA 320, materiality should be considered by the

auditor:
✓ In the planning stage, to determine the scope of audit
procedures
✓ In the completion phase of the audit, to evaluate the effect of
misstatement on the financial statements.
Using Materiality Levels
▪ The following steps may be used as a guide when using materiality levels:
➢ Steps 1 and 2 are performed in planning stage.
➢ Step 3 is performed in the completion phase of audit.
✓ Step 1 – Determine the Overall Materiality – Financial Statement Level
❖ Determine the amount of misstatement that could be material to the
financial statement taken as a whole.
❖ If the materiality level is set too low, auditor will be wasting time
auditing accounts that are not important.
❖ If the materiality level is too high, auditor may not detect
misstatements that could be material to the readers of the financial
statement.
❖ Consider that financial statements are interrelated- that misstatement
in balance sheet usually affects the income statement.
❖ A common method of estimating materiality at the financial statement
level is to multiply a statement base 9 total assets, sales, or net
income) by a certain percentage,
Using Materiality Levels
✓ Step 2 – Determine the Tolerable Misstatement-Account Balance
Level
❖ Once the overall materiality is established, the auditor determines
materiality at the account balance level.
❖ Allocate the overall materiality to the financial statement account balances.
❖ This allow the auditor to determine the audit procedures that will be applied
to specific accounts.
❖ The allocated materiality to an account is called tolerable misstatement for
the account (performance materiality)
▪ The professional standards do not provide specific guidelines as to how the
allocation should be done. This process is highly subjective and requires the
exercise of great deal of judgement by the auditor.
✓ Step 3 – Compare the Aggregate Sum Total of Uncorrected
Misstatements with the Overall Materiality.
❖ After performing audit procedures, the auditor will have to compare the
aggregate uncorrected misstatements to determine whether the
financial statements are materially misstated.
Bases that can be used to Determine the Materiality Level
• Since audit planning is often performed before year-end, annual financial
statements are usually not available.
• As a results, the auditor uses alternative bases to compute the materiality level,
such as:
✓ Annualized interim financial statements
✓ Prior year’s financial statements
✓ Budgeted financial statements of the current year

Summary of Materiality in an Audit

Planning Stage:
• Determine the overall materiality – Financial Statement Level
• Determine the tolerable misstatement – Account Balance Level
Perform Audit Procedures:
Completion Stage:
▪ Compare the aggregate sum total of misstatement with overall materiality
 Audit Risk
▪ After determining the materiality level, the auditor should design the audit to provide
a reasonable assurance that the financial statements taken as a whole are free from
material misstatements.
▪ Reasonable assurance means that the auditor can not possibly expect to detect all
material misstatement.
▪ Instead, the auditor should perform audit procedures to increase the likelihood of
detecting these misstatements.
▪ The auditor should use professional judgement when designing substantive audit
procedures, anchored on the three (3) main issues:
✓ What level of assurance does the auditor wish to attain that FS do not contain
material misstatements? As this level of assurance increases, the scope of
auditor’s substantive test also increase.
✓ How susceptible is the account to material misstatement? As the
susceptibility of account to misstatement increases, the scope of
auditor’s substantive tests also increases.
✓ How effective is the client’s internal control in preventing or detecting
misstatements? As the effectiveness of the client’s internal control
increase, the scope of the auditor’s substantive test decreases.
Audit Risk Model
• These three issues are the preliminary basis for the development of the
risk mode:
Audit Risk = Inherent Risk * Control Risk * Detection Risk
• Audit Risk
✓ Refers to the risk that the auditor that the auditor gives an inappropriate audit
opinion on the financial statements.
✓ This occurs because the auditor believes that the financial statements are fairly
stated when the fact the financial statement are materially misstated.
✓ Audit risk is the complement of audit assurance.
✓ If the auditor is willing to accept 5% audit risk, he must design the audit to have
a 95% assurance or confidence level that his opinion is correct.
✓ Because of the inherent limitation of the audit, the auditor can not totally
eliminate the audit risk.
✓ Therefore, the auditor should perform audit procedures in order to limit his
exposure to this risk to a low level.
✓ As the desired level of audit risk decreases, the auditor should design more
effective substantive procedures.
Audit Risk Model
• These three issues are the preliminary basis for the development of the
risk mode:
Audit Risk = Inherent Risk * Control Risk * Detection Risk
• Inherent Risk
✓ Is the susceptibility of an account balance or class of transactions to a material
misstatement assuming that there were no related internal control.
✓ This concept recognizes that some account balances, by nature, are more
susceptible to misstatement than others.
✓ PSA 315 requires the auditor to assess inherent risk at the financial statement
and account balance or transaction class levels.
✓ Factors that affect the risk of misstatement at the financial statement level
include:
❖ The management integrity

❖ Management characteristics ( aggressive attitude toward financial

reporting)
❖ Operating Characteristics ( profitability of the entity relative to its
industry)
❖ Industry characteristics ( industry is experiencing large number of
business failures)
Audit Risk Model
• These three issues are the preliminary basis for the development of the
risk mode:
Audit Risk = Inherent Risk * Control Risk * Detection Risk

