Part Two Audit objectives, Planning The Audit ＆ Materiality

1. Part Two Audit objectives, Planning The Audit ＆ Materiality

2. Structure of Seminar • Audit objectives • Planning the audit • The importance of planning • The overall audit strategy and the detailed audit plan • Materiality

3. 1. Audit objectives • Overall objective of the audit • Specific audit objectives - The overall is reasonable • Truth • Integrity • Ownership • Valuation • Close • Accuracy

4. Audit objectives • Disclosure • Classification

5. 2. Planning the audit • Steps in planning the audit: • Obtain an understanding of the entity and its environment • Make preliminary judgments about materiality levels • Consider the audit risk • Obtain an understanding of the entity’s internal control structure • Develop preliminary audit strategies for significant assertions

6. Planning the audit • ASA 300 ‘Planning the Audit of a Financial Report’ • “The auditor shall plan the audit so that the engagement will be performed in an effective manner” • ASA 315 ‘Understanding the Entity and Its Environment and Assessing the Risk of Material Misstatement’ • “the auditor shall obtain an understanding of the entity and its environment, including its internal controls, sufficient to identify and assess the risks of material misstatements of the financial statements whether due to fraud or error, and sufficient to design and perform further audit procedures”

7. Planning the audit • Obtaining an understanding of the entity and its environment • Why? To understand the events, transactions, practices & risks that may have a significant effect on the F/S • What knowledge is needed? • Industry, regulatory & other external factors • Industry conditions • Regulatory environment • Economy-wide factors

8. Planning the audit • What knowledge is needed? (cont.) • Nature of entity, including its accounting policies • Business operations • Investments • Financing • Financial reporting • Entity’s objectives, strategies & business risks • Measurement & review of entity’s financial performance

9. Audit Planning • How is knowledge obtained? • Review industry and business data • Review prior year’s working papers • Review past experience with client • Tour client’s operations • Interim audit • Make inquiries of audit committee • Make inquiries of management • Perform analytical procedures

10. 3. The importance of planning • An effective and efficient audit relies on proper planning procedures. The planning process is covered in general terms by ISA 300 Planning an audit of financial statements which states that the auditor shall plan the audit so that the engagement is performed in an effective manner. • Audits are planned to: • Help the auditor devote appropriate attention to important areas of the audit. • 􀁸 Help the auditor identify and resolve potential problems on a timely basis.

11. The importance of planning Help the auditor properly organise and manage the audit so it is performed in an effective manner. 􀁸 Assist in the selection of appropriate team members and assignment of work to them. 􀁸 Facilitate the direction, supervision and review of work. 􀁸 Assist in coordination of work done by auditors of components and experts. • Audit procedures should be discussed with the client's management, staff and/or audit committee in order to

12. The importance of planning co-ordinate audit work, including that of internal audit. However, all audit procedures remain the responsibility of the external auditors. A structured approach to planning will include: • Step 1 Ensuring that ethical requirements are met, including independence • Step 2 Ensuring the terms of the engagement are understood • Step 3 Establishing the overall audit strategy that sets the scope, timing and direction of the audit and

13. The importance of planning guides the development of the audit plan Identify the characteristics of the engagement that define its scope. Ascertain the reporting objectives to plan the timing of the audit and nature of communications required. Consider significant factors in directing the team’s efforts. Consider results of preliminary engagement activities.

14. The importance of planning Ascertain nature, timing and extent of resources necessary to perform the engagement. • Step 4 Developing an audit plan that includes the nature, timing and extent of planned risk assessment procedures and further audit procedures.

15. 4. The overall audit strategy and the detailed audit plan The overall audit • The overall audit strategy and audit plan shall be updated and changed as necessary during the course of the audit. • The matters the auditor may consider in establishing an overall audit strategy are set out in the table below.

17. The overall audit strategy and the detailed audit plan • Examples of items to include in the overall audit strategy could be: Industry-specific financial reporting requirements Number of locations to be visited Audit client's timetable for reporting to its members Communication between the audit team and the client

18. The overall audit strategy and the detailed audit plan The detailed audit plan risk assessment procedures Plans to implement further audit procedures Plans to implement additional audit procedures

19. 4.Audit Engagement Letter ASA 210 ‘Terms of Audit Engagements’ Purpose Confirms terms of the engagement Effect Legal contract between auditor and client See textbook pp.231-3 for an example Content Identification of the entity and the financial report to be audited

20. Audit Engagement Letter • Content (cont.) • Objectives of the audit • Reference to professional standards and statutes • Auditor’s responsibilities • Limitations of the audit • Management’s responsibilities • Auditor independence requirements • Basis of fee • Acceptance by client

21. 5. Materiality • ISA 320 Materiality in planning and performing an audit provides guidance to auditors on this area. The objective of the auditor is to apply the concept of materiality appropriately in planning and performing the audit. Information is generally consider to be material if its omission or misstatement could influence the economic decisions of users taken on the basis of the financial statements.

22. Materiality 1) Determining materiality and performance materiality when planning the audit • Performance materiality is the amount or amounts set by the auditor at less than materiality for the financial statements as a whole to reduce to an appropriately low level the probability that the aggregate of uncorrected and undetected misstatements exceeds materiality for the financial statements as a whole. Performance materiality also refers to the

23. Materiality amount or amounts set by the auditor at less than the materiality level or levels for particular classes of transactions, account balances or disclosures. • During planning, the auditor must establish materiality for the financial statements as a whole. Howeer, if thvere are classes of transactions, account balances or disclosures for which misstatements less than materiality for the financial statements as a whole couldreasonably

24. Materiality be expected to influence the economic decisions of users taken on the basis of the financial statements, the auditor must also determine materiality levels to be applied to these. • Determining materiality for the financial statements as a whole involves the exercise of professional judgement (which we covered in section 1 of this chapter). Generally, a percentage is applied to a chosen benchmark as a starting point for determining materiality for the

25. Materiality financial statements as a whole. The following factors may affect the identification of an appropriate benchmark: • Elements of the financial statements (e.g. assets, liabilities, equity, revenue, expenses) • 􀁸 Whether there are items on which users tend to focus • 􀁸 Nature of the entity, industry and economic environment

26. Materiality • Entity’s ownership structure and financing • 􀁸 Relative volatility of the benchmark

27. Materiality 2) Revision of materiality • The level of materiality must be revised for the financial statements as a whole if the auditor becomes aware of information during the audit that would have caused the auditor to have determined a different amount during planning.

28. Materiality 3) Documentation of materiality • ISA 320 requires the following to be documented: • 􀁸 Materiality for the financial statements as a whole • 􀁸 Materiality level or levels for particular classes of transactions, account balances or disclosures if applicable • 􀁸 Performance materiality • 􀁸 Any revision of the above as the audit progresses