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Scope and Purposes of Audit Planning (PSA 300) Mary Therese A. Alcozero
The auditor should plan the audit work so that the audit will be performed in an effective manner.
Planning means developing a general strategy and a detailed approach for the expected nature, timing,
and extent of the audit. The auditor plans to perform the audit in an efficient and timely manner.
The extent of planning will vary according to the size of the entity, the complexity of the audit, the
auditor’s experience with the entity and his knowledge of the business. The auditor should develop and
document an audit plan describing the expected scope and conduct of the audit.
o Assessment of going concern assumption (PSA 570)- in planning the audit, the auditor
should be alert to the evidence of events which may cast doubts on the company’s ability
to continue as a going concern
o Identification of related parties (PSA 550)- the auditor should obtain a written
representation from management concerning completeness of information provided
regarding the identification of related parties and he should also modify the audit report if
he is unable to obtain sufficient evidence concerning the related parties
o Clients legal obligations- the auditor should verify the client’s legal compliance with legal
obligations
The points discussed by the auditor and the client and the matters covered in the terms of
engagement are stated in an audit engagement memorandum becomes among the first parts of the
auditor’s file on the client. This audit engagement memorandum serves as a guide to the audit firm
personnel and as a start off to set the preparation for the audit engagement in motion.
The auditor should develop and document his plan for the audit work in each engagement. The
overall audit plan divides audit work basically into the pre-year-end work where the auditor normally
performs the evaluation of internal control and the year-end work. The audit plan should also include the
scheduling of audit procedures and the year-end substantive tests to be performed during the audit,
commonly referred to as an audit program.
The audit program is a procedural guide as well as a checklist on the progress of the audit. It is a
control mechanism outlining the phases of an audit, listing procedures, and providing evidence of work
done as each step is signed by whoever performed the audit work.
Planning a Repeat Engagement
In planning for a repeat engagement, the auditor refers to working papers of the prior year’s audit.
He goes over the client’s permanent file and inquires about any changes or amendments to the articles of
incorporations and by-laws; he scans the minutes of meetings and re-examines areas subject to risks or
uncertainties in the prior year’s audit. Normally, planning for a repeat engagement is easier than planning
an initial audit engagement.
Small entities have limited internal controls since there are few employees and segregation of
duties is not very practicable. However, for key areas, some degree of segregation of duties may be
implemented and some supervisory controls may be exercised by the owner manager because when the
owner-manager is not involved, there is a greater risk that employee fraud may occur and may not be
detected.
The impact of the owner-manager and the potential of management override of internal control on
the audit depend on the integrity, attitude, and motives of the owner-manager. The auditor of a small entity
should exercise professional scepticism; he should neither assume that the owner-manager is dishonest
nor should he assume unquestionable honesty.
Risk-based audit approach is an audit approach that begins with an assessment of the types and
likelihood of misstatements in account balance and then adjusts the amount and type of audit work, to the
likelihood of material misstatements. Under this approach, the auditor performs the following:
1. Identification of the client’s strategy and the processes for developing that strategy.
2. Examination of the core business process and resource management.
3. Identification for each of the key process (as well as sub-processes) the objectives, inputs, activities,
outputs, systems, and transactions.
4. Assessment of the risks that the processes will not meet the goals and controls related to those risks.
In account-based auditing, auditors first obtain an understanding of control and assess control risk for
particular types of errors and frauds in specific accounts and cycle.
In risk-based audit, the audit team views all activities in the organization first in terms of risks to
strategies and objectives and then in terms of management’s plans and processes to mitigate the risk. The
auditors obtain an understanding of the client’s objectives. Then risks are identified and the auditors
determine how management plans to mitigate the risk and whether those plans are in place and operating
effectively.
L2. Know the nature of risk and the critical components of risk relevant to conducting an audit and their
interrelationships.
Nature of Risk
Risk is a concept used to express uncertainty about events and/or their outcomes that could have a
material effect to the organization.
The four critical components of risk that are relevant to conducting the audit are:
1. Audit Risk. The risk that an auditor may give an unqualified opinion on financial statements that is
materially misstated.
