This article teaches you how to develop your audit plan and strategy. Once you complete your risk assessment, it’s time to build these critical pieces of your audit engagement.
Effectiveness and efficiently are both possible with a good audit plan. Below I explain how to do this. Additionally, we’ll also take a look at three common mistakes made in planning. See if you make any of these.
To be in compliance with audit standards, we need to develop:
What’s in the audit strategy? AU-C 300, Planning an Audit, states that the audit strategy should include the following:
Think of the audit strategy as the big picture.
We are documenting:
Much can be achieved with the right strategy—even walking on the moon.
When NASA planned to put a man on the moon, a strategy was created. It could have read as follows:
We will put a man on the moon. The significant factors of our mission include mathematical computations, gravitational pull, thrust, and mechanics. The risks include threats to our astronauts’ lives, so we need to provide sufficient food, air, sound communications, and a safe vessel. The deliverable will be the placement of one man on the moon and the safe return of our three astronauts. The engagement team will include three astronauts, launch personnel at Kennedy Space Center, and mission-control employees in Houston, Texas.
A sound strategy led to Neil Armstrong’s historic walk on July 20, 1969.
Our audit strategy—in a more pedestrian pursuit—is a summary of objectives, resources, and risk. It’s the big picture. Our strategy leads to the successful issuance of our audit opinion (not quite as exciting as walking on the moon, but still important).
The audit strategy doesn’t have to be complicated or long, especially for smaller entities—it can be a short memo. What are we after? A summary of risks, needed resources, and objectives.
My firm uses an internally-developed strategy form—mainly, to ensure consistency. The form contains structure, such as references to risk assessment work and blank boxes in certain areas—such as partner directions—so it is flexible. As a result, the form has structure and flexibility.
Here are the main areas we cover:
Who should create the strategy? The in-charge can create it with the assistance of the engagement partner, or the partner can do so.
If you want to see one document that summarizes the entire audit, this is it. As you can see, the strategy is general in nature, but you also need a detailed plan to satisfy the demands of the strategy—this is the audit plan (commonly referred to as the audit program). NASA had a mission statement for Apollo 11, but—I’m sure—written guidelines directed the step-by-step execution of the project.
Now we create the detailed planning steps—the audit program. Think of the audit program as the final stage of audit planning. What have we done to get to this stage of the audit?
Now it’s time to create the audit plan.
The audit plan is the linkage between planning and further audit procedures.
What are “further audit procedures”? They are the tactical steps to address risk including substantive procedures and test of controls. The audit program links back to the identified risks and points forward to the substantive procedures and test of controls. Substantive procedures include tests of details and substantive analytical procedures.
How—in a practical sense—do we create the audit programs? Most auditors tailor the prior year audit programs. That works—as long as we revise them to address the current year risks. Audit programs are not—at least, they should not be—static documents. Even so, the current year audit program can be the same as last year—as long as the risks are the same.
How do we know if we have adequate audit program steps? Look at your risks of material misstatement (RMM)—which, hopefully, are assessed at the assertion level (e.g., completeness). An auditor assesses the risk of material misstatement because it informs the audit plan—or the steps to be performed. Audit steps should address all high and moderate RMMs.
How else can we integrate our documentation? Put the relevant assertions next to each audit step—this makes the connections between the RMMs (at the assertion level) and the audit steps clear.
AU-C 330 says the auditor is required to apply substantive procedures to all relevant assertions related to each material class of transactions, account balance, and disclosure. So, the audit program should reflect steps for all material areas.
Once you complete your risk assessment work, you want to ask, “Which is the more efficient route? Testing controls or performing substantive procedures.” Then go with your instincts.
Generally, I assess control risk at high. While we can’t default to a high control, we can—once the risk assessment work is complete—decide to assess control risk at high as an efficiency measure. Why? If we assess control risk at below high, we must test the controls as a basis for the lower risk assessment. The testing of controls can—sometimes—take longer than substantive procedures.
For example, is it better to test the controls related to fixed asset additions or is it more efficient to vouch the invoices for significant additions? Usually, the vouching of the invoices will get you to your desired destination quicker than testing controls. Generally—at least in my opinion—this line of reasoning is less true for more complex organizations. Larger organizations process more transactions and tend to have better controls. So it can be better to test controls for larger entities.
There you have it—the creation of the audit strategy and the audit plan. Your strategy includes the risks, needed resources, and objectives. And your audit program contains the tactical steps to address risks. You are set to go.
I find that auditors usually understand the above, but still make one of the following three audit planning mistakes.
