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Audit Planning andAnalytical ProceduresAudit Planning andAnalytical Procedures
Chapter 8Chapter 8
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Learning Objective 1Learning Objective 1
Discuss why adequate auditDiscuss why adequate audit
planning is essential.planning is essential.
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Three Main Reasons forPlanningThree Main Reasons forPlanning
1.To obtain sufficient appropriate evidence
for the circumstances
2.To help keep audit costs reasonable
3.To avoid misunderstanding with the client
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Risk TermsRisk Terms
Acceptable audit risk
Inherent risk
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Planning an Audit andDesigning an Audit ApproachPlanning an Audit andDesigning an Audit Approach
Accept client and perform initial audit planning.
Understand the client’s business and industry.
Assess client business risk.
Perform preliminary analytical procedures.
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Planning an Audit andDesigning an Audit ApproachPlanning an Audit andDesigning an Audit Approach
Set materiality and assess acceptable audit risk
and inherent risk.
Understand internal control and assess control risk.
Gather information to assess fraud risks.
Develop overall audit plan and audit program.
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Learning Objective 2Learning Objective 2
Make client acceptance decisionsMake client acceptance decisions
and perform initial audit planning.and perform initial audit planning.
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Initial Audit PlanningInitial Audit Planning
1. Client acceptance and continuance
2. Identify client’s reasons for audit
3. Obtain an understanding with the client
4. Develop overall audit strategy
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Learning Objective 3Learning Objective 3
Gain an understanding of theGain an understanding of the
client’s business and industry.client’s business and industry.
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Understanding of the Client’sBusiness and IndustryUnderstanding of the Client’sBusiness and Industry
Factors that have increased the
importance of understanding the
client’s business and industry:
Global operations
Information technology
Human capital
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Understanding of the Client’sBusiness and IndustryUnderstanding of the Client’sBusiness and Industry
Industry and external environment
Business operations and processes
Management and governance
Objectives and strategies
Measurement and performance
Understand client’s business and industry
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Industry and ExternalEnvironmentIndustry and ExternalEnvironment
Reasons for obtaining an understanding of the
client’s industry and external environment:
1.Risks associated with specific industries
2.Inherent risks common to all clients in
certain industries
3.Unique accounting requirements
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Business Operationsand ProcessesBusiness Operationsand Processes
Factors the auditor should understand:
Major sources of revenue
Key customers and suppliers
Sources of financing
Information about related parties
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Tour the Plant and OfficesTour the Plant and Offices
By viewing the physical facilities,
the auditor can asses physical
safeguards over assets and interpret
accounting data related to assets.
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Identify Related PartiesIdentify Related Parties
A related party is defined as an affiliated
company, a principal owner of the client
company, or any other party with which
the client deals, where one of the parties
can influence the management or
policies of the other.
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Management and GovernanceManagement and Governance
Management establishes the strategies and
processes followed by the client’s business.
Governance includes the client’s organizational
structure, as well as the activities of the board
of directors and the audit committee.
Corporate charter and bylaws
Meeting minutes
Code of ethics
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Code of EthicsCode of Ethics
In response to the Sarbanes-Oxley Act, the SEC
now requires each public company to disclose
whether is has adopted a code of ethics that
applies to senior management.
The SEC also requires companies to disclose
amendments and waivers to the code of ethics.
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Client Objectives and StrategiesClient Objectives and Strategies
Strategies are approaches followed by the
entity to achieve organizational objectives.
Auditors should understand client objectives.
Effectiveness and efficiency of operations
Financial reporting reliability
Compliance with laws and regulations
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Measurement and PerformanceMeasurement and Performance
The client’s performance measurement system
includes key performance indicators. Examples:
market share
sales per employee
unit sales growth
Web site visitors
same-store sales
sales/square foot
Performance measurement includes ratio analysis
and benchmarking against key competitors.
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Learning Objective 4Learning Objective 4
Assess client business risk.Assess client business risk.
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Assess Client Business RiskAssess Client Business Risk
Client business risk is the risk that the
client will fail to achieve its objectives.
What is the auditor’s primary concern?
Material misstatements in the financial
statements due to client business risk
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Client’s Business, Risk, andRisk of Material MisstatementClient’s Business, Risk, andRisk of Material Misstatement
Understand client’s
business and industry
Industry and external environment
Business operations and processes
Management and governance
Objectives and strategies
Measurement and performance
Assess client business
risk
Assess risk of material
misstatements
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Sarbanes-Oxley ActSarbanes-Oxley Act
The Sarbanes-Oxley Act requires that
management certify it has designed
disclosure controls and procedures to
ensure that material information about
business risks is made known to them.
It also requires that management certify
it has informed the auditor and audit
committee of any significant deficiencies
in internal control.
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Learning Objective 5Learning Objective 5
Perform preliminary analyticalPerform preliminary analytical
procedures.procedures.
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Preliminary AnalyticalProceduresPreliminary AnalyticalProcedures
Comparison of client ratios to industry
or competitor benchmarks provides an
indication of the company’s performance.
Preliminary tests can reveal unusual
changes in ratios.
