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Chapter Three: Auditing Principles and Practices I
Chapter Three
Planning and Conducting the Audit
3.1 Meaning and purpose of Audit planning
Planning means to think in advance before work is performed. It involves making
decisions about the work to be carried out. Audit planning requires making decisions about
whether to accept a client for audit in the first place and this is called pre-engagement
planning. Once the engagement is accepted, audit planning involves making decision about
specific steps that help determine an overall audit strategy and this is called engagement
planning. Adequate planning and supervision is the first and the important auditing
standards of field work. An audit plan is a broad overview of an audit engagement
prepared in the planning stage of the engagement.
The first standard of field work states: “The work is to be adequately planned and
assistants, if any, are to be properly supervised.” The concept of adequate planning
includes investigating a 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.
3.2 Aims of Audit Planning
An effective and efficient audit relies on proper planning procedures. Auditors should plan the
audit work so as to perform the audit in an effective manner.
The objectives of planning work involve:
 ensuring the appropriate attention is devoted to the different areas of the audit
 ensuring that potential problems are identified and facilitating review
3.3 Importance of Audit planning
Auditors have to plan their audit work carefully before simply entering in to it. Audit
panning is required because it helps the auditors:
 To weigh the risks and rewards of taking on a new client in the case of preengagement planning
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 To obtain knowledge of the nature of the client’s business so that appropriate
attention is devoted to important areas of the audit.
 To identify the potential problems in advance and deal with them effectively.
 To ensure that sufficient and competent evidence is obtained
 To complete the work expeditiously by controlling costs and to meet important
dead lines
 To properly assign work to assistants and coordinate work carried out by other
auditors and experts.
Although the audit plan differs in form and content among public accounting firms, a
typical audit plan includes the following:
 Description of the client company its structure, business and organization
 Objective of the audit (audit for shareholders, special purpose audit etc)
 Nature and extent of the other services
 Timing and scheduling of the audit work
 Work to be done by the client’s staff
 Staffing requirement during the engagement
 Target dates for completing major segments of the engagement
 Any special problems to be resolved in the course of the engagement
 Preliminary judgments about materiality level for the engagement.
3.4 Planning Procedures
3.4.1 Accepting the audit engagement
What are the steps involved in deciding whether or not to accept an engagement?
This is the first phase in the audit panning and it involves a decision to accept or refuse the
opportunity to become the auditor for the new client or to continue as an auditor for an
existing clients. The auditors should investigate the history of the prospective client,
including such matters as the identities and reputations of the directors, officers and major
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shareholders, its financial statements. Thus decision to accept the audit engagement should
not be taken lightly as it has a bearing on the quality of the audit.
The following steps should be considered in accepting the audit engagement. Those are;
Evaluate the integrity of management
An auditor accepts an audit engagement only when reasonable assurance exists that the
client’ management can be trusted. Some times when an auditor accepts a new client, the
auditor will be replacing another auditor. In addition to his knowledge about the client’s
management the successor auditor can seek information, regarding this matter from the
predecessor auditor.
Identify special circumstances and unusual risks
The intended users of the audited financial statements and prospective client’s legal and
financial stability should be understood.
Competence to perform the audit
Auditors should determine whether they have the professional competence to complete the
engagement in accordance with GAAS. If the auditors are not familiar with the potential
client’ business they should decline the offer.
Evaluate Independence
The auditor must evaluate whether there are circumstances that would impair its
independence with respect to the client.
Obtaining the Engagement
After the auditors have collected the necessary information on the potential client, they will
be in a position to assess the various risks involved with the audit and determine whether
to attempt to obtain the engagement. After accepting the engagement, the auditor should
document arrangements made with the client and clarify matters that may be
misunderstood. The preliminary understandings with the client should be summarized by
the auditors in an engagement letter, making clear the nature of the engagement and
limitations on the scope of the audit work to be performed by the client’s staff, schedule
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dates for performance and completion of examination and the basis for computing the
auditor’s fee.
Obtaining an understanding of the clients’ Business
After the engagement is accepted the auditors must obtain a detailed understanding of such
factors as the client’s financial position and operating results, organizational structure,
product lines and methods of production and distribution. This will help the auditors to
evaluate the appropriateness of the accounting principles in use or the reasonableness of
the many estimates and assumptions embodied in the client’s financial statements.
3.4.2 Developing an overall audit strategy
After obtaining the knowledge of the client’s business, the auditor should formulate an
overall audit strategy for the upcoming engagement. The best audit strategy is the approach
that results in the most efficient audit.
3.4.3 Designing Audit program
After the audit plan has been prepared, a detailed written audit program describing the
various steps and procedures which are needed to implement the audit plan should be
developed. An audit program lists the audit procedures to be applied in an audit in the
given circumstances along with proper instructions. Thus, an audit program contains the
description of the specific audit procedures to be performed in respect of different aspects
to be covered.
