Audit Planning and Analytical Procedures Chapter http://www.authorstream.com/shengv n/ ©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 8-1 Learning Objective Discuss why adequate audit planning is essential ©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 8-2 Three Main Reasons for Planning To obtain sufficient appropriate evidence for the circumstances 2.To help keep audit costs reasonable 3.To avoid misunderstanding with the client ©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 8-3 Three Main Reasons for Planning ©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 8-4 Risk Terms  Acceptable audit risk  Inherent risk ©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 8-5 Learning Objective Make client acceptance decisions and perform initial audit planning ©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 8-6 Initial Audit Planning Client acceptance and continuance Identify client’s reasons for audit Obtain an understanding with the client Develop overall audit strategy ©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 8-7 Client Acceptance and Continuance New client investigations If previously audited, the new auditor is required to communicate with the predecessor auditor Client permission required Continuing clients Annual evaluations whether to continue based on issues, fees, and client integrity ©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 8-8 Identify Reasons for the Audit Two major factors affecting acceptable risk Likely statement users Intended uses of the statements Likely to accumulate more evidence for companies that are Publicly held Have extreme indebtedness Likely to be sold ©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 8-9 Obtaining an Understanding with the Client Engagement terms should be understood between CPA and client Standards require an engagement letter describing: objectives responsibilities of auditor and management schedules and fees Informs client that auditor cannot guarantee all acts of fraud will be discovered See figure 8-2 ©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley - 10 Timing and Purposes of Analytical Procedures ©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley - 34 Learning Objective Select the most appropriate analytical procedure from among the five major types ©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley - 35 Five Types of Analytical Procedures Compare client data with: Industry data Similar prior-period data Client-determined expected results Auditor-determined expected results Expected results using nonfinancial data ©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley - 36 Compare Client and Industry Data Client 2009 2008 Inventory turnover 3.4 Gross margin 26.3% 3.5 26.4% ©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley Industry 2009 2008 3.9 27.3% 3.4 26.2% - 37 Internal Comparisons ©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley - 38 Compare Client Data with Similar Prior Period Data 2009 Net sales Cost of goods sold Gross profit Selling expense Administrative expense Other Earnings before taxes Income taxes Net income 2008 (000) % of Prelim Net sales (000) % of Prelim Net sales $143,086 100.0 103,241 72.1 $ 39,845 27.9 14,810 10.3 17,665 12.4 1,689 1.2 $ 5,681 4.0 1,747 1.2 $ 3,934 2.8 $131,226 100.0 94,876 72.3 $ 36,350 27.7 12,899 9.8 16,757 12.8 2,035 1.6 $ 4,659 3.5 1,465 1.1 $ 3,194 2.4 ©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley - 39 Learning Objective Compute common financial ratios ©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley - 40 Common Financial Ratios  Short-term debt-paying ability Liquidity activity ratios Ability to meet long-term debt obligations Profitability ratios ©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley - 41 Short-term Debt-paying Ability Cash ratio (Cash + Marketable securities) = Current liabilities Quick ratio (Cash + Marketable securities = + Net accounts receivable) Current liabilities Current assets Current ratio = Current liabilities ©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley - 42 Liquidity Activity Ratios Accounts receivable Net sales = turnover Average gross receivables Days to collect receivable 365 days = Accounts receivable turnover Inventory turnover Cost of goods sold = Average inventory Days to sell inventory 365 days = Inventory turnover ©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley - 43 Ability to Meet Long-term Debt Obligation Debt to equity = Total liabilities Total equity Times interest = earned Operating income Interest expense ©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley - 44 Profitability Ratios Earnings per share = Gross profit = percent Profit margin Net income Average common shares outstanding (Net sales – Cost of goods sold) Net sales Operating income = Net sales ©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley - 45 Profitability Ratios Return on = assets Income before taxes Average total assets Return on common = equity (Income before taxes – Preferred dividends) Average stockholders’ equity ©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley - 46 Summary of Analytical Procedures Compare ratios of recorded amounts to auditor expectations Used in planning to understand client’s business and industry Used throughout the audit to identify possible misstatements reduce detailed tests assess going-concern issues ©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley - 47 End of Chapter ©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley - 48 ... Publishing, Auditing 14/e, Arens/ Elder/Beasley - 13 Understanding of the Client’s Business and Industry ©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/ Elder/Beasley - 14 Industry and External... Publishing, Auditing 14/e, Arens/ Elder/Beasley - 11 Learning Objective Gain an understanding of the client’s business and industry ©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/ Elder/Beasley... charter and bylaws Code of ethics Meeting minutes Management establishes the strategies and processes followed by the client’s business ©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/ Elder/Beasley