The audit approach refers, in broad terms, to the manner in which auditors plan to gather and evaluate the evidence relating to the completeness, validity and accuracy of each material financial statement item during the final three audit stages.
Auditors determine the audit approach during the audit planning stage based on an evaluation of relevant audit risk components [fn] obtained through a detailed knowledge of the client's business. However, as the audit progresses and the auditor obtains more knowledge of the entity's business, the auditor subsequently may amend the audit approach. The auditor documents the initial audit approach for each material account balance assertion (and any changes to it) in the audit working papers as part of the tactical audit plan.
In order to identify which account balances are material, the auditor calculates a level of planning materiality for financial statement items, account balances, and, where appropriate, classes of transactions. This is a monetary amount that filters out financial statement items, account balances and transactions that are not material. Auditors generally select for examination only those transactions and account balances that equal or exceed the value of planning materiality.
Auditors generally cannot gather evidence directly about the completeness, validity and accuracy of financial statement items. Instead, auditors gather evidence about the completeness, validity and accuracy of account balances underlying the financial statement items. Auditors refer to this as gathering evidence at the account balance assertion level. Furthermore, in some instances, auditors are not able to gather sufficient appropriate evidence at the account balance assertion level and have to examine transactions at the underlying level of aggregation: that is, gather evidence at the class of transaction level. Auditors refer to gathering evidence at the class of transaction level as transaction testing. Also, and irrespective of whether auditors gather evidence at either the account balance level or the class of transaction level, auditors, in some instances, are able to rely on the controls over the entity's accounting information system.
Thus, the three factors that auditors use to determine the audit approach are:
When an auditor plans to gather evidence of the completeness, validity or accuracy of a particular account balance, without detailed examination of underlying classes of transaction, the approach for that account balance assertion is referred to as a non in-depth approach. Where the auditor chooses to examine transactions which underlie the account balance (that is, chooses to perform transaction testing) the approach is an in-depth approach.
The extent of an in-depth approach relating to a particular account balance assertion depends on the quantity and quality of evidence required by the auditor to form an opinion as to the extent of misstatements in the account balance. For example, when a very high quantity of evidence is required, such as when the acceptable detection risk DR*2 for a particular account balance assertion is evaluated as low and control risk CR2 is evaluated as high, the auditor adopts an in-depth approach for that account balance assertion. On the other hand, when DR*2 is evaluated as moderate or high and CR2 is evaluated as moderate or low, there is generally no need for an in-depth approach.
The general rule is the higher the quantity and quality of evidence required in relation to an account balance assertion, the greater the need for an in-depth approach. Note that when auditors gather evidence in relation to revenue and expense account balances, there is often little evidence available at the account balance level. This means that auditors will often adopt an in-depth approach for those revenue and expense account balances that have been selected for examination in order to gather the quantity and quality of evidence required to form an opinion as to the extent of misstatements in the account balance.
If the auditor plans, in relation to a particular account balance assertion, extensive reliance on controls over management's accounting information system, the approach for that account balance assertion is referred to as a controls testing approach; where some reliance is planned, a part controls testing approach; and where no reliance is planned, a substantive (or verification) approach. A controls testing, or part controls testing approach, is referred to as an in-depth controls testing/part controls testing approach when the auditor relies on controls over underlying classes of transaction and non in-depth controls testing/part controls testing approach when no such reliance is planned. Similarly, a substantive approach is referred to as an in-depth substantive approach when the auditor plans to gather evidence of the completeness, validity and accuracy of underlying classes of transaction and a non in-depth substantive approach when the auditor plans not to gather evidence at the class of transaction level.
Where (extensive or partial) reliance on controls over the accounting information system is planned, auditors gather evidence of the effectiveness of operation of those internal control procedures upon which reliance is planned (however, see Journal of Accountancy article Top 10 Audit Deficiencies), as well as gather direct evidence of the completeness, validity and accuracy of the account balance [fn].
As a general rule, when control risk CR2 relating to a particular account balance assertion is evaluated as high, the auditor adopts a substantive approach; when it is moderate, a part controls testing (or part substantive) approach; when it is low, a controls testing approach. However, note that an auditor only adopts a controls testing (or part controls testing) approach if it is economical to do so [fn].
In some instances, the auditor may be able to gather significant evidence about the overall completeness, validity and accuracy of an account balance assertion without gathering specific and detailed evidence about completeness and/or validity and/or accuracy. This approach is referred to as an analytical approach. An analytical approach may be a substantive, controls testing (or part controls testing) approach, as well as in-depth or non in-depth, but is usually a non in-depth controls testing approach.
In broad terms, an auditor adopts an analytical approach for an account balance assertion when the DR*2 is evaluated as high, a part analytical approach when it is moderate and a non-analytical approach when it is low.
After the auditor decides on the audit approach for each account balance assertion (see example), the auditor then goes on to prepare audit programs. Note that there is likely to be not only a different audit approach for different account balances, but also a different audit approach for different assertions relating to the same account balance. Also, every audit approach for an assertion has three dimensions - a controls testing/ substantive dimension, an in-depth/ non in-depth dimension and an analytical/ non analytical dimension. The dimensions are continuous in scale, in that there are degrees of these dimensions. For example, the audit approach for one particular account balance assertion might be described as part substantive, part in-depth, and part analytical, while another might be described as a part substantive, non in-depth, and analytical approach.
See the table that, given the level of control risk [CR2] and the acceptable level of detection risk [DR*2], may be used to assist in determining the audit approach.
Copyright, Australian Educational Research Pty Ltd. Any person accessing this site agrees to the Terms of Use.