ACTG492 Lecture 05 Auditing is essentially a systematic examination

Auditing is essentially a systematic examination and evaluation of a system, process, or organization to assess its compliance with established standards, rules, regulations, or internal controls. It's a crucial process used to verify the accuracy, reliability, and effectiveness of various aspects of an entity.

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ACTG 492-AUDITING
40 hours
Lecturer: Dam ThiHai Au

2. Lecture 5
AUDIT PLANNING AND
MATERIALITY
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3. This chapter focuses on
the Audit Planingand
Materiality
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4. Learning Objectives
•5-1 Discuss why adequate audit planning is essential.
•5-2 Determine performance materiality during audit
planning.
•5-3 Use materiality to evaluate audit findings.
•5-4 Prepare prepare audit working papers for payroll
audit
•5-5 Prepare prepare audit working papers for account
payable audit
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5. Learning Objective 1
LO5-1:
Discuss why adequate
audit planning is
essential
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6. There are three main reasons why an auditor should
properly plan audit engagements.
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• To enable the auditor to obtain sufficient competent
evidence for the circumstances. This is essential for
minimizing legal liability and maintaining a good
reputation in the business community.
• To help keep audit costs reasonable. Given the
competitive auditing environment, keeping costs
reasonable helps the firm obtain and retain clients.

7. There are three main reasons why an auditor should
properly plan audit engagements.
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• To avoid misunderstandings with the client. This is
important for good client relations.

8. Describe various organizational forms
and business decision-makers.
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9. Three risk terms
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These risks significantly influence the conduct and
cost of audits. Much of the early planning of audits
deals with obtaining information to help auditors
assess these risks.

10. 1. Acceptable
audit risk
-isameasureofhowwillingtheauditoris
toacceptthatthefinancialstatements
maybemateriallymisstatedaftertheaudit
iscompletedandanunmodifiedopinion
hasbeenissued.
-Whentheauditordecidesonalower
acceptableauditrisk,itmeansthatthe
auditorwantstobemorecertainthatthe
financialstatementsarenotmaterially
misstated.
-Zeroriskiscertainty,anda100percent
riskiscompleteuncertainty.
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11. 2. Client
business
risk
-istheriskthattheentityfailstoachieve
itsobjectivesorexecuteitsstrategies.
-Businessriskcanarisefromfactorssuch
assignificantchangesinindustry
conditionsoreventssuchasregulatory
changes,orfromthesettingof
inappropriateobjectivesorstrategies.
-For example, the auditor may identify
declines in economic conditions that
adversely affect sales and the collectibility
of accounts receivable.
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12. 3. The risk of
material
misstateme
nt
-istheriskthatthefinancialstatements
containamaterialmisstatementdueto
fraudorerrorpriortotheaudit.
-Continuingwiththepreviousexample,
decliningeconomicconditionsmay
increasethelikelihoodthatthecompany
maytakeinappropriateactionstomeet
salestargetsorunderstatetheallowance
fordoubtfulaccounts,especiallyifthe
clientdoesnothaveadequatecontrols
oversalesandcollectionofaccounts
receivable.
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13. Three risk terms
Assessing acceptable audit risk, client business risk,
and risk of material misstatement is an important
part of audit planning because it helps determine the
audit procedures and amount of evidence that will
need to be accumulated, as well as the experience
level of staff needed for the engagement.
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14. Three risk terms
For example, if the auditor identifies a risk of
material misstatement for inventory valuation
because of complex valuation issues, additional
evidencewill be accumulated in the audit of
inventory valuation and more experienced staff
will be assigned to perform testing in this area.
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15. Learning Objective 1 LO5-2:
Determine performance
materiality during audit
planning.
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16. Materiality
-Information is material if omitting it or
misstating it could influence decisions that users
make based on the financial information of a
specific report entity.
-Materiality is related to professional judgment.
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95%
Reasonable
Assurance
$ 1mm
100%
Absolute
Assurance
$ 10mm
5% assurance more
Not need
Look at every single one of the transactions
let’s compare the benefit and input cost
Eg.1,000 transaction a day

