Audit Planning

Audit Planning

As per Auditing and Assurance Standard 1, “Basic Principles Governing an Audit”, Audit Planning is one of the basic principles.

 Accordingly, it states “The  auditor  should  plan  his  work  to  enable  him  to  conduct  an  effective  audit  in  an efficient and timely manner. Plans should be based on knowledge of the client’s business.


Plans should be made to cover, among other things :

(a)   acquiring knowledge of the client’s accounting systems, policies and internal control procedures;

(b)   establishing the expected degree of reliance to be placed on internal control;

(c)   determining and programming the nature, timing, and extent of the audit procedures to be performed; and

(d)   coordinating the work to be performed.


Plans should be further developed and revised as necessary during the course of the audit.”

SA-300 further expounds this principle. According to it, planning should be continuous throughout the engagement and involves :

     developing an overall plan for the expected scope and conduct of the audit; and
       developing  an  audit  programme  showing  the  nature,  timing  and  extent  of  audit procedures.

Changes in conditions or unexpected results of audit procedures may cause revisions of the overall plan of and the audit programme. The reasons for significant changes may be documented.


Objectives of Planning : Adequate audit planning helps to :

 ensure that appropriate attention is devoted to important areas of the audit;

     ensure that  potential problems are promptly identified;
       ensure that the work is completed expeditiously;
        utilise the assistants properly; and
       co-ordinate the work done by other auditors and experts.

In planning his audit, the auditor will consider factors such as complexity of the audit, the environment  in which the entity operates, his previous experience with the client and knowledge of the client’s business.

The auditor may wish to discuss elements of his overall plan and certain audit procedures with the  client to improve the efficiency of the audit and to coordinate audit procedures with  work  of  the  client’s personnel. The  overall audit  plan  and  the  audit programme,however, remain the auditor’s responsibility.



Audit Objective

The auditor must gather sufficient competent evidential matter as a basis for forming his opinion on :


 (a)  the truth and fairness of the accounts and also their compliance with the provisions of the related laws, rules and regulations;

(b)   the proper keeping of the accounting records, and other records and related registers of the client.

These broad objectives may be amplified as follows :

To determine whether :


(1)   all assets and liabilities are properly stated and classified on a basis consistent with that of the previous year;
(2)   proper disclosure is made of securities for  liabilities and of assets charged or secured;

(3)   the client has complied with the provisions of the applicable laws and documents created under them, loan agreements and other documents to which he is a party;
(4)   income and expenses are properly classified and disclosed and are properly matched.

They relate to the period in which they are reported and have been determined on a basis consistent with that of the previous year;
(5)   all contingencies and commitments are properly disclosed;

(6)   no material omissions have been made in the financial statements;


(7)   no material error or inaccuracy in reporting or disclosing income, expenses, assets and liabilities has been created in the financial statements;

(8)   the books and records have been properly kept in accordance with the requirements of the client.


The  expression  of  opinion  on  the  overall  balance  sheet  and  profit  and  loss  account involves initially forming an opinion on each of the balance sheet or profit and loss items; it is necessary first to decide what are the essential conditions or pre-requisites for each balance sheet or profit and loss account item in order to give a true and fair view of the particular assets or liabilities  or  item of income or expense being represented. These conditions are well established and may be illustrated by reference to the areas of sundry debtors and sales revenues.


Sundry Debtors : The audit of sundry debtors should be sufficiently comprehensive to enable the auditor to form an opinion as to whether :

(1)   The amounts shown represent bonafide receivables of the company.

(2)   The receivables are properly classified.

 (3)  Adequate provisions have been made for uncollectible receivables and for discounts and freight allowable, returns adjustments, etc.

(4)   Any receivables have been pledged, discounted, assigned or sold, and if so whether they are properly disclosed.


Sales Revenues : Specific objectives in the audit of sales revenues are to determine whether:


(1)   Sales accounting procedures are operating effectively to produce reliable sales revenue figures for the period.