• Inherent Risk
✓ Factors that affect the risk of misstatement at the account
balance level include:
❖ Susceptibility of the account to theft
❖ Complexity of calculation related to account
❖ The complexity underlying transactions and other events
❖ The degree of judgement involved in determining account
balances.
✓ As the assessed level of inherent risk increases, the auditor
should design more effective substantive procedures
Audit Risk Model
• These three issues are the preliminary basis for the development of the
risk mode:
Audit Risk = Inherent Risk * Control Risk * Detection Risk

• Detection Risk
✓ Risk that an auditor’s substantive procedure will not detect a
material misstatement.
✓ Detection risk is a function of the effectiveness of the auditor’s
substantive procedures.
✓ As the acceptable level of detection risk decreases, the
assurance directly provided from substantive tests increases.
✓ Hence, auditor should design more effective audit procedures
in order to achieve the desired level of assurance.
✓ The acceptable level of detection risk is inversely related to the
assessed level of both inherent and control risks.
Steps in Using the Audit Risk Model
• Step 1 - Set the desired level of Audit Risk
✓ There is no specific guidelines for setting audit risk.
✓ The auditor uses his judgment in determining the risk that he is
willing to take of accepting an assertion as fairly stated when in
fact it is materially misstated.
✓ The auditor should plan the audit in such a way that, after
performing audit procedures, an opinion can be issued on the
financial statement at a low level of audit risk.
• Step 2 - Assess the Level of Inherent Risk
✓ When assessing inherent risks for each account, the auditor
must consider specific factors related to the client that may
affect the risk of material misstatement for a particular account.
✓ In making this assessment, the auditor will rely on his
knowledge of the client’s business industry, and the results of
his preliminary analytical procedures.
Steps in Using the Audit Risk Model
• Step 3 - Assess Level of Control Risk
✓ Assess the control risk by studying and evaluating the effectiveness of
the client’s accounting and internal control system.
✓ When assessing the level of control risk, the auditor should recognize
that some control risk will always be present because of the inherent
limitation of the internal control.
✓ If the client maintains effective control system, the risk of material
misstatement in the financial statements can be minimized.
• Step 4 - Determine the Acceptable Level of Detection Risk
✓ Based on the desired audit risk level (step 1) and the auditor’s
assessment of inherent and control risks (steps 2 & 3), the auditor
determines the acceptable level of detection risk. By rearranging the
audit risk model, the acceptable level of detection can be determined
as follows:
Detection Risk = Audit risk________________
Inherent Risk * Control Risk
Steps in Using the Audit Risk Model
• Step 5 - Design Substantive Test
✓ Unlike inherent risk and control risk, detection risk can be increased or decreased by the auditor
by performing substantive tests.
✓ Detection risk can be looked at as the complement of the assurance provided by substantive
tests.
✓ A 10% acceptable level of detection risk means that substantive tests must be designed to
provide a 90% assurance of detecting material misstatements.
✓ Thus, a lower acceptable level of detection risk increases the assurance to be provided by
substantive tests.
✓ To obtain a greater assurance, the auditor will modify the scope of his substantive test such as:
❖ Performing more effective substantive procedures (Nature)
❖ Performing year-end procedures (timing)
❖ Using larger sample size (extent)
✓ If the acceptable level of detection risk is high, the assurance provided by substantive tests will
decrease. As a result, the auditor could reduce the scope of his substantive procedures like:
❖ Performing less effective substantive procedures (nature)
❖ Performing the test at interim (timing)
❖ Using smaller sample size (extent)
Summary Steps in Using the Audit Risk Model
• Audit Planning
✓ Set Desired Level of Audit Risk
✓ Assess Inherent Risk

• Consideration of Internal Control

✓ Assess Control Risk

• Performing Substantive Tests

✓ Determine Acceptable Level of Detection Risk
Relating Inherent, Control and Detection Risk to Overall Audit Risk
• The inherent, control and detection risk is the components of the overall audit
risk.
• An increase or decrease in any components would cause a corresponding
increase or decrease in the overall risk.
• Of the three (3) components, only the detection risk can be controlled by the
auditor.
• Inherent and control risks are functions of the management and its
environment , and such the auditor can not change the levels of inherent and
control risks.
• The auditor can only assess their levels.
• On the other hand, the detection risk can be controlled by the auditor by
performing substantive procedures.
• For example, if the assessed level of inherent and control risk is high, the
auditor should minimize the level of detection risk to be able to maintain the
planned overall audit risk level.
• Conversely, if the assessed level of inherent and control risk is low, the auditor
could accept a high level of detection risk and still maintain the desired audit
risk level.
Relationship Between Materiality and Risk
• When planning the audit, the auditor considers what would make the financial
statements materially misstated.
• The auditor’s assessment of materiality related to specific account helps the
auditor select audit procedures that can be expected to reduce audit risk to an
acceptable level.
• The 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.
• For example, if , after planning for specific audit procedure, the auditor
determines that the acceptable materiality level is lower, audit risk is
increased.
• The auditor would compensate for this by either:
❖ Reducing the assessed level of control risk by carrying out extended or
additional tests of control
❖ Reducing detection risk by modifying the nature, timing and extent of
planned substantive procedures.
Effect of Materiality on Audit Risk and Planned Audit Procedures

