Topic 7 audit planning (2)

AUDITING AND ASSURANCE SERVICES IN MALAYSIA

TOPIC 7: AUDIT PLANNING

References: Chapter 8 & 9AUD390 2014AUDITING AND ASSURANCE SERVICES IN MALAYSIA

LEARNING OUTCOMESAUD390 2014ENGAGEMENT LETTERPLANNING ACTIVITIESUNDERSTANDING THE CLIENTS BUSINESS & INDUSTRYFUNDAMENTAL CONCEPTS OF MATERIALITY & AUDIT RISK RELATIONSHIP BETWEEN MATERIALITY VALUE & EVIDENCEPREPARATION OF AUDIT PROGRAMMEDETERMINATION OF AUDIT OBJECTIVESANALYTICAL PROCEDURES - PLANNING, FIELDWORK & COMPLETION STAGE

OVERVIEW OF AUDIT PLANNINGDefinition: involves general strategy and detail approach for the expected nature, timing and extent of an auditReasons for Audit PlanningTo enable the auditor to obtain sufficient competent evidence for the circumstancesTo help keep audit costs reasonableTo avoid misunderstandings with the clientAUD390 2014

Overall Timing Of Engagement

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STAGES OF AUDIT PLANNINGAUD390 2014Accept client & perform initial audit planningUnderstand the clients business & industryAssess client business riskPerform preliminary analytical proceduresSet materiality & assess AAR & IRUnderstand internal control & assess CRGather information to assess fraud risk

Develop overall audit plan & audit program

Accept Client & Perform Initial Audit PlanningInitial Audit Planning:Decides whether to accept a new or continue serving an existing oneIdentifies why the client wants or needs an auditObtains an understanding with the client about the terms of the engagementSelect the staff for the engagement

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1. Client Acceptance & Continuance New Client InvestigationReasons for investigation:Prospective clients standing in the business communityFinancial stabilityRelations with previous auditorProcedure to communicate with predecessor auditorThe successor auditor should get the prospective clients permission to communicate with the existing predecessor auditor. If the permission is not given, the successor auditor should decline the appointment.

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ContThe successor auditor should inquire the predecessor auditor whether there is any professional reason for the proposed change. If there are such reasons, the successor auditor should request the predecessor auditor to provide him with all necessary details in order to decide the acceptance of the appointment.If the successor auditor does not receive a reply to his inquiry, he is required to send a reminder to the predecessor auditor or communicate with him through other means.If no response within a reasonable period after sending of 2 reminders, the successor auditor should inform the predecessor auditor of his attention to accept the engagement.

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ContContinuing ClientsDetermine reason for not continuing to do the auditIs there any previous conflicts over scope of audit, the type of opinion to issue or audit fees?

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2. Identify Clients Reason for AuditStatutory requirementsFinancial statement auditCompliance auditWeaknesses noted in the operationsOperations auditAudit on Internal Control System

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3. Obtain an Understanding With the ClientISA210 requires that auditors must document their understanding of an engagement in the audit files, including the engagements objectives, the responsibility of the auditor & management, and the engagements limitationsEngagement Letter (refer pp. 199)An agreement between the CA firm and the client for the conduct of the audit and related servicesContents:Specify job performed by the auditor (audit, review, compilation, tax return, etc.)Restriction to be imposed on the auditors workDeadlines for completing the auditAssistance to be provided by clientsSchedules of audit to be performed by auditorAudit fees

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4. Select Staff for EngagementMIA By-Laws statedA member should carry out his work with a proper regard for the technical & professional standards expected of him as a member and should not undertake or continue professional work which he is not himself competent to perform unless he obtains such advice and assistance as will enable him competently to carry out his workAUD390 2014

STAGES OF AUDIT PLANNINGAUD390 2014

Accept client & perform initial audit planningUnderstand the clients business & industryAssess client business riskPerform preliminary analytical proceduresSet materiality & assess AAR & IRUnderstand internal control & assess CRGather information to assess fraud risk