(2)   Sales  revenues  have  been  recorded  in  the  proper  accounting  period  and  are  not overstated through improper credits for fictitious sales of goods neither supplied nor set aside.  Conversely, whether sales or other revenues are understated through deferring the recording  thereof to subsequent periods or omitting to record sales despatched as sales.

(3)   Allowance, returns and other sales deductions are fairly stated and properly treated in the financial statements and that adequate provisions have been made for any significant additional amount that may be anticipated to be paid but not yet finally settled.


(4)   Non-operating revenues have been segregated from sales revenues and have been appropriately treated in the profit and loss statement.





What is Audit Risk

Audit  risk  is  the  risk  that  an  auditor  may  give  an  inappropriate  opinion  on  financial information that is materially mis-stated.  For example, an auditor may give an unqualified opinion on financial statements without knowing that they are materially mis-stated.  Such risk may exist  at  overall level or while verifying various transactions and balance-sheet items.


1. Audit risk at the financial statement level : Audit risk is considered at the financial statement  level  during  the  audit  planning  process.  At  this  time,  the  auditor  should undertake  an  overall  audit  risk  assessment  based  on  his  knowledge  of  the  client’s business,    industry,   management,   control   environment   and   operations.   Such   an assessment   provides   preliminary   information   about   the   general   approach   to   the engagement, the auditor’s staffing needs and the framework within which materiality and audit  risk  assessments  can  be  made  at  the  individual  account  balance  or  class  of transactions  level.   As part of this overall risk assessment, the auditor should consider whether there is potential for pervasive problems, for example, liquidity or going concern problems.


2. Audit risk at the account balance and class of transactions level: The majority of audit  procedures are directed to, and carried out at the account balance and class of transactions level. Accordingly, audit risk should be considered by the auditor at this level taking into account the results of the overall audit risk assessment made at the financial statement  level.  To  assess  inherent  risk,  the  auditor  uses  professional judgement  to evaluate numerous factors, examples of which are:

At the financial statement level :

     the integrity of management;

     management experience, knowledge and changes during the period (e.g. the in ex- perience of management may affect the preparation of the financial statements of the entity);

     unusual  pressures  on  management  (e.g.  circumstances  that  might  predispose management to mis-state the financial statements, such as an entity in an industry experiencing a large number of business failures or an entity that lacks sufficient capital to continue operations);

     the nature of the entity’s business (e.g. its technological obsolescence of products and  services,  complex  capital  structure,  significance  of  related  parties,  and  the number  of  locations  and  geographical  spread  of  its  production  facilities); factors affecting the  industry  in which the entity operates (e.g. economic and competitive conditions, and changes in technology, accounting practices common to the industry and, if available, financial trends and ratios);

At the Account balance and class of transaction level:


     financial  statement  of  accounts  likely  to  be  susceptible  to  misstatement  (e.g.  a financial statement of account which required adjustment in the previous period);

     the complexity of underlying transactions which might require the use of the work of an expert;

     the amount of judgement involved in determining account balances;

     susceptibility of assets to loss or misappropriation;

     the completion of unusual and complex transactions, particularly at or near year end;


Assessment  of  audit  risk  by  reference  to  its  components  :  Audit  risk  has  been discussed at length in SA-400. As per SA-400 three components of audit risk are:


     inherent risk (risk that material errors will occur);


     control risk (risk that the client’s system of internal control will not prevent or correct such errors); and

     detection risk (risk that any remaining material errors will not be detected by the auditor).


The nature of each of these types of risk and their interrelationship is discussed below:


Inherent  risk  is  the  susceptibility  of  an  account  balance  or  class  of  transactions  to misstatement that could be material, individually or when aggregated with mis-statements in other balances or classes, assuming that there were no related internal controls.  It is a function  of  the  entity’s  business  and  its  environment  and  the  nature  of  the  account balance  or  class  of  transactions.  For  example,  accounts  involving  a  high  degree  of management judgement, or  that are difficult to compute, such as a complex accounting estimate, or that involve highly  desirable and movable assets, such as jewellery, or that are  particularly susceptible to changes  in  consumer  demand  or  technology  that  could affect their value, will involve more inherent risk than other accounts.