Materiality Audit Risk

Risks of Material Error PPlanned Audit
Planning Materiality
and/or Tolerable Error
Occurring and/or not Procedures
being determined

LOW HIGH More Extensive

HIGH LOW Less Extensive

Risk Assessment Procedures
• The procedures performed by auditors to obtain an understanding of
the entity and its environment including its internal control and to
assess the risks of material misstatement in the financial statements
are called “risk assessment procedures”. These include:
❖ Inquiries of management and others within the entity
❖ Analytical procedures
❖ Observation and inspection
• Information obtained in performing these risk assets procedures may
be used by the auditor as evidence to support assessment risk of
material misstatement.
• The auditor may obtain audit evidence about fair presentation of
financial statements or about the operating effectiveness of internal
control even though such procedures were not specifically planned as
substantive tests or tests of control.
Analytical Procedures
• Analytical procedures involve analysis of significant ratios and trends,
including resulting investigation of fluctuations and relationships that
are consistent with other relevant information or deviate from predicted
amounts.
• A basic premise underlying the use of analytical procedures is that
plausible relationship among data may reasonably be expected to
exist and continue in the absence of knowns to the contrary.
• PSA 250 requires the auditor to use analytical procedures in the
planning and overall review stages of the audit.
• The application of analytical procedures helps the auditor assess the
risk of material misstatements in the financial statements.
• Analytical procedures also helps the auditor in identifying unusual transactions
and events that may affect the fair presentation of financial statements.
Steps in Applying Analytical Procedures
Step – 1 Develop expectations regarding financial statement using:
❖ Prior year’s financial statements
❖ Anticipated results such as budgets or forecasts
❖ Industry average
❖ Non-financial information
❖ Typical relationship among financial statement account balances
Step – 2 Compare the expectation with financial statement under audit
❖ The auditor compares the financial statements with his
expectations to identify significant fluctuations that are inconsistent
with the auditor’s knowledge or that deviate from predicted
amounts.
Step – 3 Investigate significant unexpected differences (unusual
fluctuations) to determine whether financial statements contain material
misstatements.
❖ It begins with inquiries of management, followed by corroborations
of management responses and applying other appropriate audit
procedures.
Uses of Analytical Procedures
Analytical procedures may be used for the
following purposes:
• As a planning tool, to determine the nature, timing,
and extent of other auditing procedures.
• As a substantive test to obtain corroborative
evidence about particular assertions related to the
account balance or transaction class.
• As an overall review of the financial statements in the
completion phase of the audit.
Uses of Analytical Procedures in an Audit

Stage of the Audit Objectives

• To understand the client’s business

Planning the Audit • To identify areas that may represent specific
risks
• To obtain evidence to confirm (or refute)
Substantive Tests individual account balance

• To identify unusual fluctuation that were not

Overall Review identified in the planning and testing phases of
the audit.
• To confirm conclusions reached with respect to
the fairness of the financial statements.
 Using Analytical Procedures as a Planning Tool

Compare financial statements

with expectations

Determine the difference

between the expected and
recorded balances

Is the Design more

difference extensive
Yes
significant? substantive tests
N
o

Design less extensive

substantive tests
Documenting The Audit Plan
The final step in the planning process is the documentation of the audit plan process by
preparing an overall audit plan, audit program, and time budget.
• Audit Plan
✓ An audit plan is an overview of the expected scope and conduct of the audit.
✓ The overall audit plan sets out in broad terms the nature, timing and extent of
the audit procedures to be performed.
✓ While the audit plan varies for each client, it should be sufficiently detailed to
guide in the development of an audit program.
• Audit Program
✓ The auditor should develop and document an audit program setting out the
nature, timing and extent of the planned audit procedures required to
implement the overall audit plan.
✓ It sets out in detail the audit procedures to be performed in each segment of
the audit.
✓ The form and content of the audit program may vary for each engagement, but
is should always include a detailed list of audit procedures that the auditor
believes are necessary to accomplish the audit objectives.
Documenting The Audit Plan
The final step in the planning process is the documentation of the audit plan
process by preparing an overall audit plan, audit program, and time budget.
• Time Budget
✓ A time budget is an estimate of the time that will be spent in executing
the audit procedures listed in the audit program.
✓ This provides a basis for estimating audit fees and assists the auditor
in assessing the efficiency of the assistants.

• Changes Audit Plan and Program

✓ Planning continuous throughout the engagement because of changes
in conditions or unexpected results of audit procedures.
✓ The overall audit plan and the audit program should be revised as
necessary during the audit and the reasons for significant changes
would be recorded.
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Auditing &
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