2. Engagement Risk. The economic risk that a CPA firm is exposed to simply because it is associated
with a particular client including loss of reputation, inability of the client to pay the auditor, or financial
loss because management is not honest and inhibits the audit process. Engagement risk is controlled
by careful selection and retention of client.
3. Financial Reporting Risk. That risk that relate directly to the recording of transactions and the
presentation of financial data in an organization’s financial statements.
4. Business Risk. Those risks that affect the operations and potential outcomes of organizational
activities.
Risk Elements Affecting an Audit
L4. Understand what and how the auditor performs the preliminary engagement activities in relation to:
I. Client selection and retention
II. Planning the audit to develop an overall audit strategy and audit plan
III. Applying the concept of materiality to audit
IV. Preparing an audit plan
The purpose of performing these preliminary engagement activities is to help ensure that the auditor
has considered any events or circumstances that may adversely affect the auditor’s ability to plan and
perform the audit engagement to reduce audit risk to an acceptably low level. Performing these preliminary
engagement activities helps to ensure that the auditor plans an audit engagement for which:
The auditor maintains the necessary independence and ability to perform the engagement.
There are no issues with management integrity that may affect the auditor’s willingness to continue the
engagement.
There is no misunderstanding with the client as to the terms of the engagement.
Recurring Audits
The auditor shall assess whether circumstances require the terms of the audit engagement to be
revised and whether there is a need to remind the entity of the existing terms of the audit engagement. The
auditor shall not agree to the change in the terms of the audit engagement where there is no reasonable
justification for doing so.
If the terms of audit engagement are changed, auditor and management shall agree on and record the
new terms of the engagement in an engagement letter or other suitable form of written agreement. If the
auditor is unable to agree to a change in the terms of the audit engagement and is not permitted by
management to continue the original audit engagement, the auditor shall:
(a) Withdraw from the audit engagement where withdrawal is possible under applicable law or
regulation; and
(b) Determine whether there is any obligation, either contractual or otherwise, to report the
circumstances to other parties, such as those charged with governance, owners or regulators.
PHASE I-B. II. Planning the Audit to Develop an Overall Audit Strategy and Audit Plan
PSA 300 (Clarified), “Planning an Audit of Financial Statements” establishes standards and provides
guidance on the considerations and activities applicable to planning an audit of financial statements. It
states that the auditor should plan the audit so that the engagement will be performed in an effective
manner.
The nature and extent of planning activities will vary according to the size and complexity of the entity,
the auditor’s previous experience with the entity, and changes in circumstances that occur during the audit
engagement.
A. Materiality
III. Application of the Concept of Materiality to Audit
PSA 320 (Clarified), “Materiality in Planning and Performing an Audit” establishes standards and deals
with the auditor’s responsibility to apply the concept of materiality in planning and performing an audit of
financial statements.
Materiality involves both quantitative and qualitative considerations. In assessing the quantitative
importance of a misstatement, it is necessary to relate the peso amount of the error to the financial
statements under examination. Qualitative considerations, on the other hand, relate to the causes of
misstatement. The assessment of what is material is a matter of professional judgment. In planning the
audit, materiality should be considered by the auditor when:
(a) Determining the nature, timing and extent of audit procedures;
(b) Identifying and assessing the risks of material misstatements; and
(c) Determining the nature, timing and extent of further audit.
Levels of Materiality
First is the overall materiality (or materiality level for the financial statements as a whole)
It is based on the auditor’s professional judgment as to the highest amount of misstatement(s) that could be
included in the financial statements without affecting the economic decisions taken by a financial statement
user.
Second is the specific materiality (materiality level for particular classes of transactions, account
balances, or disclosures)
In some cases, there may be a need to identify misstatements of lesser amounts than overall materiality
that would affect the economic decisions of financial statement users. This could relate to sensitive areas,
compliance with legislation or certain terms in a contact, or transactions upon which bonuses are based.
