Strategies in audit planning

Basically there are three approaches
        
i.           
Substantive
approach
This is usually adopted for the audit of small
organizations where the internal systems are weak and there are a limited
number of staff. For example, a small charity or perhaps a small family company
requiring an audit might have a simple proprietary

computer based bookkeeping
system and a part-time bookkeeper who does all the accounting work.

There are no real controls within the system and
the auditor has little choice but to test a large number of transactions.
Clearly this approach is not practicable in any but the smallest organizations.
We look at the audit of small organizations in chapter 30.
      
ii.           
Systems-based
auditing
This approach is used on larger organizations where
there is a proper accounting system and sufficient staff to constitute a proper
system of internal control. We look at this in detail in chapter 13.
This is an approach to auditing which relies on the
controls contained within the client’s financial systems to validate the
accounting records. The auditors test the controls by means of testing a sample
of transactions and extrapolating the results of those sample tests to the
population as a whole. In this way they can draw conclusions as to the
reliability of the accounting records.
Note that the individual transactions are only
chosen because they are representative of the types of transaction checked by
the particular control or set of controls the auditors are testing.
The auditors will carry out detailed testing (known
as substantive testing) on balance sheet items or unusual transactions which
haven’t gone through the normal accounting system.
     
iii.           
Risk-based
auditing
We will look at this specifically in chapter 14.
Basically this is used to audit very large organizations or those with
excellent internal control systems. The auditors carry out a limited amount of testing
of transactions and balances and concentrate their efforts on analyzing the
business risks faced by the organization. These then become the subject of the
auditors’ attention.
This approach requires the auditors to use
experienced and competent staff and to have faith in the client’s underlying
systems. It is, however, an efficient way of auditing very impact on the
financial statements. The audit logic is that these will not arise from wrongly
recorded day-to-day transactions, but will have their source in an identified
area of risk. The risks can be either actual operational risks arising from the
nature of the business (e.g. oil exploration) or from the complexity of the
accounting required (e.g. derivatives trading).
Case study 4
Prepare a plan and a budget
Jane will have to choose one of these approaches.
Clearly for a company such as metalbash a systems-based approach is likely to
be the most appropriate. She could consider moving to a more risk-based
approach once she is confident the new systems are working properly and the new
financial controller is competent and understands the business.
The overall plan which Jane needs to prepare takes
into account:
·        
An
amendment of the letter of engagement to include the repot to the lorry parts
manufacturer’s association and the visits to Wigan and the new company.
·        
Assessment
of the impact of new directors staff and managers and the need for Jane to meet
all the relevant staff and tour the works
·        
Extra
time needed to audit capital expenditure and consider the impact of all the
changes on the organization as a whole.
·        
Identification
of audit risk areas. These include:
·                    
Going
concern;
·                    
Capital/revenue
identification on new plant;
·                    
The
branch in Wigan;
·                    
New
company in Essex, formerly insolvent;
·                    
Increased
stocks and debtors;
·                    
Identification
of all creditors especially as payment is likely to be slower;
·                    
The new
computer system even though this is apparently going well;
·                    
The
viability of the new products.
·        
Need to
plan year-end presence at stocktaking at all locations.
·        
Need to
spent time evaluating the new computer system and the changes in internal controls
which have been introduced.
·        
Identification
of areas which are not material and setting preliminary materiality levels.
·        
The
making of a list of all assets and liabilities, revenues and expenses so that
detailed schedules of these can be requested from the client. For example, she
may request a breakdown of sales by product in order to examine the success/
failure of the new products.
·        
Need to
identify and test, at the interim audit, internal controls which she may wish
to rely on.
·        
Need to
audit assets and liabilities as much as possible before the year-end in view of
the short time available after the year end.
·        
Jane will
need staff for interim (which is flexibly dated), at the yaer-end stock take
(at an awkward time and in widely separated locations), and at the final audit
which will be rapid and therefore may need extra staff.
·        
Extra
work is required this year (capital expenditure, new computer system, faster
audit, wigan, new company in Essex, liquidity problems) and the fee will need
to reflect this.
Discuss the specific audit areas, the timing and
the work the client will undertake in terms of providing draft accounts and
supporting schedules.
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