Audit Planning
factors, including financial reporting
DEFINED
planning involves developing a general audit
strategy and a detailed approach for the
expected conduct of the audit
Auditor’s main objective- determine the
scope of the audit procedures
In addition: auditor should plan the audit
work in effective and efficient manner
Extend of planning depends according
to: size of entity, the complexity of the audit and
auditor’s experience with the entity, and
knowledge of the business
Adequate planning of the audit work is important
because:
 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 assists in the proper assignment and
coordination of work.
 It helps ensure that the audit is
conducted effectively and efficiently
PSA 315- requires auditor to obtain sufficient
understanding of the entity and its internal
control. Such understanding involves obtaining
knowledge about:
 Industry, regulatory, and other external
framework;
 Nature of the entity, including the entity’s
selection and application of accounting
policies;
 Objectives and strategies and the
related business risks that may result in
a material misstatement of the financial
statements;
 Measurement and review of the entity’s
performance; and
 Internal control
UNDERSTANDING THE ENTITY AND ITS
ENVIRONMENT
Essential to audit: Knowledge of the client’s
business and industry
Sufficient knowledge of the entity’s business will
help the auditor to identify and understand the
events, transactions and practices that may
have a significant effect on the financial
statements
This knowledge includes
1. understanding the entity’s objective
and strategies, and the related
business risk
2. measurement of performance
 SOURCES OF INFORMATION
 Review of prior years’ working papers
 Tour of client’s facilities
 Discussion with people within and
outside the entity
 Reading books, periodicals, and other
publication related to the client’s industry
 Reading corporate documents and
financial reports
 USES OF INFORMATION OBTAINED
 Assessing risks and identifying potential
problems
 Planning and performing the audit
effectively and efficiently
  Evaluating audit evidence as well as the
reasonableness of client’s
representations and estimates
 Providing better service to the client
 ADDITIONAL CONSIDERATION ON
NEW ENGAGEMENTS
A first-time audit requires more work than a
repeat engagement because of the problem
associated with the verification of opening
balances.
PSA 510 requires the auditor to obtain sufficient
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; and
 appropriate accounting policies are
consistently applied or changes in
accounting policies have been properly
accounted for and adequately disclosed.
- Auditor may be able to obtain evidence
by reviewing the predecessor auditor’s
working papers (auditor would also
consider the independence and
reputation of predecessor auditor)
UNDERSTANDING THE INTERNAL CONTROL
- important step in planning to sufficiently
plan and develop an effective audit
approach.
DEVELOPING AN OVERALL AUDIT
STRATEGY
- The best audit strategy is the approach
that results in the most efficient audit
and with a least possible cost.
- The plan should be made regarding:
 How much evidence to accumulate;
 How and when this should be done
- When auditor is developing audit
strategy, he must consider the
appropriate levels of materiality and
audit risk
 MATERIALITY
“Information is material is its omission or
misstatement could influence the
economic decision of users taken on the
basis of the financial statements.”
In designing an audit plan, the auditor
should make a preliminary estimate of
materiality. Materiality may be viewed
as:
 the largest amount of
misstatement that the auditor
could tolerate in the financial
statements, or
 the smallest aggregate amount
that could misstate the financial
statements
- materiality is a matter of professional
judgement and necessarily involves
quantitative (amount of item) and
qualitative ( nature of misstatement)
factors
o Importance of materiality in planning
an audit
- To determine the amount of evidence to
accumulate
- There’s inverse relationship between
materiality and evidences.
- More evidences will be required to a low
peso amount of materiality
o Uses of materiality
- PSA 320 requires the auditor to consider
materiality:
1. In the audit planning stage, to
determine the scope of audit
procedures; and
2. In the completion phase of the
audit, to evaluate the effect of
misstatements on the financial
statements.
o Using materiality levels
The following steps may be used as a guide
when using materiality levels. Steps 1 and 2
are performed in the planning phase while
 Step 3 is performed in the completion phase
of the audit:

Step 1: Determine the Overall Materiality –

Financial Statement Level

- The auditor should determine the

amount of misstatement that could
possibly by material to the financial
statements taken as a whole
- the auditor should consider materiality in
terms of the smallest aggregate level
of misstatement that could distort
any one of the financial statements.
