Running Head: AUDIT PLANNING AND CONTROL

Assignment 2 Audit Planning and Control

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It is common knowledge in the industry that an audit plan offers the particular guidelines

auditors have to follow when conducting an external audit (Gray, 2007). External public

accounting firms conduct external audits to assure outside stakeholders that the firm’s financial

statements are prepared by generally accepted accounting principles (GAAP) or International

Financial Reporting Standards (IFRS) standards. The International Standards on Auditing (ISA)

states that the auditor has an objective to plan the audit to ensure that the audit process is

effective (Gray, 2007). The plan shall establish a general audit strategy that sets the audit’s

timing, scope, and direction, and that guides the audit plan’s development (Lee, 2006).

This essay discusses the audit planning and control. As a senior partner in price water

house Coopers, I will lead the audit planning and control for General Motors Inc. GM is a

multinational automobile and finance company that is publicly traded on the New York Stock

Exchange.

1. Critical steps inherent in planning an audit

Audit planning consists of eight critical steps (Gray, 2007). As an accounting firm, we

must first (1) accept the client and carry out an initial audit planning. This step involves

accepting the client and continuing with the audit program and identifying the client’s key reason

for needing an external audit (Johnstone, et al., 2014). We must then obtain an understanding

with the client and select staff, from the client’s side, for the Engagement. Secondly (2), we must

understand the client's industry and business. This is a key success factor for designing an

effective audit program. It is essential that an auditor has a detailed knowledge of the client's

industry and business. Among the business and industry dimensions that the auditor must be
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keen about are external and industry the environment, business processes and operations,

management and governance, strategies and objectives and performance and measurements.

Thirdly (3), the auditor must assess the client’s business risk. Using disclosure procedures

and controls, the auditor must gain access to material information about business (Lee, 2006).

Also, management must inform the auditor and the audit committee of any internal control’s

substantial deficiencies, including material weaknesses. The auditor then (4) carries out

preliminary analytical procedures. This involves comparing GM’s financial ratios to industry

standard ratios. The aim is to have a view of how the client compares to the industry, as well as

to determine any change in the client’s ratios from previous years (Gray, 2007).

The fifth step (5) involves setting materiality and assessing acceptable audit and inherent

risks in the automobile industry and for the company. The auditor must then, in the sixth step

understand the GM’s internal control and assess the control risk. In the seventh step the auditor

then gatherers all the available information to assess and evaluate fraud risks. Lastly, in the

eighth step, the auditor develops the overall audit program and plan (Gray, 2007).

2. Performance ratios & Analytical procedures

The auditor will perform GM’s liquidity, financial leverage, and profitability ratios. This

will help in determining the analytical tests to perform for the overall state of the company

(Gray, 2007). Liquidity, a huge concern for creditors, is the measure of the ability of a company

to meet its due financial obligations (Riley & Rezaee, 2013). A company might be having a

substantial amount of assets, but if it is difficult to convert those assets to cash, there is a

likelihood of the company’s inability to timely pay its creditors. Among the liquidity, analytical
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tests are the company’s short Term Debt Paying Ability analytics like cash, current and quick

ratios, Accounts Receivable Turnover and Inventory Turnovers (Lee, 2006).

Leverage means using borrowed money to purchase assets and is measured by debt-to-

equity ratio and Times Interest Earned. Financial leverage occurs when the fixed cost (machine

operation) operates in a debt i.e. its acquisition is through borrowed money (Lee, 2006). The

creditors and investors of a company are always interested of leverage used to obtain assets.

From the creditors’ standpoint, a high degree of the company’s leverage represents a risk due to

the probability of the company’s inability to pay the debts. From the investors’ standpoint, a

lower return on investment than the cost of borrowing used to obtain assets makes the investment

unattractive (Gray, 2007).

A company’s Profitability is a greater concern to all the stakeholders and investors (Lee,

2006). For any hope of increasing its worth in the marketplace through expanding or enhancing a

product line, then profit margin is the most important capital source to make the needed

improvements. Profitability is measured by return on equity, return on assets and net profit

margin. The auditor will examine the balance sheet, statement of cash flows and the statement of

income to obtain the financial ratios (Gray, 2007).

3. Evidence collection

The amount and sources of evidence required to attain the essential level of assurance

depend on the auditor’s judgment. The auditor will, however, be influenced by the evidence’s

materiality, the reliability and relevance of the available evidence from each source and the time

and cost used in obtaining the evidence (Gray, 2007). Often, the auditor will obtain evidence

from several sources, which together, will provide him with the necessary assurance (Johnstone,
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et al., 2014). Rarely can the auditor be certain of the fairness and trueness of the accounts on

which he is reporting. However, he must obtain sufficient, reliable and relevant evidence to base

his conclusive opinion on the financial statements (Lee, 2006).

