05 Planning & Audit Tests[CompatibilityMode]

  Chapter 5 Chapter 5 Audit Planning and Types of Audit Tests McGraw-Hill/Irwin Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. LO# 1 The Phases of an Audit That Relate to Audit Planning Client acceptance and continuance Establish an understanding with client Preliminary engagement activities Assess risks and establish materiality Plan the audit _5-2

  LO# 1

Prospective Client Acceptance 1. Obtain and review financial information

  2. Inquire of third parties.

  3. Communicate with the predecessor auditor.

  4 C 5. Determine if the firm is independent.

  4. Consider unusual business or audit risks. id l b i dit i k

  6. Determine if the firm has the necessary skills and knowledge.

  7. Determine if acceptance violates any applicable regulatory agency requirements or the Code of Professional Conduct.

  Continuing Client Retention Evaluate client retention periodically Near audit completion or after a significant event Conflicts over accounting & auditing Dispute over fees issues _5-4

  LO# 2 Establish an understanding with client

  The terms of the engagement, which are documented in the engagement letter, should include the objectives of the engagement, management’s responsibilities, the auditor’s responsibilities, and the limitations of the engagement engagement. In establishing an understanding with client, three topics must be discussed:

  1.The engagement letter;

  2.The internal auditors; 3.The audit committee. _5-5 LO# 3

  The Engagement Letter The engagement letter formalizes the arrangement reached between the auditor and the client. In addition to the items mentioned in the sample engagement letter in Exhibit 5-1 in the textbook, the engagement letter may include:

• Arrangements for use of specialists or internal auditors.
• Any limitations of liability of the auditor or client.
• Additional services to be provided.

  Internal Auditors 5-7 LO# 4

  Internal Auditors 5-8 LO# 5

  The Audit Committee

  Regulation no. IX.1.5 of Bapepam Regulation no. Kep-29/PM/2004, dated September 23, 2004 requires the following for audit committee

  Responsible

  members of publicly held companies:

  directly to the board of

• Minimum one of them is the independent commissioner.

  commissioners

• Review all issued financial information by company.

  No specific

• Review the complaints to the capital market and other regulations.

  requirements for privately

• Review the activities of internal auditors.

  held companies

• Report to the BoC regarding any business risks

  faced by the company and management risks faced by the directors. Preliminary Engagement Activities Determine the Audit Engagement Team Requirements Assess Compliance with Ethical Requirements, Including Independence _5-10

  LO# 6 Preliminary Engagement Activities

Use audit

  Assess Establish

  risk model

  Risks Materiality Achieve Restrict risk at acceptable account level of audit balance level risk

  You may want to review the detailed discussion in You may want to review the detailed discussion in

  Chapter 3 of the process used to assess the client’s Chapter 3 of the process used to assess the client’s business risks and to establish materiality. business risks and to establish materiality. _5-11 LO# 7

  Planning the Audit

• The auditor will develop an overall audit strategy for

  conducting the audit. This will help the auditor to determine what resources are needed to perform the engagement.

• An audit plan is more detailed than the audit

  strategy. t t

• Basically, the audit plan should consider how to

  conduct the engagement in an effective and efficient manner.

  Planning the Audit

  When preparing the audit plan, the auditor should be guided by the results of the risk assessment procedures performed to gain an understanding of the entity.

Additional steps: 5-13 • Assess the need for specialist

• Assess the possibility of illegal acts.
• Identify related parties.
• Conduct preliminary analytical procedures.
• Consider additional value-added services.
• Document Audit Strategy and Plan

  and Prepare Audit Programs Let’s look at each of these steps.

  Specialists

  A major consideration is planning the audit is the need for specialist (SA 336). The use of an IT specialist i i ifi t t f ^{LO# 7}

  5-14

  is a significant aspect of most audit engagements. The presence of complex information technology may require the use of an IT specialist.

  Illegal Acts Illegal Acts ^{LO# 7}

  Direct & Material Consider laws & regulations as part of audit

Material & Indirect

  Be aware may have occurred; investigate if brought to attention Illegal Acts 5-16 LO# 7

  Related Parties

Some examples from PSAK No. 7, How to Identify “Related Party Disclosure” Related Parties • • Affiliates of the enterprise. Review board minutes

• Entities using equity method to Review conflict-of-interest account for investments. statements.