Understand The Clients Business & IndustryFactors that increased the importance of understanding the clients business & industry:IT connects client companies with major customers & suppliersClients have expanded operations globallyIT affects internal client process, improving the quality & timeliness of accounting informationThe increased importance of human capital & other intangible assets has increased accounting complexity and the importance of management judgments and estimatesAUD390 2014

ContAuditors need to understand clients business & industry to provide additional value-added services to clients.Tools to understand the client's business & industry: Strategic Systems ApproachIndustry & External EnvironmentBusiness Operations & ProcessesManagement & GovernanceObjectives & StrategiesMeasurement & Performance

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1. Industry & External EnvironmentReasons for understanding the clients business & industry:There are risk associated with specific industryThere are inherent risk that are typically common to all clients in certain industryMany industries have unique accounting requirement that the auditor must understand before start to auditAUD390 2014

2. Business Operations & ProcessesFactors to understand:Sources of revenuesKey customers & suppliersSources of financingInformation about related parties that may indicate areas of increased client business riskAccording to FRS 124, require to disclose transactions with related parties in the financial statements if they are materialsRelated party: Parties are considered to be related if one party has the ability to control the other party or exercise significant influence over the other party in making financial decisionsA Related transaction: any transaction between the client and related partyE.g. sales or purchase transactions between a parents company & its subsidiary, exchanges of equipment between 2 companies owned by the same person

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3. Management & GovernanceAreas that require auditor to understandManagements philosophy & operating styleMemorandum & Article of AssociationMinutes of MeetingAbility to identify & respond to riskSignificant impact the risk of material misstatement in the financial statementsE.g. significant annual increase in sales and earnings reported by the company was ultimately determined to be based on various improper accounting technique encouraged by the CEOAUD390 2014

4. Objectives & StrategiesAuditors should understand client objectives related to:Reliability of financial reportingEffectiveness & efficiency of operationsCompliance with laws and regulations AUD390 2014

5. Measurement & PerformancePerformance measurement systems: the key performance indicators that management uses to measure progress towards objectivesE.g. market share & sales per employee, unit sales growth, unique visitors to a Web site, sales per square foot for a retailer, ratio analysis, benchmarking against key competitorsAUD390 2014



Assess Client Business RiskAudit Risk :Risk that the auditor gives an inappropriate opinion when the FS are materially misstatedRisk that the auditor delivers an incorrect audit opinion an opinion which states that the account presents a true & fair view while in reality they do notMeasure of how willing the auditor is to accept that the FS may be materially misstated after the audit is completed & unqualified audit opinion has been issuedFactors result in uncertainty in audit performanceNature of audit testInherent limitations of an auditInherent limitations of the effectiveness of clients internal control system

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ContAUD390 2014AUDIT RISKInherent RiskRisk that the accounts may contain misstatementsDetection RiskControl Risk

Risk related to the characteristics of the business that may cause material FSFactors used in assessing inherent risksNature of clients businessIntegrity of managementClient motivationClients knowledge of accounting standardsResults of previous auditSusceptibility of defalcationNature of clients inventory & technological developmentFor example external factors such as technological development might make a particular product obsoleteIR is high if no internal control system & IR is low of internal control exist

AUD390 2014Inherent Risk (IR)

Control Risk (CR)Risk that the clients internal control will not prevent or detect material errors or misstatements in the account balanceControl risk exist due to the inherent limitation of internal control system & inadequacy of the segregation of duties such as human error, faulty judgmentCR high if internal control system is not effective & CR low if internal controls system is effectiveAUD390 2014

Detection Risk (Dr)Risk that any remaining material misstatements after assessing IR & CR will not be detected by auditorRisk that the auditors substantive procedures & review FS will not detect material errors misstatementsDR high if the auditors are not competent & due care & DR low if the auditors are competent & exercise due careAUD390 2014



Perform Preliminary Analytical ProceduresDefinition: a study of relationship between elements of financial information expected to conform to a predictable pattern based on the auditors knowledge of the business relationship between financial and non financial information

