The first standard of fieldwork of auditing requires adequate planning and proper supervision, but until SAS 22 was issued, the only observations on planning in the authoritative literature related to the advantages of early appointment of the auditor. The need for more guidance on planning and supervision was identified when the general area of quality control received extensive attention in the early 1970s. It was recognized that quality control involved policies and procedures of CPA firms in the administration of a practice and policies and procedures of an individual auditor in planning and supervising an audit. The new SAS also would remove the auditor’s consideration of the entity’s business from audit planning. Instead, the understanding of the entity is a vital part of the audit that provides audit evidence supporting the auditor’s assessment of the risks of material misstatement.
This post provides practical guidelines in developing audit planning and supervision procedure in accordance with SAS, interpretaion and technical application. The Auditing Standards Board (ASB) has issued Exposure Drafts of eight proposed SASs that relate to the risk assessment process. Under the Exposure Drafts, the guidance in Sections 310 and 311 would be combined. A proposed new SAS would cover, among other things, organizing the engagement, documenting the audit program, determining the extent that specialists are involved, and supervising assistants.
In the development of the SAS the need for answers to the following questions was identified:
- What documentation of planning is required in every engagement? (A written audit program or programs)
- What knowledge of the client is required? (Enough to understand the events, transactions, and practices that significantly affect the financial statements)
- How should assistants’ disagreements with significant conclusions be handled?
(Note: Assistants should be able to document disagreement if they want to disassociate themselves from the resolution). These matters are covered in more detail on the next paragraph [Fundamental Requirements].
Fundamental Requirements Planning
Planning Documentation – When planning the audit, the auditor should
- Consider the nature, extent, and timing of work to be performed.
- Prepare a written audit program (or a set of written audit programs).
Note: Preparation of a memorandum on the preliminary audit plan is desirable, particularly for large and complex entities, but is not required.
Planning Considerations – These matters, among others, should be considered in planning the audit.
- Client. The nature of the entity’s business and industry.
- Accounting. The entity’s accounting policies and procedures.
- Processing methods. The processing methods used by the entity for significant accounting applications.
- Control risk. Planned assessed level of control risk [see: Risk Assessment Questionnaire Example]
- Materiality. Preliminary estimate of what amount or amounts will be considered material in the audit.
- Other risks. Audit areas likely to cause problems or require unusual attention: (a) Financial statement items likely to require adjustment (b) Conditions likely to require modification of audit tests, such as related-party transactions or possible fraud.
- Reports. The kind of reports to be issued, such as filings with regulatory agencies or special reports on compliance with contractual provisions.
Knowledge of Business and Industry
The auditor should obtain enough knowledge about the client’s business, organization, and operations to understand the events, transactions, and practices that may have an effect on financial statements. According to AU 311.07, the auditor should obtain knowledge of matters such as:
- Type of business.
- Types of products and services.
- Capital structure.
- Related parties.
- Business locations.
- Production and distribution methods.
- Compensation methods.
Industry matters the auditor should consider include:
- Economic conditions.
- Government regulations.
- Technological changes.
- Accounting practices common in the industry.
- Competitive conditions.
- Available financial trends and ratios.
Note: The auditor’s consideration of these matters, particularly industry matters, is directed at aspects that relate to the audit. General or extensive background research on the industry is not required.
Use of Computer Processing
In considering the effect of computer processing on internal control and audit procedures, the auditor should consider the:
- Extent of computer processing in each significant accounting application.
- Complexity of that processing, including use of outside service organizations.
- Organizational structure of computer processing.
- Availability of data, since some data may exist only for a short period.
- Use of computer-assisted audit techniques.
- Need for specialized computer skills from the auditor’s staff or outside consultants.
If used, the auditor should:
- Have sufficient computer knowledge to communicate the audit objectives.
- Evaluate whether the objectives will be achieved.
- Evaluate the results.
Specific Planning Procedures
The auditor’s procedures for planning purposes usually involve:
- Review of his or her own records on the entity.
- Discussions with others in the firm.
- Discussions with the client’s personnel.
Examples of Auditor’s Procedures for Audit Planning
- Reviewing correspondence files, prior year’s audit documentation, permanent files, prior years’ financial statements, and auditor’s reports.
- Discussions with firm personnel responsible for nonaudit services to the client.
- Asking about current business developments affecting the entity.
- Reading current interim financial statements.
- Discussions with management and the board of directors, or its audit committee, about the type, scope, and timing of the audit.
- Considering implications of relevant accounting and auditing pronouncements, particularly recent pronouncements.
- Coordinating the assistance of client personnel in preparing data and schedules.
- Determining the involvement of consultants, specialists, and internal auditors.
- Establishing the timing of audit work.
- Establishing and coordinating staffing requirements.
- Reviewing various sources of industry information, such as AICPA guides, industry publications, and annual reports of other entities in the industry.