18. Overall materiality
(Mứctrọngyếutổngthể)
Overall materiality is a number that said for the
materiality of the Financial Statements as a
whole.
Eg. 10% for all items in Financial Statements.
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19. Performance materiality
(Mứctrọngyếuchotừngkhoảnmục)
Performance materiality is defined as the
amount(s) set by the auditor at less than
materiality for the financial statements as a whole
to reduce to an appropriately low level the
probability that the aggregate of uncorrected
and undetected misstatements exceeds
materiality for the financial statements as a
whole.
Performance materiality < Overall FS
Materiality
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20. Performance materiality
For example, For an accounts receivable balance
of $1,000,000, the auditor should accumulate
more evidence if a misstatement of $50,000 is
considered material than if $300,000 were
considered material.
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21. Performance materiality
-Many auditors set performance materiality for most
tests as a standard percentage of the preliminary
judgment about materiality for the financial
statements as a whole.
-Performance materiality is commonly set at 50–75
percent of overall materiality.
-However, performance materiality can vary for
different classes of transactions, account balances,
or disclosures, especially if there is a focus on a
particular area.
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22. Allocation of the preliminary judgment about
materiality
-Allocating the preliminary judgment about
materiality to individual accounts (segments) is
necessary because evidence is accumulated for
accounts (segments) rather than for the financial
statements as a whole. Allocating to accounts
(segments) establishes a tolerable misstatement
(mứcsaisóttốiđa) amount for each account,
which helps the auditor decide the appropriate
audit evidence to accumulate for each account.
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23. -We refer to the process of determining performance
materiality as the allocation of the preliminary
judgment about materiality. If auditors do not use
a standard percentage 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.
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Allocation of the preliminary judgment about
materiality

24. -Because there are fewer balance sheet
accounts than income statement accounts in
most audits, and because most audit
procedures focus on balance sheet accounts,
materiality should be allocated only to balance
sheet accounts.
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Allocation of the preliminary judgment about
materiality

25. Performance materiality
-For example, a $20,000 overstatement of accounts
receivableis also a $20,000 overstatement of sales.
Because most audit procedures focus on balance
sheet accounts, materiality is usually allocated only
to balance sheet accounts.
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26. The auditor’s difficulties…
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Auditors face three major difficulties in allocating
materiality to balance sheet accounts:
1. Auditors expect certain accounts to have more
misstatements than others.
2. Both overstatements and understatements
must be considered.
3. Relative audit costs affect the allocation.

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28. Learning Objective 1 LO5-3:
Prepare prepare audit
working papers for
account payable audit
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29. Learning Objective 1 LO5-4:
Use materiality to
evaluate audit
findings.
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30. Describe various organizational forms
and business decision-makers.
Use materiality….
-When auditors perform audit procedures for each
segment of the audit, they document all
misstatements found.
-Misstatements in an account can be of two types:
known misstatements and likely misstatements.
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31. Describe various organizational forms
and business decision-makers.
Known misstatements
-Known misstatements are those where the auditor
can determine the amount of the misstatement in the
account. For example, when confirming accounts
receivable, the auditor may identify a sales
transaction incorrectly recorded in the wrong fiscal
period due to a cutoff error.
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32. Describe various organizational forms
and business decision-makers.
Likely misstatements
There are two types of likely misstatements.
-The first are misstatements that arise from
differences between management’s and the auditor’s
judgment about estimates of account balances.
Examplesare differences in the estimate for the
allowance for uncollectible accounts or for warranty
liabilities.
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33. Describe various organizational forms
and business decision-makers.
Likely misstatements
Scenario: An auditor is analyzing a company's aging
of accounts receivable. They observe a higher-than-
normal percentage of past-due accounts. Based on
industry standards and historical data, the auditor
estimates that the company's allowance for doubtful
accounts is understated by $20,000.
Explanation: The auditor has not identified specific
bad debts that have not been written off, but the
aging analysis suggests that the company's provision
for uncollectible accounts is insufficient.
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34. Describe various organizational forms
and business decision-makers.
Likely misstatements
-The second likely misstatements are projections of
misstatements based on the auditor’s tests of a
sample from a population. For example, assume the
auditor finds six client misstatements in a sample of
200 in testing inventory costs. The auditor uses these
misstatements to estimate the total likely
misstatements in inventory.The total is called an
estimate or a “projection” or “extrapolation” because
only a sample, rather than the entire population, was
audited.
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35. Describe various organizational forms
and business decision-makers.
Example
The auditor calculates likely
misstatements for accounts
receivable and inventory using
known misstatements detected
in those samples.
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36. Describe various organizational forms
and business decision-makers.
Example
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It is a likely misstatements
calculated for this sample.

37. Describe various organizational forms
and business decision-makers.
When evaluating the audit findings, the auditor
should be satisfied that the estimate of the total
known and likely misstatements is less than a
material amount.
Known misstatement:
$2,000 (overstated inventory) + $500
(unrecorded expense) = $2,500
Likely misstatement: $2,000 (sales cut-offs) +
$1,500 (allowance for doubtful accounts) =
$3,500
Total: $2,500 + $3,500 = $6,000 < material amount
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38. Describe various organizational forms
and business decision-makers.
The five steps in applying materiality in an audit.
Step 1. Set materiality for the financial statements as
a whole.
Step 2. Determine performance materiality.
Step 3. Estimate total misstatement in the segment.
Step 4. Estimate the combined misstatement.
Step 5. Compare combined estimates with
preliminary or revised judgment about materiality.
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39. Learning Objective 1
LO5-5:
Prepare prepare audit
working papers for
payroll audit
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40. End of Lecture 5
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