Performance Materiality
PSA 320 likewise requires that performance materiality be set. Performance materiality is used by the
auditor to reduce the risk to an appropriate low level that the accumulation of uncorrected and unidentified
misstatements exceeds materiality for overall materiality or specific materiality. It is set at (a) lower
amount(s) than overall or specific materiality. The objective is to perform more audit work than would be
required by the overall or a specific materiality to:
Ensure that misstatements less than overall or specific materiality are detected, so as to appropriately
reduce the probability that the aggregate of uncorrected errors and undetected misstatements exceed
materiality for the financial statements as a whole; and thus
Provide a margin or buffer for possible undetected misstatements. This buffer is between detected and
uncorrected misstatements in the aggregate and the overall or specific materiality.
Other Considerations
When accepting new audit engagement, inquire about the overall materiality used by the previous
auditor. If available, this would help in determining whether further audit procedures may be required
on opening asset and liability balances.
Ensure that any experts employed by the entity (to assist the entity in preparing the financial
statements) or used by the audit team are instructed to use on appropriate materiality level in relation
to the work they perform.
Normally, the audit plan is prepared before starting work at the client’s office. It may, however be modified
throughout the engagement as the auditor deems necessary depending on his consideration of internal
control or as special problems are encountered.
The auditor shall undertake the following activities prior to starting an initial audit:
a) Performing procedures required by PSA 220 regarding the acceptance of the client relationship and the
specific audit engagement; and
b) Communicating with the predecessor auditor, where there has been a change of auditors, in
compliance with relevant ethical requirements.
The nature and extent of planning activities will vary according to the size and complexity of the entity,
the key engagement team embers’ previous experience with the entity, and changes in circumstances that
occur during the audit engagement.
*Principal auditor means he auditor with responsibility for reporting on the financial
statements of an entity when those financial statements include financial information of one or
more components audited by another auditor.
c. Specialists – Brings unique knowledge and judgment in a field other than accounting and auditing.
d. Use of Client’s Staff – audit working papers can be prepared for the auditors by client’s staff, thus
reducing the cost of the audit and freeing the auditors from routine work.
e. Internal Auditors – they can enhance internal control, and the can affect an audit by assisting
independent auditors in performing specific audit procedures.
5. Identification of Related Parties – transactions with related parties are important to auditors because
they will be disclosed in the financial statements if they are material.
6. Client’s Legal Obligations – Pertinent current-year information that auditors should review includes
(1) minutes of directors’ and stockholders’ meetings, (2) changes to articles of incorporation or by-laws,
and (3) any significant contracts executed during the year.
7. Completion of the Initial Audit Program – An audit program is a set of audit procedures specifically
designed for each audit. The program which includes both substantive tests and tests of controls will
enable the auditor to express an opinion on the financial statements taken as a whole.
On initial engagements, the audit program typically will develop in three stages:
(1) the broad phases of the program can be outlined at the time of engagement;
(2) other details of the program can be identified after the review of the internal control structure and
accounting procedures has begun; and
(3) procedures on specific phases of the audit can be further challenged and revised as the work
progresses.
8. Preparation of a Time Budget – a time budget is an estimate of the total hours an audit is expected to
take. It is based on the information obtained in the first major step in the audit, which is, obtaining an
understanding of the client. It takes into consideration such things as:
(a) The client’s size as indicated by its gross assets, sales, number of employees
(b) Location of client facilities
(c) The anticipated accounting and auditing problems
(d) The competence and experience of staff available
9. Assignment of Personnel to the Engagement – Staff must, therefore, be assigned with that standard
in mind. On larger engagements, there are likely to be one or more partners and staff at several
experience levels doing the audit. Specialists in such technical areas as statistical sampling and
computer auditing may also be assigned. On smaller audits there may be only one or two staff
members.
10. Scheduling of Work – Performance of other substantive tests is scheduled near at, and after year-
end. Consideration should be given to such factors as:
(a) Deadline for submitting final audit report and filing of income tax returns
(b) Ability of the client’s staff o submit required schedules
(c) Other audit clients
Documentation of the planning process is done through the preparation of working papers showing:
(1) Audit Plans
(2) Audit Programs
(3) Time Budget
References:
Cabrera, Ma. Elenita B., Public Accountancy Profession: Assurance Principles, Professional Ethics
and Good Governance. 2013-2014. Manila. GIC Enterprises & Co., Inc.
Galanza, Raquel M., Auditing: Assurance Principles, Professional Ethics, and Good Governance.
2015. Quezon City. Rex Printing Company, Inc.