In this video, I discuss audit planning.

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The auditor must plan the work and properly supervise any assistants.

There are three main reasons why the auditor should properly plan engagements: to enable the auditor to obtain sufficient appropriate evidence for the circumstances, to help keep audit costs reasonable, and to avoid misunderstandings with the client. Obtaining sufficient appropriate evidence is essential if the CPA firm is to minimize legal liability and maintain a good reputation in the business community. Keeping costs reasonable helps the firm remain competitive. Avoiding misunderstandings with the client is necessary for good client relations and for facilitating high-quality work at reasonable cost. Suppose that the auditor informs the client that the audit will be completed before June 30 but is unable to finish it until August because of inadequate scheduling of staff. The client is likely to be upset with the CPA firm and may even sue for breach of contract.

Audit planning, Audit risk, acceptable audit risk, audit risk module, inherent risk, control risk.

Before beginning our discussion, we briefly introduce three risk terms: acceptable audit risk, client business risk, and risk of material misstatement. These risks significantly influence the conduct and cost of audits. Much of the early planning of audits deals with obtaining information to help auditors assess these risks.

Acceptable audit risk is a measure of how willing the auditor is to accept that the financial statements may be materially misstated after the audit is completed and an unmodified opinion has been issued. When the auditor decides on a lower acceptable audit risk, it means that the auditor wants to be more certain that the financial statements are not materially misstated. Zero risk is certainty, and a 100 percent risk is complete uncertainty.

Client business risk is the risk that the entity fails to achieve its objectives or execute its strategies. Business risk can arise from factors such as significant changes in industry conditions or events such as regulatory changes, or from the setting of inappropriate objectives or strategies. For example, the auditor may identify declines in economic conditions that adversely affect sales and the collectibility of accounts receivable.

The risk of material misstatement is the risk that the financial statements contain a material misstatement due to fraud or error prior to the audit. The risk of material misstatement is a function of the susceptibility of the financial statements (as a whole or in individual accounts) to misstatement, and the effectiveness of the client’s controls in preventing or detecting and correcting the misstatements. Continuing with the previous example, declining economic conditions may increase the likelihood that the company may take inappropriate actions to meet sales targets or understate the allowance for doubtful accounts, especially if the client does not have adequate controls over sales and collection of accounts receivable.

Assessing acceptable audit risk, client business risk, and risk of material misstatement is an important part of audit planning because it helps determine the audit procedures and amount of evidence that will need to be accumulated, as well as the experience level of staff needed for the engagement. For example, if the auditor identifies a risk of material misstatement for inventory valuation because of complex valuation issues, additional evidence will be accumulated in the audit of inventory valuation and more experienced staff will be assigned to perform testing in this area.