Chapter 3

Audit Planning,
Types of Audit
Tests, and
Materiality

McGraw-Hill/Irwin

Copyright 2012 by The McGraw-Hill Companies, Inc. All

LO# 1

The Phases of an Audit That Relate to Audit

Planning

3-2

LO# 2

Preliminary Engagement Activities

Determine the Audit
Engagement Team
Requirements

Assess Compliance with

Ethical Requirements,
Including Independence
3-3

Establish Terms of the

Engagement

LO# 3

In establishing the terms of the engagement,

three topics must be discussed:
1.The engagement letter;
2.Using the work of the internal auditors;
and
3.The role of the audit committee.

The terms of the engagement, which are documented in

the engagement letter, should include the objectives of
the engagement, managements responsibilities, the
auditors responsibilities, and the limitations of the
engagement.
Who signs the engagement letter?
3-4

LO# 4

The Engagement Letter

The engagement letter formalizes the arrangement reached
between the auditor and the client.
In addition to the items mentioned in the
sample engagement letter in Exhibit 3-1 in
the textbook, the engagement letter may
include:

Arrangements for use of specialists or

internal auditors.

Any limitations of liability of the auditor

or client.

Additional services to be provided.

Arrangements regarding other services.

3-5

LO# 5

Internal Auditors

3-6

LO# 6

The Audit Committee

Subcommittee
of the board of
directors
No specific
requirements
for privately
held companies

Section 301 of Sarbanes-Oxley Act requires the

following for audit committee members of
publicly held companies:

Member of board of directors and independent.

Directly responsible for overseeing work of any

registered public accounting firm employed by the

company.

Must preapprove all audit and nonaudit services

provided by its auditors.

Must establish procedures to follow for complaints.

Must have authority to engage independent counsel.
3-7

LO# 7

Planning the Audit

When preparing the audit plan, the auditor should be guided
by the results of the client acceptance/continuance process,
procedures performed to gain an understanding of the entity,
and preliminary engagement activities.
Additional steps:

Assess business risks.

Establish materiality.
Consider multilocations.
Assess the need for specialists.
Assess the possibility of illegal acts.
Identify related parties.
Consider additional value-added services.

Lets look at each

of these steps.

3-8

LO# 7

Document Audit Strategy

3-9

LO# 9

Types of Audit Tests

Risk Assessment
Procedures

Used to obtain an understanding of

the entity and its environment,
including its internal control.

Tests of Controls

Directed toward the evaluation of the

effectiveness of the design and
operation of internal controls.

Substantive
Procedures

Detect material misstatements in a

transaction class, account balance,
and disclosure component of the
financial statements.
3-10

LO# 10

Materiality
The
The magnitude
magnitude of
of an
an omission
omission or
or misstatement
misstatement of
of
accounting
accounting information
information that
that makes
makes itit probable
probable that
that
the
the judgment
judgment of
of aa reasonable
reasonable person
person relying
relying on
on
the
the information
information would
would be
be changed
changed or
or influenced
influenced
by
by the
the omission
omission or
or misstatement.
misstatement.
Materiality is not an absolute and
it is not a black or white issue!
The determination of materiality
requires professional judgment.
3-11

Steps in Applying Materiality

on an Audit

LO# 11

Step
Step 1:
1:
Determine
Determine aa materiality
materiality level
level for
for the
the overall
overall financial
financial statements
statements
(planning
(planning materiality)
materiality)
Step
Step 2:
2:
Determine
Determine tolerable
tolerable misstatement
misstatement
(allocation
(allocation of
of materiality
materiality at
at individual
individual account/class
account/class of
of transactions
transactions level)
level)

Step
Step 3:
3:
Evaluate
Evaluate auditing
auditing findings
findings
(near
(near the
the end
end of
of the
the audit)
audit)
3-12

End of Chapter 3

3-13