CHAPTER THREE AUDIT PLANNING, CONTROLLING AND RECORDING.pptx

Audit planing and accurate supervision

1. CHAPTER THREE AUDIT PLANNING AND CONDUCTING THE AUDIT 10/20/2025

2. 3.1. Reasons for Audit planning The first generally accepted auditing standard of field work requires adequate planning . It asserts that t he auditor must adequately plan the work and must properly supervise any assistants . In planning the audit, the auditor needs to consider the following: the terms of the engagement and the expected date of the report the nature of the client's business, including applicable statutory and contractual requirements the experience gained during previous audit engagements the accounting policies and degree of complexity of the accounting system 10/20/2025

3. Cont’d materiality and the components of audit risk any involvement of other auditors any involvement of internal auditors and persons having special expertise the intended reliance on internal control the level of experience and the number of audit staff for the engagement the timing and effectiveness of performing the audit procedures. 10/20/2025

4. Cont’d The Main Reasons for Planning To obtain sufficient appropriate evidence for the circumstances To help keep audit costs reasonable To avoid misunderstandings with the clients To gain an understanding of the client’s business and industry. To assess acceptable audit risk, client business risk and the risk of material misstatements in the financial statements. to minimize legal liability and maintain a good reputation in the business community. To better achieve the audit objectives To control and direct the audit To due attention on too critical and high risk areas To determine the time needed to finalize the audit work 10/20/2025

5. 3.2 Planning procedures Obtaining Clients 10/20/2025 Submit a proposal The starting point for audit procedures are obtaining clients. To obtain the audit, the auditor may be asked to submit a competitive proposal that will include information on the nature of service that the firm offers, the qualifications of the firm’s personnel, anticipated fees and other information to convince the prospective client to select the firm. The audit firm also may be asked to make an oral presentation to the prospective client’s audit committee and management to provide a basis of for the selection. The auditor identifies why the client wants or needs an audit. This information is likely to affect the remaining parts of the planning process

6. Cont’d 2. Communicate with the predecessor auditor- Statement on Auditing Standards No.84 states that “communication between predecessor and successor auditors”, requires the successor auditors attempts to communicate with predecessor before accepting the engagement. Topics Integrity of management Disagreements over accounting principles Communications to those charged with governance regarding fraud and noncompliance with laws Communication to management and those charged with governance concerning internal control significant deficiencies and material weaknesses. Predecessor’s understanding of reason for change of auditors 10/20/2025

7. Cont’d Audit firms refuse to those clients who lack integrity or argue constantly about the proper conduct of the audit and fees clients in certain high-risk industries, such as software technology companies, health, and casualty insurance companies, and may even discontinue auditing existing companies in those industries. publicly held clients because of the risk of litigation To accept a new client or continue serving an existing client if acceptable audit risk is below the risk threshold the firm is willing to accept. 10/20/2025

8. Cont’d New Client Investigation Audit firms investigate the company to determine its acceptability. Can be done through prospective client’s standing in the business community Client’s Financial stability Assessing the clients relations with its previous CPA firm- Code of Professional Conduct requires that the predecessor auditor obtain permission from the client before the communication can be made. Gathering information from local attorneys, other CPAs, banks, and other businesses. 10/20/2025

9. Cont’d Continuing Clients Audit firms evaluate existing clients annually to determine whether there are reasons for not continuing to do the audit. Some of the reasons for not continuing the audit are Previous conflicts over the appropriate scope of the audit the type of opinion to issue. the client lacks integrity excessive risk unpaid fees Other matters may cause the auditor to discontinue association 10/20/2025

10. Cont’d. . 10/20/2025 After obtaining a client, the audit process includes: 1. Plan the audit 2. Obtain an understanding of the client and its environment, including internal control 3. Assess the risks of material misstatement and design further audit procedures 4. Perform further audit procedures 5. Complete the audit 6. Form an opinion and issue the audit report Attachment.docx

11. . . 10/20/2025 Stages of an Audit--Diagram

12. 1. Plan the Audit. . 10/20/2025 The auditors must adequately plan the work and must properly supervise any assistants. Audit planning involves developing an over all audit strategy for the conduct, organization, and staffing the audit.

13. Cont’d Establishing an understanding with the client This is ordinarily accomplished through use of an engagement letter, which includes the responsibilities of the auditor and management, and the engagement’s limitations. The auditors will perform procedures to determine that: The firm meets professional independence requirements There are issues relating to management integrity There is misunderstanding with the client as to the terms of the engagement 10/20/2025

14. Items Included in Engagement Letters The engagement letter state the following information any restrictions to be imposed on the auditor’s work. deadlines for completing the audit. assistance to be provided by the client’s personnel in obtaining records and documents, and schedules to be prepared for the auditor. It often includes an agreement on fees. The engagement letter also serves the purpose of informing the client that the auditor cannot guarantee that all acts of fraud will be discovered. 10/20/2025

