Overall Audit Plan and Audit Program Chapter 12

Overall Audit Plan and Audit Program Chapter 12 © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 12 - 1

Learning Objective 1 Use the five types of audit tests to determine whether financial statements are fairly stated. © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 12 - 2

Types of Tests Procedures to obtain an understanding of internal control Tests of control Substantive tests of transactions Analytical procedures Tests of details of balances © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 12 - 3

Types of Audit Tests and the Audit Risk Model AAR = PDR IR × CR Procedures Substantive Types Tests of to obtain an tests of + controls + of Audit understanding of transactions Tests (TOC) internal control (STOT) © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 12 - 4

Types of Audit Tests and the Audit Risk Model Types of Audit Tests AAR = PDR IR × CR Analytical procedures (AP) Tests of Sufficient details of competent = + balances evidence (TDP) per GASS © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 12 - 5

Role of all Audit Tests in the Sales and Collection Cycle Sales transactions Accounts Receivable Audited by TOC, STOT, and AP Ending balance Cash receipts transactions Cash in Bank Audited by TOC, STOT, and AP Ending balance Audited by AP and TDP TOC + STOT + AP + TDP = Sufficient competent evidence per GAAS © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 12 - 6

Learning Objective 2 Select the appropriate types of audit tests. © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 12 - 7

Relationship Between Types of Tests and Evidence Observation Documentation Confirmation Type of Test Procedures for internal control Tests of controls Substantive tests of transactions Analytical procedures Tests of details of balances Physical Examination Type of Evidence © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 12 - 8

Relationship Between Types of Tests and Evidence Analytic performance Reperformance Type of Test Procedures for internal control Tests of controls Substantive tests of transactions Analytical procedures Tests of details of balances Inquiries of the client Type of Evidence © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 12 - 9

Acceptable assurance No assurance AUDIT ASSURANCE Audit Assurance at Different Levels of Internal Control Effectiveness C 3 Audit assurance from substantive tests C 2 C 1 Audit assurance from control risk assessment and tests of control A C B INTERNAL CONTROL EFFECTIVENESS Weak control Strong control Reliance on controls: C 3 – None, C 2 – Some, C 1 – Maximum © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 12 - 10

Learning Objective 3 Understand how information technology affects audit testing. © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 12 - 11

Impact of Information Technology on Audit Testing SAS 80 (AU 326) and SAS 94 (AU 319) provide guidance for auditors of entities that transmit, process, maintain, or access significant information electronically. © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 12 - 12

Impact of Information Technology on Audit Testing Computer assisted audit techniques may be used to test automated controls or data. Reports produced by IT may be used to test the effectiveness of IT general controls. Program change controls Access controls © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 12 - 13

Learning Objective 4 Understand the concept of evidence mix and how it should be varied in different circumstances. © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 12 - 14

Variations in Evidence Mix Audit 1 Procedures to Obtain an Understanding of Internal Control E Tests of Controls E Audit 2 M M Audit 3 M N Audit 4 M M Amount of testing: Extensive, Medium, Small, None © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 12 - 15

Variations in Evidence Mix Audit 1 Substantive Analytical Tests of Transactions Procedures S E Tests of Details of Balances S Audit 2 M E M Audit 3 E M E Audit 4 E E E Amount of testing: Extensive, Medium, Small, None © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 12 - 16

Learning Objective 5 Design an audit program. © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 12 - 17

Audit Program Part 1: Tests of controls and substantive tests of transactions Part 2: Analytical procedures Part 3: Tests of details and balances © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 12 - 18

Audit Procedures 1. Apply the transaction-related audit objectives to the class of transactions being tested. 2. Identify key controls that should reduce control risk for each audit objective. 3. Develop appropriate tests of controls. 4. Design substantive tests of transactions. © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 12 - 19

Methodology for Designing Controls and Substantive Tests Perform procedures to understand internal control. Assess control risk. Evaluate cost-benefit of testing controls. Design tests of controls and substantive tests of transactions to meet transaction-related audit objectives. Audit procedures Sample size Items to select Timing © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 12 - 20

