In these videos, we walk through 5 AUD practice questions in each to teach about preparing a draft engagement plan. These questions are from AUD content area 2 on the AICPA CPA exam blueprints: Assessing Risk and Developing a Planned Response.
The best way to use each video is to pause each time we get to a new question in the video, and then make your own attempt at the question before watching us go through it.
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Preparing a Draft Engagement Plan
Below is an overview of key considerations and best practices when preparing a draft engagement plan. The following points distill the essential aspects of risk-based auditing, focusing on how to incorporate prior-year findings, address new or changing conditions in the current period, and ensure adequate coverage through appropriate testing strategies.
Revisit Prior-Period Findings
A crucial first step in preparing an engagement plan is to examine the results of prior audits. Any material misstatements or significant deficiencies identified previously should automatically raise a red flag for the current year. Even if management has implemented corrective actions, these areas often remain at higher risk of misstatement and typically require enhanced procedures or additional testing. Failing to reassess previously flagged issues can result in overlooking recurring problems or assuming that prior corrections fully resolve the risk.
Address Changes in the Current Period
Your engagement plan must account for any operational or systemic changes that happened since the last audit. Examples include:
- New Accounting Systems: Implementation risks, data migration errors, and unfamiliar controls can all lead to heightened potential for misstatement.
- Geographical Expansion: Moving into new markets or regions can introduce new regulatory requirements, staffing challenges, and control environment shifts.
- Changes in Key Personnel: While a change in leadership (e.g., a new CFO) might not always present a direct risk like an unresolved internal control deficiency, personnel turnover can still affect accounting processes and the consistency of controls.
In these scenarios, the engagement plan should outline how audit procedures will adjust—be it larger samples, targeted substantive testing, or a closer look at specific processes newly introduced.
Align Testing with Identified Risks
Risk assessment underpins a well-structured engagement plan. Inherent risk and control risk must be evaluated so that tests of controls and substantive procedures are balanced effectively. For instance:
- When Inherent Risk Is High: Estimation accounts (like allowance for doubtful accounts) or subjective valuations often require more substantive testing, even if control risk is low.
- When Control Risk Is Low: Strong, tested internal controls can reduce—but not eliminate—the need for substantive testing.
Overall, the key is to design procedures that match the combined assessment of inherent and control risks, ensuring no critical areas are overlooked or under-tested.
Set Appropriate Materiality and Performance Materiality
Materiality thresholds guide the scope and nature of testing. Performance materiality is set lower than overall materiality to safeguard against the possibility that individually small errors could accumulate to a materially significant total. In other words, if you only rely on one overall materiality figure, you risk overlooking multiple smaller misstatements that could add up. By using performance materiality, you set a cushion that keeps the aggregate risk of uncorrected errors well below overall materiality.
Focus on Relevant Assertions
Every account or class of transactions carries specific financial statement assertions—existence, completeness, valuation, rights and obligations, and presentation/disclosure. A properly drafted engagement plan pinpoints the assertions most relevant to the risk of misstatement. For instance:
- Completeness is often the primary focus for liabilities (e.g., accounts payable) at risk of understatement.
- Existence is critical for assets at risk of overstatement.
- Valuation matters greatly where subjective estimates and management judgments are significant (inventory valuation, intangible assets, etc.).
Tailoring your approach to these assertions helps ensure your audit procedures effectively address the most susceptible elements of the financial statements.
Conclusion
Preparing a robust draft engagement plan means balancing what you learned from the past with what has changed in the present. By thoroughly reviewing prior-year findings, understanding new or expanded operations, aligning testing procedures to inherent and control risks, setting calculated materiality thresholds, and targeting the right assertions, you significantly increase the likelihood of uncovering material misstatements. This structured and risk-focused plan will enable a more efficient, effective audit that meets professional standards and safeguards the credibility of the financial statements.