Instructing Assistants – The auditor with final responsibility for the audit should inform assistants about:
- Their responsibilities.
- The objectives of the procedures they are to perform.
- Matters that may affect the scope of the procedures they are to perform, such as: (a) Aspects of the entity’s business relevant to their assignment (b) Possible accounting and auditing problems.
- The need to bring to his or her attention significant accounting and auditing questions raised during the audit.
Extent – The extent of supervision necessary depends on such factors as:
- Complexity of the subject matter.
- Qualifications of the assistants.
Reviewing Work – The auditor should review the work of each assistant to:
- Determine whether it was adequately performed.
- Evaluate whether the results support the conclusions to be expressed in the auditor’s report.
Disagreements – If differences of opinion arise among firm personnel about accounting or auditing issues in an audit, there should be:
- Consultation to attempt resolution.
- Documentation of an assistant’s disagreement, if he or she wants to be disassociated from the final resolution.
- Documentation of the basis for the final resolution.
Communications Between The Auditor And Firm Personnel Responsible For Nonaudit Services (February 1980) – The auditor should:
- Consider the nature of non-audit services that have been performed.
- Assess whether the services affect the financial statements or performance of the audit.
- Discuss the non-audit services with personnel who performed such services, if they have implications for the audit.
Responsibility Of Assistants For The Resolution Of Accounting And Auditing Issues (February 1986) – Each assistant has a responsibility to:
- Bring to the attention of the appropriate auditor significant disagreements about accounting and auditing issues.
- Document his or her disagreement and disassociate himself or herself from the resolution of the matter, if the issue is not satisfactorily resolved.
Audit Planning Techniques For Application
The extent of the auditor’s planning depends on the nature of the client and the experience of the auditor with that client. For example, planning for the audit of a new client is more extensive than planning for the audit of an existing client.
When planning an audit, the auditor should consider the following:
- The economy.
- The client’s industry.
- The client’s business.
- Firm requirements.
These factors are discussed below. All factors are not appropriate for every audit. The size and complexity of the client determine which factors are relevant.
The Economy – There are certain economic conditions that significantly influence the industry and the business of the client. The auditor should be aware of these conditions and should consider them when planning the audit. Some economic factors that might affect client operations and, therefore, should be considered in planning an audit follow:
- Interest rates.
- Unemployment rates.
- Money supply.
- Foreign currency exchange rates.
- International trade agreements.
- Government regulations and legislation.
- Overall business conditions—depression, recession, inflation.
Client’s Industry – When planning the audit, the auditor should be aware of conditions in the client’s industry. Factors to consider include the following:
- Growth and financial results of the industry. Possible sources of this information are the following: (a) Industry trade association literature (b) Publications issued by agencies such (c) Government publications issued by the Government Printing Office, Washington, D.C.
- Cyclical and seasonal nature of the industry.
- Is the industry labor intensive or capital intensive?
- Industry labor conditions: (a) Is the industry unionized? (b) Has the industry recently experienced a strike?
- Industry accounting practices. This information may be obtained from firm members with clients in the same industry and AICPA Industry Audit and Accounting Guides.
- Industry price patterns and consumer reactions to price changes.
- State of industry technology.
- Competitiveness of industry: (a) Number of bankruptcies during the past year (b) Number of new companies organized during the current year\
In addition to the information the auditor obtains about the client’s industry from industry-related publications, he or she may obtain industry information from bankers, client management, auditors with clients in the same industry, and general business publications, such as the Wall Street Journal, Business Week, Forbes, and Fortune.
Client’s Business [New Client] – When planning the audit, the auditor should have a knowledge of the client’s operations. For a new client, the primary sources of information are discussions with the predecessor auditor and inquiries of client management. For a new client, the auditor should learn about the client and plan the audit by doing the following:
- Communicate with predecessor auditor.
- Visit client’s administrative office and major facilities.
- Review year-end financial statements of prior year and interim financial statements of current and prior year.
- Review auditor’s report on prior year’s financial statements: (a) Was there a scope limitation? (b) Were certain matters emphasized? (c) Did the auditor disclaim an opinion or issue an adverse opinion? (d) Were there other modifications of the auditor’s standard report?
- Review prior year’s income tax returns.
- Obtain the results of the most recent income tax examination.
- Review reports issued to agencies, such as the following: (a) Securities and Exchange Commission (b) Federal Housing Administration, Small Business Administration, and Department of Labor (c) Credit agencies and banks.
Visit to Administrative Office – During his or her visit to the client’s administrative office, the auditor should do the following:
. Meet with financial and administrative officers and obtain or determine the following:
- The functions of each executive.
- The executive responsible for the audit.
- Organization charts.
- locations and relative importance of all offices, showrooms, warehouses and factories.