15. . . 10/20/2025 Cont’d Name of the entity Management responsibilities Provision of Financial statements Establishing effective internal control over financial reporting Compliance with laws and regulations Making records available to the auditors

16. Cont’d Auditor responsibilities Conducting an audit in accordance with GAAS Obtaining an understanding of internal control to plan audit and to determine the nature, timing and extent of procedures Making communications required by GAAS Providing written representations at end of the audit, including that adjustments discovered by the auditors and not recorded to the financials are not material 10/20/2025

17. . . 10/20/2025 Engagement Letters--Optional Items Arrangements regarding Conduct of the audit (e.g., timing, client assistance) Use of specialists or internal auditors Obtaining information from predecessor auditors Fees and billing Other services to be provided, such as examination of internal control over financial reporting Limitation of other arrangements regarding liability of auditors or client Conditions under which access to the auditors’ working papers may be granted to others

18. . . 10/20/2025 Audit Planning—Overall Develop an overall audit strategy and an audit plan Plan use of client’s staff Plan involvement of other auditor’s Arrange for specialists On first year audits: Communicate with predecessor auditors Establish opening balances on the financial statements

19. . . 10/20/2025 2. Obtain an Understanding of the Client and its Environment Perform risk assessment procedures, including Inquiries of management and others within the entity Analytical procedures Observation and inspection relating to client activities, operations, documents, reports and premises. Other procedures, such as inquiries of others outside the company (e.g., legal counsel, valuation experts) and reviewing information from external sources such as analysts, banks, rating organizations, journals.

20. . . 10/20/2025 Understanding the Client’s Business—Nature of the Client Competitive position Organizational structure Accounting policies and procedures Ownership Capital structure Product and service lines Critical business processes Internal control

21. . . 10/20/2025 Understanding the Client’s Business, Industry, Regulatory, and Other Factors Competitive environment Supplier and customer relationships Technology developments Major laws and regulations Economic conditions Attractiveness of the industry Barriers to entry Strength of competitors Bargaining power of suppliers of raw materials and labor Bargaining power of customers

22. . . 10/20/2025 Understanding the Client’s Business—Objectives, Strategies & Business Risks Objectives—Overall plans Operating and financial strategies—Operational actions to achieve objectives Business risks—Threats to achieving objectives

23. . . 10/20/2025 Understanding the Client’s Business—Measuring and Reviewing Performance Budgets Key performance indicators Variance analysis Segment performance reports Balanced scorecard External parties

24. . . 10/20/2025 Understanding the Client’s Business – Internal Control Need knowledge and understanding of how a client’s internal control works: What controls exists? Who performs them? How various types of transactions are processed and recorded? What accounting records and supporting documentation exist?

25. . . 10/20/2025 Understanding the Client’s Business—Sources of Information Inquiries of management Industry Accounting and Auditing Guides Industry Risk Alerts Trade journals and news stories Government publications Prior company annual reports and SEC filings Prior tax returns Electronic sources Ex. www.fasb.org , web pages for company Tour of plant and offices Analytical procedures The statement of cash flows and obtaining an understanding of the client

26. . . 10/20/2025 3. Assess the Risks of Material Misstatement and Design Further Audit Procedures Overall approach What could go wrong? How likely is it that it will go wrong? What are the likely amounts involved? Particularly consider Inherent risks Risks of material misstatement due to fraud (fraud risks) Design further audit procedures

27. . . 10/20/2025 Assessing Fraud Risks Two types Fraudulent financial reporting (management fraud) Misappropriation of assets (defalcations) Procedures to assess fraud risks Discussion among engagement team Inquiries of management and other personnel Risk assessment analytical procedures (to aid in planning the audit) Considering fraud risk factors Incentives Opportunity Attitude

28. . . 10/20/2025 Assessing Fraud Risks – Identifying Fraud Risks Considerations in identifying fraud risks Type Significance Likelihood that it will result in a material misstatement Pervasiveness

29. . . 10/20/2025 Responding to Fraud Risks Overall response Professional skepticism and audit evidence Assigning personnel and supervision Accounting principles Predictability of auditing procedures Alterations in audit procedures More reliable evidence Shifting timing to year end Increasing sample sizes Response to the possibility of management override Examining journal entries Review accounting estimates for biases Evaluating the business rationale for significant unusual transactions

30. . . 10/20/2025 Consideration of Fraud Throughout the Audit Evaluating the results of audit tests Discovery of fraud Communication to appropriate level of management If fraud involves senior management or material misstatement communicate to audit committee

31. . . 10/20/2025 4. Design Further Audit Procedures (1/2 ) Types(approaches) Tests of controls Analytical procedures Tests of details of transactions and balances Audit procedures Inspection Observation Inquiry Confirmation Recalculation Reperformance

