07/08/2017

1 Planning An Audit of Financial Statements

AUD 05

2 Major Audit Planning Activities

- PSA 200 (Revised and Redrafted), Overall Objective of the Independent Auditor and the Conduct
of an Audit in Accordance with the Phil. Standards on Auditing.

3 Audit Planning
The auditor shall plan the audit so that it will be performed in an effective manner.
Planning involves
1. Establishing overall audit strategy; and
2. Developing a detailed audit plan.
Planning is an iterative process.

4 Documentation
Audit Planning Memorandum
Summarizes the decisions taken during the planning process.
It communicates the main emphasis of these decisions and can be referred to by the audit
team at any time during the audit.
Provides direction to members of engagement team.
Audit Program
List of detailed audit procedures to be performed to obtain evidence.

5 Principal Planning Activities

Obtain an understanding of the client and its environment (PSA 315).
Assessing the possibility of non-compliance (PSA 250).
Establishing materiality and assessing risks (PSA 315, 320)
Identifying related parties (PSA 550).
Performing preliminary analytical procedures (PSA 520)

6 Principal Planning Activities

Consider use of experts, internal auditors, client personnel, service organization and other
auditors (PSA 620, 610, 402, 600).
Develop overall audit strategy (PSA 300).
Prepare intial audit program (PSA 300).

7 Understanding the Business

- PSA 315, Understanding the Entity and Its Environment and Assessing the Risks of Material
Misstatement

8 Understanding the Entity

The auditor shall obtain knowledge about general economic and industry factors affecting the
entity, nature of entitys business, financial performance and condition, reporting requirements
and changes thereto and general level of managements competence

9 Required Understanding
Industry, regulatory and other external factors, including the applicable financial reporting

1
 07/08/2017

Industry, regulatory and other external factors, including the applicable financial reporting
framework (complex, stringent, PFRS)
Nature of the entity (operations, ownership & governance, investments, structure, capitalization)
Accounting policies (Alternatives/unusual transactions, absence of guidance, accounting changes)
Objectives and strategies, business risks (Business risk is broader than risk of material
misstatement)
Key Performance Indicators (KPI) (Pressures/incentive to misstate financial statements)
Internal Controls (effective & efficient operations, reliable financial reporting, compliance)

10 Sources of Auditors Understanding

Prior audit experience
Discussion with client & others
Industry publications
Legislations and regulations related to entity industry
Plant visits
Documents produced by the entity

11 Risk Assessment Procedures
Performed to obtain understanding of the entity and its environment, including internal control
and identify and assess risks of material misstatements at financial statement level and assertion
level, whether due to fraud or error.
Include:
1. Inquiry with management & those
responsible for financial reporting
2. Analytical procedures
3. Observation and inspection

12 Assess the Possibility of Non-compliance

- PSA 250, Consideration of Laws and Regulations in an Audit of Financial Statements
13 Assessing the Possibility of Non-compliance
Non-compliance refers to acts of omission or commission by the entity, either intentional or
unintentional, which are contrary to prevailing laws or regulations.
Source of Business Risk
Required understanding of auditor = General Understanding only

14 Responsibilities of Auditor
Assess the effect on the FS
If material = reflected on the FS
If immaterial = consider the impact on other aspect of the audit, integrity of management, legal
effect.
If management does not take remedial action = consider withdrawing/ask legal advice

15 Indicators of Non-compliance
Payment of unspecified services/loans to lawyers, consultants, related parties or gov. officials.
Payment for goods/services to a country other than where the goods/services originated

2
 07/08/2017

Payment for goods/services to a country other than where the goods/services originated
Purchase/sale at significantly higher/lower market price
Commissions/fees beyond the reasonable amount that is ordinarily paid for those type of
transactions

16 Audit Procedures re Non-compliance

Use of existing understanding
Inquiry of management
concerning entity policies and procedures regarding compliance with laws and regulations.
as to the laws or regulations that may be expected to affect entity operations.
Discussion with management the policies and procedures adopted to identify, evaluate and
account for litigation claims and assessments.
Discussion of legal and regulatory framework with auditors of subsidiaries in other geographical
area or segments.
17 Establishing Audit Materiality
- PSA 320, Audit Materiality

