AUDIT PLANNING – STEPS 1 to 3 (Detailed Study Notes)

Audit Planning

Purposes & Benefits of Audit Planning

  • Planning = formulation of a general strategy + a detailed approach covering expected nature, timing & extent of audit work.
  • Core purposes / benefits:
    • Conduct audit in an efficient & timely manner (avoids last-minute rush, facilitates deadline compliance).
    • Obtain sufficient & appropriate evidence—planning aligns procedures with assertions & risks.
    • Ensure adequate attention is paid to critical / high-risk areas (e.g. complex estimates, unusual transactions).
    • Help keep audit costs at a reasonable minimum; inefficient re-work is reduced.
    • Minimise legal liability by documenting rationale, professional scepticism & risk-based focus.
    • Avoid misunderstandings with client (clear expectations, agreed timetables, responsibilities).
    • Creates an audit roadmap that can be communicated to the team and those charged with governance (TCWG).

Seven Standard Steps in Audit Planning (high-level)

  1. Pre-plan; agree terms via Engagement Letter (EL); resolve changes in professional appointment; clarify objectives of FS audit; identify management assertions.
  2. Obtain client background information.
  3. Obtain information about client’s legal obligations.
  4. Perform preliminary analytical procedures.
  5. Set materiality & acceptable audit risk.
  6. Understand internal control & assess control risk.
  7. Develop overall audit plan & detailed audit programme (AP).

(Note: Current lecture covers only Steps 1–3; Steps 4–7 follow in next lecture.)

STEP 1 – Pre-Plan, Engagement & Associated Matters

A) Pre-Plan
  • Goal: Ensure pre-conditions for an audit exist before accepting / continuing an engagement.
  • How to assess pre-conditions:
    1. Evaluate whether the financial reporting (FR) framework adopted by client is acceptable (e.g. IFRS, local GAAP, cash basis for small NPOs).
    2. Obtain written agreement from management (mgt) that it:
    • Acknowledges responsibility to prepare FS in accordance with the chosen FR framework.
    • Is responsible for establishing internal control (IC) to enable FS free of material misstatement.
    • Will provide all information & unrestricted access deemed necessary by auditor.
  • Initial audit (first-year engagements) – additional actions:
    • Obtain ethical clearance and comply with professional codes (e.g. IFAC Code, MIA By-Laws).
    • Communicate with predecessor auditor (if any) to obtain insight on:
      • Management integrity.
      • Disagreements about accounting or auditing issues.
      • Fraud, illegal acts, significant IC matters previously reported to TCWG.
      • Reason(s) for change in auditor.
  • Identify client’s reasons for audit: routine FR audit or special purpose (loan covenant, M&A, takeover, regulatory requirement).
  • Determine staffing requirements: engagement size, complexity, risk level, need for specialists (IT, valuation, tax), timing & availability.
B) Engagement Letter (EL)
  • A formal letter from auditor to client issued upon acceptance, before audit commences.
  • Serves as the binding contract (many practitioners treat it as such; exam tip: Yes, it can function as a contract that sets mutual obligations).
  • Purposes:
    1. Provide written confirmation of the auditor’s appointment.
    2. Clearly define auditor’s responsibilities, objectives & scope.
    3. Minimise misunderstandings between auditor & client.
  • Typical contents:
    1. Objectives & scope of the audit – to express an opinion on whether FS give a “true & fair view” / “present fairly, in all material respects.”
    2. Management responsibilities – prepare FS, select policies, maintain effective IC, design anti-fraud programmes, provide written representations, inform auditor of subsequent events, supply records & information.
    3. Auditor responsibilities – conduct audit per GAAS/ISA, obtain understanding of IC, plan & perform procedures to provide reasonable (not absolute) assurance, explain inherent limitations (some material misstatements may not be detected).
    4. Basis for fees & billing arrangements.
    5. Arrangements for planning & performance (e.g. composition of audit team, timetables).
    6. Involvement of other auditors, specialists, or internal audit.
    7. Coordination with predecessor auditor (initial audit only).
    8. Request that management acknowledge receipt & agree to terms (sign & return).
C) Changes in Professional Appointment
  • Occurs when a new auditor is appointed, replacing predecessor.
  • New auditor must:
    • Attempt to communicate with predecessor (ethics & courtesy).
    • Enquire about management integrity & reasons for change.
    • Obtain predecessor’s insights on disputes, fraud, illegal acts, IC weaknesses.
  • Predecessor, subject to confidentiality & legal constraints, should respond promptly & honestly once client authorises.
  • If predecessor raises significant red flags, new auditor must evaluate whether to accept engagement or impose safeguards.
D) Objective (Obj) of Financial Statement (FS) Audit
  • To express an opinion on whether FS are prepared, in all material respects, according to an applicable FR framework (true & fair / fairly present).
  • Emphasises materiality and adherence to framework rather than absolute accuracy.
E) Management Assertions (per ISA 315; textbook p.143)
  • Assertions = implied / expressed representations by management embedded in FS.
  • Categories (commonly used mix of PCAOB & ISA language):
    • Existence – assets, liabilities & equity balances actually exist at period-end.
    • Occurrence – recorded transactions & events actually happened.
    • Rights & Obligations – entity holds rights to assets & owes obligations for liabilities.
    • Completeness – all transactions & accounts that should be recorded/presented are included.
    • Valuation & Allocation – assets & liabilities recorded at appropriate amounts; revenues & expenses allocated to proper period.
    • Detail Tie-In – details in subsidiary records agree (tie in) with control accounts & totals.
    • Presentation & Disclosure – components are appropriately classified, described & disclosed in FS.
  • Auditor designs procedures to gather evidence on each relevant assertion.

