Chapter Three Basic Concepts of Audit Planning

CHAPTER THREE
Basic concepts of audit planning

INTRODUCTION
 auditors consider the professional responsibility and
potential legal liability to start auditing.
 The audit work should be adequately planned and
properly executed.
 If assistants are employed, they should be properly
supervised.

DEFINITION
 According to AAS-8, “Audit planning refers to planning
by the auditor made to enable him to conduct an
effective audit, in an efficient and timely manner, and
includes planning about area, scope, depth of
transactions to be audited, persons to be assigned for
audit etc”.
 “Audit planning is the process of deciding in advance
what is to be done, who is to do it, how it is to be done,
and when it is to be done by the auditor in order to have
an effective and efficient completion of audit”.
CONT’D
The concept of adequate planning includes;
 investigating a prospective client before deciding
whether to accept the engagement,
 obtaining an understanding of the client's business
operations, and
 developing an overall strategy to organize, coordinate,
and schedule the activities of the audit staff.
CONT’D
In planning the audit, the auditor needs to consider the ff;
 the terms of the engagement and the expected date of the report
 the nature of the client's business, including applicable statutory

and contractual requirements
 the experience gained during previous audit engagements
 the accounting policies and degree of complexity of the

accounting system
 materiality and the components of audit risk
 any involvement of internal auditors and persons having special

expertise
 the intended reliance on internal control
 the level of experience and the number of audit staff for the
engagement
AIM OF AUDIT PLANNING
An effective and efficient audit relies on proper planning

procedures.
The objectives of planning work involve:
 ensuring that appropriate attention is devoted to the different
areas of the audit
 ensuring that potential problems are identified; and
 facilitating review
Good planning helps in assigning those proper tasks to the

members of the audit team, coordinating outside experts
All members of the audit team must have an understanding of
the entity's affairs.
SOURCE OF INFORMATION FOR
AUDITORS
 previous experience of the client and its industry
 visits to the client's premises and plant facilities
 discussion with the client's staff and directors
 discussion with other auditors and with legal and other

advisors who have provided services to the client or within
the industry
 Publications related to the industry (eg. Government
statistics, surveys, texts, journals, financial newspapers)
 legislation and regulations that significantly affect the client
 Documents produced by the client (eg. Minutes of meetings)
 Professional literature giving industry specific guidance.

CONT’D
Matters to Consider in Relation to Knowledge of the
Business
 General economic factors
 The industry: conditions affecting the client's business
 The entity: directors, management and ownership
 The entity's business: products, markets, suppliers,

expenses and operations
 Financial performance: factors concerning the entity's
financial condition and profitability
 Information technology
 Reporting environment: external influences which affect

the directors in the preparation of financial statements.
CONT’D
Using the information, the auditors must use it:
 to assess risks and identify problems
 to plan and perform the audit effectively and efficiently

and
 to evaluate audit evidence.
AUDIT RISK
 Audit risk is the risk that auditors may give an
inappropriate opinion on the financial statements. i.e the
statements will contain material misstatement which the
auditors fail to find
 Audit risk is the risk that the auditors give an unqualified
opinion on the accounts when they should have given a
qualified opinion.
 The concept of audit risk is consistent with the fact that
the audit is designed to provide reasonable assurance,
not absolute assurance
CONT’D
Audit risk has three components; inherent risk, control risk
and detection risk.
 Inherent risk
 The probability that material misstatements have

occurred
 is the susceptibility of an account balance or class of
transactions to material misstatement, either individually
or when aggregated with misstatements in other
balances or classes, irrespective of related internal
control.
CONT’D
 Control risk
Control risk is the risk that client internal controls fail to
detect material misstatements.
It is the risk that a misstatement;
 could occur in an account balance or transaction
 could be material, either individually or when

