AUDITING & ASSURANCE SERVICEB. B. mgt. Accountancy (Special) DegreeYear II Semester I

AUDIT PLANNING PLANNING AN AUDIT OF FINANCIAL STATEMENTS SLAuS 300AUDIT MATERIALITY SLAuS 320

Planning an audit involvesEstablishing the overall audit strategy for the engagement andDeveloping an audit plan in order to reduce audit risk to an acceptably low level

Adequate planning helps to ensure thatappropriate attention is devoted to important areas of the auditpotential problems are identified and resolved on a timely basis andthe audit engagement is properly organized and managed in order to be performed in an effective and efficient manner

Importance of Audit PlanningAdequate planning also assists in the proper assignment of work to engagement team members, facilitates the direction and supervision of engagement team members and the review of their work, and assists, where applicable, in coordination of work done by auditors of components and experts.

Preliminary Engagement ActivitiesPerform procedures regarding the continuance of the client relationship and the specific audit engagement (SLAuS 220, Quality Control)Evaluate compliance with ethical requirements, including independence (SLAuS 220)Establish an understanding of the terms of the engagement (SLAuS 210)

Audit Strategy V Audit PlanThe overall audit strategyThe auditor should establish the overall audit strategy for the audit.

The overall audit strategy sets the scope, timing and direction of the audit, and guides the development of the more detailed audit plan.

ScopeTimingDirectionOverall Audit Strategy

The establishment of the overall audit strategy involvesScopeDetermining the characteristics of the engagement that define its scope,TimingAscertaining the reporting objectives of the engagement to plan the timing of the audit and the nature of the communications requiredDirectionConsidering the important factors that will determine the focus of the engagement teams efforts

The overall audit strategy sets out clearlyThe resources to deploy for specific audit areasThe amount of resources to allocate to specific audit areasWhen these resources are deployedHow such resources are managed, directed and supervised

The Audit PlanThe auditor should develop an audit plan for the audit in order to reduce audit risk to an acceptably low levelThe audit plan includesA description of the nature, timing and extent of planned risk assessment procedures sufficient to assess the risks of material misstatementA description of the nature, timing and extent of planned further audit procedures at the assertion level for each material class of transactions, account balance, and disclosureSuch other audit procedures required to be carried out for the engagement in order to comply with SLAuSs

Risk Assessment Procedures (RAP)The audit procedures performed to obtain an understanding of the entity and its environment, including the entitys internal control, to identify and assess the risk of material misstatement, whether due to fraud or error, at the financial statement and assertion levels.

RAP and FAP at what stage..?Planning of the auditors risk assessment procedures ordinarily occurs early in the audit process. However, planning of the nature, timing and extent of specific further audit procedures depends on the outcome of those risk assessment procedures.

AUDIT MATERIALITYAuditors RequirementThe auditor should consider materiality and its relationship with audit risk when conducting an audit.

Materiality meansFramework for the Preparation and Presentation of Financial Statements defines the materiality as Information is material if its omission or misstatement could influence the economic decisions of users taken on the basis of the financial statements.Materiality depends on the size of the item or error judged in the particular circumstances of its omission or misstatement.

The assessment of what is material is a matter of professional judgment I designing the audit plan, the auditor establishes an acceptable materiality level so as to detect quantitatively material misstatements. However, both the amount (quantity) and nature (quality) of misstatements need to be considered.

Examples of Qualitative MisstatementsThe inadequate or improper description of an accounting policy when it is likely that a user of the financial statements would be misledWhen it is likely that the consequent imposition of regulatory restrictions will significantly impair operating capabilityThe auditor needs to consider the possibility of misstatements of relatively small amounts that, cumulatively, could have a material effect on FSs.

The auditor considers materiality at both the overall financial statement level and in relation to classes of transactions, account balances, and disclosures.Materiality should be considered by the auditor when:(a) Determining the nature, timing and extent of audit procedures; and(b) Evaluating the effect of misstatements.

The Relationship Between Materiality and Audit RiskWhen planning the audit, the auditor considers what would make the financial statements materially misstated.There is an inverse relationship between materiality and the level of audit risk, that is, the higher the materiality level, the lower the audit risk and vice versa.The auditor takes the inverse relationship between materiality and audit risk into account when determining the nature, timing and extent of audit procedures.

For example..If, after planning for specific audit procedures, the auditor determines that the acceptable materiality level is lower, audit risk is increased.The auditor would compensate for this by either:Reducing the assessed risk of material misstatement, Reducing detection risk by modifying the nature, timing and extent of planned substantive procedures.

Evaluating the Effect of MisstatementsIn evaluating whether the financial statements are prepared, in all material respects, in accordance with an applicable financial reporting framework, the auditor should assess whether the aggregate of uncorrected misstatements that have been identified during the audit is material.

The aggregate of uncorrected misstatements comprises:

(a) Specific misstatements identified by the auditor including the net effect of uncorrected misstatements identified during the audit of previous periods; and(b) The auditors best estimate of other misstatements which cannot be specifically identified (i.e., projected errors).

The auditor needs to consider whether the aggregate of uncorrected misstatements is material. If the auditor concludes that the misstatements may be material, the auditor needs to consider reducing audit risk by extending audit procedures or requesting management to adjust the financial statements.

If management refuses to adjust the financial statements and the results of extended audit procedures do not enable the auditor to conclude that the aggregate of uncorrected misstatements is not material, the auditor should consider the appropriate modification to the auditors report in accordance with SLAuS 700

Calculation of Materiality LevelIn practice to set the materiality level the auditors need to decide the level of error, which would distort the view given by the financial statements.Materiality level is often expressed as a percentage of profit since the users of financial statements are primarily interested in the profitability of the company.

Rule of ThumbDetermining the materiality involves the exercise of professional judgment. A percentage is often applied to a chosen benchmark as a starting point in determining materiality for the financial statements.

Factors that may affect the identification of an appropriate benchmark The elements of financial statementsWhether there are items on which the attention of the users of the particular entitys financial statements tends to be focusedThe nature of the entity, where the entity is in its life cycle, and the industry and economic environment in which the entity operatesEntitys ownership structure and the way it is financedThe relative volatility of the benchmark

In calculating materiality level for Not for Profit organization auditor may use funds received / expenditure in calculating the materiality level.

BaseRangeApplicabilityProfit Before Tax5% to 10%When the business is profit driven/ key business decisions are made based on the profitability E.g. Manufacturing / ServiceRevenue0.5% to 1%When the business is revenue driven / key business decisions are made based on the revenueE.g. Buying & Selling companyNet AssetsTotal Assets2% to 5% 1% to 2%Entities where net assets provides the basis for most of stake holders decisions.E.g. Unit trust