18 Establishing Materiality
The auditor determines materiality for the FS as a whole and materiality for particular class of
transactions, account balances or disclosure.
Planning
Preliminary judgment about materiality
Determine tolerable Misstatement
Completion of audit
Estimate likely misstatements and compare with preliminary judgment

19 Materiality levels
Materiality for the FS as a whole
Materiality for specific accounts, class of transaction or disclosure (if relevant)
Performance materiality (Tolerable Misstatement)
Clearly trivial misstatement (Audit Adjustment Nominal Amount)

20 Materiality for the FS as a whole

Also known as Planning Materiality or Overall Materiality
The largest amount that the FS could be misstated and still the auditor believes that the FSs are
fairly stated for purposes of users of FS
Matter of professional judgment
No straight and fast rule provided in the standards
In practice, covered by policy of the firm based on its experience

21 Materiality for the FS as a whole

Benchmark x percentage = starting point
Adjusted for qualitative characteristics
Benchmarks
Elements of FSs

3
 07/08/2017

Elements of FSs
Focus of users on particular items on FSs
Nature of the entity
Ownership structure
Volatility
Typical benchmark: profit before tax

22 Determining Materiality In Practice

Selecting an Appropriate Benchmark

23 Determining Materiality In Practice

Apply a range of percentage and adjust for qualitative characteristics
24 Materiality for Particular Items
For certain entities, there may be one or more particular classes of transactions, account balances,
or disclosures for which misstatements of lesser amounts than materiality for the FSs as a whole
could reasonably be expected to influence the economic decisions of users taken on the basis of
the FSs.
Factors to consider:
law, regulation or the applicable financial reporting framework
key disclosures in relation to the industry
attention focused on a particular aspect of the entitys business

25 Tolerable Error
Application of Performance Materiality
Set by the auditor at less than materiality for the FSs as a whole
To reduce to an appropriately low level the probability that the aggregate of uncorrected and
undetected misstatements exceeds materiality for the FSs as a whole
Allocated to specific account balances, class of transactions and disclosures using professional
judgment of the auditor.

26 Tolerable Error
Used in
Assessing the risks of material misstatement; and
Determining the nature, timing, and extent of further audit procedures.

27 Nominal Amount
The nominal amount is an amount at which any adjustments below it, individually or in aggregate,
would be immaterial to the financial statements being audited and the amount is consistently
within the Company's expectation.

28 Documentation of Materiality
The auditor shall document the following:
Materiality for financial statements as a whole
Materiality level(s) for particular items
Performance materiality for the above

4
 07/08/2017

Revisions to the above as the audit progresses

29 Illustrative Documentation

30 Illustration

31 Evaluation of Misstatements
Misstatements
amount per FSs vs. the amount per applicable financial reporting framework.
Due to fraud or error

32 Evaluation of Misstatements
Understand the nature and cause of identified misstatements
Accumulate misstatements identified
Evaluate overall scope of audit, perform further audit procedures and propose adjustments to
management
Evaluate the effect of uncorrected misstatements on the FSs
Communicate with management and TCWG

33 Identification of Material Account Balances, Class of Transactions, Disclosures
Focuses the audit only on what is deemed material
Professional judgment and should consider both the accounts nature and amount

34 Materiality and Audit Procedures

The level of materiality has an inverse relationship on audit procedures.
The lower the materiality, the more extensive the required audit procedures.
The higher the materiality, less extensive audit procedures may be required.

35 Materiality and Audit Risk

There is an inverse relationship between materiality and the level of assessed risk of material
misstatements.

36 Materiality and Audit Evidence

Materiality and audit evidence are inversely related.
The lower the level of materiality the auditor determines, the more audit evidence must be
obtained (and vice versa) in order to gain more confidence that the item is not materiality
misstated.

