Three main reasons for audit planning
1. Enable auditor to obtain sufficient appropriate evidence
2. Help keep audit costs reasonable
3. Avoid
... [Show More] misunderstandings with the client
Eight major parts of audit planning:
1. Accept client and perform initial audit planning
2. Understand the client's business and industry
3. Perform preliminary analytical procedures
4. Set materiality and assess acceptable audit risk and inherent risk
5. Identify significant risks due to fraud and error
6. Assess Inherent risk
7. Understand internal control and assess risk
8. Develop overall audit strategy and audit program
Client Business Risk
the risk that the client will fail to achieve its objectives or execute its strategy
Acceptable Audit Risk
a measure of how willing the auditor is to accept that the financial statements may be materially misstated after the audit is completed and an unqualified opinion has been issued.
(lower risk = more certainty)
Inherent Risk
a measure of the likelihood of material misstatement BEFORE considering internal control
Audit risk and inherent risk influence
the amount of evidence that will need to be collected and the experience level of staff assigned to the engagement
risk of material misstatement
the risk that the financial statements con tain a material misstatement due to fraud or error prior to the audit
Initial audit planning involves
1. Auditor decides whether to accept or continue client
2. Auditor identifies why the client wants and needs an audit
3. To avoid misunderstandings the auditor obtains an understanding with the client about the terms of the engagement
4. Develop overall strategy for the audit
Auditor decides whether to accept or continue client (New client investigation)
-Successor auditor is required to communicate with predecessor
-Successor initiates
-Predecessor required to respond
-Predecessor must obtain permission of client before responding (Rule 301)....What if this is not given?
audit strategy
sets the scope, timing, and direction of the audit and that guides the development of the audit plan
risk assessment procedures
obtain an understanding of the client's business and its environment to assess the risk of material misstatements in the financial statements, including inquiries of man- agement and analytical procedures
Understand the Client's Business and Industry
- Industry and External Environment
-Business Operations and Procedures
-Management and Governance
-Objectives and Strategies
-Measurement and Performance
Three primary reasons for obtaining a good understanding of the client's industry and external environment are:
1. Risks associated with specific industries (like financial services or health care)
2. Inherent risks common in industries (like obsolescence of retail clothing inventory)
3. Unique industry accounting requirements (Revenue recognition, etc.)
A few methods for gaining understanding of client's Business and Industry
- Tour facilities
- Identify related parties
- Read the client's Code of Ethics
- Read corporate minutes of meeting
Related Party
An affiliated company, a principal owner of the client company, or any other party with which the client deals, where one of the parties can influence the management or operating policies of the other
Related Party Transaction
any transaction between the client and a related party (not an "arms length" transaction)
corporate minutes
theofficialrecordofthemeetings of the board of directors and stockholders
Related party transactions have high INHERENT RISK because of:
1. Disclosure requirements
2. Lack of independence between parties
3. Opportunities for fraudulent reporting
Auditors should understand client objectives related to
-Reliability of financial reporting
-Effectiveness and efficiency of operations
-Compliance with laws and regulations
materiality
the magnitude of misstatements that individually, or when aggregated with other misstatements, could reasonably be expected to influence the economic decisions of users made on the basis of the financial statements
performance materiality
which is materiality for segments of the audit (classes of transactions, account balances, or disclosures)
preliminary judgment about materiality
Auditing standards require auditors to decide on the combined amount of mis- statements in the financial statements that they would consider material early in the audit as they are developing the overall strategy for the audit
Steps in applying materiality
-Set materiality for the financial statements as a whole
-Determine performance materiality
-Estimate total misstatement in segment
-Estimate the combined misstatement
-Compare combined estimate with preliminary or revised judgment about materiality
revised judgment about materiality
During the audit, auditors may change the preliminary judgment about material- ity
allocation of the preliminary judgment about materiality
If auditors do not use a standard percentage and consider audit assurance and the cost of audit evidence in determining performance materiality, most practitioners allocate materiality to balance sheet rather than income statement accounts, because most income statement misstatements have an equal effect on the balance sheet due to the nature of double-entry accounting
tolerable misstatement
AICPA standards define this as the application of perfor- mance materiality to a particular sampling procedure
Known misstatements
are those where the auditor can determine the amount of the misstatement in the account
likely misstatements
There are two types:
-The first are misstatements that arise from differences between management's and the auditor's judgment about estimates of account balances
-The second are projections of misstatements based on the auditor's tests of a sample from a population
sampling risk
results because the auditor has sampled only a portion of the population and there is a risk that the sample does not accurately represent the population [Show Less]