Audit Planning and Analytical Procedures

Audit Planning and Analytical Procedures with Materiality and Risk

• Why Audit Planning is Essential

  • Obtaining sufficient appropriate evidence for the circumstances
  • Maintaining competitive audit costs
  • Avoiding client misunderstandings and facilitating quality work at a reasonable cost

• Major Purpose of the Parts of Auditing Planning

  • Gaining understanding of the client's business and industry
  • Assessing inherent and acceptable risks to influence audit conduct and cost

• Inherent Risk

  • Auditor's assessment of the likelihood of material misstatements in account balances before considering internal control effectiveness (e.g., high likelihood of misstatement in accounts receivable due to changing economic conditions).

• Acceptable Risk

  • Measure of auditor's willingness to accept that financial statements might be materially misstated after the audit is completed. (Lower acceptable risk means more certainty that statements are not misstated).

• Initial Audit Planning

  • Client Acceptance and Continuance
    • CPA firms carefully evaluate potential clients for acceptability based on legal/professional responsibilities, integrity, and consistent conduct during audit.
    • Thorough investigations of new clients, including communication with previous auditors if applicable, are required, along with client permission.
    • Ongoing evaluation of existing clients is done annually regarding continued engagements with regards to issues, fees and client integrity.

• Obtain an Understanding with the Client

  • Engagement terms should be clearly understood and documented between the CPA firm and the client in an engagement letter
  • The letter includes the engagement's objectives, responsibilities of the auditor and management, and limitations.

• Understanding of the Client's Business and Industry

  • Understanding client's business, industry, and environmental factors, including areas with higher risk of misstatements.

• Develop Overall Audit Strategy

  • Preliminary Analytical Procedures
    • The auditor uses analytical procedures to compare client ratios to industry or competitor benchmarks to help understand the client's business and evaluate business risk
  • Preliminary audit strategy should consider:
    • Material misstatement risk areas identification
    • Number of client locations
    • Past effectiveness of controls

• Preliminary Analytical Procedures

  • Auditors compare recorded ratios to auditor expectations
  • Key purpose is planning, understanding client's business and industry
  • Used throughout the audit to:
    • Identify possible misstatements
    • Reduce detailed tests of account balances
    • Assess going-concern issues

• Types of Analytical Procedures

  • Auditors evaluate client data against industry data, prior-period data, client-determined expected results, auditor-determined expected results and non-financial data

• Compare Client and Industry Data

  • Analyze client data against industry benchmarks to identify potential issues
  • Compare inventory turnover and gross margin percentages to determine stability

• Compare Client Data with Similar Prior Period Data

  • Assess changes in performance metrics (like gross margin) to detect anomalies that suggest potential misstatements.

• Planning an Audit and Designing an Audit Approach

  • Set materiality and assess acceptable audit risk and inherent risk
  • Understand internal control and assess control risk
  • Gather information to assess fraud risks
  • Develop overall audit plan and audit program.

• Materiality

  • Determining the appropriate audit report, based on the magnitude of omission/misstatement that would affect the user's decision, considering circumstances.
  • FASB Concept Statement 2 defines materiality

• Audit Risk

  • Auditors accept some level of risk in performing the audit task
  • Risks exist, are difficult to measure, and require careful considerations and response

• Risk and Evidence

  • Auditors need to understand the client's business and assess business risk.
  • The audit risk model helps auditors identify the potential and likelihood of misstatements.

• Risk Assessment

  • Procedures used to identify and evaluate the risk of material misstatement.
  • Includes inquiries of management, analytical procedures, observation and inspection, discussions among engagement team members and discussions with predecessor auditors.

• Audit Risk Model for Planning

  • Helps auditors determine the appropriate amount and types of evidence for each area of the audit.
  • Model components are planned detection risk, acceptable audit risk, inherent risk, and control risk

• Audit Risk Model Components - Planned Detection Risk - Acceptable Audit Risk - Inherent Risk - Control Risk

• Impact of Engagement Risk on Acceptable Audit Risk

  • Auditors consider engagement risk (risk client will have financial difficulties, or concerns about management integrity) when determining acceptable audit risk.

• Measurement Limitations in the Audit Risk Model

  • Difficulty in accurately measuring components of the audit risk model.
  • Preliminary risk assessment knowledge is known, but the actual achieved level of risk is unknown.

References

• Auditing and Assurance Services (Arens, Elder, Beasley, 14th edition)
• Auditing Cases, International Edition (Knapp, 9th edition)