- Common method of estimating
materiality is to multiply a statement
base (total assets, sales, or net income)
by certain percentage.
Step 2: Determine the Tolerable
Misstatement – Account Balance Level
- done by allocating the overall materiality
to the financial statement account
balances
- allows the auditor to determine the audit
procedures that will be applied to
specific accounts
- Tolerable misstatement- allocated
materiality to an account
- Performance materiality
Step 3: Compare all the aggregate amount of
uncorrected misstatements with the overall
materiality
- Auditor will compare the aggregate
uncorrected misstatements with overall
materiality to determine whether FS are
materially misstated or not.
o Bases that can be used to determine
the materiality level (if annual FS are
not available)
- Annualized interim financial statements
- Prior years’ financial statements
- Budgeted financial statements of the
current year
 AUDIT RISK
- the auditor should design the audit to
provide reasonable assurance that the
financial statements are free from
material misstatement.
- Reasonable assurance- auditor
increase the likelihood of detecting
material misstatement.
- auditor use professional judgement to
assess audit risk and design audit
procedure (to ensure it reduced to
acceptably low level)
o 3 main issue when designing
substantive audit procedure:
1. What level of assurance does the
auditor wish to attain that the financial
statements do not contain material
misstatements? As this level of
assurance increases, the scope of
the auditor’s substantive tests
increases.
2. How susceptible is the account to
material misstatements? As the
susceptibility of the accounts to
material misstatements increases,
the scope of the auditor’s substantive
tests also increases.
3. How effective is the client’s internal
control in preventing or detecting
misstatements? As the effectiveness
of the clients internal control
increases, the scope of auditor’s
substantive tests decreases
 o Audit Risk Model
Audit Risk = Inherent Risk x
Control Risk x Detection Risk
 Audit risk refers to the risk that the
auditor gives an inappropriate audit
opinion on the financial statements. This
occurs because the auditor believes that
the financial statements are materially
misstated
- Complement of Audit Assurance
- as the desired level of audit risk
decreases, the auditor should design
more effective substantive
procedures
 Inherent Risk
- susceptibility of an account balance or
class of transactions to a material
misstatement (assuming that there’s no
related internal control)
- This concept recognizes that some
account balances, by nature, are more
susceptible to misstatement than others
- PSA 315 requires auditor to assess
inherent risk.
- Factors that affect risk of
misstatement @FS level
1. The management integrity
2. Management Characteristics (e.g.
aggressive attitude toward financial
reporting
3. Operating Characteristics (e.g.
profitability of the entity relative to its
industry is inadequate)
4. Industry Characteristics (e.g. the
industry is experiencing a large
number of business failures)
- Factors that affect risk @ account
balance level
1. Susceptibility of the account to theft.
2. Complexity of calculations related to
account.
3. The complexity underlying
transactions and other events.
4. The degree of judgment involved in
determining account balances
As the assessed level of inherent risk
increases, the auditor should design more
effective substantive procedures
 Control Risk
- Risk in material misstatement (that
occur in account balance or transaction)
that cannot be prevented or detected on
a timely basis
- Related to effectiveness of clients
internal control
- Exists independently of audit FS
- If the entity’s internal control is
effective, the assessed level of
control risk decreases
as the assessed level of control risk
increases, the auditor should design more
effective substantive procedures.
 Detection Risk
- risk that an auditor’s substantive
procedure will not detect the material
misstatement
As the acceptable level of detection risk
decreases, the assurance directly provided
from substantive test increases. Hence the
auditor should design more effective audit
procedures in order to achieve the desired
level of assurance.
- the auditor can control the level of
detection risk unlike inherent and control
risk.
- 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.
- no specific guidelines, auditor uses his
judgment in determining risk he is willing
to take
- auditor will plan the audit in a way that
after performing audit, an opinion can be
issued in FS at a low level of risk
 Step 2: Assess the Level of Inherent
Risk
- In making this assessment, the auditor
will rely primarily on his knowledge of
the client’s business and industry,
and the results of his preliminary
analytical procedures.
Step 3: Assess the Level of Control
Risk.
- involve studying and evaluating the
effectiveness of the client’s
accounting and internal control
systems
- when client maintains effective internal
control systems, risk in material
misstatement can be minimized.
