What Does the Planning Phase of the Audit Entail?

Planning is the most important part of any audit as it allows auditors to build a foundation upon which the actual audit process is undertaken. This planning phase includes the auditor understanding the client in detail and what the key risks will be based on the client’s industry, size, scope and other individual factors. This planning phase occurs directly after the audit engagement process where the client has signed the engagement letter with the audit firm, agreed to the fees and the auditor has received ethical clearance from the previous auditor to takeover the file.

When clients ask “what does the planning phase of the audit entail?”, it is often due to a degree of frustration that the auditor has commenced work but no actual testing has begun making the beginning of an audit sometimes feel like a very slow start. This is unfortunately just the practical reality of auditing that building up the audit plan and risk analysis is just as important and time consuming as document checking and other testing activities.

When done correctly this planning phase should reduce audit risk and focus the auditors time and energy on the areas with the greatest materiality for the stakeholders. It also ensures that the audit work is well planned, resourced and in line with the Australian Auditing Standards.

Why the Planning Phase of the Audit Is Critical

All assurance activities require a planning phase which changes in size depending on the extent of the audit being undertaken. It is mandatory under the standards and will ensure:

The audit team understands the client, their industry and the environment
Material audit risks are identified as early as possible
Audit personnel have their time allocated and used efficiently
The higher risk areas identified receive appropriate attention
Appropriate robust audit evidence is being gathered to support an eventual audit opinion

Understanding the Client and Its Environment

As mentioned, a key part of the audit planning process is understanding the client and their industry in detail. It is a truism that no two clients are the same and each client will have specific risks that need to be factored into their assurance activities.

Areas which will affect the audit include:

Number, type and breadth of the stakeholders
The length of time the client has been operating
Any history of noncompliance, audit contraventions or other legal issues
Whether there are related party transactions to be considered
The industry the client operates in and the level of competition
The level of staff turnover
The regulatory and legal environment

An audit firm will consider both internal and external factors when they are analysing a client to look to identify financial and other risks which will be material for stakeholders.

Understanding the Entity’s Accounting Policies

Auditors will work directly with the clients’ accountants, whether internal or external, to understand the accounting policies being adopted by the entity and the justification behind those policies and disclosures.

This includes assessing:

Whether accounting policies selected by the accountant are appropriate in all material aspects for the client
Whether all disclosures have been made consistent with the Australian Accounting Standards
What changes have been made over the last few years in the disclosure policies
Whether sufficient documentation exists to support areas which require a level of judgement or estimation such as effective life of assets, asset valuations or provisions.

Identifying Business Risks and Audit Risks

Business risks may be defined for these purposes as conditions or events which could materially affect an entity’s ability to meet its business goals. These business risks in turn can be used to determine where audit risks develop by seeing areas where material misstatements could arise due to these pressures. Some basic examples of where a business risk will show an audit risk include:

Weak cash flow effecting going concern assumptions leading to pressure to overestimate asset values, decrease provisions and overestimate forward budgets
Missed profit or revenue targets increasing the risk of overstatement in order to meet predetermined business goals
A plethora of related party transactions increasing the risk of inadequate disclosures to stakeholders
Rapid turnover of key management creating internal control weaknesses

Assessing Internal Controls During Planning

Getting a full understanding of the internal controls of an organisation is an important part of the audit planning phase. As part of a Registered Companies Auditors role they must get a full understanding of the internal systems of an organisation and whether those controls are sufficient to prevent or detect material misstatements.

As part of the planning process the auditor will look to identify key processes and systems that will need to be included in the audit. Understand what internal controls exist to prevent fraud and provide for management oversight and detect which areas where controls may be weak or informal.

It is worth noting that for small entities, especially not for profits, often internal controls are very weak and less formalised due to the nature of these organisations. Audit firms do take this into account when conducting audits by having a heavier reliance on substantive tests rather than testing of the underlying controls.

Planning Analytical Procedures

As part of the planning process the financial statements will be reviewed to look for changes from previous years looking to detect unusual trends. These include:

Comparing the current financial statements to previous years looking for material changes
Analysis of the carrying balances of assets and changes to prior years
Looking at the ratios against industry benchmarks such as gross profit margins for material variances
Review the budget from the previous years audit against the actuals this year and look for anomalies

It is worth nothing that not ever variance will be considered material enough to be investigated. This concept of materiality is fundamental to the audit and is designed to ensure resources are directed towards areas which are significant as opposed to insignificant. There is no one size that makes something material, each audit instead involves determining a materiality threshold based on the size and nature of the entity, the scope of the audit and the needs of the stakeholders reviewing the financial statements.

Need Help With Your Audit?

As you can see the planning phase it not a tix box exercise but rather the foundation of the entire audit process. It requires professional judgement to build an audit plan which is efficient, effective and defensible.

If you are looking for support with your audit reach out to one of our friendly team today. We work closely with our clients to understand their business, identify key risks, and deliver high-quality audit outcomes with minimal disruption.