Efficient Tests of Balances Series—No. 1: Audit Strategies and Audit Plans
Designing an audit plan and selecting types of tests based on risk assessment procedures is the first step for performing tests of balances. Risks or the lack thereof, strengths and deficiencies in the client’s internal controls, provide the foundation for deciding on the most cost-beneficial audit plan and tests of balances procedures.
Knowledge of specific strengths and deficiencies also enable an auditor to fine tune the procedures on a standard tests of balances program. As a profession, we are usually good at modifying procedures to collect additional evidence when risks are high. We often are not very good, however, at modifying and eliminating procedures and related documentation when risks are low.
When an auditor finds a control deficiency, i.e., a risk of material misstatement, he/she must make inquiries and/or observe or inspect additional evidence to mitigate the weakness and determine any affects on the financial statements. When strengths in a client’s internal controls are discovered, the problem is the auditor often doesn’t know how to reduce or eliminate related auditing procedures! Many times, the extent of the deficiencies in a client’s internal controls simply overshadows the strengths and it is hard to imagine reducing any procedures!
Reducing or Eliminating Procedures
Here’s the secret. We must look for strengths in a client’s system of internal controls that will mitigate or offset control deficiencies. Strengths are generally key controls designed and operating to prevent material misstatements from occurring undetected. For smaller entities, these key controls will ordinarily be performed at the entity level by the person or persons with the highest level of financial management authority. Identifying key controls will enable us to determine when they offset specific control deficiencies and when we can reduce or eliminate tests of balances procedures.
SAS No. 109 permits us to consider our prior period audit results for a client while evaluating current year risk of material misstatement. Minimal misstatements from the prior year’s engagement, therefore, also create opportunities for reducing or eliminating some tests of balances procedures. As we identify strengths or low risk situations in our risk assessment procedures, an audit strategy and audit plan can be designed to maximize both quality and efficiency!
When we understand the opportunities the risk assessment standards give us to do less work in low-risk audit areas, we’ll truly have the power to produce the most efficient audit in each engagement’s circumstances. Understand that this power is related to one’s ability to think and reason within a conceptual framework based on generally accepted auditing standards. Designing cost-beneficial audit strategies is decision-making of the highest order and the heart of an auditor’s professional judgment.
My live and on-demand webcasts on these topics can be accessed by clicking the applicable box on the left side of my home page, www.cpafirmsupport.com.