Audit Planning 1. Accept the client & initial planning a. Accept new client/continue with existing client ü Integrity of management ü Auditor's competence & capabilities ü Ethics & independence ü Significant matters arising from current/previous audit b. Identify the reasons for the audit ü Identify users and uses c. Engagement Letter d. Select audit team ü Engagement partner ü Expertise ü Outside specialist Error 5. Set materiality XAccount balance 2. Understanding the client a) Industry, regulatory and external factors ü Accounting principles, Competitors, exchange rate b) The nature of the entity ül Tour the client's plants and offices ü Related parties, Constitution c) Management and governance d) Entity's objectives & strategies e) Entity's financial performance Sample 3. Assess business risk ü Review management's risk management controls and procedures 4. Perform preliminary analytical procedures ü Compare key ratios or data for the company with those of industry competitors/ benchmarks · A preliminary judgment about materiality is set for the financial statements as a whole. · Tolerable misstatement is the maximum amount of misstatement that would be considered immaterial for an individual account balance -> account balance materiality = maximum misstatement · Materiality levell -> Evidence1 · Larger or more significant an account balance is -> Evidence needed1 · Steps in applying materiality: [1. Set materiality for the financial statements as a whole; 2. Determine performance materiality] Planning extent of tests [3. Estimate total misstatement in segment; 4. estimate the combined misstatement; 5. Compare combined estimate with assessment about materiality] Evaluating results · If the total misstatements > preliminary judgment of misstatement: (1) reassess their preliminary estimate of materiality; (2) If no change to the preliminary judgment of misstatement is appropriate, then do additional audit procedures e.g. increase sample size or use alternative audit procedures; (3) If the total misstatements still exceed, the auditor approach the client to correct the misstatements; (4) Fail to correct the misstatements may result in a modified audit opinion.
Acceptable Audit Risk = an auditor expresses an inappropriate audit opinion when a financial report is materially misstated a) Reliance by external users ül The company changed from a privately held company to a public company -> AARI b) Likelihood of financial failure ül The client lacks sufficient working capital to continue operations -> AARI ül The client's management materially increased long-term contractual debt -> AARI ü Working capital, debt to equity ratio and other indicators of financial performance has improved -> AART c) Integrity of management ül The company's management are known to have good integrity -> AART ü Frequent disagreements with prior auditors & regulators ü Frequent turnover of key financial and internal audit personnel ü Ongoing conflicts with labor unions and employees
Inherent risk = risk of misstatement in the absence of internal controls a) Industry factors · Competition 1 -> sales \ -> profit \ -> misstatement 1 b) Nature of the client's business · Small local business accounts for its sales very easily vs highly complicated business (e.g. construction business) c) Integrity of