32. . . 10/20/2025 Design Further Audit Procedures (2/2) Further audit procedures should include Substantive procedures for all relevant assertions Tests of controls when the auditors’ risk assessment includes an expectation that controls are operating effectively, or when substantive procedures alone are not sufficient Procedures should be linked with the assessed risks of material misstatement at the relevant assertion level Overall responses when assessed risks of material misstatement are high Heightened professional skepticism Assigning more experienced staff Assigning staff with specialized skills Providing more supervision

33. 5 Complete the audit work. Audit procedures: Search for unrecorded liabilities Review minutes of meeting Perform final analytical procedures Perform procedures to identify loss contingencies Perform review for subsequent events Obtain representation letterer Evaluate audit procedures 10/20/2025

34. 6.Form an opinion and issue the audit report .public company reporting requires reporting on internal control and on financial statement Non public company reporting ordinarily involves only reporting on the financial statement. 10/20/2025

35. Cont’d An audit program is a set of instructions to the audit team that sets out the audit procedures the auditors intend to adopt and may include references to other matters such as the audit objectives, timing, sample size, and basis of selection for each area. It also serves as a means to control and record the proper execution of the work. The level of detail and complexity depends not only on the complexity and size of the audit, but also the experience of the members of the audit team and the extent of other documentation. 10/20/2025

36. . . 10/20/2025 Audit Program The audit program includes two major sections 1. Systems(internal control) portion of the program Deals with client’s internal control Evidence of test of controls and assessing control risk 2.Substantive procedures portion of the program Deals with financial statement account balances Indirect and direct verification of income statement accounts

37. . . 10/20/2025 Objectives of Substantive Programs for Asset Accounts Establish the existence of assets Establish that the company has rights to the assets Establish the completeness of recorded assets Verify the cutoff of transactions Determine the appropriate valuation of the assets and accuracy of related transactions Determine the appropriate financial statement presentation and disclosure of the assets

38. . . 10/20/2025 Recording the audit (working papers) (Audit Documentation) Audit documentation is the record of audit procedures performed, relevant audit evidence obtained and conclusions reached. The term 'working papers' or 'work papers' are also used to refer to recording the audit. All audit work must be documented : the working papers are the tangible evidence of the work done in support of the audit opinion. Audit documentation states that the auditor shall prepare audit documentation on a timely basis. Audit Documentation contains: 1. Risk assessment Discussion of the audit team, elements of understanding, assessment of risk of material misstatement and risks identified 2.Procedure results Overall responses, nature, timing and extent of further audit procedures, linkage of procedures with assessed risks, results of audit procedures, conclusions reached about operating effectiveness of controls, significant risk identified, circumstances in which substantive procedures alone will not provide sufficient evidence 3. Consideration of fraud Similar to risk assessment as document discussion, procedures used to identify fraud risks, fraud risk and response, any other conditions that caused fraud-related procedures and communications with management or audit committee.

39. Audit Risk An auditor should understand two risk terms before starting audit planning activities. These are: Acceptable audit risk and Inherent risk. These two risks significantly influence the conduct and cost of audits. The first four steps of audit planning deals with obtaining information to help auditors assess these two type of risks. Once an auditor go through the first four steps of audit planning it is easy to asses acceptable audit risk and inherent risk and set materiality which is the fifth step of audit planning process. 10/20/2025

40. A. Acceptable audit risk Acceptable audit risk is 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 (the best) has been issued. When the auditor decides on a lower acceptable audit risk, it means that the auditor wants to be more certain that the financial statements are not materially misstated. Zero risk is certainty, and a 100 percent risk is complete uncertainty. 10/20/2025

41. B. Inherent risk Inherent risk is a measure of the auditor’s assessment of the likelihood that there are material misstatements in an account balance before considering the effectiveness of internal control . If, for example, the auditor concludes that there is a high likelihood of material misstatement in accounts receivable due to changing economic conditions, the auditor concludes that inherent risk for accounts receivable is high. 10/20/2025

42. Cont’d Assessing acceptable audit risk and inherent risk is an important part of audit planning because it helps determine the amount of evidence that will need to be accumulated and staff assigned to the engagement . For example, if inherent risk for inventory is high because of complex valuation issues, more evidence will be accumulated in the audit of inventory, and more experienced staff will be assigned to perform testing in this area. 10/20/2025

43. . . 10/20/2025 Determining Materiality Use professional judgment and based on reasonable person Considers both Quantitative and qualitative factors Materiality used in Planning the audit At the overall financial statement level Allocate to individual accounts Evaluating audit findings

44. . . 10/20/2025 Materiality Definitions FASB (included in SASs)—The magnitude of an omission or misstatement of financial information that, in the light of surrounding circumstances, makes it probable that he judgment of a reasonable person relying on the information could have been changed or influenced by the omission or misstatement. PCAOB interpretation of federal securities laws—A fact is material if there is a substantial likelihood that the… fact would have been viewed by the reasonable investor as having significantly altered the “total mix” of information made available.

45. THE END OF CHAPTER 3 10/20/2025