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Lecturer: Nguyễn Hoàng Tố Loan Auditing Department, School of Accounting, UEH
Topic 4
Audit Planning
Course tittle: Principles of Auditing
Prescribed Reading
Session Topic 4 Materials Exercises Notes 6,7,8 Audit Planning Textbook (1): Chapter 4,5, Textbook (2): Chapter 3 Textbook (1): Chapter 4,5, Workbook: Chapter 3 Relevant Guidance (Quy định có liên quan) ISA/VAS200 Overall Objectives^ of the Independent Auditor, and the Conduct of an Audit in Accordance with International Standards on Auditing ISA/VAS300 Planning an Audit of Financial Statements ISA/VAS315 Identifying and Assessing the Risks of Material Misstatement through Understanding the Entity and Its Environment ISA/VAS320 Materiality in planning and performing an audit ISA/VAS330 The Auditor's Responses to Assessed Risks ISA/VAS450 Evaluation of Misstatements Identified During the Audit ISA/VAS520 Analytical Procedures 4.1 Explain the concept of materiality. 4.2 Understand the definition of audit risk and components of audit risks. 4.3 Outline the audit risk model. 4.4 Understand the business-risk approach in an audit of a financial report. 4 .5 Understand the relationships between audit risk, materiality, and audit evidence. 4.6 Explain how an auditor develops an overall audit strategy and prepares an audit plan. 4.7 Identify the management assertions about financial information; link the identified management assertions to related audit objectives; then, select the appropriate audit procedures. 4.8 Define types of audit tests. (^3)
Learning objectives of Topic 4
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Contents of Topic 4
1 Materiality in a financial statement audit (chapter 4)
Audit Risk and Client Business Risk (chapter 4,5,6)
Client Acceptance and Continuance (chapter 5)
Audit planning (chapter 5)
Financial statement assertions, audit objectives,
and audit procedures (chapter 4)
6 Types of Audit Tests^ (chapter^4 )
5 1.1. What is Materiality in Accounting and Auditing? 1.2. Factors Affecting Judgment about Materiality. 1.3. The Applications of Materiality in Auditing Processes.
1. Materiality in a financial statement audit 1.1. Definition of Materiality in Accounting Definition of Material (International Accounting Standards Board - IABS, Amendments to IAS 1 and IAS 8, Oct, 2018) Information is material if omitting, misstating or obscuring it could reasonably be expected to influence the decisions that the primary users of general purpose financial statements make on the basis of those financial statements, which provide financial information about a specific reporting entity. In other words, materiality is a magnitude/threshold of misstatements (individually/or in aggregated) may adversely affect decisions about the allocation of scarce resources made by financial report users^ (ISA^320 ). 7 Materiality in Accounting Process Economic transactions and events occurred during the accounting period è could be reported in the FSs. Economic transactions and events actually presented and disclosed in the FSs. Eg.,
- Shall we record “20 feather dusters” (US$20) as expenses or prepaid expenses (asset)? Materiality in Auditing We need to obtain reasonable assurance about whether the financial statements as a whole are free from material misstatements, whether due to or fraud or errors. Auditors
13 1.2. Factors affecting Judgment about materiality Materiality is a relative rather than an absolute concept. Bases are needed for evaluating materiality. Materiality is determined on quantitative and qualitative factors. On quantitative basis, materiality is the maximum amount of misstatement that is considered as acceptable in FSs. On qualitative basis, materiality is used to evaluate the effect of frauds, errors on user’s decisions beside the quantitative aspect. Qualitative Factors A quantitatively small misstatement may be considered as material include: Changing trend (Xu hướng thay đổi bất thường) Financial statements users Conceals an^ illegal^ act (che đậy hành vi phạm pháp) Loan covenants (thoả thuận cho vay) Management compensation (thưởng cho nhà quản lý) Using reading materials for group discussions 15
1.3. The applications of Materiality in Auditing
v ISA 320 deals with the auditor’s responsibility to apply the concept of materiality in planning and performing an audit of FSs. v ISA 450 explains how materiality is applied in evaluating the effect of identified misstatements on the audit and of uncorrected misstatements, if any, on the FSs. à It’s compulsory requirements of ISAs Completing /reporting Planning Performing 16
The Applying of Materiality in Audit (1)
v Auditor must make preliminary assessment of materiality
when planning the audit.
v In audit planning, auditor uses materiality to:
o Determine the nature, timing and extent of risk assessment procedures. o Identify and assess the risk of material misstatements; and o Determine the nature, timing and extent of further audit procedures.
ISA/VSA 320
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The Applying of Materiality in Audit (2)
v Materiality is a concept of relative significance. (mang tính tương đối) èIt depends on the amount of the item of interest and some relevant basis of comparison. vTo estimate an amount for planning materiality, the auditor selects a base and a suitable percentage to apply to that base. èThis requires professional judgment , and not all auditors do it the same way.