Four-Step Approach to Designing Control and Substantive Tests Apply transactionrelated audit objectives to a class of transactions (Step 1). Identify key controls and make an assessment of control risk (Step 2). Design substantive tests of transactions (Step 4). Design tests of controls (Step 3). Audit procedures Sample size Items to select Timing © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 12 - 21

Methodology for Designing Tests of Balances – Accounts Receivable Identify client business risks affecting accounts receivable. Set tolerable misstatement and assess inherent risk for accounts receivable. Assess control risk for sales and collection cycle. © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 12 - 22

Methodology for Designing Tests of Balances – Accounts Receivable Design and perform tests of controls and substantive tests of transactions for sales and collection cycle. Design and perform analytical procedures for accounts receivable balance. © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 12 - 23

Methodology for Designing Tests of Balances – Accounts Receivable Design tests of details of accounts receivable balance to satisfy balance-related audit objectives. Audit procedures Sample size Items to select Timing © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 12 - 24

Approach to Designing Tests of Details of Balances Apply transactionrelated audit objectives to a class of transactions. Identify key controls and make a preliminary assessment of control risk. Design substantive tests of transactions. Design tests of controls. Audit procedures Sample size Items to select Timing © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 12 - 25

Approach to Designing Tests of Details of Balances Design tests of controls. Apply balance-related audit objectives to an account balance. Design substantive tests of transactions. Design tests of details of balances. Audit procedures Sample size Items to select Timing © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 12 - 26

Approach to Designing Tests of Details of Balances Apply balancerelated audit objectives to an account balance. Decide tolerable misstatement. Make preliminary judgment about materiality. Design analytical procedures. Assess inherent risk. Design tests of details of balances. Assess client business risk. Decide acceptable audit risk. © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 12 - 27

Learning Objective 6 Compare and contrast transaction-related audit objectives and balancerelated audit objectives. © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 12 - 28

Relationship of Transaction- to Balance-Related Audit Objectives Transaction-Related Balance-Related Nature of Audit Objective Relationship Existence or Direct completeness Completeness or Direct existence Accuracy Direct © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 12 - 29

Relationship of Transaction- to Balance-Related Audit Objectives Transaction-Related Balance-Related Nature of Audit Objective Relationship Classification Direct Timing Cutoff Direct Posting and Detail tie-in. Direct summarization © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 12 - 30

Relationship of Transaction- to Balance-Related Audit Objectives Transaction-Related Balance-Related Nature of Audit Objective Relationship Realizable value None Rights and None obligations Presentation and None disclosure © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 12 - 31

Learning Objective 7 Integrate the four phases of the audit process. © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 12 - 32

Summary of the Audit Process Plan and design Phase I an audit approach. Phase II Perform tests of controls and substantive tests of transactions. Perform analytical procedures and Phase III tests of details of balances. Phase IV Complete the audit and issue an audit report. © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 12 - 33

Summary of the Audit Process Phase I Accept client and perform initial planning. Understand the client’s business and industry. Assess client’s business risk. Perform preliminary analytical procedures. Set materiality and assess acceptable audit risk and inherent risk. Understand internal control and assess control risk. Develop overall audit plan and audit program. © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 12 - 34

Summary of the Audit Process Phase II Plan to reduce assessed level of control risk? No Yes Perform tests of controls. Perform substantive tests of transactions. Assess likelihood of misstatements in financial statements. © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 12 - 35

Summary of the Audit Process Phase III Low Medium High or unknown Perform analytical procedures. Perform tests of key items. Perform additional tests of details of balances. © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 12 - 36

Summary of the Audit Process Phase IV Review for contingent liabilities. Review for subsequent events. Accumulate final evidence. Evaluate results. Issue audit report. Communicate with audit committee and management. © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 12 - 37

End of Chapter 12 © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 12 - 38