Control risk is the risk that misstatement that could occur in an account balance or class of  transactions  and  that  could  be  material,  individually  or  when  aggregated  with  mis- statements  in other balances or classes, will not be prevented or detected on a timely basis by the system of internal control.  There will always be some control risk because of the intrinsic limitation of any system of internal control.  To assess control risk, the auditor should consider the adequacy of  control design, as well as test adherence to control procedures.   In the absence of such an  assessment, the auditor should assume that control risk is high.

Detection risk is the risk that an auditor’s procedures will not detect a misstatement that exists in an account balance or class of transactions that could be material, individually or when aggregated with misstatements in other balances or classes. The level of detection risk relates directly to  the  auditor’s procedures. Some detection risk would always be present even if an auditor were to examine 100 percent of the account balance or class of transaction  because,  for  example,   the   auditor  may  select  an  inappropriate  audit procedure, misapply an appropriate audit procedure or misinterpret the audit results.



Interrelationship of the components of audit risk :   Inherent and control risks differ from  detection risk in that they exist independently of an audit of financial information. Inherent and  control risks are functions of the entity’s business and its environment and the nature of the  account balances or classes of transactions, regardless of whether an audit is conducted.   Even  though inherent and control risks cannot be controlled by the auditor, the auditor can assess them and design his substantive procedures to produce an acceptable level of detection risk, thereby reducing audit risk to an acceptably low level.




Concept of Test Checking , Audit Sampling


Very often we come across this term when an audit is conducted on the basis of a part checking. This, it is said, owes its origin to the statistical theory of sampling.
The  auditor  according  to  his  best  judgment,  having  regard  to  the  nature,  size  and materiality  of  transactions,  picks  up  the  entries  for  examination.  Normally,  entries involving large amounts or relating to material accounts are seen exhaustively and entries are picked up for verification at random from the remainder according to a certain plan.
Sometimes, entries are checked for a few specified months exhaustively and the rest go unchecked. Though it is stated that the technique is an adaptation of the sampling theory, it is in reality far from it. It lacks any acceptable basis and gives the auditor no idea about the degree of reliability that he can place on the findings for application to the whole set of entries. The so-called  random picking is not random in the statistical sense. To be truly random, the selection should  be  free from any bias and that is possible only through a statistical process and by reference to the random number tables.
The only quality that this technique can claim lies in its keenness to cover larger amounts and  material  accounts.  Even  if  errors,  frauds  etc.,  remain  undetected  in  the  part  not checked, they are not likely to be too big as to upset the truth and fairness of the financial statement.  But  auditors  cannot  be  certain  about  this  even  after  checking  100%  of transactions. The cost  and   time involved in conducting an audit has to be visualised in relation to benefits which shall  accrue from such an approach. If fairly lesser amount of checking may lead to admit same conditions there is absolutely no point in checking entire transaction. Moreover, there are constraints within audit has to be completed.
In any audit, the question of fact is more important because essentially the auditor’s job is to test  the assertions in financial statements by reference to available evidence, apart from the following aspects:
i.           presentation,
ii.          disclosure,
(iii)   arithmetical accuracy,
(iv)   adherence to accepted accounting principles, and
(v)   compliance with the requirements of law.
An auditor is also concerned about the existence of errors and frauds in the financial accounts. The few matters listed above are fundamental questions affecting the true and fair  concept and due consideration to these are given at the appropriate stage of audit. However,  errors and frauds stand on a slightly different footing inasmuch as there is a need to eliminate  them if they exist to affect truthfulness and fairness materially. It is therefore necessary that an  auditor should have a fair idea about why error and frauds occur, how they are committed and what are the usual means to locate them.