- Obtain corporate manuals or memoranda that provide information about the following: (1) Nature and description of the entity’s products (2) Production and distribution methods (3) Internal control (4) General ledger chart of accounts.
- Methods of financing the entity’s operations.
- Schedule of long-term debt.
- Names of banks and account executive at each bank. For each bank, determine the following: (1) Outstanding indebtedness and terms of payment (2) Lines of credit (3) Other banking services.
- For nonpublic companies, a schedule of stockholders with the following information: (1) Names (2) Addresses (3) Certificate numbers (4) Number of shares held. (5) Shareholder function in the business
- Purchase terms: (1) Terms of payment (2) Are letters of credit used for foreign purchases?
- Sales terms: (1) Terms of payment (2) Are letters of credit used for foreign sales?
- The existence of related-party transactions such as the following: (1) Purchases and sales (2) Loans (3) Receiving or providing services, such as management, legal, and administrative
- Schedule of all affiliates and non-consolidated subsidiaries.
- Customers and suppliers on whom the entity is economically dependent.
- Most recent trial balance.
- General ledger and books of original entry: (1) Are accounting records up-to-date? (2) What is the quality of accounting records?
- Extent of client responsibility for preparation of the following: (1) Trial balance (2) Schedules (3) Adjustments and accruals (4) Confirmations (5) Inventory instructions (6) Financial statements (7) Income tax returns.
- Tentative audit schedule. Agree to dates for the following: (1) Physical inventory (2) Cash and securities count (3) Mailing and confirmations (4) Start of fieldwork.
. Obtain the entity’s forms and documents, such as the following:
- Purchase requisitions.
- Purchase orders.
- Sales authorizations.
- Sales orders.
- Sales invoices.
- Production orders.
- Production requisitions.
- Payroll cards.
- Sales returns and credits.
- Purchase returns and credits.
. Examine work area that will be allocated to the auditor.
. Walk through the accounting area.
- Observe work conditions.
- Meet employees.
- Determine employee functions.
Visit to Facility – During the visit to the client’s facility, the auditor should do the following:
. Meet with management.
. Walk through a production cycle and note the following:
- Initiation of order.
- Requisition of materials.
- Movement of production.
- Completion of production.
- Storage of completed product.
- Shipment to customer.
. Document flow of production.
. Note conditions of facility and equipment.
. Visit materials stockroom, observe condition of the inventory, and review the following:
- Inventory records.
- Receiving reports.
- Inventory reports.
Client’s Business [Continuing Client] – For a continuing client, information about the business is obtained from the following:
- Client permanent file.
- Prior year’s audit documentation.
- Prior year’s audit team.
- Client’s current year budgets.
- Client’s current year interim financial statements.
- Members who had professional assignments with the client during the year. These assignments include the following: (a) Review of interim financial statements (b) Income tax planning (c) Systems and other consulting services.
Discussions with Client Management
The in-charge auditor and the staff member who will supervise the audit should visit the client before beginning the audit to determine the following:
- Change in product line.
- Addition or deletion of factories, offices, warehouses, or showrooms.
- Addition of new administrative departments.
- Acquisition of subsidiaries.
- Existence of new or continuing related parties.
- Changes in production or distribution methods.
- Changes in sources of financing.
- Changes in internal control.
- Acquisition of new office equipment such as a computer.
- Changes in key personnel.
- New long-term commitments, such as: (a) Leases (b) Employment contracts.
- Adoption of employee compensation and benefit plans.
During the discussion with management, items that are discussed with a new client also should be discussed with a continuing client. These include:
- Timing of audit.
- Auditor working conditions.
- Client participation.
After he or she has obtained knowledge of the client and agreed with the client about the timing of, and client participation in, the audit, the auditor should do the following:
- Obtain an engagement letter or prepare a memo about the understanding with the client.
- Estimate staff requirements.
- Prepare audit plan (if considered appropriate) and audit programs.
- Prepare time budgets.
Staff requirements include the following:
. Number of staff members required for the audit.
. The levels of staff required—supervisor, manager, senior, semisenior staff.
. Timing of need for staff.
- Year-end work, such as inventory observation, cash and securities counts, mailing of confirmations.
- Beginning of fieldwork.
- During fieldwork.
. Number of staff members with previous audit experience with client.
. Expertise required of staff.
- Computer applications.
- Familiarity with industry.
Preparation of Audit Plan
The audit plan provides the framework for the design of detailed audit procedures to be performed during the audit. The decision to use an audit planning memorandum and the content of the memorandum are matters of firm policy and there is substantial variation in practice.
A time budget indicates time allocated to each aspect of the audit and what staff level will perform the specific audit task. Factors to be considered in the preparation of time budgets are the following:
- Preliminary assessment of control risk [See: Risk Assessment Questionnaire Example]
- Audit materiality levels.
- Prior year’s time budget and its relationship to actual time.
- Key audit areas.