STEP 2 – Obtain Client’s Background Information

Purpose: Build a holistic understanding of the client and its environment, thereby informing risk assessment & audit strategy.

  1. Understand the Entity:
    • History, ownership, governance structure, management integrity & competence.
    • Nature of major activities, products/services, organisational structure.
    • Evaluate work performed by internal audit; assess reliability for potential reliance.
  2. Tour of Client Facilities (plant, warehouses, data centres):
    • Observe operations, IC in action, asset safeguards, potential obsolescence, environmental issues.
  3. Industry & Business Knowledge:
    • Identify industry-specific accounting requirements (e.g. construction %-of-completion, banking loan loss provisions).
    • Gauge inherent risk (e.g. commodity price volatility, regulatory exposure, tech obsolescence).
  4. Related Parties & Regulatory Environment:
    • Identify related parties, significant transactions, government regulations, tax considerations.
  5. Need for Experts:
    • Determine whether valuation, actuarial, IT, legal or environmental specialists are required.

STEP 3 – Obtain Client’s Legal Information

Gather documents that evidence legal obligations, ownership rights, commitments & contingencies.

Sources / examples:

  • Constitution / Articles of Association – corporate objectives, share classes, dividend policy.
  • Contracts & Agreements – loan covenants, lease agreements, supplier commitments, employee share schemes.
  • Minutes of Shareholders’ Meetings – authorisations for dividends, capital raising, appointments, litigation discussions.
  • Minutes of Board of Directors (BOD) Meetings – approval of significant transactions, related-party dealings, asset purchases, restructuring, contingent liabilities.

Auditor’s use of minutes:

  • Identify events/decisions occurring after year-end but before report date (subsequent events).
  • Confirm authorisation of significant transactions recorded in FS.
  • Detect unrecorded commitments or contingencies (e.g. guarantees, legal claims).
  • Verify compliance with corporate governance & regulatory requirements.

Pedagogical / Practical Connections & Reminders

  • Step 1 constitutes the “big chunk” of planning; forms foundation for risk assessment & nature/timing/extent of later procedures.
  • Stress-check slide encourages auditors (and students) to self-monitor well-being; audit quality is linked to cognitive focus.
  • Quote: “The elevator to success is out of order. You’ll have to use the stairs, one step at a time.” —Joe Girard. Reinforces incremental learning & audit planning ethos.
  • Upcoming tutorial: Will discuss MIA By-Laws interplay with Chapter (code of ethics, independence, client acceptance).
  • Exam hint: Chapter will appear as FA – Question 1; mind-map submission required.

Quick Self-Test / Reflection Prompts

  • Why is an Engagement Letter critical for limiting auditor’s legal liability?
  • Which management assertions are most relevant for inventory valuation in a manufacturing client?
  • Outline the safeguards if predecessor auditor refuses to respond to professional clearance request.
  • Give concrete examples of information you would expect to find in BOD minutes that might lead to audit adjustments.

Concluding Takeaways

  • Effective audit planning is not optional; it intertwines ethical acceptance, risk evaluation, resource allocation & client communication.
  • Steps 1–3 lay the groundwork; without solid understanding of client, legal environment and formally agreed terms, later audit evidence may be inefficient or insufficient.
  • Documentation of planning decisions is itself audit evidence and subject to quality review & peer inspection.