 Precautions to be taken in Adopting Test Checking Techniques

Generally, a  large   manufacturing   concern   is   associated  with a  large   volume   of transactions.  Also,  the  nature of the  transactions  is  determined by  the  nature  of  the business. For example, one  may            find  numerous  purchases  of  raw  materials, stores, spares, etc.; there may be thousands of workers to be paid wages on weekly basis; the wages again may be calculated on a job or time basis. Depending upon the product lines, the sales mechanics may be different for different products - some may be to dealers and agents, some to  wholesalers and some others even to retailers and consumers directly. Sales and purchase  operations may stretch even to overseas markets. There may be various forms in which such a concern can raise bank finance, like letter of credit, packing credit, overdraft, bills discounted, etc. Basically, in a large manufacturing concern the problem is the problem of volume and variety.
In the circumstances when necessarily the test check technique has got to be adopted for audit  work, it should be done by taking certain precautions so that a reliable idea about the truth and  fairness of the accounts can be obtained by the auditor. The precautions that should be taken may be the following :
(i)    The transactions of the concern should be classified under appropriate heads and may be stratified if wide variations are there between transactions of the same kind.
(ii)    Systems and procedures for entering into and processing a transaction right from the beginning  to the end should be studied in a sequential order. It involves questions of authorisations, documentation and recording and evidencing the same.
(iii)   The whole of the system of internal control in the areas of accounts and finance should be  studied  and  evaluated  for  its  efficiency,  soundness  and  capability  for  producing reliable  accounting and financial data. This can be done by studying the controls and internal checks, evaluating their general soundness in the context of the business of the concern and testing their  actual operation. If, and only if, the auditor is satisfied about soundness of the controls and  their  operation in actuality, can he decide to have test checks.  For  testing  the  operation  of  the  control  system,  he  should  select  a  few transactions and check them in depth by the application of procedural tests.
(iv)   A properly thought-out test check plan should be prepared and the objective of each check should be clearly understood by the auditing staff. For example, each voucher may be checked by the test check method for a number of objectives - one may be to ensure that the cash payments are properly authorised and acknowledged, others may be to see whether the amount actually payable has in fact been paid and whether the payment has been debited to the proper account. If there is a mix-up in the objectives or the objective is to test a number of variables in one test scheme, the result may not be helpful. Hence it requires a clear definition of the audit objective related to the particular test check plan.
 (v)  The transactions falling under each test-check plan should be selected in a manner so that   bias cannot enter in the selection. For the purpose, selection should be made by reference to the random number tables.
(vi)   Identification of the areas where test check may not be done. For example, if there are only 20  overseas sales in the year, it would be preferable to have them all thoroughly checked.
(vii)  The  number  of  transactions  to  be  selected  for  each  test-check  plan  should  be predetermined. This can be done by deciding upon the degree of reliance that should be placed on the test-check result and the confidence that can be placed - the result to be obtained  should be veering round the degree of reliance set up. Once the degree of reliance and the confidence level required in the audit for expression of the opinion have been decided, the number to be tested out of the given population can be easily known by reference to the statistical tables.
(viii) Errors that may be found may be material or immaterial in the context of the particular audit.  Since errors of immaterial nature are not likely to distort the overall truth and fairness  of  the  accounts,  it  is  necessary  to  decide  upon  the  criteria  to  judge  what constitutes a material error. Further investigation of immaterial error may be avoided and only the material errors may be properly and thoroughly investigated.