37 Assessing Risks of Material Misstatements

- PSA 315, Understanding the Entity and Its Environment and Assessing the Risks of Material
Misstatement
-

38 Assessing the Risks of Material Misstatements

The auditor is required to identify and assess the risks of material misstatements at the financial

5
 07/08/2017

The auditor is required to identify and assess the risks of material misstatements at the financial
statements and assertion levels.

39 Assessing the Risks of Material Misstatements

Identify risk by considering the entity & its environment, controls, & classes of transactions,
account balances & disclosures in the financial statements
Assessment may be quantitative or qualitative
Relate identified risks to what can go wrong (WCGWs) at the assertion level
Consider significance and likelihood of the risks

40 Assessing IR at Financial Statements Level

Management integrity
Experience and competence of management and audit committee
Management motivations
Nature of entity business
Industry factors

41 Assessing IR at Assertion Level

Financial statement line items more susceptible to misstatement (those involving judgment)
Complexity of transactions
Susceptibility to misappropriation
Transactions occurring near period-end
Transactions not subjected to ordinary processing

42 Assessing Control Risks

Auditor makes preliminary assessment of control risk
Identify significant class of transactions (SCOTs)
Assess the controls in SCOTs if reliable
The more reliable ICS = Less substantive tests

43 Significant Risks
Risks that requires special audit
consideration.
Considerations
Presence of fraud risk factors
Related to recent significant or accounting
event
Involves subjectivity and/or complexity
Transactions with Related parties
Transactions outside the normal course of business

44 Identifying Related Party Transactions

- PSA 550, Related Parties
-

45 Consideration of Related Parties

6
 07/08/2017

Related party vs. Related party transactions

Significant risk
Stringent disclosure requirements
Usually not arms length
Opportunity for fraud

46 Auditors Focus Area

All related parties are identified
Material RPTs are adequately disclosed.
RPTs are recorded so as to reflect economic substance rather than form.

47 Audit Procedures
Understanding the business
Inquiry of management
Review SEC filings & stockholder listings
Review of unusual transactions (without clear business rationale)

48 Preliminary Analytical Procedures

- PSA 520, Analytical Procedures
-

49 Timing of Analytical Procedures

Planning stage (Required)

Substantive test procedures (Not Required)

Final Review stage (Required)

50 Determine the Need for Experts

- PSA 620, Using The Work of An Expert
-

51 Use of Experts
Expert is a person or firm possessing special skill, knowledge and experience in a particular field
other than accounting and auditing.
Experts may be
Engaged or employed by client
Engaged or employed by auditor

52 Use of Experts
The auditor considers
Materiality of FS item in question
Risk of material misstatement

7
 07/08/2017

Quantity and quality of other audit evidence available

53 Use of Experts
Competence and Objectivity
Professional certification & membership in professional org.
Experience and reputation in experts field.
Evaluate the objectivity of the expert.

54 Use of Experts
Risk of impaired objectivity
Employed by entity
Not independent in relation to the entity
The auditor discusses with the client if the auditor has reservations regarding the experts
competence or objectivity.

55 Use of Experts
Assessment of experts work
Consider source data used,
Assumptions made and consistency
Results of the work of expert in relation to auditors overall knowledge of clients business and
operations
If the experts work does not constitute sufficient appropriate evidence.

56 Development of Audit Strategy

57 Audit strategy
Scope, timing and direction
Characteristics of engagement;
Reporting objectives;
Consider other important factors.

58 Detailed Audit Plan

Addresses various matters identified in the overall audit strategy
Often overlaps with the development of overall strategy and not necessarily discrete or sequential
in process
Audit plan includes description of
Risk assessment procedures
Further audit procedures
Other audit procedures

59 Audit Program
List of procedures used to gather sufficient appropriate audit evidence.
Procedures relating to
Test of controls

8
 07/08/2017

Substantive procedures

60 Timing of Audit Work

Not all procedures are done at period end.
Often, auditors perform procedures during the intervening period before period end known as
the interim period.
Audit timetable should be prepared and agreed upon with the client.

61 Other Considerations
Company personnel assistance
Work of Internal Auditors
Work of Other Auditors
Work of Service Organizations

62

63 End of Discussion
QUESTIONS