Chapter 8 Audit Planning and Analytical Procedures The 1st field work standard of GAAS imposes on an auditor an obligation

of adequately planning the audit. Chapter 8 discusses the steps involved in the audit planning process as well as the usefulness of analytical procedures in the planning process, especially in helping the auditor gain an understanding of the clients business and industry. Client acceptance and initial audit planning Initial audit planning consists of 4 parts: 1) evaluating whether to accept a new client or to continue with an existing audit client; 2) determining the clients reason for the audit; 3) obtaining an understanding with the client about the terms of the engagement; and 4) developing an overall strategy for the audit. Early on, the auditor must decide whether to accept a new client or to continue with an existing audit client. In deciding whether to accept a new client, the audit firm should investigate the client and its management. In the case of new clients that have previously been audited by another CPA firm, AU 315 requires the new auditor (successor auditor) to communicate with the clients predecessor auditor. In communicating with the predecessor auditor, the successor auditor may learn that the predecessor auditor and client severed their relationship due to disagreements over accounting principles or audit procedures, or that the clients management lacks integrity. For confidentiality reasons, the predecessor auditor is required to obtain permission from its former client prior to disclosing any information to the successor auditor. If the client refuses to permit the predecessor auditor to communicate with the successor auditor, the successor auditor should consider treating the refusal as a scope limitation and decline the engagement. For existing clients, the auditor must annually consider whether to continue as the clients auditor. Again, the auditor should consider managements integrity (or lack thereof) and whether it imposes increased risk to the audit firm. The auditor should also consider whether any issues of independence (or lack thereof) have arisen since last years audit. The auditor also must identify the clients reasons for having an audit and the likely users of the audited financial statements. The greater the number of users (creditors, investors, etc.), the higher the risk faced by the auditor (risk of potential lawsuits). To compensate for the increased risk, the auditor will want to accumulate more audit evidence which, in turn, will lead to a higher audit fee. The auditor must decide whether the audit fee justifies the risk involved with the audit. It is imperative that the auditor and client have a meeting of the minds with respect to the terms of the engagement. Because of its importance, AU 311 requires the auditor to document the understanding in the audit files. Such documentation is generally done with an engagement letter, a contractual agreement between the CPA and client. You should be familiar with the general contents of an engagement letter, a good example of which can be found in Fig. 2 on page 228 of the text.

Finally, the CPA firm must develop a strategy for the audit, which includes assigning appropriate and competent staffing for the audit engagement. The firm should consider the audit team members familiarity with the clients industry, and whether the engagement requires the expertise of certain individuals in the firm. On occasion, the CPA firm may have to engage the services of an outside specialist. In doing so, the CPA firm must comply with the requirements of AU 336. The CPA firm must verify the specialists licenses and certifications as well as the reputation, professional affiliations, and professional qualifications of the specialist. The CPA firm also must determine whether the specialist is independent of the client. Gaining an understanding of clients business & industry Gaining an understanding of the clients business and the environment in which the client operates is critical to the audit process. As shown in Fig. 3 on page 231, gaining that understanding can be broken down into 5 areas: 1) Industry and external environment, 2) Business operations and processes, 3) Management and governance, 4) Objectives and strategies, and 5) Measurement and performance. In evaluating the industry and external environment in which the client operates, the auditor must consider whether there are risks associated with the clients specific industry, whether there are inherent risks faced by all companies in the clients industry, and whether there are accounting requirements unique to the clients industry. All of these factors may lead to an increase in the risks faced by the auditor. In evaluating the clients business operations and processes, the auditor should gain an understanding of the clients major sources of revenue and key customers and suppliers (is the clients business dependent upon a few major customers or suppliers) and the clients ability to obtain financing (inability of client to obtain financing may indicate going concern issue). The auditor also must gain a thorough understanding of the clients related party transactions, which are susceptible to abuse, and ensure that such transactions are properly disclosed. In gaining an understanding of a clients management and corporate governance, the auditor should review the clients corporate charter and bylaws, code of ethics, and corporate minutes. Corporate minutes often disclose important information such as officers compensation and the existence of loans. The auditor must understand the clients objectives with respect to financial reporting reliability, effectiveness and efficiency of operations, and compliance with laws and regulations. If clients management views financial reporting as an important objective, the auditor can have more confidence in the accuracy and reliability of the clients financial reporting system. Finally, in gaining an understanding of the clients measurement and performance system, the auditor should consider whether clients management has set unreasonable

objectives or if the clients performance measurement system encourages aggressive accounting. Analytical procedures Analytical procedures consist of comparing, and evaluating the relationships between, financial and/or non-financial data to assess whether account balances or other data appear reasonable. They are used by the auditor during the planning stage to gain an understanding of the clients business and to assess the clients business risk. The auditor may use analytical procedures to determine whether the client is performing in line with its competitors by, for example, comparing the clients gross profit margin with that of its competitors. The auditor relies upon analytical procedures for detecting possible misstatements. For example, the auditor may compare the clients gross profit margin for the current year with prior years profit margins. An unusual change in the ratio may indicate a possible misstatement in sales. The use of analytical procedures is so important that they are required to be used in the planning and completion phases of every audit. Although not required, they also are frequently used during the testing phase. There are 5 types of analytical procedures: 1) comparing client and industry data, 2) comparing client data with similar prior-period data, 3) comparing client data with clientdetermined expected results, 4) comparing client data with auditor-determined expected results, and 5) comparing client data with expected results, using non-financial data. NOTE: Figure 5 on page 238 is an excellent summary of the planning process. My faceto-face students have found it to be very helpful.