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Planning the Audit

Linking Audit procedures to RiskBy Muhammad Khurshid KhanLecturerBIT, JCC, KAAU

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Planning The Audit

The standard of filed work requires “the work is to be adequately planned and assistant if any are to be adequately supervised”.

Audit planning is carried out before start of audit. But when any problem is faced plan is made to respond it. Audit planning involves:

– Investigating client before deciding to accept audit engagement,– Obtaining understanding of client business,– Assessing audit risk and materiality, and– Developing strategy to organize staff, schedule audit activities and

link risk to audit.

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Obtaining Audit

Competitive process. Submit audit proposal. Maintain integrity, objectivity and reputation. Assess risk associated with audit. 3rd party report on management. High risk, litigation, extended audit procedures, high

compensation. Skill specialization and condition preventing audit.

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Submitting Proposal

Audit proposal: services performed, qualifications, estimated fees.

Presentation: audit committee, management. Audit arrangement: audit committee. Issues found during audit-discussed with audit

committee. Audit committee-only corporation with 3

independent directors. Fees: estimate made, possible adjustments

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Communication with Predecessors

Approval of Management: communication with predecessors need approval.

Issues: Disagreement with management, irregularities etc.

Management avoid approval: serious concern and review acceptance of engagement.

Change of auditors: Submit a from to SEC with reasons and auditor opinion.

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First Year

Investigate validity: opening balances in inventories, plants, other assets and propriety of depreciation.

Communicate with predecessors: if any, on management integrity, disagreements, opening balances and accounting principles.

Cost and analysis: Extended analysis of last year transaction and increased cost of first audit, if no predecessors.

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Use of Client Staff

Routine work: use Internal auditors for routine work, reduce time and cost.

Format and templates provided. Work done: trial balance, analysis of receivables,

aging of receivables, write offs, list of property with addition/ retirements, analysis of revenues and expenses.

Verification: work of internal auditors not taken on face value, cross check and signature of auditors.

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Other CPAs

Distant subsidiaries: audited by other CPAs.

Communicate with other CPAs: on issues of concerns.

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Arranging of Specialists

Lacking skill areas: valuation of derivatives, chemicals, metals diamonds etc.

Probable use of specialists: tracing specialists, sorting out arrangements.

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Engagement Letter

Scope of engagement: establish and document objective of engagement, responsibility of auditors, responsibility of management, the limitation of engagement.

Communicate: scope to management. Obtain approval: of management.

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Planning Process

After obtaining audit engagement, auditors must understanding of:– Business risk of client– Develop audit strategy– Assess risk of material misstatements.

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1. Obtaining Understanding of Client's Business and Environment

Understanding of client’s business risk and its environment includes:

– Nature of client and accounting policies followed– Industry regulation and other factor affecting client business– Clients objectives and strategies and related risk– Methods used by client to measure performance– Client’s internal control

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1. Understanding Client's Business Risk and Environment

Understanding of client’s business and its environment is essential to plan and perform audit. It helps in:

– Considering appropriateness of accounting policies– Identifying areas where special focus is needed– Establishing appropriate level of materiality– Developing expectations for analytical procedures– Designing and performing auditing procedures– Evaluating audit evidence

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Nature of Client’s Business

What is client business? who are its supplier and customers? What types of transaction client engages? how are these accounted for?

Clint's competitors, organizational structures, accounting policies and procedures, capital structure, product lines etc.

Critical business processes i.e. material, production, marketing, sales, after sales service, human resources and R&D.

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Industry Regulations and External Factors

Industry conditions viz. competitive environment, customer supplier relations, technological development, regulatory issues, legal-political environment and general economic conditions need attention.

Attractiveness of industry depend on:– Barrier to entry– Strength of competitors– Bargaining power of supplier and labor– Bargaining power of customers

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Clients’ Objectives and Strategies and Business Risk

Objectives are goals and strategies are plan of action to achieve these goals.

Changes in regulation, technology, competition, markets and interest rates affect ability of management to achieve its goals.

Companies identify major risks and take actions to mitigate these.

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Methods of Measuring and Reviewing Performance

Management uses budgets, KPIs, balance scorecard to measure achievement of their goals.

External agencies like rating agencies, financial analysts measure performance of business.

Auditors must gain understanding of these methods to establish their fairness.

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Developing Audit Plan

Audit plan is required for effective audit at low cost. Audit planning must take into account materiality and audit risk.

Materiality; is the smallest estimate that would affect the judgment of financial statement users. Auditors have to quantify materiality.

Audit risk; is possibility that auditors unknowingly fail to modify their opinion on financial statements that are materially misstated.

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Nature of Risks

Fraudulent financial reposting and in appropriation of assets. Auditors’ response includes:

Discussion among engagement personnel Making inquiries Performing analytical procedures Considering fraud factors Identify fraud risks

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Auditor’s Response

Modify audit approach Alteration in nature, timing and extent of audit

procedures Performance of procedure to address

management override of internal controls Seeking corroborating information Assiging personnel and supervision Predictability of auditing procedures.

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Planning Audit

Audit plan focuses on time budgets and audit programs.

Audit plan

1. Is required under standard of field work and

2. helps auditors to coordinate, supervise and schedule work.

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Audit Plan

Overview of engagement Nature and extent of other services performed Timing and scheduling of work Work to done by client’s staff Staff requirement during engagement Target dates for completing major assignments Discussion among firm members about major risks Significant risk of fraud and auditors’ response Preliminary estimate of materiality

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Time Budgets

Auditors charge client on the basis of time. Detailed time budgets asset auditors to evaluate their fees.

Time budget involves time required for each assignment at various levels.

Time budget divert attention to more risk areas. Some situation and conditions may demand more

time but even if more time is not possible there is no bargain over quality of field work.

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Audit Program

It is list of detailed procedure performed.

This may be modified as audit progress.

Even final version of procedures may change

depending upon materiality and risk.

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Audit and Risk

Auditor need to design procedures that focus on:

1. Inherent risk and

2. Control risks.

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Audit Trial

Source Document Journals Ledgers

Finish Start

Start Finish

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Audit Program

Assess existence and effectiveness of internal controls; like revenues cycle, purchase cycle, conversion cycle, payroll cycle, financing cycle, investing cycle etc.

Substantive testing of financial statement accounts and adequacy of disclosures; i.e. testing of major financial statements accounts viz. cash, receivables, inventories, plan equipment etc.