- The auditor’s assessment of inherent risk is based on the knowledge of the business. Inherent risk is the susceptibility (likelihood, sensitive, touchy, receptive or quick to be affected, having a tendency, prone to) of an account balance to misstatement. Inherent risk also exists at financial statements level.
Susceptibility of financial statements to misstatement is affected by general economic factors, and industry conditions, characteristics of the entity, unusual’ pressures on management, competence and integrity of management.
- The knowledge of the business is also used in determining materiality level, evaluation of accounting estimates, and identifying related parties.
- Furthermore, the knowledge of the business is useful in determining whether or not the management assertions are consistent with the auditor’s knowledge of the business.
How does the audit risk and materiality affect planning?
A transaction or disclosure is material if it would affect the decision made by a prudent investor. At the planing stage, the auditor determines preliminary estimate of materiality for the financial statements as whole That is, the maximum amount by which the financial statements may be misstated and still not considered by the auditor that the decision of the users will be affected. For example, if Rs. 40,000 is the materiality level, combined errors in the financial statements less than Rs. 40,000 will be considered as immaterial.
At the planning stage, the assessment of materiality level helps the auditor to decide the extent of audit procedures. In this case, if the materiality level is lowered down to Rs. 10,000, he would require more evidence in order to detect a smaller misstatement.
Audit risk implies that financial statements may contain undetected errors or irregularities which may affect the decision of the users of the financial statements. Thus both the materiality and audit risk are closely related. The higher is the audit risk, the lower the materiality levels needs to be. The best audit strategy is the approach which results in most efficient and effective audit, i.e., audit is performed at the least possible cost to client with an acceptably low audit risk.
Developing an efficient and effective audit strategy requires that the auditor should carefully consider the level of audit risk and materiality for each client.
The auditor’s assessment of audit risk will have a significant impact on overall audit strategy and conduct of audit. Thus, where audit risk is high more qualified and experienced assistance will be required to conduct the ·audit. Similarly, in a high-risk audit a high degree of professional skepticism will be required.
How does the new accounting or auditing pronouncements affect planning?
Special audit procedures and accounting treatment may apply to certain industries. The auditor should be aware of changes in IAS and IFRS in order to ascertain compliance with revised standards planning.
THE OVERALL AUDIT STRATEGY
Overall audit strategy involves consideration of
- Characteristics of Entity.
- Reporting objectives, timings of audit and nature of communication.
- Significant factors and preliminary engagement activities.
- Nature timing and extent of resources.
Scope of the audit
Scope of the audit involves consideration of following factors:
- Reporting framework, i.e., IFRS and the Companies Ordinance, 1984.
- Industry specific reporting requirements, for example, cost audit report in case of certain industries.
- Group structure.
- Reliance on the work of internal auditor.
The auditor should ascertain client’s time table and work backwards, for example you are the auditor of a company for year ending December 31, 20 x 8.
The auditor will also communicate and coordinate with auditor of components.
Audit approach including administrative matters
- Risks assessment.
- Materiality level for overall financial statements.
- Materiality level for account balance and class of transactions.
- Direction, supervision and reviews.
- Time budget.
- Areas where it IS intended to seek reliance on internal controls.
- Need for an expert.
- Changes since previous audit.
AUDIT PLAN (Audit Program)
Audit program specifies the procedures to be followed to attain audit
objective of verification. of financial statement assertions for each balance sheet and income statement account.
The assistants sign off each step of audit program when it is completed and record hours consumed for each step. Thus the supervisor is informed on day to day basis of the progress on the audit. The program also provides a checklist to ensure that essential audit procedures in verification are not overlooked. The program helps inexperienced assistants to work effectively with relatively less supervision.
Audit firms often charge clients on the basis of time spent. Detailed time records should therefore be maintained. At the planning stage a time budget is prepared, setting up estimated time for each step in audit programme for various grades of audit staff. The total hours for each grade provide a basis for estimating audit fee.
While preparing audit programme, the auditor considers his assessment of inherent and controls risk and the level of assurance to be provided by performing verification procedures. Inherent and control risks are directly related to the amount of evidence needed. That is higher are such risks, the more evidence is needed to reduce the detection risk.
In order to complete the audit within the required time framework, the auditors commence the audit quite a few weeks before year-end. The period before the year-end is called the interim period. Certain audit procedures that can be performed in the interim period include obtaining understanding of the system, tests of controls and substantive tests up the interim date.