Chapter 3: Planning and Conducting the Audit

Dear Learners!

As we have discussed in the earlier chapters, the audit work should be performed by person or
persons having adequate training and skill about the audit procedures. The audit procedures have
various stages or phases. Auditors are responsible to do different tasks fairly and independently
during these various phases of audit process. The three major phases of the audit work are
planning the audit work, performing the field work of auditing, and reporting audit findings.

Objectives of the Chapter: After completing study on this chapter, you are expected to;

1. Discuss reasons for Audit planning

2. Describe audit planning procedures

3. Understand Designing of Audit program

4. Prepare audit working paper

5. Discuss about audit risk

6. Discuss about materiality in auditing

3.1. Reasons for Audit Planning

Audit planning is the process of determining an overall strategy for the conduct and scope of the

engagement. There are many reasons for planning the audit work. Some of them are discussed

below.

 To enable the auditors to obtain sufficient and competent evidence for the circumstance

 To keep reasonable audit cost. If the organization is complex, senior auditors are

required and high cost will be incur to perform the audit work. On the other hand if the

organization is small, junior auditors are required and less cost will be incur.

To avoid misunderstanding with the client

To assign assistant, if any.

3.2. Audit Planning Procedures

As per Auditing and Assurance Standard 1, ―Basic Principles Governing an Audit‖, Audit
Planning is one of the basic principles. Accordingly, it states the auditor should plan his work to
enable him to conduct an effective audit in an efficient and timely manner. Plans should be based
on knowledge of the client‘s business. Plans should be made to cover, among other things
acquiring knowledge of the client‘s accounting systems, policies and internal control procedures;
establishing the expected degree of reliance to be placed on internal control; determining and
programming the nature, timing, and extent of the audit procedures to be performed; and
coordinating the work to be performed. Plans should be further developed and revised as
necessary during the course of the audit

Audit planning process includes:

A. Pre-plan

B. Obtained back ground information

C. Obtain information about client‘s legal documents

D. Develop overall audit programs

E. Schedule the audit work

F. Assigning professional staff to engagement.

1. Pre-plan: before planning the audit work, auditors should do two things:

i. Client acceptance (accept or reject the audit contract)

ii. Obtain an understanding with the client

Auditors should avoid clients who lack integrity. That is auditors should evaluate public image,
financial stability, relationship with the previous auditors of a new client. To do this, the auditor
should read the past financial statements of the client, contract with past and present business
associates like banks and attorneys, by discussing with the potential client the need for the audit,
and by contacting the potential client‘s former auditors with the consent of the organization. If
there are no serious doubts raised about the integrity of the client, then the auditor will sign to
close a deal. The audit contract is called an Engagement Letter. The audit engagement letter
includes the following expressed duties:

The nature of the work to be performed

The dead line of the audit contract

The amount of the audit fee

Limitations of the auditor with respect to detection of errors, irregularities, and illegal acts.

2. Obtaining background information

Auditors should have feedback about the client‘s unique accounting requirements, the possibility
of risk, and the controlling system on its assets. Different forms of enterprises require different
accounting requirements. For instance, if the client is Construction Company, percentage of
contract completion is applied or required to recognize revenue. On the other hand if the client is
government organization, government accounting is used. Thus, the auditor should identify the
client‘s accounting requirement and follow appropriate audit procedures at times when he/she
performs the audit work. The possibility of risk also varied from client to client. That means the
chance of occurring errors, irregularities, illegal acts, and misuse of cash or other resources may
vary from one organization to the other. In order to adjust or aware themselves about their future
activities, auditors should get feedback about the problems of the client.

Finally, the auditor should tour (observe) the client‘s personnel and assets controlling technique.

For example, if the auditor sees the store keeper sleeps at his/her desk with the store door open,
or the cashier talking on the phone while he/she is counting money, there will be the sign to
weakness in the client‘s internal control system. Or if the auditor sees broken or obsolete
equipment, that might be the signal that plant assets are possible overvalued.
3. Obtaining information about the client’s legal documents

There are three documents of the client that should be observed by the auditors. Examining these

documents and records enable auditors to enter prate related evidences during their engagement.

The three legal documents are discussed below.

i. Corporate charters and by laws

ii. Minutes of meetings

iii. Contracts

i. Corporate charters and by laws: the corporate charter is granted by the government in which
the company is incorporated. It includes name, address, date of establishment, types of business
activities, voting right, dividend allocation systems, etc. By laws include rules and regulations
adopted by the organization in order to accomplish different activities of the organization.

ii. Minutes of meetings: are the official records to the meetings of the management and

higher body of the organization. These minutes of meeting include the management

decision such as compensation of officers, bonus rates, dividend rates, etc.

iii. Contracts: clients may enter in to different contracts to others like pension plans, contracts
with suppliers, government contracts with completion and delivery of manufacturing products,
lease, etc.