 Methods of Statistical Sampling

As per SA 530, “Audit Sampling”, the auditor should select sample items in such a way that the sample can be expected to be representative of the population. This requires that all items in the population have an opportunity of being selected.
There  are  two  major  methods  in  which  the  size  of  the  sample  and  the  selection  of individual  items  of  the  sample  are  determined.  These  methods  are  :  (1)  judgmental sampling; and (2) statistical sampling.
Whatever may be the method, judgmental or statistical sampling, the sample must be representative. This means that it must be closely similar to the whole population although not necessarily exactly the same. The sample must be large enough to provide statistical- ly meaningful results.
Judgmental  Sampling  :  Under  this  method,  the  sample  size  and  its  composition  are determined on the basis of the personal experience and knowledge of the auditor. This method has been in common application for many years because of its simplicity in operation. Traditionally, the auditor on the basis of his personal experience, will determine the size of the sample and express it in terms that number of pages or personal accounts in the purchases or sales ledger to be checked. For example, March, June and September may be selected in year one and different months would be selected in the next year. An attempt  would be made to avoid establishing a pattern of selection year after year to maintain an element of surprise as to what the auditor is going to check. It is a common practice  to check  large  number  of  items  towards  the  close  of  the  year  so  that  the adequacy of cut-off procedures can also be determined.
The  judgmental  sampling  is  criticised  on  the  grounds  that  it  is  neither  objective  nor scientific.  The expected degree of objective cannot be assured in judgmental sampling because the risk of personal bias in selection of sample items cannot be eliminated. The closeness  of  the   qualities  projected  by  the  sample  results  with  that  of  the  whole population cannot be measured because the sample has not been selected in accordance with the mathematically  based  statistical techniques. However, it may be stated that the auditor  with  his  experience   and   knowledge  of  the  client’s  business  can  evaluate accurately enough the sample findings to make audit decision and the mathematical proof of accuracy in some cases may be a luxury which the auditor cannot afford.
In judgmental sampling the auditor’s opinion determines the sample size but it cannot be measured how far the sample size would fulfill the audit objective. In statistical sampling, the  sample  results  are  measurable  as  to  the  adequacy  and  reliability  of  the  audit objectives.
Statistical  Sampling  :  Statistical  sampling  is  a  method  of  audit  testing  which  is  more scientific  than testing based entirely on the auditor’s own judgment because it involves use of  mathematical laws of probability in determining the appropriate sample size in varying  circumstances.  Statistical  sampling  has  reasonably  wide  application  where  a population to be tested consists of a large number of similar items and more in the case of transactions   involving   compliance   testing,   debtors’   confirmation,   payroll   checking, vouching of invoices and petty cash vouchers.
Students may note that it is unnecessary for the auditor to gain indepth knowledge of statistics  before  making  use  of  statistical  sampling  for  audit  testing  since  published statistical tables  are available which indicate the sample size based on pre-determined criteria.