AUD390 2014Types of data, ratios, etcComparison withFinancial Data (Account balances, budgets, etc)Corresponding period, budget & forecastsNon Financial Data (Production, employment statistics)Entries in accounting records, other financial dataRatios & PercentagePreceding period, budget & forecast, industry statistics

ContTypes of analytical procedures:Compare client data & industry dataCompare client data with similar prior-period dataCompare client data client-determined expected resultsCompare client data & auditor-determined expected resultsCompare client data with expected results, using non financial data

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Common financial ratiosShort-term Debt-Paying AbilityE.g. Cash ratio, quick ratio & current ratioLiquidity Activity RatiosE.g. Accounts receivable turnover, Days to collect receivables, Inventory turnover, Days to sell inventoryAbility to meet Long-term Debt ObligationsE.g. Debt to equity, Times interest earnedProfitability RatiosE.g. Earnings per share, Gross profit margin, Profit margin, Return on assets, Return on common equityAUD390 2014Cont

ContAUD390 2014STAGESPLANNINGDETAILED TESTREVIEW FSTIMINGBefore the FS are availableStart after client had submitted FS with supporting schedulesCarry out overall review of FS when most of audit testing are completedPURPOSES1.To understand the clients industry & business2.To assess going concern3.To indicate possible misstatement4.To reduced detailed tests1. To ensure completeness, accuracy & validity of information contain in the FS2.To obtain sufficient audit evidence by reducing the work done through substantive tests1.To update auditors knowledge of clients business2.To ensure the FS are not materially misstated3.To corroborate conclusions form during the auditSOURCES OF INFORMATIONSInterim FS, Management reports, Budget & forecasts, Internal audit reportAnnual FS, Accounting & other records, Management reports, Internal audit reportsDrafted audited FSEXAMPLESCalculate key ratios for client and compare against industrys ratiosReasonable test on EPF contribution accountRecalculate ratios/figures noted in the audit findings



Set Materiality And Assess AAR & IRMATERIALITYDefinition: A misstatement or omission of financial information that may influence or affect the decision made by the user of financial statementsFactors effecting preliminary judgment about materialityMateriality is a relative rather than an absolute conceptBases is needed for evaluating materialityQualitative factors will affect materiality decisionsExpected dissemination (various types of users) of FSThe level of acceptable audit risk

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ContAssessment of audit risk & materialityThe assessment of audit risk & materiality is a matter of the auditors professional judgmentFactors that auditor consider to decide whether an item is material or not:Its absolute sizeIts natureIts relative sizeAUD390 2014



Understand IC & Assess CRRefer topic on Internal Control System & Control RiskAUD390 2014

STAGES OF AUDIT PLANNINGAUD390 2014

Accept client & perform initial audit planningUnderstand the clients business & industryAssess client business riskPerform preliminary analytical proceduresSet materiality & assess AAR & IRUnderstand internal control & assess CRGather information to assess fraud risk


Gather Information To Assess Fraud RiskDefinition : Intentional misstatement of the FSTypes of fraud:Misappropriation of assets, often called as defalcation or employee fraudE.g. a clerk taking case at the time a sale is madeFraudulent financial reporting, often called as management fraudE.g. intentional overstatement of sales near the balance sheet date to increase reported earnings

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Types Of Audit TestsProcedure to obtain an understanding of internal controlTests of controlsSubstantive tests of transactionsAnalytical proceduresTests of detailed of balancesAUD390 2014

Audit ProgramAUD390 2014It is the list of audit procedures for an audit areaIt normally includes a list of the audit procedures, audit sample sizes, items to select & the timing for testsRefer Table 13-4 (pp. 397)

TUTORIAL QUESTIONSWhat are the purposes of an engagement letter?What are the contents of an engagement letter?Preliminary engagement activities are undertaken at the beginning stage of an audit process. List and explain 3 activities to be performed by external auditor during the preliminary engagement.State 2 benefits of audit planning.AUD390 2014

Topic 7 audit planning (2)

Education