Chapter 3Chapter 3Audit Planning, Audit Planning, Types of Audit Types of Audit

Tests, and Tests, and MaterialityMateriality

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The Phases of an Audit That Relate to The Phases of an Audit That Relate to Audit PlanningAudit Planning

LO# 1

3-2

PreliminaryPreliminary EngagementEngagement ActivitiesActivities

Determine the Audit Engagement Team

Requirements

Assess Compliance with Ethical Requirements,

Including Independence

LO# 2

3-3

Establish Terms of the Establish Terms of the EngagementEngagement

The terms of the engagement, which are documented in the engagement letter, should include the objectives of

the engagement, management’s responsibilities, the auditor’s responsibilities, and the limitations of the

engagement.

Who signs the engagement letter?

In establishing the terms of the engagement, three topics must be discussed:

1.The engagement letter;

2.Using the work of the internal auditors; and

3.The role of the audit committee.

LO# 3

3-4

The Engagement LetterThe Engagement LetterThe engagement letter formalizes the arrangement reached

between the auditor and the client.

In addition to the items mentioned in the sample engagement letter in Exhibit 3-1 in the textbook, the engagement letter may

include:

• Arrangements for use of specialists or internal auditors.

• Any limitations of liability of the auditor or client.

• Additional services to be provided.

•Arrangements regarding other services.

LO# 4

3-5

Internal AuditorsInternal AuditorsLO# 5

3-6

The Audit CommitteeThe Audit Committee

Subcommittee of the board of

directors

No specific requirements for privately

held companies

Section 301 of Sarbanes-Oxley Act requires the following for audit committee members of

publicly held companies:

•Member of board of directors and independent.

•Directly responsible for overseeing work of any registered public accounting firm employed by the company.

•Must preapprove all audit and nonaudit services provided by its auditors.

•Must establish procedures to follow for complaints.

•Must have authority to engage independent counsel.

LO# 6

3-7

Planning the AuditPlanning the AuditWhen preparing the audit plan, the auditor should be guided by the results of the client acceptance/continuance process, procedures performed to gain an understanding of the entity,

and preliminary engagement activities.

Additional steps:

•Assess business risks.

•Establish materiality.

•Consider multilocations.

•Assess the need for specialists.

•Assess the possibility of illegal acts.

•Identify related parties.

•Consider additional value-added services.

Let’s look at eachof these steps.

LO# 7

3-8

Document Audit Strategy Document Audit Strategy LO# 7

3-9

Types of Audit TestsTypes of Audit Tests

Risk Assessment Procedures

Used to obtain an understanding of the entity and its environment, including its internal control.

Tests of ControlsDirected toward the evaluation of the

effectiveness of the design and operation of internal controls.

Substantive Procedures

Detect material misstatements in a transaction class, account balance,

and disclosure component of the financial statements.

LO# 9

3-10

MaterialityMateriality

The magnitude of an omission or misstatement of accounting information that makes it probable that

the judgment of a reasonable person relying on the information would be changed or influenced

by the omission or misstatement.

The magnitude of an omission or misstatement of accounting information that makes it probable that

the judgment of a reasonable person relying on the information would be changed or influenced

by the omission or misstatement.

Materiality is not an absolute and it is not a black or white issue!

The determination of materiality requires professional judgment.

LO# 10

3-11

Steps in Applying MaterialitySteps in Applying Materialityon an Auditon an Audit

Step 1: Determine a materiality level for the overall financial statements

(planning materiality)

Step 1: Determine a materiality level for the overall financial statements

(planning materiality)

Step 2: Determine tolerable misstatement

(allocation of materiality at individual account/class of transactions level)

Step 2: Determine tolerable misstatement

(allocation of materiality at individual account/class of transactions level)

Step 3:Evaluate auditing findings(near the end of the audit)

Step 3:Evaluate auditing findings(near the end of the audit)

LO# 11

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End of Chapter 3End of Chapter 3

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