 Selection of the Sample

Sample should be selected in such a manner that it is representative of the population from  which  the  sample  is  being  selected.  It  will  necessitate  that  each  item  in  the population has  an equal chance of being included in the sample. Some of the important methods of selecting the sample are discussed below -
 Random Sampling  : Random selection ensures that all items in the population or within  each stratum have a known chance of selection. It may involve use of random number tables. Random sampling includes two very popular methods which are discussed below:—
i.                     Simple random sampling : Under this method each unit of the whole population e.g. purchase  or sales invoice has an equal chance of being selected. The mechanics of selection  of  items  may  be  by  choosing  numbers  from  table  of  random  numbers  by computers or picking up  numbers randomly from a drum. It is considered that random number tables are simple and easy to use and also provide assurance that the bias does not affect the selection. This method is considered appropriate provided the population to be sampled consists of reasonably similar units and fall within a reasonable range. For example the population can be considered  homogeneous, if say, debtors balances fall within the range of Rs. 5,000 to Rs. 25,000 and not in the range between Rs. 25 to Rs.2,50,000.
(ii)    Stratified Sampling : This method involves dividing the whole population to be tested in a few separate groups called strata and taking a sample from each of them. Each stratum is treated as if it were a separate population and if proportionate of items are selected from each of these stratum. The number of groups into which the whole population has to be divided is determined on  the basis of auditor judgment. For example in the above case, debtors balances may be divided into four groups as follows:-
(a)   balances in excess of Rs. 1,00,000;
(b)   balances in the range of Rs. 75,000 to Rs. 1,00,000;
(c)   balances in the range of Rs. 25,000 to Rs. 75,000; and
(d)   balances below Rs. 25,000.
From these above groups the auditor may pick up different percentage of items from each of the group. From the top group i.e. balances in excess of Rs. 1,00,000, the auditor may examine all  the  items; from the second group 25 per cent of the items; from the third group 10 per cent of the items; and from the lowest group 2 per cent of the items may be selected.
The reasoning behind the stratified sampling is that for a highly diversified population, weights  should be allocated to reflect these differences. This is achieved by selecting different proportions from each strata. It can be seen that the stratified sampling is simply an extension of simple random sampling.
2.    Interval  sampling  or  systematic  sampling  :  It  involves  selecting  items  using  a constant interval between selections, the first interval having a random start. The interval might be based on a certain number of items (for example every 20th voucher) or a monetary totals (for example every Rs. 1,000 in the cumulative value of the population). When using systematic selection, the auditor should determine that the population is not structured  in  such  a  manner  that  the  sampling  interval  corresponds  with  a  particular pattern in the  population. For example, if in a population of branch sales, a particular branch sales occur only  as every 100th item and the sampling interval selected is 100. The result would be that either the auditor would have selected all or none of the sales of that particular branch. To minimise  the  effect of the possible known buyers through a pattern in the population, more than one starting point may be taken. The multiple random starting point is taken because it minimises the risk of interval sampling pattern with that of the population being sampled.
(i)    Block Sampling : This method involves the selection of a defined block of consecutive items. For example take the first 200 sales invoices from the sales day book in the month of September, alternatively take any four blocks of 50 sales invoices. Therefore, once the first item in the block is selected, the rest of the block follows an items to the completion. There is a close similarity between this method and judgmental sampling. Consequently it has similar characteristics, namely, simplicity and economy. On the other hand there is a risk of bias and of establishing a  pattern of selection which may be noted by the auditees.
(ii)    Cluster sampling : This method involves dividing the population into groups of items known  as  clusters. A number of clusters are randomly selected from all the clusters rather than individual items of the population. Cluster sampling can be used together with both unrestricted random and stratified sampling, for example 500 to 540, 2015 to 2055 etc. The first item i.e. 500, 2015 is randomly selected from random number tables. The items  of  selected  cluster  can  either be checked completely or  a randomly selected proportion of them can be examined.
The  cluster  is  less  effective  for  a  given  sample  size  than  unrestricted  random  and stratified samples as items are not individually selected. However, the time saved can be utilised to have a larger sample to make the sample results more reliable.  As per SA 530, when determining the sample size, the auditor should consider sampling risk, the tolerable error, and the expected error.  Sampling risk arises from the possibility that the auditor‘s conclusion,  based  on  a  sample,  may  be  different  from  the  conclusion  that  would  be reached if the entire population were subjected to the same audit procedure.

 Advantages of Statistical Sampling in Auditing

The advantages of statistical sampling may be summarized as follows -
1.    The amount of testing (sample size) does not increase in proportion to the increase in the size of the area (universe) tested.
2.    The sample selection is more objective and thereby more defensible.
3.    The method provides a means of estimating the minimum sample size associated with a specified risk and precision.
4.    It  provides  a  means  for  deriving  a  “calculated  risk”  and  corresponding  precision (sampling error) i.e. the probable difference in result due to the use of a sample in lieu of examining all the records in the group (universe), using the same audit procedures.
5.    It may provide a better description of a large mass of data than a complete examination of all the data, since non-sampling errors such as processing and clerical mistakes are not as large.

Under some audit circumstances, statistical sampling methods may not be appropriate. The auditor should not attempt to use statistical sampling when another approach is either necessary  or  will  provide  satisfactory  information  in  less  time  or  with  less  effort,  for instance when exact accuracy is required or in case of legal requirements etc.