In general, if the auditor have information about the three legal documents of the client before

starting his/her main task, he/she will be aware and inform about such information while
examining and evaluating the difference evidences of the client and finally he/she is adequate to

give suggestion and recommendation in his/her final report.

An audit program is the detailed list of the audit procedures to be pertained/refer /concern by the
auditor in examining the financial statements. Before starting the work, the auditor should
ordinarily establish a preliminary program for a review this audit program should be documented
in a manner that will permit the auditor to record completion of the audit work and identify work
that remains to be done. As the work progresses, the auditor should evaluate the adequacy of the
program based on information gathered during the audit. The audit program may be modified if
the auditor believes that the planned procedures are not sufficient.

The objectives of preparing audit program are:

To assist in planning the audits so that efficient and effective procedures are applied in

accordance with the audit strategy

To provide clear instruction to staff as to the nature, extent, and timing of the audit work.

To provide a record of the work done and the conclusions drawn, as a basis for effective

quality control and to meet audit evidence requirements.

An audit program has two major sections.

a. The system section: this section of the audit program focuses on the procedures used to

evaluate the effectiveness of the internal control structure and it is organized around major

transactions cycles of the internal control structure. ;

b. The substantive test section: this section deals with the procedures for substantive testing of

financial statement amounts and the adequacy of financial statement disclosures. Besides this
section of the audit program is organized in terms of major financial statement items.
5. Scheduling the audit work

Auditors should plan or forecast the beginning and ending of the audit work. In order to
complete based on the established time in advance. One of the completeness/integrity of the
auditors is measured whether they complete their work based on the stated time in the contract.

6. Assigning professional staff to engagement

The final phase of planning of the audit work is assigning of professional staff to engage the
audit work. As we have been discussed earlier, the audit work should be done by those having
sufficient skill. Assistance should also assign, if necessary. Once the auditor is clear about the
objectives and internal control system of the client, he/she has to collect and evaluate relevant
evidence for his/her audit work through different techniques. These various ways of evidence
accumulation techniques are discussed below.

A. Physical inspection: the auditor may physically inspect/visit the actual existence of certain
assets. For instance, the auditor may count cash box, observe the physical handling of inventories
though it is not necessary that handling of inventories means ownership because goods may be
handled on behalf of the others.

B. Examination of documents: the auditor may collect relevant data by examining related
documents. Thus, the auditor who wishes to verify the payment of cash for any reason may
examine or test checks stubs, for purchase of merchandise on account he/she may verify
purchase invoice, for receipts of cash from any source the auditor may check receipt stubs, and
so on. Examination of documents can be performed through:

i. Vouching: examining documents started with the recorded transactions (journals, ledger, F/S)
back to source documents, called test of occurrence.

ii. Tracing: determining whether source documents have been properly recorded in the
accounting record, called of completeness.

iii. Scanning: verifying documents through quick or selective reading of the recorded documents
of the client.
iv. Mechanical accuracy/truth or quality or inaccuracy: are checks of work performed by
others such as verifying client computations of the balance of accounts. For example, re
calculating the balance of A/P, A/R, cash, etc.

C. Questionnaires (Inquiry): the auditor also can collect relevant information through
preparing questionnaires. The auditor may obtain primary data (from those related persons e.g.
employees) or secondary data (from unrelated persons e.g. outsiders) about certain information.

D. Confirmation letter: the auditor may obtain evidences through confirmation from the third
parties such as banks, debtors, and creditors about the balance of some accounts. There are two
confirmation letters- positive and negative.

i. Positive confirmation letter: is prepared when the client asks his/her or its business associates
such as banks, creditors, or debtors to give response to the auditor whether or not the balance of
the concerned account is similar. For instance, the client may ask the creditor about the similarity
or difference in the balance of Accounts Receivable and a response to the auditor for the
auditor‘s address.

ii. Negative confirmation letter: is prepared when the audited organization asks its business
associates to give a response to the auditor only if there is difference in the balance of accounts.

E. Analytical review: the auditor can compute significant ratios, carryout a trend analysis or
compare and contrast different accounting data in order to gather necessary evidence for his/her
audit task. The comparison may be between current and past data, current and anticipated
(budgeted) data, company information and industry average, or current information with current
information.