In collecting evidence, the auditor will use the following methods (Lee, 2006). 1)

Analytical procedures will be used to compare the actual information on the client’s books to the

expected information to be on the books. 2) Inspection and observation of records will be done

by asking for relevant documents to support the management’s assertions in the books and

financial statements (Riley & Rezaee, 2013). 3) Observation will help the auditor to obtain an

understanding of job performance in the company. 4) Recalculation involves verifying the

client’s computations mathematical accuracy. 5) The auditor will then undertake Re-performance

of the client’s internal control procedure or accounting to validate that the firm is following its

own rules (Gray, 2007).

The auditor’s judgment in deciding on relevancy, reliability and sufficiency of the audit

evidence will be influenced by such factors like a) his knowledge of the client’s industry and

business; b) the degree of risk of miss-statement through irregularities or errors (Gray, 2007).

The audit evidence’s relevance should be considered regarding the usual audit objective of

account’s reporting and forming an opinion. The evidence audit reliability is dependent upon the

specific circumstance. (a) Documentary evidence is obviously more reliable than oral evidence;

(b) independent sources evidence is more reliable than the client’s, and (c) the auditor’s evidence

from his physical inspection and analytical reviews is more reliable than all other evidence. The

consistency of all evidence from different methods is also very important (Lee, 2006).
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4. Audit risk model & audit materiality

Audit Risk is the risk that an auditor expresses an inappropriate opinion on the financial

statements. The audit risk model consists of detection, control, and inherent risk. It helps the

auditor to determine the auditing procedures for transactions or accounts shown on the client's

financial statements. In the Model, Audit Risk = [Inherent Risk x Control Risk x Detection Risk]

(Lee, 2006).

Inherent Risk is often the risk that errors will occur e.g. material misstatement, omission

or deviations in the financial statements (Riley & Rezaee, 2013). Control Risk is the risk that the

client's internal control system will fail to prevent, detect or correct errors in the financial

statements. Detection Risk is the risk that the auditor's procedures will fail to detect existing

errors (Lee, 2006).

The auditor will then make preliminary judgments about materiality (Riley & Rezaee,

2013). Materiality is the magnitude of a misstatement or an omission of accounting information

that, due to the surrounding circumstances, increases the probability that the judgment of a

rational individual relying on the information would have been influenced or changed by the

misstatement or omission (Lee, 2006).

The auditor will use both Quantitative and qualitative materiality measures. Qualitatively,

the auditor will use the available evidence and personal, professional judgment to establish his

preliminary judgment about materiality. The emphasis in materiality planning lies on the

quantitative considerations. Since the audit errors are yet to be known, their qualitative effects

can only be considered during the audit’s testing phase as evidence becomes available (Riley &

Rezaee, 2013). Qualitative considerations, therefore, relate to the misstatements’ causes.

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Quantitative materiality measures depend on the client’s business size, the likelihood that

the client will have financial difficulties (e.g. liquidity and profitability position) and the auditor's

evaluation of the management's integrity (e.g. the client’s relationship with previous or current

auditors and with employees.)

5. Primary responsibilities of the audit firm in case of an unqualified audit report

The ordinary audit has an objective of expressing an opinion on the fairness with which

financial statements present, financial position, in all material respects, results of operations, and

its cash flows in conformity with generally accepted accounting principles (Gray, 2007). In the

case of an unqualified report, the audit firm must assure the public that the auditor has with high

regard examined the financial reports and were of the opinion that the presented financial

information fairly and in conformance with the Generally Accepted Accounting Principles

(GAAP). The firm must also say that the presented Financial Statements comply with the

relevant regulations and statutory requirements. Furthermore, the firm must indicate that there

was the adequate release of all material matters for the proper presentation of the financial

information as regards statutory requirements (Johnstone, et al., 2014). Finally, the firm must

indicate that any alterations in the accounting principles and the effects thereof have been

properly determined and disclosed in the Financial Statements (Lee, 2006).

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References

Gray, I. (2007). The audit process: Principles, practice and cases. London: Thomson Learning.

Lee, T. A. (2006). Financial reporting and corporate governance. Chichester [u.a.: John Wiley &

Sons.

Johnstone, K. M., Gramling, A. A., & Rittenberg, L. E. (2014). Auditing: A risk-based approach

to conducting a quality audit.

Riley, R., & Rezaee, Z. (2013). Financial statement fraud: Prevention and detection. Hoboken,

N.J: Wiley.