aggregated with misstatements in other balances or
classes; and
 Would not be prevented, or detected and corrected on a
timely basis, by the entities internal control systems.
CONT’D
 Detection risk
 The risk that errors could but would not be detected by
the auditor’s procedures.
 is the risk that the auditors' substantive procedures do
not detect a misstatement that exists in an account
balance or class of transactions that could be material,
either individually or when aggregated with
misstatements in other balances or classes.
CONT’D
 Detection risk is the risk that audit procedures will fail to
detect material errors.
 Detection risk relates to substantive procedures and the
inability of the auditors to examine all evidence.
 Detection risk is directly controllable by the auditor
through substantive tests of details and others
substantive audit procedures e.g if both control risk and
inherent risk are high an auditor reduce allowable
detection risk by increasing sample size
CONT’D
 Substantive procedures are tests performed to obtain audit
evidence to detect material misstatements in the financial
statements
Substantive tests consists of:
a. Analytical procedures involve the use of comparisons to
assess fairness. Example: Sale per square foot of retail price.
b. Tests of details of transactions involve examining support
for the individual transactions posted to an account.
Example: Vouching debits to accounts receivable to entries in
the sales journal and supporting sales invoices.
c. Tests of details of balances involve examining support for
the ending balance directly. Example: Confirming an ending
accounts receivable balance directly with the customers.
CONT’D
 the audit risk model may be expressed quantitatively as
follows:
AR = IR×CR×DR
 to illustrate the use of the model, assume that the auditor
made the following professional judgments for a
particular assertion, such as the valuation or allocation
assertion for accounts receivable:
AR=5%, IR=90%, AND CR=28%
Detection risk can be determined by solving the model for
dr as follows:
DR = (AR) / (IR×CR)
= .05 / (0.9 × 0.28)
=.0.984, approximately 0.20 OR 20%
CONT’D
Classification of Audit Procedures:
 An auditor performs audit procedures to obtain evidence to
support an opinion on the financial statements. They are:

a. Procedures to obtain an understanding: In performing the
audit, an auditor usually performs procedures to obtain an
understanding of the client, its business and industry, and factors
that may affect the inherent risk of misstatement in an assertion.
b. Tests of Controls: They are made to provide evidence about the
effectiveness of the design and operation of internal control
structure policies and procedures. Example: A computer control
procedure uses batch totals to ensure that the entire batch of
transactions is recorded.
c. Substantive Tests: They provide evidence as to the fairness of
management’s financial statement assertions.
MATERIALITY’
 Materiality is an expression of the relative significance or
importance of a particular matter in the context of financial
statement as a whole.
 A matter is material if its omission or misstatement would
reasonably influence the decisions of users of the auditors'
report.
 The concept of 'true and fair' is linked with the concept of
materiality, which is fundamental to the whole process of
financial accounting. The auditors' task is to decide whether
accounts show a true and fair view.
CONT’D
 Auditors plan and perform the audit to be able to provide

reasonable assurance that the financial statements are
free of material misstatement and give a true and fair
view.
 The assessment of what is material is a matter of
professional judgment and includes consideration of both
the amount (quantity), and the nature (quality) of
misstatements.
CONT’D
The assessment of materiality at this stage

should be based on the most recent and reliable
financial information and will help to determine
effective and efficient audit approach.
Materiality assessment will help the auditors to
decide:
how many and what items to examine
whether to use sampling techniques
What level of error is likely to lead to a
qualified audit opinion

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CHAPTER THREE

Basic concepts of audit planning

 the nature of the client's business, including applicable statutory

 the accounting policies and degree of complexity of the

 any involvement of internal auditors and persons having special

An effective and efficient audit relies on proper planning

Good planning helps in assigning those proper tasks to the

 discussion with the client's staff and directors

 discussion with other auditors and with legal and other

 Documents produced by the client (eg. Minutes of meetings)

 Professional literature giving industry specific guidance.

 The industry: conditions affecting the client's business

 The entity: directors, management and ownership

 The entity's business: products, markets, suppliers,

 Reporting environment: external influences which affect

 to plan and perform the audit effectively and efficiently

 The probability that material misstatements have

 could be material, either individually or when

support an opinion on the financial statements. They are:

 Auditors plan and perform the audit to be able to provide

The assessment of materiality at this stage

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