Auditors make three common planning mistakes: (1) not tailoring audit programs and (2) allowing prior year work papers to drive the audit process, and (3) using a balance sheet audit approach. Let’s see how these happen.
Where do most audit programs come from? They are purchased from forms providers, usually international publishing companies. These purchased programs are useful, but they can become a crutch, leading to canned audit approaches that are not responsive to risks.
If we use unrevised audit programs and if our audit approach is always the same, what good is risk assessment? Another way to say this is, If audit programs never change, why perform walkthroughs, preliminary analytics, and other risk assessment procedures?
Canned audit programs are one reason auditors give lip-service to risk assessment. In the auditor’s mind, he may be thinking, I already know what I’m going to do, so why waste time with risk assessment? This cookie-cutter approach is dangerous, but quite common. And why is it dangerous? Because it can lead to an intentional blindness toward internal controls and significant risks. And deficiencies in risk assessment lead to deficiencies in audit procedures. The result: material misstatements are not identified and an unmodified audit opinion is rendered. In other words, audit failure occurs.
Audit programs can be tailored: steps can be added, changed, or deleted. These steps can be amended based on the risk of material misstatement. But some auditors don’t change their audit plan.
And not tailoring audit programs can lead to several problems such as:
In addition to not tailoring audit programs, some auditors hit autopilot and use their prior year work papers as their current year plan.
Audit documentation should develop sequentially:
But poor auditors tend to follow the prior year work papers and complete the audit program as an afterthought. Worse yet, the risk assessment work is completed at the end of the engagement, if at all. The tail wags the dog. This same-as-last-year approach leads to incongruities in risks of material misstatement and the procedures performed. In effect, the prior year work papers become the current year audit program.
Another common audit planning mistake is the use of a balance sheet audit approach.
Many auditors use a fully substantive approach, meaning they don’t test controls for effectiveness. Moreover, some auditors test balance sheet accounts and little else. But this approach can lead to problems.
I have heard auditors say: If I audit all of the balance sheet accounts, then the only thing that can be wrong is the composition of revenues and expenses. But is this true?
The accounting equation says:
Totals assets = Total liabilities plus Total equity
Another way to say this is:
Total equity = Total assets minus Total liabilities
If we disregard stock purchases and sales, equity is usually the accumulation of retained earnings. And retained earnings comes from the earnings or losses on the income statement. In other words, retained earnings comes from revenues and expenses. So the net income or loss (revenues minus expenses) has to fit into the accounting equation (equity equals assets minus liabilities).
Therefore, if we audit all assets and liability accounts, doesn’t it make sense that the only thing that can be wrong is the composition of revenues and expenses? Mathematically I see why someone might say this, but a flaw lurks in the construct.
I once saw an audit firm sued for several million dollars. The CPAs audited the company for several years, issuing an unqualified opinion each year, but a theft was occurring all along.
So what were the audit firm’s mistakes? They relied too heavily upon a balance sheet audit approach, and they did not gain an understanding of the company’s key internal controls.
The auditors used substantive procedures such as:
The balance sheet accounts reconciled to the general ledger, and no problems were noted in the audit of the balance sheet accounts. But millions were missing.
So what flaw lies in a balance sheet audit approach? Millions can go missing while the balance sheet accounts reconcile to the general ledger. Consequently, auditing the balance sheet accounts alone may not detect theft. Therefore, gaining an understanding of the internal controls and developing appropriate responses is critical to identifying material misstatements, especially when fraud is possible.
So as we plan our substantive procedures, we need to avoid the flawed balance sheet approach. Yes, substantive procedures for the balance sheet accounts are important, but fraud detection procedures are necessary when control weaknesses are present. A test of details is necessary when a significant risk (such as a fraud risk) is present.
Develop an audit strategy and plan once you complete your risk assessments procedures. Then link the risks of material misstatement to your further audit procedures. Doing so will help ensure that your audit is successful. In other words, that no material misstatements are present when you issue an unmodified opinion.
Moreover, don’t make these three audit planning mistakes: (1) not tailoring audit programs and (2) allowing prior year work papers to drive the audit process, and (3) using a balance sheet audit approach.
See my audit series The Why and How of Auditing to learn even more about the full audit process, including how to audit transaction cycles such as cash, receivables, payables, and debt.
Charles Hall is a practicing CPA and Certified Fraud Examiner. For the last thirty-five years, he has primarily audited governments, nonprofits, and small businesses. He is the author of The Little Book of Local Government Fraud Prevention, The Why and How of Auditing, Audit Risk Assessment Made Easy, and Preparation of Financial Statements & Compilation Engagements. He frequently speaks at continuing education events. Charles consults with other CPA firms, assisting them with auditing and accounting issues.