Principal owners of enterprise. Review transactions with major customers, suppliers, borrowers, • Management. and lenders

• Immediate families of the
• Review large, unusual, or principal owners & management.

  nonrecurring transactions • Other parties that can have especially at year end. significant influence.

• Review loan agreements for guarantees.
_5-17 LO# 7

  Preliminary Analytical Procedures

  To identify To understand the financial statement client’s business accounts likely to and transactions contain errors

  By understanding the client’s business and identifying where errors are likely to occur, the auditor can allocate more resources to investigate necessary accounts.

  Additional Value-Added Services

  System Internal Tax Planning Design and Reporting Integration Risk Electronic Benchmarking Assessment Commerce

  Auditors who audit public companies are limited in the types of consulting services that they can offer their audit clients. _5-19 LO# 7

  Document Audit Strategy and Plan Document overall audit strategy and The auditor documents how the audit plan, which involves documenting client is managing its risk (via the decisions about internal control processes) and the effects of the risks and A controls on the planned audit U procedures. procedures

  Nature Nature

  D Auditors ensure they have addressed the risks they

  I identified by documenting the linkage from the T client’s business, objectives, and strategy to the

  Timing audit plan.

  T The auditor’s preliminary decision concerning E control risk determines the level of control testing, which in turn affects the auditor’s substantive tests S Extent of the account balances and transactions. T _5-20 S LO# 8

  Types of Audit Tests

  Used to obtain an understanding of Risk Assessment the entity and its environment, Procedures including internal controls. Di Directed toward the evaluation of the t d t d th l ti f th effectiveness of the design and Tests of Controls implementation of internal controls. Detect material misstatements in a Substantive transaction class, account balance, and disclosure component of the Procedures financial statements. Tests of Controls

Inquiry Inspection 5-22 Walk Through Reperformance Observation

  Tests of Controls ^{LO# 8} 5-23

  Substantive Procedures Analytical Procedures Tests of Details ^{LO# 8}

  Obtains evidential matter about particular assertions related to account balances or classes of transactions Tests for errors or fraud in individual transactions Dual Purpose Tests Tests of Substantive Controls Tests Dual Purpose Test _5-25

  LO# 9 Purposes of Analytical Procedures

Used to assist the auditor to better Preliminary understand the business and to plan the Analytical nature, timing, and extent of audit procedures. Procedures Substantive Substantive Used to obtain evidential matter about particular assertions related to account Analytical balances or classes of transactions. Procedures Final Used as an overall review of the financial information in the final review stage of the Analytical audit. Procedures

  _5-26 LO# 9

  Types of Analytical Procedures Trend Analysis Ratio Ratio Analysis Reasonableness Analysis

  Substantive Analytical Procedures Decision Process 5-28

  Develop an Expectation Developing an expectation is the first step in the decision process for the amount or account balance. This is the most important step in performing analytical procedures. Auditing standards require the auditor to have an expectation whenever analytical procedures are used. An expectation can be developing using a variety of information sources such as: ^{LO# 9}

• Financial and operating data
• Budgets and forecasts
• Industry publications
• Competitor information
• Management’s analyses • Analyst’s reports.

  5-29 developing using a variety of information sources such as:

  Define a Tolerable Difference

The size of the tolerable difference depends on

• the significance of the account,
• the desired degree of reliance on the substantive analytical procedures ^{LO# 9} analytical procedures,
• the level of disaggregation in the amount being tested, and
• the precision of the expectation.

  Compare and Investigate

Compare the expectation to the recorded amount and investigate any differences greater than the tolerable difference. 5-31 LO# 9

  Investigate Differences for Planning and Final Analytical Procedures

  Preliminary Final Analytical Analytical Procedures Procedures Differences Differences Corroborating Corroborating evidence evidence

  is not required is required _5-32 LO# 10

  Audit Testing Hierarchy Filling the Assurance Bucket 5-34

  Example of Filling the Assurance Buckets for Each Assertion (Accounts Payable) ^{LO# 10} 5-35

Short-Term Liquidity Ratios

  Current Ratio ^{LO# 11} Quick Ratio Operating Cash Flow Ratio

  Activity Ratios

  Receivables Turnover Days Outstanding in Accounts Receivable

  5-37

  Inventory Turnover Days of Inventory on Hand

  Profitability Ratios Gross Profit Percentage Profit Margin ^{LO# 11}

  5-38 Return on Assets Return on Equity

Coverage Ratios

  Debt to Equity ^{LO# 11} Times Interest Earned

  End of Chapter 5 5-40