ISA/VSA 320
Materiality level Materiality for the FSs as a Whole (Mức trọng yếu tổng thể cho toàn bộ BCTC) Performance materiality (Mức trọng yếu thực hiện) Clearly trivial threshold (Ngưỡng sai sót không đáng kể) Two types of Materiality à It’s not material. It’s a threshold to consider a small misstatement as trivial 19 Overall level: Materiality for the FSs as a Whole (M) This is the amount is applied at FSs level, at which it may influence FS user’s economic decisions taken on the basis of the FSs as a whole. v Determining of M: the exercises of professional judgment. ( usually, it’s a percentage of a chosen benchmark ) v The chosen benchmark: elements of FSs, eg., profit, revenues, assest, equity, ect. è The appropriate benchmark depends on “the specific circumstances” of the entity and relevant changes of conditions in the industry or economic environment in which the entity operates. (phụ thuộc vào hoàn cảnh cụ thể)
ISA/VSA 320
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Rules of thumb for Overall Materiality (M)
v There is no specific quantitative guidelines è The choice of a base depends on value judgements about relevance, stability and predictability. v Financial information used as base: Ø Financial report to be audited (if available) Ø Annualised interim financial information; or Ø Previous period’s financial reports.
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Clearly trivial threshold
v It’s not a materiality. v Auditor designate an amount below which misstatements of amounts in the individual statements would be clearly trivial, and would not need to be accumulated because the auditor expects that “the accumulation of such amounts clearly WOULD NOT have a material effect on FSs.” v It is used in the performance of an audit and determined at the same time as the determination of M & PM. v In practice, it is set at a rather small percentage of PM. --> eg. 5 %, 10 % of PM. VSA 450: The applying of Materiality in Evaluating the effect of identified misstatements v The auditor uses the materiality to: o Evaluate the effect of identified misstatements in the audit; and o The effect of uncorrected misstatements, if any, on the FSs.
ISA/VSA 450 Use materiality to evaluate audit findings
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Types of misstatements in the FSs.
v Factual misstatements (SS thực tế) are misstatements about which there is not doubt. v Judgment misstatements (SS xét đoán) are differences arising from the judgment of management, including those concerning recognition, measurement, presentation and disclosure in the FSs. v Projected misstatements (SS dự đoán) are the auditors’s best estimate of misstatements in population, involving the projection of misstatements identified in audit samples to the entire populations from which the samples were drawn.
ISA/VSA 450
Example 1: Applying of Materiality in Audit ISA 320
Balance Sheet (ABC Ltd company) Assets (^) Amount Liabilities Amount Current Assets (^) Liabilities Cash and cash equivalents 80,000,000 (^) Short term loan 500,000, Inventory 390,000,000 Account payables 350,000, Account receivables (ARs) 840,000,000 Other payables 60,000, Non current assets Equity Tài sản cố định 8,500,000,000 Working capital 8,640,000, Investment & development fund 260,000, Total Assets 9,810,000,000 Total Liabilities 9,810,000, ABC is a publicly traded (listed) company that gained profit before tax is 2 billion VND. è Perform audit procedures for Account Receivables in “Existence” assertion only.
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Example 1 (cont.) ISA 320
ABC Ltd company ABC is a publicly traded (listed) company that gained profit before tax is 2 billion VND. è Perform audit procedures for Account Receivables in “Existence” assertion only. M = PM = Breakdown of Account Receivables (ARs) 31.12.20X Corporation A 120.000. Corporation B 18 0.000. Corporation C 6 0.000. Corporation D 80. 000. 000 60 other clients unders 50 million VND 400.000. Total 840.000. 000 M = 100 million VND PM = 50 million VND How to perform audit procedure? Sending^ Letter^ of^ Confirmation Auditor’s decisions: Apply substantive test on Account Receivables (ARs) to collect sufficient and appropriate audit evidence supporting “Existence” assertion: Ø Substantive test on balance would be applied to Ars by the way of sending Confirmation letters to ABC’s trade debtors : Ø Confirmation letters to be sent to corp A, B, C, D. Ø Sampling technique was applied on remaining debtors as follow: Number of samples: [(840.000.000 – 440.000.000): 50.000.000 ] * 1.5 = 12 debtors (Assumed risk factor = 1.5) 31 How to evaluate the test results? v To give opinion on the truth and fairness of an account: o Assessment on size of misstatements. o Assessment on nature of misstatements. v To give opinion on the truth and fairness of the FSs as a whole: o Assessment on size of misstatements. o Assessment on nature of misstatements. Results of received Confirmation Letters v The balance of A, B, C, D on the books of audit client (ABC Ltd Co) matched with what were on the books of A, B, C, D corp. v The confirmation letters from other 12 trade debtors showed the understatement of 9 milliion VND in the balance of 3 debtors as compared to what were recorded in ABC’s books. ABC agreed to adjust the misstatement of 9 milliion VND. èThe projected misstatement of remaining ARs balance: :[(9.000.000 : 12) x 60] – 9.000.000 = 36 milliion v Auditors’s assessment: o Assessment on size of misstatements: 36 <50 (PM) o Assessment on nature of misstatements: Errors (not frauds) è Auditors’s conclusion: The balance of ARs existed.
