Overall Audit Plan and Audit Program Chapter 13

Overall Audit Plan and Audit Program Chapter 13 © 2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 13 - 1

Learning Objective 1 Use the five types of audit tests to determine whether financial statements are fairly stated. © 2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 13 - 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 © 2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 13 - 3

Types of Audit Tests and the Audit Risk Model Audit risk model AAR = PDR IR × CR Procedures Substantive Types of Tests of to obtain an tests of audit controls + transactions understanding + tests (TOC) of internal control (STOC) © 2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 13 - 4

Types of Audit Tests and the Audit Risk Model 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 © 2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 13 - 5

Role of all Audit Tests in the Sales and Collection Cycle Sales Accounts Cash in Receivable Bank Sales Cash receipts transactions Audited by TOC, STOT, and AP Ending balance Audited by AP and TDB TOC + STOT + AP + TDB = Sufficient competent evidence per GAAS © 2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 13 - 6

Learning Objective 2 Select the appropriate types of audit tests. © 2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 13 - 7

Procedures for internal control Tests of controls Substantive tests of transactions Analytical procedures Tests of details of balances © 2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Observation Documentation Confirmation Type of Test Physical examination Relationship Between Types of Tests and Evidence Type of Evidence 13 - 8

© 2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Analytic performance Procedures for internal control Tests of controls Substantive tests of transactions Analytical procedures Tests of details of balances Reperformance Type of Test Inquiries of the client Relationship Between Types of Tests and Evidence Type of Evidence 13 - 9

Acceptable assurance No assurance AUDIT ASSURANCE Audit Assurance at Different Levels of Internal Control Effectiveness C 3 C 2 C 1 Audit assurance from control risk assessment and tests of control Audit assurance from substantive tests A C B INTERNAL CONTROL EFFECTIVENESS Weak control Strong control Reliance on controls: C 3 – None, C 2 – Some, C 1 – Maximum © 2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 13 - 10

Learning Objective 3 Understand how information technology affects audit testing. © 2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 13 - 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. © 2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 13 - 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 © 2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 13 - 13

Learning Objective 4 Understand the concept of evidence mix and how it should be varied in different circumstances. © 2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 13 - 14

Variations in Evidence Mix Procedures to obtain an understanding of internal control Tests of controls Audit 1 E E Audit 2 M M Audit 3 M N Audit 4 M M Amount of testing: Extensive, Medium, Small, None © 2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 13 - 15

Variations in Evidence Mix Substantive tests of transactions Analytical procedures Tests of details of balances Audit 1 S E S Audit 2 M E M Audit 3 E M E Audit 4 E E E Amount of testing: Extensive, Medium, Small, None © 2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 13 - 16

Learning Objective 5 Design an audit program. © 2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 13 - 17

Audit Program Part 1: Tests of controls and substantive tests of transactions Part 2: Analytical procedures Part 3: Tests of details and balances © 2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 13 - 18

Tests of Controls and Substantive Tests of Transactions 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. © 2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 13 - 19

Methodology for Designing Controls and Substantive Tests Perform procedures to understand internal control. Design tests of controls and substantive tests of transactions to meet transaction-related audit objectives. Audit procedures Assess control risk. Determine extent of testing controls. Sample size Items to select Timing © 2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 13 - 20

Four-Step Approach to Designing Control and Substantive Tests Apply transaction- related audit objectives to a class of transactions. (Step 1) Identify key controls and make a preliminary 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 © 2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 13 - 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. Design and perform analytical procedures for accounts receivable balance. Design tests of details of accounts receivable balance to satisfy balance-related audit objectives. Assess control risk for sales and collection cycle. Design and perform tests of controls and substantive tests of transactions for sales and collection cycle. Audit procedures Items to select Sample size Timing © 2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 13 - 22

Approach to Designing Tests of Details of Balances Apply transaction-related audit objectives to a class of transactions. Identify key controls and make an assessment of control risk. Design substantive tests of transactions. Design tests of controls. Audit procedures Sample size Items to select Timing © 2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 13 - 23

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. © 2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Decide acceptable audit risk. 13 - 24

Learning Objective 6 Compare and contrast transaction-related audit objectives and balance-related audit objectives. © 2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 13 - 25

Relationship Among Five Key Evidence-Related Terms Phases of the audit process Audit objectives Types of tests Evidence decisions Types of evidence © 2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 13 - 26

Phases of the Audit Process 1. Plan and design an audit approach. 2. Perform tests of controls and substantive tests of transactions. 3. Perform analytical procedures and tests of details of balances. 4. Complete the audit and issue an audit report. © 2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 13 - 27

Audit Objectives Transaction-related 1. Existence 2. Completeness 3. Accuracy 4. Classification 5. Timing 6. Posting and summarization Balance-related 1. Existence 2. Completeness 3. Accuracy 4. Classification 5. Cutoff 6. Detail tie-in 7. Realizable value 8. Rights and obligations 9. Presentation and disclosure © 2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 13 - 28

Types of Tests 1. Procedures to obtain an understanding of internal control 2. Tests of controls 3. Substantive tests of transactions 4. Analytical procedures 5. Tests of details of balances © 2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 13 - 29

Evidence Decisions 1. Audit procedures 2. Sample size 3. Items to select 4. Timing of performance © 2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 13 - 30

Types of Evidence 1. Physical examination 2. Confirmation 3. Documentation 4. Analytical procedures 5. Observation 6. Inquiry of the client 7. Reperformance © 2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 13 - 31

Learning Objective 7 Integrate the four phases of the audit process. © 2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 13 - 32

Summary of the Audit Process Phase I Plan and design an audit approach. Perform tests of controls and Phase II substantive tests of transactions. Perform analytical procedures and Phase III tests of details of balances. Complete the Phase IV audit and issue an audit report. © 2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 13 - 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. © 2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 13 - 34

Summary of the Audit Process: Phase I Set materiality and assess acceptable audit risk and inherent risk. Understand internal control and assess control risk. Gather information to assess fraud risks. Develop overall audit plan and audit program. © 2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 13 - 35

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. © 2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 13 - 36

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. © 2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 13 - 37

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. © 2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 13 - 38

End of Chapter 13 © 2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 13 - 39