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Audit Planning and the components of audit plan
Audit planning involves coming up with the overall audit strategy to be used in carrying out the audit engagement. An audit strategy needs to be set where the firm will identify the scope and timing of the audit. This is done by referring to the terms of engagement. The plan includes the objectives of the audit. The audit plan should contain the audit procedures that will be used to assess the risk in the organisation. The nature, extent and timing of the procedures should be stated. They should also be sufficient and effective to assess the risk. It should also document further audit procedures to be carried out at the assertion level for the different material classes of transactions.
Thirdly it should include details on how the work of other auditors or experts. The plan should have information such the nature of the business and its operations. The auditors need to identify the risk areas. Any complex aspect of the business should also be highlighted. There will be a budget of the resources expected to be used for example staff, time and money for administrative purposes. Audit planning is important as it ensures that attention is paid to the critical areas (Collings, 2010).
The materiality level is set during the planning stage. The areas which are more prone to material misstatements are identified. The audit manager also determines the audit team that will handle the assignment. He will need the right number of people with the appropriate skills, experience and knowledge. The auditors also on how the review of the audit work of the audit staff will be carried out. The complexity of the audit and the risk in financial misstatements will determine the nature, timing and extent of the reviews. If the auditors have never audited the company before they will need to get an understanding of the entity and the environment in which the company operates in.
Planning also assists the team to create adequate time to work, coordinate and consult with the former auditors, internal auditors and experts in technical areas. The previous audit reports done will be analysed to see the key issues that emerged during the last audit. Where it is an initial audit for the auditors they will need to verify the opening balances of the financial statements. Overall the audit plan assists the audit team manage the audit assignment and do it in an effective and efficient manner. The audit plan and strategy is not static and may at times change due to unforeseen circumstances.
The Audit Risk Model
The audit risk refers to where an auditor states the financial statements are free from financial misstatements yet that is not true. It can also happen when the auditor rejects financial statements that are free from misstatements. The risk model however ignores this error though. It can happen due to auditor performing tests on an unrepresentative sample (Woodhead, 1997). The audit risk model includes three levels of risk.
There is control risk where in a company the misstatements in the financial statements will not be detected by the internal controls of the company. In planning the audit, the internal controls of the company will be assessed to see whether they are adequate and sufficient to prevent errors and frauds in the company. On determining level of assurance to place on internal controls may involve examining the documents used to perform transactions to see whether internal controls are being adhered to and recalculating various transactions to see whether the system is calculating them correctly. The management in setting internal controls should be performing continuous risk assessments on the company operations. This process should be credible and receive positive reviews from regulatory bodies (Busby & Hughes, 2009).
Can the internal controls be circumvented thru collusion or abused by management? Where there are indicators of fraud, it will have an impact on the audit planning and fraud risk assessment procedures (Graham & Bedard, 2003). There is detection risk which measures the probability that the auditor will not detect errors and misstatements in the financial statements when performing the audit. In planning, this will be tackled by the audit company ensuring that there is proper audit planning, collection of sufficient audit evidence and having proper working papers. There is also inherent risk which is the probability of material misstatements in financial statements due to the nature of the company operations and its environment.
This involves looking at the nature of business and factors affecting it for example technology, complexity, economic and competitive factors and any undue pressure on management. The formulae for the audit risk model is the multiplicative model of Detection Risk *Control Risk*Inherent risk (Pine, 2008)
Risk Assessment and Audit Procedures
In auditing the Tutti Fruity Limited I will identify the risk areas and the factors that highlight these areas as critical. There are audit activities that will be carried out in these areas as follows:
Busby, G. & Hughes, E. (2009). Credibility in Risk Assessment: A Normative Approach. International Journal of Accounting, Auditing and Performance Management, vol 6, no 4, pg 508-527.
Collings, S. (2010). The Importance of Audit Planning (Online). Accountancy Students. Web.
Graham, L. & Bedard J. (2003). Fraud Risk and Audit Planning. International Journal of Auditing, volume 7, issue 1, pg 55-70.
Pine, B. (2008) A Risk-Based Approach to Auditing Financial Statements. Acca. Web.
Woodhead, A. (1997). The Other Audit Risk: Impact of False Rejection on Audit Planning. Managerial Auditing Journal, vol. 12, issue 1, pg 4-8.
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