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Examples of Planning AnalyticalProceduresExamples of Planning AnalyticalProcedures
Liquidity activity ratio:
Inventory turnover3.365.20
Ability to meet long-term obligations:
Debt to equity1.732.51
Profitability ratio:
Profit margin0.050.07
Short-term debt-paying ability:
Current ratio3.865.20
ClientClient
IndustryIndustry
Selected RatiosSelected Ratios
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Summary of the Partsof Auditing PlanningSummary of the Partsof Auditing Planning
A major purpose is to gain an understanding
of the client’s business and industry.
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Key Parts of PlanningKey Parts of Planning
Accept client and perform initial planning
New client acceptance and continuance
Identify client’s reasons for audit
Obtain an understanding with client
Staff the engagement
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Key Parts of PlanningKey Parts of Planning
Understand the client’s business and industry
Understand client’s industry and external
environment
Understand client’s operations, strategies,
and performance system
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Key Parts of PlanningKey Parts of Planning
Assess client business risk
Evaluate management controls
affecting business risk
Assess risk of material misstatements
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Key Parts of PlanningKey Parts of Planning
Perform preliminary analytical procedures
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Learning Objective 6Learning Objective 6
State the purposes of analyticalState the purposes of analytical
procedures and the timingprocedures and the timing
of each purpose.of each purpose.
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Analytical ProceduresAnalytical Procedures
1.Required in the planning phase
2.Often done during the testing phase
3.Required during the completion phase
AU 329 emphasizes the expectations
developed by the auditor.
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Timing and Purposes ofAnalytical ProceduresTiming and Purposes ofAnalytical Procedures
(Required)
Planning
Phase
Purpose
Understand client’s
industry and business
Assess going concern
Indicate possible
misstatements
(attention directing)
Reduce detailed tests
Testing
Phase
(Required)
Completion
Phase
Primary
purpose
Secondary
purpose
Primary
purpose
Secondary
purpose
Primary
purpose
Primary
purpose
Secondary
purpose
Secondary
purpose
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Learning Objective 7Learning Objective 7
Select the most appropriateSelect the most appropriate
analytical procedure fromanalytical procedure from
among the five major types.among the five major types.
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Five Types of AnalyticalProceduresFive Types of AnalyticalProcedures
Compare client data with:
1.Industry data
2.Similar prior-period data
3.Client-determined expected results
4.Auditor-determined expected results
5.Expected results using nonfinancial data.
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Compare Client and IndustryDataCompare Client and IndustryData
Inventory turnover 3.4 3.5 3.9 3.4
Gross margin26.3%26.4%27.3%26.2%
ClientClient
IndustryIndustry
2009
2008
2009
2008
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Compare Client Data withSimilar Prior Period DataCompare Client Data withSimilar Prior Period Data
Net sales$143,086 100.0$131,226100.0
Cost of goods sold 103,241 72.1 94,876 72.3
Gross profit$ 39,845 27.9$ 36,350 27.7
Selling expense 14,810 10.3 12,899 9.8
Administrative expense 17,665 12.4 16,757 12.8
Other 1,689 1.2 2,035 1.6
Earnings before taxes$ 5,681 4.0$ 4,659 3.5
Income taxes 1,747 1.2 1,465 1.1
Net income$ 3,934 2.8$ 3,194 2.4
20092009
(000)(000)
Prelim.Prelim.
% of% of
Net salesNet sales
20082008
(000)(000)
Prelim.Prelim.
% of% of
Net salesNet sales
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Learning Objective 8Learning Objective 8
Compute common financial ratios.Compute common financial ratios.
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Common Financial RatiosCommon Financial Ratios
Short-term debt-paying ability
Liquidity activity ratios
Ability to meet long-term debt obligations
Profitability ratios
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Short-term Debt-paying AbilityShort-term Debt-paying Ability
Current ratio
Current assets
Current liabilities
=
Cash ratio
(Cash + Marketable securities)
Current liabilities
=
Quick ratio
(Cash + Marketable securities
+ Net accounts receivable)
Current liabilities
=
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Liquidity Activity RatiosLiquidity Activity Ratios
Accounts receivable
turnover
Net sales
Average gross receivables
=
Days to collect
receivable
365 days365 days
Accounts receivable turnover
=
Inventory
turnover
Cost of goods soldCost of goods sold
Average inventory
=
Days to sell
inventory
365 days365 days
Inventory turnover
=
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Ability to Meet Long-term DebtObligationAbility to Meet Long-term DebtObligation
Debt to equity
Total liabilities
Total equity
=
Times interest
earned
Operating income
Interest expense
=
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Profitability RatiosProfitability Ratios
Earnings
per share
Net income
Average common shares outstanding
=
Gross profit
percent
(Net sales – Cost of goods sold)
Net sales
=
Profit margin
Operating income
Net sales
=
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Profitability RatiosProfitability Ratios
Return on
common
equity
(Income before taxes
– Preferred dividends)
Average stockholders’ equityAverage stockholders’ equity
=
Return on
assets
Income before taxes
Average total assets
=
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Summary of AnalyticalProceduresSummary of AnalyticalProcedures
They involve the computation of ratios
and other comparisons of recorded
amounts to auditor expectations.
They are used in planning to understand
the client’s business and industry.
They are used throughout the audit to identify
possible misstatements, reduce detailed tests,
and to assess going-concern issues.
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End of Chapter 8End of Chapter 8