Step 4: Determine the Acceptable
Level of Detection Risk
- the auditor determines the acceptable
level of detection risk. By rearranging
the audit risk model,
Detection risk = Audit Risk/(Inherent
risk)(Control Risk)
Step 5: Design 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 90% assurance of
detecting material misstatements.
a lower acceptable level of detection
risk increases the assurance to be
provided by substantive tests.
- To obtain greater assurance, auditor will
have to modify the scope of substantial
test such as;
1. performing more effective
substantive procedures (nature)
2. performing year-end procedures
(timing)
3. 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:
1. performing less effective
substantive procedures (nature)
2. performing tests at interim (timing)
3. using smaller sample size (extent)
Relating inherent, control and
detection risks to the overall audit risk
- Of the three components, only the
detection risk can be controlled by the
auditor
- Inherent and control risks are functions
of management and its environment,
and as such, the auditor cannot change
the levels of inherent and control risks
- the level of detection risk can be
controlled by the auditor by
performing substantive procedures.
- Based on the result of inherent and
control risk assesment, the auditor will
determine the acceptable level of
detection risk and modifies the scope of
his substantive test.
- 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 maintain the
planned overall audit risk level.
Conversely, if the assessed level of
inherent and control risk low, the
 auditor could accept a high level of
detection risk and still maintain the
desired audit risk level.
Relationship between materiality and risk
- 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.
- 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, where this is possible,
and supporting the reduced level by
carrying out extended or additional
tests of control; or
reducing detection risk by
modifying the nature, timing and extend
of planned substantive procedures.
Effect of materiality on audit risk and
planned audit procedures
RISK
ASSESSMENT PROCEDURES
- procedures performed by auditors to
obtain understanding of the entity
and its environment including its
internal control
- assess the risks of material
misstatements in the financial
statements
- includes;
a. Inquiries of management and others
within the entity
b. Analytical procedures; and
c. Observation and inspection
- The information obtained by the auditor
in this procedure may be used as
evidence to support assessment of risk
material misstatement (since it may
obtain audit evidence about fair
presentation of FS or operating
effectiveness of internal control)
 ANALYTICAL PROCEDURES
- involve analysis of significant ratios and
trends
- A basic premise underlying the use of
analytical procedures is that plausible
relationships among data may
reasonably be expected to exist and
continue in the absence of known
conditions to the contrary.
- PSA 520 requires the auditor to use
analytical procedures in the planning
and overall review stages of the audit
o Steps in Applying Analytical
Procedures
Step 1: Develop expectations
regarding financial statements using
- Prior year’s financial statements
- Anticipated results such as budgets or
forecasts
- Industry averages (financial statements
of other entities operating within the
same industry)
- Non-financial information
- Typical relationships among financial
statement account balances
Step 2: Compare the expectations
with the financial statements 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
the financial statements contain
material misstatements
- Investigation of unusual fluctuations
ordinarily begins with inquiries of
management, followed by corroboration
of management responses and applying
other appropriate audit procedures.
o Uses of analytical procedures
Analytical procedures may be used for
the following purposed:
 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
o The use of Analytical Procedures in
Audit
o Analytical procedures in planning the
audit
- The audit should focus on;
 Enhancing the auditor’s understanding
Changes to audit plan and program
of the client’s business
 Identifying areas that may represent
specific risks.
Using Analytical Procedures as a
Planning Tool
Documenting the Audit Plan
- The final step in the planning process is
the documentation of the audit planning
process by preparing an overall audit
plan, audit program, and time budget.
 AUDIT PLAN
- an overview of the expected scope and
conduct of the audit
- sets out in broad terms the nature,
timing and extent of the audit
procedures to be performed
 AUDIT PROGRAM
- executes the audit strategy
- program serves as a set of instructions
to assistants involved in the audit and as
a means to control and record the
proper execution of the work.
- include a detailed list of audit
procedures that the auditor believes
are necessary to accomplish the
audit objectives.
 TIME BUDGET
- an estimate of the time that will be spent
in executing the audit procedures listed
in the audit program
- The overall audit plan and the audit
program should be revised as necessary
during the course of the audit and the
reasons for significant changes would
be recorded.