An audit program may be formulated at all stages of audit engagement. At the first stage, it
may list the procedures required to gain sufficient knowledge of the client. At the second
stage an audit program focusing on the compliance procedures required to study and
evaluate the relevant internal controls might be developed. Finally it may list the
substantive procedures useful to decide and carry out based on the knowledge of the
client’s business and the results of his compliance procedures.
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In conducting an audit of any organization, there are certain essential elements that should
be kept in mind while formulating audit program. These essential elements of audit
program are:
 Study the relevant legal requirements
 Familiarization with other aspects of the enterprise under audit.
 Analytical review of past performance
 Study and evaluation of internal control
 Examination of arithmetical accuracy or accounting records
 Inspection of documentary evidence and application of other substantive
procedures
 Analyzing and review of financial statements and
 Finalization of audit reports
3.4.3.1 Advantages of audit program
An audit program is a basic tool of control over the implementation of the audit. Thus, it
has several advantages as listed below.
Provides a coordinated view of the total audit
To develop an audit program, auditors need to consider all aspects of the audit in a
coordinated manner. In the absence of a written audit program, the auditor may not cover
all aspects adequately or even important aspects of the audit may be forgotten. It through an
audit program that you can plan how you would gather sufficient evidence in a specific
situation
Provide a valuable tool for manpower planning
In any organization while conducting audits there are persons with different skills and
experience They have to be assigned on various audits in such a manner that the audits are
performed effectively, the time schedules are met and the costs are minimized. If you
prepare written audit programs for all audits you can identify the nature of skills and
experience that would be required for various audits.
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Provides clear instructions
A written audit program provides clear instruction to all personnel involved in an audit.
Minimize costs and misunderstandings
A clear listing various steps and procedures can minimize the cost and misunderstandings
of the audit personnel during the audit process.
Serves as a basis for planning future audits
Written audit program and observation of the audit personnel provide a valuable basis of
planning the audit in succeeding years. In many situations, auditors prepare the audit
program for the current year by making appropriate modifications in the audit program of
the previous year.
3.3 Materiality and Audit risk
In planning the audit, the auditors must consider carefully the appropriate levels of
materiality and audit risk. Materiality for planning purpose is the auditor’s preliminary
estimate of the smallest amount of misstatement that would probably influence the
judgment of a reasonable person relying upon the financial statements. Materiality and
audit risk need to be considered at the financial statement level as a part of general
planning and at the account balance or transaction class level in planning audit procedures
for a specified balances or classes.
The term materiality is used both often and loosely in accounting and auditing. The
underlying concept is always essentially the same it is the criterion for distinguishing the
trivial from the important. It refers to the magnitude of the an omission or misstatement of
accounting information that makes it probable that the judgment of a reasonable person
relying on the information would have been changed or influenced by the omission or
misstatement.
Audit risk is the risk that the auditor may unknowingly fail to appropriately modify his/her
opinion on financial statements that are materially misstated. This means that the auditor
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will fail to qualify an audit report that he should have qualified. There is always the risk
that an auditor provides a wrong audit opinion. This arises when there is a material error in
the financial statements, which was not corrected before the accounts were published and
to which the auditor did not refer in the audit report. An audit risk can only occur if three
things have happened in sequence.
 If a material errors occurred.
 If the errors have not been detected by the client’s system of internal control.
 If the auditor failed to find the error in the course of his substantive testing or
analytical review procedures.
It is only when all of these conditions are fulfilled simultaneously that the auditor will give an
inappropriate opinion on a set of financial statements and the audit risk will materialize. There
are different sort of audit risk. Some of them are;
Inherent risk: refers to the possibility of a material misstatement occurring in an account
assuming that there are no related internal controls. Inherent risk exists independently of
the audit of financial statements. Thus the auditor cannot change the actual level of
inherent risk. However, the auditor can change the assessed level of inherent risk.
Control risk: is the risk that a material misstatement will not be prevented or detected on a
timely basis by the company’s internal control. Effective internal controls over an assertion
reduce control risk. Control risk can never be zero because internal controls cannot provide
complete assurance that all material misstatements will be prevented or detected. Like
inherent risk, the auditor cannot change the actual level of control risk for an assertion.
Detection risk: is the risk that the auditor’s procedures will lead them to conclude that a material
misstatement does not exist in an account balance, when in fact the account is materially misstated.
Detection risk is a function of the effectiveness of auditing procedures and their application by the
auditor. Unlike inherent and control risk, the auditor can change the actual level of detection risk
by varying the nature, timing and extent of substantive tests performed on assertion. Applying
more effective audit procedures, use of larger samples, adequate planning and adherence to quality
control standards result in lower levels of detection risk.
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